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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 1934For the Fiscal Year Ended
    December 31, 2006oro

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934For 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.)2200 Faraday Ave,
    Suite 100
    Carlsbad, CA(Address of principal
    executive offices)

92008(Zip Code)   Registrants telephone number, including area code:
 (760) 931-5500
      Securities registered pursuant to Section 12(b) of the
    Act:
   Title of Each Class

Name of Each Exchange on Which RegisteredCommon stock, $0.001 par
    value

The Nasdaq Stock
    Market   Securities registered pursuant to Section 12(g) of the
    Act:
  None
  o þ
  o þ
  þ
  Regulation S-K Form 10-K Form 10-K. þ
  Rule 12b-2
 o þ o
  Rule 12b-2 o þ
       Form 10-K.




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##### 



DOT HILL
    SYSTEMS CORP.
  INDEX TO
    ANNUAL REPORT ON
    FORM 10-K
    FOR THE YEAR ENDED DECEMBER 31, 2006
  PagePART IItem 1.


Business


2Item 1A.


Risk
    Factors


15Item 1B.


Unresolved Staff
    Comments


25Item 2.


Properties


25Item 3.


Legal
    Proceedings


25Item 4.


Submission of
    Matters to a Vote of Security Holders


27PART IIItem 5.


Market for
    Registrants Common Equity, Related Stockholder Matters and
    Issuer Purchases of Equity Securities


28Item 6.


Selected Financial
    Data


29Item 7.


Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations


30Item 7A.


Quantitative and
    Qualitative Disclosures About Market Risk


44Item 8.


Financial
    Statements and Supplementary Data


44Item 9.


Changes in and
    Disagreements With Accountants on Accounting and Financial
    Disclosure


44Item 9A.


Controls and
    Procedures


45Item 9B.


Other
    Information


48PART IIIItem 10.


Directors,
    Executive Officers and Corporate Governance


48Item 11.


Executive
    Compensation


48Item 12.


Security Ownership
    of Certain Beneficial Owners and Management and Related
    Stockholder Matters


48Item 13.


Certain
    Relationships and Related Transactions, and Director
    Independence


49Item 14.


Principal
    Accounting Fees and Services


49PART IVItem 15.


Exhibits and
    Financial Statement Schedules


49EXHIBIT 10.14EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1




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Forward-Looking
    Statements
  Form 10-K.
   PART I  Item 1.
    Business  ®
       2




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configure-to-order
  Form 10-K. Form 10-K, Form 10-Q, Form 8-K 1-800-SEC-0330.
  Industry
    Background
  Growth
    of Data Storage
    
    the proliferation of different types of data and data forms such
    as digital 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 growing use of RAID systems in the
    back-up
    market in place of, or in addition to, automated tape libraries,
    due to new applications of technologies that offer improved
    alternatives in the trade-off between performance and cost of
    ownership.   3




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Entry-level.
  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. plug-and-play
 5




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Modular Scalability.
  Reliability.
  Open Systems, Multi-Platform
    Support.
  Manageability. tm ®
  Data Management Software. tm
  Our
    Strategy
    Focus on Profitable Growth.
  Utilize indirect sales
    channels.
  Outsource manufacturing and service
    operations.
  Focus on existing customers and develop new
    customer relationships.
 6




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Grow and extend technology
    leadership.
  Leverage our R/Evolution
    architecture.
  Pursue strategic alliances, partnerships and
    acquisitions.
  Our
    Products
     7




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GeneralProduct Line

Description

Availability

Capacity

Target Market

FeaturesHardwareSANnet 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 capacitySANnet 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
    interruptionsSANnet II Blade

1 unit high, 4 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 portsSANnet II SATA

2 unit high, 12 to 72 drives,
    2 Gigabit Fibre Channel DAS and SAN storage

2Q04

800GB to 81 TB using 750 GB SATA
    drives

Entry-level and Midrange

Complete SAN solution in a single
    enclosure, scalable performance and capacity without
    interruptions2730

2 unit high, 12-56 SAS or SATA
    drives, 4Gb FC DAS and SAN storage

3Q06

876 GB-42TB using 750 GB SATA drives

Entry-level

Complete SAN solution in a single
    enclosure, scalable performance and capacity with interruptions
    for general purpose applications. AssuredSnap DMS includedSoftwareAssuredSnap

Data Management Services (DMS)

3Q06

N/A

Entry-level and Midrange

Snapshot technology for Backup,
    Data Mining and Disaster RecoverySANpath

Storage area networking software

1Q00

N/A

Entry-level and Midrange

Load balancing, multipathing, path
    fail over, path fail back and LUN maskingRAIDar & 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.
  R/Evolution Modular Storage
    Architecture. SAS/SATA
  2730.
  Software.
  SANpath.
  SANscape.
  AssuredSnap.
  RAIDar
 9




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Sales and
    Marketing
    OEMs
    Indirect
    Channels
    Marketing
    Our
    Relationship with Key OEMs
   10




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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 and we provide that final level of
    support and service.
    Focused on providing the higher levels of support for a fee.
    Established authorized service providers.
    Entered into an agreement with GAVS Information Services LLC, or
    GAVS, to provide warranty and non-warranty services for
    customers who purchase new maintenance agreements for our prior
    generation SANnet product family as well as our new R/Evolution
    platform. Anacomp, Inc., or Anacomp, our current service
    provider will manage our SANnet I support for our non-warranty
    customers.   11




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Research
    and Development
        Manufacturing
    and Suppliers
    configure-to-order
  Intellectual
    Property
  ® ® ® ® ® ®
 12




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Competition
        
    product performance, features, scalability and reliability;
    price;
    product breadth;
    timeliness of new product introductions; and
    interoperability and ease of management.    Employees
   13




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Executive
    Officers and Key Employees of the Registrant
  Officer orName

Age

Position

Key Employee SinceDana W. Kammersgard


52


Chief Executive Officer  and
    President

August 1984(1)Hanif I. Jamal


46


Senior Vice President, Chief
    Financial Officer and Corporate Secretary

July 2006Philip A. Davis


39


Executive Vice President of
    Worldwide Field Operations

March 2006James Kuenzel(2)


53


Senior Vice President of
    Engineering

February 2006Robert Finley(2)


57


Vice President of Manufacturing
    Operations

March 2006     (1)
    
    In 1999, Artecon and Box Hill merged to form Dot Hill.
    Artecon was founded in 1984 and Mr. Kammersgard was an
    officer of Artecon from its inception until the merger, and has
    been an officer of Dot Hill since that date.(2)
    
    Key employees    Dana W. Kammersgard
  Hanif I. Jamal
  Philip A. Davis
 14




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James Kuenzel
  Robert Finley
  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.
  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 levels for our products
    sufficient to meet the expectations of our OEM customers;
    our ability to produce, ship and deliver a sufficient quantity
    of our products in a timely manner to meet the needs of our OEM
    customers;
    our ability to continue to develop and launch new products that
    our OEM customers feel meet their needs and requirements, with
    respect to cost, timeliness, features, performance and other
    factors; and
    the ability of Sun, NetApp, Fujitsu or our other OEM customers
    to effectively launch, ramp, ship, sell and market their own
    products based on our products.  Our
    contracts with our OEM customers do not include minimum purchase
    requirements and are not exclusive, and we cannot assure you
    that our relationship with these major customers will not be
    terminated or will generate significant sales.
   15




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We may
    continue to experience losses in the future, and may require
    additional capital.
      
    our plans to maintain and enhance our engineering, research,
    development and product testing programs;
    our ability to achieve acceptable gross profit margins;
    the success of our manufacturing strategy;
    the success of our sales and marketing efforts;
    field failures resulting in product replacements or recalls;
    the extent and terms of any development, marketing or other
    arrangements;
    changes in economic, regulatory or competitive conditions;
    costs of filing, prosecuting, defending and enforcing
    intellectual property rights; and
    costs of litigating and defending law suits.    Our
    inability to successfully transition manufacturing of our 2730
    and successor products from Solectron to MiTAC and SYNNEX could
    significantly impact our operating results.
   16




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Our
    inability to lower product costs or changes in the mix of
    products we sell may significantly impact our gross margins and
    operating results.
    The
    market for our products is subject to substantial pricing
    pressure that may harm our net revenues, gross margins and
    operating results.
    Our
    operating results are subject to substantial quarterly and
    annual fluctuations, our period to period comparisons are not
    necessarily meaningful and we may not meet the expectations of
    public market analysts and investors.
   17




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Quarter

Net Revenue


Net Income (Loss)First Quarter 2003

$
30.5


$
(1.5
)Second Quarter 2003


48.4



2.6Third Quarter 2003


51.0



4.3Fourth Quarter 2003


57.5



6.6First Quarter 2004


47.9



(2.6
)Second Quarter 2004


69.0



6.7Third Quarter 2004


57.0



3.5Fourth Quarter 2004


65.5



4.0First Quarter 2005


58.0



2.1Second Quarter 2005


65.9



3.3Third Quarter 2005


53.6



(1.3
)Fourth Quarter 2005*


56.3



22.5First Quarter 2006


58.7



(5.0
)Second Quarter 2006


66.3



(6.6
)Third Quarter 2006**


54.8



(60.1
)Fourth Quarter 2006


59.4



(9.1
)     *
    
    Includes deferred tax benefit from reversal of valuation
    allowance of $25.3 million.**
    
    Includes income tax expense related to establishing valuation
    allowance of $47.1 million.    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
    customer orders;
    our ability to reduce product costs and improve operating
    margins;
    market acceptance of our new products and product enhancements
    and new product announcements or introductions by our
    competitors;
    product configuration, mix and quality issues;
    changes in pricing by us or our competitors;
    the cost of litigation and settlements involving intellectual
    property and other issues;
    deferrals of customer orders in anticipation of new products or
    product enhancements;
    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 sole-source
    providers and major component suppliers such as disk drives,
    memory and legacy RAID controllers; 18




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
    our success in creating brand awareness and in expanding our
    sales and marketing programs;
    the level of competition;
    our ability to win business with new customers;
    potential reductions in inventories held by OEM customers;
    slowing sales of the products of our OEM customers;
    technological changes in the open systems storage market;
    levels of expenditures on research, engineering and product
    development;
    levels of expenditures in our manufacturing and support
    organization and our ability to manage variances in component
    costs and inventory levels of components held by our
    manufacturing partners;
    the quality of products being manufactured by Solectron, MiTAC,
    and SYNNEX;
    changes in our business strategies;
    personnel changes; and
    general economic trends and other factors.  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;
    our engineering work necessary to integrate a storage solution
    with a customers system;
    the complexity of technical challenges that need to be overcome
    during the development process;
    meeting unique customer specifications and requirements; and
    difficulties by our customers in integrating our products and
    technologies into their own products.    Our
    business and operating results may suffer if we encounter
    significant product defects due to the introduction of our new
    storage systems.
   19




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The
    loss of one or more suppliers could slow or interrupt the
    production and sales of our products.
    Manufacturing
    and supplier disruptions could harm our business.
       20




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Any
    shortage of disk drives, memory 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.
    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.
            
    performance, features, scalability and reliability;
    price;
    product breadth;
    product availability and quality;
    timeliness of new product introductions; and
    interoperability and ease of management.   21




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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.
    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.
        A
    significant percentage of our expenses are fixed, and if we fail
    to generate revenues in associated periods, our operating
    results will be harmed.
   22




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
    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 our
    competitors, which, in turn, may harm our ability to meet our
    sales obligations;
    the reduction, rescheduling or cancellation of customer
    orders; and
    our inability to market products with competitive features, or
    the inability to market certain products in any form, due to the
    patents or other intellectual property rights of third parties.    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.
   23




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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, which has resulted in
    litigation.
     24




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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    Item 3.
    Legal
    Proceedings  Crossroads
    Systems Litigation
   25




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##### Table of Contents



end-to-end,
      Chaparral
    Securities Class Action
   26




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Dot
    Hill Securities Class Actions and Derivative
    Suits
      Other
    Litigation
    Other
    Item 4.
    Submission
    of Matters to a Vote of Security Holders   27




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PART II  Item 5.
    Market
    for Registrants Common Equity, Related Stockholder Matters
    and Issuer Purchases of Equity Securities      Low


HighYear Ended December 31,
    2005First Quarter

$
5.57


$
7.62Second Quarter


4.64



5.90Third Quarter


5.25



6.73Fourth Quarter


6.46



7.40Year Ended December 31,
    2006First Quarter


6.11



7.91Second Quarter


3.00



7.06Third Quarter


3.03



3.96Fourth Quarter


3.18



4.40     Regulation S-K, Securities Authorized for Issuance Under Equity
    Compensation Plans, Form 10-K.
 28




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Item 6.
    Selected
    Financial Data  Form 10-K.
  Form 10-K.
  2002


2003


2004(2)


2005


2006Statement of Operations
    Data:Net revenue

$
46,936


$
187,448


$
239,376


$
233,799


$
239,217Cost of goods sold


45,444



142,550



179,875



180,196



202,561Gross profit


1,492



44,898



59,501



53,603



36,656Operating expenses:Sales and marketing


22,513



14,086



16,839



19,120



15,996Research and development


10,043



11,950



17,993



23,628



36,529General and administrative


5,150



7,418



9,992



12,933



18,119Legal settlement(1)


















3,395In-process research and
    development(2)










4,700







Merger and restructuring
    expenses(3)


1,550







(434
)






Operating income (loss)


(37,764
)


11,444



10,411



(2,078
)


(37,383
)Other income, net


344



775



1,458



3,478



5,496Income tax (expense)/benefit(4)


3,117



(88
)


(272
)


25,197



(48,885
)Net income (loss)

$
(34,303
)

$
12,131


$
11,597


$
26,597


$
(80,772
)Net income (loss) attributable to
    common stockholders

$
(34,759
)

$
11,990


$
11,597


$
26,597


$
(80,772
)Net income (loss) per share:Basic

$
(1.39
)

$
0.35


$
0.27


$
0.61


$
(1.80
)Diluted

$
(1.39
)

$
0.31


$
0.25


$
0.58


$
(1.80
)Weighted average shares
    outstanding:Basic


24,953



33,856



43,460



43,903



44,757Diluted


24,953



38,164



46,395



45,639



44,757   2002


2003


2004


2005


2006Balance Sheet Data:Cash, cash equivalents, and
    short-term investments

$
10,082


$
191,545


$
126,186


$
122,234


$
99,663Working capital


2,224



177,650



123,384



135,293



102,941Total assets


32,228



218,443



246,567



267,294



201,651Total long-term debt


275



247











Total stockholders equity


5,785



184,133



196,827



232,051



155,912     (1)
    
    See discussion of our legal settlement Note 18 to our 2006
    consolidated financial statements.(2)
    
    The results of operations of Chaparral have been included in our
    results prospectively from February 23, 2004.(3)
    
    See discussion of our restructuring activities in Note 5 to
    our 2006 consolidated financial statements.(4)
    
    See discussion of income taxes in Note 11 to our 2006
    consolidated financial statements. 29




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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



We are a provider of storage systems for organizations requiring
    high reliability, high performance networked storage and data
    management solutions in an open systems architecture. Our
    storage solutions consist of integrated hardware and software
    products employing a modular system that allows end-users to add
    capacity as needed. Our broad range of products, from medium
    capacity stand-alone storage units to complete turn-key,
    multi-terabyte storage area networks, provides end-users with a
    cost-effective means of addressing increasing storage demands
    without sacrificing performance.



Our products and services are sold worldwide to end-users
    primarily through our channel partners, including OEMs, SIs and
    VARs. In May 2002, we entered into a three-year OEM agreement
    with Sun to provide our storage hardware and software products
    for private label sales by Sun. We have been shipping our
    products to Sun for resale to Suns customers since October
    2002. We continued to develop new products primarily for resale
    by Sun, such as our SANnet II FC, which began shipping to
    Sun in March 2003 and our SANnet II SATA product which
    began shipping in June 2004. In September 2005, our existing OEM
    partner agreement with Sun, first announced in May 2002, was
    extended until January 2011 and now provides for automatic
    renewal for additional one-year periods unless either party
    notifies the other of its intent not to renew within a specified
    period of time. The agreement does not contain any minimum
    purchase requirements.



In February 2004, we acquired all the outstanding shares of
    Chaparral, a privately held storage system provider. This
    acquisition provided us with a core of RAID hardware and
    software technology and a team of hardware and software
    professionals located in Longmont, Colorado.



In July 2005, we entered into a Development and OEM Supply
    Agreement with NetApp. Under the agreement, we are designing and
    developing general purpose disk arrays for a variety of products
    to be developed for sale to NetApp. We expect to start shipping
    products under this agreement over the next several quarters.
    The agreement does not contain any minimum purchase requirements
    and expires three years after shipping the first product, but
    renews annually unless it is terminated by either party.



In January 2006, we entered into a Master Purchase Agreement
    with Fujitsu. Under the agreement, Dot Hill and Fujitsu will
    jointly develop storage solutions utilizing key components and
    patented technologies from Dot Hill. We began shipping products
    under this agreement in July 2006. The agreement does not
    contain any minimum purchase commitments by Fujitsu. The initial
    agreement term is five years.



As part of our focus on indirect sales channels, we have
    historically outsourced substantially all of our manufacturing
    operations to Solectron, a leading electronics manufacturing
    services company. Our agreement with

30




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configure-to-order
               31




---



##### Table of Contents



Critical
    Accounting Policies and Estimates
      Revenue
    Recognition
  Revenue Recognition.
    Valuation
    of Inventories
  first-in,
  Valuation
    of Goodwill
  Goodwill and Other Intangible Assets.
 32




---



##### Table of Contents



Deferred
    Income Taxes
           33




---



##### Table of Contents



Stock-Based
    Compensation
  Accounting for Stock Issued to
    Employees.
  out-of-the-money
  Share-Based Payment Accounting for
    Stock Issued to Employees. Share-Based Payment
    Accounting for Stock-Based
    Compensation.
  Contingencies
  Accounting for
    Contingencies
 34




---



##### Table of Contents



Results
    of Operations
    Year Ended December 312004


2005


2006Net revenue


100.0
%


100.0
%


100.0
%Cost of goods sold


75.1



77.1



84.7Gross profit


24.9



22.9



15.3Operating expenses:Sales and marketing


7.0



8.2



6.7Research and development


7.5



10.1



15.3General and administrative


4.2



5.5



7.6Legal settlement










1.4In process research and development


2.0







Restructuring expenses


(0.2
)






Operating income (loss)


4.4



(0.9
)


(15.6
)Other income, net


0.6



1.5



2.3Income (loss) before income taxes


5.0



0.6



(13.3
)Income tax expense (benefit)


0.1



(10.8
)


20.4Net income (loss)


4.8
%


11.4
%


(33.8
)%       Year
    Ended December 31, 2006 Compared to Year Ended
    December 31, 2005
  Net
    Revenue
    Cost of
    Goods Sold
   35




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##### Table of Contents



Gross
    Profit
      Sales and
    Marketing Expenses
    Research
    and Development Expenses
    General
    and Administrative Expenses
   36




---



##### Table of Contents



Legal
    Settlement Expense
    Other
    Income
    Income
    Taxes
           37




---



##### Table of Contents



Year
    Ended December 31, 2005 Compared to Year Ended
    December 31, 2004
  Net
    Revenue
    Cost of
    Goods Sold
     38




---



##### Table of Contents



Gross
    Profit
      Sales and
    Marketing Expenses
    Research
    and Development Expenses
    General
    and Administrative Expenses
   39




---



##### Table of Contents



Restructuring
    expenses
    In-Process
    Research and Development Charges
    Other
    Income
    Income
    Taxes
       40




---



##### Table of Contents



Liquidity
    and Capital Resources
         41




---



##### Table of Contents



Payments Due by PeriodLess Than








More ThanContractual Obligations

Total


1 Year


1-3 Years


3-5 Years


5 YearsOperating Lease Obligations

$
7,088


$
1,245


$
2,317


$
2,077


$
1,449     Recent
    Accounting Pronouncements
  Accounting Changes and Error
    Corrections
  No. 143-1, Accounting for Electronic Equipment Waste Obligations No. 143-1 No. 143-1 Accounting for Asset Retirement
    Obligations. FSP No. 143-1
 42




---



##### Table of Contents



No. 143-1 No. 143-1 No. 143-1
  No. 115-1, The Meaning of
    Other-Than-Temporary
    Impairment and Its Application to Certain Investments. No. 115-1 other-than-temporary No. 115-1 No. 115-1
  Share-Based Payment Accounting for Stock-Based Compensation, Accounting for Stock Issued to
    Employees.
  Accounting for Uncertainty in Income
    Taxes  an interpretation of FASB Statement
    No. 109.
  Financial Statements  Considering the Effects of
    Prior Year Misstatements When Quantifying Misstatements in
    Current Year Financial Statements.
  Fair Value Measurements
  The Fair
    Value Option for Financial Assets and Financial
    Liabilities  including an amendment of SFAS
    No. 115,
 43




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##### Table of Contents



Item 7A.
    Quantitative
    and Qualitative Disclosures About Market Risk  Interest
    Rate and Credit Risk
      2005


2006Cash equivalents

$
99,899


$
95,845Average interest rate


4.3
%


5.3
%Short-term investments

$
13,431


$
Average interest rate


3.2
%


Total portfolio

$
113,330


$
95,845Average interest rate


4.2
%


5.3
%     Foreign
    Currency Exchange Rate Risk
    Item 8.
    Financial
    Statements and Supplementary Data  page F-1 Form 10-K.
  Item 9.
    Changes
    In and Disagreements With Accountants On Accounting and
    Financial Disclosure   44




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##### Table of Contents



Item 9A.
    Controls
    and Procedures  Evaluation
    of Disclosure Controls and Procedures
  Rule 13a-15(e)) Form 10-K,
  Changes
    in Internal Control over Financial Reporting
    Dot Hill
    Systems Corp.s Report on Internal Control Over Financial
    Reporting
  Rules 13a-15(f) 15d-15(f).
  Internal Control  Integrated
    Framework.
   45




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##### 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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##### Table of Contents



DELOITTE &
    TOUCHE LLP
    47




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##### Table of Contents



Item 9B.
    Other
    Information    PART III  Item 10.
    Directors,
    Executive Officers and Corporate Governance  Form 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 Averagebe Issued Upon


Exercise Price of


Number of SecuritiesExercise of Outstanding


Outstanding Options


Remaining AvailableStock Plan

Options and Rights


and Rights


for Future Issuance2000 EIP(1)


4,995,930


$
6.08



1,225,6642000 ESPP(2)


Not Applicable



Not Applicable



1,711,5352000 NEDSOP


440,000


$
6.49



473,124Total


5,435,930


$
6.12



3,410,323     (1)
    
    The 2000 EIP 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 2000 ESPP 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.   48




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##### Table of Contents



Item 13.
    Certain
    Relationships and Related Transactions, and Director
    Independence    Item 14.
    Principal
    Accounting Fees and Services   PART IV  Item 15.
    Exhibits
    and Financial Statement Schedules                ExhibitNumber

Description2
.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 June 22, 2006.(27)4
.7

Common Stock Warrant dated
    December 19, 2002.(5)4
.8

Warrant to Purchase Shares of
    Common Stock dated June 26, 2006.(27)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)* 49




---



##### Table of Contents



ExhibitNumber

Description10
.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.(14)*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.(14)*10
.7

Product Supplement/Award Letter
    (SATA) by and between Sun Microsystems, Inc. and Dot Hill
    Systems Corp. dated as of March 22, 2004.(14)*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 Dana W
    Kammersgard.(7)10
.10

2000 Amended and Restated Equity
    Incentive Plan.(8)10
.11

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
.12

Form of Stock Option Grant Notice
    used in connection with the 2000 Amended and Restated Equity
    Incentive Plan.(8)10
.13

2000 Amended and Restated Employee
    Stock Purchase Plan.(9)10
.14

2000 Non-Employee Directors Stock
    Option Plan.10
.15

Form of Stock Option Agreement
    used in connection with the 2000 Non-Employee Directors
    Stock Option Plan.(10)10
.16

Credit Agreement dated
    July 1, 2004 by and between Dot Hill Systems Corp. and
    Wells Fargo Bank, National Association.(11)10
.17

Revolving Line of Credit Note
    dated July 1, 2004 issued by Dot Hill Systems Corp. to
    Wells Fargo Bank, National Association.(11)10
.18

Security Agreement and Addendum
    dated July 1, 2004 by and between Dot Hill Systems Corp.
    and Wells Fargo Bank, National Association.(11)10
.19

Manufacturing Agreement between
    Dot Hill Systems Corp. and Solectron Corporation dated
    May 20, 2002.(12)*10
.20

OEM Agreement between Dot Hill
    Systems Corp. and Infortrend Technology, Inc. dated May 20,
    2002.(12)*10
.21

2005 Executive Compensation Plan
    for Dana Kammersgard effective January 1, 2005.(13)10
.22

Amended and Restated Change of
    Control Agreement dated April 6, 2006 between Dot Hill
    Systems Corp. and Dana Kammersgard.(25)10
.23

Change of Control Agreement dated
    April 6, 2006 between Dot Hill Systems Corp. and Philip A.
    Davis.(25)10
.24

Offer letter agreement dated
    July 5, 2006 between Dot Hill Systems Corp. and Hanif I.
    Jamal.(26)10
.25

Change of Control Agreement dated
    July 14, 2006 between Dot Hill Systems Corp. and Hanif I.
    Jamal.(26)10
.26

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
.27

Registration Rights Agreement
    dated March 11, 2003 between Dot Hill Systems Corp. and
    each of the purchasers listed on the signature pages thereto.(5) 50




---



##### Table of Contents



ExhibitNumber

Description10
.28

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
.29

Amendment to Manufacturing
    Agreement between Dot Hill Systems Corp. and Solectron
    Corporation dated April 5, 2005.(15)*10
.30

Description of Amended and
    Restated Policy for Director Compensation.(16)10
.31

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.(17)10
.32

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.(18)*10
.33

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.(18)*10
.34

Second Amendment to Manufacturing
    Agreement dated September 16, 2005 between Dot Hill Systems
    Corp. and Solectron Corporation.(18)*10
.35

Second Award Letter dated
    September 16, 2005 between Dot Hill Systems Corp. and
    Solectron Corporation.(18)*10
.36

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.(18)*10
.37

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.(19)*10
.38

Description of Accelerated Vesting
    of Options.(20)10
.39

Form of Indemnity Agreement.(21)10
.40

Patent Cross License dated
    December 29, 2005 between Dot Hill Systems Corp. and
    International Business Machines Corporation.(19)*10
.41

Consulting letter agreement
    effective March 1, 2006 and dated March 2, 2006
    between Dot Hill Systems Corp. and James L. Lambert.(23)10
.42

Description of 2006 Executive
    Compensation Plan.(23)10
.43

Master Purchase Agreement
    effective January 13, 2006 by and among Dot Hill Systems
    Corp., Dot Hill Systems B.V., Fujitsu Siemens Computers GmbH and
    Fujitsu Siemens Computers (Holding) B.V.(24)*10
.44

Amended Settlement and License
    Agreement dated October 5, 2006 by and between Dot Hill
    Systems Corp. and Crossroads, Inc.(25)*10
.45

Agreement between Dot Hill Systems
    and Infortrend Re Settlement of Crossroads Lawsuit dated
    June 28, 2006 by and between Dot Hill Systems Corp. and
    Infortrend Technology Inc.(25)*10
.46

First Amendment to Credit
    Agreement dated July 1, 2006 by and between Dot Hill
    Systems Corp. and Wells Fargo Bank, National Association.(27)*10
.47

Second Amendment to Credit
    Agreement dated September 14, 2006 by and between Dot Hill
    Systems Corp. and Wells Fargo Bank, National Association.(27)*10
.48

Revolving Line of Credit Note
    dated July 1, 2006 issued by Dot Hill Systems Corp. to
    Wells Fargo Bank, National Association.(27)*10
.49

Security Agreement and Addendum
    dated July 1, 2006 by and between Dot Hill Systems Corp.
    and Wells Fargo Bank, National Association.(27)*10
.50

First Amendment dated
    August 3, 2006 to Development and OEM Supply Agreement
    dated July 26, 2005 by and among Dot Hill Systems Corp.,
    Dot Hill Systems B.V., Network Appliance, Inc., Network
    Appliance Holding and Manufacturing B.V.(27)*10
.51

Description of 2007 Executive
    Compensation Plan (28)21
.1

Subsidiaries of Dot Hill Systems
    Corp.(5)23
.1

Consent of Deloitte &
    Touche LLP24
.1

Power of Attorney. Reference is
    made to the signature page hereto. 51




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##### Table of Contents



ExhibitNumber

Description31
.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.*
    
    Confidential treatment has been granted by, or requested from,
    the SEC.(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 March 31, 2004 and incorporated
    herein by reference.(15)
    
    Filed as an exhibit to our Quarterly Report on
    Form 10-Q
    for the quarter ended June 30, 2005 and incorporated herein
    by reference.(16)
    
    Incorporated herein by reference to the description contained in
    our Current Report on
    Form 8-K
    filed with the SEC on July 29, 2005.(17)
    
    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.(18)
    
    Filed as an exhibit to our Quarterly Report on
    Form 10-Q
    for the quarter ended September 30, 2005 and incorporated
    herein by reference. 52




---



##### Table of Contents



(19)
    
    Filed as an exhibit to our Annual Report on
    Form 10-K
    for the year ended December 31, 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.(24)
    
    Filed as an exhibit to our Quarterly Report on
    Form 10-Q
    for the quarter ended March 31, 2006 and incorporated
    herein by reference.(25)
    
    Filed as an exhibit to our Quarterly Report on
    Form 10-Q
    for the quarter ended June 30, 2006 and incorporated herein
    by reference.(26)
    
    Filed as an exhibit to our Current Report on
    Form 8-K
    filed with the SEC on July 17, 2006 and incorporated herein
    by reference.(27)
    
    Filed as an exhibit to our Quarterly Report on
    Form 10-Q
    for the quarter ended September 30, 2006 and incorporated
    herein by reference.(28)
    
    Filed as Item 5.02(e) of our Current Report on
    Form 8-K
    filed with the SEC on March 2, 2007 and incorporated herein
    by reference. 53




---



##### Table of Contents



SIGNATURES
      By:
    /s/  Dana
    W. Kammersgard   Chief Executive Officer and President
    attorneys-in-fact attorneys-in-fact attorneys-in-fact
    Name

Title

Date/s/  Dana
    W.
    KammersgardDana
    W. Kammersgard

Chief Executive Officer, President
    and Director (Principal Executive Officer)

March 16, 2007/s/  Hanif
    I. JamalHanif
    I. Jamal

Chief Financial Officer, and
    Treasurer (Principal Financial and Accounting Officer)

March 16, 2007/s/  Charles
    ChristCharles
    Christ

Chairman of the Board of Directors

March 16, 2007/s/  Kimberly
    AlexyKimberly
    Alexy

Director

March 16, 2007/s/  Joseph
    D. MarkeeJoseph
    D. Markee

Director

March 16, 2007/s/  W.R.
    SaueyW.R.
    Sauey

Director

March 16, 2007/s/  Roderick
    M.
    Sherwood IIIRoderick
    M. Sherwood III

Director

March 16, 2007  54




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##### Table of Contents



INDEX TO
    FINANCIAL STATEMENTS
  PageREPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


F-1FINANCIAL STATEMENTS:Consolidated
    balance sheets as of December 31, 2005 and 2006


F-2Consolidated
    statements of operations and comprehensive income (loss) for the
    years ended December 31, 2004, 2005 and 2006


F-3Consolidated
    statements of stockholders equity for the years ended
    December 31, 2004, 2005 and 2006


F-4Consolidated
    statements of cash flows for the years ended December 31,
    2004, 2005 and 2006


F-5Notes to
    consolidated financial statements for the years ended
    December 31, 2004, 2005 and 2006


F-6FINANCIAL STATEMENT SCHEDULES:Schedule II 
    Valuation and Qualifying Accounts


F-34  55




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##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM              Internal Control 
    Integrated Framework
  DELOITTE &
    TOUCHE LLP
    F-1




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS
    AS OF DECEMBER 31, 2005 AND 2006
    (In thousands, except per share amounts)
  2005


2006ASSETSCurrent Assets:Cash and cash equivalents

$
108,803


$
99,663Short-term investments


13,431



Accounts receivable, net of
    allowance of $294 and $629


34,312



39,758Inventories


2,804



2,210Prepaid expenses and other


4,539



5,039Deferred tax assets


5,762



Total current assets


169,651



146,670Property and equipment, net


7,891



9,738Goodwill


40,725



40,725Other intangible assets, net


7,414



4,382Deferred tax assets


41,379



Other assets


234



136Total assets

$
267,294


$
201,651LIABILITIES AND
    STOCKHOLDERS EQUITYCurrent Liabilities:Accounts payable

$
25,732


$
31,099Accrued compensation


3,561



3,231Accrued expenses


3,633



8,652Deferred revenue


1,327



521Income taxes payable


60



226Restructuring accrual


45



Total current liabilities


34,358



43,729Other long-term liabilities


885



2,010Total liabilities


35,243



45,739Commitments and Contingencies
    (Note 18)Stockholders
    Equity:Preferred stock, $.001 par
    value, 10,000 shares authorized, no shares issued and
    outstanding at December 31, 2005 and 2006, respectively






Common stock, $.001 par
    value, 100,000 shares authorized, 44,417 and
    45,009 shares issued and outstanding at December 31,
    2005 and 2006, respectively


44



45Additional paid-in capital


285,377



290,705Deferred compensation






Accumulated other comprehensive
    loss


(118
)


(814
)Accumulated deficit


(53,252
)


(134,024
)Total stockholders equity


232,051



155,912Total liabilities and
    stockholders equity

$
267,294


$
201,651    F-2




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS AND
    COMPREHENSIVE INCOME (LOSS)
    FOR THE YEARS ENDED DECEMBER 31, 2004, 2005 AND 2006
    (In thousands, except per share amounts)
  2004


2005


2006NET REVENUE

$
239,376


$
233,799


$
239,217COST OF GOODS SOLD


179,875



180,196



202,561GROSS PROFIT


59,501



53,603



36,656OPERATING EXPENSES:Sales and marketing


16,839



19,120



15,996Research and development


17,993



23,628



36,529General and administrative


9,992



12,933



18,119In process research and development


4,700







Restructuring expenses


(434
)






Legal settlement










3,395Total operating expenses


49,090



55,681



74,039OPERATING INCOME (LOSS)


10,411



(2,078
)


(37,383
)OTHER INCOME:Interest income, net


1,425



3,394



5,505Other income (expense), net


33



84



(9
)Total other income, net


1,458



3,478



5,496INCOME (LOSS) BEFORE INCOME TAXES

$
11,869


$
1,400


$
(31,887
)INCOME TAX EXPENSE (BENEFIT)


272



(25,197
)


48,885NET INCOME (LOSS)

$
11,597


$
26,597


$
(80,772
)NET INCOME (LOSS) PER SHARE:Basic

$
0.27


$
0.61


$
(1.80
)Diluted

$
0.25


$
0.58


$
(1.80
)WEIGHTED AVERAGE SHARES USED
    TO CALCULATE NET INCOME (LOSS) PER SHARE:Basic


43,460



43,903



44,757Diluted


46,395



45,639



44,757COMPREHENSIVE INCOME (LOSS):Net income (loss)

$
11,597


$
26,597


$
(80,772
)Foreign currency translation
    adjustments


(45
)


255



(736
)Net unrealized gain (loss) on
    short-term investments


(154
)


89



40Comprehensive income (loss)

$
11,398


$
26,941


$
(81,468
)    F-3




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS
    EQUITY
    FOR THE YEARS ENDED DECEMBER 31, 2004, 2005 AND 2006
    (In thousands)
  AccumulatedAdditional





Other





TotalPreferred Stock


Common Stock


Paid-In


Deferred


Comprehensive


Accumulated


StockholdersShares


Amount


Shares


Amount


Capital


Compensation


Loss


Deficit


EquityBalance, January 1,
    2004





$




43,307


$
43


$
275,827


$
(28
)

$
(263
)

$
(91,446
)

$
184,133Amortization of deferred
    compensation






















20











20Exercise of stock options and
    warrants










349



1



1,275















1,276Foreign currency translation
    adjustment


























(45
)






(45
)Net unrealized loss on short- term
    investments


























(154
)






(154
)Net income






























11,597



11,597Balance, December 31,
    2004










43,656



44



277,102



(8
)


(462
)


(79,849
)


196,827Amortization of deferred
    compensation






















8











8Exercise of stock options and
    warrants










561







1,780















1,780Sale of common stock under ESPP










200







1,040















1,040Tax benefit for disqualifying
    dispositions of stock options


















5,455















5,455Foreign currency translation
    adjustment


























255







255Net unrealized gain on short- term
    investments


























89







89Net income






























26,597



26,597Balance, December 31,
    2005










44,417



44



285,377







(118
)


(53,252
)


232,051Exercise of stock options and
    warrants










303



1



947















948Sale of common stock under ESPP










289







1,055















1,055Share-based compensation expense
    from stock options


















2,835















2,835Share-based compensation expense
    from ESPP


















397















397Share-based compensation expense
    from historical grant practices


















94















94Foreign currency translation
    adjustment


























(736
)






(736
)Net unrealized gain on short- term
    investments


























40







40Net loss






























(80,772
)


(80,772
)Balance, December 31,
    2006





$




45,009


$
45


$
290,705


$



$
(814
)

$
(134,024
)

$
155,912    F-4




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS
    FOR THE YEARS ENDED DECEMBER 31, 2004, 2005 AND 2006
    (In thousands)
  2004


2005


2006Cash Flows Related to Operating
    Activities:Net income (loss)

$
11,597


$
26,597


$
(80,772
)Adjustments to reconcile net
    income (loss) to net cash provided by (used in) operating
    activities:Depreciation and amortization


5,657



7,504



7,200Write-off of in-process research
    and development


4,700







Non-cash settlement of
    restructuring charges


(434
)






Loss on disposal of property and
    equipment






892



148Provision for doubtful accounts


176



(560
)


188Share-based compensation expense










3,326Deferred taxes, including reversal
    of valuation allowance






(25,300
)


47,141Other


8



(67
)


Changes in operating assets and
    liabilities (net of effects of acquisition):Accounts receivable


(24,637
)


6,422



(5,234
)Inventories


442



785



612Prepaid expenses and other assets


277



(1,598
)


(344
)Accounts payable


14,653



(14,398
)


4,259Accrued compensation and other
    expenses


25



(231
)


4,757Deferred revenue


(527
)


680



(961
)Income taxes payable


(473
)


(470
)


166Restructuring accrual


(312
)


(133
)


(45
)Other liabilities


107



600



1,145Net cash provided by (used in)
    operating activities


11,259



723



(18,414
)Cash Flows Related to Investing
    Activities:Purchases of property and equipment


(4,949
)


(4,733
)


(6,548
)Proceeds from sales of equipment


38







Sales of short-term investments


111,933



71,852



23,824Purchases of short-term investments


(85,083
)


(26,500
)


(10,337
)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


(43,444
)


38,119



6,939Cash Flows Related to Financing
    Activities:Proceeds from exercise of stock
    options and warrants


1,276



1,781



948Proceeds from sale of stock to
    employees






1,040



1,055Proceeds from bank and other
    borrowings


13,662







Payments on bank and other
    borrowings


(21,075
)






Net cash provided by (used in)
    financing activities


(6,137
)


2,821



2,003Effect of Exchange Rate Changes
    on Cash


(45
)


(356
)


332Net Increase (Decrease) in Cash
    and Cash Equivalents


(38,367
)


41,307



(9,140
)Cash and Cash Equivalents,
    beginning of year


105,863



67,496



108,803Cash and Cash Equivalents, end
    of year

$
67,496


$
108,803


$
99,663Supplemental Disclosures of Cash
    Flow Information:Construction in progress costs
    incurred but not paid

$



$
885


$
418Deferred tax asset for stock-based
    compensation credited to equity

$



$
5,455


$
Reduction of goodwill resulting
    from the recognition of deferred tax assets

$



$
16,386


$
Cash paid for interest

$
1,213


$



$
Cash paid for income taxes

$
724


$
499


$
1,482    F-5




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
  DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
 FOR THE YEARS ENDED DECEMBER 31, 2004, 2005 and
    2006
  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. available-for-sale
  Accounts
    Receivable
   F-6




---



##### 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.
  Long-Lived
    Assets
  Accounting for the Impairment or
 F-7




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Disposal of Long-Lived Assets.
  Revenue
    Recognition
  Revenue
    Recognition.
    Product
    Warranties
    Balance at








Deductions forBeginning of


Charged to


Deductions for


Change in


Balance atAccrued Warranty Costs

Year


Operations


Costs Incurred


Estimates


End of Year2004

$
262


$
1,703


$
(861
)

$



$
1,1042005

$
1,104


$
2,445


$
(2,803
)

$



$
7462006

$
746


$
2,363


$
(2,446
)

$



$
663   Advertising
    Costs
   F-8




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Research
    and Development
  Accounting for
    the Costs of Computer Software to Be Sold, Leased, or Otherwise
    Marketed
  Change
    in Accounting for Share-Based Compensation
  Share-Based Payment Accounting for Stock-Based Compensation Accounting for Stock Issued to
    Employees.
    No. 96-18, Accounting for Equity Instruments That Are Issued to Other
    Than Employees for Acquiring, or in Conjunction with Selling,
    Goods or Services
 F-9




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     2004


2005Net income

$
11,597


$
26,597Stock-based employee compensation
    expense included in reported net income attributable to common
    stockholders


20



8Stock-based employee compensation
    expense determined under fair value based method for all awards


(4,553
)


(6,374
)Pro forma net income

$
7,064


$
20,231Basic net income per share:As reported

$
0.27


$
0.61Pro forma

$
0.16


$
0.46Diluted net income per share:As reported

$
0.25


$
0.58Pro forma

$
0.15


$
0.44   Foreign
    Currency Transactions and Translation
      Income
    Taxes
    Net
    Income (Loss) Per Share
   F-10




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
       2004


2005


2006Weighted average shares used to
    calculate basic net income (loss) per share


43,460



43,903



44,757Dilutive effect of stock options
    and stock warrants


2,935



1,736



Weighted average shares used to
    calculate diluted net income (loss) per share


46,395



45,639



44,757         Recent
    Accounting Pronouncements
  Accounting Changes and Error
    Corrections
  No. 143-1, Accounting for Electronic Equipment Waste Obligations No. 143-1 No. 143-1 Accounting for Asset Retirement
    Obligations. No. 143-1 No. 143-1 No. 143-1 No. 143-1
 F-11




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   No. 115-1, The Meaning of
    Other-Than-Temporary
    Impairment and Its Application to Certain Investments. No. 115-1 other-than-temporary No. 115-1 No. 115-1
  Share-Based Payment Accounting for Stock-Based Compensation, Accounting for Stock Issued to
    Employees.
  Accounting for Uncertainty in Income
    Taxes  an interpretation of FASB Statement
    No. 109.
  Financial Statements  Considering the Effects of
    Prior Year Misstatements When Quantifying Misstatements in
    Current Year Financial Statements.
  Fair Value Measurements
  The Fair
    Value Option for Financial Assets and Financial
    Liabilities  including an amendment of SFAS
    No. 115
  2.
    Acquisition  Business
    Combinations
 F-12




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Assets:Cash and cash equivalents

$
2,202Accounts receivable


1,769Inventories


955Prepaid expenses and other


147Property and equipment


648Goodwill


56,768Intangible assets:Developed technology


2,600Core technology


5,000Customer relationships


2,500Backlog


100In-process research and development


4,700Total assets


77,389Liabilities:Current liabilities


2,859Convertible debt and accrued
    interest


6,945Total liabilities


9,804Net assets acquired

$
67,585      F-13




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  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.
      3.
    Risks and
    Uncertainties  Concentration
    of Credit Risk
    Cash,
    Cash Equivalents, and Short-Term Investments,
    Concentrations
   F-14




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Foreign
    Sales
      2004


2005


2006Europe


4.0
%


4.6
%


6.6
%Asia


2.8



2.4



2.2Total foreign sales


6.8
%


7.0
%


8.8
%     Dependence
    on Suppliers
         F-15




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   4.
    Accumulated
    Other Comprehensive Loss    2005


2006Foreign currency translation
    adjustments

$
(78
)

$
(814
)Unrealized loss on marketable
    equity securities classified as available for sale


(40
)


$
(118
)

$
(814
)   5.
    Restructuring
    Costs and Asset Write-downs    Employee termination costs

$
1,271Impairment of property and
    equipment


1,007Facility closures and related costs


637Professional fees and other


20Total

$
2,935     Employee termination costs

$
259Impairment of property and
    equipment


350Facility closures and related costs


861Total

$
1,470        F-16




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     March
    2001 Restructuring
  Accrued








Accrued








AccruedRestructuring








Restructuring








RestructuringExpenses at


Additional


Current


Expenses at


Additional


Current


Expenses atJanuary 1,


Restructuring


Amounts


December 31,


Restructuring


Amounts


December 31,2004


Expenses


Utilized


2005


Expenses


Utilized


2006Facility closures and related costs

$
168



17



(140
)


45







(45
)

$
   June
    2001 Restructuring
  Accrued








Accrued








AccruedRestructuring








Restructuring








RestructuringExpenses at


Additional


Current


Expenses at


Additional


Current


Expenses atJanuary 1,


Restructuring


Amounts


December 31,


Restructuring


Amounts


December 31,2004


Expenses


Utilized


2005


Expenses


Utilized


2006Facility closures and related costs

$
10



75



(85
)













$
     6.
    Short-Term
    Investments    December 31, 2005Net Unrealized


Net UnrealizedCost


Losses


Gains


Fair ValueUnited States Government securities

$
11,395


$
(39
)

$



$
11,356Corporate debt


2,076



(1
)






2,075$
13,471


$
(40
)

$



$
13,431     United States Government Securities.
  Corporate Debt Securities.
 F-17




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   7.
    Inventories    2005


2006Purchased parts and materials

$
1,058


$
612Finished goods


1,746



1,598Total inventory

$
2,804


$
2,210   8.
    Property
    and Equipment    2005


2006Machinery and equipment

$
8,770


$
11,620Furniture, fixtures, and computer
    software


1,433



3,862Leasehold improvements


670



2,042Construction in progress


3,259



77Total property and equipment, at
    cost


14,132



17,601Less accumulated depreciation


(6,241
)


(7,863
)Total property and equipment, net

$
7,891


$
9,738       9.
    Goodwill
    and Intangible Assets     F-18




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     December 31, 2005AccumulatedGross


Amortization


NetCore technology

$
5,000


$
(2,037
)

$
2,963Developed technology


2,600



(1,907
)


693Customer relationships


2,500



(1,309
)


1,191Backlog


100



(100
)


Licensed Patent Portfolio


2,570



(3
)


2,567Total intangible assets

$
12,770


$
(5,356
)

$
7,414   December 31, 2006AccumulatedGross


Amortization


NetCore technology

$
5,000


$
(3,148
)

$
1,852Developed technology


2,600



(2,600
)


Customer relationships


2,500



(2,023
)


477Backlog


100



(100
)


Licensed Patent Portfolio


2,570



(517
)


2,053Total intangible assets

$
12,770


$
(8,388
)

$
4,382       2007

$
2,1022008


1,2552009


5142010


511Total

$
4,382   10.
    Credit
    Facilities  Line
    of Credit
   F-19




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   11.
    Income
    Taxes    2004


2005


2006Current:Federal

$
217


$
624


$
State, local and foreign


55



41



1,744272



665



1,744Deferred:Federal






(18,697
)


39,914State, local and foreign






(7,165
)


7,227



(25,862
)


47,141Total income tax provision
    (benefit)

$
272


$
(25,197
)

$
48,885     2004


2005


2006Federal statutory rate

$
4,154


$
490


$
(11,160
)State and local income taxes, net
    of federal effect


930



(4,569
)


4,699Decrease (increase) in deferred
    income tax asset valuation allowance


(6,626
)


(22,112
)


49,281Foreign losses without tax benefit


306



1,418



6,171In-process research and development


1,645







Research and development credit






(393
)


(805
)Other


(137
)


(31
)


699Income tax provision (benefit)

$
272


$
(25,197
)

$
48,885  F-20




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    2005


2006Deferred income tax assets:Net operating loss and tax credit
    carry forwards

$
51,911


$
61,652Inventory reserve and uniform
    capitalization


454



734Stock warrants


1,532



2,279Restructuring accrual


19



In-process research and development


445



390Acquisition costs


302



Allowance for bad debts


51



111Vacation accrual


425



389Deferred rent


94



931Warranty accrual


313



278Deferred revenue


343



25Depreciation and amortization






183Other accruals and reserves


101



354Total deferred income tax assets


55,990



67,326Deferred income tax liabilities:State taxes


(2,469
)


(3,196
)Depreciation and amortization


(930
)


Acquired intangibles


(1,889
)


(872
)Total deferred income tax
    liabilities


(5,288
)


(4,068
)Deferred income tax asset
    valuation allowance


(3,561
)


(63,258
)Net deferred income tax asset

$
47,141


$
        F-21




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
              12.
    Stockholders
    Equity  Increase
    in Authorized Common Shares
    Stockholders
    Rights Plan
   F-22




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    13.
    Preferred
    Stock        14.
    Stock
    Options and Warrants  Stock
    Incentive Plans
  2000 EIP.
  2000 NEDSOP.
  2000 ESPP.
 F-23




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Year EndedDecember 31,2006Cost of goods sold

$
327Sales and marketing


307Research and development


627General and administrative


1,972Share-based compensation expense
    before taxes


3,233Related deferred income tax
    benefits


Share-based compensation expense,
    net of income taxes

$
3,233Net share-based compensation
    expense per basic and diluted common share

$
0.07Share-based compensation expense
    is derived from:Stock options

$
2,8362000 ESPP


397Total

$
3,233    F-24




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Weighted averageWeighted


remaining


Aggregateaverage


contractual term


intrinsic valueNumber of shares


exercise price


(in years)


(in thousands)Outstanding at January 1, 2004


3,255,727


$
5.08Granted


1,626,750



10.31Exercised


(281,794
)


3.75Forfeited


(346,790
)


10.73Expired


(39,798
)


9.66Outstanding at December 31,
    2004


4,214,095



6.68Granted


1,328,000



5.78Exercised


(315,112
)


3.11Forfeited


(309,677
)


7.72Expired


(86,495
)


11.40Outstanding at December 31,
    2005


4,830,811



6.52Granted


2,162,501



5.16Exercised


(278,855
)


3.11Forfeited


(900,262
)


6.16Expired


(378,265
)


7.88Outstanding at December 31,
    2006


5,435,930


$
6.12



6.96


$
1,665Vested and expected to vest at
    December 31, 2006


4,986,192


$
6.22



6.78


$
1,601Exercisable at December 31,
    2006


3,345,683


$
6.81



5.78


$
1,389      F-25




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Options Outstanding


Options ExercisableWeightedAverage


Weighted





WeightedRemaining


Average





AverageRange of Exercise

Number


Contractual


Exercise


Number


ExercisePrices

Outstanding


Life (yrs.)


Price


Exercisable


Price$1.34 - 3.10


1,086,038



6.01


$
2.54



843,954


$
2.40$3.15 - 3.92


919,436



8.19



3.76



174,436



3.39$4.01 - 6.10


1,222,422



6.87



5.52



880,886



5.62$6.12 - 6.87


994,626



8.25



6.56



295,499



6.32$6.88 - 13.50


969,508



5.65



10.35



907,008



10.59$13.88 - 17.14


243,900



6.85



15.30



243,900



15.30Total


5,435,930



6.96


$
6.12



3,345,683


$
6.81     out-of-the-money
        2000 EIP and 2000 NEDSOP


2000 ESPPYears Ended


Years EndedDecember 31,


December 31,2004


2005


2006


2004


2005


2006Risk-free interest rate


3.23
%


3.86
%


4.89
%


3.36
%


4.08
%


4.98
%Expected dividend yield



%



%



%



%



%



%Volatility


87
%


78
%


68
%


85
%


75
%


68
%Expected life


4.0 years



4.1 years



5.5 years



0.5 years



0.5 years



0.5 years    F-26




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Warrants
        15.
    Stock
    Option Expense related to Historical Grant Practices    16.
    Related
    Party Transactions    17.
    Employee
    Benefit Plans  Dot
    Hill Retirement Savings Plan
   F-27




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Employee
    Stock Purchase Plan
    18.
    Commitments
    and Contingencies  Operating
    Leases
      2007

$
1,2452008


1,2242009


1,0932010


1,0252011


1,052Thereafter


1,449Total minimum lease payments

$
7,088   Employment
    Agreements
     F-28




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Consulting
    Agreements with Former Executive
    Crossroads
    Systems Litigation
     F-29




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  end-to-end,
      Chaparral
    Securities Class Action
     F-30




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Dot
    Hill Securities Class Actions and Derivative
    Suits
      Other
    Litigation
    Other
    19.
    Segment
    and Geographic Information     F-31




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Legacy andSANnet Families


Other


Services


TotalYear ended December 31,
    2004:Net revenue

$
231,264


$
5,172


$
2,940


$
239,376Gross profit (loss)

$
56,882


$
2,244


$
375


$
59,501Year ended December 31,
    2005:Net revenue

$
225,705


$
5,388


$
2,706


$
233,799Gross profit

$
51,856


$
1,243


$
504


$
53,603Year ended December 31,
    2006:Net revenue

$
232,298


$
3,100


$
3,819


$
239,217Gross profit

$
35,087


$
385


$
1,184


$
36,656     SANnet


Legacy andFamilies


Other


Services


TotalAs of:December 31, 2005

$
256,028


$
8,240


$
3,026


$
267,294December 31, 2006

$
195,332


$
3,024


$
3,295


$
201,651     As of and for the Year EndedDecember 31,2004


2005


2006Net revenue:United States

$
223,133


$
217,469


$
218,009Europe


9,546



10,730



15,851Asia


6,697



5,600



5,357$
239,376


$
233,799


$
239,217Income (loss) before income taxes:United States

$
11,786


$
4,571


$
(18,306
)Europe


(812
)


(2,636
)


(13,220
)Asia


895



(535
)


(361
)$
11,869


$
1,400


$
(31,887
)Assets:United States

$
237,376


$
260,826


$
192,539Europe


6,444



3,997



6,358Asia


2,747



2,471



2,754$
246,567


$
267,294


$
201,651    F-32




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   20.
    Quarterly
    Financial Information (Unaudited)    First


Second


Third


FourthQuarter


Quarter


Quarter


QuarterYear Ended December 31,
    2005:Net revenue

$
58,011


$
65,897


$
53,616


$
56,275Gross profit


13,277



16,145



12,353



11,828Income (loss) before income taxes


1,991



3,723



(1,467
)


(2,847
)Net income (loss)


2,102



3,297



(1,275
)


22,473Basic net income (loss) per share


0.05



0.08



(0.03
)


0.51Diluted net income (loss) per share


0.05



0.07



(0.03
)


0.49Year Ended December 31,
    2006:Net revenue

$
58,686


$
66,265


$
54,846


$
59,420Gross profit


11,161



13,770



7,033



4,692Loss before income taxes


(7,545
)


(8,415
)


(7,618
)


(8,309
)Net loss


(4,975
)


(6,626
)


(60,086
)


(9,085
)Basic net loss per share


(0.11
)


(0.15
)


(1.34
)


(0.20
)Diluted net loss per share


(0.11
)


(0.15
)


(1.34
)


(0.20
)  F-33




---



##### Table of Contents



DOT HILL
    SYSTEMS CORP. AND SUBSIDIARIES
  SCHEDULE II 
    VALUATION AND QUALIFYING ACCOUNTS
 FOR THE
    YEARS ENDED DECEMBER 31, 2004, 2005 AND 2006
  Balance at


Charged to





BalanceBeginning of


Costs and





at End ofYear


Expenses


Deductions


Year(In thousands)Allowance for doubtful accounts
    and sales returns:Year ended December 31, 2004

$
467


$
176


$
152
(1)

$
491Year ended December 31, 2005


491



560



757
(1)


294Year ended December 31, 2006


294



335







629Reserve for excess and obsolete
    inventories:Year ended December 31, 2004

$
6,594


$
785


$
5,694
(2)

$
1,685Year ended December 31, 2005


1,685



1,856



2,548
(2)


993Year ended December 31, 2006


993



1,082



333
(2)


1,743     (1)
    
    Uncollectible receivables charged off and credit issued for
    product returns.(2)
    
    Consists primarily of the write-off of excess/obsolete
    inventories. F-34