UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
  
 
 FORM
10-Q
  (Mark One)x
              
              QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For
the quarterly period ended March 31, 2009
 
 OR
   ̈
              
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934
 
 For
the transition period
from                                                                to
 
 Commission
file number: 001-33517
 
 Data
Domain, Inc.
 (Exact
name of registrant as specified in its charter)
  
  Delaware
              
              94-3412175(State
      or Other Jurisdiction of Incorporation or Organization)
              
              (IRS
      Employer Identification No.)2421
      Mission College Blvd., Santa Clara, CA
              
              95054(Address
      of Principal Executive Offices)
              
              (Zip
      Code)Registrant’s
      Telephone Number, Including Area Code
              
              (408)
      980-4800
 
 
 Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.    Yes  x
    No   ̈
 
 Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such
files).       Yes   ̈
    No   ̈
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company. See the definitions of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check
one):
   ̈  Large
      accelerated filer
              
              x  Accelerated
      filer
              
               ̈  Non-accelerated
      filer
              
               ̈  Smaller reporting
      company(Do
      not check if a smaller reporting
company)
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).    Yes   ̈    No  x
 
 The
number of outstanding shares of the registrant’s common stock as of April 30,
2009 was 61,284,046.
 
 
 
 
 1
 
 
 
 
 
 
 INDEX
  PART I. FINANCIAL
    INFORMATION
              
              Page No.Item 1.
              
              Financial Statements
      (unaudited)
              
              3Condensed Consolidated Balance Sheets as of March
      31, 2009 and December 31, 2008
              
              3Condensed Consolidated Statements of Income for
      the three months ended March 31, 2009 and 2008
              
              4Condensed Consolidated Statements of Cash Flows
      for the three months ended March 31, 2009 and 2008
              
              5Notes to Condensed Consolidated Financial
      Statements
              
              6Item 2.
              
              Management’s Discussion and Analysis of Financial
      Condition and Results of Operations
              
              21Item 3.
              
              Quantitative and Qualitative Disclosures About
      Market Risk
              
              27Item 4.
              
              Controls and Procedures
              
              28PART II. OTHER INFORMATIONItem 1.
              
              Legal Proceedings
              
              29Item 1A.
              
              Risk Factors
              
              29Item 2.
              
              Unregistered Sales of Equity Securities and Use of
      Proceeds
              
              38Item 6.
              
              Exhibits
              
              38
   2
 
 PART I.
FINANCIAL INFORMATION
 
 Item
      1.
              Financial
      Statements
  
  DATA
DOMAIN, INC.
  CONDENSED
CONSOLIDATED BALANCE SHEETS
 (in
thousands)
 
 March 31,
              
              
              December 31,2009
              
              
              2008Current
      Assets:
              
              (unaudited)Cash
      and cash equivalents
              
              $
              119,167
              
              
              $
              128,380Short-term
      investments
              
              
              127,685
              
              
              
              105,512Accounts
      receivable (net of allowances of $250 and $120,
    respectively)
              
              
              60,563
              
              
              
              60,322Inventories,
      net
              
              
              4,051
              
              
              
              4,638Deferred
      tax asset, net
              
              
              8,517
              
              
              
              7,531Prepaid
      expenses and other current assets
              
              
              4,737
              
              
              
              5,116Total
      current assets
              
              
              324,720
              
              
              
              311,499Long-term
      investments
              
              
              30,931
              
              
              
              30,866Long-term
      deferred tax asset, net
              
              
              5,629
              
              
              
              5,629Intangible
      asset
              
              
              100
              
              
              
              133Property,
      plant and equipment, net
              
              
              39,333
              
              
              
              38,854Total
      assets
              
              $
              400,713
              
              
              $
              386,981Current
      Liabilities:Accounts
      payable
              
              $
              10,804
              
              
              $
              10,970Accrued
      compensation and related benefits
              
              
              11,692
              
              
              
              16,720Other
      accrued liabilities
              
              
              8,267
              
              
              
              10,441Income
      taxes payable
              
              
              2,150
              
              
              
              1,051Deferred
      revenue, current
              
              
              43,749
              
              
              
              39,321Total
      current liabilities
              
              
              76,662
              
              
              
              78,503Deferred
      revenue, non-current
              
              
              31,985
              
              
              
              28,399Long-term
      exercised unvested stock options
              
              
              260
              
              
              
              285Other
      liabilities
              
              
              2,058
              
              
              
              2,910Commitments
      and contingenciesStockholders’
      equity:Common
      stock and additional paid-in capital
              
              
              308,619
              
              
              
              295,564Accumulated
      other comprehensive loss
              
              
              (1,451
              )
              
              
              (10
              )Accumulated
      deficit
              
              
              (17,420
              )
              
              
              (18,670
              )Total
      stockholders’ equity
              
              
              289,748
              
              
              
              276,884Total
      liabilities and stockholders’ equity
              
              $
              400,713
              
              
              $
              386,981
 
 
 
 See Notes
to Condensed Consolidated Financial Statements
 
 
 3
 
 DATA
DOMAIN, INC.
  CONDENSED
CONSOLIDATED STATEMENTS OF INCOME
 (in
thousands, except per share data)
 (unaudited)
  Three
      months endedMarch
      31,
                2009
              
              
              March
      31,
                2008Revenue:Product
              
              $
              63,921
              
              
              $
              45,247Support
      and services
              
              
              15,115
              
              
              
              7,368Total
      revenue
              
              
              79,036
              
              
              
              52,615Cost
      of revenue:Cost
      of product
              
              
              17,295
              
              
              
              11,317Cost
      of support and services
              
              
              5,536
              
              
              
              2,489Total
      cost of revenue
              
              
              22,831
              
              
              
              13,806Gross
      profit
              
              
              56,205
              
              
              
              38,809Operating
      expenses:Sales
      and marketing
              
              
              32,726
              
              
              
              23,232Research
      and development
              
              
              14,211
              
              
              
              8,736General
      and administrative
              
              
              7,146
              
              
              
              5,606Total
      operating expenses
              
              
              54,083
              
              
              
              37,574Operating
      income
              
              
              2,122
              
              
              
              1,235Other
      income (expense), net:Interest
      income
              
              
              1,041
              
              
              
              2,163Other
      income (expense), net
              
              
              77
              
              
              
              1,243Total
      other income (expense), net
              
              
              1,118
              
              
              
              3,406Income
      before provision for income taxes
              
              
              3,240
              
              
              
              4,641Provision
      for income taxes
              
              
              1,990
              
              
              
              1,900Net
      income
              
              $
              1,250
              
              
              $
              2,741Net
      income per share, basic
              
              $
              0.02
              
              
              $
              0.05Net
      income per share, diluted
              
              $
              0.02
              
              
              $
              0.04Shares
      used in computing net income per share, basic
              
              
              60,157
              
              
              
              56,414Shares
      used in computing net income per share, diluted
              
              
              65,739
              
              
              
              65,378
 
 
 See Notes
to Condensed Consolidated Financial Statements
  4
 
 DATA DOMAIN, INC.
  CONDENSED
CONSOLIDATED STATEMENT OF CASH FLOWS
 (in
thousands)
 (unaudited)
 
 
 Three
      months endedMarch
      31,
                  2009
              
              
              March
      31,
                  2008Cash
      flows from operating activities:Net
      income
              
              $
              1,250
              
              
              $
              2,741Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and
      amortization
              
              
              2,576
              
              
              
              1,201Stock-based
      compensation
      expense
              
              
              6,462
              
              
              
              5,380Tax
      benefit from employee stock
      transactions
              
              
              1,382
              
              
              
              —Excess
      tax benefit from stock-based
      compensation
              
              
              (1,382
              )
              
              
              —Deferred
      income
      taxes
              
              
              (986
              )
              
              
              —Provision
      for accounts receivable
      allowances
              
              
              130
              
              
              
              4Amortization
      of evaluation units in
      inventory
              
              
              580
              
              
              
              654Loss
      on value of option to put
      securities
              
              
              1,527
              
              
              
              —Mark-to-market,
      trading
      gain
              
              
              (1,592
              )
              
              
              —Changes
      in operating assets and liabilities:(Increase)
      decrease in accounts
      receivable
              
              
              (371
              )
              
              
              4,945(Increase)
      decrease in
      inventories
              
              
              7
              
              
              
              (826
              )(Increase)
      decrease in prepaid expenses and other current assets
              
              
              379
              
              
              
              (1,242
              )Increase
      (decrease) in accounts
      payable
              
              
              (166
              )
              
              
              1,562Decrease
      in accrued compensation and related
      benefits
              
              
              (5,028
              )
              
              
              (3,092
              )Increase
      (decrease) in other accrued
      liabilities
              
              
              (3,026
              )
              
              
              595Increase
      in income taxes
      payable
              
              
              1,099
              
              
              
              1,743Increase
      in deferred
      revenue
              
              
              8,014
              
              
              
              6,360Net
      cash provided by operating
      activities
              
              
              10,855
              
              
              
              20,025Cash
      flows from investing activities:Purchases
      of property, plant and
      equipment
              
              
              (3,022
              )
              
              
              (8,349
              )Purchases
      of available-for-sale
      securities
              
              
              (57,075
              )
              
              
              (42,004
              )Proceeds
      from maturity of available-for-sale
      securities
              
              
              34,389
              
              
              
              49,400Net
      cash used in investing
      activities
              
              
              (25,708
              )
              
              
              (953
              )Cash
      flows from financing activities:Excess
      tax benefit from stock-based
      compensation
              
              
              1,382
              
              
              
              —Proceeds
      from issuance of common stock, net of
      repurchases
              
              
              5,186
              
              
              
              4,501Net
      cash provided by financing
      activities
              
              
              6,568
              
              
              
              4,501Effect
      of exchange rate changes on cash and cash
      equivalents
              
              
              (928
              )
              
              
              10Net
      increase (decrease) in cash and cash
      equivalents
              
              
              (9,213
              )
              
              
              23,583Cash
      and cash equivalents at beginning of the
      period
              
              
              128,380
              
              
              
              102,939Cash
      and cash equivalents at end of the
      period
              
              $
              119,167
              
              
              $
              126,522Supplemental
      disclosure of cash flow information:Cash
      paid for income
      taxes
              
              $
              260
              
              
              $
              248
 
 
 See Notes
to Condensed Consolidated Financial Statements
  5
 
 DATA DOMAIN, INC.
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (unaudited)
 
  1.
ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
  
  Organization
  Data
Domain, Inc. was incorporated in the State of Delaware in October 2001. Our
appliances provide storage solutions for backup and archive applications based
on deduplication technology. We began selling our products and services in
February 2004. Our product sales generally include a software license, hardware,
post-contract customer support and, in some cases, installation and professional
services.
 
  Summary
of Significant Accounting Policies
   Basis
of Presentation
  The
condensed consolidated financial statements include our accounts and the
accounts of our wholly-owned subsidiaries. Intercompany transactions and
balances have been eliminated. The accompanying condensed consolidated balance
sheet as of March 31, 2009, the condensed consolidated statements of income for
the three months ended March 31, 2009 and 2008, and the condensed consolidated
statements of cash flows for the three months ended March 31, 2009 and 2008 are
unaudited. The condensed consolidated balance sheet data as of December 31, 2008
was derived from the audited consolidated financial statements which are
included in our annual report on Form 10-K filed with the Securities and
Exchange Commission, or SEC, on March 13, 2009. The accompanying financial
statements should be read in conjunction with the audited consolidated financial
statements and related notes contained in such Form 10-K.
   The
accompanying condensed consolidated financial statements have been prepared in
accordance with United States generally accepted accounting principles, or GAAP,
pursuant to the rules and regulations of the SEC. They do not include all of the
financial information and footnotes required by GAAP for complete financial
statements. We believe the unaudited condensed consolidated financial statements
have been prepared on the same basis as the audited financial statements and
include all adjustments necessary for the fair presentation of our statement of
financial position as of March 31, 2009, our results of operations for the three
months ended March 31, 2009 and 2008, and our cash flows for the three months
ended March 31, 2009 and 2008. All such adjustments are of a normal recurring
nature. The results for the three months ended March 31, 2009 are not
necessarily indicative of the results to be expected for any subsequent quarter
or for the fiscal year ending December 31, 2009.
   Use
of Estimates
   The
preparation of financial statements in conformity with GAAP requires us to make
certain estimates and judgments that can affect the reported amounts of assets
and liabilities as of the date of the condensed consolidated financial
statements, as well as the reported amounts of revenue and expenses during the
periods presented. Significant estimates and assumptions made by management
include revenue recognition, the determination of the fair value of stock
awards, inventory valuation, warranty reserve, the allowance for doubtful
accounts, short and long-term investments and the accounting for income taxes.
We believe that the estimates and judgments upon which we rely are reasonable
based upon information available to us at the time that these estimates and
judgments are made. To the extent there are material differences between these
estimates and actual results, our condensed consolidated financial statements
will be affected.
   Revenue
Recognition
   We derive
our revenue from sales of our products and support services through third-party
value added resellers and distributors, or channel partners, and directly to
customers. Product revenue primarily consists of revenue from sales of our
appliances and expansion shelves. Revenues are recorded net of customer returns
for certain direct customers which are estimated at the time of sale. Shipping
charges billed to customers are included in product revenue and the related
shipping costs are included in cost of product revenue.
   Our
software is integrated with our industry standard appliance hardware and is
essential to the functionality of the integrated system product. We provide
unspecified software updates and enhancements related to our products through
support and services contracts. Accordingly, we recognize revenue in accordance
with the guidance provided under the American Institute of Certified Public
Accountants, or AICPA, Statement of Position No. 97-2, Software Revenue Recognition,
or SOP 97-2, and No. 98-9, Modification of SOP No. 97-2
Software Revenue Recognition with Respect to Certain Transactions, or SOP
98-9. Product revenue is recognized when all of the following have occurred: (1)
we have entered into a legally binding arrangement with a customer; (2) delivery
has occurred, which is when the product title has transferred to the customer;
(3) customer payment is deemed fixed or determinable and free of contingencies
and significant uncertainties; and (4) collection is probable. Our fees are
considered fixed or determinable upon the establishment of an arrangement that
contains the final terms of sale including the description, quantity and price
of each product purchased. Our indirect channel partner arrangements do not
include rights of return or acceptance provisions. We assess the ability to
collect from our customers based on a number of factors, including
creditworthiness and past transaction history of the customer. If the customer
is deemed not creditworthy, all revenue from the arrangement is deferred until
payment is received and all other revenue recognition criteria have been
met.
   Substantially
all of our products have been sold in combination with support and services,
which primarily consist of hardware and software support. Hardware support
includes repair or replacement in the event of breakage or failure, and
telephone and internet access to technical information and support personnel
during the term of the support period. Software support provides customers with
rights to unspecified software updates and to maintenance releases and patches
released during the term of the support period. Installation or professional
services, when provided, are also included in support and services revenue. We
have established vendor specific objective evidence, or VSOE, of fair value of
our support and services as measured by the renewal prices offered to and paid
by our customers. Accordingly, we use the residual method, as allowed by SOP
98-9, to determine the amount of product revenue to be recognized. Under the
residual method, the fair value of the undelivered support and services, which
is a specified dollar amount, is deferred and the remaining portion of the
arrangement is recognized as product revenue. This product revenue is generally
recognized upon shipment, except for certain customers whose terms are FOB
destination point wherein the revenue is recognized upon delivery, based on
freight terms of FOB shipping point or FCA (Incoterms 2000) shipping point,
assuming all other criteria for revenue recognition discussed above have been
met and, in the case of all indirect channel sales, persuasive evidence of the
identity of the end customer has been obtained. In all cases of direct or
indirect channel sales, we recognize revenue once an end customer is identified
and shipment has occurred, assuming all other criteria for revenue recognition
discussed above have been met. The fair value of the support and services is
recognized as support and services revenue on a straight-line basis over the
term of the related support period, which is typically one to three
years.
   Product
sales sometimes include installation services. Installation revenue is deferred
and recognized upon the earlier of customer notice that the installation is
complete or sixty days after shipment. We have established VSOE of fair value
for our installation services based on the price separately charged to our
customers. Revenue from installation, which is included in support and services
revenue, was $1.0 million and $851,000 for the three months ended March 31,
2009 and 2008, respectively.
  6
 Stock-Based
Compensation
  We
account for stock-based compensation using the fair value method in accordance
with the provisions of Statement of Financial Accounting Standards, or SFAS, No.
123 (Revised 2004), Share-Based Payment, or SFAS
123R, and Securities Exchange Commission Staff Accounting Bulletin No. 107, or
SAB 107. We recognize this expense on a straight-line basis over the optionees’
requisite service period, which is the same as the vesting schedule of the
options. We estimate the grant date fair value of stock option awards under the
provisions of SFAS 123R using the Black-Scholes option valuation model, which
requires the input of highly subjective assumptions, including the expected life
of the share-based award and stock price volatility. The assumptions used in
calculating the fair value of stock-based compensation represent management’s
best estimates, but these estimates involve inherent uncertainties and the
application of management judgment. In addition, we are required to estimate the
expected forfeiture rate and only recognize expense for those awards expected to
vest. If our actual forfeiture rate is materially different from our estimate,
the stock-based compensation expense could be materially different.
  We
account for stock compensation arrangements with non-employees in accordance
Emerging Issues Task Force, or EITF, No. 96-18,Accounting for Equity Instruments
That Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services, using a fair value approach. For stock
options granted to non-employees, the fair value of the stock options is
estimated using a Black-Scholes valuation model. This model utilizes the
estimated fair value of common stock and requires that we use the contractual
term of the option, the expected volatility of the price of our common stock,
risk free interest rates and expected dividend yield of our common stock.
Non-employee stock options have a contractual term of four to ten years,
expected volatility of 65-70% and no dividend yield. Stock-based compensation
expense associated with grants to non-employees was zero and $148,000 for the
three months ended March 31, 2009 and 2008, respectively.
  Cash and Cash Equivalents and
Short-Term and Long-term
Investments
 
 Cash and Cash Equivalents.We
consider all highly liquid investments purchased with an original maturity of 90
days or less to be cash equivalents. Cash and cash equivalents are stated at
cost, which approximates fair value.
  Short-term and Long-term
Investments. Our investments are comprised of money market funds,
commercial paper, corporate bonds, auction-rate securities and U.S. government
agency securities. Investments with original maturities greater than
approximately three months and remaining maturities less than one year are
classified as short-term investments as these investments are considered
available for current operations. Investments with remaining maturities greater
than one year are classified as long-term investments. All investments, except
for auction-rate securities, are designated as available-for-sale and are
therefore reported at fair value, with unrealized gains and losses recorded in
accumulated other comprehensive income (loss). Unrealized gains or losses
amounted to $154,000 of net unrealized losses and $362,000 of net unrealized
gains at March 31, 2009 and December 31, 2008, respectively. During the
fourth quarter of fiscal 2008, we reclassified our auction-rate securities from
available-for-sale to trading securities, which are reported at fair value, with
gains or losses resulting from changes in fair value recognized in earnings. See
Note 2, “Cash and Investments and Fair Value Measurements” for further detailed
discussion. The cost of securities sold is based on the specific identification
method. Realized gains and losses on the sale of investments are recorded in
other income (expense), net.
   Effective
January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements, or
SFAS 157. In February 2008, the FASB issued FSP 157-2, Effective Date of FASB Statement No.
157, or FSP 157-2, which delayed the effective date of SFAS 157 for all
non-financial assets and non-financial liabilities, except for items that are
recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually), until the beginning of the first quarter of 2009.
Effective January 1, 2009, we adopted FSP 157-2 for non-financial assets and
non-financial liabilities. The adoption of FSP 157-2 did not have a significant
impact on our condensed consolidated financial statements. SFAS 157 defines fair
value, establishes a framework for measuring fair value under GAAP and enhances
disclosures about fair value measurements. Fair value is defined under SFAS 157
as the exchange price that would be received for an asset or paid to transfer a
liability (an exit price) in the principal or most advantageous market for the
asset or liability in an orderly transaction between market participants on the
measurement date. Valuation techniques used to measure fair value under SFAS 157
must maximize the use of observable inputs and minimize the use of unobservable
inputs. See Note 2, “Cash and Investments and Fair Value Measurements,” of our
condensed consolidated financial statements.
   Other-Than-Temporary
Impairment. All of our available-for-sale investments are subject to a
periodic impairment review. We recognize an impairment charge when a decline in
the fair value of our investments below our cost basis is judged to be
other-than-temporary. We consider various factors in determining whether to
recognize an impairment charge, including the length of time and extent to which
the fair value has been less than our cost basis, the financial condition and
near-term prospects of the investee, and our intent and ability to hold the
investment for a period of time sufficient to allow for any anticipated recovery
in the market value. No other-than-temporary impairment charges were recorded on
any of our available-for-sale investments during the three months ended March
31, 2009 and 2008, respectively.
  Fair
Value of Financial Instruments
  The
carrying amounts of cash and cash equivalents, accounts receivable, accounts
payable and income taxes payable approximate their fair values due to the
short-term maturity of these instruments. Beginning in the first quarter of
fiscal 2008, the assessment of fair value is based on the provisions of SFAS
157. We determine the fair values for cash equivalents, short-term investments
and long-term investments using industry standard pricing services, data
providers and other third-party sources and by performing valuation analyses.
See Note 2, “Cash and Investments and Fair Value Measurements,” of our condensed
consolidated financial statements for details of the valuation
methodologies.
  Concentrations
of Risk
  Financial
instruments that are potentially subject to concentrations of credit risk
consist primarily of cash and cash equivalents and accounts receivable.
Investment policies have been implemented that limit investments to investment
grade securities. We conduct business outside of North America in Europe and
Asia Pacific, and are considering other regions. The risk with respect to
accounts receivable is mitigated by credit evaluations we perform on our
customers and by the diversification of our customer base. Historically, we have
not hedged any of our foreign currency risk associated with accounts receivable.
No individual customer has represented more than 10% of our total revenue in the
three months ended March 31, 2009 and 2008.
  We
purchase all of our appliances from our contract manufacturer, Flextronics
International, or Flextronics. Our capacity expansion shelves and the chassis
for our DD 6XX appliances are currently supplied exclusively by a single vendor,
Xyratex Technology Limited, or Xyratex. Our appliances depend on NVRAM cards
that currently are only available from a single vendor, Curtiss-Wright
Corporation. Any disruption in our suppliers’ ability to timely procure
necessary components in the quantities required, or at reasonable prices, could
result in a delay in the shipment of our appliances.
  Foreign
Currency Translation
  The
majority of our sales arrangements are denominated in United States dollars or
Euros, while a smaller portion of our sales agreements are denominated in
Canadian dollars, British sterling and Australian dollars. In addition, we incur
operating expenses in local foreign currencies in those countries where we have
sales and marketing and administrative personnel. The functional currency of our
foreign operations is the local country’s currency. Consequently, expenses of
operations outside the United States are translated into United States dollars
using average exchange rates for the period reported, while assets and
liabilities of operations outside the United States are translated into United
States dollars using end-of-period exchange rates. The effects of foreign
currency translation of the financial statements of our foreign operations are
included in stockholders’ equity as a component of accumulated other
comprehensive loss in the accompanying condensed consolidated balance sheets.
The effects of foreign currency remeasurements for non-U.S. currency denominated
assets and liabilities related to our domestic operations are recognized in our
condensed consolidated statements of income, and amounted to a gain of $12,000
and $1.2 million for the three months ended March 31, 2009 and 2008,
respectively.
  7
 Allowance
for Doubtful Accounts
  We
perform credit evaluations of our customers’ financial condition and generally
do not require collateral from our customers. These evaluations require
significant judgment and are based on a variety of factors including, but not
limited to, current economic trends, historical payments, bad debt write-off
experience and financial review of the customer.
  We
maintain an allowance for doubtful accounts for estimated losses resulting from
the inability or unwillingness of our customers to make required payments. When
we become aware that a specific customer is unable or unwilling to meet its
financial obligations, we record a specific allowance to reflect the level of
credit risk in the customer’s outstanding receivable balance. In addition, we
record additional allowances based on certain percentages of aged receivable
balances. We classify bad debt expenses against revenue. For the three months
ended March 31, 2009 and 2008, we did not have any write-offs of accounts
receivable. To date, our accounts receivable write-offs have not been
significant and the allowance for doubtful accounts has not been
material.
  Inventory
Valuation
  Inventories
consist of hardware and related component parts and are stated at the lower of
cost (on a first-in, first-out basis) or market value. Finished goods constitute
a large portion of our inventory and include customer evaluation units which are
carried at cost less accumulated amortization. We amortize the cost of these
evaluation units on a straight-line basis over twelve months upon the initial
transfer of a unit into the evaluation pool. The cost of the amortization of
evaluation units is included in cost of product revenue. If an evaluation unit
is purchased, we record a sale pursuant to our revenue recognition policy. We
assess the valuation of our inventory on a quarterly basis and write down the
value for estimated excess and obsolete inventory based upon estimates of future
demand, including warranty requirements. Inherent in our estimates of market
value in determining inventory valuation are estimates related to economic
trends, future demand for our products and technological obsolescence of our
products.
  Inventory
write-downs are recorded in cost of product revenue and have not been material
in any period. Spares are expensed as part of our warranty accrual to cost of
product revenue. We do not allocate indirect overhead costs to finished goods
inventory as these amounts are not material.
  We
outsource the assembly of our products to a third-party manufacturing facility
under an annual contract which renews automatically but may be terminated by
either party with 90 days’ written notice. We also purchase some finished
products from a single source supplier under a three-year agreement that expires
in March 2010. At March 31, 2009, we had $18.4 million of non-cancellable
purchase commitments with a third-party supplier.
  Warranty
Reserve
  Upon
shipment of products to our customers, we provide for the estimated cost to
repair or replace products that may be returned under warranty. Our warranty
period is typically 12 months from the date of shipment to the customer for
hardware and 90 days for software. For existing products, the warranty reserve
is based on actual historical experience. For new products, the warranty reserve
is based on historical experience of similar products until such time as
sufficient historical data has been collected for the new product. To the extent
there are differences between our estimates and actual results, our condensed
consolidated financial statements will be affected. The following table is a
summary of our warranty activity that is included in other accrued liabilities
in the condensed consolidated balance sheets:
  March
      31,
              
              
              March
      31,(in
      thousands)
              
              2009
              
              
              2008Warranty
      reserve—beginning
              
              $
              668
              
              
              $
              596Warranty
      expense
              
              
              420
              
              
              
              229Warranty
      usage
              
              
              (542
              )
              
              
              (263
              )Warranty
      reserve—ending
              
              $
              546
              
              
              $
              562
  Income
Taxes
  We
account for income taxes in accordance with SFAS No. 109,Accounting for Income Taxes,or SFAS 109. Deferred income taxes are recorded for the expected tax
consequences of temporary differences between the tax bases of assets and
liabilities for financial reporting purposes and amounts recognized for income
tax purposes. Effective January 1, 2007, we adopted Financial Accounting
Standards Interpretation, or FIN, No. 48,Accounting for Uncertainty in
Income Taxes—an interpretation of FASB Statement No. 109, or FIN
48.
  Comprehensive
Income (Loss)
  Comprehensive
income (loss) consists of net income and changes in accumulated other
comprehensive loss. Comprehensive income (loss) for the three months ended March
31, 2009 and 2008 was as follows:
  Three
      months endedMarch
      31,
              
              
              March
      31,(in
      thousands)
              
              2009
              
              
              2008Net
      income
              
              $
              1,250
              
              
              $
              2,741Change
      in unrealized loss on available-for-sale investments
              
              
              (516
              )
              
              
              (1,322
              )Foreign
      currency translation adjustments
              
              
              (925
              )
              
              
              10Comprehensive
      income (loss)
              
              $
              (191
              )
              
              $
              1,429
  Accumulated
other comprehensive loss presented in the accompanying condensed consolidated
balance sheets consists of foreign currency translation and unrealized gains and
losses on available-for-sale investments, net of taxes, for all periods
presented:
  March
      31,
              
              
              December
      31,(in
      thousands)
              
              2009
              
              
              2008Accumulated
      net unrealized gain (loss) on:Available-for-sale
      investments
              
              $
              (154
              )
              
              $
              362Foreign
      currency translations
              
              
              (1,297
              )
              
              
              (372
              )Total
      accumulated other comprehensive loss
              
              $
              (1,451
              )
              
              $
              (10
              )
  8
 Recent
Accounting Pronouncements
 
 In April
2009, the FASB issued FASB Staff Position, or FSP, No. 141(R)-1, Accounting for Assets Acquired and
Liabilities Assumed in a BusinessCombination That Arise from
Contingencies, or FSP 141(R)-1. FSP 141(R)-1 amends and clarifies FASB
Statement No. 141 (revised 2007), Business Combinations, to
address application issues raised by preparers, auditors, and members of
the legal profession on initial recognition and measurement, subsequent
measurement and accounting, and disclosure of assets and liabilities
arising from contingencies in a business combination. FSP 141(R)-1 is
effective for business combinations occurring after the beginning of the
first annual reporting period beginning on or after December 15, 2008. The
impact of FSP 141(R)-1 will depend upon the nature, terms, and size of the
acquisitions we consummate after the effective date, if any.
 
 In April
2009, the FASB issued FSP FAS No. 107-1 and APB 28-1, Interim Disclosures about Fair Value
of Financial Instruments, or FSP 107-1. This FSP amends FASB Statement
No. 107, Disclosures about
Fair Value of Financial Instruments, to require disclosures about fair
value of financial instruments for interim reporting periods of publicly
traded companies as well as in annual financial statements. This FSP also
amends APB Opinion No. 28, Interim Financial Reporting,
to require those disclosures in summarized financial information at
interim reporting periods. This FSP shall be effective for interim
reporting periods ending after June 15, 2009, with early adoption permitted
for periods ending after March 15, 2009. An entity may early adopt this FSP
only if it also elects to early adopt FSP FAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly, or FSP
157-4, and FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments. This FSP does not require
disclosures for earlier periods presented for comparative purposes
at initial adoption. In periods after initial adoption, this FSP requires
comparative disclosures only for periods ending after initial adoption. The
adoption of FSP 107-1 is not expected to have an impact on our consolidated
results of operations or financial condition.
 
 In April
2009, the FASB issued FSP No. 115-2 and FAS 124-2, Recognition and Presentation of
Other-than-Temporary Impairments, or FSP 115-2. This FSP amends the
other-than-temporary impairment guidance in U.S. GAAP for debt securities
to make the guidance more operational and to improve the presentation and
disclosure of other-than-temporary impairments on debt and equity
securities in the financial statements. This FSP does not amend existing
recognition and measurement guidance related to other-than-temporary
impairments of equity securities. FSP 115-2 shall be effective for interim and
annual reporting periods ending after June 15, 2009, with early adoption
permitted for periods ending after March 15, 2009. Earlier adoption for
periods ending before March 15, 2009, is not permitted. If an entity elects to
adopt early either FSP 157-4 or FSP 107-1, the entity also is required
to adopt early this FSP. Additionally, if an entity elects to adopt early
this FSP, it is required to adopt FSP FAS 157-4. This FSP does not
require disclosures for earlier periods presented for comparative purposes
at initial adoption. In periods after initial adoption, this FSP requires
comparative disclosures only for periods ending after initial adoption. We
are currently evaluating the impact of FSP 115-2, although the adoption of FSP
115-2 is not expected to have a material impact on our consolidated results of
operations or financial condition.
 
 In April
2009, the FASB issued FSP No. 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly, or FSP
157-4. This FSP provides additional guidance for estimating fair value in
accordance with FAS 157, when the volume and level of activity for the
asset or liability have significantly decreased. This FSP also includes
guidance on identifying circumstances that indicate a transaction is
not orderly. FSP 157-4 shall be effective for interim and annual reporting
periods ending after June 15, 2009, and shall be applied prospectively.
Early adoption is permitted for periods ending after March 15, 2009.
Earlier adoption for periods ending before March 15, 2009, is not
permitted. If a reporting entity elects to adopt early either FSP 115-2 or FSP
107-1, the reporting entity also is required to adopt early this
FSP. Additionally, if the reporting entity elects to adopt early this FSP,
FSP 115-2 also must be adopted early. This FSP does not require disclosures for
earlier periods presented for comparative purposes at initial adoption. In
periods after initial adoption, this FSP requires comparative disclosures
only for periods ending after initial adoption. The adoption of FSP 157-4
is not expected to have a material impact on our consolidated results of
operations or financial condition.
  
 9
  2. CASH
AND INVESTMENTS AND FAIR VALUE MEASUREMENTS
 
  We
consider all highly liquid investments purchased with an original maturity of 90
days or less to be cash equivalents. Cash and cash equivalents consist primarily
of highly liquid investments in time deposits held at major banks, commercial
paper, U.S. government agency securities and other money market securities.
Investments with original maturities greater than approximately three months and
remaining maturities less than one year are classified as short-term investments
as these investments are considered available for current operations.
Investments with remaining maturities greater than one year are classified as
long-term investments. All investments, except for auction-rate securities, are
designated as available-for-sale and are therefore reported at fair value, with
unrealized gains and losses recorded in accumulated other comprehensive loss.
Unrealized gains or losses amounted to $154,000 of net unrealized losses and
$362,000 of net unrealized gains at March 31, 2009 and December 31, 2008,
respectively. As of March 31, 2009, all of our debt securities classified as
available-for-sale had maturities of one year or less.  During the
fourth quarter of fiscal 2008, we reclassified our auction-rate securities from
available-for-sale to trading securities, which are reported at fair value, with
gains or losses resulting from changes in fair value recognized in
earnings.
  The
following tables summarize our cash and investments classified as
available-for-sale as of March 31, 2009 and December 31, 2008:
 
 (in
      thousands)
              
              Adjusted
      Cost at
                March 31,
                2009
              
              
              Gross
                Unrealized
                Gains
              
              
              Gross
                Unrealized
                Losses
              
              
              Fair
                Value
      at
                March 31,
                2009Cash
      and cash equivalents:Cash
              
              $
              63,525
              
              
              $
              —
              
              
              $
              —
              
              
              $
              63,525Money
      market funds
              
              
              55,642
              
              
              
              —
              
              
              
              —
              
              
              
              55,642Total
      cash and cash equivalents
              
              
              119,167
              
              
              
              —
              
              
              
              —
              
              
              
              119,167Short-term
      investments:Commercial
      paper
              
              
              2,990
              
              
              
              —
              
              
              
              (5
              )
              
              
              2,985Corporate
      bonds
              
              
              42,565
              
              
              
              33
              
              
              
              (316
              )
              
              
              42,282U.S.
      government agencies
              
              
              82,284
              
              
              
              137
              
              
              
              (3
              )
              
              
              82,418Total
      short-term investments
              
              
              127,839
              
              
              
              170
              
              
              
              (324
              )
              
              
              127,685Total
      cash and cash equivalents and short-term investments
              
              $
              247,006
              
              
              $
              170
              
              
              $
              (324
              )
              
              $
              246,852
  
 (in
      thousands)
              
              Adjusted
      Cost at
                December 31,
                2008
              
              
              Gross
                Unrealized
                Gains
              
              
              Gross
                Unrealized
                Losses
              
              
              Fair
                Value
      at
                December 31,
                2008Cash
      and cash equivalents:Cash
              
              $
              51,019
              
              
              $
              —
              
              
              $
              —
              
              
              $
              51,019Commercial
      paper
              
              
              5,875
              
              
              
              3
              
              
              
              —
              
              
              
              5,878Money
      market funds
              
              
              63,942
              
              
              
              —
              
              
              
              —
              
              
              
              63,942Corporate
      bonds
              
              
              1,018
              
              
              
              —
              
              
              
              —
              
              
              
              1,018U.S.
      government agencies
              
              
              6,521
              
              
              
              2
              
              
              
              —
              
              
              
              6,523Total
      cash and cash equivalents
              
              
              128,375
              
              
              
              5
              
              
              
              —
              
              
              
              128,380Short-term
      investments:Commercial
      paper
              
              
              12,957
              
              
              
              29
              
              
              
              —
              
              
              
              12,986Corporate
      bonds
              
              
              26,472
              
              
              
              89
              
              
              
              (62
              )
              
              
              26,499U.S.
      government agencies
              
              
              65,726
              
              
              
              302
              
              
              
              (1
              )
              
              
              66,027Total
      short-term investments
              
              
              105,155
              
              
              
              420
              
              
              
              (63
              )
              
              
              105,512Total
      cash and cash equivalents and short-term investments
              
              $
              233,530
              
              
              $
              425
              
              
              $
              (63
              )
              
              $
              233,892
 
  The
following table summarizes at March 31, 2009, those available-for-sale
securities that were in an unrealized loss position, the fair value and gross
unrealized losses aggregated by type of investment instrument and the length of
time that individual securities have been in a continuous unrealized loss
position. All unrealized losses on our available-for-sale investments have been
in a continuous unrealized loss position for less than 12 months. Investments
that were in an unrealized gain position have been excluded from the
table:
  Less
      than 12 months(in
      thousands)
              
              Fair
      Value
              
              
              Gross
      Unrealized LossesCorporate
      bonds
              
              $
              31,218
              
              
              $
              (316
              )Commercial
      paper
              
              
              2,985
              
              
              
              (5
              )U.S.
      government agencies
              
              
              8,599
              
              
              
              (3
              )Total
              
              $
              42,802
              
              
              $
              (324
              )
 
  10
 The gross
unrealized losses on the investments in corporate bonds and U.S. government
agencies were the result of overall market aversion, lack of demand for
securities that are non-government guaranteed, and the relative widening of
credit spreads relative to the U.S. treasuries. Gross unrealized losses on all
available-for-sale securities at March 31, 2009 are considered temporary in
nature. Factors considered in determining whether a loss is temporary include
the length of time and extent to which fair value has been less than the cost
basis and our intent and ability to hold an investment for a period of time
sufficient to allow for any anticipated recovery in market value.
   As of
March 31, 2009, we had auction-rate securities with a face value of $31.0
million that had a fair value of $27.7 million. In February 2008, auctions began
to fail for these securities and each auction since then has failed. An auction
failure means that the parties wishing to sell securities could not. As a
result, our ability to liquidate these auction-rate securities and fully recover
the carrying value of these investments in the near term may be limited or not
exist. All of our auction-rate securities are currently AAA-rated by at least
one rating agency.  Our auction-rate securities are taxable municipal
revenue bond obligations which are supported by higher education student loan
trusts.  These trusts contain student loans which are substantially
backed by the U.S. Federal Government, via the U.S. Department of Education's
Higher Education Act, which is known as the Federal Family Education Loan
Program (FFELP). Based on the overall failure rate of these auctions, the
frequency of the failures, and the underlying maturities of the securities, a
portion of which are up to 40 years, we have classified auction-rate securities
as long-term investments on our balance sheet.
   In
November 2008, we signed a broad-based settlement proposal from UBS in which we
have the right to sell the securities back to affiliates of UBS at par during
the period from June 30, 2010 to July 2, 2012 if liquidity does not return to
the auction-rate securities market sooner.  The affiliates of UBS will
retain the right to sell our auction-rate securities on our behalf, without
prior notification, at any time prior to July 2, 2012 as long as we receive par
value from such sale. Although we expect to exercise our right, if we do not
exercise it before July 2, 2012, it will expire and UBS will have no further
rights or obligations to buy our auction-rate securities. The auction-rate
securities will continue to accrue interest as determined by the auction process
or the terms outlined in the prospectus of the auction-rate securities if the
auction process fails.
  The
enforceability of this right results in a put option that is accounted for
separately from the auction-rate securities. The put option represents a firm
agreement in accordance with FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities, which defines a firm agreement with
an unrelated party, binding on both parties and usually legally enforceable,
with the following characteristics: a) the agreement specifies all significant
terms, including the quantity to be exchanged, the fixed price, and the timing
of the transaction, and b) the agreement includes a disincentive for
nonperformance that is sufficiently large to make performance probable. We
elected to account for this put option at fair value under FASB Statement No.
159, The Fair Value Option for
Financial Assets and Liabilities, or SFAS 159.
   Prior to
acquiring the put option, we recorded our auction-rate securities as
available-for-sale investments, and therefore recorded resulting unrealized
gains or losses, net of tax, in accumulated other comprehensive income in
stockholders’ equity. In connection with the acquisition of the put option, we
reclassified our auction-rate securities from available-for-sale to trading
securities. The transfer to trading securities reflects management’s intent to
exercise the put option during the period June 30, 2010 to July 2,
2012.
   The fair
value of the put option of $3.2 million is included in the condensed
consolidated balance sheet as of March 31, 2009 as a long-term
investment.  The net effect of the fair value of the put option and
the fair value of the auction-rate securities for the three months ended March
31, 2009 was a gain of $65,000, which was recorded in other income (expense),
net in our condensed consolidated statement of income. We believe that
subsequent changes in the value of the put option will largely offset the
subsequent fair value movements of the auction-rate securities, subject to the
continued expected performance by UBS of its obligations under the
agreement.
  Fair
Value Measurements
  Effective
January 1, 2008, we adopted SFAS 157. In February 2008, the FASB, issued FSP
157-2, which provides a one year deferral of the effective date of SFAS 157 for
non-financial assets and non-financial liabilities, except those that are
recognized or disclosed in the financial statements at fair value at least
annually. Effective January 1, 2009, we adopted FSP 157-2 for non-financial
assets and non-financial liabilities. SFAS 157 defines fair value, establishes a
framework for measuring fair value under GAAP and enhances disclosures about
fair value measurements. Fair value is defined under SFAS 157 as the exchange
price that would be received for an asset or paid to transfer a liability (an
exit price) in the principal or most advantageous market for the asset or
liability in an orderly transaction between market participants on the
measurement date. Valuation techniques used to measure fair value under SFAS 157
must maximize the use of observable inputs and minimize the use of unobservable
inputs.
  Our
financial instruments are measured and recorded at fair value. Our non-financial
assets, such as intangible assets and property, plant and equipment are measured
at fair value when there is an indicator of impairment and recorded at fair
value only when an impairment charge is recognized. The adoption of this
statement did not have a material impact on our condensed consolidated results
of operations and financial condition.
  In
February 2007, the FASB issued SFAS 159. SFAS 159 permits companies to choose to
measure many financial instruments and certain other items at fair value that
are not currently required to be measured at fair value and establishes
presentation and disclosure requirements designed to facilitate comparisons
between companies that choose different measurement attributes for similar types
of assets and liabilities.  We elected not to adopt the fair value
option on existing eligible financial instruments as of January 1, 2008.
However, because the SFAS 159 election is based on an instrument-by-instrument
election at the time the company first recognizes an eligible item or enters
into an eligible firm commitment, we may decide to exercise the option on new
items in the future. The adoption of SFAS 159 did not have a significant impact
on our condensed consolidated results of operations and financial
condition.
  The
standard describes a fair value hierarchy based on three levels of inputs, of
which the first two are considered observable and the last unobservable, that
may be used to measure fair value, as follows:
  ·
              Level
      1 - Quoted prices in active markets for identical assets or
      liabilities.·
              Level
      2 - Inputs other than Level 1 that are observable, either directly or
      indirectly, such as quoted prices for similar assets or liabilities;
      quoted prices in markets that are not active; or other inputs that are
      observable or can be corroborated by observable market data for
      substantially the full term of the assets or
  liabilities.·
              Level
      3 - Unobservable inputs that are supported by little or no market activity
      and that are significant to the fair value of the assets or
      liabilities.
  Instruments
that are classified within Level 1 of the fair value hierarchy generally include
most money market securities.  Determination of fair value for Level 1
instruments does not require significant judgment or estimation. Instruments
that are classified within Level 2 of the fair value hierarchy generally include
U.S. agency securities, commercial paper and corporate bonds. We determine the
fair values for these instruments using industry standard pricing services, data
providers and other third-party sources.
  11
 In
accordance with SFAS 157, the following table represents our fair value
hierarchy for our financial assets (cash equivalents and short-term and
long-term investments) measured at fair value on a recurring basis as of March
31, 2009:
  
 (in
      thousands)
              
              Level
      1
              
              
              Level
      2
              
              
              Level
      3
              
              
              TotalMoney
      market funds
              
              $
              55,642
              
              
              $
              —
              
              
              $
              —
              
              
              $
              55,642Commercial
      paper
              
              
              —
              
              
              
              2,985
              
              
              
              —
              
              
              
              2,985Auction-rate
      securities
              
              
              —
              
              
              
              —
              
              
              
              27,703
              
              
              
              27,703Put
      option
              
              
              —
              
              
              
              —
              
              
              
              3,228
              
              
              
              3,228Corporate
      bonds
              
              
              —
              
              
              
              42,282
              
              
              
              —
              
              
              
              42,282U.S.
      government agencies
              
              
              —
              
              
              
              82,418
              
              
              
              —
              
              
              
              82,418Total
              
              $
              55,642
              
              
              $
              127,685
              
              
              $
              30,931
              
              
              $
              214,258
 
 Level 3
instruments consist of auction-rate securities whose underlying assets are
generally taxable municipal revenue bond obligations which are supported by
higher education student loan trusts and the UBS put option. Currently there is
not an active market for the auction-rate securities, and therefore they do not
have a readily determinable market value. At March 31, 2009, the auction-rate
securities had a face value of $31.0 million and were valued at a fair value of
$27.7 million. The fair value of these auction-rate securities was determined
using a discounted cash flow pricing model that incorporated financial inputs
such as projected cash flows, discount rates, expected interest rates to be paid
to investors and an estimated liquidity discount. The weighted average life over
which cash flows were projected was determined to be approximately five years,
given the collateral composition of the securities and related historical and
projected prepayments. The discount rates that were applied to the pricing model
were based on market data and information for comparable or similar term student
loan asset-backed securities. The expected interest rate to be paid to investors
in a failed auction was determined by the contractual terms for each security.
The liquidity discount represents an estimate of the additional return an
investor would require to compensate for the lack of liquidity of the student
loan auction-rate securities. Because there can be no assurance of a successful
auction in the future, all of our auction-rate securities are recorded in
long-term investments.
  We valued
the UBS put option using a discounted cash flow approach including estimates of,
based on data available as of March 31, 2009, interest rates, timing and amount
of cash flows, adjusted for any bearer risk associated with UBS’s financial
ability to repurchase the auction-rate securities beginning June 30, 2010. Based
on the discounted cash flow model, we determined the fair value of the put
option to be $3.2 million. Any change in these assumptions and market conditions
would affect the value of this put option.
  The
following table provides a reconciliation for all financial instruments measured
at fair value using significant unobservable inputs (Level 3) for the three
months ended March 31, 2009:
  (in
      thousands)
              
              Put
      Option
              
              
              Auction-rate
      SecuritiesBalance
      at December 31,
      2008
              
              $
              4,755
              
              
              $
              26,111Total
      gains (losses) included in
      earnings
              
              
              (1,527
              )
              
              
              1,592Balance
      at March 31, 2009
              
              $
              3,228
              
              
              $
              27,703
  
  12
  3. INVENTORIES
  Inventories
consisted of the following:
  
 March
      31,
              
              
              December
      31,(in
      thousands)
              
              2009
              
              
              2008Raw
      materials and
      accessories
              
              $
              1,662
              
              
              $
              876Evaluation
      units,
      net
              
              
              1,466
              
              
              
              2,672Finished
      goods
              
              
              923
              
              
              
              1,090Total
              
              $
              4,051
              
              
              $
              4,638
 
 Amortization
related to evaluation units was $580,000 and $654,000 for the three months ended
March 31, 2009 and 2008, respectively.
  13
 4.
DEFERRED REVENUE
  Deferred
revenue consisted of the following:
  March
      31,
              
              
              December
      31,(in
      thousands)
              
              2009
              
              
              2008Product
              
              $
              298
              
              
              $
              924Support
      and services
              
              
              43,544
              
              
              
              38,589Less:
      deferred cost of product revenue
              
              
              (93
              )
              
              
              (192
              )Deferred
      revenue, current
              
              $
              43,749
              
              
              $
              39,321Support
      and services, non-current
              
              $
              31,985
              
              
              $
              28,399Deferred
      revenue, non-current
              
              $
              31,985
              
              
              $
              28,399
  Deferred
product revenue relates to arrangements where not all revenue recognition
criteria have been met. Deferred support and services revenue represents
customer payments made in advance for annual support and services contracts.
Support and services contracts are typically billed in advance on a per annum
basis and revenue is recognized ratably over the support period. All customers
are known to us upon sale of our appliances.
  14
 5.
GUARANTEES
  Our
agreements with our channel partners and customers generally include certain
provisions for indemnifying the channel partners and customers against
liabilities if our products infringe a third party’s intellectual property
rights. To date, we have not incurred any material costs as a result of such
indemnification provisions and have not accrued any liabilities related to such
obligations in our condensed consolidated financial statements.
  As
permitted or required under Delaware law and to the maximum extent allowable
under that law, we have certain obligations to indemnify our officers, directors
and certain key employees for certain events or occurrences while the officer,
director or employee is or was serving at our request in such capacity. These
indemnification obligations are valid as long as the director, officer or
employee acted in good faith and in a manner the person reasonably believed to
be in or not opposed to the best interests of the corporation, and, with respect
to any criminal proceeding, had no reasonable cause to believe his or her
conduct was unlawful. The maximum potential amount of future payments we could
be required to make under these indemnification obligations is unlimited;
however, we have a director and officer insurance policy that mitigates our
exposure and generally enables us to recover a portion of any future amounts
paid.
  15
 6.
NET INCOME PER SHARE
  Basic net
income per share is computed by dividing net income by the weighted average
number of common shares outstanding during the period. Diluted net income per
share is computed by giving effect to all potential dilutive common shares,
including options, common stock subject to repurchase and convertible preferred
stock.
  The
following table sets forth the computation of net income per share:
  Three
      months ended(in
      thousands, except per share amounts)
              
              March
      31,
                2009
              
              
              March
      31,
                2008Net
      income
              
              $
              1,250
              
              
              $
              2,741Shares
      used in computing net income per share, basic
              
              
              60,157
              
              
              
              56,414Net
      income per share, basic
              
              $
              0.02
              
              
              $
              0.05Dilutive
      potential common shares:Weighted
      average common shares
      outstanding
              
              
              60,157
              
              
              
              56,414Incremental
      common shares attributable to exercise of outstanding employee stock
      options, restricted stock and restricted stock units (assuming proceeds
      would be used to purchase common stock)
              
              
              5,582
              
              
              
              8,964Shares
      used in computing net income per share, diluted
              
              
              65,739
              
              
              
              65,378Net
      income per share, diluted
              
              $
              0.02
              
              
              $
              0.04
  The
following weighted average outstanding options and common stock subject to
repurchase were excluded from the computation of diluted net income per share
for the periods presented because including them would have had an antidilutive
effect:
  
 Three
      months ended(in
      thousands)
              
              March
      31,
                2009
              
              
              March
      31,
                2008Options
      to purchase common stock
              
              
              5,536
              
              
              
              939Common
      stock subject to repurchase
              
              
              —
              
              
              
              1,038
  
 16
  7. 
STOCK-BASED COMPENSATION
  Stock-Based
Compensation Plan Activities
  Stock
Options.  A summary of option activity under all of our plans
as of March 31, 2009 and changes during the three months ended March 31, 2009 is
presented below (in thousands, except for the weighted average exercise price
and weighted average remaining contractual term):
  
 Options
      OutstandingAvailable for
      Grant
              
              
              Shares
              
              
              Weighted
      Average Exercise Price
              
              
              Weighted
      Average Remaining Contractual Term
              
              
              Aggregate
      Intrinsic ValueDecember
      31, 2008
              
              
              5,052
              
              
              
              13,765
              
              
              $
              10.49
              
              
              
              7.59
              
              
              $
              132,922Additional
      shares authorized
              
              
              3,008
              
              
              
              —
              
              
              
              —Options
      granted
              
              
              (1,079
              )
              
              
              1,079
              
              
              $
              14.58Restricted
      stock units granted
              
              
              (872
              )
              
              
              —
              
              
              
              —Options
      exercised
              
              
              —
              
              
              
              (567
              )
              
              $
              2.03Options
      forfeited
              
              
              699
              
              
              
              (699
              )
              
              $
              19.19Restricted
      stock units cancelled
              
              
              15
              
              
              
              —
              
              
              
              —March
      31, 2009
              
              
              6,823
              
              
              
              13,578
              
              
              $
              10.72
              
              
              
              7.76
              
              
              $
              70,786Vested
      and expected to vest after March 31, 2009, net of expected
      forfeitures
              
              
              
              
              
              
              12,826
              
              
              $
              10.48
              
              
              
              7.70
              
              
              $
              69,156Exercisable
      at March 31, 2009
              
              
              
              
              
              
              5,457
              
              
              $
              6.16
              
              
              
              6.67
              
              
              $
              46,222
  The
weighted-average grant-date fair value per share of stock options granted was
$7.83 and $11.91 for the three months ended March 31, 2009 and 2008,
respectively. As of March 31, 2009, the total compensation expense related to
options granted to employees but not yet recognized was approximately $54.6
million, net of estimated forfeitures. This expense will be amortized on a
straight-line basis over a weighted average remaining life of approximately 2.67
years.
  Restricted Stock
Awards.  On June 20, 2007, we granted 383,998 shares of
restricted stock, granted at fair value based on the Black-Scholes valuation
model, 10,000 shares of which vested immediately on June 27, 2007 and the
remainder vest over a four year period that commenced on June 27, 2007. In
addition, during the years ended December 31, 2007 and 2006, we awarded
30,000 and 72,270 shares of restricted stock, respectively that granted the
recipient fully vested shares of our common stock based on the deemed market
value of our common stock on the date of grant. As of March 31, 2009, we had
$3.0 million of total unrecognized compensation expense, net of estimated
forfeitures, related to all restricted stock awards, which will be recognized
over a weighted average estimated remaining life of 2.24 years.
  The
following table summarizes unvested restricted stock awards outstanding at
December 31, 2008 and March 31, 2009 and the activity during the three months
(in thousands except for weighted average grant date fair value):
   Shares
              
              
              Weighted
      Average Grant Date Fair ValueUnvested
      stock outstanding at December 31, 2008
              
              
              257
              
              
              $
              15.00Vested
              
              
              (23
              )
              
              $
              15.00Unvested
      stock outstanding at March 31, 2009
              
              
              234
              
              
              $
              15.00
  Restricted Stock
Units.In December 2008, we began issuing RSUs to employees.
The cost of these awards is determined using the fair value of our common stock
on the date of the grant, and compensation is recognized on a straight-line
basis over the requisite service period. No RSUs were vested as of March 31,
2009. As of March 31, 2009, we had $13.5 million of total unrecognized
compensation expense, net of estimated forfeitures, related to RSUs, which will
be recognized over a weighted average estimated remaining life of 3.81
years.
  The
following table summarizes unvested restricted stock awards outstanding at
December 31, 2008 and March 31, 2009 and the activity during the three months
(in thousands except for weighted average grant date fair value):
  
 Shares
              
              
              Weighted
      Average Grant Date Fair ValueUnvested
      stock outstanding at December 31, 2008
              
              
              19
              
              
              $
              18.15Awarded
              
              
              872
              
              
              $
              16.84Forfeited
              
              
              (15
              )
              
              $
              16.85Unvested
      stock outstanding at March 31, 2009
              
              
              876
              
              
              $
              16.87
  Employee Stock
Purchase Plan.Our employee stock purchase plan is compensatory, and we
recognized $645,000 and $1.0 million of expense in the three months ended
March 31, 2009 and 2008, respectively. At March 31, 2009, there was $1.1
million of total unrecognized compensation cost related to the ESPP that is
expected to be recognized over the next 4 months.
  At March
31, 2009 and December 31, 2008, there were 527,000 and 586,000 shares,
respectively, subject to repurchase under all common stock repurchase agreements
upon forfeiture or early termination of employment. The cash received from the
sale of these shares is initially recorded as a liability in long-term exercised
unvested options and is subsequently reclassified to common stock as the shares
vest. At March 31, 2009 and December 31, 2008, there was $260,000 and
$285,000, respectively, recorded in non-current liabilities related to the
issuance of these shares.
  17
 Stock-Based
Compensation
  We
account for stock-based compensation using the fair value method in accordance
with the provisions of SFAS 123R. We recognize this expense on a straight-line
basis over the optionees’ requisite service period, which is assumed to be the
same as the vesting schedule of the options. We estimate the grant date fair
value of stock option awards under the provisions of SFAS 123R using the
Black-Scholes option valuation model, which requires the input of highly
subjective assumptions, including the expected life of the share-based award and
stock price volatility. The assumptions used in calculating the fair value of
stock-based compensation represent management’s best estimates, but these
estimates involve inherent uncertainties and the application of management
judgment. As a result, if other assumptions had been used, our stock-based
compensation expense could have been materially different. In addition, we are
required to estimate the expected forfeiture rate and only recognize expense for
those awards expected to vest. We estimated the expected forfeiture rate at the
time of grant to be 5%. If our actual forfeiture rate is materially different
from our estimate, the stock-based compensation expense could be materially
different. We will revise the expected forfeiture rate, if necessary, in
subsequent periods if actual forfeitures differ from those
estimated.
  Valuation
Assumptions
  The
following table summarizes the weighted average assumptions used in determining
the fair value of stock options granted and shares issued under our
ESPP:
  Three
      months endedMarch
      31,
                2009
              
              
              March
      31,
                2008Stock
      Option PlansRisk-free
      interest rate
              
              
              2.37
              %
              
              
              2.78
              %Dividend
      yield
              
              
              —
              
              
              
              —Volatility
              
              
              58
              %
              
              
              58
              %Expected
      life (years)
              
              
              5.55
              
              
              
              5.8Employee
      Stock Purchase PlanRisk-free
      interest rate
              
              
              0.33
              %
              
              
              2.78
              %Dividend
      yield
              
              
              —
              
              
              
              —Volatility
              
              
              68
              %
              
              
              58
              %Expected
      life (months)
              
              
              6
              
              
              
              6
   For all
of our stock option grants and issuance of ESPP shares, the risk-free interest
rate is based on the yield available on U.S. Treasury zero-coupon issues with an
equivalent remaining expected life. We have not paid dividends in the past and
do not plan to pay any dividends in the foreseeable future. We estimated our
expected volatility based on reported market value data for a group of publicly
traded companies, which we selected from market indices that we believed were
relatively comparable after consideration of their size, maturity,
profitability, growth, risk and return on investment. We used the average
expected volatility rates reported by the comparable group for an expected term
that approximated the expected term that we estimated. The expected life for
options granted is based on an analysis of our historical exercise and
cancellation data.
  Stock-Based
Compensation Expense
  Stock-based
compensation expense included in our condensed consolidated statements of income
for the three months ended March 31, 2009 and 2008 was as follows:
  Three
      months ended(in
      thousands)
              
              March
      31,
                  2009
              
              
              March
      31,
                  2008Cost
      of product(1)
              
              $
              (115
              )
              
              $
              134Cost
      of support and services
              
              
              6
              
              
              
              121Sales
      and marketing
              
              
              3,192
              
              
              
              2,792Research
      and development
              
              
              1,976
              
              
              
              1,320General
      and administrative
              
              
              1,403
              
              
              
              1,013Total
      stock-based comensation expense
              
              $
              6,462
              
              
              $
              5,380
 ______________________
 (1) The
negative value represents the recapture of expense for those that left within
one year and whose shares were not vested.
 
 18
  8.
INCOME TAXES
 
 We
account for income taxes under the provisions of SFAS No. 109, Accounting for Income Taxes.
Under this method, deferred tax assets and liabilities are recognized based on
the differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases and carryforwards of net
operating losses and tax credits. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. Valuation allowances are established, when necessary, to reduce
deferred tax assets to the amounts that will more likely than not be
realized.
 
 Effective
January 1, 2007, we adopted FASB Interpretation No. 48, or FIN 48. FIN 48
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of uncertain tax positions taken or
expected to be taken in a company’s income tax return, and also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure, and transition.  As a result of the
implementation of FIN 48, we recognized no change in the liability for
unrecognized tax benefits related to tax positions taken in prior periods, and
no corresponding change in retained earnings. Additionally, FIN 48 specifies
that tax positions for which the timing of the ultimate resolution is uncertain
should be recognized as long-term liabilities. We made no reclassifications
between current taxes payable and long-term taxes payable upon adoption of FIN
48.
 
 Upon
adoption of FIN 48, our policy to include interest and penalties related to
unrecognized tax benefits within our provision for income taxes did not change.
The tax years 2002 through 2008 remain open to examination by the major domestic
taxing jurisdictions to which we are subject, and for the international
jurisdictions the tax years open to examination vary depending on the local tax
laws.
 
 On
October 3, 2008, the Emergency Economic Stabilization Act of 2008, Energy
Improvement and Extension Act of 2008 and Tax Extenders and Alternative Minimum
Tax Relief Act of 2008 (HR1424) was signed into law, which, as enacted, includes
a provision that retroactively extends the research tax credit to
January 1, 2008 through December 31, 2009.
 
 We file
federal, state, and foreign income tax returns in many jurisdictions in the
United States and abroad. For U.S. federal and California income tax purposes,
the statute of limitations currently remains open for all years since our
inception due to utilization of net operating losses and research and
development tax credits generated in prior years.
 
 During 2008, we commenced the
implementation of a global strategy that we believe will, in the long run,
result in certain operational benefits as well as provide us with a lower
overall tax rate. There can be no assurances that, when completed,ourefforts will produce the anticipated
operational benefits or provide an overall lower tax rate for the Company. The
expected benefits will depend on a number of factors, including our future
business results and profitability, and the effectiveness and timing of our
implementation of our global strategy, and changes in tax laws or the
interpretation of such tax laws, and changes in generallyaccepted accounting
principles.Wemay experience continued unbenefited
foreign losses and, as a result, higher tax rates untilourglobal strategy is operational. As a
result of undertaking these efforts, we anticipate an overall tax rate in 2009
that is materially higher than our statutory tax rate.
  19
 
 9.
SEGMENT INFORMATION
 
  Statement
of Financial Accounting Standards No. 131,Disclosures about Segments of an
Enterprise and Related Information, establishes standards for reporting
information about operating segments. Operating segments are defined as
components of an enterprise about which separate financial information is
available that is evaluated regularly by the chief operating decision maker, or
decision making group, in deciding how to allocate resources and in assessing
performance. Our chief operating decision maker is our Chief Executive Officer.
Our Chief Executive Officer reviews financial information presented on a
consolidated basis, accompanied by information about revenue by geographic
region for purposes of allocating resources and evaluating financial
performance. We have one business activity and there are no segment managers who
are held accountable for operations, operating results and plans for levels or
components below the consolidated unit level. Accordingly, we consider ourselves
to be in a single reporting segment and operating unit structure.
  Revenue
by geography is based on the billing address of the customer. The following
tables set forth revenue and long-lived assets by geographic area:
  Revenue
  Three
      months ended(in
      thousands)
              
              March
      31,
                2009
              
              
              March
      31,
                2008North
      America
              
              $
              62,666
              
              
              $
              38,646Europe,
      Africa and Middle East
              
              
              13,464
              
              
              
              10,417Asia
      Pacific
              
              
              2,906
              
              
              
              3,552Total
              
              $
              79,036
              
              
              $
              52,615
  For the
above periods presented, no one country outside the United States represented
10% or more of our total revenue.
  Long-lived
Assets
 
 March
      31,
              
              
              December
      31,(in
      thousands)
              
              2009
              
              
              2008Domestic
              
              $
              38,947
              
              
              $
              38,444International
              
              
              386
              
              
              
              410Total
              
              $
              39,333
              
              
              $
              38,854
 
 
 10.
LEGAL MATTERS
 
 From time
to time, we may be involved in various legal proceedings arising in the ordinary
course of business. There were no legal matters at March 31, 2009 that, in the
opinion of management, might have a material adverse effect on our financial
position, results of operations or cash flows.
 
 
 20
 
  Item 2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
 
 The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the condensed consolidated
financial statements and related notes included elsewhere in this Form 10-Q. The
information in this Form 10-Q contains forward-looking statements within the
meaning of Section 27A of the Securities Act and Section 21E of the
Exchange Act. Such statements are based upon current expectations that involve
risks and uncertainties. Any statements contained herein that are not statements
of historical facts may be deemed to be forward-looking statements. For example,
words such as “may,” “will,” “should,” “estimates,” “predicts,” “potential,”
“continue,” “strategy,” “believes,” “anticipates,” “plans,” “expects,” “intends”
and similar expressions are intended to identify forward-looking statements. Our
actual results and the timing of certain events may differ significantly from
the results discussed in the forward-looking statements. Factors that might
cause or contribute to such a discrepancy include, but are not limited to, those
discussed elsewhere in this Form 10-Q in the section titled “Risk Factors.”
Except as required by law, we undertake no obligation to publicly release any
revisions to the forward-looking statements after the date of this Form
10-Q.
 
 Overview
 
 We are a
leading provider of storage solutions for backup and archive applications based
on deduplication technology.  Our deduplication storage systems are
designed to deliver reliable, efficient, and cost-effective solutions that
enable enterprises of all sizes to manage, retain and protect their
data.
 
  We
believe offering a simple-to-manage deduplication storage product family
supporting both high throughput for backup/restore and adaptability to other
nearline applications, such as archiving, provides the application independent,
consolidative infrastructure required for enterprise data protection storage. In
addition to our storage systems, we provide global product support as well as
software updates to customers that purchase a support and services contract, and
we offer professional services.
 
  Our
products and services are designed to meet the demands of data protection for
enterprise backup and archive applications.  To this end, we work with
leading application providers such as Symantec Corporation and F5 Networks to
help ensure reliable, high performance joint deployments. To meet the needs of
backup applications and disaster recovery, our systems must have high throughput
to meet backup windows and sophisticated wide area network, or WAN, replication
options.  To meet the needs of file archiving, our products must support
many millions of files and offer specialized features such as deduplicated
snapshots and governance-oriented file locking.  For both requirements, we
believe the simplifying nature of our inline deduplication technology and
plug-in appliances makes our products cost effective and easy to
manage.
 
  We
shipped the world’s first inline deduplication storage appliance in 2004. Since
then, we have brought to market many significant innovations and industry firsts
in deduplication storage and data management. We sell our appliances to
enterprises worldwide in a variety of industries, including defense, education,
entertainment, finance, government, healthcare, technology, legal, media and
retail. As of March 31, 2009, the total number of customers that have
purchased our appliances since inception was approximately 3,100 customers
worldwide.
 
 We are
headquartered in Santa Clara, California. Our personnel are located throughout
the United States and in numerous countries worldwide. We have grown to
over 820 employees as of March 31, 2009, with operations in over 25
countries around the world. We expect to continue to add personnel in the
United States and internationally to provide additional geographic sales and
technical support coverage.
  We sell
our appliances through a network of channel partners and through our direct
sales force. In the three months ended March 31, 2009 and 2008, approximately
75% and 83%, respectively, of our revenue was generated by sales through
indirect channels. As of March 31, 2009, we had approximately 500 channel
partners, and we expect that we will continue to sell a majority of our products
and services through our channel partners. We consider the development of
indirect sales channels in domestic and international markets to be important to
future revenue growth and widespread acceptance of our products. We intend to
expand these channel partner relationships in the future to further extend our
distribution coverage. Over the past few quarters, we have been migrating toward
a distribution model which incorporates master distributors in a two-tier
distribution model. This model will provide us with various benefits including
lower overall trade and credit risk, but will also result in increased discount
levels to compensate the various value add participants in this distribution
network.
  Growth of
our product revenue will depend on our ability to attract new customers and to
make additional sales to existing customers. Our growth will also depend on our
ability to introduce and achieve market acceptance of new products with higher
capacity and performance and new products designed to serve other sectors of the
storage market beyond protection storage that we believe will benefit from
deduplication technology. Revenue from existing customers increased as a
percentage of total revenue, a trend we expect to generally continue. It is
important to note, however, that our revenue, including our revenue from
existing customers, may be impacted by the timing of large orders which tend to
have a longer sales cycle and are more difficult to forecast. The recent
downturn of the global economy could negatively impact the timing of these large
orders and spending by our customers’ information technology, or IT, departments
generally. We also expect growth in international markets to be a significant
factor contributing to our revenue growth in future periods. International
revenue accounted for approximately 21% and 27% of our total revenue in the
three months ended March 31, 2009 and 2008, respectively. Over time, we expect
international revenue to increase in absolute dollars and as a percentage of our
total revenue, as we add additional sales personnel and enhance our distribution
channels internationally. However, our international revenue will also be
susceptible to any further deterioration in global economic conditions. Our
growth in support and services revenue will depend upon increasing the number of
systems under support and services contracts. Any such increases will depend on
a growing customer base and the renewal of existing support and services
contracts. To date, no individual customer has accounted for greater than 10% of
our total revenue in any year.
  We intend
to continue to hire in our sales and research and development organizations,
with selective hiring across all other functional areas. We also intend to
continue to invest significantly in our direct marketing campaigns, both
domestically and internationally, to drive customer lead generation, which we
feel is a key requisite to position us for future revenue growth.
  Our
ability to sustain profitability will be affected by the extent to which we
incur additional expenses to expand our sales, marketing, product development
and general and administrative capabilities. Personnel costs constitute the
largest component of our operating expenses and include salaries, benefits,
incentive compensation and stock-based compensation expense. We recognize that
we may need to reduce our hiring plans to the extent we continue to be affected
by the challenging global economy. As we expand internationally, we may incur
additional costs to conform our products to comply with local laws or local
product specifications and to ship our products to our international
customers.
   We
believe our operations are more efficient and flexible because we outsource
manufacturing of our products, and because we subcontract with third parties to
provide onsite hardware repair and replacement services for our appliances,
except in those instances where channel partners provide these services directly
to our customers.
  As a
consequence of the rapidly evolving nature of our business and our limited
operating history, we believe that period-to-period comparisons of revenue and
operating results, including gross margin and operating expenses as a percentage
of total revenue, are not necessarily meaningful and should not be relied upon
as indications of future performance. Although we have experienced significant
growth in our total revenue, you should not assume that our historical growth
rates are indicative of future growth.
 
 Critical
Accounting Policies and Estimates
 
 Our
condensed consolidated financial statements are prepared in accordance with U.S.
generally accepted accounting principles, or GAAP. These accounting principles
require us to make certain estimates and judgments that can affect the reported
amounts of assets and liabilities as of the date of the condensed consolidated
financial statements, as well as the reported amounts of revenue and expenses
during the periods presented. We believe that the estimates and judgments upon
which we rely are reasonable based upon information available to us at the time
that these estimates and judgments are made. To the extent there are material
differences between these estimates and actual results, our condensed
consolidated financial statements will be affected. The accounting policies that
reflect our more significant estimates and judgments and that we believe are the
most critical to aid in fully understanding and evaluating our reported
financial results include revenue recognition, stock-based compensation,
inventory valuation, warranty reserve, short-term and long-term investments and
allowance for doubtful accounts.  There were no significant changes to
our critical accounting policies since the filing of our Annual Report on Form
10-K for the year ended December 31, 2008 with the SEC on March 13,
2009.
 
 
 21
 Results
of Operations
 
 Revenue
 
  The
following table sets forth each of our sources of revenue for the specified
periods and as a percentage of our total revenue for those periods.
  Three
      months ended(dollars
      in thousands, except for percentages)
              
              March
      31,
                2009
              
              
              March
      31,
                2008Total
      revenue
              
              $
              79,036
              
              
              $
              52,615Total
      revenue by type:Product
              
              $
              63,921
              
              
              $
              45,247Support
      and services
              
              
              15,115
              
              
              
              7,368%
      of revenue by type:Product
              
              
              81
              %
              
              
              86
              %Support
      and services
              
              
              19
              %
              
              
              14
              %Total
      revenue by geography:North
      America
              
              $
              62,666
              
              
              $
              38,646Europe,
      Africa, Middle East
              
              
              13,464
              
              
              
              10,417Asia
      Pacific
              
              
              2,906
              
              
              
              3,552%
      of revenue by geography:North
      America
              
              
              79
              %
              
              
              73
              %Europe,
      Africa, Middle East
              
              
              17
              %
              
              
              20
              %Asia
      Pacific
              
              
              4
              %
              
              
              7
              %
 
 For the three months ended March 31, 2009, product revenue increased $18.7
million to $63.9 million from the $45.2 million reported for the three months
ended March 31, 2008. This increase was due to an increase in the number of
units sold to new and existing customers, an increase in average deal size and
higher sales of the DD690, which had higher average selling prices. For the
three months ended March 31, 2009, we had eleven customers who entered into
arrangements to purchase product, support and services exceeding $1.0 million
compared to three customers who entered into arrangements to purchase product,
support and services exceeding $1.0 million for the three months ended
March 31, 2008. New customers accounted for 43% of the value of transactions
recognized during the three months ended March 31, 2009 compared to 57% of the
value of transactions during the three months ended March 31, 2008. The DD690,
which was introduced in May 2008, accounted for 47% of our product revenue
during the three months ended March 31, 2009.
 
 For the
three months ended March 31, 2009, support and services revenue increased $7.7
million to $15.1 million from the $7.4 million reported for the three months
ended March 31, 2008. This increase was the result of increased product sales
and, to a lesser extent, an increase in the renewal of support and services
contracts by existing customers. Substantially all of our customers purchase
support and service contracts when they purchase our appliances. As our customer
base grows, we expect the revenue we generate from support and services will
continue to grow at a faster rate than our product revenue, as a result of both
an increase in new contracts and higher renewal of existing
contracts.
 
 International
revenue was 21% and 27% of total revenue for the three months ended March
31, 2009 and March 31, 2008, respectively. Although revenue outside North
America, excluding Asia Pacific, increased in the three months ended March 31,
2009 in absolute amounts, the percentage of total revenue it represented
decreased compared to the three months ended March 31, 2008. This was due
to the higher growth rate of sales in North America as new sales personnel were
added more rapidly and became productive more quickly in North America than
elsewhere. As we continue to expand into international locations and introduce
our products in new markets, we expect international revenue to increase in
absolute dollars and as a percentage of revenue.
 
 Cost
of Revenue, Gross Profit and Gross Margin
 
 The
following table sets forth each of our costs of revenue, gross profit and gross
margin for the specified periods.
  Three
      months ended(dollars
      in thousands, except for percentages)
              
              March
      31,
                2009
              
              
              March
      31,
                2008Total
      revenue
              
              $
              79,036
              
              
              $
              52,615Cost
      of product
              
              
              17,295
              
              
              
              11,317Cost
      of support and services
              
              
              5,536
              
              
              
              2,489Total
      cost of revenue
              
              
              22,831
              
              
              
              13,806Gross
      profit
              
              $
              56,205
              
              
              $
              38,809Margin
      by type:Product
      (as a percentage of product
      revenue)
              
              
              73
              %
              
              
              75
              %Support
      and services (as a percentage of support and services
    revenue)
              
              
              63
              %
              
              
              66
              %Total
      gross margin (as a percentage of total revenue)
              
              
              71
              %
              
              
              74
              %
 
 For the
three months ended March 31, 2009, cost of product revenue increased $6.0
million to $17.3 million from the $11.3 million reported for the three months
ended March 31, 2008. This increase was due to increased aggregate product costs
associated with an increased volume of shipments of our appliances to our
customers and to a lesser extent, increased personnel costs. Salaries and
employee-related benefits accounted for $641,000 of the increase in cost of
product as the result of an increase in headcount from 15 at March 31, 2008 to
34 at March 31, 2009. This increase was offset by a net reversal of stock-based
compensation expense of $115,000 in the three months ended March 31, 2009 for
those that left within one year and whose shares were not vested. We expect the
cost of product revenue to continue to increase for the remainder of
2009.
 
 For the
three months ended March 31, 2009, cost of support and services revenue
increased $3.0 million to $5.5 million from the $2.5 million reported for the
three months ended March 31, 2008. This increase was due to increases in
installation costs and in our support personnel headcount from 30 at March 31,
2008 to 64 at March 31, 2009, which increased our salary expense and
employee-related benefits by $1.4 million. Also included in the overall increase
is increased outside service costs of $1.2 million related to third party
logistics support of the larger installed base of our products. We expect the
cost of support and services revenue to continue to increase for the remainder
of 2009 as our installed base continues to grow.
 
 For the
three months ended March 31, 2009, our total gross margin decreased 3% to 71%
from 74% for the three months ended March 31, 2008. The decrease was primarily
driven by product margins which were impacted by our continued investment in our
operations organization and increased average discount rates. Additionally,
support margins decreased due to an increase in support personnel as well as an
increase in third-party support costs. Although we experienced slightly
higher discounting this quarter, this was completely offset by cost reductions
realized with respect to our products from increased sales volume and decreases
in hardware costs.
 
 Over
time, we expect our total cost of revenue to grow at a slightly faster rate than
total revenue in the future as our customer base will grow and support and
services will become a larger percentage of our overall revenue which has a
lower margin than product revenue. We will be doing more business through
two-tier distribution over time which will cost us margin on deals and dealing
with larger enterprise customers will increase the pressure on us to offer more
volume discounting in large transactions.
 
 22
 Sales
and Marketing Expenses
 
 Three
      months ended(dollars
      in thousands)
              
              March
      31,
                2009
              
              
              March
      31,
                2008Sales
      and marketing expenses
              
              $
              32,726
              
              
              $
              23,232Percent
      of total revenue
              
              
              42
              %
              
              
              44
              %Headcount
      at period-end
              
              
              449
              
              
              
              301
 
 For the
three months ended March 31, 2009, sales and marketing expenses increased $9.5
million to $32.7 million from the $23.2 million reported for the three months
ended March 31, 2008. This increase was primarily due to the increase in the
number of our sales and marketing employees, which increased by 148 employees.
The increase in employees resulted in higher salary expense, employee-related
benefits expense and fees for recruitment of new employees. In addition,
commission expenses increased due to the substantial increase in our total
bookings and revenue and the higher number of employees on commission plans. The
total of the increase from the above factors was $6.1 million. Travel and
entertainment costs accounted for $984,000 of the increase, global marketing
costs accounted for $742,000 of the increase, costs related to the opening of
new sales offices accounted for $554,000 of the increase, stock-based
compensation accounted for $400,000 of the increase and the remainder was the
result of increased costs from outside services and depreciation.
 
 We
anticipate that sales and marketing expenses will increase in absolute dollars
during the remainder of 2009 due to our plans to continue to expand our sales
force, both domestically and internationally, and to make significant
investments in our direct marketing campaigns. However, based upon our
expectations of future revenue, we expect sales and marketing expenses will
remain relatively stable as a percentage of our total revenue.
 
 Research
and Development Expenses
 
 Three
      months ended(dollars
      in thousands)
              
              March
      31,
                2009
              
              
              March
      31,
                2008Research
      and development expenses
              
              $
              14,211
              
              
              $
              8,736Percent
      of total revenue
              
              
              18
              %
              
              
              17
              %Headcount
      at period-end
              
              
              197
              
              
              
              133
 
 For the
three months ended March 31, 2009, research and development expenses increased
$5.5 million to $14.2 million from the $8.7 million reported for the three
months ended March 31, 2008. These increases were the direct result of hiring
additional personnel to support new product introductions and broaden our
product line. Salaries and employee-related benefits and bonuses accounted for
$3.0 million of the increase as the result of an increase in headcount of 64.
Also contributing to the increase were increases in stock-based compensation of
$656,000, use of consultants of $326,000 and depreciation of $570,000 related to
test and lab equipment.
 
 We
anticipate that research and development expenses will increase as we continue
to invest in research, new product development and enhancements to our existing
appliances and hire additional research and development personnel, particularly
at our Research Triangle Park, North Carolina facility. However, based on our
expectations of future revenue, we expect research and development expenses will
remain relatively stable as a percentage of our total revenue.
  General
and Administrative Expenses
 
 Three
      months ended(dollars
      in thousands)
              
              March
      31,
                2009
              
              
              March
      31,
                2008General
      and administrative expenses
              
              $
              7,146
              
              
              $
              5,606Percent
      of total revenue
              
              
              9
              %
              
              
              11
              %Headcount
      at period-end
              
              
              79
              
              
              
              48
 
 For the
three months ended March 31, 2009, general and administrative expenses increased
$1.5 million to $7.1 million from the $5.6 million reported for the three months
ended March 31, 2008. This increase was primarily due to an increase in general
and administrative headcount of 31. Salaries and employee-related benefits
associated with the increased headcount accounted for $1.2 million of the
increase and stock-based compensation accounted for $390,000 of the
increase.
 
 We expect
the absolute amount of our general and administrative expenses to increase in
the future as we expand our finance function to manage our expected growth.
However, based on our expectations of future revenue, we expect general and
administrative expenses will remain relatively stable as a percentage of our
total revenue.
 
 23
 Other
Income (Expense), Net
 
 Three
      months ended(dollars
      in thousands)
              
              March
      31,
                2009
              
              
              March
      31,
                2008Interest
      income
              
              $
              1,041
              
              
              $
              2,163Gain
      on trading securities, net
              
              
              65
              
              
              
              —Foreign
      exchange and other income (expense), net
              
              
              12
              
              
              
              1,243Total
      other income (expense), net
              
              $
              1,118
              
              
              $
              3,406
 
 For the
three months ended March 31, 2009, total other income (expense), net decreased
$2.3 million to $1.1 million from the $3.4 million reported for the three months
ended March 31, 2008. This decrease was the result of a decrease in interest
income and a decrease in other income (expense), which is primarily composed of
foreign exchange gains net of foreign exchange losses. The decrease in interest
income of $1.1 million was the result of a reduction in the weighted average
interest rate earned from our cash equivalents, short-term and long-term
investments from 4.1% in the three months ended March 31, 2008 to 1.7% in the
three months ended March 31, 2009. Foreign currency net gains for the three
months ended March 31, 2009 decreased $1.2 million as compared to the three
months ended March 31, 2008 due to an unfavorable revaluation of the Euro and
other foreign currency-denominated cash balances and losses on foreign exchange
transactions during the period.
 
 Provision
for Income Taxes
 
 Our provision for income taxes increased $91,000
to $2.0 million in the three months ended March 31, 2009 compared to $1.9
million for the three months ended March 31, 2008. The effective tax rate
for the three months ended March 31, 2009 was 61% compared with 41% for the
comparable period ended March 31, 2008. This change in the effective rate was
primarily due to the implementation of an international tax structure in fiscal
year 2008 for which no tax benefit is currently being recognized. We believe
this international tax structure will, in the long run, result in certain
operational benefits as well as provide us with a lower overall tax rate. There
can be no assurances that, when completed, our efforts will produce the
anticipated operational benefits or provide an overall lower tax rate for the
Company. We may experience continued unbenefited foreign losses and, as a
result, higher tax rates until our global strategy is operational. As a result
of undertaking these efforts, we anticipate an overall tax rate in 2009 that is
materially higher than our statutory tax rate.
 
 The
effective tax rate for the first quarter of 2009 differs from the U.S. federal
statutory rate of 35% primarily due to the unfavorable impact of stock-based
compensation and increases in foreign taxes based on our expansion into new
foreign markets, and due to unbenefitted foreign losses.
  There
have been no material changes to the balance of unrecognized tax benefits
reported at March 31, 2009.  We do not anticipate any material changes
to the unrecognized tax benefits over the next twelve months.
 
 24
 Liquidity
and Capital Resources
 
  March
      31,
              
              
              December
      31,(in
      thousands)
              
              2009
              
              
              2008Working
      capital
              
              $
              248,058
              
              
              $
              232,996Cash
      and cash equivalents
              
              
              119,167
              
              
              
              128,380Short-term
      investments
              
              
              127,685
              
              
              
              105,512
 
 
 Working
capital consists principally of cash and cash equivalents, short-term
investments, accounts receivable, inventories, prepaid expenses and other
current assets, net of accounts payable, accrued compensation and related
benefits, other accrued liabilities, income taxes payable and current deferred
revenue. Working capital at March 31, 2009 increased $15.1 million from
December 31, 2008 due primarily to positive operating cash flows from
operations of $10.9 million and cash flows from financing activities of $6.6
million. Other changes of note are:
 
 ·
              The
      decrease in cash and cash equivalents was the result of investing our cash
      in short-term investments, and to a lesser extent, an increase in our
      days’ sales outstanding from an average of 64 days as of December 31, 2008
      to an average of 69 days as of March 31, 2009, computed based on the
      respective revenue from the immediately preceding quarter. We anticipate
      that accounts receivable will comprise a significant portion of working
      capital as we continue to grow revenue because a substantial portion of
      our sales, and therefore our shipping and billing, occurs near the end of
      each quarter.
 
 ·
              Short-term
      investments increased due to purchases of available-for-sale securities,
      as more funds were invested in short-term securities from cash and cash
      equivalents.
 
 ·
              Inventory
      decreased due to a decrease in finished goods and the number of units held
      in the evaluation inventory pool, partially offset by an increase in
      raw materials.
 
 ·
              Prepaid
      expenses and other current assets decreased due to the release of
      restricted cash related to a reduction in a letter of credit for our
      corporate headquarters, offset by increases in prepaid maintenance
      contracts and commissions.
 
 ·
              Current
      deferred revenue increased due to support renewals from existing customers
      as well as the support sold in initial product sales to new and existing
      customers in the quarter that we recognize over the maintenance and
      support life.
 
 ·
              Accrued
      compensation decreased due to lower accrued commissions from lower net
      bookings and a reduction of accrued ESPP due to the purchase of shares
      from our employee stock purchase plan on January 31, 2009, partially
      offset by an increase in accrued vacation due to less vacation time taken
      and an increase in accrued bonuses.
 
 ·
              Other
      accrued liabilities decreased due to lower accruals and lower accrued
      sales tax, partially offset by higher accrued legal costs and accrued
      tradeshow costs.
 
 
 Cash
and Cash Equivalents
 
 Cash and
cash equivalents consist of highly liquid investments in time deposits held at
major banks, commercial paper, money market mutual funds and other money market
securities with original maturities of 90 days or less.
 
 Since
2005, we have expanded our operations internationally. Our sales contracts are
mainly denominated in United States dollars for sales in Asia and Japan,
denominated in Euros and British sterling for sales in Europe, denominated in
Australian dollars for sales in Australia and denominated in Canadian dollars
for certain sales in Canada. We are evaluating the desirability of entering into
foreign currency hedging contracts, primarily Euro-based revenue contracts, to
reduce our exposure to fluctuations in currency exchange rates. We currently do
not hedge the operating expenses that are primarily denominated in foreign
currency in countries where we have sales or operating personnel because we
believe those situations create natural hedges. We may begin to sell our
products in local currency in other locations. As we fund our international
operations, our cash and cash equivalents are affected by changes in exchange
rates for those expenses. The foreign currency effect on our cash and cash
equivalents and working capital was a gain of $12,000 compared to a gain of $1.2
million in the three months ended March 31, 2009 and 2008,
respectively.
 
 Short-term
and Long-term Investments
 
  Short-term
investments consist of commercial paper, U.S. government agency securities and
corporate bonds with original maturities of 90 to 365 days.
  Long-term
investments consist of auction-rate securities. As of March 31, 2009, we had
$31.0 million of principal valued at $27.7 million related to auction-rate
securities.  In November 2008, we signed a broad-based settlement
proposal from UBS in which we would have the right to sell the securities back
to UBS at the principal value during the period from June 30, 2010 to July 2,
2012 if liquidity does not return to the auction-rate securities market sooner.
See Note 2 of the Notes to our condensed consolidated financial
statements.
  Due to
current market conditions these investments have continued to experience failed
auctions. These failed auctions have resulted in a lack of liquidity for the
securities but do not affect the underlying collateral of the securities. We
believe that given their government guaranteed status, we will ultimately
recover at par all amounts invested in these securities. Based on our expected
operating cash flows and our other sources of cash, we do not anticipate the
potential lack of liquidity of these investments will affect our ability to
execute our current business plan. We will continue to monitor efforts by the
financial markets to find alternative means for restoring the liquidity of these
investments. These investments will remain classified as non-current assets
until we have better visibility as to when their liquidity will be restored. The
classification and valuation of these securities will continue to be reviewed
quarterly.
 
 
 25
 Cash
Flows
 
 (in
      thousands)
              
              March
      31,
                2009
              
              
              March
      31,
                2008Cash
      provided by operating activities
              
              $
              10,855
              
              
              $
              20,025Cash
      used in investing activities
              
              
              (25,708
              )
              
              
              (953
              )Cash
      provided by financial activities
              
              
              6,568
              
              
              
              4,501
 
 
 Cash
Flows from Operating Activities
 
 Our cash
flows from operating activities will continue to be affected principally by our
sales and associated collection of accounts receivable, and by the extent to
which we spend on increasing personnel, primarily in sales and marketing and
research and development, in order to grow our business. The timing of hiring
sales personnel in particular affects cash flows as there is a lag between the
hiring of sales personnel and the generation of revenue and cash flows from such
recently hired sales personnel. Our largest source of cash flows from operating
activities is cash collections from our customers. Our primary uses of cash from
operating activities are for employee-related expenditures, rent payments,
inventory purchases to support our revenue growth and research and development
costs.
 
 Cash
provided by operating activities decreased in the three months ended March 31,
2009 as compared to the three months ended March 31, 2008 due to lower net
profit, an increase in accounts receivable and a decrease in accrued
compensation and other accrued liabilities. Based on our expectations of future
revenue levels, we believe we will be able to continue to generate positive cash
flows from operating activities in the near term even as we continue to add
personnel, increase inventory purchases, increase research and development
activities and invest in functions associated with being a public
company.
 
 Cash
Flows from Investing Activities
 
 Cash
flows from investing activities primarily relate to capital expenditures to
support employee headcount growth, and net proceeds from the purchase and
maturities of investment securities. Cash used in investing activities was $25.7
million in the three months ended March 31, 2009 as compared to cash used of
$953,000 for the three months ended March 31, 2008. Cash used in investing
activities in the three months ended March 31, 2009 included purchases, net of
maturities of investments of $22.7 million as well as $3.0 million for purchases
of property, plant and equipment, driven by leasehold improvements at our
corporate headquarters and IT infrastructure, as well as our increase in
headcount in the period and investments in computer equipment and lab equipment
for research and development. Cash used in investing activities in the three
months ended March 31, 2008 included $8.4 million for purchases of property,
plant and equipment, offset by maturities, net of purchases of investments of
$7.4 million.
  Cash
Flows from Financing Activities
 
 Cash flow
provided by financing activities in the three months ended March 31, 2009 of
$6.6 million resulted from the proceeds of the cash exercise of stock options to
purchase 567,000 shares of our common stock by our employees, the purchase of
365,000 shares of our common stock by our employees through our employee stock
purchase plan and the realized tax benefit related to the excess of the
deductible amount over the compensation cost recognized. Cash flow provided by
financing activities in the three months ended March 31, 2008 of $4.5 million
resulted from the proceeds of the cash exercise of stock options to purchase
964,000 shares of our common stock by our employees as well as the purchase of
285,000 shares of our common stock by our employees through our employee stock
purchase plan.
 
 Contractual
Obligations
 
 The
following is a summary of our contractual obligations as of March 31,
2009:
 
 Total
              
              
              Less Than
                One
      Year
              
              
              1-3
                Years
              
              
              3-5
                Years
              
              
              More Than
                5
      YearsOperating
      leases
              
              $
              51,094
              
              
              $
              4,479
              
              
              $
              11,885
              
              
              $
              11,965
              
              
              $
              22,765Purchase
      obligations(1)
              
              
              29,854
              
              
              
              29,854
              
              
              
              —
              
              
              
              —
              
              
              
              —Total
      contractual obligations
              
              $
              80,948
              
              
              $
              34,333
              
              
              $
              11,885
              
              
              $
              11,965
              
              
              $
              22,765
 
 (1)
              Represents
      amounts associated with agreements that are enforceable, legally binding
      and specify terms, including: fixed or minimum quantities to be purchased;
      fixed, minimum or variable price provisions; and the approximate timing of
      payment. Obligations under contracts that we can cancel without a
      significant penalty are not included in the table
  above.
  We
purchase all of our appliances from our contract manufacturer, Flextronics
International, or Flextronics, which became our contract manufacturer through
its acquisition of Solectron Corporation. We provide Flextronics with a rolling
six-month forecast for planning purposes and place firm purchase orders for 30
days of expected purchases, which we are contractually committed to purchase. As
of March 31, 2009, we had $18.4 million in aggregate non-cancellable
purchase commitments placed with Flextronics. In addition, as of March 31, 2009,
we had an additional $11.5 million of other non-cancellable purchase commitments
with other third-party vendors.
  On
July 10, 2007, we entered into a lease for our new corporate headquarters.
The term of the lease is from November 1, 2007 to October 31, 2017 and
the approximate aggregate rent due over the term of the lease is $23.0 million.
Under the terms of the lease, we are obligated to provide a letter of credit for
$209,000, which we have funded.
  In
January 2008, we signed an agreement to lease approximately 100,000 square feet
of office space adjacent to our existing corporate facility. The term of the
lease is from January 1, 2009 to June 30, 2018 and the approximate
aggregate rent due over the term of the lease is $24.0 million. Under the terms
of the lease, we are obligated to provide a letter of credit for $1.2 million,
which we have funded. In March 2009, we signed an amendment to reduce the letter
of credit by $1.0 million, which was reclassified from restricted cash to cash
and cash equivalents.
  Our
agreements with our channel partners and customers generally include certain
provisions for indemnifying the channel partners and customers against
liabilities if our products infringe a third party’s intellectual property
rights. To date, we have not incurred any material costs as a result of such
indemnification provisions and have not accrued any liabilities related to such
obligations in our condensed consolidated financial statements.
  At March
31, 2009, we had a liability for unrecognized tax benefits and an accrual for
the payment of related interest totaling $2.7 million, of which none is expected
to be paid within one year. Due to uncertainties related to these tax matters,
we are unable to make a reasonably reliable estimate when cash settlements with
the taxing authority will occur.
 
 Off-Balance
Sheet Arrangements
 
 At March
31, 2009 and December 31, 2008, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes.
  Recent
Accounting Pronouncements
 
 See Note
1 of the Notes to our Condensed Consolidated Financial Statements for recent
accounting pronouncements that could have an effect on us.
   26
 
  Item 3.
              Quantitative
      and Qualitative Disclosures About Market
Risk
 
 Foreign
Currency Risk
 
 Our
European revenue is denominated in Euros and British sterling. As a result, our
European revenue is subject to foreign currency risk due to fluctuations in the
value of the Euro and British sterling compared to the U.S. dollar. We had
Euro-denominated revenue of approximately $10.3 million and $9.4 million for the
three months ended March 31, 2009 and 2008, respectively.  We had
British sterling denominated revenue of $2.2 million and $1.0 million for the
three months ended March 31, 2009 and 2008, respectively. In addition, we had
$3.9 million and $379,000 in Canadian dollar denominated revenue for the three
months ended March 31, 2009 and 2008, respectively.
 
 Our
international sales and marketing operations incur expenses that are denominated
in foreign currencies. As a result, our operating expenses and cash flows
are subject to fluctuations in the value of the U.S. dollar compared to the
British sterling, Euro, Canadian dollar and, to a lesser extent, the Australian
and Singapore dollar, and Danish, Chinese, Korean, Taiwanese, New Zealand,
Mexican, Malaysian, Israeli and Swedish currencies. We had foreign currency
denominated expenses of approximately $27.2 million and $6.8 million for the
three months ended March 31, 2009 and 2008, respectively.
 
 As of
March 31, 2009, we had approximately $11.6 million of accounts receivable
denominated in Euros, $2.1 million of accounts receivable denominated in
Canadian dollars, $2.0 million of accounts receivable denominated in British
sterling and approximately $300,000 of accounts receivable denominated in
Australian dollars.
  Changes
in currency exchange rates could adversely affect our revenue and profitability,
and require us to reduce our prices to remain competitive in foreign markets,
which could also have a material adverse effect on our results of
operations. We have not entered into any foreign currency hedging
contracts. We are presently evaluating the desirability of entering into
foreign currency hedging contracts to offset our exposure to revenue in foreign
currencies, primarily Euro-based contracts, to reduce our exposure to
fluctuations in currency exchange rates.
  We
estimate that a 10% decline in the value of the U.S. dollar as measured against
the other currencies in which our transactions are denominated would have
negatively impacted our net income in the three months ended March 31, 2009 by
approximately $2.7 million. This sensitivity analysis disregards the
possibilities that rates can move in opposite directions and that losses from
one geographic area may be offset by gains from another
geographic area.
 
 Interest
Rate Sensitivity
 
  The primary objective of our investment activities is to
preserve principal while at the same time maximizing the income we receive from
our investments, without significantly increasing risk. To achieve this
objective, we maintain our portfolio of cash equivalents and short-term and
long-term investments in a variety of high quality securities, including U.S.
government agency securities, corporate bonds, money market funds, commercial
paper and auction-rate securities. All investments, except for auction-rate
securities, are classified as available-for-sale and held for working capital
purposes. We do not enter into investments for trading or speculative purposes.
We believe that we do not have any material exposure to changes in fair value as
a result of changes in interest rates. Declines in interest rates, however, will
reduce future investment income. If overall interest rates fell by 10% in the
three months ended March 31, 2009 and 2008, our interest income would have
declined approximately $104,000 and $216,000, respectively, assuming consistent
investment levels.
  At March
31, 2009, we held approximately $31.0 million in principal, valued at $27.7
million, of auction-rate securities, classified as long-term investments. In
February 2008, the majority of these auction-rate securities failed to auction,
causing access to these funds to be restricted. An auction failure means that
the parties wishing to sell securities could not. As a result, our ability to
liquidate these investments and fully recover the carrying value of our
investment was restricted. All of our auction-rate securities are currently
AAA-rated by at least one rating agency.  Our auction-rate securities
are taxable municipal revenue bond obligations which are supported by higher
education student loan trusts.  These trusts contain student loans
which are substantially backed by the U.S. Federal Government, via the U.S.
Department of Education's Higher Education Act, which is known as the Federal
Family Education Loan Program (FFELP). If the issuers are unable to successfully
close future auctions and their credit ratings deteriorate, we may in the future
be required to record an impairment charge on these investments.
  In
November 2008, we signed a broad-based settlement proposal from UBS in which we
would have the right, in the form of a put option, to sell the securities back
to UBS at par value during the period from June 30, 2010 to July 2, 2012 if
liquidity does not return to the auction-rate securities market sooner. We
valued the put option using a discounted cash flow approach including estimates
of, based on data available as of March 31, 2009, interest rates, timing and
amount of cash flow, adjusted for any bearer risk associated with UBS’s
financial ability to repurchase the auction-rate securities beginning June 30,
2010. Based on the discounted cash flow model, we determined the fair value of
the put option to be $3.2 million as of March 31, 2009. In connection with the
put option, we transferred our auction-rate securities from available-for-sale
to trading securities. The transfer to trading securities reflects management’s
intent to exercise the put option during the period June 30, 2010 to July 2,
2012.
  We expect
to sell our auction-rate securities under the put option. However, if the put
option is not exercised before July 2, 2012, it will expire and UBS will have no
further rights or obligations to buy our auction-rate securities. As long as we
hold our auction-rate securities, they will continue to accrue interest as
determined by the auction process or the terms specified in the auction-rate
securities if the auction process fails. We expect that the future changes in
value of the put option will largely be offset by the changes in fair value of
the auction-rate securities, assuming UBS will continue to be able to honor the
put option.
  UBS’s
obligations under the put option are not secured by its assets and do not
require UBS to obtain any financing to support its performance obligations under
the put option. UBS has disclaimed any assurance that it will have sufficient
financial resources to satisfy its obligations under the put option. If UBS has
insufficient funding to buy back the auction-rate securities and the auction
process continues to fail, then we may incur further losses.
  The
valuation of our investment portfolio is subject to uncertainties that are
difficult to predict. Factors that may impact its valuation include changes to
credit ratings of the securities, discount rates and ongoing strength and
quality of market credit and liquidity. If the current market conditions
deteriorate further, or the anticipated recovery in market values does not
occur, we may be required to record impairment charges in future
quarters.
  27
 
 Item 4.
              Controls
      and Procedures
 
 Evaluation
of Disclosure Controls and Procedures
 
 An
evaluation was carried out under the supervision and with the participation of
our management, including our principal executive officer and principal
financial officer, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934) as of the end of the period covered
by this report. Based upon that evaluation, our principal executive officer
and principal financial officer concluded that those disclosure controls and
procedures were effective to ensure that information required to be disclosed by
us in the reports that we file or submit under the Exchange Act is
(i) recorded, processed, summarized and reported, within the time periods
specified in the Commission’s rules and forms and (ii) accumulated and
communicated to our management, including our principal executive officer and
principal financial officer, as appropriate to allow timely decisions regarding
required disclosure.
 
 Changes
in Internal Control over Financial Reporting
 
 There
were no changes in our internal control over financial reporting during our most
recent fiscal quarter that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
 
 Inherent
Limitations of Internal Controls
 
 Our
management, including our Chief Executive Officer and Chief Financial Officer,
does not expect that our disclosure controls and procedures or our internal
control over financial reporting will prevent all errors and all fraud. A
control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the company have been detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management override of the
control. The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions. Over time, controls may become inadequate because of changes
in conditions, key personnel or the degree of compliance with the policies or
procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
 
 28
 PART
II. OTHER INFORMATION
  Item 1.
              Legal
      Proceedings
 
  We are
subject to various claims, complaints and legal actions in the normal course of
business from time to time. We do not believe we are party to any currently
pending legal proceedings the outcome of which will have a material adverse
effect on our operations or financial position. There can be no assurance that
existing or future legal proceedings arising in the ordinary course of business
or otherwise will not have a material adverse effect on our business,
consolidated financial position, results of operations or cash
flow.
 
 Item 1A.
              Risk
      Factors
 
 Set
forth below and elsewhere in this quarterly report on Form 10-Q, and in other
documents we file with the SEC, are risks and uncertainties that could cause
actual results to differ materially from the results contemplated by the
forward-looking statements contained in this quarterly report on Form 10-Q.
Because of the following factors, as well as other variables affecting our
operating results, past financial performance should not be considered as a
reliable indicator of future performance and investors should not use historical
trends to anticipate results or trends in future periods.
 
 Risks Related to Our Business and Industry
 
  Recent
turmoil in the financial markets and the global economic recession has adversely
affected and may continue to adversely affect our industry, business and gross
margins.
 
  The U.S.
and world economic markets are undergoing a recession, and the future economic
environment may continue to be significantly less favorable than that of recent
years. Our business depends on the overall demand for information technology, in
particular for deduplication storage appliances for backup storage and
network-based disaster recovery. Information technology spending has
historically declined with worsening general economic and market conditions and
we believe the current recession has already caused our customers to
significantly reduce or delay their information technology purchases and that
these reductions and delays have negatively impacted demand for our products and
services and our business.  If the U.S. and global recession continues
to worsen, and the U.S. and world economies remain depressed for an extended
period of time, or if our customers believe such a downturn will continue for
the foreseeable future or become more severe, then our customers
may continue to significantly reduce their information technology
budgets and may decrease their demand for our products and
services.
  
 As
a result of this economic slowdown and the continued tightening of credit
markets, our customers may be delayed in obtaining, or may not be able to
obtain, necessary financing for their purchases of our products. A lack of
liquidity in the capital markets or the continued global recession may cause our
customers to delay or cancel their purchases, increase the time they take to pay
or default on their payment obligations. Currency fluctuations relating to the
financial crisis could also negatively affect our international customers’
ability or desire to purchase our products. In addition, continued weakness in
the economy could cause some of our resellers and other customers to become
illiquid, delay payments or adversely affect our collection on their accounts,
any of which would result in a higher level of bad debt expense. In February
2009, one of our resellers filed for Chapter 11 bankruptcy. As of January 30,
2009, we had a trade receivable of $1.2 million from this reseller, for which we
did not record an allowance. As part of the bankruptcy proceeding, a primary
investor in this reseller agreed to purchase the assets and assume certain
liabilities of this reseller in its efforts to recapitalize the reseller. On
April 15, 2009, this investor purchased the assets of the reseller and assumed
the $1.2 million liability payable to us. We agreed to have the $1.2 million
liability paid to us in six equal monthly payments starting April 15,
2009.  We received our first payment of $208,000 on April 17,
2009.
  The
global economic recession may not only cause our customers to significantly
reduce or delay their information technology budgets, which would negatively
impact demand for our products and services, but may also result
in:
   •
              increased
      price competition for our products, not only from our competitors, but
      also as a result of our customer’s or potential customer’s utilization of
      inventoried or underutilized products, which could put additional pressure
      on our near term gross profits;
  •
              risk
      of excess or obsolete inventories;
  •
              excess
      manufacturing capacity and higher associated overhead costs as a
      percentage of revenue; and
  •
              more
      limited ability to accurately forecast our business and future financial
      performance.
 
 The lack
of liquidity and economic slowdown may also adversely affect our suppliers,
including those on whom we are dependent as sole source suppliers, and their
liquidity, and the availability of, and/or terms and conditions on which we
purchase their products and services. Any of these events could limit our
ability to obtain necessary products and services, including components for our
products, contract manufacturing services from our contract manufacturer, and
break-fix services from our break-fix services supplier, and could adversely
impact our supply chain or the delivery schedule to our customers. This also
could require us to purchase more expensive components, or re-design systems, or
find new suppliers of manufacturing or break-fix services, any of which could
increase the cost of our systems and support and delay the manufacturing and
delivery of our systems or negatively impact the performance or quality of our
products and services. Such events would likely negatively impact our business
and gross margins and harm our reputation and our customer
relationships.
 
  As a
result of the recession, we may face new risks that we have not yet identified.
In addition, a number of the risks associated with our business, which are
disclosed in these risk factors, may increase in likelihood, magnitude or
duration.
 
 29
 We
face significant competition and expect this competition to intensify, which
could prevent us from increasing our revenue, reduce our gross margins and
result in the loss of market share.
 
 The
market for our products is highly competitive and we expect competition to
intensify in the future. Other companies have introduced and may in the future
introduce new products in the same markets we serve or intend to enter. New
competitive offerings have been recently announced or introduced in our
marketplace by our competitors EMC, HP and IBM, and we anticipate additional
offerings by our competitors may be announced or introduced in 2009. Competition
in the past has resulted in pricing pressure on our products and services, and
we anticipate that pricing pressure will increase in the future. Competition has
in some instances resulted in a negative impact on the length of our sales
cycle, and we may experience longer sales cycles in future periods due to
increased competition. In particular, if a large number of orders, or a large
dollar value order, is delayed or cancelled, our financial results may be
harmed. Competition may result in reduced gross margins for our appliances,
increased sales and marketing expenses and a failure to increase, or the loss
of, market share.
 
 Competitive
products may have better performance, lower prices and broader acceptance than
our appliances. Many of our current or potential competitors have longer
operating histories, greater name recognition, larger customer bases and
significantly greater financial, technical, sales, marketing and other resources
than we have. Potential customers may prefer to purchase from their existing
vendors rather than a new vendor regardless of product performance or features.
In addition, our competitors may be able to bundle products and services that we
do not offer together with products that compete with ours at a combined price
that is more attractive than the price we charge for our appliances. Currently,
we face competition from traditional providers of tape-based storage systems
such as Sun Microsystems and Quantum Corporation as well as a number of
established storage companies that offer a variety of different disk-based
storage products, including EMC and NetApp and, to a lesser extent, HDS, HP
and IBM. Some of our competitors sell, or have announced plans to sell,
deduplication storage products that compete directly with our appliances, and
additional competitors may introduce deduplication storage products in the
future. Pursuant to a cross-license agreement with Quantum, we have licensed our
current, and certain future, patents relating to data storage or data
transmission, which could assist Quantum in competing with us. We also compete
with a number of emerging hardware and software companies that may become more
significant competitors in the future. In addition, at the low-end of our
product line, we may compete with WAN acceleration and backup software providers
that incorporate deduplication capabilities in their products.
 
 We expect
increased competition from other established and emerging companies if our
market continues to develop and expand. Some of our channel partners currently
market products and services that compete with our appliances. If these channel
partners cease to distribute our appliances for competitive reasons, our sales
may decrease or not grow as quickly. In addition, some of our competitors have
made acquisitions or entered into partnerships or other strategic relationships
with one another to offer a more comprehensive solution than they individually
are able to offer. We believe additional consolidation or partnerships are
likely to occur in the future as companies attempt to strengthen or maintain
their market positions in an evolving industry. The companies resulting from
these consolidations or partnerships could significantly change the competitive
landscape and adversely affect our ability to compete effectively. Some of our
competitors have also entered into relationships with original equipment
manufacturers, or OEMs, that could provide those competitors with sales,
marketing, distribution and other advantages.
 
 We
derive all of our revenue from sales of a single line of systems and related
software, customer support and services, and if demand for these systems does
not continue to grow, our business, results of operations and financial
condition would be harmed.
 
 We derive
all of our revenue from sales of a single line of deduplication storage systems
and associated customer support and services. As a result, we are vulnerable to
fluctuations in demand for these systems, whether as a result of competing
technologies and products, the impact of the continuing weakening of U.S. and
global economic conditions, decreases or delays in corporate spending for
information technologies, product obsolescence, lack of customer acceptance,
technological change, customer budgetary constraints or other factors. As we
have evolved our product line, we have continuously introduced products with
more storage capacity and processing throughput, while the price per unit of
storage capacity and processing throughput has declined. If demand for our
systems does not continue to grow, our business, results of operations and
financial condition would be harmed.
 
 With
the recent volatility in the capital markets, there is a risk that we could
suffer a loss of principal in our cash and cash equivalents and short-term
investments and suffer a reduction in our interest or return on
investments.
 
 We invest
our cash and cash equivalents and short-term investments pursuant to our
investment policy in cash, money market funds, commercial paper, corporate bonds
and U.S. government agency securities, and we actively manage our portfolio
with an objective of capital preservation. Certain of these investments are
subject to general credit, liquidity, market and interest rate risks, which may
be exacerbated by the continuing deterioration of global economic conditions. To
date, we have determined that any declines in the market value of our short-term
investments have been temporary. There could be future declines in the value of
our short-term investments, which we may determine to be other-than-temporary.
These market risks associated with our investment portfolio may have a negative
adverse effect on our results of operations, liquidity and financial
condition.
 
 Our
short-term investments portfolio has a relatively short duration consistent with
our policy of principle preservation. As a consequence, our interest income is
significantly affected from period to period by the level of short-term interest
rates in effect during each period. During the fourth quarter of 2008, these
rates were under significant downward pressure, and it is likely we will
experience a significant diminution in interest income during the first quarter
of 2009, and until short-term interest rates increase.
 
 At
March 31, 2009, we had $31.0 million of principal in auction-rate
securities, valued at $27.7 million. All of our auction-rate securities are
currently AAA-rated by at least one rating agency.  Our auction-rate
securities are taxable municipal revenue bond obligations which are supported by
higher education student loan trusts.  These trusts contain student
loans which are substantially backed by the U.S. Federal Government, via the
U.S. Department of Education's Higher Education Act, which is known as the
Federal Family Education Loan Program (FFELP). In January 2008, these
auction-rate securities had auctioned successfully. On February 14,
2008, the majority of these auction-rate securities failed to auction, causing
access to these funds to be restricted, and each auction since then has failed.
An auction failure means that the parties wishing to sell securities could not.
In the fourth quarter of fiscal 2008, we classified these auction-rate
securities as long-term investments, and have reclassified these securities from
available-for-sale to trading. In November 2008, we signed a broad-based
settlement proposal from UBS AG, or UBS, in which we have the right to sell the
securities back to affiliates of UBS (the “put option”) at par value during the
period from June 30, 2010 to July 2, 2012 if liquidity does not return to the
auction-rate securities market sooner. The affiliates of UBS will retain the
right to sell our auction-rate securities on our behalf, without prior
notification, at any time prior to July 2, 2012 as long as we receive par value
from such sale.  We will continue to monitor these investments going
forward.
  We expect
to exercise our right, or put option, to sell our auction-rate securities under
the UBS agreement. As of March 31, 2009, the put option was valued at $3.2
million and recorded in long-term investments. The net effect of the fair value
of the put option and the fair value of the auction-rate securities for the
three months ended March 31, 2009 was a gain of $65,000, which was recorded in
other income (expense), net in our condensed consolidated statements of income.
However, if we do not exercise the put option before July 2, 2012, this put
option will expire and UBS will have no further rights or obligations to buy our
auction-rate securities. As long as we hold our auction-rate securities, they
will continue to accrue interest as determined by the auction process or the
terms specified in the auction-rate securities if the auction process
fails.
  UBS’s
obligations under the put option are not secured by its assets and do not
require UBS to obtain any financing to support its performance obligations under
the put option. UBS has disclaimed any assurance that it will have sufficient
financial resources to satisfy its obligations under the put option. If UBS has
insufficient funding to buy back the auction-rate securities and the auction
process continues to fail, then we may incur further losses.
 
 30
 We
experience quarterly fluctuations in our operating results due to a number of
factors, which make our future results difficult to predict and could cause our
operating results to fall below expectations or our guidance.
 
 Our
quarterly operating results may fluctuate due to a variety of factors, many of
which are outside of our control. As a result, comparing our operating results
on a period-to-period basis may not be meaningful. You should not rely on our
past results as an indication of our future performance. If our revenue or
operating results fall below the expectations of investors or securities
analysts, or below any guidance we may provide to the market, the price of our
common stock could decline substantially.
 
 In
addition to other risk factors listed in this “Risk Factors” section, factors
that may affect our quarterly operating results include:
 
 ·
              fluctuations
      in demand for our appliances;·
              fluctuations
      in sales cycles and prices for our appliances, particularly for large
      orders which tend to have a longer sales cycle;·
              reductions
      in customers’ budgets for information technology purchases and delays in
      their purchasing cycles;·
              the
      timing of recognizing revenue in any given quarter as a result of revenue
      recognition rules;·
              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 by us or by our
      competitors;·
              our
      ability to hire additional sales personnel and the length of time required
      for any such additional personnel to generate significant
      revenue;·
              any
      lack of availability of, delay in the availability of, or quality problems
      with, any components we acquire from third-party suppliers, particularly
      any components we acquire from a third-party that is our sole source of
      supply for the components;·
              any
      significant changes in the competitive dynamics of our market, including
      new entrants or substantial discounting of products;·
              our
      ability to control costs, including our operating expenses and the costs
      of the components we purchase;·
              our
      experience with product reliability and associated warranty claims;
      and·
              general
      economic conditions in our domestic and international
    markets.
 
 In
addition, we may experience seasonality in the sales of our appliances. We
believe our rapid growth and limited operating history may have masked the
nature or magnitude of seasonal or cyclical factors that might have influenced
our business to date. Seasonal variations in our sales may lead to significant
fluctuations in our quarterly operating results.
 
 Our
international sales and operations subject us to additional risks that may harm
our operating results.
 
 In the
three months ended March 31, 2009, we derived approximately 21% of our revenue
from international customers. We have sales personnel in numerous countries
worldwide. We expect to continue to add personnel in additional countries. Our
international operations subject us to a variety of risks,
including:
 
 ·
              the
      difficulty of managing and staffing international offices and the
      increased travel, infrastructure and legal compliance costs associated
      with multiple international locations;·
              the
      management of our relationships with channel partners outside the United
      States, whose sales and lead generation activities are very important to
      our international operations;·
              difficulties
      in enforcing contracts and collecting accounts receivable, and longer
      payment cycles, especially in emerging markets;·
              tariffs
      and trade barriers and other regulatory limitations on our ability to sell
      our appliances in certain foreign markets;·
              increased
      exposure to foreign currency exchange rate risk;·
              increased
      exposure to possible violations of, or non-compliance with, the Foreign
      Corrupt Practices Act;·
              increased
      exposure to possible violations of U.S. laws regulating the export of our
      products, and to other U.S. and foreign laws affecting the conduct of
      business globally such as product certification, environmental and waste
      management and data privacy laws;·
              reduced
      protection for intellectual property rights in some countries;
      and·
              political
      and economic instability.
 
 Sales to
international customers may also result in greater shipping costs and additional
expenses to conform our appliances to the requirements of local laws or local
product specifications. As we continue to expand our business internationally,
our success will depend, in large part, on our ability to anticipate and
effectively manage these and other risks associated with our international
operations. Our failure to manage any of these risks successfully could harm our
international operations, reduce or delay our international sales, and result in
fines and penalties.
 
 Changes
in our effective tax rate may reduce our net income in future
periods.
  If our
international revenues do not grow in absolute dollars and as a percentage of
total revenues, then our effective tax rate will not meet our planning
objectives and our profitability will be negatively impacted. Our provision for
income taxes is also subject to volatility and could be adversely affected by
changes in the valuation of our deferred tax assets and liabilities; by
jurisdictions in which profits are determined to be earned and taxed; by
expiration of or lapses in the available tax credits; by transfer pricing
adjustments; by the repatriation of non-U.S. earnings for which we have not
previously provided U.S. taxes, by tax effects of nondeductible compensation; or
by changes in tax laws, regulations, accounting principles, including accounting
for uncertain tax positions or interpretations thereof. Significant judgment is
required to determine the recognition and measurement attribute prescribed in
Financial Interpretation No. 48, Accounting for Uncertainty in Income
Taxes-an interpretation of FASB Statement No. 109, or FIN 48. In
addition, FIN 48 applies to all income tax positions, including the potential
recovery of previously paid taxes, which if settled unfavorably could adversely
impact our provision for income taxes or additional paid-in capital. We
anticipate future audits from various tax authorities. We regularly assess the
likelihood of adverse outcomes resulting from these examinations to determine
the adequacy of our provision for income taxes. There can be no assurance that
the outcomes from these future potential audits may result in an adverse effect
on our operating results and financial condition.
 
 In
addition, the recent turmoil in the financial markets, global recession, and
change in U.S. federal administration could result in changes to the U.S. tax
code and/or changes in the tax law and regulations applicable to Data Domain in
the various jurisdiction around the world in which we operate with the effect of
causing our effective tax rate to not meet our planning objectives and our
profitability to be negatively impacted.
 
 U.S.
Government officials have recently expressed interest in revising the tax code
surrounding offshore tax havens.  While it is unclear when or how the
code might be revised, if at all in this area, it is possible that in the
future, we may experience a lower long-term benefit from our current tax
strategy than currently contemplated.  The net result of this could be
that we pay more U.S. taxes in the aggregate than if we had not pursued our
current lower cost tax strategy.
 
 Based on
projections of future operations and profitability, we have recognized a benefit
for all of our deferred tax assets, having reversed the then existing reserve
against 100% of our deferred tax assets in the fourth quarter of
2008.  While this reversal was based on management’s good faith
estimates of future profitability, the realization of any one of several of the
risks within this risk factor section could result in lower or even no
profitability for us over a sustained period, and the attendant inability to
realize the benefit of the deferred tax assets.  In such event, we
could be required to re-establish a reserve against such tax assets, which would
have an unfavorable effect on our effective tax rate, or even require us to
provision for income taxes during one or more periods of no
income.
  31
 We
are exposed to fluctuations in currency exchange rates that could negatively
impact our financial results and cash flows.
  Because a
portion of our business is conducted outside the United States, we face exposure
to adverse movements in foreign currency exchange rates. These exposures may
change over time as business practices evolve, and they could have a material
adverse impact on our financial results and cash flows. Historically, our
primary exposures have related to nondollar-denominated sales in Europe, UK,
Canada, and Australia and nondollar-denominated operating expenses in Europe,
Japan, Australia and Asia. Additionally, we have exposures for operating
expenses to emerging market currencies, which can have extreme currency
volatility. An increase in the value of the dollar could increase the real cost
to our customers of our products in those markets outside the United States
where we sell in dollars and other currencies, and a weakened dollar could
increase the cost of local operating expenses.
 
 We
have a history of losses and we may not be able to sustain profitability in the
future.
 
 As of
March 31, 2009, our accumulated deficit was approximately $17.4 million, and
despite the fact we achieved profitability in fiscal 2008 and the three months
ended March 31, 2009, we might incur additional losses in future periods. We
expect to make significant expenditures related to the development of our
business, including expenditures to hire additional personnel relating to sales
and marketing and product development. In addition, we will continue to incur
significant legal, accounting and other expenses that we did not incur as a
private company. Our operating expenses are largely based on anticipated revenue
trends, which could be negatively impacted by deteriorating global economic
conditions, and a high percentage of our expenses are, and will continue to be,
fixed in the short term. As a result, a delay in generating or recognizing
revenue could cause significant variations in our operating results from quarter
to quarter and annually and could result in substantial operating losses. Our
revenue growth trends in prior periods are not likely to be sustainable, and we
may not generate sufficient revenue to maintain profitability. We may incur
significant losses in the future for a number of reasons, including those
discussed in other risk factors and factors that we cannot foresee. If we
are not able to sustain profitability in the future, all or a portion of our net
deferred tax assets may not be considered realizable, which could increase
future income tax expense if we are required to establish a valuation allowance
against our net deferred tax assets.
 
 Our
sales are difficult to predict, even in the near term, and a substantial portion
of our quarterly sales typically occurs during the last several weeks of the
quarter.
 
 A
substantial portion of our quarterly sales typically occurs during the last
several weeks of the quarter, which we believe largely reflects customer buying
patterns of products similar to ours and other products in the technology
industry generally. In addition, a significant portion of our sales in any
quarter is not forecast at the start of the quarter and is generated by sales
activity initiated within the quarter. Similarly, we have little visibility at
the start of any quarter as to which existing customers, if any, will make
additional purchases and when any additional purchases may occur, if at all. As
a result, our quarterly operating results are difficult to predict even in the
near-term.
 
 The
market we serve is emerging and the purchase of our appliances by new customers
may involve material changes to established purchasing patterns and policies.
Our sales efforts involve educating potential customers about the uses and
benefits of our appliances, including their technical capabilities and potential
cost savings. Potential customers may undertake a significant evaluation process
that has in the past resulted in a longer sales cycle. In addition, our sales
cycle may be extended if potential customers decide to re-evaluate other aspects
of their backup storage infrastructure at the same time they are considering a
purchase of our appliances. We spend substantial time, money and other resources
in our sales process without any assurance that our efforts will produce any
sales. In addition, customer purchases are frequently subject to budget
constraints, which could be negatively impacted by deteriorating global economic
conditions, multiple approvals and unplanned administrative, processing and
other delays. If sales expected from a specific customer for a particular
quarter are not realized in that quarter, or at all, our business may
suffer.
 
 We have a limited
operating history and compete in a new and rapidly evolving market, which makes
our future operating results difficult to predict.
 
 We were
incorporated in October 2001 and first shipped our appliances in February 2004.
We have a limited operating history in an industry characterized by rapid
technological change, changing customer needs, evolving industry standards and
frequent introductions of new products and services. As we encounter rapidly
changing customer requirements and increasing competitive pressures, we likely
will be required to reposition our product and service offerings and introduce
new products and services. We may not be successful in doing so in a timely and
appropriately responsive manner, or at all. Furthermore, because we compete in
an early stage market, many of our target customers have not purchased products
similar to ours and might not have a specific budget for the purchase of our
appliances. Historically, enterprises have relied on non-deduplication,
tape-based technologies for backup and recovery, and we might not succeed in
generating increased demand for our products. All of these factors make it
difficult to predict our future operating results, which may impair our ability
to manage our business and investors’ ability to assess our
prospects.
 
 If
we lose key personnel or are unable to attract and retain qualified personnel on
a cost-effective basis, our business would be harmed.
 
 Our
success is substantially dependent upon the performance of our senior management
and key technical and sales personnel. Our management and employees can
terminate their employment at any time, and the loss of the services of one or
more of our executive officers or other key employees could harm our business.
Our success also is substantially dependent upon our ability to attract
additional personnel for all areas of our organization, particularly in our
sales and research and development departments. Our dependence on attracting and
retaining qualified personnel is particularly significant as we attempt to grow
our organization. Competition for qualified personnel in our industry is
intense, and we may not be successful in attracting and retaining such personnel
on a timely basis, on competitive terms, or at all. If we are unable to attract
and retain the necessary technical, sales and other personnel on a
cost-effective basis, our business would be harmed.
 
 32
 We
rely on channel partners to sell our appliances, and disruptions to, or our
failure to develop and manage our channel partners would harm our
business.
 
 Our
future success is dependent upon establishing and maintaining successful
relationships with a large number of channel partners. A substantial majority of
our revenue is generated by sales through our channel partners, and we expect
channel sales to continue to make up a significant portion of our total revenue
in the future, particularly outside the United States. In the three months ended
March 31, 2009 and 2008, approximately 75% and 83%, respectively, of our revenue
was generated by sales through our channel partners. Accordingly, our revenue
depends in large part on the effective sales and lead generation activities of
these channel partners.
 
 Recruiting
and retaining qualified channel partners and training them in our technology and
product offerings requires significant time and resources. In order to develop
and expand our distribution channel, we must continue to scale and improve our
processes and procedures that support our channel, including investment in
systems and training. Those processes and procedures may become increasingly
complex and difficult to manage as we grow our organization. We have no minimum
purchase commitments from any of our channel partners, and our contracts with
these channel partners do not prohibit them from offering products or services
that compete with ours. Our competitors may provide incentives to existing and
potential channel partners to favor their products or to prevent or reduce sales
of our appliances. Our channel partners may choose not to offer our appliances
exclusively or at all. Establishing relationships with channel partners who have
a history of selling our competitors’ products may also prove to be difficult.
In addition, some of our channel partners are also competitors. Our failure to
establish and maintain successful relationships with channel partners would
seriously harm our business and operating results. The weak economic situation
will place additional pressures on this channel model, since we may experience
the failure of one or more of our resellers, potentially resulting in our
inability to collect outstanding receivables from such resellers, and
necessitating additional efforts on our part to replace such resellers in order
to maintain access to the various markets around the globe.
 
 If
we fail to manage growth effectively, our business would be harmed.
 
 We have
expanded our operations significantly since inception and anticipate that
further expansion of our operations and headcount will be required. For example,
our headcount increased from 777 employees as of December 31, 2008 to 827
employees as of March 31, 2009. Our growth has placed, and any future growth
will place, significant demands on our management, infrastructure and other
resources. To manage any future growth, we will need to hire, train, integrate
and retain a large number of highly skilled and motivated employees. We will
also need to continue to improve our financial and management controls and
reporting systems and procedures. We implemented new enterprise resource
planning software for our finance and inventory management processes in October
2007, and we may in the future upgrade other finance, sales and inventory
management systems. We could encounter delays or difficulties in implementing
any of these systems. If we do not effectively hire, train, integrate and retain
sufficient highly qualified personnel to support any future growth, and if we do
not effectively manage the associated increases in expenses, our business,
results of operations and financial condition would be harmed.
 
 Our
financial results would suffer if demand for deduplication storage appliances
does not continue to grow.
 
 Our
products are disk-based deduplication storage appliances for backup and
network-based disaster recovery. Deduplication is a relatively new and emerging
technology. Historically, enterprises have relied on non-deduplication
tape-based technologies for backup and recovery. A reduction in demand for
deduplication storage appliances for backup storage or network-based disaster
recovery could be caused by, among other things, weakening economic conditions,
decreases in information technology spending, lack of customer acceptance or
competing technologies and products. Our future financial results would suffer
if the demand for deduplication storage appliances does not continue to
grow.
 
 If
we fail to predict accurately our manufacturing and component requirements, we
could incur additional costs or experience manufacturing delays which would harm
our business.
 
 Our
agreement with our contract manufacturer, Flextronics, does not provide for
specific quantities or inventory levels for our appliances or the components
used in our appliances. Instead, we provide purchase orders to Flextronics on a
monthly basis. If we overestimate our manufacturing needs, Flextronics may
assess charges or we may have liabilities for excess or obsolete
inventory.  Conversely, because lead times for required materials and
components vary significantly and depend on factors such as the specific
supplier, contract terms and demand for the particular component at any given
time, if we underestimate our requirements, Flextronics may have inadequate
materials and components required to produce our appliances. In that event, the
manufacturing of our appliances could be interrupted, shipments could be delayed
and revenue could be deferred or lost. Flextronics generally carries very little
inventory of components for our appliances, and we rely on suppliers to deliver
necessary components to Flextronics in a timely manner based on forecasts
provided to the suppliers.
 
 Any
shortages in components used in our appliances could delay shipment of our
appliances or increase our product costs, which could harm our
business.
 
 We may
experience shortages in components that we use in our appliances, and we may not
accurately predict the availability of and demand for such components. We rely
on Flextronics to procure a majority of the components used in our appliances.
As a result, any disruption in Flextronics’s ability to timely procure necessary
components in the quantities required, or at reasonable prices, could result in
a delay in the shipment of our appliances. Due to technological, pricing or
business reasons, some of the components used in our appliances are available
only from a single or limited source of supply. Flextronics generally carries
very little inventory of components for our appliances, and we rely on suppliers
to deliver necessary components to Flextronics in a timely manner based on
forecasts provided to the suppliers.
 
 Our
capacity expansion shelves and the chassis for our DD 6XX appliances are
currently supplied exclusively by a single vendor, Xyratex Technology Limited,
or Xyratex. Neither our agreement with Xyratex, nor any agreement between
Flextronics and Xyratex, provides for specific quantities or inventory levels of
expansion shelves or the DD 6XX chassis. Instead, Flextronics provides purchase
orders to Xyratex on a monthly basis based on purchase orders we place with
Flextronics and our forecasts.  If Flextronics is unable to acquire
the expansion shelves or DD 6XX chassis from Xyratex for whatever reason, the
manufacturing of our expansion shelves and DD 6XX appliances could be
interrupted and shipments could be delayed and revenue could be deferred or
lost. Our agreement with Xyratex for expansion shelves has a three-year term
ending in March 2010, subject to early termination by either party under certain
circumstances.
 
 Our
appliances depend on NVRAM cards that currently are only available from a single
vendor, Curtiss-Wright Corporation. Neither we nor Flextronics has an agreement
with Curtiss-Wright Corporation providing for specific quantities or inventory
levels of NVRAM cards. We or Flextronics order NVRAM cards under a standard
purchase order arrangement with Curtiss-Wright Corporation or its
distributor.
 
 Our
appliances depend on DiskOnModule (DOM) flash memory devices that are only
available from a single vendor, PQI Corporation.  Neither we nor
Flextronics has an agreement with PQI Corporation providing for specific
quantities or inventory levels of NVRAM cards. We or Flextronics order the
PQI DOM under a standard purchase order arrangement with PQI Corporation or its
distributor.
 
 Our
appliances depend on microprocessors that are only available from a single
vendor, Intel Corporation, and certain of our products rely on motherboards that
are only available from Intel. Neither we nor Flextronics has an agreement with
Intel providing for specific quantities or inventory levels of these components.
We or Flextronics order these components under a standard purchase order
arrangement with Intel or its distributor.
 
 We
acquire the chassis used in our appliances other than the DD 6XX appliances
and expansion shelves from a single vendor, Super Micro Computer, Inc., or Super
Micro. Neither we nor Flextronics has an agreement with Super Micro providing
for specific quantities or inventory levels of chassis. We or Flextronics
order chassis under a standard purchase order arrangement with Super Micro or
its distributor.
 
 Significant
time and effort would be required to locate new vendors for any of the foregoing
components, if available at all, to qualify replacement components or to develop
our appliances using alternative suppliers. The unavailability of any of these
or other necessary components could delay or prevent us from shipping our
appliances. Component suppliers may be vulnerable to pressure from large
purchasers of their products, who may be competitors of ours, to allocate
available component supplies to them. The global recession may also adversely
affect our suppliers, including those on whom we are dependent as sole source
suppliers, and their liquidity, and the availability of, and/or terms and
conditions on which we purchase, their products and services. In addition,
increased demand generally by third parties for the components we use in our
appliances may lead to decreased availability and higher prices for those
components. Further, we are dependent in some instances upon these sole source
suppliers for support of their products, and for new product introductions, and
we are subject to their end of life practices, including timing of product end
of life, post end of life support, and last time buy notice, availability and
pricing.
 
 If we
experience shortages in components that we use in our appliances, or do not
accurately predict the availability of and demand for such components, or if new
product introductions by our suppliers do not meet our expectations for timing,
availability, functionality/performance, quality or price, then our business and
gross margins could be negatively impacted, and our reputation and customer
relationships could be harmed.
 
 33
 We
are dependent on a single contract manufacturer and changes to that relationship
may result in delays or disruptions that could harm our business.
 
 We rely
on a single independent contract manufacturer, Flextronics, to manufacture and
assemble our appliances. We currently have an agreement in place with
Flextronics that is subject to automatic extensions in one-year increments
absent notice of termination by us or Flextronics. However, either party can
terminate the agreement for any reason at any time with at least 90 days’
advance written notice. We may not be able to effectively manage our
relationship with Flextronics, and Flextronics may not meet our future
requirements for timely delivery. Our orders represent only a small percentage
of the overall orders received by Flextronics from its customers. As a result,
fulfilling our orders may not be considered a priority by Flextronics in the
event it is constrained in its ability to fulfill all of its customer
obligations in a timely manner. Although the services required to manufacture
and assemble our appliances may be readily available from a number of other
established contract manufacturers, it would be time consuming and costly to
qualify and implement a new contract manufacturer relationship. Although we have
a contingency plan in place with Flextronics in the event that its capacity at
the location used to manufacture and assemble our appliances is reduced or
temporarily eliminated, any event that disrupts the manufacturing and assembly
process could harm our business. If Flextronics suffers an interruption in its
business, or experiences delays, disruptions or quality control problems in its
manufacturing operations, or if we have to change or add additional contract
manufacturers, our ability to manufacture and ship appliances to our customers
would be delayed and our business would suffer.
  We
rely on a single third party to provide onsite hardware and repair and
replacement services to a substantial majority of our customers, and any
disruption to the availability of those services or their quality could harm our
business.
 
 We
subcontract with a third party, Glasshouse, Inc., or Glasshouse, to provide
onsite hardware repair and replacement services for the substantial majority of
our customers that have purchased a support and services contract from us. For
each such covered customer, we purchase a support contract from Glasshouse. Our
master agreement with Glasshouse has a three-year term ending in June 2010,
except that after the initial 12 months, which ended in June 2008, either party
may terminate the agreement by providing the other party with 90 days’ prior
written notice. We may not be able to effectively manage our relationship with
Glasshouse, and Glasshouse may not meet our future requirements for high
quality, timely delivery of services. Although the break fix services performed
by Glasshouse may be readily available from a number of other established
suppliers, it could be time consuming and costly to qualify and implement a new
supplier. If Glasshouse suffers an interruption in its business, or experiences
delays, disruptions or quality control problems in its services, or if we have
to change or add additional service providers, our ability to deliver high
quality and timely break fix services to our customers could be delayed and our
business and gross margins could be negatively impacted, and our reputation and
customer relationships could be harmed.
 
 If
we do not successfully anticipate market needs and develop products and product
enhancements that meet those needs, or if those products do not gain market
acceptance, our business will suffer.
 
 The
market in which we currently operate is rapidly developing. We may not be able
to anticipate future market needs or be able to develop new products or product
enhancements to meet such needs, either in a timely manner or at all. Our
business depends upon the introduction of successive new generations of products
with improved performance, capacity and functionality. We anticipate that for
future product introductions we will be required to establish new relationships
with original design manufacturers (ODMs) and other suppliers on whom we will be
dependent for design services, component supplies, manufacturing and
support.  Establishing new suppliers can be time consuming and costly,
and new designs and new suppliers present risks of delay, costs,
functionality/performance, quality and availability. If we fail to introduce
successive new generations of products with improved the performance, capacity
and functionality, and/or fail to successfully establish relationships with ODMs
and other suppliers on whom we will be dependent for achieving our objectives,
then our business and gross margins could be negatively impacted. We also may
not be able to develop our products in a manner that enables us to successfully
address the needs of other parts of the enterprise storage market. For example,
we have recently introduced products for classes of applications other than
backup and disaster recovery. These nearline classes of applications, such as
archival storage and fixed-content data storage, manage largely static files and
benefit from the fast storage and retrieval of disk-based systems, but do not
require the performance characteristics of primary storage. Our failure to
extend our deduplication technology into these nearline applications,
particularly if our competitors are able to do so, could harm our business. In
addition, any new products or product enhancements that we introduce may not
achieve any significant degree of market acceptance or be accepted into our
sales channel by our channel partners, which would harm our
business.
 
 If
we fail to offer high quality customer support and services, our business would
suffer.
 
 Once our
appliances are deployed within our customers’ networks, our customers depend on
our support organization to resolve any issues relating to our appliances. A
high level of customer support and services is important for the successful
marketing and sale of our appliances. If we or our channel partners do not help
our customers quickly resolve post-deployment issues and provide effective
ongoing support, our ability to sell our appliances to existing customers would
suffer and our reputation with potential customers would be harmed. Some of our
international channel partners offer primary support for the appliances they
sell to customers, and we rely on third parties to provide onsite hardware
repair and replacement services for most of our customers. If the third parties
fail to provide timely and effective services, our business could be harmed. As
we expand our sales, we will be required to hire and train additional support
personnel. In addition, as we expand our operations internationally, our support
organization will face additional challenges including those associated with
delivering support, training and documentation in languages other than English.
If we fail to maintain high quality customer support or to grow our support
organization to match any future sales growth, our business
will suffer.
 
 If
we elect to discount our support and services pricing to attract or retain
customers, we may be required to defer a portion of our revenue to future
periods.
 
 If we
elect to discount our support and services pricing or otherwise introduce
significant variability in our support and services arrangements, this
variability may require us to defer the recognition of revenue from sales of our
appliances. We recognize revenue for our appliances using the residual method as
allowed by the American Institute of Certified Public Accountants, or AICPA,
Statement of Position No. 98-9,Modification of SOP No. 97-2,
Software RevenueRecognition, with Respect to Certain
Transactions, or SOP 98-9. Under this method, in order to recognize
product revenue upon shipment, we must establish sufficient evidence, which is
referred to as vendor specific objective evidence, or VSOE, of fair value of our
undelivered support and services. We have established VSOE of fair value of our
support and services based on the price charged when support and services are
sold separately. If we are required to change the pricing of support and
services through discounting, or otherwise introduce variability in the pricing
of support and services on certain transactions to attract or retain customers,
we may be unable to maintain VSOE of the fair value of support and services for
similar types of transactions. As a result, we could be required to defer all
revenue for these transactions and recognize revenue ratably over the term of
the related support and services contracts, which is typically one to three
years. If this were to occur, our revenue would decline and our operating
results would be negatively impacted.
  34
 Our
appliances handle mission-critical data for our customers and are highly
technical in nature. If customer data is lost or corrupted, or our appliances
contain software errors or hardware defects, we could have product liability
exposure and our reputation and business could be harmed.
 
 Our
appliances are involved in storing and replicating mission-critical data for our
customers. The process of storing and replicating that data is highly technical
and complex. If any data is lost or corrupted in connection with the use of our
appliances, our reputation could be seriously harmed and market acceptance of
our appliances could suffer. In addition, our appliances have contained and may
in the future contain software errors, hardware defects or security
vulnerabilities. We rely on our suppliers to deliver high quality components for
use in our products and we have limited or no control over our suppliers’
product development and production processes. Some software errors or defects in
the hardware components of our appliances may only be discovered after an
appliance has been installed and used by customers. In April 2007, we initiated
a field replacement program to replace a circuit board used in some of our
appliances. To date, these circuit boards have experienced failures in less than
1% of the appliances that we believe are potentially affected. All of the
circuit boards that have failed were manufactured by fabricators that are no
longer supplying parts for use in our appliances. Through the replacement
program, we are offering to replace the potentially affected circuit boards with
circuit boards manufactured by a particular fabricator. We accrued estimated
warranty costs of $1.2 million in the first quarter of 2007 for this replacement
program. We accrued an additional $450,000 in the third quarter of 2007 to
expand this program for additional circuit boards used in some of our
appliances. During the second quarter of 2008, we recorded an additional charge
of $25,000 as we revised our estimate of the costs of the replacement program.
These estimates were based on the number of circuit boards we expect to replace
under the program, the anticipated cost of replacement and refurbishment and
other associated costs. As of March 31, 2009, we had incurred approximately
$1.6 million of costs associated with these field replacement programs and
$22,000 remained in accrued liabilities to cover future costs for the units
potentially affected. Although we believe our estimates and judgments for the
replacement program are reasonable, if the problem is more extensive than we
currently believe or the actual costs of the program otherwise exceed our
estimate, our operating results will be negatively impacted. Any such errors,
defects or security vulnerabilities discovered in our appliances after
commercial release could result in loss of revenue, loss of customers, increased
service and warranty cost, harm to our reputation and diversion of attention of
our management and technical personnel, any of which could significantly harm
our business. In addition, we could face claims for product liability, tort or
breach of warranty. Defending a lawsuit, regardless of its merit, is costly and
may divert management’s attention and adversely affect the market’s perception
of us and our appliances.
 
 Changes
in existing technologies or the emergence of new products or technologies could
reduce demand for our appliances and significantly harm our
business.
 
 Changes
in existing technologies could cause demand for our appliances to decline. For
example, if changes in technology result in a significant reduction in the price
for hard disk drives, enterprises may not need to utilize deduplication storage
in order to cost-effectively backup and protect their data. One or more new
technologies also could be introduced that compete favorably with our appliances
or that cause our appliances to no longer be of significant benefit to our
customers. In addition, because our appliances work with enterprise backup
software applications to transfer and store data in the protection storage
environment, we are dependent on enterprises’ use of these applications for data
protection and disaster recovery purposes. If enterprises adopt products or
technologies that enable them to protect and recover their data without the need
for backup software, demand for our appliances would be reduced
significantly.
 
 The
inability of our appliances to interoperate with backup software applications
would cause our business to suffer.
 
 We have
designed our appliances to interoperate with the leading enterprise backup
software applications available in the market. If our appliances are not
compatible with the leading backup software applications, demand for our
appliances will decline. Some backup software providers currently offer products
that compete with ours and other providers may do so in the future. Backup
software providers may in the future make changes that would diminish the
ability of our appliances to interoperate with their applications. If this were
to occur, we may need to spend significant time and effort to ensure the
continued compatibility of our appliances, which may not be possible at all. Any
of these developments could significantly harm our business.
 
 Data
formats may change in a way that reduces the value of our compression
technologies.
 
 Our
compression technologies have been designed to work well for data formats
commonly seen in customer data centers today. The format of data stored on our
appliances may change in ways that reduce the benefit of our compression
technologies. Such format changes could result from changes in the applications
that create or transmit the data, changes in the systems that store the data, or
changes in policies concerning data encryption, compression, or encoding. For
example, some potential customers in the past have employed encryption or
compression technologies that they were unable or unwilling to disable and
therefore did not find the benefits of our Global Compression technologies
compelling. If the number of such potential customers were to increase
significantly in the future, our business could suffer.
 
 The
U.S. government has become an important customer for us, and if it or individual
agencies within the U.S. government reduce or shift their capital spending
pattern, our financial results may be harmed.
  The
U.S. government has become an important customer for us. Government
agencies are subject to budgetary processes and expenditure constraints, which
constraints could increase due to current economic conditions, that could lead
to delays or decreased capital expenditures in information technology spending
on infrastructures. If the U.S. government or individual agencies within
the U.S. government reduce or shift their capital spending pattern, our
financial results may be harmed.  Our sales to the U.S. government may
involve longer sales cycles than is typical of our non-government customers,
increasing the likelihood that an order may not occur in the quarter in which we
had anticipated the sale, if at all.  In addition, our sales to the
U.S. government require us to comply with U.S. laws applicable to enterprises
and products that are offered for sale to the U.S. government.  Any
failure by us to comply with and manage these obligations could result in a
reduction or delay in sales to the U.S government, or result in fines and
penalties.
 
 If
we fail to establish and maintain proper and effective internal control over
financial reporting, our operating results and our ability to operate our
business could be harmed.
 
 The
Sarbanes-Oxley Act of 2002 requires, among other things, that we establish and
maintain internal control over financial reporting and disclosure controls and
procedures. We performed, under the supervision and with the participation of
our management, system and process evaluations and testing of our internal
control over financial reporting, as required by Section 404 of the
Sarbanes-Oxley Act, and our management reported that our internal control over
financial reporting was effective as of December 31, 2008. However, if in the
future we are not able to comply with the requirements of Section 404 in a
timely manner, or if we or our independent registered public accounting firm
identify deficiencies in our internal control over financial reporting that are
deemed to be material weaknesses, the market price of our common stock could
decline and we could be subject to investigations or sanctions by the SEC, the
NASDAQ Stock Market, or NASDAQ, or other regulatory authorities or subject to
litigation. To the extent any material weaknesses in our internal control over
financial reporting are identified in the future, we could be required to expend
significant management time and financial resources to correct such material
weaknesses or to respond to any resulting regulatory investigations or
proceedings.
 
 35
 If
we are unable to protect our intellectual property rights, our competitive
position could be harmed, and we could be required to incur significant expenses
to enforce our rights.
 
 We depend
on our ability to protect our proprietary technology. We rely on trade secret,
patent, copyright and trademark laws and confidentiality agreements with
employees and third parties, all of which offer only limited protection. Despite
our efforts, the steps we have taken to protect our proprietary rights may not
be adequate to preclude misappropriation of our proprietary information or
infringement of our intellectual property rights, and our ability to police such
misappropriation or infringement is uncertain, particularly in countries outside
of the United States. Further, we do not know whether any of our pending patent
applications will result in the issuance of patents or whether the examination
process will require us to narrow our claims. Even issued patents may be
contested, circumvented or invalidated. Moreover, the rights granted under any
issued patents may not provide us with proprietary protection or competitive
advantages, and, as with any technology, competitors may be able to develop
similar or superior technologies to our own now or in the future. In addition,
we have entered into a cross-license agreement with Quantum, a competitor of
ours, that provides Quantum and its controlled affiliates a license to our
current and future patents that relate to or are useful with respect to data
transmission or data storage and that are or may be issued or applied for (or
otherwise entitled to a priority date) on or prior to January 1, 2012. As a
result of this agreement, we will not be able to assert our existing patent
rights and many or all of our future patent rights against Quantum or its
controlled affiliates for the foreseeable future, and Quantum has certain rights
to assign this license to an acquirer of Quantum. It is also possible that we
may find it necessary or advantageous to enter into similar cross licenses in
the future with other actual or potential competitors.
 
 Protecting
against the unauthorized use of our patents, trademarks and other proprietary
rights is expensive, difficult and, in some cases, impossible. Litigation may be
necessary in the future to enforce or defend our intellectual property rights,
to protect our trade secrets or to determine the validity and scope of the
proprietary rights of others. Such litigation could be costly and divert
management resources, either of which could harm our business. Furthermore, many
of our current and potential competitors have the ability to dedicate
substantially greater resources to enforce their intellectual property rights
than we do. Accordingly, despite our efforts, we may not be able to prevent
third parties from infringing upon or misappropriating our intellectual
property.
 
 Claims
by others that we infringe their proprietary technology could harm our
business.
 
 Third
parties could claim that our appliances or technology infringe their proprietary
rights. We expect that infringement claims may increase as the number of
products and competitors in our market increases and overlaps occur. In
addition, to the extent that we gain greater visibility and market exposure as a
public company, we face a higher risk of being the subject of intellectual
property infringement claims. Any claims of infringement by a third party, even
those without merit, could cause us to incur substantial costs defending against
the claim, and could distract our management from our business. Furthermore, a
party making such a claim, if successful, could secure a judgment that requires
us to pay substantial damages. A judgment could also include an injunction or
other court order that could prevent us from offering our appliances. In
addition, we might be required to seek a license for the use of such
intellectual property, which may not be available on commercially reasonable
terms or at all. Alternatively, we may be required to develop non-infringing
technology, which could require significant effort and expense and may
ultimately not be successful. Any of these events could seriously harm our
business.
 
 Third
parties may also assert infringement claims relating to our appliances against
our customers and channel partners. Any of these claims may require us to
initiate or defend potentially protracted and costly litigation on their behalf,
regardless of the merits of these claims, because we generally are obligated to
indemnify our channel partners and our customers from claims of
infringement of proprietary rights of third parties. If any of these claims
succeed, we may be forced to pay damages to, or on behalf of, our customers or
channel partners, which could seriously harm our business.
 
 Our
use of open source software could impose limitations on our ability to
commercialize our appliances.
 
 We
incorporate open source software into our appliances. The terms of many open
source licenses have not been interpreted by United States courts, and there is
a risk that such licenses could be construed in a manner that could impose
unanticipated conditions or restrictions on our ability to commercialize our
appliances. In that event, we could be required to seek licenses from third
parties in order to continue offering our appliances, to re-engineer our
appliances, to discontinue the sale of our appliances in the event
re-engineering cannot be accomplished on a timely basis or to litigate any
disputes relating to our use of open source software, any of which could harm
our business.
 
 Our
business is subject to increasingly complex environmental legislation that has
increased both our costs and the risk of noncompliance and may continue to do so
in the future.
 
 We face
increasing complexity in the design and manufacture of our appliances as we
adjust to new and upcoming requirements relating to the materials composition of
many of our appliances. For example, the European Union, or EU, has adopted
certain directives to facilitate the recycling of electrical and electronic
equipment sold in the EU, including the Restriction on the Use of Certain
Hazardous Substances in Electrical and Electronic Equipment, or RoHS, directive.
The RoHS directive restricts the use of lead, mercury and certain other
substances in electrical and electronic products placed on the market in the EU.
A companion EU directive, the Waste Electrical and Electronic Equipment
Directive imposes responsibility for the collection, recycling and recovery for
certain electrical and electronic products on the manufacturers of such
equipment.
 
 We have
incurred costs to comply with these regulations in the past and could incur
additional costs in the future. In addition, compliance with these regulations
could disrupt our operations and logistics. We will need to ensure that we can
design and manufacture compliant appliances and that we can be assured a supply
of compliant components from suppliers. Similar laws and regulations have been
proposed or may be enacted in other regions, including the United States,
Australia, Canada, China, Korea and Japan. These and other environmental
regulations may require us to reengineer our appliances to utilize new
components that are compatible with these regulations, which may result in
additional costs to us.
 
 We
may not generate positive returns on our research and development
investments.
 
 Developing
our products is expensive, and our investment in product development may involve
a long investment return cycle. For the three months ended March 31, 2009, our
research and development expenses were $14.2 million, or approximately 18.0% of
revenue. Our future plans include significant investments in research and
development and related product opportunities. We believe that we must continue
to dedicate a significant amount of resources to our research and development
efforts to maintain our competitive position. These investments may not generate
positive returns in the near term, or at all.
 
 36
 We
may engage in future acquisitions that could disrupt our business, cause
dilution to our stockholders and harm our business, operating results and
financial condition.
 
 In the
future we may acquire other businesses, products or technologies. We have not
made any acquisitions to date and, as a result, our ability as an organization
to make acquisitions is unproven. We may not be able to find suitable
acquisition candidates and we may not be able to complete acquisitions on
favorable terms, if at all. If we do complete acquisitions, we may not
ultimately strengthen our competitive position or achieve our goals, and any
acquisitions we complete could be viewed negatively by customers, financial
markets or investors. In addition, any acquisitions that we make could lead to
difficulties in integrating personnel and operations from the acquired
businesses and in retaining and motivating key personnel from these businesses.
Acquisitions may disrupt our ongoing operations, divert management from
day-to-day responsibilities, increase our expenses and harm our business. Future
acquisitions may also reduce our cash available for operations and other uses
and could result in an increase in amortization expense related to identifiable
assets acquired, potentially dilutive issuances of equity securities or the
incurrence of debt.
 
 We
have incurred, and will continue to incur, significant costs as a result of
operating as a public company, and our management is required to devote
substantial time to compliance efforts.
 
 As a
public company, we incur significant legal, audit, accounting and other expenses
that we did not incur as a private company. The Sarbanes-Oxley Act, as well as
rules subsequently implemented by the SEC and NASDAQ, impose additional
requirements on public companies, including enhanced corporate governance
practices. For example, the NASDAQ listing requirements require that listed
companies satisfy certain corporate governance requirements relating to
independent directors, audit committees, distribution of annual and interim
reports, stockholder meetings, stockholder approvals, solicitation of proxies,
conflicts of interest, stockholder voting rights and codes of business conduct.
Our management and other personnel are required to devote a substantial amount
of time to these requirements. Moreover, these rules and regulations have
increased our legal and financial compliance costs and have made some activities
more time-consuming and costly. These rules and regulations could also make it
more difficult for us to attract and retain qualified persons to serve on our
board of directors and board committees or as executive officers.
 
 Our
business is subject to the risks of earthquakes, fire, floods and other natural
catastrophic events, and to interruption by man-made problems such as computer
viruses or terrorism.
 
 Our
corporate headquarters and the operations of the contract manufacturer for our
appliances are located in the San Francisco Bay Area, a region known for seismic
activity. A significant natural disaster, such as an earthquake, fire or a
flood, could harm our business. In addition, our servers are vulnerable to
computer viruses, break-ins and similar disruptions from unauthorized tampering
with our computer systems. In addition, acts of terrorism or war could cause
disruptions in our or our customers’ business or the economy as a whole. To the
extent that such disruptions result in delays or cancellations of customer
orders, or delay the manufacture and shipment of our appliances, our business
would be harmed.
 
 
 Risks
Related to Ownership of Our Common Stock
 
 The
trading price of our common stock has been volatile and is likely to be volatile
in the future.
 
 The
trading prices of our common stock as well as the securities of other technology
companies have been highly volatile, particularly in the last several months as
a result of deteriorating economic conditions. Further, our common stock has a
limited trading history. Factors affecting the trading price of our common stock
could include:
 
 ·
              variations
      in our operating results;·
              announcements
      of technological innovations, new products and services, strategic
      alliances or significant agreements by us or by our
      competitors;·
              recruitment
      or departure of key personnel;·
              changes
      in the estimates of our operating results or changes in recommendations by
      any securities analysts that elect to follow our common
    stock;·
              market
      conditions in our industry, the industries of our customers and the
      economy as a whole; and·
              adoption
      or modification of regulations, policies, procedures or programs
      applicable to our business.
 
 In
addition, if the market for technology stocks or the stock market in general
continues to experience a loss of investor confidence, the trading price of our
common stock could continue to decline for reasons unrelated to our business,
operating results or financial condition. The trading price of our common stock
might also decline in reaction to events that affect other companies in our
industry even if these events do not directly affect us, or in reaction to
reports from industry analysts about us or our competitors or others in the
technology industry generally. Some companies that have had volatile market
prices for their securities have had securities class actions filed against
them. A suit filed against us, regardless of its merits or outcome, could cause
us to incur substantial costs and could divert management’s
attention.
 
 Anti-takeover
provisions in our charter documents and Delaware law could discourage, delay or
prevent a change in control of our company and may affect the trading price of
our common stock.
 
 We are a
Delaware corporation and the anti-takeover provisions of the Delaware General
Corporation Law may discourage, delay or prevent a change in control by
prohibiting us from engaging in a business combination with an interested
stockholder for a period of three years after the person becomes an interested
stockholder, even if a change in control would be beneficial to our existing
stockholders. In addition, our restated certificate of incorporation and amended
and restated bylaws may discourage, delay or prevent a change in our management
or control over us that stockholders may consider favorable. Our restated
certificate of incorporation and amended and restated bylaws:
 
 ·
              authorize
      the issuance of “blank check” preferred stock that could be issued by our
      board of directors to thwart a takeover attempt;·
              establish
      a classified board of directors, as a result of which the successors to
      the directors whose terms have expired will be elected to serve from the
      time of election and qualification until the third annual meeting
      following their election;·
              require
      that directors only be removed from office for cause;·
              provide
      that vacancies on the board of directors, including newly created
      directorships, may be filled only by a majority vote of directors then in
      office;·
              limit
      who may call special meetings of stockholders;·
              prohibit
      stockholder action by written consent, requiring all actions to be taken
      at a meeting of the stockholders; and·
              require
      supermajority stockholder voting to effect certain amendments to our
      restated certificate of incorporation and amended and restated
      bylaws.
 
 37
 
 Item 2.
              Unregistered
      Sales of Equity Securities and Use of
Proceeds
 
 The
effective date of the registration statement filed on Form S-1 under the
Securities Act of 1933 (File No. 001-33517) for our initial public offering was
June 26, 2007. As a result of our initial public offering, we raised a total of
$109.3 million in net proceeds after deducting underwriting discounts,
commissions and offering expenses. To date, we have not used any of the proceeds
from our initial public offering for operating activities. We have invested all
of the net proceeds in short-term investment grade instruments. None of the
payments were made, directly or indirectly, to our directors, officers or
persons owning 10% or more of our common stock.
 
 Item 6.
              EXHIBITS
  Exhibit No.
              
              Description31.1
              
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
              
              Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.32.1
              
              Certification
      of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.32.2
              
              Certification
      of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.
 
 The
certifications attached as Exhibits 32.1 and 32.2 that accompany this Quarterly
Report on Form 10-Q are not deemed filed with the Securities and Exchange
Commission and are not to be incorporated by reference into any filing of Data
Domain, Inc. under the Securities Act of 1933 or the Securities Exchange Act of
1934, whether made before or after the date of this Quarterly Report on Form
10-Q, irrespective of any general incorporation language contained in such
filing.
 
 
 38
 
 SIGNATURES
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
  Data
      Domain, Inc.Date:
      May 8, 2009
              
              /s/
      Michael P. ScarpelliMichael
      P. Scarpelli, Senior Vice President and Chief Financial
      Officer(Principal
      Financial and Accounting Officer)