<PAGE>
- -------------------------------------------------------------------------------
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 MARCH 31, 2000
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 (I.R.S. Employer Identification No.)
of incorporation or organization)
6305 EL CAMINO REAL, CARLSBAD, CA 92009
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
(760) 931-5500
----------------------------------------------------
(Registrant's telephone number, including area code)
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. 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, 24,167,347 shares outstanding as of May 8, 2000.
- --------------------------------------------------------------------------------
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PAGE
PART I. FINANCIAL INFORMATION
<S> <C> <C>
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets -March 31, 2000
and December 31, 1999................................................................... 1
Condensed Consolidated Statements of Operations and Comprehensive
Operations -Three months ended March 31, 2000 and 1999.................................. 3
Condensed Consolidated Statements of Cash Flows -
Three months ended March 31, 2000 and 1999.............................................. 4
Notes to Condensed Consolidated Financial Statements...................................... 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................ 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................................................... 15
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......................................................................... 16
Item 6. Exhibits and Reports on Form 8-K.......................................................... 16
SIGNATURES.............................................................................................. 17
</TABLE>
<PAGE>
PART I. - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share information)
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
--------- ------------
ASSETS (unaudited)
<S> <C> <C>
Current Assets:
Cash and cash equivalents .............. $ 49,258 $ 44,451
Short-term investments ................. -- 3,500
Accounts receivable, net of allowance of
$2,444 and $1,727 .................... 21,297 20,403
Inventories, net ....................... 16,262 12,279
Prepaid expenses and other ............. 2,442 2,503
Deferred income taxes .................. 5,879 5,879
-------- --------
Total current assets .................. 95,138 89,015
Property and equipment, net ............. 2,743 2,675
Other assets ........................... 61 46
Goodwill, net .......................... 528 554
Other intangible assets, net ........... 139 258
Deferred income taxes .................. 11,110 11,110
-------- --------
$109,719 $103,658
======== ========
</TABLE>
(continued)
-1-
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share information)
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
--------- ------------
LIABILITIES AND SHAREHOLDERS' EQUITY (unaudited)
<S> <C> <C>
Current Liabilities:
Accounts payable ..................................... $ 20,543 $ 15,094
Accrued expenses ..................................... 6,405 6,644
Merger and restructuring accrual ..................... 725 1,474
Customer deposits .................................... 1,319 1,692
Deferred revenue ..................................... 3,404 3,626
Income taxes payable ................................. 2,038 1,539
--------- ---------
Total current liabilities ........................... 34,434 30,069
Borrowings under line of credit ....................... 255 272
Other long-term liabilities ........................... 211 448
Minority interest ..................................... 65 46
--------- ---------
Total liabilities ..................................... 34,965 30,835
--------- ---------
Commitments and contingencies (Note 5)
Shareholders' Equity:
Preferred stock, $.01 par value, 5,000,000 shares
authorized, none issued
Common stock, $.01 par value, 40,000,000 shares
authorized, 24,131,325 and 23,887,871 shares issued
and outstanding ................................... 241 239
Additional paid-in capital ........................... 98,148 97,137
Accumulated other comprehensive operations ........... (252) (215)
Accumulated deficit .................................. (23,383) (24,338)
--------- ---------
Total shareholders' equity .......................... 74,754 72,823
--------- ---------
$ 109,719 $ 103,658
========= =========
</TABLE>
The accompanying notes are an integral part of these statements.
-2-
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE OPERATIONS
(unaudited)
(in thousands, except per share information)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
---------------------------
2000 1999
--------- ---------
<S> <C> <C>
Net revenue ............................. $ 30,853 $ 32,612
Cost of goods sold ...................... 18,831 21,212
--------- ---------
Gross margin ............................ 12,022 11,400
Operating expenses:
Sales and marketing ..................... 7,079 7,559
Engineering and product development ..... 2,085 2,013
General and administrative .............. 1,737 2,939
Impairment of intangible assets ......... -- 287
--------- ---------
Total operating expenses ......... 10,901 12,798
Operating income (loss) ................. 1,121 (1,398)
Interest income ......................... 496 444
Interest expense ........................ (16) (266)
Other income (expense), net ............. (18) 380
Gain (loss) on foreign currency
transactions, net ....................... (17) 10
--------- ---------
445 568
Income (loss) before income taxes ....... 1,566 (830)
Income tax provision (benefit) .......... 611 (240)
--------- ---------
Net income (loss) ....................... $ 955 $ (590)
========= =========
Basic net income (loss) per share ....... $ 0.04 $ (0.03)
========= =========
Weighted average shares used to calculate
basic net income (loss) per share ..... 24,047 23,021
========= =========
Diluted net income (loss) per share ..... $ 0.04 $ (0.03)
========= =========
Weighted average shares used to calculate
Diluted net income (loss) per share ... 25,052 23,021
========= =========
Comprehensive Operations
Net income (loss) ....................... $ 955 $ (590)
Foreign currency translation adjustments (37) --
--------- ---------
Comprehensive income (loss) ............. $ 918 $ (590)
========= =========
</TABLE>
The accompanying notes are an integral part of these statements
-3-
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
--------------------------
2000 1999
-------- --------
<S> <C> <C>
Operating activities:
Net income (loss) ............................................. $ 955 $ (590)
Adjustments to reconcile net income (loss) to net cash used in
operating activities--
Depreciation and amortization ........................... 412 90
Deferred income taxes ................................... -- (546)
Provision for doubtful accounts ......................... 717
Changes in operating assets and liabilities:
Accounts receivable ................................. (1,611) 2,394
Inventories ......................................... (3,983) 443
Prepaid expenses and other .......................... 43 140
Accounts payable .................................... 5,449 1,125
Accrued expenses .................................... (239) 537
Merger and restructuring accrual .................... (749) 5
Customer deposits ................................... (373) (120)
Deferred revenue .................................... (222) 483
Long-term liabilities ............................... (237) 5
Income taxes payable ................................ 499 (785)
Other ............................................... 19 (2)
-------- --------
Net cash provided by operating activities ......... 680 3,179
-------- --------
Investing activities:
Sales (purchases) of short-term investments ................... 3,500 (2,500)
Purchases of property and equipment ........................... (332) (34)
-------- --------
Net cash provided by (used in) investing activities 3,168 (2,534)
-------- --------
Financing activities:
Proceeds from exercise of stock options ....................... 912 19
Proceeds from sale of stock to employees ...................... 101 25
Payments on bank and other borrowings ......................... (17) --
-------- --------
Net cash provided by financing activities ................ 996 44
-------- --------
Effect of exchange rate changes on cash ........................... (37) --
Adjustment for change in Artecon year-end ......................... -- 1,700
-------- --------
Net increase in cash and cash equivalents ......................... 4,807 2,389
Cash and cash equivalents, beginning of period .................... 44,451 56,307
-------- --------
Cash and cash equivalents, end of period .......................... $ 49,258 $ 58,693
======== ========
Supplemental cash flow disclosure:
Cash paid (refunded) for income taxes ........................ $ 42 $ (972)
======== ========
Cash paid for interest ........................................ $ -- $ 263
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
-4-
<PAGE>
DOT HILL SYSTEMS CORP. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(in thousands except per share data)
(unaudited)
1. BASIS OF PRESENTATION:
On 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"). In connection with the
Merger, the combined company changed its name to Dot Hill Systems Corp. ("Dot
Hill" or the "Company"). The accompanying unaudited consolidated financial
statements included herein have been prepared by Dot Hill pursuant to the rules
and regulations of the Securities and Exchange Commission (the "SEC").
Accordingly, they do not include all of the information and disclosures required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments and reclassifications considered
necessary for a fair and comparable presentation have been included and are of a
normal recurring nature. The unaudited consolidated financial statements should
be read in conjunction with the audited consolidated financial statements and
notes thereto included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1999. Operating results for the three months ended March 31,
2000 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2000.
The accompanying condensed consolidated financial statements set forth a
presentation of the Company's financial statements retroactively restated to
reflect the combination with Artecon.
2. EARNINGS PER SHARE:
The Company computes net income (loss) per share in accordance with SFAS
No. 128, EARNINGS PER SHARE. Basic earnings per share is computed by dividing
net income available to common shareholders by the weighted average number of
common shares outstanding for the period. Diluted earnings per share reflects
the potential dilution of securities by including other common stock
equivalents, including stock options, in the weighted average number of common
shares outstanding for a period, if dilutive.
The following table sets forth the reconciliation of the denominator of
the earnings per share calculation for the three-month periods ended March 31:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------
2000 1999
-------- --------
<S> <C> <C>
Shares used in computing basic net income (loss) per
share........................................ 24,047 23,021
Dilutive effect of stock options ................ 1,005 -
-------- --------
Shares used in computing diluted net income (loss)
per share.................................... 25,052 23,021
======== ========
</TABLE>
-5-
<PAGE>
For the three months ended March 31, 1999, all common stock equivalents
were excluded from the computation of diluted net loss per share because a
loss was incurred for the period. At March 31, 1999 options to purchase
1,698,930 shares of the Company's common stock were outstanding at exercise
prices ranging from $.50 to $18.13. Additionally, preferred stock convertible
into 719,037 shares of common stock has also been excluded in the computation
of dilutive net loss per share because a net loss was incurred for the period.
3. INVENTORIES:
Inventories are stated at the lower of cost (first-in, first-out) or
market and consist principally of purchased components used as raw materials.
The following is a summary of inventories (in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
2000 1999
--------------- ----------------
<S> <C> <C>
Purchased parts and materials.................... $12,178 $ 9,093
Work-in-process.................................. 694 438
Finished goods................................... 3,390 2,748
------- -------
$16,262 $12,279
======= =======
</TABLE>
4. ACCRUED MERGER AND RESTRUCTURING COSTS AND IMPAIRMENT OF LONG-LIVED ASSETS
During the third quarter of 1999, and in connection with the Merger, the
Company recorded expenses totaling $13,362 related to the Merger and
management's restructuring and integration plan associated with the Merger, as
follows:
<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 included 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 completed the plan during the fourth quarter of 1999.
The accrual balance as of December 31, 1999, payments made in the first
quarter of 2000, and the remaining accrual balance as of March 31, 2000 are
as follows (in thousands):
-6-
<PAGE>
<TABLE>
<CAPTION>
Accrued Accrued
Restructuring Restructuring
Costs at Costs at
December 31, Amounts March 31,
1999 Utilized 2000
---------------- ---------------- ---------------
(in thousands)
<S> <C> <C> <C>
Professional services................... $ - $ - $ -
License termination..................... - - -
Employee termination costs.............. 480 (450) 30
Facility closures and related costs 522 (227) 295
Other integration costs................. 90 (69) 21
---------------- ---------------- ---------------
Total............................... $ 1,092 $ (746) $ 346
================ ================ ===============
</TABLE>
The Company anticipates that a majority of the remaining merger costs
liability at March 31, 2000, which consists primarily of lease and contract
termination costs, will be paid in 2000 and believes there are no unresolved
issues or additional liabilities that may result in an adjustment to the
merger and restructuring charge.
In connection with Artecon's acquisitions of Falcon and SDI, Artecon
allocated $420 and $1,600, respectively, to an assembled workforce intangible
asset. Artecon recorded an impairment of these intangible assets of $300,000
during the year ended December 31, 1998, which has been included as a component
of the restructuring charge, as the impairment was a direct result of employee
terminations associated with activities that were exited. Furthermore, as a
result of significant attrition and terminations of employees, which had been
utilized as the basis for the assembled workforce valuation, the Company
recognized a write-down of the intangible assets associated with the workforce
of $867.
In connection with the merger with SDI, Artecon recorded a reserve for
acquisition related costs of $6.6 million, of which $661,000 was outstanding at
December 31, 1998. All of the acquisition related costs were included in the
purchase price allocation performed at December 31, 1997. The following is a
summary of the accrued merger costs as of March 31, 2000.
<TABLE>
<CAPTION>
Accrued Accrued
Restructuring Restructuring
Costs at Costs at
December 31, Amounts March 31,
1999 Utilized 2000
---------------- ---------------- ---------------
(in thousands)
<S> <C> <C> <C>
Employee termination costs..................... $ - $ - $ -
Professional service fees...................... 316 - 316
Other costs.................................... 66 3 63
-------- --------- --------
Total............................ $ 382 $ 3 $ 379
======== ========= ========
</TABLE>
The Company anticipates that the remaining merger costs liability at
March 31, 2000, which consists primarily of miscellaneous professional
service obligations will be paid in 2000 and believes there are no unresolved
issues or additional liabilities that may result in an adjustment to the
purchase price allocation for the SDI merger.
5. CLASS ACTION LAWSUIT
The Company is subject to a class action lawsuit filed against Box Hill
Systems Corp., certain of its officers and directors, and the underwriters of
the Company's September 16, 1997 initial public offering (the "Offering"). The
lawsuit is proceeding in the United States District Court for
-7-
<PAGE>
the Southern District of New York. The action was filed on December 4, 1998 on
behalf of purchasers of the stock of the Company during the period 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. The formal discovery phase of the lawsuit ended on
March 31, 2000.
The Company believes that is has meritorious defenses to plaintiffs'
claims and intends to vigorously defend against those claims. However, the
Company expects to incur 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 results.
6. GEOGRAPHICAL AND SEGMENT INFORMATION
Operating segments are defined as components of an enterprise about which
separate financial information is available that is evaluated regularly by the
Company's chief operating decision-maker, or decision making group, in deciding
how to allocate resources and in assessing performance. The Company's chief
operating decision-makers are its Co-Chief Executive Officers. The operating
segments of the Company are managed separately because each segment represents a
strategic business unit that offers different products or services.
Historically, Artecon reported operating segments in certain market
divisions. Subsequent to the Merger, the Company operated in a single reporting
segment following the integration of Box Hill and Artecon. In the six months
since the Merger, the Company's operating segments are organized on the basis of
products and services. The Company has identified operating segments to consist
of Disk, Tape, Services and other products and services. The Company currently
evaluates performance based on stand-alone segment revenue and gross margin.
Because the Company does not currently evaluate performance based on segment
operating income or return on assets at the operating segment level, Company
operating expenses and total assets are not tracked internally by segment.
Therefore, such information is not presented.
Products and services revenue for the three months ended March 31, 2000 is
as follows:
<TABLE>
<CAPTION>
Disk Tape Services Other Consolidated
---- ---- -------- ----- ------------
<S> <C> <C> <C> <C> <C>
Three-months ended
March 31, 2000
Net Revenue............ $ 20,821 $ 2,396 $ 2,009 $ 5,627 $ 30,853
Gross Margin........... 8,831 361 1,003 1,827 12,022
</TABLE>
Reliable information for the three-months ended March 31, 1999 is not
available and, accordingly, has not been provided.
Information concerning principal geographic areas in which the Company
operates was as follows:
<TABLE>
<CAPTION>
Three months ended
March 31,
2000 1999
-------- -------
<S> <C> <C>
Revenue:
United States.......................................... $22,824 $29,138
Europe................................................. 5,470 2,277
Japan.................................................. 2,559 1,197
-------- -------
$30,853 $32,612
======== =======
</TABLE>
-8-
<PAGE>
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. Some of the factors that could cause actual
results to differ from those expressed or implied by such forward-looking
statements can be found in the following discussion. However, the Company
urges you to read the Company Annual Report on Form 10-K for the year ended
December 31, 1999, particularly the section entitled "Certain Risk Factors
Related to the Company's Business", to learn more about the risks and
uncertainties that the Company faces.
All forward-looking statements speak only as of the date on which they are
made. Except as required by law, 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 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, have 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 in certain regions, and to use distributors in
others. The Company focuses on providing storage solutions to high-end
customers primarily in the UNIX, Windows, Linux and Novell environments. The
Company's strategy is to leverage its expertise as a company focused
exclusively on storage solutions.
On August 2, 1999, Box Hill and Artecon completed a 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 an aggregate of 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 Series "A" preferred shares
were converted into an aggregate of 719,037 shares of Box Hill's common stock
During fiscal 1997, Artecon and Storage Dimensions, Inc. ("SDI") completed
a reverse merger accounted for as a purchase of SDI by Artecon, and the
surviving company changed its name to Artecon. As such, the historical financial
results of Artecon for all years prior to the SDI merger are
-9-
<PAGE>
those of Artecon. Additionally, in August 1997, Artecon acquired substantially
all of the assets and liabilities of Falcon Systems, Inc. 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 manufacturing operations are primarily conducted from its facilities
in Carlsbad, California. Generally, the Company extends to its customers the
warranties provided to the Company by its suppliers. To date, the Company's
suppliers have reimbursed the majority of the Company's warranty 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.
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
March 31,
-----------------------
2000 1999
--------- ---------
<S> <C> <C>
Net revenue....................................... 100.0% 100.0%
Cost of goods sold................................ 61.0 65.0
Gross profit............................. 39.0 35.0
--------- ---------
Operating expenses:
Sales and marketing.......................... 22.9 23.2
Engineering and product development.......... 6.8 6.2
General and administrative................... 5.6 9.0
Impairment of intangible assets.............. - 0.9
Total operating expenses................. 35.3 39.2
--------- ---------
Operating income (loss)...................... 3.6% (4.3)%
Net income (loss)............................ 3.1% (1.8)%
========= ==========
</TABLE>
-10-
<PAGE>
THREE MONTHS ENDED MARCH 31, 2000 COMPARED TO THREE MONTHS ENDED MARCH 31, 1999:
NET REVENUE
Net revenues reflect the invoiced amounts of products shipped, less
reserves for estimated returns and revenues from service contracts. Net revenue
decreased 5.4% to $30.9 million for the three months ended March 31, 2000 from
$32.6 million for the three months ended March 31, 1999. Comparisons of the
Company's results for the three months ended March 31, 1999 and 2000 are
difficult due to the significant corporate restructurings that the individual
companies have undergone over the last year and that Dot Hill has undergone in
connection with the Merger. The decrease in revenue was due in part to the
Company's focus on the Merger and related integration and restructuring issues,
and the unwillingness of certain customers to purchase storage products due to
Year 2000 concerns also played a role. During the first quarter of 2000, sales
of the Company's SANnet product line accounted for approximately 13% of net
revenue, tape backup for approximately 9% of net revenue, and service for
approximately 5%; the remaining 72% of net revenue was comprised of legacy disk
and RAID solutions and other products.
GROSS MARGIN
Gross margin increased 5.5% to $12.0 million for the three months ended
March 31, 2000, from $11.4 million for the comparable period of 1999. As a
percentage of net revenue, gross margin increased to 39.0% for the three
months ended March 31, 2000, from 35.0% for the comparable period of 1999.
The increase in gross margin as a percentage of net revenues is primarily
attributable to favorable product mix for company manufactured products and
cost reductions associated with the consolidation of manufacturing operations
into the Carlsbad, California facility.
SALES AND MARKETING EXPENSES
Sales and marketing expenses consist primarily of salaries and
commissions, advertising and promotional costs and travel expenses. Sales and
marketing expenses decreased 6.4% to $7.1 million for the three months ended
March 31, 2000 from $7.6 million for the three months ended March 31, 1999. The
decrease in selling and marketing expenses is primarily attributable to lower
marketing and advertising expenses and a decrease in sales commissions as result
of the decrease in sales. As a percentage of net revenue, sales and marketing
expenses decreased to 22.9% for the three months ended March 31, 2000 from 23.2%
for the comparable period of 1999.
ENGINEERING AND PRODUCT DEVELOPMENT EXPENSES
Engineering and product development expenses consist primarily of
prototype expenses and salaries for employees directly engaged in research and
development. Engineering and product development expenses increased 3.6% to $2.1
million for the three months ended March 31, 2000, from $2.0 million for the
same period in 1999. As a percentage of net revenue, engineering and product
development expenses increased to 6.8% for the three months ended March 31, 2000
from 6.2% for the comparable period of 1999 as a result of lower sales.
GENERAL AND ADMINISTRATIVE EXPENSES
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 to $1.7 million for the three months ended March 31, 2000
from $2.9 million for the three months ended March 31, 1999.
-11-
<PAGE>
As a percentage of net revenue, general and administrative expenses decreased to
5.6% for the three months ended March 31, 2000 from 9.0% for the comparable
period of 1999 primarily as a result of the efficiencies gained from
consolidating Box Hill's and Artecon's administrative operations.
OTHER INCOME
Other income is comprised of interest expense and interest income (a
significant amount 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 decreased to $445,000 for
the three months ended March 31, 2000 from $568,000 for the same period in
1999. The decrease in other income is primarily attributable to Artecon's
legal settlement income recorded in the first quarter of 1999 offset by a
reduction in interest expense associated with repayment of Artecon's
previously outstanding line of credit in the third quarter of 1999.
INCOME TAX PROVISION (BENEFIT)
The Company's effective income tax rate was 39% for the three months ended
March 31, 2000, reflecting federal, state, and local taxes partially offset by
permanent items. The Company's effective income tax rate was (28.9%) for the
three months ended March 31, 1999, reflecting federal income tax benefit, state
and local tax benefit, partially offset by permanent items.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2000, the Company had $49.3 million of cash and cash
equivalents compared to $44.5 million at December 31, 1999. As of March 31,
2000, working capital was $60.7 million.
For the three months ended March 31, 2000, cash provided by operating
activities was $680,000. The increase in net cash provided by operating
activities is primarily attributable to a $5.4 million increase in accounts
payable and $955,000 of net income, offset by a $4.0 million and $1.6 million
increase in inventories and accounts receivable, respectively, during the first
quarter of 2000. The increase in inventories is primarily attributable to
additional SANnet inventory needed to support the quarter-end shipments. The
increase in accounts payable is related to the increase in inventories.
Cash provided by investing activities was $3.2 million for the three
months ended March 31, 2000. The increase in net cash provided by investing
activities is primarily attributable to the sale of short-term investments
during the first quarter of 2000. Short-term investments generally consist of
variable rate securities that provide for early redemption within twelve
months. During the first quarter of 2000, short-term investments were
reinvested in investments classified as cash equivalents.
Cash provided by financing activities was $996,000 for the three months
ended March 31, 2000, as a result of $1.0 million from the exercise of stock
options under the Company's 1995 Stock Incentive Plan and from purchases under
the Company's 1997 Employee Stock Purchase Plan.
The Company'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
$341,000 at March 31, 2000) 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 March 31, 2000, the total amount outstanding under the two
credit lines was 26 million yen (approximately US $255,000 at March 31, 2000).
-12-
<PAGE>
The Company presently expects that cash and cash equivalents and
short-term investments, together with cash generated from operations will be
sufficient to meet its operating and capital requirements for at least the next
twelve months. However, the Company may need additional capital to pursue
acquisitions or significant capital improvements, neither of which is currently
contemplated. The actual amount and timing of working capital and capital
expenditures that the Company may incur in future periods may vary significantly
and will depend upon numerous factors, including the amount and timing of the
receipt of revenues from continued operations, the increase in manufacturing
capabilities, the timing and extent of the introduction of new products and
services, and growth in personnel and operations.
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. Current and potential competitors have established and may in
the future 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 reductions, 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 SANscape(TM),
obsolete. The Company is encouraging customers to move from legacy products
to its new products, which could delay orders, result in unknown or
unforeseen defects or bugs, make it difficult to predict future financial
performance and generally disrupt current customers' accounts. 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 the past, the Company's revenue and earnings results have fallen short of
market projections; and such shortfalls could occur again in the future.
The Company generally does not enter into long-term contracts with its
customers and sales cycles can be lengthy, particularly since the introduction
of the Company's new product line. Customers generally have certain rights to
delay or cancel orders, which could materially and adversely affect Dot Hill's
operating results.
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
-13-
<PAGE>
demanded by the Company. The loss of one or more suppliers could adversely
affect Dot Hill's ability to manufacture and sell products. 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 loss of any one of which could have a
material adverse effect on the Company. 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 customer base. The Company's international
business activities represented approximately 12% of net revenues in 1999 and
the Company currently has sales offices in Japan, France, England and the
Netherlands. These international operations are subject to a variety of risks
associated with conducting business internationally.
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, the enhanced recruiting efforts of competitors, and
relatively low unemployment rates.
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. Further, the patents of
others may affect the Company's ability to do business. The Company expects that
providers of storage will increasingly be subject to infringement claims as the
number of products and competitors grow. There can be no assurance that third
parties will not assert infringement claims against the Company in the future,
which could result in significant legal expenses, significant monetary payments
or even the need to discontinue the manufacturing and marketing of certain
products. From time to time, the Company receives letters from patent owners
that indicate a possible infringement and request to explore a licensing
relationship. In 1999, the Company received two such letters.
For a more detailed list of some of the risks and uncertainties related
to the Company's business and industry, please see the Company's Annual
Report on Form 10-K for the year ended December 31, 1999.
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
In late 1999, the Company completed remediation and testing of Dot Hill
products and hardware and software systems to assess their year 2000 readiness.
As a result of those planning and implementation efforts, the Company
experienced no significant malfunctions in Dot Hill products or disruptions in
mission-critical information technology and non-information technology systems
and believes those products and systems successfully responded to the year 2000
date changes. At this time, the Company is not aware of any material expenses
that were incurred during the first quarter of 2000 in connection with year 2000
remediation. The Company is not aware of any material problems resulting from
year 2000 issues, either with Dot Hill products and internal systems or the
products and services of third parties. The Company will
-14-
<PAGE>
continue to monitor our products and mission-critical company applications and
those of its suppliers and vendors throughout the year 2000 to ensure that any
latent year 2000 matters that may arise are addressed promptly
THE EURO CONVERSION
On January 1, 1999, eleven of the fifteen member countries of the
European Union established fixed conversion rates between their existing
sovereign currencies and the euro. These countries agreed to adopt the euro
as their common legal currency on that date. The euro now trades on currency
exchanges and is available for non-cash transactions. These countries issue
sovereign debt exclusively in euro and re-denominate outstanding sovereign
debt. Effective January 1, 1999, these countries no longer control their own
monetary policies by directing independent interest rates for the legacy
currencies. Instead, the authority to direct monetary policy, including money
supply and official interest rates for the euro, is exercised by the new
European Central Bank.
Following introduction of the euro, the legacy currencies will remain
legal tender in these countries as denominations of the euro between January
1, 1999 and January 1, 2002 (the "transition period"). During the transition
period, public and private parties may pay for goods and services using
either the euro or the country's legacy currency on a "no compulsion, no
prohibition" basis. However, conversion rates no longer are computed directly
from one legacy currency to another. Instead a "triangulation" process is
applied whereby an amount denominated in one legacy currency first is
converted into an amount denominated in euro, and the resultant
euro-denominated amount is converted into the second legacy currency.
Two countries that have converted to the euro, the Netherlands and
France, generated revenue of approximately $3.0 million and $335,000,
respectively, or 10.9% of Dot Hill's total revenue, for the three months
ended March 31, 2000. Based on this percentage of revenue generated from
these two countries, Dot Hill does not anticipate that this conversion of the
euro will have a significant impact on its financial condition and results of
operations. The Company is continuing to evaluate the impact this conversion
will have on its financial condition and results of operations.
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 Annual Report on Form 10-K for the
fiscal year ended December 31, 1999. However, the average interest rate
earned on the Company's cash equivalents and short-term investments increased
from 3.3% for the year 1999 to 3.7% during the three months ended March 31,
2000, resulting in an increase in interest income of approximately $52,000 for
the three months ended March 31, 2000 compared to the same period in 1999.
The Company does not believe these changes will have a significant impact on
its liquidity and capital resources.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS:
The Company is subject to a class action lawsuit filed against Box Hill
Systems Corp., certain of its officers and directors, and the underwriters of
the Company's September 16, 1997 public offering (the "Offering"). The
lawsuit is proceeding in the United States District Court for the Southern
District of New York. The action was filed on December 4, 1998 on behalf of
purchasers of the stock of the Company during the period from September 16,
1997 to 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
-15-
<PAGE>
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 formal discovery phase concluded on
March 31, 2000.
The Company believes that it has meritorious defenses to plaintiffs'
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, asserted or unasserted, which arise in the
ordinary course of business. The outcome of the claims against the Company
cannot be predicted with certainty, and management believes that such other
litigation and claims may 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
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
None
-16-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 15, 2000 By /s/ Philip Black
---------------------------------
Philip Black
Co - Chief Executive Officer
(Principal Executive Officer)
Date: May 15, 2000 By /s/ James L. Lambert
---------------------------------
James L. Lambert
Co - Chief Executive Officer
(Principal Executive Officer)
Date: May 15, 2000 By /s/ Preston Romm
---------------------------------
Preston Romm
Chief Financial Officer and Treasurer
(Principal Financial Officer)
-17-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 49,258
<SECURITIES> 0
<RECEIVABLES> 23,741
<ALLOWANCES> (2,444)
<INVENTORY> 16,262
<CURRENT-ASSETS> 95,138
<PP&E> 9,176
<DEPRECIATION> (6,433)
<TOTAL-ASSETS> 109,719
<CURRENT-LIABILITIES> 34,434
<BONDS> 0
0
0
<COMMON> 241
<OTHER-SE> 74,513
<TOTAL-LIABILITY-AND-EQUITY> 109,719
<SALES> 30,853
<TOTAL-REVENUES> 30,853
<CGS> 18,831
<TOTAL-COSTS> 18,831
<OTHER-EXPENSES> 10,901
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (480)
<INCOME-PRETAX> 1,566
<INCOME-TAX> 611
<INCOME-CONTINUING> 955
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 955
<EPS-BASIC> 0.04
<EPS-DILUTED> 0.04
</TABLE>
