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 June 30, 2008





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 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
            
             ̈  Accelerated
      filer
            
            x  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 July 31,
2008 was 59,289,259.







1





Data Domain, Inc.


FORM
10-Q


FOR
THE QUARTER ENDED


June
30, 2008


INDEX


PART I. FINANCIAL
    INFORMATION
              Page
      No.Item
      1.
              
              Financial Statements
      (unaudited)Condensed Consolidated Balance
      Sheets as of June 30, 2008 and December 31,
2007
              3Condensed Consolidated Statements
      of Operations for the three and six months ended June 30, 2008 and June
      30, 2007
              4Condensed Consolidated Statements of
      Cash Flows for the six months ended June 30, 2008 and June 30,
      2007
              5Notes to Condensed Consolidated
      Financial Statements
              6Item
      2.
              
              Management’s Discussion and
      Analysis of Financial Condition and Results of
      Operations
              14Item
      3.
              
              Quantitative and Qualitative
      Disclosures About Market Risk
              20Item
      4.
              
              Controls and
      Procedures
              20PART II. OTHER
      INFORMATIONItem
      1.
              
              Legal
      Proceedings
              21Item
      1A.
              
              Risk
      Factors
              22Item
      2.
              
              Unregistered Sales of Equity
      Securities and Use of Proceeds
              29Item
      4.
              
              Submission of Matters to a Vote of
      Security Holders
              29Item
      6.
              
              Exhibits
              29


2
 Index





PARTI. FINANCIAL INFORMATION




Item
      1.
            Financial
      Statements





Data
Domain, Inc.


Condensed
Consolidated Balance Sheets


(in
thousands)


(unaudited)





June 30,
              2008
            
            
            December 31,
              2007Current
      assets:Cash
      and cash equivalents
            
            $
            120,895
            
            
            $
            102,939Short-term
      investments
            
            
            75,944
            
            
            
            104,197Accounts
      receivable (net of allowances of $348 and $0,
respectively)
            
            
            46,854
            
            
            
            35,320Inventories
            
            
            2,163
            
            
            
            2,341Prepaid
      expenses and other current assets
            
            
            4,275
            
            
            
            1,711Total
      current assets
            
            
            250,131
            
            
            
            246,508Long-term
      investments
            
            
            29,246
            
            
            
            —Intangible
      asset
            
            
            200
            
            
            
            267Property,
      plant and equipment
            
            
            25,624
            
            
            
            14,589Total
      assets
            
            $
            305,201
            
            
            $
            261,364Current
      liabilities:Accounts
      payable
            
            $
            9,783
            
            
            $
            7,251Accrued
      compensation and related benefits
            
            
            13,672
            
            
            
            11,992Other
      accrued liabilities
            
            
            5,996
            
            
            
            6,731Income
      taxes payable
            
            
            388
            
            
            
            196Deferred
      revenue, current
            
            
            25,854
            
            
            
            16,650Total
      current liabilities
            
            
            55,693
            
            
            
            42,820Deferred
      revenue, non-current
            
            
            16,989
            
            
            
            9,322Long-term
      exercised unvested stock options
            
            
            408
            
            
            
            766Other
      liabilities
            
            
            1,499
            
            
            
            594Stockholders'
      equity:Common
      stock and additional paid-in capital
            
            
            268,323
            
            
            
            248,078Accumulated
      other comprehensive income (loss)
            
            
            (1,883
            )
            
            
            47Accumulated
      deficit
            
            
            (35,828
            )
            
            
            (40,263
            )Total
      stockholders' equity
            
            
            230,612
            
            
            
            207,862Total
      liabilities and stockholders' equity
            
            $
            305,201
            
            
            $
            261,364





See Notes
to Condensed Consolidated Financial Statements





3
 Index





DataDomain, Inc.


Condensed
Consolidated Statements of Operations


(in
thousands, except per share data)


(unaudited)





Three
      Months Ended
            
            
            Six
      Months EndedJune
      30,
              2008
            
            
            June
      30,
              2007
            
            
            June
      30,
              2008
            
            
            June
      30,
              2007Revenue:Product
            
            $
            51,970
            
            
            $
            23,598
            
            
            $
            97,190
            
            
            $
            41,478Support
      and services
            
            
            9,215
            
            
            
            2,838
            
            
            
            16,583
            
            
            
            4,975Ratable
      product and related support and services
            
            
            26
            
            
            
            72
            
            
            
            53
            
            
            
            264Total
      revenue
            
            
            61,211
            
            
            
            26,508
            
            
            
            113,826
            
            
            
            46,717Cost
      of revenue:Cost
      of product
            
            
            13,753
            
            
            
            6,442
            
            
            
            25,069
            
            
            
            12,291Cost
      of support and services
            
            
            3,136
            
            
            
            905
            
            
            
            5,625
            
            
            
            1,703Cost
      of ratable product and related support and services
            
            
            1
            
            
            
            21
            
            
            
            2
            
            
            
            97Total
      cost of revenue
            
            
            16,890
            
            
            
            7,368
            
            
            
            30,696
            
            
            
            14,091Gross
      profit
            
            
            44,321
            
            
            
            19,140
            
            
            
            83,130
            
            
            
            32,626Operating
      expenses:Sales
      and marketing
            
            
            27,485
            
            
            
            12,419
            
            
            
            50,717
            
            
            
            21,102Research
      and development
            
            
            9,627
            
            
            
            5,659
            
            
            
            18,363
            
            
            
            10,162General
      and administrative
            
            
            5,720
            
            
            
            2,310
            
            
            
            11,326
            
            
            
            4,088Total
      operating expenses
            
            
            42,832
            
            
            
            20,388
            
            
            
            80,406
            
            
            
            35,352Operating
      income (loss)
            
            
            1,489
            
            
            
            (1,248
            )
            
            
            2,724
            
            
            
            (2,726
            )Other
      income (expense), net:Interest
      income
            
            
            1,517
            
            
            
            180
            
            
            
            3,680
            
            
            
            336Other
      income (expense), net
            
            
            (120
            )
            
            
            (13
            )
            
            
            1,123
            
            
            
            (109
            )Total
      other income (expense), net
            
            
            1,397
            
            
            
            167
            
            
            
            4,803
            
            
            
            227Income
      (loss) before provision for income taxes
            
            
            2,886
            
            
            
            (1,081
            )
            
            
            7,527
            
            
            
            (2,499
            )Provision
      for income taxes
            
            
            1,192
            
            
            
            150
            
            
            
            3,092
            
            
            
            205Net
      income (loss)
            
            $
            1,694
            
            
            $
            (1,231
            )
            
            $
            4,435
            
            
            $
            (2,704
            )Net
      income (loss) per share, basic
            
            $
            0.03
            
            
            $
            (0.12
            )
            
            $
            0.08
            
            
            $
            (0.29
            )Net
      income (loss) per share, diluted
            
            $
            0.03
            
            
            $
            (0.12
            )
            
            $
            0.07
            
            
            $
            (0.29
            )Shares
      used in computing net income (loss) per share, basic
            
            
            57,570
            
            
            
            10,064
            
            
            
            57,059
            
            
            
            9,244Shares
      used in computing net income (loss) per share, diluted
            
            
            65,381
            
            
            
            10,064
            
            
            
            65,520
            
            
            
            9,244








See Notes
to Condensed Consolidated Financial Statements





4
 Index





DataDomain, Inc.


Condensed
Consolidated Statements of Cash Flows


(in
thousands)


(unaudited)





Six
      Months Ended June 30,2008
            
            
            2007Operating
      Activities:Net
      income (loss)
            
            $
            4,435
            
            
            $
            (2,704
            )Adjustments
      to reconcile net income (loss) to net cash provided by operating
      activities:Depreciation
      and amortization
            
            
            2,576
            
            
            
            709Stock-based
      compensation
            
            
            10,917
            
            
            
            3,203Tax
      benefit for excess stock option deduction
            
            
            2,416
            
            
            
            —Provision
      for (release of) accounts receivable allowance
            
            
            4
            
            
            
            (10
            )Provision
      for inventories
            
            
            —
            
            
            
            250Amortization
      of evaluation inventory
            
            
            1,377
            
            
            
            1,131Changes
      in operating assets and liabilities:Increase
      in accounts receivable
            
            
            (11,538
            )
            
            
            (3,011
            )Increase
      in inventories
            
            
            (1,199
            )
            
            
            (2,346
            )Increase
      in prepaid expenses and other current assets
            
            
            (2,564
            )
            
            
            (858
            )Increase
      in accounts payable
            
            
            2,532
            
            
            
            451Increase
      in accrued compensation and related benefits
            
            
            1,680
            
            
            
            1,104Increase
      in other accrued liabilities
            
            
            170
            
            
            
            3,413Increase
      in income taxes payable
            
            
            192
            
            
            
            1Increase
      in deferred revenue
            
            
            16,871
            
            
            
            5,522Net
      cash provided by operating activities
            
            
            27,869
            
            
            
            6,855Investing
      activities:Purchases
      of property, plant and equipment
            
            
            (13,544
            )
            
            
            (3,299
            )Purchases
      of available-for-sale securities
            
            
            (96,865
            )
            
            
            —Proceeds
      from maturities of available-for-sale securities
            
            
            93,938
            
            
            
            —Net
      cash used in investing activities:
            
            
            (16,471
            )
            
            
            (3,299
            )Financing
      activities:Proceeds
      from issuance of common stock, net of repurchases
            
            
            6,556
            
            
            
            621Payment
      for initial public offering costs
            
            
            —
            
            
            
            (3,850
            )Net
      cash provided by (used in) financing activities
            
            
            6,556
            
            
            
            (3,229
            )Effect
      of exchange rate changes on cash and cash equivalents
            
            
            2
            
            
            
            —Net
      increase in cash and cash equivalents
            
            
            17,956
            
            
            
            327Cash
      and cash equivalents at beginning of period
            
            
            102,939
            
            
            
            11,857Cash
      and cash equivalents at end of period
            
            $
            120,895
            
            
            $
            12,184Supplemental
      schedule of cash flow data:Cash
      paid for income taxes
            
            $
            491
            
            
            $
            231Non-cash
      operating activity:Issuance
      of common stock for legal settlement
            
            $
            —
            
            
            $
            3,319Non-cash
      financing activities:Conversion
      of mandatorily redeemable convertible preferred stock to common stock and
      additional paid in capital
            
            $
            —
            
            
            $
            41,514Receivable
      from initial public offering
            
            $
            —
            
            
            $
            113,114





See Notes
to Condensed Consolidated Financial Statements





5
 Index





DATA DOMAIN, INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





1.
ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES





Organization
and Description of Business





Data
Domain, Inc. was incorporated in the State of Delaware in October 2001. Our
appliances provide deduplication storage for disk-based backup and network–based
disaster recovery. 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 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 June 30, 2008, the condensed consolidated statements of operations
for the three
and six months ended June 30, 2008 and 2007, and the condensed consolidated
statements of cash flows for the six months ended June 30, 2008 and 2007 are
unaudited. The condensed consolidated balance sheet data as of December 31, 2007
was derived from the audited consolidated financial statements which are
included in our current report on Form 10-K filed with the Securities and
Exchange Commission, or SEC, on February 29, 2008. 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 June 30, 2008, our results of operations for the three
and six months ended June 30, 2008 and 2007, and our cash flows for the six
months ended June 30, 2008 and 2007. All such adjustments are of a normal
recurring nature. The results for the three and six months ended June 30, 2008
are not necessarily indicative of the results to be expected for any subsequent
quarter or for the fiscal year ending December 31, 2008.





Other
than the adoption of the provisions of Statement of Financial Accounting
Standards, or SFAS, No. 157, Fair Value Measurements, as
discussed in “Recent Accounting Pronouncements” below, there were no significant
changes in our accounting policies during the six months ended June 30,
2008.





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 the determination of the fair value of stock awards, the allowance for
doubtful accounts, warranty reserve and inventory valuation. 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. 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, or SOP, No. 97-2,Software Revenue
Recognition, or SOP 97-2, and SOP 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 customer 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.  Accounts receivable
are recorded net of allowance for doubtful accounts and estimated customer
trade-ins.





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 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 customer has
been obtained. In all cases of direct or indirect channel sales, we recognize
revenue once a 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.





6
 Index





DATA
DOMAIN, INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)




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 $929,000 and $273,000 for the three months ended June 30, 2008 and
2007, respectively, and $1.8 million and $535,000 for the six months ended June
30, 2008 and 2007, respectively.





Stock-Based
Compensation





Stock-based
compensation included in our condensed consolidated statements of operations for
the three and six months ended June 30, 2008 and 2007 was as
follows:




Three
      Months Ended
            
            
            Six
      Months Ended(in
      thousands)
            
            June
      30,
              2008
            
            
            June
      30,
              2007
            
            
            June
      30,
              2008
            
            
            June
      30,
              2007Cost
      of product
            
            $
            202
            
            
            $
            26
            
            
            $
            337
            
            
            $
            43Cost
      of support and services
            
            
            172
            
            
            
            26
            
            
            
            293
            
            
            
            114Sales
      and marketing
            
            
            2,782
            
            
            
            818
            
            
            
            5,574
            
            
            
            1,294Research
      and development
            
            
            1,351
            
            
            
            668
            
            
            
            2,671
            
            
            
            976General
      and administrative
            
            
            1,030
            
            
            
            555
            
            
            
            2,042
            
            
            
            776Total
      stock-based compensation expense
            
            $
            5,537
            
            
            $
            2,093
            
            
            $
            10,917
            
            
            $
            3,203





We
account for share-based payments under the fair value recognition provisions of
SFAS No. 123(R),Share-Based
Payment,or SFAS 123(R). We estimate the grant date fair value of stock
option awards using the Black-Scholes option valuation model, which requires,
among other inputs, an estimate of the fair value of the underlying common stock
on the date of grant and the expected volatility of the stock over the expected
term of the related grants. We recognize this expense on a straight-line basis
over the optionees’ requisite service period which is generally the same as the
vesting schedule of the options.





On June
27, 2007, we implemented our 2007 Employee Stock Purchase Plan, or ESPP. Under
the ESPP, employees may purchase shares of common stock at a price per share
that is 85% of the lesser of the fair market value of our common stock as of the
beginning or the end of six-month purchase periods. The ESPP is compensatory and
has resulted in compensation expense amortized on a straight-line
basis.  The expense recognized in the three and six months ended June
30, 2008 was $658,000 and $1.7 million, respectively.





The fair
value of options granted under our stock plans and the shares purchased under
the ESPP were determined using the following assumptions:





Three
      Months Ended
            
            
            Six
      Months EndedOptions
      Granted
            
            June
      30,
              2008
            
            
            June
      30,
              2007
            
            
            June
      30,
              2008
            
            
            June
      30,
              2007Average
      expected life in years
            
            
            5.40
            
            
            
            4.45
            
            
            
            5.72
            
            
            
            4.03Weighted-average
      volatility
            
            
            54
            %
            
            
            70
            %
            
            
            57
            %
            
            
            70
            %Risk-free
      interest rate
            
            
            2.74%
      - 3.57
            %
            
            
            4.60%
      - 5.15
            %
            
            
            2.51%
      - 3.57
            %
            
            
            4.47%
      - 4.75
            %ESPPAverage
      expected life in months
            
            
            6.0
            
            
            
            7.0
            
            
            
            6.0
            
            
            
            7.0Weighted-average
      volatility
            
            
            58
            %
            
            
            70
            %
            
            
            58
            %
            
            
            70
            %Risk-free
      interest rate
            
            
            2.25
            %
            
            
            4.95
            %
            
            
            2.25
            %
            
            
            4.95
            %





The
expected term represents the period that stock-based awards are expected to be
outstanding, giving consideration to the contractual terms of the stock-based
awards, vesting schedules and expectations of future employee behavior as
influenced by changes to the terms of our stock-based awards. For the three and
six months ended June 30, 2008 the expected term was based on actual data. For
the three and six months ended June 30, 2007, we elected to use the simplified
method of determining the expected term as permitted by SEC Staff Accounting
Bulletin 107. The computation of expected volatility for the three and six
months ended June 30, 2008 and 2007 was based on the historical volatility of
comparable companies from a representative peer group selected based on industry
and market capitalization data. As required by SFAS 123(R), management estimates
expected forfeitures and is recognizing compensation costs only for those equity
awards expected to vest.





At June
30, 2008, the total compensation cost related to stock-based awards granted
under SFAS 123(R) to employees and directors but not yet recognized was
approximately $61.2 million, net of estimated forfeitures. This cost will be
amortized on a straight-line basis over a weighted average period of
approximately 2.9 years.




On June
20, 2007, we granted 383,998 shares of restricted stock awards at fair value,
10,000 of which shares vested on June 27, 2007, with the remaining shares
vesting over a four-year period commencing on June 27, 2007. As of June 30,
2008, 373,998 shares remained unvested.





The
aggregate intrinsic value of outstanding stock options is calculated as the
difference between the exercise price of the stock option awards and the closing
price of our common stock on the Nasdaq Global Market. During the three and six
months ended June 30, 2008, the aggregate intrinsic value of stock option awards
exercised was $21.6 million and $41.1 million, respectively, determined at the
date of option exercise.





The
weighted-average exercise price of options granted in the three and six months
ended June 30, 2008 was $22.69 and $21.82 per share, respectively, and the
weighted-average exercise price of options exercised in the three and six months
ended June 30, 2008 was $1.93 and $1.44 per share,
respectively.





At June
30, 2008 and December 31, 2007, there were 903,000 and 1,219,000 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 was initially recorded as a liability and is subsequently
reclassified to common stock as the shares vest. At June 30, 2008 and December
31, 2007, there was $408,000 and $766,000, respectively, recorded in long-term
liabilities related to the issuance of these shares.





7
 Index





DATA
DOMAIN, INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





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 and British sterling. 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 income
(loss) in the accompanying condensed consolidated balance sheets. The effects of
foreign currency re-measurement for non-U.S. currency denominated assets and
liabilities related to our domestic operations are recognized in our condensed
consolidated statement of operations, and amounted to a net loss of $(120,000)
and $(69,000) for the three months ended June 30, 2008 and 2007, respectively,
and a net gain of $1.1 million and $52,000 for the six months ended June 30,
2008 and 2007, respectively.





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 as general and administrative expenses.
For the three and six months ended June 30, 2008 and 2007, we did not have any
write offs of accounts receivable.





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 included in cost of product and have not been material. Spares
are expensed to cost of product as purchased. 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 of written notice. We also purchase some finished
products from a single source supplier under a three-year agreement that expires
in March 2010. At June 30, 2008, we had $16.3 million of non-cancellable
purchase commitments with this third-party supplier and $2.3 million from our
single source supplier. In addition, we had an additional $5.1 million of other
non-cancellable purchase commitments with other third-party
vendors.





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.





During
the three months ended March 31, 2007, we recorded an estimated charge of $1.2
million associated with a field replacement program that was initiated in April
2007 to replace a circuit board used in some of our appliances. During the three
months ended September 30, 2007, we recorded an additional charge of $450,000 to
expand this replacement program for additional circuit boards used in some of
our appliances. During the three months ended June 30, 2008, we recorded an
additional charge of $25,000 as we have revised our estimate of the costs of the
replacement program. To date, these circuit boards have experienced failures in
less than 1% of the appliances that we believe are potentially affected. Through
the replacement program, we are offering to exchange the circuit boards in all
of the appliances that we believe are potentially affected with circuit boards
manufactured by a particular fabricator. We believe our estimates and judgments
for the replacement program continue to be reasonable based upon information
available at this time. Our estimated charge associated with the replacement
program is 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. This warranty charge does not assume any recovery from our
supplier because any recovery is uncertain at this time. As of June 30, 2008, we
had incurred approximately $1.5 million of costs associated with these field
replacement programs and $163,000 remained in accrued liabilities to cover
future costs for the units potentially affected. To the extent there are
differences between our estimates and actual results, our consolidated financial
statements will be affected. The following table is a summary of our warranty
activity for the six months ended June 30, 2008:





(in
      thousands)Warranty
      reserve—December 31, 2007
            
            $
            596Warranty
      expense
            
            
            422Warranty
      usage
            
            
            (576
            )Warranty
      reserve—June 30, 2008
            
            $
            442





Income
Taxes





We
account for income taxes in accordance with SFAS No. 109,Accounting for Income Taxes.
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. We
record a valuation allowance to reduce our deferred tax assets to the amount of
future tax benefit that is more likely than not to be realized.





8
 Index





DATA
DOMAIN, INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





Comprehensive
Income (Loss)





Comprehensive
income (loss) was $1.1 million and ($1.2) million for the three months ended
June 30, 2008 and 2007, respectively.  For three months ended June 30,
2008, comprehensive income included net income of $1.7 million, partially offset
by $610,000 of unrealized loss on short-term and long-term investments as well
as minimal foreign currency translation losses. For the three months ended June
30, 2007, comprehensive loss included a net loss of $1.2 million and minimal
adjustments related to foreign currency translation.





Comprehensive
income (loss) was $2.5 million and ($2.7) million for the six months ended June
30, 2008 and 2007, respectively. For six months ended June 30, 2008,
comprehensive income included net income of $4.4 million as well as minimal
foreign currency translation gains, partially offset by $1.9 million of
unrealized loss on short-term and long-term investments. For the six months
ended June 30, 2007, comprehensive loss included a net loss of $2.7 million and
minimal adjustments related to foreign currency translation.





Accumulated
other comprehensive income (loss) was ($1.9 million) at June 30,
2008.  The loss at June 30, 2008 resulted from unrealized losses on
our investments in auction-rate securities of $1.8 million and unrealized losses
on our short-term investment portfolio of $142,000, which were partially offset
by cumulative foreign currency translation gains.  Accumulated other
comprehensive income was $47,000 at December 31, 2007 resulting from cumulative
foreign currency translation gains and unrealized gains on our short-term
investment portfolio.





Recent
Accounting Pronouncements





Effective
January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements,or
SFAS 157. In February 2008, the Financial Accounting Standards Board, or FASB,
issued FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No.
157,” 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. Therefore, we have adopted the provisions of SFAS 157 with respect to
our financial assets and liabilities only. 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. 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 which are the
following:





•
            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.





The
adoption of this statement did not have a material impact on our consolidated
results of operations and financial condition.





In
February 2007, the FASB issued FASB Statement No. 159,The Fair Value Option for Financial
Assets and Financial Liabilities, including an amendment of FASB Statement No.
115,or 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 differentmeasurement 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 when business reason support doing so in the
future. The adoption of FAS No. 159 did not have a significant impact on our
consolidated results of operations and financial condition.





Fair
Value of Financial Instruments





The
carrying amounts of cash and cash equivalents, short-term investments, accounts
receivable, accounts payable and income taxes payable approximate their fair
values due to the short-term maturity of these instruments.





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 June
30, 2008 (in thousands):


Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            TotalMoney
      market funds
            
            $
            69,443
            
            
            $
            ——
            
            
            $
            ——
            
            
            $
            69,443Commercial
      paper
            
            
            —
            
            
            
            31,029
            
            
            
            —
            
            
            
            31,029Municipal
      bonds
            
            
            —
            
            
            
            —
            
            
            
            29,246
            
            
            
            29,246Corporate
      bonds
            
            
            —
            
            
            
            8,781
            
            
            
            —
            
            
            
            8,781U.S.
      government agencies
            
            
            —
            
            
            
            50,906
            
            
            
            —
            
            
            
            50,906Total
            
            $
            69,443
            
            
            $
            90,716
            
            
            $
            29,246
            
            
            $
            189,405





9
 Index





DATA
DOMAIN, INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)





Level 3
assets consist of municipal bonds with an auction reset feature (“auction-rate
securities”) whose underlying assets are generally student loans which are
substantially backed by the federal government. 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 investments and fully recover the
carrying value of our investments in the near term may be limited or not exist.
All of our auction-rate securities, including those subject to the failure, are
currently AAA-rated taxable municipal debt obligations, the highest rating by a
rating agency. 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. These investments were valued at
fair value as of June 30, 2008. The following table provides a summary of
changes in fair value of our Level 3 financial assets as of June 30, 2008 (in
thousands):





Auction-rate
      SecuritiesBalance
      at December 31, 2007
            
            $
            29,577Unrealized
      loss included in other comprehensive income
            
            
            (1,768
            )Purchases
      of auction-rate securities
            
            
            15,587Proceeds
      from sale of auction-rate securities
            
            
            (14,150
            )Balance
      at June 30, 2008
            
            $
            29,246








Cash
and cash equivalents and short and long-term investments





The
following table summarizes our cash and investment portfolio (in
thousands):


Amortized
              Cost
            
            
            Gross
              Unrealized
              Gains
            
            
            Gross
              Unrealized
              Losses
            
            
            Fair
              ValueJune 30,
      2008Cash
      and cash equivalents:Cash
            
            $
            36,680
            
            
            $
            —
            
            
            
            —
            
            
            $
            36,680Money
      market funds
            
            
            69,443
            
            
            
            —
            
            
            
            —
            
            
            
            69,443Commercial
      paper
            
            
            14,780
            
            
            
            —
            
            
            
            (8
            )
            
            
            14,772Total
      cash and cash equivalents
            
            $
            120,903
            
            
            $
            —
            
            
            $
            (8
            )
            
            $
            120,895Short-term
      investments:Commercial
      paper
            
            $
            16,271
            
            
            $
            9
            
            
            $
            (23
            )
            
            $
            16,257Corporate
      bonds
            
            
            8,791
            
            
            
            6
            
            
            
            (16
            )
            
            
            8,781U.S.
      government agencies
            
            
            51,016
            
            
            
            3
            
            
            
            (113
            )
            
            
            50,906Total
      short-term investments
            
            $
            76,078
            
            
            $
            18
            
            
            $
            (152
            )
            
            $
            75,944Long-term
      investments:Municipal
      bonds
            
            $
            31,014
            
            
            $
            —
            
            
            $
            (1,768
            )
            
            $
            29,246Total
      long-term investments
            
            $
            31,014
            
            
            $
            —
            
            
            $
            (1,768
            )
            
            $
            29,246Total
      cash and cash equivalents and short and long-term
    investments
            
            $
            227,995
            
            
            $
            18
            
            
            $
            (1,928
            )
            
            $
            226,085December 31,
      2007Cash
      and cash equivalents:Cash
            
            $
            29,005
            
            
            $
            —
            
            
            $
            —
            
            
            $
            29,005Money
      market funds
            
            
            66,543
            
            
            
            —
            
            
            
            —
            
            
            
            66,543Commercial
      paper
            
            
            7,392
            
            
            
            —
            
            
            
            (1
            )
            
            
            7,391Total
      cash and cash equivalents
            
            $
            102,940
            
            
            $
            —
            
            
            $
            (1
            )
            
            $
            102,939Short-term
      investments:Commercial
      paper
            
            $
            46,642
            
            
            $
            23
            
            
            $
            (4
            )
            
            $
            46,661Corporate
      bonds
            
            
            17,426
            
            
            
            11
            
            
            
            (15
            )
            
            
            17,422Municipal
      bonds
            
            
            29,577
            
            
            
            —
            
            
            
            —
            
            
            
            29,577U.S.
      government agencies
            
            
            10,529
            
            
            
            8
            
            
            
            —
            
            
            
            10,537Total
      short-term investments
            
            $
            104,174
            
            
            $
            42
            
            
            $
            (19
            )
            
            $
            104,197Total
      cash and cash equivalents and short-term investments
            
            $
            207,114
            
            
            $
            42
            
            
            $
            (20
            )
            
            $
            207,136





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. We had restricted cash from a letter of
credit on our corporate headquarters lease for $209,000 that was part of our
cash balance at December 31, 2007.  In June 2008, we deposited an
additional $1.2 million as collateral for a letter of credit on a second
building in our corporate complex.  At June 30, 2008, all restricted
cash balances, which totaled $1.4 million, were classified as other current
assets.





Cash and
cash equivalents consist primarily of highly liquid investments in time deposits
held at major banks, commercial paper and other money market securities with
original maturities of 90 days or less. The carrying value of cash and cash
equivalents at June 30, 2008 and December 31, 2007 was approximately $120.9
million and $102.9 million, respectively, and the weighted average interest
rates were 2.7% and 4.79%, respectively.





We
classify our portfolio of short-term investments as available for sale.
Short-term investments consist of corporate bonds, United States government
agency securities and commercial paper with original maturities of 90 to 365
days.  At June 30, 2008, municipal bonds, which are auction-rate
securities, are classified as long-term investments.  At June 30, 2008
and December 31, 2007, the value of long-term investments was $29.2 million and
zero dollars, respectively. As of June 30, 2008 and December 31, 2007, net
unrealized losses on available-for-sale securities of $1.8 million and net
unrealized gains on available-for-sale securities of $22,000, respectively, were
included in accumulated other comprehensive income.





10
 Index





DATA
DOMAIN, INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


(unaudited)




2.
NET INCOME (LOSS) PER SHARE





Basic net
income (loss) per share is computed by dividing net income (loss) by the
weighted average number of vested shares of common stock outstanding during the
period. Diluted net income (loss) per share is computed by giving effect to all
potential dilutive shares of common stock, including options and common stock
subject to repurchase.





The
following table sets forth the computation of net income (loss) per
share:





Three
      Months Ended
            
            
            Six
      Months Ended(in
      thousands, except per share amounts)
            
            June
      30,
              2008
            
            
            June
      30,
              2007
            
            
            June
      30,
              2008
            
            
            June
      30,
              2007Net
      income (loss)
            
            $
            1,694
            
            
            $
            (1,231
            )
            
            $
            4,435
            
            
            $
            (2,704
            )Shares
      used in computing net income (loss) per share, basic
            
            
            57,570
            
            
            
            10,064
            
            
            
            57,059
            
            
            
            9,244Dilutive
      potential common shares:Stock
      options and ESPP
            
            
            7,811
            
            
            
            —
            
            
            
            8,461
            
            
            
            —Shares
      used to compute net income (loss) per share, diluted
            
            
            65,381
            
            
            
            10,064
            
            
            
            65,520
            
            
            
            9,244Net
      income (loss) per share, basic
            
            $
            0.03
            
            
            $
            (0.12
            )
            
            $
            0.08
            
            
            $
            (0.29
            )Net
      income (loss) per share, diluted
            
            $
            0.03
            
            
            $
            (0.12
            )
            
            $
            0.07
            
            
            $
            (0.29
            )




The
following weighted average outstanding options and common stock subject to
repurchase were excluded from the computation of basic and diluted net income
(loss) per share for the periods presented because including them would have had
an antidilutive effect:





Three
      Months Ended
            
            
            Six
      Months Ended(in
      thousands)
            
            June
      30,
              2008
            
            
            June
      30,
              2007
            
            
            June
      30,
              2008
            
            
            June
      30,
              2007Options
      to purchase common stock
            
            
            1,127
            
            
            
            12,178
            
            
            
            1,021
            
            
            
            10,733Common
      stock subject to repurchase
            
            
            903
            
            
            
            1,495
            
            
            
            903
            
            
            
            1,432





3.
INVENTORIES





Inventories
consisted of the following:





(in
      thousands)
            
            June
      30,
              2008
            
            
            December
      31,
              2007Finished
      goods
            
            $
            256
            
            
            $
            481Evaluation
      units
            
            
            1,686
            
            
            
            1,289Raw
      materials and accessories
            
            
            221
            
            
            
            571Total
            
            $
            2,163
            
            
            $
            2,341





Amortization
of evaluation units was approximately $723,000 and $663,000 for the three months
ended June 30, 2008 and 2007, respectively, and approximately $1.4 million and
$1.1 million for the six months ended June 30, 2008 and 2007,
respectively.




4.
DEFERRED REVENUE





Deferred
revenue consisted of the following:





(in
      thousands)
            
            June
      30, 2008
            
            
            December
      31, 2007Product
      – current
            
            $
            636
            
            
            $
            555Support
      and services
            
            
            25,321
            
            
            
            16,152Ratable
      product and related support and services
            
            
            30
            
            
            
            83Less:
      deferred cost of ratable product revenue and product
    revenue
            
            
            (133)
            
            
            
            (140)Deferred
      revenue, current
            
            $
            25,854
            
            
            $
            16,650Support
      and services, non-current
            
            $
            16,989
            
            
            $
            9,322Deferred
      revenue, non-current
            
            $
            16,989
            
            
            $
            9,322





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. Deferred
ratable product and related support and services revenue consists of revenue on
transactions prior to 2006 where VSOE of fair value of support and services had
not been established and, as a result, the entire arrangement was being
recognized ratably over the related support period. All customers are known to
us upon sale of our appliances.





11
 Index





DATA
DOMAIN, INC.


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL


(unaudited)





5.
GUARANTEES





Our
agreements with our channel partners and, less frequently, our 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 consolidated financial
statements.





Under the
terms of our lease for our former corporate headquarters, we are obligated to
provide a letter of credit for $136,000. As of June 30, 2008, this letter of
credit was not in place, and had not been required by our sub-lessor. Under the
terms of our lease for our current corporate headquarters, we have provided
a letter of credit for $1.4 million.





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.




6.
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 expected to 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. There have been no material changes to the balance of unrecognized tax
benefits reported at December 31, 2007. We do not anticipate any material
changes to the unrecognized tax benefits over the next twelve
months.





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 2007 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.





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.




7.
SEGMENT INFORMATION





SFAS 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 end-user customer. The
following table sets forth revenue and long-lived assets by geographic
area:





Revenue





Three
      Months Ended
            
            
            Six
      Months Ended(in
      thousands)
            
            June
      30,
              2008
            
            
            June
      30,
              2007
            
            
            June
      30,
              2008
            
            
            June
      30,
              2007North
      America
            
            $
            48,027
            
            
            $
            19,414
            
            
            $
            86,672
            
            
            $
            34,059Europe,
      Africa and Middle East
            
            
            10,249
            
            
            
            6,285
            
            
            
            20,666
            
            
            
            9,441Japan
      and Asia
            
            
            2,935
            
            
            
            809
            
            
            
            6,488
            
            
            
            3,217Total
            
            $
            61,211
            
            
            $
            26,508
            
            
            $
            113,826
            
            
            $
            46,717




Long-lived
      assets(in
      thousands)
            
            June
      30,2008
            
            
            December
      31,2007North
      America
            
            $
            25,357
            
            
            $
            14,456International
            
            
            266
            
            
            
            133Total
            
            $
            25,624
            
            
            $
            14,589





12
 Index





8.
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 June 30, 2008 that, in the
opinion of management, might have a material adverse effect on our financial
position, results of operations or cash flows.





13
 Index





Item2.
            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 were
founded in October 2001 with a mission to develop breakthrough compression
technology for disk-based deduplication storage. We began shipping our
appliances in February 2004 to address the backup and network-based disaster
recovery needs of enterprises. 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 June
30, 2008, our appliances had been purchased by over 2,100 customers
worldwide.





We are
headquartered in Santa Clara, California. Our personnel are located throughout
the United States and in numerous countries worldwide. We expect to continue to
add personnel in the United States and internationally to provide additional
geographic sales and technical support coverage.





Our
single product line of storage appliances is sold in different configurations
depending on a customer’s requirements for storage capacity and performance.
Variations in storage capacity and performance are delivered through the use of
a variety of interchangeable component parts such as internal disk drives and
central processing units. All of our appliances use our Global Compression
technology to deduplicate data and, therefore, reduce the storage capacity
required for backup and disaster recovery. When purchasing our appliances,
customers may license one or more of our software technologies embedded in our
appliances, including software that enables customers to utilize wide area
network, or WAN vaulting to replicate backup data offsite.





Substantially
all of our appliances have been sold in combination with support and services
contracts. Our support and services contracts are typically offered for periods
of one to three years.





We sell
our appliances through a network of channel partners and through our direct
sales force. In the three and six months ended June 30, 2008 and the year ended
December 31, 2007, approximately 86%, 85% and 86%, respectively, of our revenue
was generated by sales through indirect channels. As of June 30, 2008, we had
over 450 channel partners, and we expect that we will continue to sell asubstantial
majority of our appliances through our channel partners. We consider the
development of indirect sales channels in domestic and international markets
important to future revenue growth and widespread acceptance of our
products.





Growth of
our product revenue will depend on our ability to attract new customers and on
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 deduplication throughput performance and develop 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.  However, 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. We expect growth in international markets to
be a significant factor contributing to our revenue growth in future periods.
International revenue accounted for approximately 22% and 27% of our total
revenue in the three months ended June 30, 2008 and 2007, respectively and 24%
and 27% of our total revenue in the six months ended June 30, 2008 and 2007,
respectively. Even though international revenue was lower as a percentage of
total revenue during these periods compared with the comparable periods in the
previous year, over time, we expect international revenue to increase in
absolute dollars and as a percentage of our total revenue. 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 renewal of existing support and services contracts. To date,
no individual customer has accounted for greater than 10% of our total revenue
in any quarter or year.





Our
ability to sustain profitability will also 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. Personnel costs consist of
salaries, benefits, incentive compensation, including commissions for sales
personnel, and stock-based compensation expense. As we expand internationally,
we may incur additional costs to conform our products to comply with local laws
or local product specifications and to sell, support and 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.  Additional detail of the
composition of revenue, cost of revenue and operating expenses can be found
in our Annual Report on Form 10-K for the year ended December 31, 2007 that we
filed with the SEC on February 29, 2008.





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.  Other than the adoption of SFAS No.
157, Fair Value
Measurements, as discussed in further detail in Note 1 to the Notes to
our Condensed Consolidated Financial Statements, 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, 2007 with the SEC on
February 29, 2008.





14
 Index





Results
of Operations





Three
and Six Months Ended June 30, 2008 Compared to the Three and Six Months Ended
June 30, 2007:





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
            
            
            Six
      Months Ended(dollars
      in thousands)
            
            June
      30,
              2008
            
            
            June
      30,
              2007
            
            
            June
      30,
              2008
            
            
            June
      30,
              2007Total
      revenue
            
            $
            61,211
            
            
            $
            26,508
            
            
            $
            113,826
            
            
            $
            46,717Total
      revenue by type:Product
            
            $
            51,970
            
            
            $
            23,598
            
            
            $
            97,190
            
            
            $
            41,478Support
      and services
            
            
            9,215
            
            
            
            2,838
            
            
            
            16,583
            
            
            
            4,975Ratable
      product and related support and services
            
            
            26
            
            
            
            72
            
            
            
            53
            
            
            
            264%
      of revenue by type:Product
            
            
            85
            %
            
            
            89
            %
            
            
            85
            %
            
            
            89
            %Support
      and services
            
            
            15
            %
            
            
            11
            %
            
            
            15
            %
            
            
            10
            %Ratable
      product and related support and services
            
            
            —
            %
            
            
            —
            %
            
            
            —
            %
            
            
            1
            %Total
      revenue by geography:North
      America
            
            $
            48,027
            
            
            $
            19,414
            
            
            $
            86,672
            
            
            $
            34,059Europe,
      Africa, Middle East
            
            
            10,249
            
            
            
            6,285
            
            
            
            20,666
            
            
            
            9,441Japan
      and Asia
            
            
            2,935
            
            
            
            809
            
            
            
            6,488
            
            
            
            3,217%
      of revenue by geography:North
      America
            
            
            78
            %
            
            
            73
            %
            
            
            76
            %
            
            
            73
            %Europe,
      Africa, Middle East
            
            
            17
            %
            
            
            24
            %
            
            
            18
            %
            
            
            21
            %Japan
      and Asia
            
            
            5
            %
            
            
            3
            %
            
            
            6
            %
            
            
            6
            %





For the
three months ended June 30, 2008, product revenue increased $28.4 million to
$52.0 million from the $23.6 million reported for the three months ended June
30, 2007. For the six months ended June 30, 2008, product revenue increased
$55.7 million to $97.2 million from the $41.5 million reported for the six
months ended June 30, 2007. These increases were due to an increase in the
number of units sold to new and existing customers, facilitated by an increase
in the number of personnel in our sales organization, an increase in the number
of our channel partners and the introduction of new products. These products,
which have higher capacity and higher performance, were sold at higher average
sales prices. We expect to continue to release new products with higher
capacity, higher performance and higher average selling prices.





For the
three months ended June 30, 2008, support and services revenue increased $6.4
million to $9.2 million from the $2.8 million reported for the three months
ended June 30, 2007. For the six months ended June 30, 2008, support and
services revenue increased $11.6 million to $16.6 million from the $5.0 million
reported for the three months ended June 30, 2007. These increases were 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 services 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 22% and 27% of total revenue for the three months ended June 30,
2008 and 2007, respectively, and 24% and 27% of total revenue for the six months
ended June 30, 2008 and 2007, respectively. Although revenue outside North
America increased in the three and six months ended June 30, 2008 in absolute
amounts, the percentage of total revenue it represented in such periods declined
compared with the same periods in 2007 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
            
            
            Six
      Months Ended(in
      thousands)
            
            June
      30,
              2008
            
            
            June
      30,
              2007
            
            
            June
      30,
              2008
            
            
            June
      30,
              2007Total
      revenue
            
            $
            61,211
            
            
            $
            26,508
            
            
            $
            113,826
            
            
            $
            46,717Cost
      of product
            
            
            13,753
            
            
            
            6,442
            
            
            
            25,069
            
            
            
            12,291Cost
      of support and services
            
            
            3,136
            
            
            
            905
            
            
            
            5,625
            
            
            
            1,703Cost
      of ratable product and related support and services
            
            
            1
            
            
            
            21
            
            
            
            2
            
            
            
            97Total
      cost of revenue
            
            
            16,890
            
            
            
            7,368
            
            
            
            30,696
            
            
            
            14,091Gross
      profit
            
            $
            44,321
            
            
            $
            19,140
            
            
            $
            83,130
            
            
            $
            32,626Gross
      margin
            
            
            72
            %
            
            
            72
            %
            
            
            73
            %
            
            
            70
            %





For the
three months ended June 30, 2008, cost of product revenue increased $7.4 million
to $13.8 million from the $6.4 million reported for the three months ended June
30, 2007. 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 amortization of evaluation units and increased
personnel costs. Salaries and employee related benefits accounted for $346,000
of the increase in cost of product revenue and stock-based compensation
accounted for $176,000 of the increase. For the six months ended June 30, 2008,
cost of product revenue increased $12.8 million to $25.1 million from the $12.3
million reported for the six months ended June 30, 2007. As noted above, this
increase was due to increased aggregate product costs associated with an
increased volume of shipments of appliances to our customers, increased
amortization of evaluation units, increased personnel costs offset by lower
warranty costs from the $1.2 million charge we recorded for the field
replacement program in the first quarter of 2007 and initiated in the second
quarter of 2007. Salaries and employee related benefits accounted for $709,000
of the increase and stock-based compensation accounted for $294,000 of the
increase.  We expect the cost of product revenue to continue to
increase for the remainder of 2008.





15
 Index





For the
three months ended June 30, 2008, cost of support and services revenue increased
$2.2 million to $3.1 million from the $905,000 reported for the three months
ended June 30, 2007. This increase was due to increases in our support personnel
headcount from 17 at June 30, 2007 to 38 at June 30, 2008, which increased our
salary expense and employee-related benefits by $883,000. Included in the
overall increase is stock-based compensation which accounted for $146,000 of the
increase and increased outside service costs of $615,000 related to third party
support of the larger installed base of our products. For the six months ended
June 30, 2008, cost of support and services revenue increased $3.9 million to
$5.6 million from the $1.7 million reported for the six months ended June 30,
2007. As noted above, this increase was due to increases in our support
personnel headcount from 17 at June 30, 2007 to 38 at June 30, 2008, which
increased our salary expense and employee-related benefits by $1.5 million.
Included in the overall increase is stock-based compensation which accounted for
$179,000 of the increase, and increased outside service costs of $1.2 million
related to 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 2008 as our installed base continues to grow.





Over
time, we expect our total cost of revenue to grow at a slightly faster rate than
total revenue, causing gross margins to slightly decline in the
future.





Sales
and Marketing Expenses





Three
      Months Ended
            
            Six
      Months Ended(dollars
      in thousands)
            
            June
      30,
              2008
            
            June
      30,
              2007
            
            June
      30,
              2008
            
            June
      30,
              2007Sales
      and marketing expenses
            
            
            $
            27,485
            
            
            $
            12,419
            
            
            $
            50,717
            
            
            $
            21,102Percent
      of total revenue
            
            
            
            45
            %
            
            
            47
            %
            
            
            45
            %
            
            
            45
            %Headcount
      at period end
            
            
            
            353
            
            
            
            162
            
            
            
            353
            
            
            
            162





For the
three months ended June 30, 2008, sales and marketing expenses increased $15.1
million to $27.5 million from the $12.4 million reported for the three months
ended June 30, 2007. This increase was due to the increase in the number of
sales and marketing employees, including the addition of approximately 60
employees associated with our international operations. 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 $9.8 million. Stock-based compensation accounted for
$2.0 million of the increase and the remainder was the result of increased costs
from travel, tradeshow and promotional activities.





For the
six months ended June 30, 2008, sales and marketing expenses increased $29.6
million to $50.7 million from the $21.1 million reported for the six months
ended June 30, 2007. As noted above, this increase was due to the increase
in the number of sales and marketing employees, including the addition of
approximately 60 employees associated with our international operations. 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 $18.2 million. Stock-based
compensation accounted for $4.3 million of the increase and the remainder was
the result of increased costs from travel, tradeshow and promotional
activities.





We
anticipate that sales and marketing expenses will increase in absolute dollars
during the remainder of 2008, but remain relatively stable as a percentage of
our total revenue, 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.





Research
and Development Expenses





Three
      Months Ended
            
            
            Six
      Months Ended(dollars
      in thousands)
            
            June
      30,
              2008
            
            June
      30,
              2007
            
            
            June
      30,
              2008
            
            
            June
      30,
              2007Research
      and development expenses
            
            
            $
            9,627
            
            
            $
            5,659
            
            
            $
            18,363
            
            
            $
            10,162Percent
      of total revenue
            
            
            
            16
            %
            
            
            21
            %
            
            
            16
            %
            
            
            22
            %Headcount
      at period end
            
            
            
            149
            
            
            
            94
            
            
            
            149
            
            
            
            94





For the
three months ended June 30, 2008, research and development expenses increased
$3.9 million to $9.6 million from the $5.7 million reported for the three months
ended June 30, 2007. Salaries, employee-related benefits and fees for
recruitments accounted for $1.9 million of the increase as the result of
increased headcount. Also contributing to the increase were increases in
stock-based compensation of $683,000, and facility related costs for equipment
and depreciation on capitalized equipment of $1.2 million. These increases were
the direct result of hiring additional personnel to support new product
introductions and broaden our product line.





For the
six months ended June 30, 2008, research and development expenses increased $8.2
million to $18.4 million from the $10.2 million reported for the six months
ended June 30, 2007. Salaries, employee-related benefits and fees for
recruitments accounted for $4.2 million of the increase as the result of
increased headcount. Also contributing to the increase were increases in
stock-based compensation of $1.7 million, and facility related costs for
equipment and depreciation on capitalized equipment of $2.0 million. These
increases were the direct result of hiring additional personnel to support new
product introductions and broaden our product line.





We
anticipate that research and development expenses as a percentage of our total
revenue will remain relatively stable for the remainder of 2008, but expect that
the absolute dollar amount will increase as we continue to invest in research,
new product development and enhancements to our existing appliances and hire
additional R&D personnel, particularly at our Research Triangle Park, North
Carolina facility.





General
and Administrative Expenses





Three
      Months Ended
            
            Six
      Months Ended(dollars
      in thousands)
            
            June
      30,
              2008
            
            June
      30,
              2007
            
            June
      30,
              2008
            
            June
      30,
              2007General
      and administrative expenses
            
            $
            5,720
            
            
            $
            2,310
            
            
            $
            11,326
            
            
            $
            4,088Percent
      of total revenue
            
            
            9
            %
            
            
            9
            %
            
            
            10
            %
            
            
            9
            %Headcount
      at period end
            
            
            54
            
            
            
            21
            
            
            
            54
            
            
            
            21





For the three months ended
June 30, 2008, general and administrative expenses increased $3.4 million to
$5.7 million from the $2.3 million reported for the three months ended June 30,
2007. This increase was the result of increases in personnel costs associated
with increased headcount, which accounted for $1.5 million of the increase.
Professional service fees accounted for $790,000 of the increase and stock-based
compensation accounted for $475,000.





16
 Index





For the
six months ended June 30, 2008, general and administrative expenses increased
$7.2 million to $11.3 million from the $4.1 million reported for the six months
ended June 30, 2007. This increase was the result of increases in personnel
costs associated with increased headcount, which accounted for $2.7 million of
the increase. Professional service fees accounted for $1.4 million of the
increase and stock-based compensation accounted for $1.3 million.





For both
periods, the additional personnel and professional service fees were the result
of our ongoing efforts to build our legal, finance, human resources, recruiting
and information technology functions. 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 and as we incur additional
costs associated with being a public company, but our aggregate general and
administrative expenses should remain relatively stable as a percentage of our
total revenue.





Other
Income (Expense), Net





Three
      Months Ended
            
            
            Six
      Months Ended(in
      thousands)
            
            June
      30,
              2008
            
            
            June
      30,
              2007
            
            
            June
      30,
              2008
            
            
            June
      30,
              2007Interest
      income
            
            $
            1,517
            
            
            $
            180
            
            
            $
            3,680
            
            
            $
            336Other
      income (expense), net
            
            
            (120
            )
            
            
            (13
            )
            
            
            1,123
            
            
            
            (109
            )Total
      other income (expense), net
            
            $
            1,397
            
            
            $
            167
            
            
            $
            4,803
            
            
            $
            227





For the
three months ended June 30, 2008, total other income (expense), net increased
$1.2 million to $1.4 million from the $167,000 reported for the three months
ended June 30, 2007. This increase was the result of income earned from the
investment of our net initial public offering, or IPO, and secondary offering
proceeds and other funds, partially offset by unfavorable revaluation of foreign
exchange transactions during the period.





For the
six months ended June 30, 2008, total other income (expense), net increased $4.6
million to $4.8 million from the $227,000 reported for the six months ended June
30, 2007. This increase was the result of income earned from the investment of
our net IPO and secondary offering proceeds and other funds as well as favorable
increases in our revaluation of Euro denominated cash balances.





Foreign
currency net losses for the three months ended June 30, 2008 as compared to the
three months ended June 30, 2007 increased $107,000 due to an unfavorable
revaluation of Euro denominated cash balances. Foreign currency net gains for
the six months ended June 30, 2008 as compared to the six months ended June 30,
2007 increased $1.2 million due to increases in our favorable revaluation of
Euro denominated cash balances. 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.





Provision
for Income Taxes




For the
three months ended June 30, 2008, provision for income taxes increased $1.0
million to $1.2 million from the $150,000 reported for the three months ended
June 30, 2007 and for the six months ended June 30, 2008, provision for income
taxes increased $2.9 million to $3.1 million from the $205,000 reported for the
six months ended June 30, 2007. These increases were due to our increased
international activities resulting in increased foreign taxes, as well as state
income taxes and our shift to profitability.





The
effective tax rate for the three months ended June 30, 2008 was 41 % compared
with (14 %) for the comparable period ended June 30, 2007. This change in the
effective rate was primarily due to our conversion from a pre-tax loss for the
three and six months ended June 30, 2007 to a pre-tax income for the three and
six months ended June 30, 2008. The effective tax rate for the second quarter of
2008 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.  The effective tax
rate for the second quarter of 2007 differs from the U.S. federal statutory rate
of 35% primarily due to the fact that we had no regular tax expense for Federal
and California provision due to Net Operating Loss utilization except for
foreign taxes for our overseas taxable activities in various
jurisdictions.





There
have been no material changes to the balance of unrecognized tax benefits
reported at December 31, 2007.  We do not anticipate any material
changes to the unrecognized tax benefits over the next twelve
months.





Liquidity
and Capital Resources





(in
      thousands)
            
            June
      30, 2008
            
            
            December,
      312007Working
      capital
            
            $
            194,438
            
            
            $
            203,688Cash
      and cash equivalents
            
            $
            120,895
            
            
            $
            102,939Short-term
      investments
            
            $
            75,944
            
            
            $
            104,197





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 June 30, 2008 decreased $9.3 million from December
31, 2007 due primarily to reclassifying $29.2 million of our investments in
auction-rate securities as long-term investments. Other changes of note
are:





•
              The
      increase in cash was the result of improved collections from accounts
      receivable reflected in our decrease in days’ sales outstanding from an
      average of 71 days as of December 31, 2007 to an average of 69 days as of
      June 30, 2008, 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 decreased due to the reclassification of investments in
      auction-rate securities to a long-term investment due to 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.





•
              Inventory
      decreased due to a decrease in finished goods and raw materials, partially
      offset by an increase in the number of units held in the evaluation
      inventory pool.





•
            Prepaid
      expenses and other current assets increased for prepaid maintenance
      contracts, insurance, rent and other deposits, as well as due to
      restricted cash funded as required by our lease for our corporate
      headquarters.




17
 Index


•
              Accounts
      payable increased due to increased purchases of inventory and property,
      plant and equipment to support increased headcount and research and
      development spending.
 
 •
              Current
      deferred revenue increased due to higher product revenue and the related
      support that we recognize over the maintenance and support
      life.
 
 •
              Accrued
      compensation increased due to contributions to our Employee Stock Purchase
      Plan, an increase in accrued commissions from net bookings, an increase in
      accrued vacation from the increase in employees and an increase in accrued
      payroll.
 
 •
                Other
      accrued liabilities decreased due to lower accruals that were offset by an
      increase in accounts payable, partially offset by higher accrued travel
      and professional services
costs


We
commenced our IPO of common stock on June 27, 2007, and the offering was
completed on July 2, 2007. We sold and issued 8,108,500 shares of our common
stock in our IPO, including 1,108,500 shares sold by us pursuant to the
underwriters’ full exercise of their option to purchase additional shares, at an
issue price of $15.00 per share. We raised approximately $109.2 million in net
proceeds after deducting underwriting discounts and commissions of $8.5 million
and other offering costs of $3.9 million, which were received on July 2, 2007.
Upon the closing of the IPO, all shares of our mandatorily redeemable
convertible preferred stock outstanding automatically converted into 34,780,625
shares of common stock.





We
completed a follow-on offering of common stock on December 3, 2007. We sold and
issued 3,051,114 shares of our common stock, including 251,114 shares sold by us
pursuant to the underwriters’ partial exercise of their option to purchase
additional shares, at an issue price of $27.00 per share. We raised
approximately $77.8 million in net proceeds after deducting underwriting
discounts and commissions of $3.4 million and other offering costs of $1.2
million, which were received on November 21, 2007 and December 3,
2007.





We have
funded operations since our IPO from internal cash generated from
operations.  We have not used funds raised from our IPO and secondary
offering in operations.  Due to these factors, we believe we have
sufficient ability to fund our operations for at least the next twelve
months.





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 Asia and Japan, and denominated
in Euros and British pounds in Europe and Canadian dollars for Canada on certain
transactions. 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 we do not hedge. The foreign currency effect on our cash and cash
equivalents and working capital was a loss of ($120,000) and ($13,000) in the
three months ended June 30, 2008 and 2007, respectively, and a gain of $1.1
million compared to a loss of ($109,000) in the six months ended June 30, 2008
and 2007, respectively.





Short-term
and Long-term Investments





Short-term
investments consist of commercial paper, corporate bonds, and investments in
U.S. government agencies with original maturities of 90 to 365
days.





Effective
January 1, 2008, we adopted SFAS No. 157, “Fair Value Measurements,” or SFAS
157, with respect to our financial assets and liabilities only.  SFAS
157 defines fair value, establishes a framework for measuring fair value under
U.S. generally accepted accounting principles 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. 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 which are the
following:





•
            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.





Level 3
assets consist of municipal bonds with an auction reset feature (“auction-rate
securities”) whose underlying assets are generally student loans which are
substantially backed by the federal government. 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 investments and fully recover the
carrying value of our investment in the near term may be limited or not exist.
All of our auction-rate securities, including those subject to the failure, are
currently AAA-rated taxable municipal debt obligations, the highest rating by a
rating agency. 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 assets on our balance sheet. At June 30, 2008, we had $29.2 million
classified as a long-term asset on the balance sheet.  At December 31,
2007, our investment in auction-rate securities was $29.6 million and was
classified as short-term investments because there existed an active market for
auction-rate securities at that time. We have recorded a $1.9 million unrealized
loss to other comprehensive income (loss) on our investments in auction-rate
securities. Given the time period from when the auction’s initially failed, we
do not believe that there has been an other-than-temporary
impairment for these investments as it is not necessary for us to
liquidate these investments to fund current operations, as well as that these
investments continue to pay interest. We continue to closely monitor these
investments and if the auctions for these investments continue to fail, we may
determine these instruments to be other-than-temporarily impaired, which would
result in any previous and future decline in the fair value of these investments
to be recorded in our statement of operations.





18
 Index





Cash
Flows





Six
      Months Ended June 30,(in
      thousands)
            
            2008
            
            
            2007Net
      cash provided by operating activities
            
            $
            27,869
            
            
            $
            6,855Net
      cash used in investing activities
            
            $
            (16,471
            )
            
            $
            (3,299
            )Net
      cash provided by (used in) financing activities
            
            $
            6,556
            
            
            $
            (3,229
            )





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 personnel-related expenditures, rent payments,
inventory purchases to support our revenue growth and research and development
costs.





Cash
provided by operating activities increased in the six months ended June 30, 2008
as compared to the six months ended June 30, 2007 due to increased sales
activity and an increase in deferred revenue resulting from payments on support
and services contracts. 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 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 sale
of investment securities. Cash used in investing activities was $16.5 million in
the six months ended June 30, 2008 as compared to cash used of $3.3 million for
the six months ended June 30, 2007. Cash used in investing activities in the six
months ended June 30, 2008 included purchases, net of maturities of
investments of $3.0 million as well as $13.5 million for purchases of property,
plant and equipment, driven by our increase in headcount of 179 in the period,
and investments in computer equipment, lab equipment for research and
development, leasehold improvements for our corporate headquarters and new
system infrastructure. The $3.3 million cash used in investing activities in the
six months ended June 30, 2007 reflected an increase in headcount of 124 in the
period, and investments in computer equipment, lab equipment for research and
development and new system infrastructure.




Cash
Flows from Financing Activities





Cash flow
provided by financing activities in the six months ended June 30, 2008 of $6.6
million resulted from the proceeds of the cash exercise of stock options to
purchase 2,031,000 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, partially offset by our repurchase of 5,000 shares
of our common stock from former employees. Cash flow used in financing
activities in the six months ended June 30, 2007 of $3.3 million resulted from
$3.8 million of offering costs related to our IPO, partially offset by proceeds
of $621,000 from the cash exercise of stock options to purchase 432,000 shares
of our common stock by our employees, net of 87,000 restricted shares
repurchased by us from former employees, and the cash we received in connection
with the purchase of common stock awarded to one of our non-employee
directors.





Contractual
Obligations





The
following is a summary of our contractual obligations as of June 30,
2008:





(in
      thousands)
            
            Total
            
            
            Less
      Than
              One
      Year
            
            
            1-3
              Years
            
            
            3-5
              Years
            
            
            More
      Than
              5
      YearsOperating leases(1)
            
            $
            47,659
            
            
            $
            4,453
            
            
            $
            9,021
            
            
            $
            9,571
            
            
            $
            24,614Purchase obligations(2)
            
            
            23,720
            
            
            
            23,720
            
            
            
            —
            
            
            
            —
            
            
            
            —Total
      contractual obligations
            
            $
            71,379
            
            
            $
            28,173
            
            
            $
            9,021
            
            
            $
            9,571
            
            
            $
            24,614





(1)
            In
      July 2007, we entered into an operating lease for our corporate
      headquarters.  In January 2008, we entered in to an agreement to
      lease office space adjacent to our existing corporate
      facility.


(2)
            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, 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 June 30, 2008,
we had $16.3 million in aggregate, non-cancellable purchase commitments placed
with Flextronics which are included in the table above. In addition, as of June
30, 2008, we had an additional $7.4 million of other non-cancellable purchase
commitments with other third-party vendors which are included in the table
above. Under the terms of the lease for our former corporate headquarters, we
are obligated to provide a letter of credit for $136,000. To date, this letter
of credit is not in place and has not been required by our
sub-lessor.





On July
10, 2007, we entered into a lease for office space for our corporate
headquarters. The term of the lease runs 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.  We have spent approximately
$13.1 million for leasehold improvements, equipment and furniture for the
building through June 30, 2008. All of our Santa Clara based employees have
relocated to the new facility.





In
January 2008, we signed an agreement to lease approximately 100,000 square feet
of office space adjacent to our existing corporate facility. The new lease takes
effect on January 1, 2009. Future minimum lease payments will be $24.3 million,
commencing in January 2009 and continuing through June 2018. As part of signing
the lease, we are obligated to provide a letter of credit for $1.2 million,
which we have funded.





The lease
for our former corporate headquarters in Santa Clara expires in February
2009.  We have entered in to an agreement to sub-lease this space
through November 30, 2008 with an option for the sub-lessee to extend the
sub-lease to the end of the lease term.





19
 Index





Our
agreements with our channel partners and, less frequently, our 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 consolidated financial
statements.





Also, as
discussed in Note 6 of the Notes to our Condensed Consolidated Financial
Statements, effective January 1, 2007, we adopted the provisions of SFAS
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an
Interpretation of SFAS Statement No. 109.” At June 30, 2008, we had a liability
for unrecognized tax benefits on an accrual for the payment of related interest
totaling $1.8 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 June
30, 2008 and December 31, 2007, 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.




Item3.
            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 $8.5 million and $6.2 million for the
three months ended June 30, 2008 and 2007, respectively, and $17.9 million and
$9.4 million for the six months ended June 30, 2008 and 2007,
respectively.  We had British sterling denominated revenue of $1.8
million and zero dollars for the three months ended June 30, 2008 and 2007,
respectively, and $2.8 million and zero dollars for the six months ended June
30, 2008 and 2007, respectively.





We also
have revenue dominated in the Canadian dollar, which subjects us to foreign
currency risk due to fluctuations in the value of the Canadian dollar compared
to the U.S. dollar.  We had $346,000 and $217,000 dollars in Canadian
dollar denominated revenue for the three months ended June 30, 2008 and 2007,
respectively, and $725,000 and $217,000 for the six months ended June 30, 2008
and 2007, 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, Korea and Swedish currencies. We had
foreign currency denominated expenses of approximately $7.3 million and $3.0
million for the three months ended June 30, 2008 and 2007, respectively, and
$14.1 million and $5.1 million for the six months ended June 30, 2008 and 2007,
respectively.





As of
June 30, 2008, we had approximately $6.2 million and $2.1 million in accounts
receivable denominated in Euros and British pounds, respectively.  As
of June 30, 2008, we had approximately $11.1 million in cash denominated in
foreign currencies, primarily in Euros. 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 are presently
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.  Other income (expense), net for the six
months ended June 30, 2008 included $1.1 million of net gain resulting from the
revaluation of cash held in Euros of $836,000 and the remaining $287,000 net
gain was a result of the revaluation of Euro-denominated accounts receivable and
other accounts.  We have transferred some Euro-denominated cash to
U.S. dollars to address the risk of foreign currency fluctuation.





Interest
Rate Sensitivity





We had
cash and cash equivalents totaling $120.9 million and $12.2 million as of June
30, 2008 and 2007, respectively. These amounts were invested primarily in money
market funds, and at June 30, 2008 were also invested in commercial paper. We
have invested the funds from our IPO and follow-on offering according to our
investment policy. The unrestricted cash and cash equivalents are 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 June 30, 2008 and 2007, our
interest income would have declined approximately $152,000 and $18,000,
respectively, and $368,000 and $34,000 in the six months ended June 30, 2008 and
2007, respectively, assuming consistent investment levels.





We had
short-term investments of $75.9 million as of June 30, 2008. 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, these amounts were
invested primarily in auction-rate securities, corporate bonds, government
agency securities and commercial paper. These investments are classified as
available for sale and held for working capital purposes. On June 30, 2008,
we had $29.2 million of auction-rate securities. 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. As a
result, our ability to liquidate these investments and fully recover the
carrying value of our investment in the near term may be limited or not exist.
All of our auction-rate securities, including those subject to the failure, are
currently AAA-rated taxable municipal debt obligations, the highest rating by a
rating agency. 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. It could take until the final
maturity of the underlying notes (up to 40 years) to realize our investments’
recorded value. Based on our expected operating cash flows, and our other
sources of cash, we do not anticipate the potential lack of liquidity on these
investments will affect our ability to execute our current business
plan.





Item4.
            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.





20
 Index





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, 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.





PART II. OTHER INFORMATION




Item1.
            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.





21
 Index





Item1A.         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





We
derive all of our revenue from sales of a single line of systems and related
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, weakening 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. If demand for our systems does not continue to grow, our
business, results of operations and financial condition would be
harmed.





Our
business could be harmed as a result of deteriorating general economic and
market conditions that lead to reduced spending on information technology
products.





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 as
general economic and market conditions have worsened, and if the domestic or
global economy undergoes a downturn, or if our customers believe such a downturn
is imminent, our customers would likely reduce their information technology
budgets. We may be particularly susceptible to reductions in information
technology spending because the purchase of our appliances is often
discretionary and may involve a significant commitment of capital and other
resources. 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.
Delays in or a reduction in information technology spending, domestically or
internationally, would harm our business, results of operations and financial
condition in a number of ways, including by leading to longer sales cycles,
lower prices for our appliances and reduced unit sales.





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 Corporation, Hewlett-Packard Company and
International Business Machines Corporation, and we anticipate additional
offerings by our competitors may be announced or introduced in 2008. 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, Inc. and Quantum Corporation as well as a number of
established storage companies that offer a variety of different disk-based
storage products, including EMC Corporation and Network Appliance, Inc. and, to
a lesser extent, Hitachi Data Systems Corporation, Hewlett-Packard Company and
International Business Machines Corporation. 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.





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, auction-rate securities, money market funds,
commercial paper, corporate bonds and government agency certificates, 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 U.S. sub-prime mortgage
defaults that have affected various sectors of the financial markets and caused
credit and liquidity issues. To date, we have determined that any declines in
the market value of our investments have been temporary. There could be future
declines in the value of these 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.





At
December 31, 2007 and June 30, 2008, we had $29.6 million and $31.0 million of
principal in auction-rate securities, respectively. In January 2008, these
securities, which consist of AAA-rated, taxable municipal debt obligations, 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. As of June 30, 2008, we have
recorded a temporary impairment provision of ($1.8) million which has been
included in other comprehensive income (loss).  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 directly through our income statement. Determining whether
there has been an other-than-temporary impairment of our short-term investments
requires significant judgment. At this time, we believe the interest is
collectable, and we do not believe that there has been an other–than-temporary
impairment of these investments. With the recent volatility in the capital
markets, there is a risk that we could suffer a loss of principal and suffer a
reduction in our interest or return on these and other investments, which could
harm our operating results and financial condition. In addition, we may suffer a
potential lack of liquidity of these investments and it could take until the
final maturity of the underlying notes (up to 40 years) to realize our
investments’ recorded value.  We have determined any declines in the
market value of our investments as temporary and have recorded the temporary
impairment in other comprehensive income (loss). If these instruments continue
to fail at auction, we may be required to record any previous and future
declines in the fair value of these investments in our statement of operations,
which could impact our future income before taxes, net income and earnings
per share.





22
 Index





We
experience quarterly fluctuations in our operating results due to a number of
factors, which makes 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
year ended December 31, 2007, we derived approximately 28% of our revenue from
international customers. In the three and six months ended June 30, 2008, we
derived approximately 22% and 24%, respectively, 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.





23
 Index





We
have a history of losses and we may not be able to sustain profitability in the
future.





Although
we achieved a net profit of approximately $1.7 million and $4.4 million for
the three and six months ended June 30, 2008, respectively, we have not yet
achieved profitability for any fiscal year. As of June 30, 2008, our accumulated
deficit was approximately $35.8 million and we may incur additional losses in
the future. 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, 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.





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, 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.





If
we fail to manage future growth effectively, our business would be
harmed.





We have
expanded our operations significantly since inception and anticipate that
further significant expansion of our operations and headcount will be required.
For example, our headcount increased from 303 employees as of June 30, 2007 to
614 employees as of June 30, 2008, and we have recently established a new
operations center in North Carolina’s Research Triangle Park. The new
facility houses additional engineering, customer support and sales personnel.
Our growth has placed, and is expected to continue to place, significant demands
on our management, infrastructure and other resources. To manage our expected
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 and continue our growth, and if we do not effectively manage our
expected growth and the associated increase 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 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, lack of customer acceptance, weakening
economic conditions, competing technologies and products, or decreases in
corporate spending. 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.





24
 Index





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 690 appliance are currently supplied exclusively by a single
vendor, Xyratex Technology Limited. 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 690 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 690 chassis from
Xyratex for whatever reason, the manufacturing of our expansion shelves and DD
690 appliance 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, Micro Memory, LLC, which was
acquired by VMETRO. Neither we nor Flextronics has an agreement with Micro
Memory providing for specific quantities or inventory levels of NVRAM cards, and
either we or Flextronics order NVRAM cards under a standard purchase order
arrangement with Micro Memory or its distributor. We acquire the chassis used in
our appliances other than the DD 690 from a single vendor. Neither we nor
Flextronics has an agreement with this chassis supplier providing for specific
quantities or inventory levels of chassis, and either we or Flextronics order
chassis under a standard purchase order arrangement with this chassis supplier
or its distributor. Significant time and effort would be required to locate new
vendors for any of these 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. 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.





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.





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. 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, or SOP, No. 98-9,Modification of SOP No.
97-2, Software Revenue Recognition, 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 the 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.





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 2007 to expand
this program for additional circuit boards used in some of our appliances.
During the second quarter 2008, we recorded an additional charge of $25,000 as
we have 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 June 30, 2008, we had incurred approximately $1.5
million of costs associated with these field replacement programs and $163,000
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.





25
 Index





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.





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 and six
months ended June 30, 2008 and the year ended December 31, 2007, approximately
86%, 85% and 86%, 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.





TheU.S.government has
become an important customer for us, and if it or
individual agencies within theU.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 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 any 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. In particular, under the current rules of the SEC, beginning with
the year ending December 31, 2008, we must perform system and process evaluation
and testing of our internal control over financial reporting to allow management
to report on the effectiveness of our internal control over financial reporting,
as required by Section 404 of the Sarbanes-Oxley Act. Our independent registered
public accounting firm will also be required to report on our internal control
over financing reporting. Our and our auditor’s testing may reveal deficiencies
in our internal control over financial reporting that are deemed to be material
weaknesses and render our internal control over financial reporting ineffective.
We expect to incur substantial accounting and auditing expense and expend
significant management time in complying with the requirements of Section 404.
If 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 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. Our
independent registered public accounting firm identified a material weakness in
our financial statement close process as of December 31, 2006, and we
implemented additional formal policies, procedures and processes, hired
additional accounting personnel and increased management review and oversight
over the financial statement close and reporting processes in order to remediate
this material weakness. 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.





26
 Index





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 Corporation, 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, less frequently, 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,
Canada, China, Korea, Japan and Australia. 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 year ended December 31, 2007, our
research and development expenses were $23.5 million, or approximately 19% of
revenue. For the three months ended June 30, 2008 and 2007, our research and
development expenses were $9.6 million and $5.7 million, or approximately 16%
and 21% of revenue, respectively. For the six months ended June 30, 2008 and
2007, our research and development expenses were $18.4 million and $10.2
million, or approximately 16% and 22% of revenue, respectively.  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.





27
 Index





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. 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
experiences loss of investor confidence, the trading price of our common stock
could 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;




28
 Index


•
              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.


Item2.
            Unregistered
      Sales of Equity Securities and Use of
Proceeds





The
effective date of the registration statement 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 and
commissions of $8.5 million and offering expenses of approximately $3.8 million.
In the first six months of 2008, we used none of the proceeds from our initial
public offering for working capital purposes. None of the payments were made,
directly or indirectly, to our directors, officers or persons owning 10% or more
of our common stock.





Item4.
            Submission
      of Matters to a Vote of Security
Holders





The 2008
annual meeting of stockholders of Data Domain, Inc. was held on June 4, 2008.
The results of the voting on the matters submitted to the stockholders were as
follows:






1. To
elect two members of our Board of Directors to serve as Class I
directors of the Board until our 2011 annual meeting of
stockholders or until such persons’ successors have been duly elected and
qualified.





Votes
      For
            
            
            WithheldKai
      Li, Ph.D.
            
            
            51,007,092
            
            
            
            219,866Scott
      D. Sandell
            
            
            50,188,944
            
            
            
            1,038,014









The
following directors, in addition to Messrs. Li and Sandell, will continue to
serve as members of the Board of Directors until the expiration of their
respective terms or until their respective successors have been duly elected and
qualified: Aneel Bhusri, Frank Slootman, Ronald E. F. Codd, Reed E. Hundt,
Jeffrey A. Miller, Ronald D. Bernal.






2.  To
reapprove the Internal Revenue Code Section 162(m) limits of our 2007 Equity
Incentive Plan to preserve our ability to receive corporate income tax
deductions that may become available pursuant to Section 162(m).





Votes
      for
            
            
            44,606,109Votes
      against
            
            
            1,949,368Abstain
            
            
            7,531Broker Non-Votes
            
            
            4,663,950






3. To
ratify the appointment by our Board of Directors of Ernst & Young LLP
as our independent registered public accounting firmfor our fiscalyear ending December 31, 2008.





Votes
      for
            
            
            51,184,102Votes
      against
            
            
            24,495Abstain
            
            
            18,361




Item6.
            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.





29
 Index





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:
      August 7, 2008
            
            /s/
      Michael P. ScarpelliMichael
      P. Scarpelli, Senior Vice President and Chief Financial
      Officer(Principal
      Financial and Accounting Officer)






30