##### Table of Contents



UNITED
    STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C.
    20549
     Form 10-K
  (Mark One)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
    001-33196
  Isilon Systems, Inc.
 (Exact name of registrant as
    specified in its charter)
  Delaware

91-2101027(State or other jurisdiction
    of

(IRS Employerincorporation or
    organization)

Identification No.)3101 Western Ave
    Seattle, WA(Address of principal
    executive offices)

98121(Zip code)   Registrants telephone number, including area code:
 206-315-7500
     Securities registered pursuant to Section 12(b) of the
    Act:
  Title of Each Class

Name of Exchange on Which RegisteredCommon Stock, par value $0.00001
    per share

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




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##### 



TABLE OF
    CONTENTS
  
  Part IItem 1.

Business


3Item 1A.

Risk
    Factors


20Item 1B.

Unresolved Staff
    Comments


34Item 2.

Properties


35Item 3.

Legal
    Proceedings


35Item 4.

Submission of
    Matters to a Vote of Security Holders


35Part IIItem 5.

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


36Item 6.

Selected Financial
    Data


39Item 7.

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


40Item 7A.

Quantitative and
    Qualitative Disclosures About Market Risk


59Item 8.

Financial
    Statements and Supplementary Data


60Item 9.

Changes in and
    Disagreements with Accountants on Accounting and Financial
    Disclosure


86Item 9A.

Controls and
    Procedures


86Item 9B.

Other
    Information


86Part IIIItem 10.

Directors and
    Executive Officers of the Registrant


86Item 11.

Executive
    Compensation


87Item 12.

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


87Item 13.

Certain
    Relationships and Related Transactions


87Item 14.

Principal
    Accounting Fees and Services


87Part IVItem 15.

Exhibits and
    Financial Statement Schedules


87Signatures


88EXHIBIT 23.1EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2   2




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This report contains forward-looking statements that involve
    risks and uncertainties. The statements contained in this report
    that are not purely historical 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. We use words such as
    anticipate, believe, plan,
    expect, future, intend,
    may, will, should,
    estimate, predict,
    potential, continue, and similar
    expressions to identify such forward-looking statements.
    Forward-looking statements are subject to known and unknown
    risks, uncertainties and other factors that may cause our
    results, levels of activity, performance, achievements and
    prospects, and those of the data storage industry generally, to
    be materially different from those expressed or implied by such
    forward-looking statements. These risks, uncertainties and other
    factors include, among others, those identified under
    Factors Affecting Our Operating Results, Business
    Prospects and Market Price of Stock, Special
    Note Regarding Forward-Looking Statements and
    elsewhere in this report.
  On December 12, 2006, we effected a
    1-for-2.4
    reverse split of our issued and outstanding common stock.
    Historical share numbers and prices throughout this report on
    Form 10-K
    are split-adjusted.
  Isilon Systems, Inc. was incorporated in the State of
    Delaware on January 24, 2001. Our principal corporate
    offices are located in Seattle, Washington. We design, develop
    and market clustered storage systems for storing and managing
    digital content. We began selling our products and services in
    January 2003. We sell systems that generally include a software
    license, hardware, post-contract customer support and, in some
    cases, additional elements. Our common stock is listed on The
    Nasdaq Global Market under the symbol ISLN.
  In this report, Isilon Systems, the
    company, we, us, and
    our refer to Isilon Sytems, Inc., and its
    consolidated subsidiaries, unless the context otherwise
    dictates.
  ITEM 1.
    Business  Overview
    Industry
    Background
  Proliferation
    of Digital Content
     3




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
    Large File Sizes and Data Stores Versus Small File Sizes and
    Data Stores.  Digital content files are typically
    much larger than structured data files and can range from a
    megabyte to a terabyte or more in size. In contrast, a
    structured data file, such as that generated for a credit card
    transaction, can be as small as one kilobyte. As the number of
    files containing digital content increases, enterprises will
    require storage systems with capacities that can scale from a
    few terabytes to hundreds of petabytes.
    Rapid and Unpredictable Data Growth Versus Stable and
    Consistent Data Growth.  Digital content files are
    often stored in several different formats, resolutions and
    locations. As a consequence, multiple files are often created
    for each new piece of digital content, resulting in a growth
    rate that can be rapid and very difficult to predict. In
    addition, new classes of applications for creating and
    delivering digital content are proliferating, such as Internet
    delivery,
    video-on-demand
    and computer modeling. The growth rate of traditional,
    text-based, transactional data has typically been steadier and
    more predictable.
    High or Concurrent User Access Versus Discrete Single User
    Access.  Digital content is often used in
    environments where it must be simultaneously available to many
    systems, applications, groups and users, both inside and outside
    an enterprise. Accordingly, systems that manage and store
    digital content must be able to sustain high rates of concurrent
    access to multiple files by multiple users. Requests for
    structured data, on the other hand, are typically made by a
    small number of simultaneous users or applications querying the
    appropriate database.
    High Throughput Versus Input/Output
    Intensive.  Digital content applications typically
    require high data transfer rates, or throughput, from storage
    devices to applications or users, with some applications
    requiring throughput of multiple gigabytes per second. In
    particular, sequential access and high data throughput are
    required for larger files such as video, audio and digital
    images to avoid delayed or interrupted sessions. In contrast,
    structured data files are typically accessed in a more random
    transaction-based pattern where throughput is less critical.  Widespread
    and Increasing Use of Digital Content
    
    Media and Entertainment.  Digitization of
    production and delivery of content in the media and
    entertainment industry is driving significant increases in data
    storage and access requirements. Examples include the emergence
    of high-definition television, digital video standards like
    HD-DVD and Blu-Ray, streaming 4




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media formats for online delivery of content and new
    high-resolution digital images used in movie production. As
    these and similar formats proliferate and the media industry
    moves towards an all-digital workflow that includes the
    creation, management, delivery and archiving of television
    programs, music, films and publishing materials, digital content
    storage requirements will continue to grow. In movie production,
    for example, ten seconds of high-resolution digital footage can
    require as many as 12 gigabytes of storage, and in the
    publishing industry, sophisticated digital cameras can take up
    to eight photos per second, each of which can create an image
    file of up to 20 megabytes.  
    Internet.  Internet users upload and download
    millions of digital images, digital videos, music, documents and
    other web-based content daily. In addition, businesses that rely
    on the Internet as a distribution channel for their products or
    services often must accommodate millions of concurrent users
    accessing data, deliver 24x7x365 online availability, manage
    rapidly expanding amounts of digital content and provide
    aggregate data throughput of multiple gigabytes per second.
    Cable and Telecommunications.  Cable,
    telecommunications and satellite television providers are
    seeking to offer consumers a triple play of video,
    voice and data services in a single bundled offering. In
    particular, the build-out of
    video-on-demand
    services has required and will continue to require many
    centralized and distributed storage systems to keep pace with
    the availability and distribution of new content, including DVD
    movies, on-demand digital television programming and digital
    music.
    Oil and Gas.  As the demand for and price of
    oil and natural gas increase, energy companies are investing in
    innovative exploration and development technologies to find new
    reserves and to extract more from existing reserves. New
    geo-seismic imaging applications process raw seismic data into
    two- and three-dimensional images, creating multidimensional
    visualization models that can result in the creation of data
    files exceeding one terabyte and total data stores ranging in
    size from hundreds of terabytes to tens of petabytes.
    Life Sciences.  Research and development in the
    life sciences and drug discovery fields are increasingly
    characterized by statistically-driven, information-based
    analyses using proteomic, genomic and DNA sequencing data. In
    addition, new digital microscopes can capture digital images
    with digital resolutions as high as 18 megapixels and
    three-dimensional display capability. As a result, life sciences
    professionals are storing, retrieving and analyzing increasingly
    large amounts of digital content. For instance, in the area of
    cancer research, an image of a single drop of blood analyzed by
    a mass spectrometer can create more than 60 gigabytes of
    data. As scientists build statistically significant sample sizes
    for research projects, they can collect tens of thousands and,
    ultimately, millions of patient data files in the form of
    digital content.
    Manufacturing.  New testing and digital
    simulation technologies used to enhance manufacturing processes
    are creating significant amounts of digital content and require
    high-performance storage systems. In some manufacturing
    applications, test instruments capture, write and analyze more
    than 100,000 data samples per second. In addition, as
    manufacturers increasingly incorporate digital design and
    automation technology into their workflows, they are creating a
    large number of files containing digital content.
    Federal Government.  Advances in defense and
    intelligence technologies, such as the capture and analysis of
    high-resolution satellite images, digital video and audio feeds,
    and digital imaging, are fueling increased demand for storage
    capacity from the federal government. Defense initiatives, such
    as the use of unmanned aircraft and vehicles, rely on very
    large, high-resolution topographical maps, while civilian
    initiatives, such as hurricane and weather modeling, document
    scanning, and public health services, create large files and
    require large data stores.  Storage
    Challenges for Digital Content
   5




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
    High Scalability.  Enterprises require a
    storage architecture that can increase in performance and
    capacity in a linear fashion and which can scale in parallel
    with the growth of their digital content. In order to scale to
    very large storage capacities, traditional systems rely on
    multiple separate file systems, or silos, of storage. Each of
    these silos is typically accessed and managed independently,
    which can result in operating inefficiencies. Enterprises also
    want the flexibility to scale either processing power or storage
    capacity separately as their business needs evolve. For example,
    an archive application where information is accessed
    infrequently might need more storage capacity relative to total
    data throughput, while an active development project might need
    greater data throughput relative to total storage capacity. In
    general, traditional storage systems do not provide the type of
    flexibility that will permit an enterprise to tailor a system to
    its unique capacity and performance requirements.
    High Performance.  Enterprises require a
    storage solution that can provide the data throughput necessary
    to enable multiple users to have concurrent read and write
    access to files. The rapid proliferation of digital content
    requires a file system architecture that enables multiple
    concurrent users to access and process files that can be
    megabytes, gigabytes or even terabytes in size. In accessing,
    delivering and processing digital content, traditional storage
    systems have inherent performance limitations associated with
    their inability to aggregate performance across multiple
    devices. In addition, traditional storage systems typically
    cannot deliver the same data for multiple concurrent users in a
    quick or efficient manner.
    Ease of Management.  Enterprises require a
    storage solution that simplifies and automates the management
    and monitoring of storage systems as they expand. Scaling
    traditional systems is a complex, labor-intensive,
    time-consuming process that frequently requires IT personnel to
    map applications to newly added storage resources and manually
    migrate data to ensure maximum storage utilization. This process
    typically requires system downtime or application downtime,
    which can interrupt critical business operations.
    Reliability.  Enterprises require a storage
    system that will preserve critical digital assets as well as
    ensure that customers and business units have uninterrupted
    access to those assets. As digital content becomes increasingly
    important to an enterprises success, and as data stores
    and disk density continue to increase, it becomes more critical
    and difficult to protect and quickly rebuild storage systems in
    the event of a disk drive or other hardware failure. Storage
    solutions for digital content must be fault tolerant and be able
    to analyze systems for potential hardware or software failures
    to ensure uninterrupted user access.
    Cost Efficiency.  Traditional storage systems
    are becoming increasingly complex and expensive to install and
    configure, which increases the upfront cost of storage for
    enterprises. Enterprises want storage systems that offer the
    capital expenditure benefits of modular clustered systems that
    allow a pay-as-you-grow capability and we believe
    are shifting their purchasing practices accordingly.
    Additionally, enterprises are looking for management and
    scalability benefits that reduce the overall cost of purchasing,
    storing and managing storage resources as they grow.  Need
    for a New Storage System Architecture
    
    Clustered Computing Architectures.  Clustered
    computing architectures have been widely adopted in the
    enterprise server market. We believe a similar trend is
    beginning to occur with respect to clustered computing
    architectures in the storage systems market. Clustered computing
    systems use intelligent software to unify disparate computing
    resources and enable them to operate as a single system. Each
    device, or node, in a clustered system can operate independently
    or in concert with other nodes to create a distributed
    architecture that achieves higher levels of aggregate
    performance. A distributed architecture also enables an
    enterprise to scale its computing infrastructure commensurate
    with its needs by adding more 6




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nodes as necessary, maximizing cost efficiency. Clustered
    architectures also eliminate single points of failure by
    distributing data across independent nodes.  
    Industry Standard Computing Hardware.  The
    proliferation of high-performance industry standard hardware has
    been a key element in enabling the development and successful
    adoption of clustered server systems. This type of hardware
    minimizes integration risk and provides attractive
    price-performance attributes that were not previously
    achievable. As a result, clustered server architectures that use
    industry standard hardware can offer high levels of performance
    and reliability, making them an attractive alternative to
    traditional server systems.    Our
    Intelligent Clustered Storage Solutions
    3.5-inch 1.75-inch
    
    Scalability and Performance.  We believe our
    systems provide industry-leading scalability and performance.
    Our OneFS operating system software can currently combine up to
    96 separate nodes and up to 1,000 terabytes, or one
    petabyte, of storage capacity in a single cluster, and can
    deliver total data throughput of ten gigabytes per second from a
    single file system and single pool of storage, providing linear
    scalability in both storage capacity and performance. Our
    systems support either Gigabit Ethernet or high-performance
    InfiniBand interconnect for low-latency, high-bandwidth,
    intra-cluster communication. We are continually seeking to
    increase the storage capacity and throughput of our systems.
    Reliability.  Our clustered storage systems
    have data protection capabilities, built-in redundancy and
    self-healing capabilities. Each Isilon IQ storage system is
    designed to withstand the failure of multiple disks or entire
    nodes so that a customer does not lose access to any files. Each
    node in an Isilon IQ cluster is a peer, and any node can handle
    a request from any application server to provide the file
    requested. Our OneFS operating system software allocates, or
    stripes, files and meta-data across all nodes in a cluster so
    that, if one node or multiple nodes fail, any other node can
    perform the requested function, thereby preventing any single
    point of failure. In the event of one or more disk or node
    failures, OneFS automatically rebuilds files in parallel across
    all of the existing distributed free space in the cluster,
    eliminating the need to have the dedicated hot spare
    drives required with most traditional storage systems. We
    believe our Isilon IQ storage systems can utilize this free
    space, while also drawing on the multiple microprocessors and
    aggregate computing power of the cluster, to rebuild data from
    failed drives five to ten times faster than traditional storage
    systems, enabling a more reliable storage solution.
    Reduced Storage Cost.  Our customers can
    purchase our Isilon IQ storage systems on a
    pay-as-you-grow model that allows them to expand
    their storage capacity and performance commensurate with their
    needs. In 7




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contrast, traditional storage systems typically require the
    purchase of excess performance and capacity, which remains
    underutilized until an enterprise grows into it. Our modular
    product architecture enables each customer to purchase an
    initial combination of performance and capacity tailored to its
    current needs, and to add performance, capacity or both in
    incremental quantities to support the growth in its digital
    content. In contrast to traditional storage systems, our
    systems, which utilize industry standard hardware, can
    significantly lower the initial capital expenditures required
    for storage, as well as the cost of acquiring additional storage
    capacity or performance.  
    Increased IT Operating Efficiency.  Our
    clustered storage systems enable customers to manage their
    growing amounts of digital content in an automated and efficient
    manner that is more cost-effective than traditional storage
    systems. Our Isilon IQ storage systems automatically balance
    data across nodes to enhance performance and optimize
    utilization, eliminating the need for the planned storage
    outages that are common during the manual data-balancing
    processes required with traditional storage systems. The
    simplicity, ease of use and automation of our Isilon IQ storage
    systems have enabled individual customers to scale deployments
    from a few terabytes to more than 2,000 terabytes without any
    additional investment in IT staff. Each Isilon IQ storage system
    has been designed to interface with existing Ethernet networks,
    and our plug and store design automates many of the
    tasks that must be performed manually to deploy traditional
    storage systems. As a result, once installed in a rack, a 100
    terabyte cluster can typically be configured and operational in
    less than 15 minutes. Additionally, capacity can typically be
    added to existing clusters in less than 60 seconds, without any
    downtime.
    Enhanced Business Processes and Revenue
    Opportunities.  By providing faster data access,
    faster data processing and streamlined workflows, our systems
    enable customers to manage the rapid growth in their digital
    content, capitalize on new products and service models for
    delivering digital content and unlock new revenue opportunities.
    For example, NBC used Isilon IQ solutions to store, access and
    edit more than 1,200 broadcast hours over six networks
    during the 17 days of events at the 2004 Summer Olympics,
    providing immediate access to all programming and tripling the
    number of broadcast hours compared with previous Olympics.
    Similarly, using our Isilon IQ storage system, a major aerospace
    and defense company unified its engine test results from
    previously disparate data sources into one large pool of
    storage, greatly improving the efficiency, speed and cost of its
    test operations.
    Complementary to Existing Solutions for Structured
    Data.  Our customers typically deploy our
    solutions specifically for digital content while maintaining
    their existing storage systems for structured data. Our use of
    industry standard hardware and standard file sharing protocols
    greatly eases integration with existing enterprise systems and
    substantially reduces the need to change existing data center
    infrastructures or use proprietary tools or software. In
    addition, our software enables our storage systems to be
    adaptable to technology that exists in our customers data
    center environments.  Our
    Strategy
    
    Focus on High-Growth, Data-Intensive
    Markets.  We intend to expand our customer base by
    focusing on markets where the storage and management of digital
    content are critical to the success of many enterprises. To
    date, our solutions have been deployed by customers in
    industries such as media and entertainment, Internet, cable and
    telecommunications, oil and gas, life sciences and
    manufacturing, and by the federal government. We intend to
    invest in our direct sales force and channel partners to further
    penetrate these and other markets domestically and
    internationally.
    Continue to Enhance OneFS and Deliver Additional Software
    Applications.  Our OneFS operating system software
    is the core of our Isilon IQ clustered storage architecture. We
    intend to continue to enhance our OneFS operating system
    software with greater levels of automation, functionality and
    performance and to add new software applications in areas such
    as archiving, data protection and storage management. 8




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
    Leverage Trends in Commodity Hardware to Improve
    Price-Performance Attributes of Our Systems.  Our
    software-based architecture is designed to allow us to integrate
    quickly and easily into our systems technology improvements,
    including those in components such as CPUs, disk drives and
    memory chips. Our systems are built using industry standard
    hardware rather than proprietary hardware, enabling us to
    address our customers needs in a cost-effective manner. As
    a result, our customers benefit as the price-performance
    attributes of these components improve over time. We intend to
    proactively incorporate advances in computing, storage and
    networking technologies into our storage systems.
    Optimize Repeat Order Business Model.  Because
    of the modular nature of our clustered storage systems, our
    customers have typically deployed our systems in an incremental
    fashion. We intend to continue to design our systems to take
    advantage of our modular architecture, enabling our customers to
    scale deployments in step with their growing capacity and
    performance needs.
    Utilize Channel Partners to Expand Global Market
    Penetration.  We received 45% of our total revenue
    in 2006 through indirect channels. We have established a
    distribution channel program that, as of December 31, 2006,
    had more than 100 value-added resellers and distributors
    worldwide. We believe the ease of use and installation of our
    systems makes them well-suited for distribution by channel
    partners. We believe the international opportunity for our
    systems is significant and we have expanded the number of our
    channel partners in Asia-Pacific and Europe. We intend to
    continue adding value-added resellers and distributors to expand
    the global distribution of our systems.
    Realize Operating Leverage.  We intend to
    realize operating leverage from the flexibility of our business
    model. By leveraging partners, including value-added resellers
    and distributors, offshore third-party software development
    teams, contract manufacturers, providers of international
    back-office support and providers of support services, we intend
    to maintain a flexible cost structure and focus on our core
    competencies. We are also able to benefit from our contract
    manufacturing partners purchasing power, lowering our
    costs of components. In addition, by selling to our existing
    customers, we believe we can realize efficiencies in our sales
    model. 9




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Technology
    and Architecture
    
  Figure 1: Typical Isilon IQ Network Architecture
    
  Figure 2: OneFS Operating System Software Architecture and
    Features
 10




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
    AutoBalance.  Automatically balances data
    across all nodes in a cluster in real-time, reducing throughput
    bottlenecks, maximizing performance and storage utilization, and
    eliminating the downtime commonly associated with the manual
    data migrations required by traditional storage systems.
    AutoBalance automatically migrates and rebalances data as
    additional nodes are added to a cluster.
    FlexProtect-AP.  Provides the functionality
    that enables peering of nodes, incorporation of redundancy and
    reduction of the vulnerability of a cluster to any single point
    of failure. Its striping policies incorporated into OneFS are
    based on the Reed Solomon error correction code, span multiple
    nodes within a cluster and can be set at any level, including
    the cluster, directory,
    sub-directory
    or even individual file level. FlexProtect-AP is designed to
    re-build files automatically across the existing distributed
    free space in the cluster in parallel, eliminating the need to
    have disks dedicated solely to potential rebuild purposes, as is
    typically required with traditional storage architectures. It
    also identifies at risk disks and preemptively
    migrates relevant data from the at risk disks to
    available free space within other parts of the cluster.
    SmartCache.  Utilizes predictive software
    algorithms and the OneFS file-striping feature to enhance
    throughput for an Isilon IQ cluster. SmartCache is a
    globally-coherent memory cache that is optimized for digital
    content, can read and write data and is able to expand
    automatically as additional nodes are added to any Isilon IQ
    cluster.
    WebAdmin.  Configures, monitors and manages an
    Isilon IQ cluster using a single, web-based management
    interface. The central, web-based interface permits a real-time,
    single level of management for cluster performance, capacity
    utilization, quotas, monitoring, diagnostics and management of
    software applications such as our SyncIQ replication software
    product. Using the web interface, users can add or remove nodes
    from the cluster with a click of the mouse.  Products
    Isilon IQ Platform Nodes. 3.5-inch
 11




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Figure 3: Isilon IQ Platform Node
  Isilon IQ Accelerator.
  
  Figure 4: Isilon IQ Accelerator
  Isilon EX 6000. 3.5-inch disk-to-disk
  
  Figure 5: Isilon EX 6000
  SyncIQ Replication Software. disk-to-disk
  SmartConnect Load-Balancing Software.
 12




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SnapshotIQ Protection Software. point-in-time
  Customers
    Sales and
    Marketing
    
    Value-Added Resellers and Distributors.  We
    currently have more than 100 channel partners that resell
    and/or
    distribute our products in the United States and
    internationally. These partners help market and sell our
    products to a broad array of enterprises and government
    organizations across our core markets. We typically enter into
    non-exclusive, written distribution agreements with our channel
    partners, and these agreements generally have a one-year term
    with no minimum sales commitment.
    Field Sales Force.  Our field sales force is
    responsible for managing all direct and indirect sales within
    our geographic territories, including North America, France,
    Germany, Japan, Korea and the United Kingdom.
    Original Equipment Manufacturers.  We are
    currently seeking to establish additional original equipment
    manufacturing, or OEM, partnerships with companies that would
    bundle their products with ours to address the challenges of a
    particular market or application. We recently entered into our
    first OEM agreement with Harris Corporation, under which this
    OEM will offer the Isilon IQ clustered storage system bundled
    with its own products.      Support
    and Services
   13




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24-hour
    Manufacturing
      90-day
    Research
    and Development
     14




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Competition
      
    scalability;
    performance, including the ability to provide high throughput as
    well as access for multiple concurrent users;
    ease of installation and management by IT personnel;
    reliability to ensure uninterrupted user access; and
    cost efficiency in acquisition, deployment and ongoing support.    Intellectual
    Property
           15




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video-on-demand
  Governmental
    Regulation
    Employees
   16




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Executive
    Officers and Directors
    Name

Age

Position(s)Executive Officers:Steven Goldman


46



President, Chief Executive Officer
    and DirectorSujal M. Patel


32



Chief Technology Officer and
    DirectorStuart W. Fuhlendorf


44



Chief Financial Officer and Vice
    President of FinanceEric J. Scollard


41



Vice President of SalesMark L. Schrandt


44



Vice President of EngineeringBrett G. Goodwin


39



Vice President of Marketing and
    Business DevelopmentJohn W. Briant


41



Vice President of OperationsThomas P. Pettigrew


50



Vice President of Global Sales
    PartnersGwen E. Weld


49



Vice President of Human Resources
    and Organizational DevelopmentOther Directors:Barry J. Fidelman


66



DirectorElliott H.
    Jurgensen, Jr.


62



DirectorGregory L. McAdoo


42



DirectorMatthew S. McIlwain


42



DirectorJames G. Richardson


49



DirectorWilliam D. Ruckelshaus


74



Chairman of the Board of Directors
    and Director   Steven Goldman
  Sujal M. Patel
  Stuart W. Fuhlendorf
 17




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Eric J. Scollard
  Mark L. Schrandt
  Brett G. Goodwin
  John W. Briant
  Thomas P. Pettigrew
  Gwen E. Weld
 18




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##### Table of Contents



Barry J. Fidelman
  Elliott H. Jurgensen, Jr.
  Gregory L. McAdoo
  Matthew S. McIlwain
  James G. Richardson
  William D. Ruckelshaus
   19




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##### Table of Contents



Available
    Information
  Form 10-K, Form 10-Q, Form 8-K, Form 10-K.
  FACTORS
    AFFECTING OUR OPERATING RESULTS,
    BUSINESS PROSPECTS AND MARKET PRICE OF STOCK
  ITEM 1A.
    Risk
    Factors  Risks
    Related to Our Business and Industry
  We
    have a history of losses, and we may not achieve profitability
    in the future.
    We
    face intense competition and expect competition to increase in
    the future, which could reduce our revenue and customer
    base.
     20




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##### Table of Contents



Our
    operating results may fluctuate significantly, which makes our
    future results difficult to predict and could cause our
    operating results to fall below expectations.
  period-to-period
    
    the timing and magnitude of shipments and timing of
    installations of our products in each quarter;
    reductions in customers budgets for information technology
    purchases, delays in their purchasing cycles or deferments of
    their product purchases in anticipation of new products or
    updates from us or our competitors;
    the rates at which customers purchase additional storage systems
    from us and renew their service contracts with us;
    the timing of recognizing revenue as a result of revenue
    recognition rules;
    fluctuations in demand, sales cycles and prices for our products
    and services;
    our ability to develop, introduce and ship in a timely manner
    new products and product enhancements that meet customer
    requirements;
    the timing of product releases or upgrades or announcements by
    us or our competitors;
    any change in the competitive dynamics of our markets, including
    new entrants or discounting of product prices;
    our ability to control costs, including our operating expenses
    and the costs of the components we use in our products;
    the possibility of seasonality of demand for our products;
    volatility in our stock price, which may lead to higher stock
    compensation expenses pursuant to Statement of Financial
    Accounting Standards No. 123(R), Share-Based
    Payment, or SFAS 123(R), which first became effective
    for us in the first quarter of 2006 and requires that employee
    stock-based compensation be measured based on its fair value on
    the grant date and treated as an expense that is reflected in
    financial statements over the recipients service period; 21




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##### Table of Contents




    future accounting pronouncements and changes in accounting
    policies; and
    geopolitical events such as war or incidents of terrorism.  Our
    limited operating history in our emerging market makes it
    difficult to evaluate our current business and future prospects,
    and may increase the risk of your investment.
    Our
    future financial performance depends on growth in the market for
    storage of digital content. If this market does not continue to
    grow at the rate that we forecast, our operating results would
    be materially and adversely impacted.
    If
    we are unable to maintain or replace our relationships with
    customers or to increase the diversification of our customer
    base, it would be more difficult to maintain or grow our revenue
    and our growth might be limited.
    If
    we are unable to develop and introduce new products and respond
    to technological changes, if our new products do not achieve
    market acceptance or if we fail to manage product transitions,
    we may fail to increase, or may lose, market
    share.
   22




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##### Table of Contents



We
    rely on value-added resellers and other distribution partners to
    sell our products, and disruptions to, or our failure to develop
    and manage, our distribution channels and the processes and
    procedures that support them could result in these resellers and
    partners discontinuing the marketing and distribution of our
    products and services.
        Our
    sales cycles can be long and unpredictable, and our sales
    efforts require considerable time and expense. As a result, our
    sales are difficult to predict and may vary substantially from
    quarter to quarter, which may cause our operating results to
    fluctuate significantly.
   23




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##### Table of Contents



Claims
    by others that we infringe their proprietary technology could
    cause us to incur substantial costs, distract our management
    and, if these claims are successful, require us to pay
    substantial damages or prevent us from offering our
    products.
  video-on-demand
    We
    derive substantially all of our total revenue from sales of our
    Isilon IQ product family and related services, and a decline in
    demand for our Isilon IQ product family would cause our revenue
    to grow more slowly or to decline.
    If
    we are unable to continue to create valuable innovations in
    software, we may not be able to generate additional high-margin
    revenue to increase our gross margins.
  and/or
 24




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##### Table of Contents



We
    currently rely on a single contract manufacturer to assemble our
    products, and our failure to forecast demand for our products
    accurately or manage our relationship with our contract
    manufacturer successfully could negatively impact our ability to
    sell our products.
      We
    rely on a limited number of suppliers, and in some cases
    single-source suppliers, and any disruption or termination of
    these supply arrangements could delay shipments of our products
    and could materially and adversely affect our relationships with
    current and prospective customers.
    
    supplier capacity constraints;
    price increases;
    timely delivery; and
    component quality.   25




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##### Table of Contents



If
    we fail to manage future growth effectively, we may not be able
    to market and sell our products and services
    successfully.
    Our
    products incorporate components that are obtained in spot
    markets, and, as a result, our cost structure and our ability to
    respond in a timely manner to customer demand are sensitive to
    volatility in the market prices for these
    components.
    We
    maintain relatively low inventory and acquire components only as
    needed; as a result, if shortages of these components arise, we
    may not be able to secure enough components to build new
    products to meet customer demand.
    If
    we lose key personnel, if key personnel are distracted or if we
    are unable to attract and retain
    highly-qualified
    personnel on a cost-effective basis, it would be more difficult
    for us to manage our existing business operations and to
    identify and pursue new growth opportunities.
   26




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##### Table of Contents



Our
    ability to sell our products is highly dependent on the quality
    of our service offerings, and our failure to offer high-quality
    service offerings would have a material adverse effect on our
    ability to market and sell our products and
    services.
    Our
    products are highly technical and may contain undetected
    software or hardware defects, which could cause data
    unavailability, loss or corruption that might, in turn, result
    in liability to our customers and harm to our reputation and
    business.
   27




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##### Table of Contents



Our
    international sales and operations and offshore development
    initiative subject us to additional risks that may adversely
    affect our international operations and reduce our international
    sales.
    
    the difficulty of managing and staffing international offices
    and the increased travel, infrastructure and legal compliance
    costs associated with multiple international locations;
    difficulties in enforcing contracts and collecting accounts
    receivable, and longer payment cycles, especially in emerging
    markets;
    the challenge of managing development teams in geographically
    disparate locations;
    tariffs and trade barriers and other regulatory or contractual
    limitations on our ability to sell or develop our products in
    various foreign markets;
    increased exposure to foreign currency exchange rate risk;
    the ability of our third-party contract engineering provider in
    Moscow, Russia to terminate our agreement for any reason upon
    90 days notice after May 31, 2007;
    reduced protection for intellectual property rights in some
    countries, including Russia; and
    political and economic instability.    If
    we are unable to protect our intellectual property rights, our
    competitive position could be harmed or we could be required to
    incur significant expenses to enforce our rights.
     28




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##### Table of Contents



Our
    use of open source and third-party software could impose
    unanticipated conditions or restrictions on our ability to
    commercialize our products.
      Our
    products must interoperate with many software applications that
    are developed by others and if we are unable to devote the
    necessary resources to ensure that our products interoperate
    with those applications, we may fail to increase, or we may
    lose, market share and we may experience a weakening demand for
    our products.
    Our
    products must interoperate with various data-access protocols
    and, if we are unable to ensure that our products interoperate
    with these protocols, our products might become less
    competitive.
   29




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##### Table of Contents



If
    our products do not interoperate with our customers
    networks, servers or software applications, installations would
    be delayed or cancelled.
    We
    may engage in future acquisitions that could disrupt our
    business, cause dilution to our stockholders, reduce our
    financial resources and result in increased
    expenses.
  day-to-day
  Changes
    in financial accounting standards or practices may cause
    adverse, unexpected financial reporting fluctuations and affect
    our reported results of operations.
    If
    we fail to maintain proper and effective internal controls, our
    ability to produce accurate financial statements could be
    impaired, which could adversely affect our operating results,
    our ability to operate our business and investors views of
    us.
  re-evaluated
 30




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##### Table of Contents



Our
    business is subject to increasingly complex environmental
    legislation that has increased both our costs and the risk of
    noncompliance.
      We
    are subject to governmental export and import controls that
    could impair our ability to compete in international
    markets.
    If
    we need additional capital in the future, it may not be
    available to us on favorable terms, or at all.
   31




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##### Table of Contents



Our
    business is subject to the risks of earthquakes and other
    natural catastrophic events, and to interruption by man-made
    problems such as computer viruses or terrorism.
    Risks
    Related Ownership of Our Common Stock
  The
    trading price of our common stock is likely to be
    volatile.
    
    variations in our operating results or those of our competitors;
    announcements of technological innovations, new products or
    product enhancements, strategic alliances or significant
    agreements by us or by our competitors;
    the gain or loss of significant customers;
    the level of sales in a particular quarter;
    lawsuits threatened or filed against us;
    the recruitment or departure of key personnel;
    changes in the estimates of our operating results or changes in
    recommendations by any securities analysts who elect to follow
    our common stock;
    market conditions in our industry, the industries of our
    customers and the economy as a whole;
    the adoption or modification of regulations, policies,
    procedures or programs applicable to our business; and
    the expiration of
    lock-up
    agreements.    Future
    sales of shares by existing stockholders could cause our stock
    price to decline.
  lock-up
 32




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##### Table of Contents



180-day lock-up lock-up lock-up
  lock-up
  lock-up
  lock-up
  Insiders
    continue to have substantial control over us and will be able to
    influence corporate matters.
    If
    securities or industry analysts cease publishing research or
    publish inaccurate or unfavorable research about our business,
    our stock price and trading volume could decline.
    Provisions
    in our certificate of incorporation and bylaws and Delaware law
    might discourage, delay or prevent a change of control of our
    company or changes in our management and, therefore, depress the
    trading price of our common stock.
    
    establish a classified board of directors so that not all
    members of our board are elected at one time;
    provide that directors may only be removed for cause;
    authorize the issuance of blank check preferred
    stock that our board of directors could issue to increase the
    number of outstanding shares and to discourage a takeover
    attempt;
    eliminate the ability of our stockholders to call special
    meetings of stockholders; 33




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##### Table of Contents




    prohibit stockholder action by written consent, which has the
    effect of requiring all stockholder actions to be taken at a
    meeting of stockholders;
    provide that the board of directors is expressly authorized to
    make, alter or repeal our bylaws; and
    establish advance notice requirements for nominations for
    election to our board of directors or for proposing matters that
    can be acted upon by stockholders at stockholder meetings.    Special
    Note Regarding Forward-Looking Statements
  We have made forward-looking statements in this document, all
    of which are subject to risks and uncertainties. When we use
    words such as may, anticipate,
    expect, intend, plan,
    believe, seek and estimate
    or similar words, we are making forward-looking statements.
    Forward-looking statements include information concerning our
    possible or assumed future business success or financial
    results. These forward-looking statements include, but are not
    limited to statements regarding:
  
    our competitive environment;
    the anticipated growth of digital content;
    the expected demand for and benefits of our storage
    products;
    our future business plans and growth strategy;
    our ability to improve existing products and to develop new
    and future products;
    our anticipated revenue and expenses;
    our ability to add value-added resellers and distributors and
    to sell our products internationally;
    our ability to realize operating leverage and realize
    efficiencies in our sales model by leveraging partners and
    selling to existing customers;
    anticipated results of potential or actual litigation;
    the anticipated sufficiency of our current office space and
    ability to find additional space as needed;
    anticipated development or acquisition of intellectual
    property and resulting benefits;
    expected impacts of changes in accounting rules, including
    the impact on deferred tax benefits;
    the impact of governmental regulation;
    employee hiring and retention, including anticipated
    reductions in force and headcount;
    the future payment of dividends;
    use of cash, cash needs and ability to raise
    capital; and
    potential liability from contractual relationships.  ITEM 1B.
    Unresolved
    Staff Comments   34




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##### Table of Contents



ITEM 2.
    Properties    ITEM 3.
    Legal
    Proceedings    ITEM 4.
    Submission
    of Matters to a Vote of Security Holders    
    The approval of the amendment and restatement of our Certificate
    of Incorporation to effect a
    1-for-2.4
    reverse stock split of our capital stock (including all
    outstanding warrants and options exercisable for shares of our
    capital stock).
    The approval of the amendment and restatement of our Certificate
    of Incorporation that became effective upon the completion of
    our initial public offering to, among other things,
    (i) delete the provisions in the certificate designating
    the rights and preferences of the preferred stock which are no
    longer outstanding following the conversion of such preferred
    stock into shares of our common stock upon the closing of the
    initial public offering, (ii) create 10,000,000 shares
    of preferred stock, (iii) increase the authorized number of
    common stock by to 250,000,000 shares and (iv) provide
    for certain stockholder protection measures.
    The approval of the amendment and restatement of our Bylaws.
    The approval and adoption of our 2006 Equity Incentive Plan and
    2006 Employee Stock Purchase Plan.
    The approval of a form of Indemnification Agreement to be
    entered into by us with each of our directors and officers.   35




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##### Table of Contents



PART II  ITEM 5.
    Market
    for Registrants Common Equity, Related Stockholder Matters
    and Issuer Purchases of Equity Securities  Market
    Information
  Form S-1
  High


LowFiscal year 2006:Period from December 15, 2006
    through December 31, 2006

$
28.50


$
21.84   Dividend
    Policy
    Holders
    Equity
    Compensation Plan
   36




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##### Table of Contents



Stock
    Performance Graph
      Comparison
    of December 2006 Cumulative Total Return
    Among Isilon Systems, Nasdaq
    Computer Index and Nasdaq Composite
  
  Recent
    Sales of Unregistered Securities
  (a)
    Sales
    of Unregistered Securities  one-for-one
     37




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##### Table of Contents



(b)
    Use of
    Proceeds from Public Offering of Common Stock  (No. 333-137078) Form S-1
    Issuer
    Purchases of Equity Securities
   38




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##### Table of Contents



ITEM 6.
    Selected
    Financial Data  Form 10-K.
  Year EndedDecember 31,


January 1,


January 2,


December 31,


December 31,2006


2006


2005


2003


2002(In thousands)Consolidated Statements of
    Operations Data:Total revenue

$
62,279


$
21,083


$
7,653


$
1,293


$
Total cost of revenue(1)


29,331



11,575



4,163



861



Gross profit


32,948



9,508



3,490



432



Operating expenses:Research and development(1)


16,524



12,478



7,446



4,410



5,016Sales and marketing(1)


24,390



12,377



6,305



2,742



1,122General and administrative(1)


7,411



3,681



2,300



1,647



1,354Total operating expenses


48,325



28,536



16,051



8,799



7,492Loss from operations


(15,377
)


(19,028
)


(12,561
)


(8,367
)


(7,492
)Total other income (expense),
    net(2)


(9,952
)


(68
)


18



103



144Loss before income tax expense and
    cumulative effect of change in accounting principle


(25,329
)


(19,096
)


(12,543
)


(8,264
)


(7,348
)Income tax expense


(109
)














Loss before cumulative effect of
    change in accounting principle


(25,438
)


(19,096
)


(12,543
)


(8,264
)


(7,348
)Cumulative effect of change in
    accounting principle(2)






(89
)










Net loss

$
(25,438
)

$
(19,185
)

$
(12,543
)

$
(8,264
)

$
(7,348
)Net loss per common share, basic
    and diluted

$
(3.02
)

$
(3.95
)

$
(3.61
)

$
(3.30
)

$
(3.93
)Shares used in computing basic and
    diluted net loss per common share


8,432



4,852



3,474



2,502



1,868(1) Includes stock-based
    compensation expense* as follows:Cost of revenue

$
24


$



$



$



$
Research and development


160















Sales and marketing


198















General and administrative


258



5



4



2



Total stock-based compensation
    expense

$
640


$
5


$
4


$
2


$
     *
    
    Note: On January 2, 2006, we adopted SFAS 123(R),
    Share-Based Payment.(2)
    
    On July 4, 2005, we adopted FASB Staff Position
    No. 150-5,
    Issuers Accounting under FASB Statement No. 150
    for Freestanding Warrants and Other Similar Instruments on
    Shares That Are Redeemable. Amounts for the 39




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##### Table of Contents



years ended December 31, 2006 and January 1, 2006
    include related warrant revaluation expense of $8.4 million
    and $52,000, respectively, and a cumulative effect of change in
    accounting principle of $89,000 for the year ended
    January 1, 2006.  As ofDecember 31,


January 1,


January 2,


December 31,


December 31,2006


2006


2005


2003


2002(In thousands)Consolidated Balance Sheet
    Data:Cash, cash equivalents and
    marketable securities

$
99,899


$
12,656


$
8,618


$
5,203


$
13,890Working capital


109,093



7,332



7,204



4,569



13,383Total assets


136,971



28,241



17,550



7,209



14,659Preferred stock warrant liability






367











Current and long-term notes
    payable and capital lease obligations






7,543



1,474



238



480Convertible preferred stock






59,549



39,736



23,253



23,253Common stock and additional
    paid-in capital


185,948



324



158



27



22Total stockholders equity
    (deficit)


110,757



(49,375
)


(30,327
)


(17,914
)


(9,641
)   ITEM 7.
    Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations  The following should be read in conjunction with our
    Consolidated Financial Statements and the notes thereto included
    in Part II, Item 8, Part I, Item 1.
    Business, and Part II, Item 6.
    Selected Financial Data, of this Annual Report on
    Form 10-K.
    We report financial results on a fiscal year of 52 or
    53 weeks ending on the Sunday closest to December 31
    of that year. For ease of reference within this section, 2006
    refers to the fiscal year ended December 31, 2006, 2005
    refers to the fiscal year ended January 1, 2006, and 2004
    refers to the fiscal year ended January 2, 2005.
  Overview
    3.5-inch 1.75-inch
     40




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##### Table of Contents



period-to-period
    Key
    Business Metrics
    Initial Sales Orders, Repeat Sales Orders and Order
    Sizes.
  Deferred Revenue.
  Gross Margin.
  Operating Cash Flow.
 41




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##### Table of Contents



Critical
    Accounting Policies and Estimates
      
    revenue recognition;
    allowance for doubtful accounts;
    stock-based compensation;
    estimation of fair value of warrants to purchase convertible
    preferred stock;
    inventory valuation; and
    accounting for income taxes.    Revenue
    Recognition
    No. 97-2, Software Revenue Recognition SOP 97-2, No. 98-9, Modification of
    SOP 97-2,
    Software Revenue Recognition, With Respect to Certain
    Transactions SOP 98-9,
     42




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##### Table of Contents



SOP 98-9,
  SOP 97-2, SOP 97-2.
  Allowance
    for Doubtful Accounts
    Stock-Based
    Compensation
    EstimatedNumber of





FairShares Subject


Exercise


Value ofto Options


Price


Common Stock


Intrinsic ValueDate of Issuance

Granted


per Share


per Share


per ShareJanuary 2005  April 2005


1,345,585


$
0.22


$
0.22


$
May 2005


212,499



0.48



0.48



June 2005  October 2005


614,360



0.46



0.46



February 2006


787,066



0.82



0.92



0.10March 2006


699,134



0.82



1.20



0.38March 2006


604,162



0.82



1.30



0.48April 2006


672,492



1.35



1.61



0.26May 2006


60,829



1.35



1.97



0.62June 2006


320,169



1.35



3.12



1.77July 2006


148,330



3.70



4.08



0.38August 2006


78,330



3.70



5.09



1.39September 2006


227,485



5.36



5.91



0.55October 2006


381,539



6.12



7.32



1.20November 2006


136,244



8.12



8.12



December 2006


254,162



13.00



13.00



   Accounting
    for Stock Issued to Employees
 43




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##### Table of Contents



Accounting for Certain
    Transactions Involving Stock Compensation, an Interpretation of
    APB No. 25 Accounting for
    Stock-Based Compensation Accounting for Stock-Based
    Compensation  Transition and Disclosure.
  Share-Based Payment
      No. 96-18, Accounting for Equity Instruments That Are Issued to Other
    Than Employees for Acquiring, or in Conjunction with Selling,
    Goods or Services EITF 96-18, EITF 96-18
   44




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##### Table of Contents




    the prices for our convertible preferred stock sold to outside
    investors in arms-length transactions, and the rights,
    preferences and privileges of that convertible preferred stock
    relative to those of our common stock;
    the hiring of key personnel;
    the increase in the number of our channel partners and our
    channel revenue in 2005;
    significant sales to one customer in 2005;
    acceptance of our products within different industries and by a
    wide variety of additional customers;
    the launch of new products;
    our stage of development and revenue growth;
    the fact that the option grants involved illiquid securities in
    a private company; and
    the likelihood of achieving a liquidity event, such as an
    initial public offering or sale of the company, for the shares
    of common stock underlying the options given prevailing market
    conditions.    
    For the three months ended January 1, 2006, total revenue
    increased approximately 59% over the immediately preceding
    quarter ended October 2, 2005;
    We generated revenue during this period from 46 new customers,
    including 21 new customers within the media and entertainment
    industry;
    We also began to generate revenue during this period from
    customers in different industries such as the online services,
    cable and telecommunications, and oil and gas industries, which
    represented some of the early sales generated by us in each of
    these industries and marked additional acceptance of our systems
    outside the media and entertainment industry; and
    We made advances in product development during this period,
    which included the release of our Isilon IQ 6000 and of our IQ
    Accelerator.     45




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##### Table of Contents




    For the three months ended April 2, 2006, total revenue
    increased approximately 20% over the immediately preceding
    fiscal quarter, and we acquired 33 new customers, particularly
    in the media and entertainment and oil and gas industries;
    For the three months ended April 2, 2006, gross profit
    increased to approximately $5.4 million, an increase of
    approximately 20% over the immediately preceding fiscal quarter;
    We achieved advances in product development, including the
    release of our next generation operating system software, OneFS
    4.0, and of our Isilon EX6000;
    The number of our value-added resellers and other distributors,
    as well as the revenue recognized through these parties,
    increased; and
    International sales and operations increased, including the
    addition of a sales office in the United Kingdom and the hiring
    of key international personnel.    
    For the three months ended July 2, 2006, total revenue
    increased approximately 29% over the immediately preceding
    fiscal quarter and we acquired 42 new customers, particularly in
    the media and entertainment and oil and gas industries;
    For the three months ended July 2, 2006, gross profit
    increased to $7.0 million, an increase of approximately 30%
    over the immediately preceding fiscal quarter; 46




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##### Table of Contents




    The number of our value-added resellers and other distributors,
    as well as the revenue recognized through these parties,
    increased; and
    International sales and operations continued to increase,
    including the addition of sales offices in South Korea, France
    and Germany and the hiring of key international personnel.    
    For the three months ended October 1, 2006, total revenue
    increased approximately 33% over the immediately preceding
    fiscal quarter, and we acquired 63 new customers, particularly
    in the media and entertainment and life sciences industries;
    For the three months ended October 1, 2006, gross profit
    increased to $9.3 million, an increase of approximately 33%
    over the immediately preceding fiscal quarter;
    The number of our value-added resellers and other distributors,
    as well as the revenue recognized through these parties,
    continued to increase; and
    International sales and operations continued to increase.      Valuation of
    Privately-Held-Company Equity Securities Issued as
    Compensation
  Estimation
    of Fair Value of Warrants to Purchase Convertible Preferred
    Stock
  No. 150-5, Issuers Accounting under FASB Statement No. 150
    for Freestanding Warrants and Other Similar Instruments on
    Shares That Are Redeemable 150-5. 150-5 150-5,
 47




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##### Table of Contents



150-5.
  Inventory
    Valuation
  first-in,
  Accounting
    for Income Taxes
  Accounting for Income Taxes.
  Results
    of Operations
  Revenue.
   48




---



##### Table of Contents



49




---



##### Table of Contents



Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(Dollars in thousands)Revenue by type:Product

$
54,181


$
18,709


$
6,847Services


8,098



2,374



806Total revenue

$
62,279


$
21,083


$
7,653% revenue by type:Product


87
%


89
%


89
%Services


13



11



11Total


100
%


100
%


100
%Revenue by geography:Domestic

$
47,449


$
17,559


$
7,397International


14,830



3,524



256Total revenue

$
62,279


$
21,083


$
7,653% revenue by geography:Domestic


76
%


83
%


97
%International


24



17



3Total


100
%


100
%


100
%Revenue by sales channel:Direct

$
34,425


$
15,464


$
7,164Indirect


27,854



5,619



489Total revenue

$
62,279


$
21,083


$
7,653% revenue by sales channel:Direct


55
%


73
%


94
%Indirect


45



27



6Total


100
%


100
%


100
%   Cost of Revenue and Gross Margin.
 50




---



##### Table of Contents



Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(Dollars in thousands)Revenue:Product

$
54,181


$
18,709


$
6,847Services


8,098



2,374



806Total revenue

$
62,279


$
21,083


$
7,653Cost of revenue:Product

$
25,709


$
10,388


$
3,453Services


3,622



1,187



710Total cost of revenue

$
29,331


$
11,575


$
4,163Gross margin:Product


53
%


44
%


50
%Services


55



50



12Total gross margin


53



45



46       Research and Development Expenses.
  Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(Dollars in thousands)Research and development expenses

$
16,524


$
12,478


$
7,446Percent of total revenue


27
%


59
%


97
%   Sales and Marketing Expenses.
 51




---



##### Table of Contents



Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(Dollars in thousands)Sales and marketing expenses

$
24,390


$
12,377


$
6,305Percent of total revenue


39
%


59
%


82
%   General and Administrative Expenses.
  Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(Dollars in thousands)General and administrative expenses

$
7,411


$
3,681


$
2,300Percent of total revenue


12
%


17
%


30
%   Other Income (Expense), Net. 150-5. 150-5
  Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(In thousands)Interest income and other

$
306


$
314


$
132Interest expense


(1,751
)


(330
)


(114
)Warrant revaluation expense


(8,431
)


(52
)


Loss on disposal of property and
    equipment


(76
)






Other income (expense), net

$
(9,952
)

$
(68
)

$
18   Fiscal
    2006 Compared to Fiscal 2005
  Revenue.
 52




---



##### Table of Contents



Gross Margin.
      Research and Development Expenses.
 53




---



##### Table of Contents



Sales and Marketing Expenses.
  General and Administrative Expenses.
  Other Income (Expense), Net.
  Fiscal
    2005 Compared to Fiscal 2004
  Revenue.
    Gross Margin.
   54




---



##### Table of Contents



Research and Development Expenses.
  Sales and Marketing Expenses.
  General and Administrative Expenses.
  Other Expense (Income), Net. 150-5.
  Fiscal
    2004 Compared to Fiscal 2003
  Revenue.
  Gross Margin.
   55




---



##### Table of Contents



Research and Development Expenses.
  Sales and Marketing Expenses.
  General and Administrative Expenses.
  Other Income (Expense), Net.
  Liquidity
    and Capital Resources
            As ofDecember 31,


January 1,


January 2,2006


2006


2005(In thousands)Working capital

$
109,093


$
7,332


$
7,204Cash, cash equivalents and
    marketable securities


99,899



12,656



8,618  56




---



##### Table of Contents



Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(In thousands)Net cash used in operating
    activities

$
(17,300
)

$
(18,411
)

$
(11,798
)Net cash (used in) provided by
    investing activities


(3,491
)


(5,536
)


611Net cash provided by financing
    activities


109,833



26,179



17,818   Cash
    Flows from Operating Activities
      Cash
    Flows from Investing Activities
          Cash
    Flows from Financing Activities
   57




---



##### Table of Contents



Contractual
    Obligations
    Payments Due by PeriodLess Than


1 - 3


3 - 5


More ThanTotal


1 Year


Years


Years


5 Years(In thousands)Operating lease obligations

$
17,770


$
2,064


$
4,644


$
5,082


$
5,980Purchase obligations


3,375



3,375











Total

$
21,145


$
5,439


$
4,644


$
5,082


$
5,980   Guarantees
    Off-Balance
    Sheet Arrangements
    Recent
    Accounting Pronouncements
  Accounting for Servicing of Financial Assets  an
    amendment of FASB Statement No. 140 Accounting for Transfers and Servicing of Financial Assets
    and Extinguishment of Liabilities. available-for-sale Accounting for Certain Investments in
    Debt and
 58




---



##### Table of Contents



Equity Securities
  No. 06-3, How Sales Taxes Collected from Customers and Remitted to
    Governmental Authorities Should Be Presented in the Income
    Statement (That Is, Gross Versus Net Presentation) 06-3, 06-3. 06-3
  Accounting for Uncertainty in Income Taxes
  ,
    Fair Value Measurements
  ITEM 7A.
    Quantitative
    and Qualitative Disclosures About Market Risk  Foreign
    Currency Risk
    Interest
    Rate Risk
     59




---



##### Table of Contents



ITEM 8.
    Financial
    Statements and Supplementary Data  INDEX TO
    CONSOLIDATED FINANCIAL STATEMENTS
  PageReport of
    Independent Registered Public Accounting Firm


61Consolidated
    Balance Sheets


62Consolidated
    Statements of Operations


63Consolidated
    Statements of Changes in Mandatorily Reedemable Convertible
    Preferred Stock and Stockholders Equity (Deficit) and
    Comprehensive Loss


64Consolidated
    Statements of Cash Flows


65Notes to
    Consolidated Financial Statements


66  60




---



##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM       Share-Based
    Payment
  150-5, Issuers Accounting under FASB Statement No. 150
    for Freestanding Warrants and Other Similar Instruments on
    Shares That Are Redeemable
  /s/  PricewaterhouseCoopers
    LLP
    61




---



##### Table of Contents



Isilon
    Systems, Inc.
  Consolidated
    Balance Sheets
  As ofDecember 31,


January 1,2006


2006(In thousands,except per share data)ASSETSCurrent assets:Cash and cash equivalents

$
99,899


$
10,853Marketable securities






1,803Trade receivables, net of
    allowances of $501 and $239


24,388



7,862Inventories


3,587



2,958Other current assets


1,939



495Total current assets


129,813



23,971Property and equipment, net


7,158



4,164Deferred financing costs, net






106Total assets

$
136,971


$
28,241LIABILITIES, MANDATORILY
    REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS
    EQUITY (DEFICIT)Current liabilities:Accounts payable

$
6,777


$
3,805Accrued liabilities


2,869



1,261Accrued compensation and related
    benefits


3,463



2,007Deferred revenue and customer
    deposits


7,611



2,762Preferred stock warrant liability






367Notes payable and capital lease
    obligations






6,437Total current liabilities


20,720



16,639Deferred revenue, net of current
    portion


3,308



322Deferred rent, net of current
    portion


2,186



Notes payable and capital lease
    obligations, net of current portion






1,106Total liabilities


26,214



18,067Commitments and contingencies
    (Note 11)Mandatorily redeemable convertible
    preferred stock, par value $0.00001: 10,000 and
    85,008 shares authorized; no shares and 41,789 shares
    issued and outstanding; $0 and $59,856 aggregate liquidation
    preference






59,549Stockholders equity
    (deficit):Common stock, par value $0.00001:
    250,000 and 44,583 shares authorized; 61,519 and
    6,906 shares issued and outstanding


1



Additional paid-in capital


185,947



324Accumulated other comprehensive
    loss


(83
)


(29
)Accumulated deficit


(75,108
)


(49,670
)Total stockholders equity
    (deficit)


110,757



(49,375
)Total liabilities, mandatorily
    redeemable convertible preferred stock and stockholders
    equity (deficit)

$
136,971


$
28,241    62




---



##### Table of Contents



Isilon
    Systems, Inc.
  Consolidated
    Statements of Operations
  Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(In thousands, except per share data)Revenue:Product

$
54,181


$
18,709


$
6,847Services


8,098



2,374



806Total revenue


62,279



21,083



7,653Cost of revenue:Product


25,709



10,388



3,453Services(1)


3,622



1,187



710Total cost of revenue


29,331



11,575



4,163Gross profit


32,948



9,508



3,490Operating expenses:Research and development(1)


16,524



12,478



7,446Sales and marketing(1)


24,390



12,377



6,305General and administrative(1)


7,411



3,681



2,300Total operating expenses


48,325



28,536



16,051Loss from operations


(15,377
)


(19,028
)


(12,561
)Other income (expense), netInterest income and other


306



314



132Interest expense


(1,751
)


(330
)


(114
)Warrant revaluation expense


(8,431
)


(52
)


Loss on disposal of property and
    equipment


(76
)






Total other income (expense), net


(9,952
)


(68
)


18Loss before income tax expense and
    cumulative effect of change in accounting principle


(25,329
)


(19,096
)


(12,543
)Income tax expense


(109
)






Loss before cumulative effect of
    change in accounting principle


(25,438
)


(19,096
)


(12,543
)Cumulative effect of change in
    accounting principle






(89
)


Net loss

$
(25,438
)

$
(19,185
)

$
(12,543
)Net loss per common share, basic
    and diluted

$
(3.02
)

$
(3.95
)

$
(3.61
)Shares used in computing basic and
    diluted net loss per common share


8,423



4,852



3,474(1) Includes stock-based
    compensation expense as follows:Cost of services revenue

$
24


$



$
Research and development


160







Sales and marketing


198







General and administrative


258



5



4Total stock-based compensation
    expense

$
640


$
5


$
4    63




---



##### Table of Contents



Isilon
    Systems, Inc.Consolidated Statements of Changes in Mandatorily
    Reedemable Convertible
    Preferred Stock and Stockholders Equity (Deficit) and
    Comprehensive Loss
  MandatorilyRedeemable











AccumulatedConvertible








Additional


Other





TotalPreferred Stock


Common Stock


Paid-in


Comprehensive


Accumulated


StockholdersShares


Amount


Shares


Amount


Capital


Income (Loss)


(Deficit)


Equity (Deficit)(In thousands)Balances as of January 1,
    2004


21,665



23,253



4,643


$




27



1



(17,942
)


(17,914
)Common stock issued in connection
    with early-exercises of stock options










1,203



















Common stock issued in connection
    with all other exercises of stock options










328







39











39Vesting of early-exercised stock
    options


















88











88Issuance of warrants






90























Issuance of Series C
    convertible preferred stock, net of issuance costs of $107


11,458



16,393























Stock-based compensation expense


















4











4Comprehensive loss:Net loss


























(12,543
)Unrealized loss on marketable
    securities






















(1
)


Total comprehensive loss






























(12,544
)Balances as of January 2,
    2005


33,123



39,736



6,174







158







(30,485
)


(30,327
)Common stock issued in connection
    with early-exercises of stock options










462



















Common stock issued in connection
    with all other exercises of stock options










270







42











42Vesting of early-exercised stock
    options


















119











119Issuance and modification of
    warrants






112























Issuance of Series D
    convertible preferred stock, net of issuance costs of $73


8,666



19,927























Stock-based compensation expense


















5











5Reclassification of warrants to
    liabilities






(226
)






















Comprehensive loss:Net loss


























(19,185
)Foreign currency translation
    adjustment






















(29
)


Total comprehensive loss






























(19,214
)Balances as of January 1,
    2006


41,789



59,549



6,906







324



(29
)


(49,670
)


(49,375
)Common stock issued in connection
    with early-exercises of stock options










333



















Common stock issued in connection
    with all other exercises of stock options










1,655







324











324Common stock issued in connection
    with exercises of warrants










245



















Vesting of early-exercised stock
    options


















143











143Repurchase of shares of unvested
    common stock










(57
)


















Issuance of Series E
    convertible preferred stock, net of issuance costs of $55


1,707



9,945























Conversion of mandatorily
    redeemable convertible preferred stock to common stock


(43,496
)


(69,494
)


43,496



1



69,493











69,494Sale of common stock, net of
    offering expenses










8,941







105,685











105,685Conversion of mandatorily
    redeemable convertible preferred stock warrants to common stock
    warrants


















9,338











9,338Stock-based compensation expense


















640











640Comprehensive loss:Net loss


























(25,438
)Unrealized gain on marketable
    securities






















14



Reclassification of unrealized gain
    on marketable securities to income upon sale






















(14
)


Foreign currency translation
    adjustment






















(54
)


Total comprehensive loss






























(25,492
)Balances as of December 31,
    2006





$




61,519


$
1


$
185,947


$
(83
)

$
(75,108
)

$
110,757    64




---



##### Table of Contents



Isilon
    Systems, Inc.
  Consolidated
    Statements of Cash Flows
  Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(In thousands)Cash flows from operating
    activitiesNet loss

$
(25,438
)

$
(19,185
)

$
(12,543
)Adjustments to reconcile net loss
    to net cash used in operating activities:Depreciation and amortization


4,169



2,596



1,026Realized gain on sale of marketable
    securities


(14
)






Non-cash interest expense


646



69



33Excess and obsolete inventory
    expense


393



1,019



203Stock-based compensation expense


640



5



4Gain on exchange of product for
    property and equipment










(69
)Loss on disposal of property and
    equipment


76







Warrant revaluation expense


8,431



141



Changes in operating assets and
    liabilities:Accounts receivable, net


(16,526
)


(4,515
)


(2,735
)Inventories


(1,022
)


(1,826
)


(1,913
)Other current assets


(1,444
)


(172
)


(207
)Accounts payable


3,200



1,113



1,571Accrued liabilities, compensation
    payable and deferred rent


1,754



1,280



992Deferred revenue and customer
    deposits


7,835



1,064



1,840Net cash used in operating
    activities


(17,300
)


(18,411
)


(11,798
)Cash flows from investing
    activitiesPurchases of property and equipment


(5,340
)


(3,733
)


(2,589
)Purchases of marketable securities


(691
)


(3,253
)


Sales of marketable securities


2,508



1,450



3,200Proceeds from sale of property and
    equipment


32







Net cash (used in) provided by
    investing activities


(3,491
)


(5,536
)


611Cash flows from financing
    activitiesProceeds from issuance of preferred
    stock, net


9,945



19,927



16,393Proceeds from issuance of common
    stock


108,801



183



224Proceeds from notes payable


54,524



13,467



1,617Payments of initial public offering
    costs


(1,376
)






Payments of notes payable and
    capital lease obligations


(62,061
)


(7,398
)


(416
)Net cash provided by financing
    activities


109,833



26,179



17,818Effect of exchange rate changes on
    cash and cash equivalents


4



3



Net increase in cash and cash
    equivalents


89,046



2,235



6,631Cash and cash equivalents at
    beginning of period


10,853



8,618



1,987Cash and cash equivalents at end of
    period

$
99,899


$
10,853


$
8,618Supplemental disclosure of cash
    flow informationCash paid for interest

$
1,141


$
243


$
60Cash paid for taxes


17







Non-cash investing and financing
    activities:Additions to property and equipment
    included in accounts payable


231



722



730Vesting of early-exercised stock
    options


143



119



88Additions to property and equipment
    provided by lessor


2,417







Issuance and modifications of
    warrants for deferred financings costs






112



90Debt discount resulting from the
    issuance of warrants


540







Additions to property and equipment
    through capital lease










28Unrealized (loss) gain on
    marketable securities


14







(1
)Accrued initial public offering
    costs


1,033







Conversion of mandatorily
    redeemable convertible preferred stock warrants to common stock
    warrants


9,338







    65




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
  1.
    Organization
    and Significant Accounting Policies  Organization
    Significant
    Accounting Policies
  Fiscal
    Year End
  52/53-week
  Accounting
    Principles
    Basis
    of Consolidation
    Use of
    Estimates
    Cash
    and Cash Equivalents
    As ofDecember 31,


January 1,2006


2006(In thousands)Bank deposits

$
6,891


$
6,549Money market funds


93,008



2,756Commercial paper






1,098U.S. government securities






450$
99,899


$
10,853  66




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Marketable
    Securities
  available-for-sale,
    Gross


GrossOriginal


Unrealized


Unrealized


FairCost


Gains


Losses


Value(In thousands)As of January 1,
    2006Corporate bonds and notes

$
907


$
1


$
(1
)

$
907U.S. government securities


896











896$
1,803


$
1


$
(1
)

$
1,803       Allowance
    for Doubtful Accounts
    Inventories
    Property
    and Equipment
   67




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    EstimatedUseful LivesSoftware and computer equipment


1 to 3 yearsFurniture, office equipment and
    other


2 to 3 yearsLeasehold improvements


1 to 7 years     Software
    Development Costs
    Impairment
    of Long-Lived Assets
    Fair
    Value of Financial Instruments
  available-for-sale
  Concentration
    of Risk
   68




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Year EndedDecember 31,


January 1,


January 2,2006


2006


2005% of Total RevenueEastman Kodak Company


10
%


20
%


60
%Comcast Corporation(1)


16



3



All other customers


74



77



40Total


100
%


100
%


100
%   As ofDecember 31,


January 1,2006


2006% of Gross Accounts ReceivableEastman Kodak Company


18
%


10
%Comcast Corporation(1)


6



11All other customers


76



79Total


100
%


100
%     (1)
    
    Comcast Corporation purchases through one of the Companys
    resellers, Computer Design and Integration LLC.    Revenue
    Recognition
    No. 97-2, Software Revenue Recognition SOP 97-2, SOP No. 98-9, Modification of
    SOP No. 97-2,
    Software Revenue Recognition, with Respect to Certain
    Transactions SOP 98-9,
 69




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     SOP 98-9,
  SOP 97-2, SOP 97-2.
  Warranties
    Guarantees
    Research
    and Development
    Advertising
   70




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Operating
    Leases
    Income
    Taxes
    Foreign
    Currency Translation and Transactions
    Accounting
    for Stock-Based Compensation
  Accounting for Stock Issued to Employees Accounting for Certain
    Transactions Involving Stock Compensation Accounting for Stock-Based
    Compensation Accounting for Stock-Based Compensation 
    Transition and Disclosure
  Share-Based Payment
     71




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    No. 96-18, Accounting for Equity Instruments That Are Issued to Other
    Than Employees for Acquiring, or in Conjunction with
    Selling Goods or Services No. 96-18,
  Other
    Comprehensive Income (Loss)
    Cumulative
    Effect of Change in Accounting Principle
  No. 150-5, Issuers Accounting under FASB Statement No. 150
    for Freestanding Warrants and Other Similar Instruments on
    Shares That Are Redeemable 150-5. 150-5 150-5 150-5 150-5,
 72




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(In thousands, except per share data)Net loss per common share, basic
    and diluted:Loss before cumulative effect of
    change in accounting principle

$
(3.02
)

$
(3.93
)

$
(3.61
)Cumulative effect of change in
    accounting principle






(0.02
)


Net loss per common share, basic
    and diluted

$
(3.02
)

$
(3.95
)

$
(3.61
)Denominator for basic and diluted
    net loss per common share


8,423



4,852



3,474   Recent
    Accounting Pronouncements
  Accounting for Servicing of Financial Assets  an
    amendment of FASB Statement No. 140 Accounting for Transfers and Servicing of Financial Assets
    and Extinguishment of Liabilities available-for-sale Accounting for Certain Investments in
    Debt and Equity Securities
  No. 06-3, How Sales Taxes Collected from Customers and Remitted to
    Governmental Authorities Should Be Presented in the Income
    Statement (That Is, Gross Versus Net Presentation) 06-3, No. 06-3. No. 06-3
  Accounting for Uncertainty in Income Taxes
  Fair Value Measurements
 73




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    2.
    Initial
    Public Offering  Form S-1
    3.
    Net Loss
    Per Common Share  No. 03-6, Participating Securities and the Two 
    Class Method under FASB Statement 128 No. 03-6,
  No. 03-6
    As ofDecember 31,


January 1,


January 2,2006


2006


2005Options to purchase common stock


6,753,969



4,766,233



3,549,919Common stock subject to vesting
    provisions


921,292



1,480,710



1,830,848Mandatorily redeemable convertible
    preferred stock






41,788,922



33,122,822Warrants to purchase mandatorily
    redeemable convertible preferred stock


129,992



214,492



110,3267,805,253



48,250,357



38,613,915   4.
    Inventories   74




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      As ofDecember 31,


January 1,2006


2006(In thousands)Components

$



$
88Finished goods


1,530



1,678Evaluation units


2,057



1,192$
3,587


$
2,958   5.
    Property
    and Equipment    As ofDecember 31,


January 1,2006


2006(In thousands)Software and computer equipment

$
8,569


$
6,610Furniture, office equipment and
    other


3,581



1,499Leasehold improvements


3,308



43215,458



8,541Less: accumulated depreciation and
    amortization


(8,300
)


(4,377
)$
7,158


$
4,164     6.
    Notes Payable  36-month
 75




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##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
                7.  Mandatorily
    Redeemable Convertible Preferred Stock and Stockholders
    Equity (Deficit)
  1-for-2.4
 76




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Mandatorily
    Redeemable Convertible Preferred Stock
      As ofJanuary 1,2006(In thousands)Mandatorily redeemable convertible
    preferred stock, par value $0.00001Series A: 7,987 shares
    authorized; 7,958 shares issued and outstanding ; $8,356
    liquidation preference

$
8,279Series B: 13,706 shares
    authorized; 3,706 shares issued and outstanding; $15,000
    liquidation preference


14,950Series C: 11,644 shares
    authorized ; 11,458 shares issued and outstanding; $0 and
    $16,500 liquidation preference


16,393Series D: 9,167 shares
    authorized; 8,666 shares issued and outstanding; $20,000
    liquidation preference


19,927Series E: no shares
    authorized; no shares issued and outstanding; $0 liquidation
    preference


Total mandatorily redeemable
    convertible preferred stock

$
59,549       Voting
    Dividends
   77




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Liquidation
    Preference
    Conversion
    Warrants
    Number of SharesSubject to WarrantsExercise


Expiration

December 31,


January 1,Issue Date

Price


Date

2006


2006Warrants to purchase convertible
    preferred stockSeries A

June 2001

$
1.05


March 2011






28,729Series C

June 2004


1.44


June 2014






81,597Series C

March 2005


1.44


March 2015






104,166Series D

March 2006


2.3078


March 2016






194,986Warrants to purchase common stock

March 2006


2.3078


March 2016


129,992



129,992



409,478    78




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
             Stock
    Options and Unvested Common Stock
       79




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Number of


Weighted-AverageUnvested Shares


Exercise/PurchaseOutstanding


PriceBalance as of January 1, 2004


1,844,262



0.08Issued


1,202,583



0.16Vested


(1,215,997
)


0.07Balance as of January 2, 2005


1,830,848



0.14Issued


462,498



0.31Vested


(812,636
)


0.15Balance as of January 1, 2006


1,480,710



0.19Issued


333,332



1.16Vested


(836,105
)


0.18Forfeited


(56,645
)


0.22Balance as of December 31,
    2006


921,292



0.55    80




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Weighted-Number of


AverageShares


ExerciseOutstanding


PriceBalance as of January 1, 2004


1,708,936



0.12Options granted


3,595,452



0.21Options exercised


(1,530,618
)


0.15Options forfeited


(223,851
)


0.15Balance as of January 2, 2005


3,549,919



0.20Options granted


2,172,444



0.31Options exercised


(732,394
)


0.25Options forfeited


(223,736
)


0.23Balance as of January 1, 2006


4,766,233



0.24Options granted


4,370,390



2.73Options exercised


(1,987,730
)


0.36Options forfeited


(394,924
)


1.05Balance as of December 31,
    2006


6,753,969



1.77       As of December 31, 2006Weighted-Shares


Average


Weighted-Subject


Remaining


Average


TotalExercise

to Options


Contractual


Exercise


IntrinsicPrices

Outstanding


Life (in Years)


Price


Value(1)(Dollars in thousands, except per share data)$ 0.12 - 0.48


2,864,183



7.9


$
0.260.85 - 1.35


2,713,151



9.2



0.983.70 - 5.36


418,731



9.7



4.536.12


379,164



9.8



6.128.12


124,578



9.9



8.1213.00


254,162



10.0



13.00$ 0.12 - 13.00


6,753,969



8.8



1.77


$
172,901Exercisable


1,200,199



7.9



0.30


$
32,486Vested and expected to vest


7,499,762



8.7



1.54


$
193,682     (1)
    
    The total intrinsic value represents the difference between the
    aggregate estimated fair value of the Companys common
    stock issuable and the aggregate exercise price payable. 81




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Risk-free interest rate

4.5% - 5.1%Expected life

4 yearsDividend yield

NoneVolatility

47 - 59%       8.
    Current
    and Deferred Income Taxes    Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(In thousands)Domestic

$
(25,577
)

$
(19,096
)

$
(12,543
)Foreign


248







$
(25,329
)

$
(19,096
)

$
(12,543
)     Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(In thousands)Domestic  current and
    deferred

$



$



$
Foreign  current and
    deferred


109







Total income tax expense

$
109


$



$
  82




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Year EndedDecember 31,


January 1,


January 2,2006


2006


2005Income tax at statutory rate


34.0
%


34.0
%


34.0
%State taxes, net of federal benefit


2.1



2.4



2.2Permanent difference


(11.3
)






Other






(0.1
)


Change in valuation allowance


(25.2
)


(36.3
)


(36.2
)Total


(0.4
)%



%



%     As ofDecember 31,


January 1,2006


2006(In thousands)Deferred tax assets, current:Inventories

$
350


$
424Deferred rent


127



Other


702



391Total gross deferred taxes, current


1,179



815Deferred tax assets, non-current:Net operating loss carryforwards


12,733



7,736Capitalized research and
    development


6,823



7,831Deferred revenue


1,273



917Deferred rent


790



Property and equipment


936



909Total gross deferred taxes,
    non-current


22,555



17,393Gross deferred tax assets


23,734



18,208Less: valuation allowance


(23,734
)


(18,208
)Net deferred tax assets

$



$
    83




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   9.
    401(k)
    Savings Plan    10.
    Segment
    Information  Disclosures About Segments of an
    Enterprise and Related Information
    Year EndedDecember 31,


January 1,


January 2,2006


2006


2005(In thousands)United States of America

$
47,449


$
17,559


$
7,397Japan


6,344



2,128



191Other


8,486



1,396



65Total

$
62,279


$
21,083


$
7,653   11.
    Commitments
    and Contingencies      Fiscal 2007

$
2,064Fiscal 2008


2,302Fiscal 2009


2,342Fiscal 2010


2,470Fiscal 2011


2,612Thereafter


5,980$
17,770  84




---



##### Table of Contents



Isilon
    Systems, Inc.
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    90-day
    12.
    Quarterly
    Results of Operations (unaudited)    Q1


Q2


Q3


Q4(In thousands, except per share data)Year ended December 31,
    2006Total revenue

$
10,423


$
13,414


$
17,786


$
20,656Gross profit


5,397



7,019



9,344



11,188Total operating expenses


9,669



11,356



13,224



14,076Loss from operations


(4,272
)


(4,337
)


(3,880
)


(2,888
)Net loss


(4,518
)


(5,497
)


(5,014
)


(10,409
)Net loss per common share, basic
    and diluted diluted

$
(0.79
)

$
(0.89
)

$
(0.70
)

$
(0.72
)Shares used in computing basic and
    diluted net loss per common share


5,709



6,177



7,172



14,550Year ended January 1,
    2006Total revenue

$
3,607


$
3,299


$
5,473


$
8,704Gross profit


1,681



1,642



1,682



4,503Total operating expenses


5,957



6,672



7,369



8,538Loss from operations


(4,276
)


(5,030
)


(5,687
)


(4,035
)Loss before cumulative effect of
    change in accounting principle


(4,292
)


(5,033
)


(5,688
)


(4,083
)Cumulative effect of change in
    accounting principle










(89
)


Net loss


(4,292
)


(5,033
)


(5,777
)


(4,083
)Net loss per common share, basic
    and diluted:Prior to cumulative effect of
    change in accounting principle

$
(0.97
)

$
(1.07
)

$
(1.13
)

$
(0.78
)Cumulative effect of change in
    accounting principle










(0.02
)


$
(0.97
)

$
(1.07
)

$
(1.15
)

$
(0.78
)Shares used in computing basic and
    diluted net loss per common share


4,426



4,708



5,021



5,251  85




---



##### Table of Contents



ITEM 9.
    Changes
    in and Disagreements with Accountants on Accounting and
    Financial Disclosure    ITEM 9A.
    Controls
    and Procedures          ITEM 9B.
    Other
    Information   PART III    ITEM 10.
    Directors
    and Executive Officers of the Registrant     86




---



##### Table of Contents



ITEM 11.
    Executive
    Compensation    ITEM 12.
    Security
    Ownership of Certain Beneficial Owners and Management and
    Related Stockholder Matters    ITEM 13.
    Certain
    Relationships and Related Transactions    ITEM 14.
    Principal
    Accounting Fees and Services   PART IV  ITEM 15.
    Exhibits,
    Financial Statement Schedules  (a)
  1.
    Consolidated Financial Statements.    2.
    Financial Statement Schedules.  Schedule II 
    Valuation and Qualifying Accounts and Reserves
  Balance at


Charges to





Balance atBeginning of


Cost and





End ofDescription

Period


Expenses


Deductions


Period(In thousands)Year ended December 31, 2006Allowance for doubtful accounts

$
239


$
501


$
(239
)

$
501Income tax valuation allowance


18,208



5,267







23,475Year ended January 1, 2006Allowance for doubtful accounts

$
116


$
257


$
(134
)

$
239Income tax valuation allowance


10,299



7,909







18,208Year ended January 2, 2005Allowance for doubtful accounts

$
12


$
116


$
(12
)

$
116Income tax valuation allowance


6,078



4,221







10,299     3.
    Exhibits.   87




---



##### Table of Contents



SIGNATURES      By:
    /s/  Steven
    Goldman     POWER OF
    ATTORNEY
  attorney-in-fact attorneys-in-fact attorneys-in-fact
    Signature

Title

Date/s/  Steven
    GoldmanSteven
    Goldman

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

March 14, 2007/s/  Stuart
    W. FuhlendorfStuart
    W. Fuhlendorf

Chief Financial Officer and
    Vice President of Finance
    (Principal Accounting and
    Financial Officer)

March 14, 2007/s/  Sujal
    M. PatelSujal
    M. Patel

Chief Technology Officer
    and Director

March 14, 2007/s/  Elliott
    H. Jurgensen, Jr.Elliott
    H. Jurgensen, Jr.

Director

March 14, 2007/s/  William
    D. RuckelshausWilliam
    D. Ruckelshaus

Chairman of Board of Directors
    and Director

March 14, 2007/s/  Barry
    J. FidelmanBarry
    J. Fidelman

Director

March 14, 2007 88




---



##### Table of Contents



Signature

Title

Date/s/  Gregory
    L. McAdooGregory
    L. McAdoo

Director

March 14, 2007/s/  Matthew
    S. McllwainMatthew
    S. Mcllwain

Director

March 14, 2007/s/  James
    G. RichardsonJames
    G. Richardson

Director

March 14, 2007  89




---



##### Table of Contents



INDEX TO
    EXHIBITS
  ExhibitNumber

Description3
.1*

Amended and Restated Certificate
    of Incorporation of the registrant.3
.2*

Amended and Restated Bylaws of the
    registrant.4
.1*

Form of registrants common
    stock certificate.4
.2*

Fourth Amended and Restated
    Investors Rights Agreement between the registrant and
    certain of its security holders dated July 19, 2006.10
.1*

Form of Indemnification Agreement.10
.2*

Amended and Restated 2001 Stock
    Plan.10
.3*

Form of Stock Option Agreement
    under the Amended and Restated 2001 Stock Plan.10
.4*

2006 Equity Incentive Plan.10
.5*

Form of Stock Option Agreement
    under the 2006 Equity Incentive Plan.10
.6*

2006 Employee Stock Purchase Plan.10
.7*

Form of Subscription Agreement
    under the 2006 Employee Stock Purchase Plan.10
.8*

Offer Letter with Steven Goldman
    dated July 17, 2003.10
.9*

Offer Letter with Eric J. Scollard
    dated October 4, 2002.10
.1*

Offer Letter with Mark L. Schrandt
    dated October 3, 2003.10
.11*

Offer Letter with Brett G. Goodwin
    dated March 10, 2002.10
.12*

Offer Letter with John W. Briant
    dated September 29, 2004.10
.13*

Offer Letter with Stuart W.
    Fuhlendorf dated March 29, 2004.10
.14*

Offer Letter with Thomas P.
    Pettigrew dated December 22, 2003.10
.15*

Manufacturing Services Agreement
    between the registrant and Sanmina-SCI Corporation dated
    February 17, 2006.10
.16*

Office Lease between the
    registrant and Selig Holdings Company dated November 11,
    2005.10
.17*

First Amendment to Office Lease
    between the registrant and Selig Holdings Company dated
    December 2, 2005.10
.18*

Second Amendment to Office Lease
    between the registrant and Selig Holdings Company dated
    August 4, 2006.10
.19*

Venture Loan and Security
    Agreement between the registrant and Horizon Technology Funding
    Company LLC dated March 22, 2006.10
.20*

Amendment to Venture Loan and
    Security Agreement between the registrant and Horizon Technology
    Funding Company LLC dated July 18, 2006.10
.21*

Loan and Security Agreement
    between the registrant and Silicon Valley Bank dated
    June 24, 2004.10
.22*

Amendment to Loan and Security
    Agreement between the registrant and Silicon Valley Bank dated
    March 10, 2005.10
.23*

Amendment to Loan and Security
    Agreement between the registrant and Silicon Valley Bank dated
    March 21, 2005.10
.24*

Amendment to Loan and Security
    Agreement between the registrant and Silicon Valley Bank dated
    June 29, 2005.10
.25*

Amendment to Loan Documents
    between the registrant and Silicon Valley Bank dated
    March 22, 2006.10
.26*

Amendment to Loan Documents
    between the registrant and Silicon Valley Bank dated
    July 18, 2006.10
.29*

Warrant to Purchase Stock issued
    by registrant to Horizon Technology Funding Company III
    LLC, dated March 22, 2006.10
.30*

Warrant to Purchase Stock issued
    by registrant to Horizon Technology Funding Company III
    LLC, dated March 22, 2006.10
.32*

Offer Letter with Gwen Weld dated
    June 5, 2006.10
.33*

Offer Letter with James Richardson
    dated October 2, 2006. 90




---



##### Table of Contents



ExhibitNumber

Description23
.1

Consent of PricewaterhouseCoopers
    LLP, independent registered public accounting firm.24
.1*

Power of Attorney.31
.1

Rule 13a-14(a)/15d-14(a)
    Certification of Chief Executive Officer.31
.2

Rule 13a-14(a)/15d-14(a)
    Certification of Chief Financial Officer.32
.1

Section 1350 Certification of
    Chief Executive Officer.32
.2

Section 1350 Certification of
    Chief Financial Officer.     *
    
    Previously filed.  
    
    Registrant has omitted portions of the referenced exhibit and
    filed such exhibit separately with the Securities and Exchange
    Commission pursuant to a grant of confidential treatment under
    Rule 406 promulgated under the Securities Act of 1933. 91