##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





Form 10-K


|   |  |                                                                                             
|-- |  | --------------------------------------------------------------------------------------------
|þ  |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934    
|  
|   |  | For the Fiscal Year Ended December 31, 2005                                                 
|  
|or
|  
|o  |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934
|  
|   |  | For the Transition Period
    From           to                                             

Commission file number 1-13317





DOT HILL SYSTEMS CORP.


(Exact name of registrant as specified in its charter)


|                                                                             |  |                                         
|---------------------------------------------------------------------------- |  | ----------------------------------------
|Delaware                                                                     |  | 13-3460176                              
|(State of Incorporation)                                                     |  | (I.R.S. Employer
    Identification No.)
|                                                                            
|6305 El Camino Real
    Carlsbad, CA(Address of principal executive offices) |  | 92009(Zip Code)                         

Registrants telephone number, including area code:


(760) 931-5500





Securities registered pursuant to Section 12(b) of the
Act:


None


Securities registered pursuant to Section 12(g) of the
Act:


Common stock, $0.001 par value


o þ


o þ


þ o


S-K 10-K 10-K. þ o


12b-2


o þ o


12b-2 o þ


10-K.












---



##### 










DOT HILL SYSTEMS CORP.


INDEX TO ANNUAL REPORT ON
FORM 10-K


FOR THE YEAR ENDED DECEMBER 31, 2005


|              |  |                                                                                                                      |  |      |    | 
|------------- |  | -------------------------------------------------------------------------------------------------------------------- |  | ---- | -- | 
|              |  |                                                                                                                      |  | Page |   
|              |  |                                                                                                                      |  |      |   
|PART I       
|Item 1.       |  | Business                                                                                                             |  |      | 2  | 
|Item 1A.      |  | Risk Factors                                                                                                         |  |      | 14 | 
|Item 1B.      |  | Unresolved Staff Comments                                                                                            |  |      | 24 | 
|Item 2.       |  | Properties                                                                                                           |  |      | 24 | 
|Item 3.       |  | Legal Proceedings                                                                                                    |  |      | 25 | 
|Item 4.       |  | Submission of Matters to a Vote of Security
    Holders                                                              |  |      | 26 | 
|             
|PART II      
|Item 5.       |  | Market for Registrants Common Equity,
    Related Stockholder Matters and Issuer Purchases of Equity
    Securities |  |      | 26 | 
|Item 6.       |  | Selected Financial Data                                                                                              |  |      | 27 | 
|Item 7.       |  | Managements Discussion and Analysis
    of Financial Condition and Results of Operations                            |  |      | 28 | 
|Item 7A.      |  | Quantitative and Qualitative Disclosures
    About Market Risk                                                       |  |      | 42 | 
|Item 8.       |  | Financial Statements and Supplementary
    Data                                                                      |  |      | 43 | 
|Item 9.       |  | Changes in and Disagreements With
    Accountants on Accounting and Financial Disclosure                             |  |      | 43 | 
|Item 9A.      |  | Controls and Procedures                                                                                              |  |      | 43 | 
|Item 9B.      |  | Other Information                                                                                                    |  |      | 45 | 
|             
|PART III     
|Item 10.      |  | Directors and Executive Officers of the
    Registrant                                                               |  |      | 47 | 
|Item 11.      |  | Executive Compensation                                                                                               |  |      | 47 | 
|Item 12.      |  | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder Matters                   |  |      | 47 | 
|Item 13.      |  | Certain Relationships and Related
    Transactions                                                                   |  |      | 48 | 
|Item 14.      |  | Principal Accounting Fees and Services                                                                               |  |      | 48 | 
|             
|PART IV      
|Item 15.      |  | Exhibits and Financial Statement
    Schedules                                                                       |  |      | 48 | 
|EXHBIIT 10.41
|EXHBIIT 10.44
|EXHIBIT 23.1 
|EXHIBIT 31.1 
|EXHIBIT 31.2 
|EXHIBIT 32.1 







---



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Forward-Looking Statements


10-K.







PART I







|        |         
|------- | --------
|Item 1. | Business

tm ®








2



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10-K. 10-K, 10-Q, 8-K 1-800-SEC-0330.


Industry Background




| |                       
| | ----------------------
| | Growth of Data Storage





| |   |                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the proliferation of different types of data, including
    graphics, video, text and audio;                                                                                                                                                                                  
|
| |  | the emergence of Internet-based communication protocols which
    enable users to rapidly duplicate, change and re-communicate
    data;                                                                                                                                      
|
| |  | new regulations and corporate policies requiring additional
    storage, such as compliance with the Sarbanes-Oxley Act of 2002,
    requirements imposed on healthcare companies and evolving
    regulatory requirements for financial services companies;                  
|
| |  | the implementation of enterprise-wide databases containing
    business management information;                                                                                                                                                                               
|
| |  | gains in network bandwidth and the technology for managing and
    classifying large volumes of data; and                                                                                                                                                                     
|
| |  | the development of the information lifecycle management, or ILM,
    and the expansion of the
    disk-to-disk backup
    market, due to new applications of technologies that offer
    improved alternatives in the trade-off between performance and
    cost of ownership.





Entry-level.


3



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Midrange.


High-end.




Migration to Network Computing.




| |   |                                                     
| | - | ----------------------------------------------------
| |  | increased connectivity capabilities;                
|
| |  | greater capacity;                                   
|
| |  | higher performance;                                 
|
| |  | the ability to share data among different platforms;
|
| |  | greater reliability; and                            
|
| |  | greater protection.                                 



Increasing Focus on Total Cost of Ownership and Return on
Investment.




| |                      
| | ---------------------
| | Storage Area Networks





4



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| |                                                                      
| | ---------------------------------------------------------------------
| | Demand for High Performance, Affordable Network Storage
    Solutions





| |            
| | -----------
| | Reliability



Our Solutions






Low Total Cost of Ownership and High Return on
Investment.


Modular Scalability.


5



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Reliability.


Open Systems, Multi-Platform Support.


Manageability. ® ®




Our Strategy




Focus on Profitable Growth.


Utilize indirect sales channels.


Outsource manufacturing and service
operations.


Develop and Expand OEM Relationships.


Grow and Extend Technology Leadership.


6



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##### Table of Contents





Pursue Strategic Alliances, Partnerships and
Acquisitions.


Our Products






7



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|                |  |                                                                                |  |              |      |  |          |                                           |               |                          |          |                                                                                                                                                    
|--------------- |  | ------------------------------------------------------------------------------ |  | ------------ | ---- |  | -------- | ----------------------------------------- | ------------- | ------------------------ | -------- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|                |  |                                                                                |  | General      |      |  |          |                                           |               |                          |         
|Product Line    |  | Description                                                                    |  | Availability |      |  | Capacity |                                           | Target Market |                          | Features
|                |  |                                                                                |  |              |      |  |          |                                           |               |                          |         
|Hardware        |  |                                                                                |  |              |      |  |          |                                           |               |                          |          |                                                                                                                                                    
|SANnet II SCSI  |  | 2 unit high, 12 to 36 drives, Ultra160 SCSI DAS storage                        |  |              | 4Q02 |  |          | 146 GB to 10 TB using 300 GB SCSI drives  |               | Entry-level and Midrange |          | Compact 3.5 inch high enclosures, fully redundant arrays of
    independent disks, or RAID, using SCSI connections, expandable
    storage capacity
|SANnet II FC    |  | 2 unit high, 12 to 108 drives, 2 Gigabit Fibre Channel DAS
    and SAN storage |  |              | 1Q03 |  |          | 146 GB to 32 TB using 300 GB FC drives    |               | Entry-level and Midrange |          | Complete SAN solution in a single enclosure, scalable
    performance and capacity without interruptions                                           
|SANnet II Blade |  | 1 unit high, drives, Ultra320 SCSI DAS                                         |  |              | 1Q04 |  |          | 146 GB to 1.2 TB using 300 GB SCSI drives |               | Entry-level              |          | Highly rack- optimized design, connects to low-cost server SCSI
    ports                                                                          
|SANnet II SATA  |  | 2 unit high, 12 to 72 drives, 2 Gigabit Fibre Channel DAS
    and SAN storage  |  |              | 2Q04 |  |          | 800GB to 28 TB using 400 GB SATA drives   |               | Entry-level and Midrange |          | Complete SAN solution in a single enclosure, scalable
    performance and capacity without interruptions                                           
|RIO Xtreme      |  | 5 unit high, 24 to 108 drives, 2 Gigabit Fibre Channel DAS
    and SAN storage |  |              | 3Q04 |  |          | 1.75 TB to 32 TB using 300 GB FC drives   |               | Midrange                 |          | Complete SAN solution, scalable performance and capacity without
    interruptions, optimized for high bandwidth applications                      
|Software        |  |                                                                                |  |              |      |  |          |                                           |               |                          |          |                                                                                                                                                    
|SANpath         |  | Storage area networking software                                               |  |              | 1Q00 |  |          | N/A                                       |               | Entry-level and Midrange |          | Load balancing, multipathing, path fail over, path fail back and
    LUN masking                                                                   
|SANscape        |  | Storage management software                                                    |  |              | 1Q00 |  |          | N/A                                       |               | Entry-level and Midrange |          | Graphical and command line consoles with diagnostics, monitoring
    and reporting                                                                 

SANnet II Family of Storage Solutions.


8



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SANnet II SATA.


SANnet II Blade.


SANnet II FC.


SANnet II SCSI.


RIO Xtreme Family of Storage Solutions.




Software.


SANpath


SANscape


Sales and Marketing






| |     
| | ----
| | OEMs



9



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| |                  
| | -----------------
| | Indirect Channels





| |          
| | ---------
| | Marketing



Our Relationship with Sun










10



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##### Table of Contents







Customer Service and Support








| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | encouraged our channel partners to provide support and service
    directly to end-users. For example, Sun, our primary channel
    partner, provides all but the fifth and final level of support
    and service to its end-users; we provide that final level of
    support and service;                                                                                                                                                                                                                            
|
| |  | focused on providing the higher levels of support for a fee and
    the establishment of authorized service providers; and                                                                                                                                                                                                                                                                                                                                                                                              
|
| |  | engaged Anacomp, Inc., or Anacomp, to be the exclusive provider
    of on-site maintenance,
    warranty and non-warranty services for customers who purchase
    new maintenance agreements for our prior generation SANnet
    product family and other legacy products. Anacomp also manages
    our non-warranty customers and is the exclusive distributor of
    spare parts for our legacy products. In addition, Anacomp
    provides first and second level technical support for all of our
    product lines.



Research and Development




11



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Manufacturing and Suppliers




Intellectual Property


® ® ® ® ® ®






Competition






12



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| |   |                                                            
| | - | -----------------------------------------------------------
| |  | product performance, features, scalability and reliability;
|
| |  | price;                                                     
|
| |  | product breadth;                                           
|
| |  | timeliness of new product introductions; and               
|
| |  | interoperability and ease of management.                   



Employees




Executive Officers of the Registrant at December 31,
2005


|                    |  |     |    |  |          |                                                                               |               |              
|------------------- |  | --- | -- |  | -------- | ----------------------------------------------------------------------------- | ------------- | -------------
|Name                |  | Age |    |  | Position |                                                                               | Officer Since
|                    |  |     |    |  |          |                                                                               |              
|James L. Lambert    |  |     | 52 |  |          | Chief Executive Officer and Vice Chairman                                     |               | August 1984* 
|Dana W. Kammersgard |  |     | 50 |  |          | President                                                                     |               | August 1984* 
|Preston S. Romm     |  |     | 52 |  |          | Chief Financial Officer, Vice President, Finance, Treasurer and
    Secretary |               | November 1999






|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|* | Note: In 1999, Artecon and Box Hill merged to form Dot
    Hill Systems Corp. Artecon was founded in 1984 by James Lambert
    and Dana Kammersgard. Both Mr. Lambert and
    Mr. Kammersgard were officers of Artecon from its inception
    until the merger, and have been officers of Dot Hill since that
    date. Effective March 1, 2006, Mr. Lambert retired as
    our Vice Chairman and Chief Executive Officer and
    Mr. Kammersgard was appointed as our Chief Executive
    Officer and President.



James L. Lambert


13



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Dana W. Kammersgard


Preston S. Romm







|         |             
|-------- | ------------
|Item 1A. | Risk Factors

Our business, results of operations and financial condition
may be materially and adversely affected due to any of the
following risks. The risks described below are not the only ones
we face. Additional risks we are not presently aware of or that
we currently believe are immaterial may also impair our business
operations. The trading price of our common stock could decline
due to any of these risks. In assessing these risks, you should
also refer to the other information contained or incorporated by
reference in this Annual Report on
Form 10-K,
including our financial statements and related notes.




| |                                                                                                                                                                                                                                                                                                   
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Under our OEM agreements with Sun, NetApp and others, our
    customers are not required to make minimum purchases or purchase
    exclusively from us, and we cannot assure you that our
    relationship with these key customers will not be terminated or
    will generate significant sales.



14



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| |                                                                    
| | -------------------------------------------------------------------
| | Any decline in Suns or NetApps sales could
    harm our business.







| |                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Lower than anticipated sales to NetApp could harm our
    business and render our expectations inaccurate, which could
    lead to a decrease in our stock price.





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





| |   |                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------
| |  | our ability to maintain our products at prices that are
    competitive with those of other storage system suppliers;                               
|
| |  | our ability to maintain quality standards for our products
    sufficient to meet the expectations of our channel
    partners; and                 
|
| |  | our ability to produce, ship and deliver a sufficient quantity
    of our products in a timely manner to meet the needs of our
    channel partners.



15



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| |                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our business and operating results may suffer if we
    encounter significant product defects due to the introduction of
    our new, integrated systems.







| |                                                                                                        
| | -------------------------------------------------------------------------------------------------------
| | The loss of one or more suppliers could slow or interrupt
    the production and sales of our products.







| |                                                   
| | --------------------------------------------------
| | Manufacturing disruptions could harm our business.





| |                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Any shortage of disk drives or other components could
    increase our costs or harm our ability to manufacture and
    deliver our storage products to our customers in a timely
    manner.



16



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| |                                        
| | ---------------------------------------
| | We may experience losses in the future.





| |   |                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------
| |  | our plans to maintain and enhance our engineering, research,
    development and product testing programs;
|
| |  | the success of our manufacturing strategy;                                                                
|
| |  | the success of our sales and marketing efforts;                                                           
|
| |  | the extent and terms of any development, marketing or other
    arrangements;                             
|
| |  | changes in economic, regulatory or competitive conditions; and                                            
|
| |  | costs of filing, prosecuting, defending and enforcing
    intellectual property rights.                   



17



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| |                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------
| | Our quarterly operating results have fluctuated
    significantly in the past and are not a good indicator of future
    performance.



|                     |  |             |      |  |                   |   |       |  
|-------------------- |  | ----------- | ---- |  | ----------------- | - | ----- | -
|Quarter              |  | Net Revenue |      |  | Net Income (Loss) |  
|                     |  |             |      |  |                   |  
|First Quarter 2002   |  | $           | 10.9 |  |                   | $ | (6.2  | )
|Second Quarter 2002  |  |             | 11.2 |  |                   |   | (8.9  | )
|Third Quarter 2002   |  |             | 8.6  |  |                   |   | (7.3  | )
|Fourth Quarter 2002  |  |             | 16.3 |  |                   |   | (11.9 | )
|First Quarter 2003   |  |             | 30.5 |  |                   |   | (1.5  | )
|Second Quarter 2003  |  |             | 48.4 |  |                   |   | 2.6   |  
|Third Quarter 2003   |  |             | 51.0 |  |                   |   | 4.3   |  
|Fourth Quarter 2003  |  |             | 57.5 |  |                   |   | 6.6   |  
|First Quarter 2004   |  |             | 47.9 |  |                   |   | (2.6  | )
|Second Quarter 2004  |  |             | 69.0 |  |                   |   | 6.7   |  
|Third Quarter 2004   |  |             | 57.0 |  |                   |   | 3.5   |  
|Fourth Quarter 2004  |  |             | 65.5 |  |                   |   | 4.0   |  
|First Quarter 2005   |  |             | 58.0 |  |                   |   | 2.1   |  
|Second Quarter 2005  |  |             | 65.9 |  |                   |   | 3.3   |  
|Third Quarter 2005   |  |             | 53.6 |  |                   |   | (1.3  | )
|Fourth Quarter 2005* |  |             | 56.3 |  |                   |   | 22.5  |  










| |                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may have difficulty predicting future operating results
    due to both internal and external factors affecting our business
    and operations, which could cause our stock price to
    decline.





| |   |                                                                                                                                                      
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------
| |  | the size, timing, cancellation or rescheduling of significant
    orders;                                                                            
|
| |  | the cost of litigation and settlements involving intellectual
    property and other issues;                                                         
|
| |  | product configuration, mix and quality issues;                                                                                                       
|
| |  | market acceptance of our new products and product enhancements
    and new product announcements or introductions by our
    competitors;            
|
| |  | manufacturing costs;                                                                                                                                 
|
| |  | deferrals of customer orders in anticipation of new products or
    product enhancements;                                                            
|
| |  | changes in pricing by us or our competitors;                                                                                                         
|
| |  | our ability to develop, introduce and market new products and
    product enhancements on a timely basis;                                            
|
| |  | hardware component costs and availability, particularly with
    respect to hardware components obtained from Infortrend, a
    sole-source provider;
|
| |  | our success in creating brand awareness and in expanding our
    sales and marketing programs;                                                       

18



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| |   |                                                                             
| | - | ----------------------------------------------------------------------------
| |  | the level of competition;                                                   
|
| |  | potential reductions in inventories held by channel partners;               
|
| |  | slowing sales of the products of our channel partners;                      
|
| |  | technological changes in the open systems storage market;                   
|
| |  | levels of expenditures on research, engineering and product
    development;
|
| |  | changes in our business strategies;                                         
|
| |  | personnel changes; and                                                      
|
| |  | general economic trends and other factors.                                  



| |                                                                                                           
| | ----------------------------------------------------------------------------------------------------------
| | If our customers delay or cancel orders or return
    products, our results of operations could be harmed.





| |                                                                                                                                          
| | -----------------------------------------------------------------------------------------------------------------------------------------
| | Our sales cycle varies substantially and future net
    revenue in any period may be lower than our historical revenues
    or forecasts.







| |   |                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------
| |  | the amount of time needed for technical evaluations by customers;                                        
|
| |  | customers budget constraints and changes to
    customers budgets during the course of the sales cycle;
|
| |  | customers internal review and testing procedures; and                                                   
|
| |  | our engineering work necessary to integrate a storage solution
    with a customers system.             





| |                                                                                                          
| | ---------------------------------------------------------------------------------------------------------
| | The market for our products is subject to substantial
    pricing pressure that may decrease our margins.



19



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| |                                                                                                                                                                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our success depends significantly upon our ability to
    protect our intellectual property and to avoid infringing the
    intellectual property of third parties, which has already
    resulted in costly, time-consuming litigation and could result
    in the inability to offer certain products.











| |                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The market for storage systems is intensely competitive
    and our results of operations, pricing and business could be
    harmed if we fail to maintain or expand our market
    position.



20



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| |   |                                                            
| | - | -----------------------------------------------------------
| |  | product performance, features, scalability and reliability;
|
| |  | price;                                                     
|
| |  | product breadth;                                           
|
| |  | timeliness of new product introductions; and               
|
| |  | interoperability and ease of management.                   





| |                                                                                                                                                         
| | --------------------------------------------------------------------------------------------------------------------------------------------------------
| | The open systems storage market is rapidly changing and we
    may be unable to keep pace with or properly prepare for the
    effects of those changes.



21



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| |                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| | A significant percentage of our expenses are fixed, and if
    we fail to generate revenues in associated periods, our
    operating results will be harmed.





| |   |                                                                                                                                                                                                                                                                                         
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | significant pricing pressures that occur because of declines in
    selling prices over the life of a product or because of
    increased competition;                                                                                                                                  
|
| |  | sudden shortages of raw materials or fabrication, test or
    assembly capacity constraints that lead our suppliers and
    manufacturers to allocate available supplies or capacity to
    other customers, which, in turn, may harm our ability to meet
    our sales obligations; and
|
| |  | the reduction, rescheduling or cancellation of customer orders.                                                                                                                                                                                                                         





| |                                                                            
| | ---------------------------------------------------------------------------
| | Our success depends on our ability to attract and retain
    key personnel.







| |                                                                                                                                                                                                               
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our executive officers and directors and their affiliates
    own a significant percentage of our outstanding shares, which
    could prevent us from being acquired and adversely affect our
    stock price.



22



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| |                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Protective provisions in our charter and bylaws and the
    existence of our stockholder rights plan could prevent a
    takeover which could harm our stockholders.





| |                                                                                     
| | ------------------------------------------------------------------------------------
| | The exercise of outstanding warrants may result in
    dilution to our stockholders.





| |                                                                                             
| | --------------------------------------------------------------------------------------------
| | Our stock price may be highly volatile and could decline
    substantially and unexpectedly.





23



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| |                                                                
| | ---------------------------------------------------------------
| | Future sales of our common stock may hurt our market
    price.





| |                                                                                                                                                                                                                                                              
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Geopolitical military conditions, including terrorist
    attacks and other acts of war, may materially and adversely
    affect the markets on which our common stock trades, the markets
    in which we operate, our operations and our
    profitability.





| |                                            
| | -------------------------------------------
| | Compliance with Sarbanes-Oxley Act of 2002.








|         |                          
|-------- | -------------------------
|Item 1B. | Unresolved Staff Comments








|        |           
|------- | ----------
|Item 2. | Properties



24



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|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

Crossroads Systems


Chaparral Securities Class Action




Dot Hill Securities Class Action




25



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|        |                                                    
|------- | ---------------------------------------------------
|Item 4. | Submission of Matters to a Vote of Security Holders






PART II







|        |                                                                                                                     
|------- | --------------------------------------------------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity, Related
    Stockholder Matters and Issuer Purchases of Equity
    Securities





|                             |                |     |   |       |      |  |   |       | 
|---------------------------- | -------------- | --- | - | ----- | ---- |  | - | ----- | 
|                             |                | Low |   |       | High | 
|                             |                |     |   |       |      | 
|Year Ended December 31, 2004 |                |     |   |       |      |  |   |      
|                             | First Quarter  |     | $ | 10.04 |      |  | $ | 17.14 | 
|                             | Second Quarter |     |   | 7.24  |      |  |   | 11.36 | 
|                             | Third Quarter  |     |   | 7.18  |      |  |   | 10.98 | 
|                             | Fourth Quarter |     |   | 6.25  |      |  |   | 8.89  | 
|Year Ended December 31, 2005 |                |     |   |       |      |  |   |      
|                             | First Quarter  |     |   | 5.57  |      |  |   | 7.62  | 
|                             | Second Quarter |     |   | 4.64  |      |  |   | 5.90  | 
|                             | Third Quarter  |     |   | 5.25  |      |  |   | 6.73  | 
|                             | Fourth Quarter |     |   | 6.46  |      |  |   | 7.40  | 



S-K, Securities Authorized for Issuance Under Equity
Compensation Plans, 10-K.


26



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|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

10-K.


10-K.


|                                                      |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |        | 
|----------------------------------------------------- | -------------------------------------- | ---- | ------- | ------ | ---- | - | ------- | ------ |  | - | ------- | ------ |  | ---- | ------- | ------ |  | - | ------- | ------ | 
|                                                      |                                        | 2001 |         |        | 2002 |   |         | 2003   |  |   | 2004(1) |        |  | 2005 |        
|                                                      |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |        
|Statement of Operations Data:                         |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|Net revenue                                           |                                        | $    | 56,277  |        |      | $ | 46,936  |        |  | $ | 187,448 |        |  | $    | 239,376 |        |  | $ | 233,799 |       
|Cost of goods sold                                    |                                        |      | 44,818  |        |      |   | 45,444  |        |  |   | 142,550 |        |  |      | 179,875 |        |  |   | 180,196 |       
|                                                      |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |        
|Gross profit                                          |                                        |      | 11,459  |        |      |   | 1,492   |        |  |   | 44,898  |        |  |      | 59,501  |        |  |   | 53,603  |       
|Operating expenses:                                   |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|                                                      | Sales and marketing                    |      |         | 23,717 |      |   |         | 22,513 |  |   |         | 14,086 |  |      |         | 16,839 |  |   |         | 19,120 | 
|                                                      | Research and development               |      |         | 6,673  |      |   |         | 10,043 |  |   |         | 11,950 |  |      |         | 17,993 |  |   |         | 23,628 | 
|                                                      | General and administrative             |      |         | 4,533  |      |   |         | 5,150  |  |   |         | 7,418  |  |      |         | 9,992  |  |   |         | 12,933 | 
|                                                      | In-process research and development(1) |      |         |       |      |   |         |       |  |   |         |       |  |      |         | 4,700  |  |   |         |       | 
|Merger and restructuring expenses(2)                  |                                        |      | 4,905   |        |      |   | 1,550   |        |  |   |        |        |  |      | (434    | )      |  |   |        |       
|                                                      |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |        
|Operating income (loss)                               |                                        |      | (28,369 | )      |      |   | (37,764 | )      |  |   | 11,444  |        |  |      | 10,411  |        |  |   | (2,078  | )     
|Other income /(expense) net                           |                                        |      | 301     |        |      |   | 344     |        |  |   | 775     |        |  |      | 1,458   |        |  |   | 3,478   |       
|Income tax (expense)/benefit(3)                       |                                        |      | (15,323 | )      |      |   | 3,117   |        |  |   | (88     | )      |  |      | (272    | )      |  |   | 25,197  |       
|                                                      |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |        
|Net income (loss)                                     |                                        | $    | (43,391 | )      |      | $ | (34,303 | )      |  | $ | 12,131  |        |  | $    | 11,597  |        |  | $ | 26,597  |       
|                                                      |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |        
|Net income (loss) attributable to common stockholders |                                        | $    | (43,391 | )      |      | $ | (34,759 | )      |  | $ | 11,990  |        |  | $    | 11,597  |        |  | $ | 26,597  |       
|                                                      |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |        
|Net income (loss) per share:                          |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|Basic                                                 |                                        | $    | (1.76   | )      |      | $ | (1.39   | )      |  | $ | 0.35    |        |  | $    | 0.27    |        |  | $ | 0.61    |       
|                                                      |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |        
|Diluted                                               |                                        | $    | (1.76   | )      |      | $ | (1.39   | )      |  | $ | 0.31    |        |  | $    | 0.25    |        |  | $ | 0.58    |       
|                                                      |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |        
|Weighted average shares outstanding:                  |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |         |        |  |   |         |       
|Basic                                                 |                                        |      | 24,703  |        |      |   | 24,953  |        |  |   | 33,856  |        |  |      | 43,460  |        |  |   | 43,903  |       
|                                                      |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |        
|Diluted                                               |                                        |      | 24,703  |        |      |   | 24,953  |        |  |   | 38,164  |        |  |      | 46,395  |        |  |   | 45,639  |       
|                                                      |                                        |      |         |        |      |   |         |        |  |   |         |        |  |      |        

27



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|                    |                                                    |      |   |        |      |  |   |        |  |  |      |         |  |      |   |         |  |  |   |         | 
|------------------- | -------------------------------------------------- | ---- | - | ------ | ---- |  | - | ------ |  |  | ---- | ------- |  | ---- | - | ------- |  |  | - | ------- | 
|                    |                                                    | 2001 |   |        | 2002 |  |   | 2003   |  |  | 2004 |         |  | 2005 |  
|                    |                                                    |      |   |        |      |  |   |        |  |  |      |         |  |      |  
|Balance Sheet Data: |                                                    |      |   |        |      |  |   |        |  |  |      |         |  |      |   |         |  |  |   |        
|                    | Cash, cash equivalents, and short-term investments |      | $ | 16,457 |      |  | $ | 10,082 |  |  | $    | 191,545 |  |      | $ | 126,186 |  |  | $ | 122,234 | 
|                    | Working capital                                    |      |   | 25,832 |      |  |   | 2,224  |  |  |      | 177,650 |  |      |   | 123,384 |  |  |   | 135,293 | 
|                    | Total assets                                       |      |   | 46,191 |      |  |   | 32,228 |  |  |      | 218,443 |  |      |   | 246,567 |  |  |   | 267,294 | 
|                    | Total long-term debt                               |      |   | 330    |      |  |   | 275    |  |  |      | 247     |  |      |   |        |  |  |   |        | 
|                    | Total stockholders equity                         |      |   | 30,611 |      |  |   | 5,785  |  |  |      | 184,133 |  |      |   | 196,827 |  |  |   | 232,051 | 






|    |                                                                                                                   
|--- | ------------------------------------------------------------------------------------------------------------------
|(1) | The results of operations of Chaparral have been included in our
    results prospectively from February 23, 2004.
|   
|(2) | See discussion of our restructuring activities in Note 5 to
    our 2005 consolidated financial statements.       
|   
|(3) | See discussion of income taxes in Note 11 to our 2005
    consolidated financial statements.                      






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | Managements Discussion and Analysis of Financial
    Condition and Results of Operations



| |                                                         
| | --------------------------------------------------------
| | Cautionary Statement for Forward-Looking
    Information

Certain statements contained in this report, including,
statements regarding the development, growth and expansion of
our business, our intent, belief or current expectations,
primarily with respect to our future operating performance and
the products we expect to offer, and other statements regarding
matters that are not historical facts, are forward-looking
statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended, and are subject to
the safe harbor created by these sections. Because
such forward-looking statements are subject to risks and
uncertainties, many of which are beyond our control, actual
results may differ materially from those expressed or implied by
such forward-looking statements. Some of the factors that could
cause actual results to differ materially from those expressed
or implied by such forward-looking statements can be found in
Item 1A Risk Factors and elsewhere in this
Annual Report on
Form 10-K. Readers
are cautioned not to place undue reliance on forward-looking
statements. The forward- looking statements speak only as of the
date on which they are made, and we undertake no obligation to
update such statements to reflect events that occur or
circumstances that exist after the date on which they are
made.


The following discussion of our financial condition and
results of operations should be read in conjunction with our
consolidated financial statements and notes thereto included
elsewhere in this Annual Report on
Form 10-K.


Overview






28



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29



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##### Table of Contents





Critical Accounting Policies and Estimates








| |                    
| | -------------------
| | Revenue Recognition

Revenue Recognition Software Revenue
Recognition 97-2).




97-2 ,




30



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| |                         
| | ------------------------
| | Valuation of Inventories

first-in,




| |                      
| | ---------------------
| | Valuation of Goodwill

Goodwill and Other Intangible Assets.






| |                      
| | ---------------------
| | Deferred Income Taxes







31



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| |                         
| | ------------------------
| | Stock-Based Compensation

Accounting for Stock Issued to Employees.


out-of


Stock-Based Compensation




| |              
| | -------------
| | Contingencies

Accounting for
Contingencies


32



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Results of Operations




|                             |                                     |                        |       |     |      |  |       |      |   |  |       |      | 
|---------------------------- | ----------------------------------- | ---------------------- | ----- | --- | ---- |  | ----- | ---- | - |  | ----- | ---- | 
|                             |                                     | Year Ended December 31 |      
|                             |                                     |                        |      
|                             |                                     | 2003                   |       |     | 2004 |  |       | 2005 |  
|                             |                                     |                        |       |     |      |  |       |      |  
|Net revenue                  |                                     |                        | 100.0 | %   |      |  | 100.0 | %    |   |  | 100.0 | %   
|Cost of goods sold           |                                     |                        | 76.0  |     |      |  | 75.1  |      |   |  | 77.1  |     
|                             |                                     |                        |       |     |      |  |       |      |  
|Gross profit                 |                                     |                        | 24.0  |     |      |  | 24.9  |      |   |  | 22.9  |     
|                             |                                     |                        |       |     |      |  |       |      |  
|Operating expenses:          |                                     |                        |       |     |      |  |       |      |   |  |       |     
|                             | Sales and marketing                 |                        |       | 7.5 |      |  |       | 7.0  |   |  |       | 8.2  | 
|                             | Research and development            |                        |       | 6.4 |      |  |       | 7.5  |   |  |       | 10.1 | 
|                             | General and administrative          |                        |       | 4.0 |      |  |       | 4.2  |   |  |       | 5.5  | 
|                             | In process research and development |                        |       |    |      |  |       | 2.0  |   |  |       |     | 
|                             | Restructuring expenses              |                        |       |    |      |  |       | (0.2 | ) |  |       |     | 
|                             |                                     |                        |       |     |      |  |       |      |  
|Operating income (loss)      |                                     |                        | 6.1   |     |      |  | 4.4   |      |   |  | (0.9  | )   
|Other income, net            |                                     |                        | 0.4   |     |      |  | 0.6   |      |   |  | 1.5   |     
|Income tax expense (benefit) |                                     |                        |      |     |      |  | 0.1   |      |   |  | (10.8 | )   
|                             |                                     |                        |       |     |      |  |       |      |  
|Net income                   |                                     |                        | 6.5   | %   |      |  | 4.8   | %    |   |  | 11.4  | %   
|                             |                                     |                        |       |     |      |  |       |      |  








| |                                                                          
| | -------------------------------------------------------------------------
| | Year Ended December 31, 2005 Compared to Year Ended
    December 31, 2004



| |            
| | -----------
| | Net Revenue





| |                   
| | ------------------
| | Cost of Goods Sold



33



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| |             
| | ------------
| | Gross Profit







| |                             
| | ----------------------------
| | Sales and Marketing Expenses





| |                                  
| | ---------------------------------
| | Research and Development Expenses



34



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| |                                    
| | -----------------------------------
| | General and Administrative Expenses





| |                       
| | ----------------------
| | Restructuring expenses





| |                                            
| | -------------------------------------------
| | In-Process Research and Development Charges





| |             
| | ------------
| | Other Income





| |             
| | ------------
| | Income Taxes



35



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| |                                                                          
| | -------------------------------------------------------------------------
| | Year Ended December 31, 2004 Compared to Year Ended
    December 31, 2003



| |            
| | -----------
| | Net Revenue



36



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| |                   
| | ------------------
| | Cost of Goods Sold





| |             
| | ------------
| | Gross Profit





| |                             
| | ----------------------------
| | Sales and Marketing Expenses





| |                                  
| | ---------------------------------
| | Research and Development Expenses



37



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| |                                    
| | -----------------------------------
| | General and Administrative Expenses





| |                       
| | ----------------------
| | Restructuring expenses





| |                                            
| | -------------------------------------------
| | In-Process Research and Development Charges



38



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| |             
| | ------------
| | Other Income





| |             
| | ------------
| | Income Taxes













Liquidity and Capital Resources






39



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|                            |  |                        |  |           |       |  |           |   |           |           |  |   |         |  |  |   |       | 
|--------------------------- |  | ---------------------- |  | --------- | ----- |  | --------- | - | --------- | --------- |  | - | ------- |  |  | - | ----- | 
|                            |  | Payments Due by Period | 
|                            |  |                        | 
|                            |  |                        |  | Less Than |       |  |           |   | More Than |          
|Contractual Obligations     |  | Total                  |  | 1 Year    |       |  | 1-3 Years |   |           | 3-5 Years |  |   | 5 Years | 
|                            |  |                        |  |           |       |  |           |   |           |           |  |   |         | 
|Operating Lease Obligations |  | $8,541                 |  | $         | 1,477 |  |           | $ | 2,462     |           |  | $ | 2,100   |  |  | $ | 2,502 | 



40



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Recent Accounting Pronouncements


Accounting for Stock
Issued to Employees. Share-Based
Payment, Share-Based Payment








Inventory Costs, and Amendment of ARB No. 43,
Chapter 4


Exchanges of Nonmonetary Assets


41



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Accounting for Conditional Asset Retirement
Obligations Accounting for Asset Retirement
Obligation


Accounting
Changes and Error Corrections


143-1, Accounting for Electronic Equipment Waste Obligations 143-1, 143-1 143-1 Accounting for Asset Retirement
Obligations. 143-1 143-1 143-1 143-1


The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments







|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures About Market
    Risk



| |                              
| | -----------------------------
| | Interest Rate and Credit Risk



42



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##### Table of Contents







|                       |  |      |         |   |      |   |         |  
|---------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                       |  | 2004 |         |   | 2005 |  
|                       |  |      |         |   |      |  
|Cash equivalents       |  | $    | 43,438  |   |      | $ | 99,899  |  
|Average interest rate  |  |      | 2.3     | % |      |   | 4.3     | %
|Short-term investments |  | $    | 58,690  |   |      | $ | 13,431  |  
|Average interest rate  |  |      | 2.2     | % |      |   | 3.2     | %
|Total portfolio        |  | $    | 102,128 |   |      | $ | 113,330 |  
|Average interest rate  |  |      | 2.2     | % |      |   | 4.2     | %





| |                                    
| | -----------------------------------
| | Foreign Currency Exchange Rate Risk








|        |                                            
|------- | -------------------------------------------
|Item 8. | Financial Statements and Supplementary Data

10-K.







|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes In and Disagreements With Accountants On
    Accounting and Financial Disclosure








|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

13a-15(e)) 10-K,


43



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Dot Hill Systems Corp.s Report on Internal Control Over
Financial Reporting














44



---



##### Table of Contents










Item 9B. Other Information




45



---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM






Internal Control  Integrated Framework








Internal
Control  Integrated Framework Internal Control  Integrated
Framework










46



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PART III







|         |                                                   
|-------- | --------------------------------------------------
|Item 10. | Directors and Executive Officers of the Registrant

10-K









|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation








|         |                                                                                                   
|-------- | --------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial Owners and
    Management and Related Stockholder Matters





|                                               |  |                         |                |  |                     |   |                |                      |  |  |           | 
|---------------------------------------------- |  | ----------------------- | -------------- |  | ------------------- | - | -------------- | -------------------- |  |  | --------- | 
|                                               |  | Number of Securities to |                |  | Weighted Average    |   |                |                     
|                                               |  | be Issued Upon          |                |  | Exercise Price of   |   |                | Number of Securities | 
|                                               |  | Exercise of Outstanding |                |  | Outstanding Options |   |                | Remaining Available  | 
|Stock Plan                                     |  | Options and Rights      |                |  | and Rights          |   |                | for Future Issuance  | 
|                                               |  |                         |                |  |                     |   |                |                      | 
|2000 Equity Incentive Plan(1)                  |  |                         | 4,505,894      |  |                     | $ | 6.47           |                      |  |  | 980,262   | 
|Employee Stock Purchase Plan(2)                |  |                         | Not Applicable |  |                     |   | Not Applicable |                      |  |  | 1,900,608 | 
|2000 Non-Employee Directors Stock Option Plan |  |                         | 324,917        |  |                     | $ | 7.24           |                      |  |  | 102,499   | 
|                                               |  |                         |                |  |                     |   |                |                      | 
|Total                                          |  |                         | 4,830,811      |  |                     | $ | 6.52           |                      |  |  | 2,983,369 | 
|                                               |  |                         |                |  |                     |   |                |                      | 






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The 2000 Amended and Restated Equity Incentive Plan provides for
    an annual increase to the share reserve, to be added on the date
    of each annual stockholders meeting, equal to the lesser
    of (i) 1 million shares; (ii) 2% of our
    outstanding shares on such date, calculated on a fully diluted
    basis and assuming the conversion of all outstanding convertible
    securities and the exercise of all outstanding options and
    warrants; or (iii) an amount to be determined by our board
    of directors.
|   
|(2) | The Employee Stock Purchase Plan provides for an annual increase
    to the share reserve, to be added on the date of each annual
    stockholders meeting, equal to the lesser of:
    (i) 100,000 shares; or (ii) an amount to be
    determined by our board of directors.                                                                                                                                                                                                                                                         



47



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|         |                                               
|-------- | ----------------------------------------------
|Item 13. | Certain Relationships and Related Transactions








|         |                                       
|-------- | --------------------------------------
|Item 14. | Principal Accounting Fees and Services






PART IV







|         |                                           
|-------- | ------------------------------------------
|Item 15. | Exhibits and Financial Statement Schedules















|        |    |             |  |                                                                                                                                                                                                                    
|------- | -- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 2  | .1          |  | Agreement and Plan of Merger dated as of February 23, 2004,
    by and among Dot Hill Systems Corp., DHSA Corp., Chaparral
    Network Storage, Inc., and C. Timothy Smoot, as
    Stockholders Representative.(1)
|        | 3  | .1          |  | Certificate of Incorporation of Dot Hill Systems Corp.(2)                                                                                                                                                          
|        | 3  | .2          |  | By-laws of Dot Hill Systems Corp.(2)                                                                                                                                                                               
|        | 4  | .1          |  | Certificate of Incorporation Dot Hill Systems Corp.(2)                                                                                                                                                             
|        | 4  | .2          |  | By-laws of Dot Hill Systems Corp.(2)                                                                                                                                                                               
|        | 4  | .3          |  | Form of Common Stock Certificate.(3)                                                                                                                                                                               
|        | 4  | .4          |  | Certificate of Designation of Series A Junior Participating
    Preferred Stock, as filed with the Secretary of State of
    Delaware on May 19, 2003.(4)                                                          
|        | 4  | .5          |  | Form of Rights Certificate.(4)                                                                                                                                                                                     
|        | 4  | .6          |  | Warrant to Purchase Shares of Common Stock dated May 24,
    2002.(5)                                                                                                                                              
|        | 4  | .7          |  | Common Stock Warrant dated December 19, 2002.(5)                                                                                                                                                                   
|        | 4  | .8          |  | Warrant to Purchase Shares of Common Stock dated
    February 14, 2003.(5)                                                                                                                                         
|        | 4  | .9          |  | Common Stock Warrant dated March 14, 2003.(5)                                                                                                                                                                      
|        | 10 | .1          |  | Product Purchase Agreement between Dot Hill Systems Corp. and
    Sun Microsystems, Inc. dated May 24, 2002.(6)                                                                                                    
|        | 10 | .2          |  | Product Supplement/ Award Letter for Blade Product under
    agreement with Sun Microsystems, Inc. dated May 24, 2002.(6)                                                                                          

48



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|        |    |             |  |                                                                                                                                                                                                                        
|------- | -- | ----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 10 | .3          |  | Product Supplement/ Award Letter for SCSI Product under
    agreement with Sun Microsystems, Inc. dated May 24, 2002.(6)                                                                                               
|        | 10 | .4          |  | Product Supplement/ Award Letter for FC Product under agreement
    with Sun Microsystems, Inc. dated May 24, 2002.(6)                                                                                                 
|        | 10 | .5          |  | Second Amendment to Product Purchase Agreement, dated as of
    January 26, 2004 by and among Sun Microsystems, Inc., Sun
    Microsystems International B.V., Dot Hill Systems Corp. and Dot
    Hill Systems B.V.(15)
|        | 10 | .6          |  | Third Amendment to Product Purchase Agreement, dated as of
    March 22, 2004, by and among Sun Microsystems, Inc., Sun
    Microsystems International B.V., Dot Hill Systems Corp. and Dot
    Hill Systems B.V.(15)  
|        | 10 | .7          |  | Product Supplement/ Award Letter (SATA) by and between Sun
    Microsystems, Inc. and Dot Hill Systems Corp. dated as of
    March 22, 2004.(15)                                                                       
|        | 10 | .8          |  | Rights Agreement dated as of May 19, 2003 by and between
    Dot Hill Systems Corp. and American Stock Transfer and Trust
    Company.(4)                                                                              
|        | 10 | .9          |  | Employment letter agreement dated August 2, 1999 between
    Dot Hill Systems Corp. and James L. Lambert.(7)                                                                                                          
|        | 10 | .10         |  | Employment letter agreement dated August 2, 1999 between
    Dot Hill Systems Corp. and Dana W Kammersgard.(7)                                                                                                        
|        | 10 | .11         |  | Employment offer letter dated November 12, 1999 between Dot
    Hill Systems Corp. and Preston Romm.(7)                                                                                                               
|        | 10 | .12         |  | Lease for Dot Hill Systems Corp.s headquarters in
    Carlsbad, California dated June 9, 1993.(5)                                                                                                                     
|        | 10 | .13         |  | 2000 Amended and Restated Equity Incentive Plan.(8)                                                                                                                                                                   
|        | 10 | .14         |  | Form of Stock Option Agreement (Incentive and Non-statutory
    Stock Options) used in connection with the 2000 Amended and
    Restated Equity Incentive Plan.(8)                                                    
|        | 10 | .15         |  | Form of Stock Option Grant Notice used in connection with the
    2000 Amended and Restated Equity Incentive Plan.(8)                                                                                                 
|        | 10 | .16         |  | 2000 Amended and Restated Employee Stock Purchase Plan.(9)                                                                                                                                                            
|        | 10 | .17         |  | 2000 Non-Employee Directors Stock Option Plan.(10)                                                                                                                                                                    
|        | 10 | .18         |  | Form of Stock Option Agreement used in connection with the 2000
    Non-Employee Directors Stock Option Plan.(10)                                                                                                    
|        | 10 | .19         |  | Credit Agreement dated July 1, 2004 by and between Dot Hill
    Systems Corp. and Wells Fargo Bank, National Association.(11)                                                                                          
|        | 10 | .20         |  | Revolving Line of Credit Note dated July 1, 2004 issued by
    Dot Hill Systems Corp. to Wells Fargo Bank, National
    Association.(11)                                                                               
|        | 10 | .21         |  | Security Agreement and Addendum dated July 1, 2004 by and
    between Dot Hill Systems Corp. and Wells Fargo Bank, National
    Association.(11)                                                                       
|        | 10 | .22         |  | Manufacturing Agreement between Dot Hill Systems Corp. and
    Solectron Corporation dated May 20, 2002.(12)                                                                                                           
|        | 10 | .23         |  | OEM Agreement between Dot Hill Systems Corp. and Infortrend
    Technology, Inc. dated May 20, 2002.(12)                                                                                                               
|        | 10 | .24         |  | 2005 Executive Compensation Plan for James L. Lambert effective
    January 1, 2005.(13)                                                                                                                              
|        | 10 | .25         |  | 2005 Executive Compensation Plan for Dana Kammersgard effective
    January 1, 2005.(13)                                                                                                                              
|        | 10 | .26         |  | 2005 Executive Compensation Plan for Preston Romm effective
    January 1, 2005.(13)                                                                                                                                  
|        | 10 | .27         |  | Change of Control Agreement dated August 23, 2001 between
    Dot Hill Systems Corp. and James L. Lambert.(14)                                                                                                        
|        | 10 | .28         |  | Change of Control Agreement dated August 23, 2001 between
    Dot Hill Systems Corp. and Dana Kammersgard.(14)                                                                                                        

49



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##### Table of Contents



|        |    |             |  |                                                                                                                                                                                                                   
|------- | -- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|Number  |    | Description
|        |    |            
|        | 10 | .29         |  | Change of Control Agreement dated August 23, 2001 between
    Dot Hill Systems Corp. and Preston Romm.(14)                                                                                                       
|        | 10 | .30         |  | Securities Purchase Agreement dated March 11, 2003 between
    Dot Hill Systems Corp. and each of the purchasers listed on the
    signature pages thereto.(5)                                                    
|        | 10 | .31         |  | Registration Rights Agreement dated March 11, 2003 between
    Dot Hill Systems Corp. and each of the purchasers listed on the
    signature pages thereto.(5)                                                    
|        | 10 | .32         |  | Registration Rights Agreement dated March 4, 2003 between
    Dot Hill Systems Corp. and each of the individuals listed on the
    signature pages thereto.(5)                                                    
|        | 10 | .33         |  | Amendment to Manufacturing Agreement between Dot Hill Systems
    Corp. and Solectron Corporation dated April 5, 2005.(16)                                                                                        
|        | 10 | .34         |  | Description of Amended and Restated Policy for Director
    Compensation.(17)                                                                                                                                     
|        | 10 | .35         |  | Lease Agreement by and between Dot Hill Systems Corp. and
    Equastone 2200 Faraday, LLC effective as of September 1,
    2005 and dated as of September 16, 2005.(18)                                           
|        | 10 | .36         |  | Fourth Amendment to Product Purchase Agreement dated
    September 26, 2005 by and among Sun Microsystems, Inc., Sun
    Microsystems International B.V., Dot Hill Systems Corp. and Dot
    Hill Systems B.V.(19)
|        | 10 | .37         |  | Product Supplement/ Award Letter dated September 27, 2005
    by and among Sun Microsystems, Inc., Sun Microsystems
    International B.V., Dot Hill Systems Corp. and Dot Hill Systems
    B.V.(19)              
|        | 10 | .38         |  | Second Amendment to Manufacturing Agreement dated
    September 16, 2005 between Dot Hill Systems Corp. and
    Solectron Corporation.(19)                                                                        
|        | 10 | .39         |  | Second Award Letter dated September 16, 2005 between Dot
    Hill Systems Corp. and Solectron Corporation.(19)                                                                                                    
|        | 10 | .40         |  | Development and OEM Supply Agreement dated July 26, 2005 by
    and among Dot Hill Systems Corp., Dot Hill Systems B.V., Network
    Appliance, Inc. and Network Appliance B.V.(19)                               
|        | 10 | .41         |  | Product Supplement/ Award Letter dated October 20, 2005 by
    and among Sun Microsystems, Inc., Sun Microsystems International
    B.V., Dot Hill Systems Corp. and Dot Hill Systems B.V.*                       
|        | 10 | .42         |  | Description of Accelerated Vesting of Options.(20)                                                                                                                                                                
|        | 10 | .43         |  | Form of Indemnity Agreement.(21)                                                                                                                                                                                  
|        | 10 | .44         |  | Patent Cross License dated December 29, 2005 between Dot
    Hill Systems Corp. and International Business Machines
    Corporation.*                                                                             
|        | 10 | .45         |  | Offer letter agreement dated February 22, 2006 between Dot
    Hill Systems Corp. and Patrick Collins.(22)                                                                                                        
|        | 10 | .46         |  | Consulting letter agreement effective March 1, 2006 and
    dated March 2, 2006 between Dot Hill Systems Corp. and
    James L. Lambert.(23)                                                                      
|        | 10 | .47         |  | Description of 2006 Executive Compensation Plan.(23)                                                                                                                                                              
|        | 21 | .1          |  | Subsidiaries of Dot Hill Systems Corp.(5)                                                                                                                                                                         
|        | 23 | .1          |  | Consent of Deloitte & Touche LLP                                                                                                                                                                                  
|        | 24 | .1          |  | Power of Attorney. Reference is made to the signature page
    hereto.                                                                                                                                            
|        | 31 | .1          |  | Certification pursuant to 17 CFR 240.13a-14(a) or
    17 CFR 240.15d-14(a), as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                             
|        | 31 | .2          |  | Certification pursuant to 17 CFR 240.13a-14(a) or
    17 CFR 240.15d-14(a), as adopted pursuant to
    Section 302 of the Sarbanes-Oxley Act of 2002.                                                             
|        | 32 | .1          |  | Certification pursuant to 18 U.S.C. Section 1350, as
    adopted pursuant to Section 906 of the Sarbanes-Oxley Act
    of 2002.                                                                                   






|  |                                                                                                               
|- | --------------------------------------------------------------------------------------------------------------
| | Indicates management or compensatory plan or arrangement
    required to be identified pursuant to Item 15(b).



50



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##### Table of Contents





| |     |                                                                                                                                                 
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------
| | (1) | Filed as an exhibit to our Current Report on
    Form 8-K filed
    with the SEC on February 24, 2004 and incorporated herein
    by reference. 
|
| | (2) | Filed as an exhibit to our Current Report on
    Form 8-K filed
    with the SEC on September 19, 2001 and incorporated herein
    by reference.
|
| | (3) | Filed as an exhibit to our Current Report on
    Form 8-K filed
    with the SEC on January 14, 2003 and incorporated herein by
    reference.  
|
| | (4) | Filed as an exhibit to our Current Report on
    Form 8-K filed
    with the SEC on May 19, 2003 and incorporated herein by
    reference.      
|
| | (5) | Filed as an exhibit to our Annual Report on
    Form 10-K for the
    year ended December 31, 2002 and incorporated herein by
    reference.    
|
| | (6) | Filed as an exhibit to our Quarterly Report on
    Form 10-Q for the
    quarter ended June 30, 2002 and incorporated herein by
    reference.  
|
| | (7) | Filed as an exhibit to our Annual Report on
    Form 10-K for the
    year ended December 31, 1999 and incorporated herein by
    reference.    
|
| | (8) | Filed as an exhibit to our Current Report on
    Form 8-K dated
    August 23, 2000 and incorporated herein by reference.                       
|
| | (9) | Filed as an exhibit to our Quarterly Report on
    Form 10-Q for the
    quarter ended June 30, 2004 and incorporated herein by
    reference   



|     |                                                                                                                                                    
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|(10) | Filed as an exhibit to our Registration Statement on
    Form S-8 (No.
    333-43834) and
    incorporated herein by reference.                    
|    
|(11) | Filed as an exhibit to our Quarterly Report on
    Form 10-Q for the
    quarter ended September 30, 2004 and incorporated herein by
    reference.
|    
|(12) | Filed as an exhibit to our Quarterly Report on
    Form 10-Q for the
    quarter ended June 30, 2002 and incorporated herein by
    reference.     



|     |                                                                                                                                               
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------
|(13) | Filed as an exhibit to our Current Report on
    Form 8-K filed
    with the SEC on February 9, 2005 and incorporated herein by
    reference.



|     |                                                                                                                                                    
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|(14) | Filed as an exhibit to our Quarterly Report on
    Form 10-Q for the
    quarter ended September 30, 2001 and incorporated herein by
    reference.
|    
|(15) | Filed as an exhibit to our Quarterly Report on
    Form 10-Q for the
    quarter ended March 31, 2004 and incorporated herein by
    reference.    
|    
|(16) | Filed as an exhibit to our Quarterly Report on
    Form 10-Q for the
    quarter ended June 30, 2005 and incorporated herein by
    reference.     
|    
|(17) | Incorporated herein by reference to the description contained in
    our Current Report on
    Form 8-K filed
    with the SEC on July 29, 2005.   
|    
|(18) | Filed as an exhibit to our Current Report on
    Form 8-K filed
    with the SEC on September 21, 2005 and incorporated herein
    by reference.   
|    
|(19) | Filed as an exhibit to our Quarterly Report on
    Form 10-Q for the
    quarter ended September 30, 2005 and incorporated herein by
    reference.
|    
|(20) | Incorporated herein by reference to the description contained in
    our Current Report on
    Form 8-K filed
    with the SEC on December 7, 2005.
|    
|(21) | Filed as an exhibit to our Current Report on
    Form 8-K filed
    with the SEC on December 13, 2005 and incorporated herein
    by reference.    
|    
|(22) | Filed as an exhibit to our Current Report on
    Form 8-K filed
    with the SEC on February 24, 2006 and incorporated herein
    by reference.    
|    
|(23) | Filed as an exhibit to our Current Report on
    Form 8-K filed
    with the SEC on March 8, 2006 and incorporated herein by
    reference.        

51



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##### Table of Contents



SIGNATURES






| |                       
| | ----------------------
| | DOT HILL SYSTEMS CORP.
| | (Registrant)          



| |     |                        
| | --- | -----------------------
| | By: | /s/ Dana W. Kammersgard

| | 
| | 
| | 



| |                                      
| | -------------------------------------
| | Dana
    W. Kammersgard              
| | Chief Executive Officer and President
|
| | Date: March 16, 2006                 

attorneys-in attorneys-in attorneys-in




|                                           |  |                                                                                                   |  |                |  | 
|------------------------------------------ |  | ------------------------------------------------------------------------------------------------- |  | -------------- |  | 
|Name                                       |  | Title                                                                                             |  | Date          
|                                           |  |                                                                                                   |  |               
|                                          
|/s/ Dana W. KammersgardDana W. Kammersgard |  | Chief Executive Officer, President and Director (Principal
    Executive Officer)                 |  | March 16, 2006
|                                          
|/s/ Preston RommPreston Romm               |  | Chief Financial Officer, Secretary and Treasurer (Principal
    Financial and Accounting Officer) |  | March 16, 2006
|                                          
|/s/ Charles ChristCharles Christ           |  | Chairman of the Board of Directors                                                                |  | March 16, 2006
|                                          
|/s/ Kimberly AlexyKimberly Alexy           |  | Director                                                                                          |  | March 16, 2006
|                                          
|/s/ Joseph D. MarkeeJoseph D. Markee       |  | Director                                                                                          |  | March 16, 2006
|                                          
|/s/ W.R. SaueyW.R. Sauey                   |  | Director                                                                                          |  | March 16, 2006

52



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##### Table of Contents



INDEX TO FINANCIAL STATEMENTS


|                                                                                                                        |  |      |      | 
|----------------------------------------------------------------------------------------------------------------------- |  | ---- | ---- | 
|                                                                                                                        |  | Page |     
|                                                                                                                        |  |      |     
|REPORT OF INDEPENDENT REGISTERED PUBLIC
    ACCOUNTING FIRM                                                             |  |      | F-1  | 
|FINANCIAL STATEMENTS:                                                                                                   |  |      |      | 
|Consolidated balance sheets as of
    December 31, 2004 and 2005                                                        |  |      | F-2  | 
|Consolidated statements of income and
    comprehensive income for the years ended December 31, 2003,
    2004 and 2005 |  |      | F-3  | 
|Consolidated statements of
    stockholders equity for the years ended December 31,
    2003, 2004 and 2005            |  |      | F-4  | 
|Consolidated statements of cash flows for
    the years ended December 31, 2003, 2004 and 2005                          |  |      | F-5  | 
|Notes to consolidated financial statements
    for the years ended December 31, 2003, 2004 and 2005                     |  |      | F-6  | 
|FINANCIAL STATEMENT SCHEDULES:                                                                                          |  |      |      | 
|Schedule II  Valuation and
    Qualifying Accounts                                                                     |  |      | F-35 | 



---



##### Table of Contents






REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM












Internal Control 
Integrated Framework








F-1



---



##### Table of Contents



DOT HILL SYSTEMS CORP. AND SUBSIDIARIES





CONSOLIDATED BALANCE SHEETS


AS OF DECEMBER 31, 2004 AND 2005


(In thousands, except per share amounts)


|                                        |                                                                                                                                                                                |                      |                                            |         |         |         |        |         |         |         | 
|--------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | -------------------- | ------------------------------------------ | ------- | ------- | ------- | ------ | ------- | ------- | ------- | 
|                                        |                                                                                                                                                                                | 2004                 |                                            |         | 2005    |        
|                                        |                                                                                                                                                                                |                      |                                            |         |         |        
|ASSETS                                 
|Current Assets:                         |                                                                                                                                                                                |                      |                                            |         |         |         |        |        
|                                        | Cash and cash equivalents                                                                                                                                                      |                      | $                                          | 67,496  |         |         | $      | 108,803 |        
|                                        | Short-term investments                                                                                                                                                         |                      |                                            | 58,690  |         |         |        | 13,431  |        
|                                        | Accounts receivable, net of allowance of $491 and $294                                                                                                                         |                      |                                            | 40,788  |         |         |        | 34,312  |        
|                                        | Inventories                                                                                                                                                                    |                      |                                            | 3,671   |         |         |        | 2,804   |        
|                                        | Prepaid expenses and other                                                                                                                                                     |                      |                                            | 2,273   |         |         |        | 4,539   |        
|                                        | Deferred tax assets                                                                                                                                                            |                      |                                            |        |         |         |        | 5,762   |        
|                                        |                                                                                                                                                                                |                      |                                            |         |         |        
|                                        |                                                                                                                                                                                | Total current assets |                                            |         | 172,918 |         |        |         | 169,651 |        
|Property and equipment, net             |                                                                                                                                                                                |                      | 7,859                                      |         |         |         | 7,891  |        
|Goodwill                                |                                                                                                                                                                                |                      | 57,111                                     |         |         |         | 40,725 |        
|Other intangible assets, net            |                                                                                                                                                                                |                      | 7,712                                      |         |         |         | 7,414  |        
|Deferred tax assets                     |                                                                                                                                                                                |                      |                                           |         |         |         | 41,379 |        
|Other Assets                            |                                                                                                                                                                                |                      | 967                                        |         |         |         | 234    |        
|                                        |                                                                                                                                                                                |                      |                                            |         |         |        
|                                        |                                                                                                                                                                                | Total assets         |                                            | $       | 246,567 |         |        | $       | 267,294 |        
|                                        |                                                                                                                                                                                |                      |                                            |         |         |        
|                                       
|LIABILITIES AND STOCKHOLDERS EQUITY   
|Current Liabilities:                    |                                                                                                                                                                                |                      |                                            |         |         |         |        |        
|                                        | Accounts payable                                                                                                                                                               |                      | $                                          | 40,512  |         |         | $      | 25,732  |        
|                                        | Accrued compensation                                                                                                                                                           |                      |                                            | 3,338   |         |         |        | 3,561   |        
|                                        | Accrued expenses                                                                                                                                                               |                      |                                            | 3,309   |         |         |        | 3,633   |        
|                                        | Deferred revenue                                                                                                                                                               |                      |                                            | 779     |         |         |        | 1,327   |        
|                                        | Income taxes payable                                                                                                                                                           |                      |                                            | 532     |         |         |        | 60      |        
|                                        | Other liabilities                                                                                                                                                              |                      |                                            | 923     |         |         |        |        |        
|                                        | Current portion of restructuring accrual                                                                                                                                       |                      |                                            | 141     |         |         |        | 45      |        
|                                        |                                                                                                                                                                                |                      |                                            |         |         |        
|                                        |                                                                                                                                                                                |                      | Total current liabilities                  |         |         | 49,534  |        |         |         | 34,358  | 
|                                        | Restructuring accrual, net of current portion                                                                                                                                  |                      |                                            | 37      |         |         |        |        |        
|                                        | Other long-term liabilities                                                                                                                                                    |                      |                                            | 169     |         |         |        | 885     |        
|                                        |                                                                                                                                                                                |                      |                                            |         |         |        
|                                        |                                                                                                                                                                                |                      | Total liabilities                          |         |         | 49,740  |        |         |         | 35,243  | 
|                                        |                                                                                                                                                                                |                      |                                            |         |         |        
|                                       
|Commitments and Contingencies (Note 17) |                                                                                                                                                                                |                      |                                            |         |         |         |        |        
|                                       
|Stockholders Equity:                   |                                                                                                                                                                                |                      |                                            |         |         |         |        |        
|                                        | Preferred stock, $.001 par value, 10,000 shares
    authorized, no shares issued and outstanding at
    December 31, 2004 and December 31, 2005, respectively                  |                      |                                            |        |         |         |        |        |        
|                                        | Common stock, $.001 par value, 100,000 shares
    authorized, 43,656 and 44,417 shares issued and outstanding
    at December 31, 2004 and December 31, 2005,
    respectively |                      |                                            | 44      |         |         |        | 44      |        
|                                        | Additional paid-in capital                                                                                                                                                     |                      |                                            | 277,102 |         |         |        | 285,377 |        
|                                        | Deferred compensation                                                                                                                                                          |                      |                                            | (8      | )       |         |        |        |        
|                                        | Accumulated other comprehensive loss                                                                                                                                           |                      |                                            | (462    | )       |         |        | (118    | )      
|                                        | Accumulated deficit                                                                                                                                                            |                      |                                            | (79,849 | )       |         |        | (53,252 | )      
|                                        |                                                                                                                                                                                |                      |                                            |         |         |        
|                                        |                                                                                                                                                                                |                      | Total stockholders equity                 |         |         | 196,827 |        |         |         | 232,051 | 
|                                        |                                                                                                                                                                                |                      |                                            |         |         |        
|                                        |                                                                                                                                                                                |                      | Total liabilities and stockholders equity |         | $       | 246,567 |        |         | $       | 267,294 | 
|                                        |                                                                                                                                                                                |                      |                                            |         |         |        



F-2



---



##### Table of Contents



DOT HILL SYSTEMS CORP. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME


FOR THE YEARS ENDED DECEMBER 31, 2003, 2004 AND 2005


(In thousands, except per share amounts)


|                                                                |                                                      |                                                |   |         |        |  |   |         |        |  |   |         |        | 
|--------------------------------------------------------------- | ---------------------------------------------------- | ---------------------------------------------- | - | ------- | ------ |  | - | ------- | ------ |  | - | ------- | ------ | 
|                                                                |                                                      | 2003                                           |   |         | 2004   |  |   | 2005    |       
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                | NET REVENUE                                          |                                                | $ | 187,448 |        |  | $ | 239,376 |        |  | $ | 233,799 |       
|                                                                | COST OF GOODS SOLD                                   |                                                |   | 142,550 |        |  |   | 179,875 |        |  |   | 180,196 |       
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                | GROSS PROFIT                                         |                                                |   | 44,898  |        |  |   | 59,501  |        |  |   | 53,603  |       
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                | OPERATING EXPENSES:                                  |                                                |   |         |        |  |   |         |        |  |   |         |       
|                                                                | Sales and marketing                                  |                                                |   | 14,086  |        |  |   | 16,839  |        |  |   | 19,120  |       
|                                                                | Research and development                             |                                                |   | 11,950  |        |  |   | 17,993  |        |  |   | 23,628  |       
|                                                                | General and administrative                           |                                                |   | 7,418   |        |  |   | 9,992   |        |  |   | 12,933  |       
|                                                                | In process research and development                  |                                                |   |        |        |  |   | 4,700   |        |  |   |        |       
|                                                                | Restructuring expenses                               |                                                |   |        |        |  |   | (434    | )      |  |   |        |       
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                |                                                      | Total operating expenses                       |   |         | 33,454 |  |   |         | 49,090 |  |   |         | 55,681 | 
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                | OPERATING INCOME (LOSS)                              |                                                |   | 11,444  |        |  |   | 10,411  |        |  |   | (2,078  | )     
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                | OTHER INCOME (EXPENSE):                              |                                                |   |         |        |  |   |         |        |  |   |         |       
|                                                                | Interest income                                      |                                                |   | 716     |        |  |   | 1,766   |        |  |   | 3,394   |       
|                                                                | Interest expense                                     |                                                |   | (105    | )      |  |   | (341    | )      |  |   |        |       
|                                                                | Other income, net                                    |                                                |   | 164     |        |  |   | 33      |        |  |   | 84      |       
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                |                                                      | Total other income, net                        |   |         | 775    |  |   |         | 1,458  |  |   |         | 3,478  | 
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                | INCOME BEFORE INCOME TAXES                           |                                                | $ | 12,219  |        |  | $ | 11,869  |        |  | $ | 1,400   |       
|                                                                | INCOME TAX EXPENSE (BENEFIT)                         |                                                |   | 88      |        |  |   | 272     |        |  |   | (25,197 | )     
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                | NET INCOME                                           |                                                | $ | 12,131  |        |  | $ | 11,597  |        |  | $ | 26,597  |       
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|NET INCOME ATTRIBUTABLE TO COMMON STOCKHOLDERS:                 |                                                      |                                                |   |         |        |  |   |         |        |  |   |        
|                                                                | Net income                                           |                                                | $ | 12,131  |        |  | $ | 11,597  |        |  | $ | 26,597  |       
|                                                                | Dividends on preferred stock                         |                                                |   | (141    | )      |  |   |        |        |  |   |        |       
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                |                                                      | Net income attributable to common stockholders |   | $       | 11,990 |  |   | $       | 11,597 |  |   | $       | 26,597 | 
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|NET INCOME PER SHARE:                                           |                                                      |                                                |   |         |        |  |   |         |        |  |   |        
|                                                                | Basic                                                |                                                | $ | 0.35    |        |  | $ | 0.27    |        |  | $ | 0.61    |       
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                | Diluted                                              |                                                | $ | 0.31    |        |  | $ | 0.25    |        |  | $ | 0.58    |       
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|WEIGHTED AVERAGE SHARES USED TO CALCULATE NET INCOME PER SHARE: |                                                      |                                                |   |         |        |  |   |         |        |  |   |        
|                                                                | Basic                                                |                                                |   | 33,856  |        |  |   | 43,460  |        |  |   | 43,903  |       
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                | Diluted                                              |                                                |   | 38,164  |        |  |   | 46,395  |        |  |   | 45,639  |       
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                | COMPREHENSIVE INCOME:                                |                                                |   |         |        |  |   |         |        |  |   |         |       
|                                                                | Net income                                           |                                                | $ | 12,131  |        |  | $ | 11,597  |        |  | $ | 26,597  |       
|                                                                | Foreign currency translation adjustments             |                                                |   | 30      |        |  |   | (45     | )      |  |   | 255     |       
|                                                                | Net unrealized gain (loss) on short-term investments |                                                |   | 25      |        |  |   | (154    | )      |  |   | 89      |       
|                                                                |                                                      |                                                |   |         |        |  |   |         |       
|                                                                |                                                      | Comprehensive income                           |   | $       | 12,186 |  |   | $       | 11,398 |  |   | $       | 26,941 | 
|                                                                |                                                      |                                                |   |         |        |  |   |         |       



F-3



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##### Table of Contents



DOT HILL SYSTEMS CORP. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY


FOR THE YEARS ENDED DECEMBER 31, 2003, 2004 AND 2005


(In thousands)


|                                                                  |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   |      |   |  |   |          |   |  |   |         |  
|----------------------------------------------------------------- |  | --------------- | -- | ------------ | ------ | - | ---------- |  |  | ----------- | ------ | ----- | ------------- | - | -- | ------------ | ----- | - | ------------- | - |  | ------- | --- | - | ------ | - | ---- | - |  | - | -------- | - |  | - | ------- | -
|                                                                  |  |                 |    |              |        |   |            |  |  | Accumulated |        |       |               |   |   
|                                                                  |  | Preferred Stock |    | Common Stock |        |   | Additional |  |  |             |        | Other |               |   |    |              | Total |  
|                                                                  |  |                 |    |              |        |   | Paid-In    |  |  | Deferred    |        |       | Comprehensive |   |    | Accumulated  |       |   | Stockholders |  
|                                                                  |  | Shares          |    |              | Amount |   | Shares     |  |  | Amount      |        |       | Capital       |   |    | Compensation |       |   | Loss          |   |  | Deficit |     |   | Equity |  
|                                                                  |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |  
|Balance, January 1, 2003                                          |  |                 | 6  |              |        | $ |           |  |  |             | 25,172 |       |               | $ | 25 |              |       | $ | 109,562       |   |  | $       | (48 | ) |        | $ | (318 | ) |  | $ | (103,436 | ) |  | $ | 5,785   |  
|Conversion of preferred stock to common stock                     |  |                 | (6 | )            |        |   |           |  |  |             | 1,846  |       |               |   | 2  |              |       |   | (2            | ) |  |         |     |   |        |   |      |   |  |   |          |   |  |   |        |  
|Issuance of common stock and stock warrant, net of issuance costs |  |                 |    |              |        |   |            |  |  |             | 14,654 |       |               |   | 15 |              |       |   | 161,268       |   |  |         |     |   |        |   |      |   |  |   |          |   |  |   | 161,283 |  
|Amortization of deferred compensation                             |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         | 20  |   |        |   |      |   |  |   |          |   |  |   | 20      |  
|Dividends on preferred stock                                      |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   |      |   |  |   | (141     | ) |  |   | (141    | )
|Exercise of stock options and warrants                            |  |                 |    |              |        |   |            |  |  |             | 1,111  |       |               |   | 1  |              |       |   | 4,240         |   |  |         |     |   |        |   |      |   |  |   |          |   |  |   | 4,241   |  
|Sale of common stock under employee stock purchase plan           |  |                 |    |              |        |   |            |  |  |             | 524    |       |               |   |    |              |       |   | 759           |   |  |         |     |   |        |   |      |   |  |   |          |   |  |   | 759     |  
|Foreign currency translation adjustment                           |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   | 30   |   |  |   |          |   |  |   | 30      |  
|Net unrealized gain on short- term investments                    |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   | 25   |   |  |   |          |   |  |   | 25      |  
|Net income                                                        |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   |      |   |  |   | 12,131   |   |  |   | 12,131  |  
|                                                                  |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   |     
|Balance, December 31, 2003                                        |  |                 |   |              |        |   |           |  |  |             | 43,307 |       |               |   | 43 |              |       |   | 275,827       |   |  |         | (28 | ) |        |   | (263 | ) |  |   | (91,446  | ) |  |   | 184,133 |  
|Amortization of deferred compensation                             |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         | 20  |   |        |   |      |   |  |   |          |   |  |   | 20      |  
|Exercise of stock options and warrants                            |  |                 |    |              |        |   |            |  |  |             | 349    |       |               |   | 1  |              |       |   | 1,275         |   |  |         |     |   |        |   |      |   |  |   |          |   |  |   | 1,276   |  
|Foreign currency translation adjustment                           |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   | (45  | ) |  |   |          |   |  |   | (45     | )
|Net unrealized loss on short- term investments                    |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   | (154 | ) |  |   |          |   |  |   | (154    | )
|Net income                                                        |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   |      |   |  |   | 11,597   |   |  |   | 11,597  |  
|                                                                  |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   |     
|Balance, December 31, 2004                                        |  |                 |   |              |        |   |           |  |  |             | 43,656 |       |               |   | 44 |              |       |   | 277,102       |   |  |         | (8  | ) |        |   | (462 | ) |  |   | (79,849  | ) |  |   | 196,827 |  
|Amortization of deferred compensation                             |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         | 8   |   |        |   |      |   |  |   |          |   |  |   | 8       |  
|Exercise of stock options and warrants                            |  |                 |    |              |        |   |            |  |  |             | 561    |       |               |   |    |              |       |   | 1,780         |   |  |         |     |   |        |   |      |   |  |   |          |   |  |   | 1,780   |  
|Sale of common stock under ESPP                                   |  |                 |    |              |        |   |            |  |  |             | 200    |       |               |   |    |              |       |   | 1,040         |   |  |         |     |   |        |   |      |   |  |   |          |   |  |   | 1,040   |  
|Tax benefit for disqualifying dispositions of stock options       |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   | 5,455         |   |  |         |     |   |        |   |      |   |  |   |          |   |  |   | 5,455   |  
|Foreign currency translation adjustment                           |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   | 255  |   |  |   |          |   |  |   | 255     |  
|Net unrealized gain on short- term investments                    |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   | 89   |   |  |   |          |   |  |   | 89      |  
|Net income                                                        |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   |      |   |  |   | 26,597   |   |  |   | 26,597  |  
|                                                                  |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   |     
|Balance, December 31, 2005                                        |  |                 |   |              |        | $ |           |  |  |             | 44,417 |       |               | $ | 44 |              |       | $ | 285,377       |   |  | $       |    |   |        | $ | (118 | ) |  | $ | (53,252  | ) |  | $ | 232,051 |  
|                                                                  |  |                 |    |              |        |   |            |  |  |             |        |       |               |   |    |              |       |   |               |   |  |         |     |   |        |   |     



F-4



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##### Table of Contents



DOT HILL SYSTEMS CORP. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF CASH FLOWS


FOR THE YEARS ENDED DECEMBER 31, 2003, 2004 AND 2005


(In thousands)


|                                                                                      |                                                                                 |      |         |         |      |   |         |         |   |   |         |         |  
|------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------- | ---- | ------- | ------- | ---- | - | ------- | ------- | - | - | ------- | ------- | -
|                                                                                      |                                                                                 | 2003 |         |         | 2004 |   |         | 2005    |  
|                                                                                      |                                                                                 |      |         |         |      |   |         |         |  
|Cash Flows Related to Operating Activities:                                           |                                                                                 |      |         |         |      |   |         |         |   |   |         |        
|Net income                                                                            |                                                                                 | $    | 12,131  |         |      | $ | 11,597  |         |   | $ | 26,597  |        
|Adjustments to reconcile net income to net cash provided by
    operating activities: |                                                                                 |      |         |         |      |   |         |         |   |   |         |        
|                                                                                      | Depreciation and amortization                                                   |      |         | 2,045   |      |   |         | 5,657   |   |   |         | 7,504   |  
|                                                                                      | Write-off of in-process research and development                                |      |         |        |      |   |         | 4,700   |   |   |         |        |  
|                                                                                      | Non-cash settlement of restructuring charges                                    |      |         |        |      |   |         | (434    | ) |   |         |        |  
|                                                                                      | Loss on disposal of property and equipment                                      |      |         | 42      |      |   |         |        |   |   |         | 892     |  
|                                                                                      | Provision for doubtful accounts                                                 |      |         | (284    | )    |   |         | 176     |   |   |         | (560    | )
|                                                                                      | Deferred taxes, including reversal of valuation allowance                       |      |         |        |      |   |         |        |   |   |         | (25,300 | )
|                                                                                      | Other                                                                           |      |         | 76      |      |   |         | 8       |   |   |         | (67     | )
|Changes in operating assets and liabilities (net of effects
    of acquisition):      |                                                                                 |      |         |         |      |   |         |         |   |   |         |        
|                                                                                      | Accounts receivable                                                             |      |         | (7,970  | )    |   |         | (24,637 | ) |   |         | 6,422   |  
|                                                                                      | Inventories                                                                     |      |         | 3,801   |      |   |         | 442     |   |   |         | 785     |  
|                                                                                      | Prepaid expenses and other assets                                               |      |         | (940    | )    |   |         | 277     |   |   |         | (1,598  | )
|                                                                                      | Accounts payable                                                                |      |         | 10,087  |      |   |         | 14,653  |   |   |         | (14,398 | )
|                                                                                      | Accrued compensation and other expenses                                         |      |         | 3,159   |      |   |         | 25      |   |   |         | (231    | )
|                                                                                      | Deferred revenue                                                                |      |         | (82     | )    |   |         | (527    | ) |   |         | 680     |  
|                                                                                      | Income taxes payable                                                            |      |         | (15     | )    |   |         | (473    | ) |   |         | (470    | )
|                                                                                      | Restructuring accrual                                                           |      |         | (662    | )    |   |         | (312    | ) |   |         | (133    | )
|                                                                                      | Other liabilities                                                               |      |         | (24     | )    |   |         | 107     |   |   |         | 600     |  
|                                                                                      |                                                                                 |      |         |         |      |   |         |         |  
|Net cash provided by operating activities                                             |                                                                                 |      | 21,364  |         |      |   | 11,259  |         |   |   | 723     |        
|                                                                                      |                                                                                 |      |         |         |      |   |         |         |  
|Cash Flows Related to Investing Activities:                                           |                                                                                 |      |         |         |      |   |         |         |   |   |         |        
|                                                                                      | Purchases of property and equipment                                             |      |         | (3,460  | )    |   |         | (4,949  | ) |   |         | (4,733  | )
|                                                                                      | Proceeds from sales of equipment                                                |      |         | 14      |      |   |         | 38      |   |   |         |        |  
|                                                                                      | Sales of short-term investments                                                 |      |         | 5,356   |      |   |         | 111,933 |   |   |         | 71,852  |  
|                                                                                      | Purchases of short-term investments                                             |      |         | (91,069 | )    |   |         | (85,083 | ) |   |         | (26,500 | )
|                                                                                      | Cash paid in Chaparral acquisition, net of cash acquired                        |      |         |        |      |   |         | (65,383 | ) |   |         |        |  
|                                                                                      | Purchase of patent license portfolio                                            |      |         |        |      |   |         |        |   |   |         | (2,500  | )
|                                                                                      |                                                                                 |      |         |         |      |   |         |         |  
|Net cash provided by (used in) investing activities                                   |                                                                                 |      | (89,159 | )       |      |   | (43,444 | )       |   |   | 38,119  |        
|                                                                                      |                                                                                 |      |         |         |      |   |         |         |  
|Cash Flows Related to Financing Activities:                                           |                                                                                 |      |         |         |      |   |         |         |   |   |         |        
|                                                                                      | Proceeds from exercise of stock options and warrants                            |      |         | 4,241   |      |   |         | 1,276   |   |   |         | 1,781   |  
|                                                                                      | Proceeds from sale of stock to employees                                        |      |         | 759     |      |   |         |        |   |   |         | 1,040   |  
|                                                                                      | Proceeds from bank and other borrowings                                         |      |         | 45,189  |      |   |         | 13,662  |   |   |         |        |  
|                                                                                      | Payments on bank and other borrowings                                           |      |         | (49,769 | )    |   |         | (21,075 | ) |   |         |        |  
|                                                                                      | Decrease in restricted cash                                                     |      |         | 2,000   |      |   |         |        |   |   |         |        |  
|                                                                                      | Proceeds from common stock and warrants, net of issuance costs                  |      |         | 161,283 |      |   |         |        |   |   |         |        |  
|                                                                                      | Dividends paid to preferred stockholders                                        |      |         | (157    | )    |   |         |        |   |   |         |        |  
|                                                                                      |                                                                                 |      |         |         |      |   |         |         |  
|Net cash provided (by used) in financing activities                                   |                                                                                 |      | 163,546 |         |      |   | (6,137  | )       |   |   | 2,821   |        
|                                                                                      |                                                                                 |      |         |         |      |   |         |         |  
|Effect of Exchange Rate Changes on Cash                                               |                                                                                 |      | 30      |         |      |   | (45     | )       |   |   | (356    | )      
|                                                                                      |                                                                                 |      |         |         |      |   |         |         |  
|Net Increase (Decrease) in Cash and Cash Equivalents                                  |                                                                                 |      | 95,781  |         |      |   | (38,367 | )       |   |   | 41,307  |        
|Cash and Cash Equivalents, beginning of year                                          |                                                                                 |      | 10,082  |         |      |   | 105,863 |         |   |   | 67,496  |        
|                                                                                      |                                                                                 |      |         |         |      |   |         |         |  
|Cash and Cash Equivalents, end of year                                                |                                                                                 | $    | 105,863 |         |      | $ | 67,496  |         |   | $ | 108,803 |        
|                                                                                      |                                                                                 |      |         |         |      |   |         |         |  
|Supplemental Disclosures of Cash Flow Information:                                    |                                                                                 |      |         |         |      |   |         |         |   |   |         |        
|                                                                                      | Construction in progress costs incurred but not paid                            |      | $       |        |      |   | $       |        |   |   | $       | 885     |  
|                                                                                      | Deferred tax asset for stock-based compensation credited to
    equity          |      | $       |        |      |   | $       |        |   |   | $       | 5,455   |  
|                                                                                      | Reduction of goodwill resulting from the recognition of deferred
    tax assets |      | $       |        |      |   | $       |        |   |   | $       | 16,386  |  
|                                                                                      | Conversion of preferred stock to common stock                                   |      | $       | 2       |      |   | $       |        |   |   | $       |        |  
|                                                                                      | Cash paid for interest                                                          |      | $       | 91      |      |   | $       | 1,213   |   |   | $       |        |  
|                                                                                      | Cash paid for income taxes                                                      |      | $       | 99      |      |   | $       | 724     |   |   | $       | 499     |  



F-5



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##### Table of Contents



DOT HILL SYSTEMS CORP.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


FOR THE YEARS ENDED DECEMBER 31, 2003, 2004 and 2005




|   |                                                          
|-- | ---------------------------------------------------------
|1. | Background and Summary of Significant Accounting Policies



| |           
| | ----------
| | Background







| |                      
| | ---------------------
| | Basis of Presentation





| |                            
| | ---------------------------
| | Principles of Consolidation





| |                            
| | ---------------------------
| | Use of Accounting Estimates





| |                          
| | -------------------------
| | Cash and Cash Equivalents





| |                       
| | ----------------------
| | Short-term Investments

Accounting for Certain Investments in Debt and Equity
Securities.




| |                    
| | -------------------
| | Accounts Receivable



F-6



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                         
| | ------------------------
| | Valuation of Inventories

(first-in,




| |                       
| | ----------------------
| | Property and Equipment





| |                      
| | ---------------------
| | Deferred Compensation





| |                                    
| | -----------------------------------
| | Fair Value of Financial Instruments





| |                      
| | ---------------------
| | Valuation of Goodwill

Goodwill and Other Intangible
Assets.


F-7



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                  
| | -----------------
| | Long-Lived Assets

Accounting for the Impairment or
Disposal of Long-Lived Assets.




| |                    
| | -------------------
| | Revenue Recognition

Revenue Recognition Software Revenue
Recognition, 97-2.




97-2,




F-8



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


Product Warranties




|                       |  |              |       |  |            |   |       |                |                |   |           |   |  |                   |     |   |  |   |       | 
|---------------------- |  | ------------ | ----- |  | ---------- | - | ----- | -------------- | -------------- | - | --------- | - |  | ----------------- | --- | - |  | - | ----- | 
|                       |  | Balance at   |       |  |            |   |       |                | Deductions for |   |           |  
|                       |  | Beginning of |       |  | Charged to |   |       | Deductions for |                |   | Change in |   |  | Balance at End of |    
|Accrued Warranty Costs |  | Year         |       |  | Operations |   |       | Costs Incurred |                |   | Estimates |   |  | Year              |    
|                       |  |              |       |  |            |   |       |                |                |   |           |   |  |                   |    
|2003                   |  | $            | 336   |  |            | $ | 876   |                |                | $ | (876      | ) |  | $                 | (74 | ) |  | $ | 262   | 
|2004                   |  | $            | 262   |  |            | $ | 1,703 |                |                | $ | (861      | ) |  | $                 |    |   |  | $ | 1,104 | 
|2005                   |  | $            | 1,104 |  |            | $ | 2,445 |                |                | $ | (2,803    | ) |  | $                 |    |   |  | $ | 746   | 



| |                  
| | -----------------
| | Advertising Costs





| |                         
| | ------------------------
| | Research and Development

Accounting for
the Costs of Computer Software to Be Sold, Leased, or Otherwise
Marketed




| |                         
| | ------------------------
| | Stock-Based Compensation

Accounting for Stock-Based Compensation Accounting for Stock Issued to Employees


out-of


F-9



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                                                                                                  |  |      |        |   |      |   |        |      |  |   |        |  
|----------------------------------------------------------------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                                                                                  |  | 2003 |        |   | 2004 |   |        | 2005 | 
|                                                                                                                  |  |      |        |   |      |   |        |      | 
|Net income attributable to common stockholders as reported                                                        |  | $    | 11,990 |   |      | $ | 11,597 |      |  | $ | 26,597 |  
|Stock-based employee compensation expense included in reported
    net income attributable to common stockholders |  |      | 20     |   |      |   | 20     |      |  |   | 8      |  
|Stock-based employee compensation expense determined under fair
    value based method for all awards             |  |      | (7,047 | ) |      |   | (4,553 | )    |  |   | (6,374 | )
|                                                                                                                  |  |      |        |   |      |   |        |      | 
|Pro forma net income attributable to common stockholders                                                          |  | $    | 4,963  |   |      | $ | 7,064  |      |  | $ | 20,231 |  
|                                                                                                                  |  |      |        |   |      |   |        |      | 
|Basic net income per share:                                                                                       |  |      |        |   |      |   |        |      |  |   |        |  
|As reported                                                                                                       |  | $    | 0.35   |   |      | $ | 0.27   |      |  | $ | 0.61   |  
|Pro forma                                                                                                         |  | $    | 0.15   |   |      | $ | 0.16   |      |  | $ | 0.46   |  
|Diluted net income per share:                                                                                     |  |      |        |   |      |   |        |      |  |   |        |  
|As reported                                                                                                       |  | $    | 0.31   |   |      | $ | 0.25   |      |  | $ | 0.58   |  
|Pro forma                                                                                                         |  | $    | 0.13   |   |      | $ | 0.15   |      |  | $ | 0.44   |  

Accounting for Equity Instruments That Are
Issued to Other Than Employees for Acquiring, or in Conjunction
with Selling, Goods or Services




| |                                              
| | ---------------------------------------------
| | Foreign Currency Transactions and Translation







| |             
| | ------------
| | Income Taxes



F-10



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                     
| | --------------------
| | Net Income Per Share







|                                                                           |  |      |        |  |      |  |        |      |  |  |        | 
|-------------------------------------------------------------------------- |  | ---- | ------ |  | ---- |  | ------ | ---- |  |  | ------ | 
|                                                                           |  | 2003 |        |  | 2004 |  |        | 2005 | 
|                                                                           |  |      |        |  |      |  |        |      | 
|Weighted average shares used to calculate basic net income per
    share   |  |      | 33,856 |  |      |  | 43,460 |      |  |  | 43,903 | 
|Dilutive effect of stock options and stock warrants                        |  |      | 3,696  |  |      |  | 2,935  |      |  |  | 1,736  | 
|Dilutive effect of convertible preferred stock                             |  |      | 612    |  |      |  |       |      |  |  |       | 
|                                                                           |  |      |        |  |      |  |        |      | 
|Weighted average shares used to calculate diluted net income per
    share |  |      | 38,164 |  |      |  | 46,395 |      |  |  | 45,639 | 
|                                                                           |  |      |        |  |      |  |        |      | 









| |                                 
| | --------------------------------
| | Recent Accounting Pronouncements

Share-Based Payment




F-11



---



##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






Inventory Costs, and Amendment of ARB No. 43,
Chapter 4


Exchanges of Nonmonetary Assets


Accounting for Conditional Asset Retirement
Obligations Accounting for Asset Retirement
Obligation


Accounting Changes and Error Corrections


F-12



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)


143-1, Accounting for Electronic Equipment Waste Obligations 143-1, 143-1 143-1 Accounting for Asset Retirement
Obligations. 143-1 143-1 143-1 143-1


The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments




|   |            
|-- | -----------
|2. | Acquisition

Business
Combinations




F-13



---



##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                      |  |   |        | 
|------------------------------------- |  | - | ------ | 
|Assets:                               |  |   |        | 
|Cash and cash equivalents             |  | $ | 2,202  | 
|Accounts receivable                   |  |   | 1,769  | 
|Inventories                           |  |   | 955    | 
|Prepaid expenses and other            |  |   | 147    | 
|Property and equipment                |  |   | 648    | 
|Goodwill                              |  |   | 56,768 | 
|Intangible assets:                    |  |   |        | 
|Developed technology                  |  |   | 2,600  | 
|Core technology                       |  |   | 5,000  | 
|Customer relationships                |  |   | 2,500  | 
|Backlog                               |  |   | 100    | 
|In-process research and development   |  |   | 4,700  | 
|                                      |  |   |       
|Total assets                          |  |   | 77,389 | 
|                                      |  |   |       
|                                     
|Liabilities:                         
|Current liabilities                   |  |   | 2,859  | 
|Convertible debt and accrued interest |  |   | 6,945  | 
|                                      |  |   |       
|Total liabilities                     |  |   | 9,804  | 
|                                      |  |   |       
|Net assets acquired                   |  | $ | 67,585 | 
|                                      |  |   |       





Accounting for the Costs of Computer Software to Be Sold,
Leased, or Otherwise Marketed Applicability of
SFAS No. 2 to Business Combinations Accounted for by
the Purchase Method. Goodwill and Other Intangible Assets




F-14



---



##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)








| |                                
| | -------------------------------
| | Pro Forma Results of Operations



|                                |  |                         |         |  |           |   |         |            |  |   |           |  |  |   |         | 
|------------------------------- |  | ----------------------- | ------- |  | --------- | - | ------- | ---------- |  | - | --------- |  |  | - | ------- | 
|                                |  | Year Ended December 31, |        
|                                |  |                         |        
|                                |  | 2003                    |         |  | 2003      |   |         | 2004       |  |   | 2004      | 
|                                |  | Historical              |         |  | Pro Forma |   |         | Historical |  |   | Pro Forma | 
|                                |  |                         |         |  |           |   |         |            |  |   |           | 
|Revenues                        |  | $                       | 187,448 |  |           | $ | 197,434 |            |  | $ | 239,376   |  |  | $ | 241,132 | 
|Net income (loss)               |  | $                       | 12,131  |  |           | $ | (1,765  | )          |  | $ | 11,597    |  |  | $ | 14,341  | 
|Basic income (loss) per share   |  | $                       | 0.35    |  |           | $ | (0.06   | )          |  | $ | 0.27      |  |  | $ | 0.33    | 
|Diluted income (loss) per share |  | $                       | 0.31    |  |           | $ | (0.06   | )          |  | $ | 0.25      |  |  | $ | 0.31    | 



|   |                        
|-- | -----------------------
|3. | Risks and Uncertainties



| |                             
| | ----------------------------
| | Concentration of Credit Risk



F-15



---



##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                                                                       
| | ----------------------------------------------------------------------
| | Cash, Cash Equivalents, and Short-Term Investments,
    Concentrations





| |              
| | -------------
| | Foreign Sales



|                    |  |      |     |   |      |  |     |      |  |  |     |  
|------------------- |  | ---- | --- | - | ---- |  | --- | ---- |  |  | --- | -
|                    |  | 2003 |     |   | 2004 |  |     | 2005 | 
|                    |  |      |     |   |      |  |     |      | 
|Europe              |  |      | 4.9 | % |      |  | 4.0 | %    |  |  | 4.6 | %
|Asia                |  |      | 1.7 |   |      |  | 2.8 |      |  |  | 2.4 |  
|                    |  |      |     |   |      |  |     |      | 
|Total foreign sales |  |      | 6.6 | % |      |  | 6.8 | %    |  |  | 7.0 | %
|                    |  |      |     |   |      |  |     |      | 





| |                        
| | -----------------------
| | Dependence on Suppliers







F-16



---



##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|   |                                     
|-- | ------------------------------------
|4. | Accumulated Other Comprehensive Loss



|                                              |  |   |      |  
|--------------------------------------------- |  | - | ---- | -
|Balance, January 1, 2003                      |  | $ | (318 | )
|                                              |  |   |     
|Foreign currency translation adjustment       |  |   | 30   |  
|Net unrealized gain on short-term investments |  |   | 25   |  
|                                              |  |   |     
|Balance, December 31, 2003                    |  |   | (263 | )
|Foreign currency translation adjustment       |  |   | (45  | )
|Net unrealized loss on short-term investments |  |   | (154 | )
|                                              |  |   |     
|Balance, December 31, 2004                    |  |   | (462 | )
|Foreign currency translation adjustment       |  |   | 255  |  
|Net unrealized gain on short-term investments |  |   | 89   |  
|                                              |  |   |     
|Balance, December 31, 2005                    |  | $ | (118 | )
|                                              |  |   |     



|                                                                                     |  |      |      |   |      |   |      |  
|------------------------------------------------------------------------------------ |  | ---- | ---- | - | ---- | - | ---- | -
|                                                                                     |  | 2004 |      |   | 2005 |  
|                                                                                     |  |      |      |   |      |  
|Foreign currency translation adjustments                                             |  | $    | (333 | ) |      | $ | (78  | )
|Unrealized loss on marketable equity securities classified as
    available for sale |  |      | (129 | ) |      |   | (40  | )
|                                                                                     |  |      |      |   |      |  
|                                                                                     |  | $    | (462 | ) |      | $ | (118 | )
|                                                                                     |  |      |      |   |      |  



|   |                                          
|-- | -----------------------------------------
|5. | Restructuring Costs and Asset Write-downs



|                                     |  |   |       | 
|------------------------------------ |  | - | ----- | 
|Employee termination costs           |  | $ | 1,271 | 
|Impairment of property and equipment |  |   | 1,007 | 
|Facility closures and related costs  |  |   | 637   | 
|Professional fees and other          |  |   | 20    | 
|                                     |  |   |      
|Total                                |  | $ | 2,935 | 
|                                     |  |   |      



F-17



---



##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                     |  |   |       | 
|------------------------------------ |  | - | ----- | 
|Employee termination costs           |  | $ | 259   | 
|Impairment of property and equipment |  |   | 350   | 
|Facility closures and related costs  |  |   | 861   | 
|                                     |  |   |      
|Total                                |  | $ | 1,470 | 
|                                     |  |   |      











| |                         
| | ------------------------
| | March 2001 Restructuring

|                                    |  |               |     |  |             |  |               |              |  |            |               |  |  |          |               |   |              |  |      |               |         |               |          |  |  |              |    |  |  |  |      |   |  |   |    | 
|----------------------------------- |  | ------------- | --- |  | ----------- |  | ------------- | ------------ |  | ---------- | ------------- |  |  | -------- | ------------- | - | ------------ |  | ---- | ------------- | ------- | ------------- | -------- |  |  | ------------ | -- |  |  |  | ---- | - |  | - | -- | 
|                                    |  | Accrued       |     |  |             |  | Accrued       |              |  |            |               |  |  | Accrued  |               |   |              |  |      |               | Accrued |              
|                                    |  | Restructuring |     |  |             |  | Restructuring |              |  | Additional |               |  |  |          | Restructuring |   |              |  |      |               |         | Restructuring |         
|                                    |  | Expenses at   |     |  | Amounts     |  |               | Expenses at  |  |            | Restructuring |  |  | Current  |               |   | Expenses at  |  |      | Additional    |         |               | Current  |  |  | Expenses at  |   
|                                    |  | January 1,    |     |  | Utilized in |  |               | December 31, |  |            | Expenses in   |  |  | Amounts  |               |   | December 31, |  |      | Restructuring |         |               | Amounts  |  |  | December 31, |   
|                                    |  | 2003          |     |  | 2003        |  |               | 2003         |  |            | (Settlement)  |  |  | Utilized |               |   | 2004         |  |      | Expenses      |         |               | Utilized |  |  | 2005         |   
|                                    |  |               |     |  |             |  |               |              |  |            |               |  |  |          |               |   |              |  |      |               |         |               |          |  |  |              |   
|Facility closures and related costs |  | $             | 661 |  |             |  | (260          | )            |  |            | 401           |  |  |          | (79           | ) |              |  | (154 | )             |         |               | 168      |  |  |              | 17 |  |  |  | (140 | ) |  | $ | 45 | 
|                                    |  |               |     |  |             |  |               |              |  |            |               |  |  |          |               |   |              |  |      |               |         |               |          |  |  |              |   



| |                        
| | -----------------------
| | June 2001 Restructuring

|                                    |  |               |     |  |             |  |               |              |  |            |               |  |  |          |               |   |              |  |      |               |         |               |          |  |  |              |    |  |  |  |     |   |  |   |   | 
|----------------------------------- |  | ------------- | --- |  | ----------- |  | ------------- | ------------ |  | ---------- | ------------- |  |  | -------- | ------------- | - | ------------ |  | ---- | ------------- | ------- | ------------- | -------- |  |  | ------------ | -- |  |  |  | --- | - |  | - | - | 
|                                    |  | Accrued       |     |  |             |  | Accrued       |              |  |            |               |  |  | Accrued  |               |   |              |  |      |               | Accrued
|                                    |  | Restructuring |     |  |             |  | Restructuring |              |  | Additional |               |  |  |          | Restructuring |   |              |  |      |               |         | Restructuring
|                                    |  | Expenses at   |     |  | Amounts     |  |               | Expenses at  |  |            | Restructuring |  |  | Current  |               |   | Expenses at  |  |      | Additional    |         |               | Current  |  |  | Expenses at 
|                                    |  | January 1,    |     |  | Utilized in |  |               | December 31, |  |            | Expenses in   |  |  | Amounts  |               |   | December 31, |  |      | Restructuring |         |               | Amounts  |  |  | December 31,
|                                    |  | 2003          |     |  | 2003        |  |               | 2003         |  |            | (Settlement)  |  |  | Utilized |               |   | 2004         |  |      | Expenses      |         |               | Utilized |  |  | 2005        
|                                    |  |               |     |  |             |  |               |              |  |            |               |  |  |          |               |   |              |  |      |               |         |               |          |  |  |             
|Facility closures and related costs |  | $             | 925 |  |             |  | (402          | )            |  |            | 523           |  |  |          | (354          | ) |              |  | (159 | )             |         |               | 10       |  |  |              | 75 |  |  |  | (85 | ) |  | $ |  | 
|                                    |  |               |     |  |             |  |               |              |  |            |               |  |  |          |               |   |              |  |      |               |         |               |          |  |  |              |   



F-18



---



##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|   |                       
|-- | ----------------------
|6. | Short-Term Investments



|                           |  |                   |        |                |        |   |                |       |  |            |   |  |  |   |        | 
|-------------------------- |  | ----------------- | ------ | -------------- | ------ | - | -------------- | ----- |  | ---------- | - |  |  | - | ------ | 
|                           |  | December 31, 2005 |       
|                           |  |                   |       
|                           |  |                   |        | Net Unrealized |        |   | Net Unrealized |       | 
|                           |  | Cost              |        |                | Losses |   |                | Gains |  | Fair Value |  
|                           |  |                   |        |                |        |   |                |       |  |            |  
|U.S. Government securities |  | $                 | 11,395 |                |        | $ | (39            | )     |  | $          |  |  |  | $ | 11,356 | 
|Corporate debt             |  |                   | 2,076  |                |        |   | (1             | )     |  |            |  |  |  |   | 2,075  | 
|                           |  |                   |        |                |        |   |                |       |  |            |   | 
|                           |  | $                 | 13,471 |                |        | $ | (40            | )     |  | $          |  |  |  | $ | 13,431 | 
|                           |  |                   |        |                |        |   |                |       |  |            |   | 

|                           |  |                   |        |                |        |   |                |       |  |   |            |  |  |   |        | 
|-------------------------- |  | ----------------- | ------ | -------------- | ------ | - | -------------- | ----- |  | - | ---------- |  |  | - | ------ | 
|                           |  | December 31, 2004 |       
|                           |  |                   |       
|                           |  |                   |        | Net Unrealized |        |   | Net Unrealized |       |  |  
|                           |  | Cost              |        |                | Losses |   |                | Gains |  |   | Fair Value | 
|                           |  |                   |        |                |        |   |                |       |  |   |            | 
|U.S. Government securities |  | $                 | 49,583 |                |        | $ | (172           | )     |  | $ | 27         |  |  | $ | 49,438 | 
|Municipal securities       |  |                   | 600    |                |        |   |               |       |  |   |           |  |  |   | 600    | 
|Corporate debt             |  |                   | 1,811  |                |        |   | (11            | )     |  |   |           |  |  |   | 1,800  | 
|Commercial paper           |  |                   | 6,825  |                |        |   |               |       |  |   | 27         |  |  |   | 6,852  | 
|                           |  |                   |        |                |        |   |                |       |  |   |            | 
|                           |  | $                 | 58,819 |                |        | $ | (183           | )     |  | $ | 54         |  |  | $ | 58,690 | 
|                           |  |                   |        |                |        |   |                |       |  |   |            | 





|                                      |  |                   |        |  |            |   |        | 
|------------------------------------- |  | ----------------- | ------ |  | ---------- | - | ------ | 
|                                      |  | December 31, 2005 |       
|                                      |  |                   |       
|                                      |  | Cost              |        |  | Fair Value |  
|                                      |  |                   |        |  |            |  
|Due in one year or less               |  | $                 | 1,276  |  |            | $ | 1,276  | 
|Due after one year through five years |  |                   | 12,195 |  |            |   | 12,155 | 
|                                      |  |                   |        |  |            |  
|Total                                 |  | $                 | 13,471 |  |            | $ | 13,431 | 
|                                      |  |                   |        |  |            |  

|                                       |  |                   |        |  |            |   |        | 
|-------------------------------------- |  | ----------------- | ------ |  | ---------- | - | ------ | 
|                                       |  | December 31, 2004 |       
|                                       |  |                   |       
|                                       |  | Cost              |        |  | Fair Value |  
|                                       |  |                   |        |  |            |  
|Due in one year or less                |  | $                 | 53,326 |  |            | $ | 53,208 | 
|Due after one year through five years  |  |                   | 4,893  |  |            |   | 4,882  | 
|Due after five years through ten years |  |                   |       |  |            |   |       | 
|Due after ten years                    |  |                   | 600    |  |            |   | 600    | 
|                                       |  |                   |        |  |            |  
|Total                                  |  | $                 | 58,819 |  |            | $ | 58,690 | 
|                                       |  |                   |        |  |            |  

F-19



---



##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                           |  |                     |       |  |                      |   |     |       |  |   |            |  |  |       |     |   |            |   |        |  |  |   |     |  
|-------------------------- |  | ------------------- | ----- |  | -------------------- | - | --- | ----- |  | - | ---------- |  |  | ----- | --- | - | ---------- | - | ------ |  |  | - | --- | -
|                           |  | Less Than 12 Months |       |  | 12 Months or Greater |   |     | Total | 
|                           |  |                     |       |  |                      |   |     |       | 
|                           |  | Fair                |       |  | Unrealized           |   |     | Fair  |  |   | Unrealized |  |  | Fair  |     |   | Unrealized |  
|                           |  | Value               |       |  | Losses               |   |     | Value |  |   | Losses     |  |  | Value |     |   | Losses     |  
|                           |  |                     |       |  |                      |   |     |       |  |   |            |  |  |       |     |   |            |  
|U.S. Government securities |  | $                   | 6,479 |  |                      | $ | (17 | )     |  | $ | 4,877      |  |  | $     | (22 | ) |            | $ | 11,356 |  |  | $ | (39 | )
|Corporate debt             |  |                     | 2,025 |  |                      |   | (1  | )     |  |   |           |  |  |       |    |   |            |   | 2,025  |  |  |   | (1  | )
|                           |  |                     |       |  |                      |   |     |       |  |   |            |  |  |       |     |   |            |  
|Total                      |  | $                   | 8,504 |  |                      | $ | (18 | )     |  | $ | 4,877      |  |  | $     | (22 | ) |            | $ | 13,381 |  |  | $ | (40 | )
|                           |  |                     |       |  |                      |   |     |       |  |   |            |  |  |       |     |   |            |  

U.S. Government Securities.


Corporate Debt Securities.




|   |            
|-- | -----------
|7. | Inventories



|                              |  |      |       |  |      |   |       | 
|----------------------------- |  | ---- | ----- |  | ---- | - | ----- | 
|                              |  | 2004 |       |  | 2005 |  
|                              |  |      |       |  |      |  
|Purchased parts and materials |  | $    | 1,507 |  |      | $ | 1,058 | 
|Work-in-process               |  |      | 37    |  |      |   |      | 
|Finished goods                |  |      | 2,127 |  |      |   | 1,746 | 
|                              |  |      |       |  |      |  
|Total inventory               |  | $    | 3,671 |  |      | $ | 2,804 | 
|                              |  |      |       |  |      |  



|   |                       
|-- | ----------------------
|8. | Property and Equipment



|                                           |  |      |        |   |      |   |        |  
|------------------------------------------ |  | ---- | ------ | - | ---- | - | ------ | -
|                                           |  | 2004 |        |   | 2005 |  
|                                           |  |      |        |   |      |  
|Machinery and equipment                    |  | $    | 15,438 |   |      | $ | 8,770  |  
|Furniture, fixtures, and computer software |  |      | 1,366  |   |      |   | 1,433  |  
|Leasehold improvements                     |  |      | 679    |   |      |   | 670    |  
|Construction in progress                   |  |      |       |   |      |   | 3,259  |  
|                                           |  |      |        |   |      |  
|Total property and equipment, at cost      |  |      | 17,483 |   |      |   | 14,132 |  
|Less accumulated depreciation              |  |      | (9,624 | ) |      |   | (6,241 | )
|                                           |  |      |        |   |      |  
|Total property and equipment, net          |  | $    | 7,859  |   |      | $ | 7,891  |  
|                                           |  |      |        |   |      |  



F-20



---



##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|   |                               
|-- | ------------------------------
|9. | Goodwill and Intangible Assets







|                        |  |                   |        |             |              |   |        |     |  |   |       | 
|----------------------- |  | ----------------- | ------ | ----------- | ------------ | - | ------ | --- |  | - | ----- | 
|                        |  | December 31, 2004 |       
|                        |  |                   |       
|                        |  |                   |        | Accumulated |              |   |       
|                        |  | Gross             |        |             | Amortization |   |        | Net | 
|                        |  |                   |        |             |              |   |        |     | 
|Core technology         |  | $                 | 5,000  |             |              | $ | (926   | )   |  | $ | 4,074 | 
|Developed technology    |  |                   | 2,600  |             |              |   | (867   | )   |  |   | 1,733 | 
|Customer relationships  |  |                   | 2,500  |             |              |   | (595   | )   |  |   | 1,905 | 
|Backlog                 |  |                   | 100    |             |              |   | (100   | )   |  |   |      | 
|                        |  |                   |        |             |              |   |        |     | 
|Total intangible assets |  | $                 | 10,200 |             |              | $ | (2,488 | )   |  | $ | 7,712 | 
|                        |  |                   |        |             |              |   |        |     | 

|                          |  |                   |        |             |              |   |        |     |  |   |       | 
|------------------------- |  | ----------------- | ------ | ----------- | ------------ | - | ------ | --- |  | - | ----- | 
|                          |  | December 31, 2005 |       
|                          |  |                   |       
|                          |  |                   |        | Accumulated |              |   |       
|                          |  | Gross             |        |             | Amortization |   |        | Net | 
|                          |  |                   |        |             |              |   |        |     | 
|Core technology           |  | $                 | 5,000  |             |              | $ | (2,037 | )   |  | $ | 2,963 | 
|Developed technology      |  |                   | 2,600  |             |              |   | (1,907 | )   |  |   | 693   | 
|Customer relationships    |  |                   | 2,500  |             |              |   | (1,309 | )   |  |   | 1,191 | 
|Backlog                   |  |                   | 100    |             |              |   | (100   | )   |  |   |      | 
|Licensed Patent Portfolio |  |                   | 2,570  |             |              |   | (3     | )   |  |   | 2,567 | 
|                          |  |                   |        |             |              |   |        |     | 
|Total intangible assets   |  | $                 | 12,770 |             |              | $ | (5,356 | )   |  | $ | 7,414 | 
|                          |  |                   |        |             |              |   |        |     | 



F-21



---



##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|      |  |   |       | 
|----- |  | - | ----- | 
|2006  |  | $ | 3,033 | 
|2007  |  |   | 2,101 | 
|2008  |  |   | 1,255 | 
|2009  |  |   | 514   | 
|2010  |  |   | 511   | 
|      |  |   |      
|Total |  | $ | 7,414 | 
|      |  |   |      



|    |                  
|--- | -----------------
|10. | Credit Facilities



| |               
| | --------------
| | Line of Credit







| |             
| | ------------
| | Note Payable





| |                        
| | -----------------------
| | Japanese Yen Facilities



F-22



---



##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |             
|--- | ------------
|11. | Income Taxes



|                                     |  |      |    |  |      |   |     |      |  |   |         |  
|------------------------------------ |  | ---- | -- |  | ---- | - | --- | ---- |  | - | ------- | -
|                                     |  | 2003 |    |  | 2004 |   |     | 2005 | 
|                                     |  |      |    |  |      |   |     |      | 
|Current:                             |  |      |    |  |      |   |     |      |  |   |         |  
|Federal                              |  | $    | 60 |  |      | $ | 217 |      |  | $ | 624     |  
|State, local and foreign             |  |      | 28 |  |      |   | 55  |      |  |   | 41      |  
|                                     |  |      |    |  |      |   |     |      | 
|                                     |  |      | 88 |  |      |   | 272 |      |  |   | 665     |  
|                                     |  |      |    |  |      |   |     |      | 
|Deferred:                            |  |      |    |  |      |   |     |      |  |   |         |  
|Federal                              |  |      |   |  |      |   |    |      |  |   | (18,697 | )
|State, local and foreign             |  |      |   |  |      |   |    |      |  |   | (7,165  | )
|                                     |  |      |    |  |      |   |     |      | 
|                                     |  |      |   |  |      |   |    |      |  |   | (25,862 | )
|                                     |  |      |    |  |      |   |     |      | 
|Total income tax provision (benefit) |  | $    | 88 |  |      | $ | 272 |      |  | $ | (25,197 | )
|                                     |  |      |    |  |      |   |     |      | 



|                                                          |  |      |        |   |      |   |        |      |  |   |         |  
|--------------------------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------- | -
|                                                          |  | 2003 |        |   | 2004 |   |        | 2005 | 
|                                                          |  |      |        |   |      |   |        |      | 
|Federal statutory rate                                    |  | $    | 4,277  |   |      | $ | 4,154  |      |  | $ | 490     |  
|State and local income taxes, net of federal effect       |  |      | 713    |   |      |   | 930    |      |  |   | (4,569  | )
|Decrease in deferred income tax asset valuation allowance |  |      | (4,731 | ) |      |   | (6,626 | )    |  |   | (22,112 | )
|Foreign taxes                                             |  |      | (141   | ) |      |   | 306    |      |  |   | 1,418   |  
|In-process research and development                       |  |      |       |   |      |   | 1,645  |      |  |   |        |  
|Research and development credit                           |  |      |       |   |      |   |       |      |  |   | (393    | )
|Other                                                     |  |      | (30    | ) |      |   | (137   | )    |  |   | (31     | )
|                                                          |  |      |        |   |      |   |        |      | 
|Income tax provision (benefit)                            |  | $    | 88     |   |      | $ | 272    |      |  | $ | (25,197 | )
|                                                          |  |      |        |   |      |   |        |      | 

F-23



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                              |                                                  |      |         |        |      |  |        |        |  
|--------------------------------------------- | ------------------------------------------------ | ---- | ------- | ------ | ---- |  | ------ | ------ | -
|                                              |                                                  | 2004 |         |        | 2005 | 
|                                              |                                                  |      |         |        |      | 
|Deferred income tax assets:                   |                                                  |      |         |        |      |  |        |       
|                                              | Net operating loss and tax credit carry forwards |      | $       | 54,238 |      |  | $      | 51,911 |  
|                                              | Inventory reserve and uniform capitalization     |      |         | 587    |      |  |        | 454    |  
|                                              | Stock warrants                                   |      |         | 1,532  |      |  |        | 1,532  |  
|                                              | Restructuring accrual                            |      |         | 75     |      |  |        | 19     |  
|                                              | In-process research and development              |      |         | 418    |      |  |        | 445    |  
|                                              | Acquisition costs                                |      |         |       |      |  |        | 302    |  
|                                              | Allowance for bad debts                          |      |         | 174    |      |  |        | 51     |  
|                                              | Vacation accrual                                 |      |         | 371    |      |  |        | 425    |  
|                                              | Deferred rent                                    |      |         |       |      |  |        | 94     |  
|                                              | Warranty accrual                                 |      |         | 464    |      |  |        | 313    |  
|                                              | Deferred revenue                                 |      |         |       |      |  |        | 343    |  
|                                              | Other accruals and reserves                      |      |         | 625    |      |  |        | 101    |  
|                                              |                                                  |      |         |        |      | 
|                                              | Total deferred income tax assets                 |      |         | 58,484 |      |  |        | 55,990 |  
|                                              |                                                  |      |         |        |      | 
|Deferred income tax liabilities:              |                                                  |      |         |        |      |  |        |       
|                                              | State taxes                                      |      |         | (3,161 | )    |  |        | (2,469 | )
|                                              | Depreciation and amortization                    |      |         | (1,292 | )    |  |        | (930   | )
|                                              | Acquired intangibles                             |      |         | (3,095 | )    |  |        | (1,889 | )
|                                              |                                                  |      |         |        |      | 
|                                              | Total deferred income tax liabilities            |      |         | (7,548 | )    |  |        | (5,288 | )
|                                              |                                                  |      |         |        |      | 
|Deferred income tax asset valuation allowance |                                                  |      | (50,936 | )      |      |  | (3,561 | )     
|                                              |                                                  |      |         |        |      | 
|                                              | Net deferred income tax asset                    |      | $       |       |      |  | $      | 47,141 |  
|                                              |                                                  |      |         |        |      | 







F-24



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)












|    |                     
|--- | --------------------
|12. | Stockholders Equity



| |                                     
| | ------------------------------------
| | Increase in Authorized Common Shares







| |                       
| | ----------------------
| | Common Stock Issuances





F-25



---



##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                         
| | ------------------------
| | Stockholders Rights Plan





|    |                
|--- | ---------------
|13. | Preferred Stock









|    |                           
|--- | --------------------------
|14. | Stock Options and Warrants



| |                                                           
| | ----------------------------------------------------------
| | Equity Incentive Plan & Non-employee Stock Option
    Plan



F-26



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                           |  |           |            |   |                  |   |       | 
|-------------------------- |  | --------- | ---------- | - | ---------------- | - | ----- | 
|                           |  | Number of |            |   | Weighted Average |  
|                           |  | Shares    |            |   | Exercise Price   |  
|                           |  |           |            |   |                  |  
|BALANCE, January 1, 2003   |  |           | 3,670,843  |   |                  | $ | 3.86  | 
|Grants                     |  |           | 961,000    |   |                  |   | 7.81  | 
|Forfeitures                |  |           | (296,280   | ) |                  |   | 3.35  | 
|Exercises                  |  |           | (1,079,836 | ) |                  |   | 3.83  | 
|                           |  |           |            |   |                  |  
|BALANCE, December 31, 2003 |  |           | 3,255,727  |   |                  |   | 5.08  | 
|Grants                     |  |           | 1,626,750  |   |                  |   | 10.31 | 
|Forfeitures                |  |           | (386,588   | ) |                  |   | 10.62 | 
|Exercises                  |  |           | (281,794   | ) |                  |   | 3.75  | 
|                           |  |           |            |   |                  |  
|BALANCE, December 31, 2004 |  |           | 4,214,095  |   |                  |   | 6.68  | 
|Grants                     |  |           | 1,328,000  |   |                  |   | 5.78  | 
|Forfeitures                |  |           | (396,172   | ) |                  |   | 8.52  | 
|Exercises                  |  |           | (315,112   | ) |                  |   | 3.11  | 
|                           |  |           |            |   |                  |  
|BALANCE, December 31, 2005 |  |           | 4,830,811  |   |                  | $ | 6.52  | 
|                           |  |           |            |   |                  |  



|                        |  |                     |           |                  |                     |  |          |       |  |        |             |          |          |       |           |  |  |   |       | 
|----------------------- |  | ------------------- | --------- | ---------------- | ------------------- |  | -------- | ----- |  | ------ | ----------- | -------- | -------- | ----- | --------- |  |  | - | ----- | 
|                        |  | Options Outstanding |           |                  | Options Exercisable | 
|                        |  |                     |           |                  |                     | 
|                        |  |                     |           | Weighted         |                     |  |          |       | 
|                        |  |                     |           | Average          |                     |  | Weighted |       |  |        |             | Weighted |         
|                        |  |                     |           | Remaining        |                     |  | Average  |       |  |        |             | Average  |         
|                        |  |                     |           | Contractual Life |                     |  | Exercise |       |  | Number |             |          | Exercise |      
|Range of Exercise Price |  | Outstanding         |           |                  | in Years            |  |          | Price |  |        | Exercisable |          |          | Price |          
|                        |  |                     |           |                  |                     |  |          |       |  |        |             |          |          |       |          
|$ 1.34  $ 3.10         |  |                     | 1,088,214 |                  |                     |  | 6.24     |       |  | $      | 2.42        |          |          |       | 952,347   |  |  | $ | 2.34  | 
|$ 3.15  $ 5.38         |  |                     | 836,475   |                  |                     |  | 7.39     |       |  |        | 4.56        |          |          |       | 401,642   |  |  |   | 4.08  | 
|$ 5.40  $ 6.10         |  |                     | 941,018   |                  |                     |  | 7.83     |       |  |        | 5.97        |          |          |       | 295,018   |  |  |   | 5.72  | 
|$ 6.12  $ 8.51         |  |                     | 866,483   |                  |                     |  | 8.37     |       |  |        | 6.71        |          |          |       | 382,041   |  |  |   | 7.13  | 
|$ 8.73  $13.50         |  |                     | 806,846   |                  |                     |  | 7.33     |       |  |        | 11.36       |          |          |       | 806,846   |  |  |   | 11.36 | 
|$13.88  $17.14         |  |                     | 291,775   |                  |                     |  | 7.94     |       |  |        | 15.30       |          |          |       | 289,775   |  |  |   | 15.30 | 
|                        |  |                     |           |                  |                     |  |          |       |  |        |             |          |          |       |          
|                        |  |                     | 4,830,811 |                  |                     |  | 7.42     |       |  | $      | 6.52        |          |          |       | 3,127,669 |  |  | $ | 6.99  | 
|                        |  |                     |           |                  |                     |  |          |       |  |        |             |          |          |       |          

out-of


F-27



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






|                        |  |      |           |   |      |  |           |      |  |  |           |  
|----------------------- |  | ---- | --------- | - | ---- |  | --------- | ---- |  |  | --------- | -
|                        |  | 2003 |           |   | 2004 |  |           | 2005 | 
|                        |  |      |           |   |      |  |           |      | 
|Risk free interest      |  |      | 2.90      | % |      |  | 3.23      | %    |  |  | 3.86      | %
|Expected dividend yield |  |      |          |   |      |  |          |      |  |  |          |  
|Expected life           |  |      | 7.5 years |   |      |  | 4.0 years |      |  |  | 4.1 years |  
|Expected volatility     |  |      | 82        | % |      |  | 87        | %    |  |  | 78        | %



| |         
| | --------
| | Warrants









|    |                           
|--- | --------------------------
|15. | Related Party Transactions





|    |                       
|--- | ----------------------
|16. | Employee Benefit Plans



| |                                 
| | --------------------------------
| | Dot Hill Retirement Savings Plan



F-28



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




| |                             
| | ----------------------------
| | Employee Stock Purchase Plan





|    |                              
|--- | -----------------------------
|17. | Commitments and Contingencies



| |                 
| | ----------------
| | Operating Leases





|                             |  |   |       | 
|---------------------------- |  | - | ----- | 
|2006                         |  | $ | 1,477 | 
|2007                         |  |   | 1,352 | 
|2008                         |  |   | 1,110 | 
|2009                         |  |   | 1,075 | 
|2010                         |  |   | 1,025 | 
|Thereafter                   |  |   | 2,502 | 
|                             |  |   |      
|Total minimum lease payments |  | $ | 8,541 | 
|                             |  |   |      



five-year




| |                      
| | ---------------------
| | Employment Agreements



F-29



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)














| |                              
| | -----------------------------
| | Crossroads Systems Litigation



F-30



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)






| |                                  
| | ---------------------------------
| | Chaparral Securities Class Action







| |                                 
| | --------------------------------
| | Dot Hill Securities Class Action







| |                 
| | ----------------
| | Other Litigation



F-31



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                                   
|--- | ----------------------------------
|18. | Segment and Geographic Information







|                              |  |                 |         |            |       |   |        |          |  |   |       |  |  |   |         | 
|----------------------------- |  | --------------- | ------- | ---------- | ----- | - | ------ | -------- |  | - | ----- |  |  | - | ------- | 
|                              |  |                 |         | Legacy and |       |   |        |          | 
|                              |  | SANnet Families |         |            | Other |   |        | Services |  |   | Total | 
|                              |  |                 |         |            |       |   |        |          |  |   |       | 
|Year ended December 31, 2003: |  |                 |         |            |       |   |        |          |  |   |       |  |  |   |         | 
|Net revenue                   |  | $               | 179,061 |            |       | $ | 5,044  |          |  | $ | 3,343 |  |  | $ | 187,448 | 
|                              |  |                 |         |            |       |   |        |          |  |   |       | 
|Gross profit (loss)           |  | $               | 47,379  |            |       | $ | (3,467 | )        |  | $ | 986   |  |  | $ | 44,898  | 
|                              |  |                 |         |            |       |   |        |          |  |   |       | 
|Year ended December 31, 2004: |  |                 |         |            |       |   |        |          |  |   |       |  |  |   |         | 
|Net revenue                   |  | $               | 231,264 |            |       | $ | 5,172  |          |  | $ | 2,940 |  |  | $ | 239,376 | 
|                              |  |                 |         |            |       |   |        |          |  |   |       | 
|Gross profit                  |  | $               | 56,882  |            |       | $ | 2,244  |          |  | $ | 375   |  |  | $ | 59,501  | 
|                              |  |                 |         |            |       |   |        |          |  |   |       | 
|Year ended December 31, 2005: |  |                 |         |            |       |   |        |          |  |   |       |  |  |   |         | 
|Net revenue                   |  | $               | 225,705 |            |       | $ | 5,388  |          |  | $ | 2,706 |  |  | $ | 233,799 | 
|                              |  |                 |         |            |       |   |        |          |  |   |       | 
|Gross profit                  |  | $               | 51,856  |            |       | $ | 1,243  |          |  | $ | 504   |  |  | $ | 53,603  | 
|                              |  |                 |         |            |       |   |        |          |  |   |       | 



|       |                   |          |   |         |            |  |   |          |  |  |       |       |  |  |   |         | 
|------ | ----------------- | -------- | - | ------- | ---------- |  | - | -------- |  |  | ----- | ----- |  |  | - | ------- | 
|       |                   | SANnet   |   |         | Legacy and |  |   |          |  | 
|       |                   | Families |   |         | Other      |  |   | Services |  |  | Total |      
|       |                   |          |   |         |            |  |   |          |  |  |       |      
|As of: |                   |          |   |         |            |  |   |          |  |  |       |       |  |  |   |        
|       | December 31, 2004 |          | $ | 235,969 |            |  | $ | 7,285    |  |  | $     | 3,313 |  |  | $ | 246,567 | 
|       |                   |          |   |         |            |  |   |          |  |  |       |      
|       | December 31, 2005 |          | $ | 256,028 |            |  | $ | 8,240    |  |  | $     | 3,026 |  |  | $ | 267,294 | 
|       |                   |          |   |         |            |  |   |          |  |  |       |      

F-32



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|                                   |               |                              |         |         |      |   |         |         |   |   |         |         |  
|---------------------------------- | ------------- | ---------------------------- | ------- | ------- | ---- | - | ------- | ------- | - | - | ------- | ------- | -
|                                   |               | As of and for the Year Ended |        
|                                   |               | December 31,                 |        
|                                   |               |                              |        
|                                   |               | 2003                         |         |         | 2004 |   |         | 2005    |  
|                                   |               |                              |         |         |      |   |         |         |  
|Net revenue:                       |               |                              |         |         |      |   |         |         |   |   |         |        
|                                   | United States |                              | $       | 175,233 |      |   | $       | 223,133 |   |   | $       | 217,469 |  
|                                   | Europe        |                              |         | 9,120   |      |   |         | 9,546   |   |   |         | 10,730  |  
|                                   | Asia          |                              |         | 3,095   |      |   |         | 6,697   |   |   |         | 5,600   |  
|                                   |               |                              |         |         |      |   |         |         |  
|                                   |               | $                            | 187,448 |         |      | $ | 239,376 |         |   | $ | 233,799 |        
|                                   |               |                              |         |         |      |   |         |         |  
|Income (loss) before income taxes: |               |                              |         |         |      |   |         |         |   |   |         |        
|                                   | United States |                              | $       | 11,022  |      |   | $       | 11,786  |   |   | $       | 4,571   |  
|                                   | Europe        |                              |         | 943     |      |   |         | (812    | ) |   |         | (2,636  | )
|                                   | Asia          |                              |         | 254     |      |   |         | 895     |   |   |         | (535    | )
|                                   |               |                              |         |         |      |   |         |         |  
|                                   |               | $                            | 12,219  |         |      | $ | 11,869  |         |   | $ | 1,400   |        
|                                   |               |                              |         |         |      |   |         |         |  
|Assets:                            |               |                              |         |         |      |   |         |         |   |   |         |        
|                                   | United States |                              | $       | 213,027 |      |   | $       | 237,376 |   |   | $       | 260,826 |  
|                                   | Europe        |                              |         | 4,196   |      |   |         | 6,444   |   |   |         | 3,997   |  
|                                   | Asia          |                              |         | 1,220   |      |   |         | 2,747   |   |   |         | 2,471   |  
|                                   |               |                              |         |         |      |   |         |         |  
|                                   |               | $                            | 218,443 |         |      | $ | 246,567 |         |   | $ | 267,294 |        
|                                   |               |                              |         |         |      |   |         |         |  





|    |                                            
|--- | -------------------------------------------
|19. | Quarterly Financial Information (Unaudited)



|                                    |  |         |        |   |         |   |        |         |  |   |         |   |  |   |        |  
|----------------------------------- |  | ------- | ------ | - | ------- | - | ------ | ------- |  | - | ------- | - |  | - | ------ | -
|                                    |  | First   |        |   | Second  |   |        | Third   |  |   | Fourth  |  
|                                    |  | Quarter |        |   | Quarter |   |        | Quarter |  |   | Quarter |  
|                                    |  |         |        |   |         |   |        |         |  |   |         |  
|Year Ended December 31, 2004:       |  |         |        |   |         |   |        |         |  |   |         |   |  |   |        |  
|Net revenue                         |  | $       | 47,865 |   |         | $ | 69,038 |         |  | $ | 56,956  |   |  | $ | 65,517 |  
|Gross profit                        |  |         | 12,078 |   |         |   | 17,041 |         |  |   | 14,668  |   |  |   | 15,714 |  
|Income (loss) before income taxes   |  |         | (2,620 | ) |         |   | 6,823  |         |  |   | 3,602   |   |  |   | 4,064  |  
|Net income (loss)                   |  |         | (2,585 | ) |         |   | 6,697  |         |  |   | 3,451   |   |  |   | 4,034  |  
|Basic net income (loss) per share   |  |         | (0.06  | ) |         |   | 0.15   |         |  |   | 0.08    |   |  |   | 0.09   |  
|Diluted net income (loss) per share |  |         | (0.06  | ) |         |   | 0.14   |         |  |   | 0.07    |   |  |   | 0.09   |  
|Year Ended December 31, 2005:       |  |         |        |   |         |   |        |         |  |   |         |   |  |   |        |  
|Net revenue                         |  | $       | 58,011 |   |         | $ | 65,897 |         |  | $ | 53,616  |   |  | $ | 56,275 |  
|Gross profit                        |  |         | 13,277 |   |         |   | 16,145 |         |  |   | 12,353  |   |  |   | 11,828 |  
|Income (loss) before income taxes   |  |         | 1,991  |   |         |   | 3,723  |         |  |   | (1,467  | ) |  |   | (2,847 | )
|Net income (loss)                   |  |         | 2,102  |   |         |   | 3,297  |         |  |   | (1,275  | ) |  |   | 22,473 |  
|Basic net income (loss) per share   |  |         | 0.05   |   |         |   | 0.08   |         |  |   | (0.03   | ) |  |   | 0.51   |  
|Diluted net income (loss) per share |  |         | 0.05   |   |         |   | 0.07   |         |  |   | (0.03   | ) |  |   | 0.49   |  

F-33



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##### Table of Contents



DOT HILL SYSTEMS CORP.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)




|    |                  
|--- | -----------------
|20. | Subsequent Events

®










F-34



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##### Table of Contents



DOT HILL SYSTEMS CORP. AND SUBSIDIARIES





SCHEDULE II  VALUATION AND QUALIFYING
ACCOUNTS


FOR THE YEARS ENDED DECEMBER 31, 2003, 2004 AND 2005


|                                                   |  |                |        |  |            |   |       |            |  |           |       |     |  |   |       | 
|-------------------------------------------------- |  | -------------- | ------ |  | ---------- | - | ----- | ---------- |  | --------- | ----- | --- |  | - | ----- | 
|                                                   |  | Balance at     |        |  | Charged to |   |       |            |  | Balance   |      
|                                                   |  | Beginning of   |        |  | Costs and  |   |       |            |  | at End of |      
|                                                   |  | Year           |        |  | Expenses   |   |       | Deductions |  |           | Year  |    
|                                                   |  |                |        |  |            |   |       |            |  |           |       |    
|                                                   |  | (In thousands) |       
|Allowance for doubtful accounts and sales returns: |  |                |        |  |            |   |       |            |  |           |       |     |  |   |       | 
|Year ended December 31, 2003                       |  | $              | 1,848  |  |            | $ | (284  | )          |  | $         | 1,097 | (1) |  | $ | 467   | 
|Year ended December 31, 2004                       |  |                | 467    |  |            |   | 176   |            |  |           | 152   | (1) |  |   | 491   | 
|Year ended December 31, 2005                       |  |                | 491    |  |            |   | 560   |            |  |           | 757   | (1) |  |   | 294   | 
|Reserve for excess and obsolete inventories:       |  |                |        |  |            |   |       |            |  |           |       |     |  |   |       | 
|Year ended December 31, 2003                       |  | $              | 13,144 |  |            | $ | 1,705 |            |  | $         | 8,255 | (3) |  | $ | 6,594 | 
|Year ended December 31, 2004                       |  |                | 6,594  |  |            |   | 785   |            |  |           | 5,694 | (2) |  |   | 1,685 | 
|Year ended December 31, 2005                       |  |                | 1,685  |  |            |   | 1,856 |            |  |           | 2,548 | (2) |  |   | 993   | 






|    |                                                                                                                                        
|--- | ---------------------------------------------------------------------------------------------------------------------------------------
|(1) | Uncollectible receivables charged off and credit issued for
    product returns.                                                       
|   
|(2) | Consists primarily of the write-off of excess/obsolete
    inventories.                                                                
|   
|(3) | Consists primarily of the sale of inventory to a third party
    service provider and the write-off of excess/obsolete
    inventories.

F-35