UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K

 

 

Commission File No. 001-33685

COMPELLENT TECHNOLOGIES, INC.

(Exact name of Registrant as specified in its charter)

 

 

7625 Smetana Lane
Eden Prairie, MN 55344
(952) 294-3300

 

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

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

 

 

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

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

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):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

 

The aggregate market value of the voting stock held by non-affiliates of the registrant based upon the closing price of the common stock listed on the New York Stock Exchange on June 30, 2009 was $174,634,597, based on a closing price of $15.25 per share, excluding 19,428,239 shares of the registrant’s common stock held by current executive officers, directors and stockholders whose ownership exceeds 5% of the common stock outstanding at June 30, 2009. The number of shares held by stockholders whose ownership exceeds 5% of the registrant’s common stock outstanding at June 30, 2009 is based on Schedules 13D and 13G filed by such stockholders for the year ended December 31, 2008 and subsequent reports, if any, filed by such stockholders pursuant to Section 16 of the Securities Exchange Act of 1934, as amended. Exclusion of such shares should not be construed to indicate that any such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the registrant or that such person is controlled by or under common control with the registrant.

 

As of February 26, 2010, 31,696,564 shares of the registrant’s common stock, $0.001 par value, were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive Proxy Statement for the 2010 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this Form 10-K are incorporated by reference in Part III, Items 10-14 of this Form 10-K.

 

 

COMPELLENT TECHNOLOGIES, INC.

 

2009 ANNUAL REPORT ON FORM 10-K

 

TABLE OF CONTENTS

 

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that are based on our management’s beliefs and assumptions and on information currently available to our management. Forward-looking statements include all statements other than statements of historical fact contained in this Annual Report on Form 10-K, including, but not limited to, statements about:

 

 

In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” and similar expressions intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Annual Report on Form 10-K in greater detail in Part I, Item IA. “Risk Factors.” Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date hereof. We hereby qualify all of our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

 

The following discussion should be read in conjunction with our financial statements and the related notes contained elsewhere in this Annual Report on Form 10-K and in our other Securities and Exchange Commission filings.

 

All references to “Compellent,” “we,” “us,” “our” or the “Company” in this report mean Compellent Technologies, Inc. and its subsidiaries, except where it is made clear that the term means only the parent company.

 

 

Overview

 

We are a leading provider of enterprise-class network storage solutions that automate the movement and management of data throughout its lifecycle. Our Storage Center is a Storage Area Network, or SAN, that is designed to significantly lower storage and infrastructure capital expenditures, reduce the skill level and number of personnel required to manage information and enable continuous data availability and storage virtualization. Storage Center is based on our innovative Fluid Data Architecture, which allows enterprises of all sizes to move beyond simply storing data to actively, intelligently managing data. With Fluid Data storage, users are able to intelligently store, recover and manage large amounts of data with minimal effort. We combine our sophisticated software with standards-based hardware into a single integrated solution. We believe that Storage Center is the most comprehensive enterprise-class network storage solution available today, providing increased functionality and lower total cost of ownership when compared to traditional storage systems.

We developed our Storage Center software and hardware solution to target mid-size enterprises. We believe mid-size enterprises are acutely impacted by the proliferation of data and that their need for a scalable and cost-effective storage solution has historically been unmet. We believe our business model is highly differentiated and provides us with several competitive advantages. We sell our products through an all-channel assisted sales model designed to enable us to quickly scale and cost effectively increase sales. We also employ a virtual manufacturing strategy, which significantly reduces inventory and eliminates the need for in-house and outsourced manufacturing.

 

We have achieved broad industry recognition for our innovative enterprise storage. Compellent was awarded storage area network “Technology of the Year” awards from InfoWorld the past three years the publication has presented them 2006, 2008 and 2010. In 2009, Compellent was also named Microsoft’s Partner of the Year for Advanced Infrastructure Solutions, Storage Solutions and in 2008 was presented Storage magazine’s “Quality” Award. Gartner, a third-party industry analyst, reported Compellent to be the fastest growing storage area network company in 2006, 2007 and 2008. In 2009, TheInfoPro, an independent research firm, announced that mid-sized and large enterprise end users gave Compellent the highest possible ratings over competitive products in 10 key areas such as technology and quality of service delivered.

 

The Compellent Solution

 

Compellent was founded by a team of storage industry veterans with the vision of delivering a highly scalable, feature rich, easy to use and cost effective SAN for enterprises of all sizes. We believe Storage Center is an innovative solution that provides a point-and-click graphical user interface, automated tiered storage, integrated data and disaster recovery, efficient thin storage provisioning, storage virtualization and the flexibility to effectively combine advances in storage technologies into one integrated solution.

 

Innovative Architecture

 

The foundation of our solution is our Fluid Data Architecture, which utilizes block-level intelligence to improve the movement, placement and access of data at a level of granularity that delivers significant improvements in the cost, administration and recovery of data.

 

Compellent’s Fluid Data Architecture records and tracks specific information about an application’s data at the block level, the lowest level of data granularity within any storage system. Fluid Data Architecture allows Storage Center to record and track specific information about each block of data in a given enterprise network. This information about the data, or metadata, provides Storage Center with intelligence on how each block is being used. The metadata that Storage Center gathers can be extensive, including access frequency, performance and availability characteristics. Storage Center combines metadata with our sophisticated data movement engine, enabling enterprises to take a more intelligent approach to storing, recovering and managing data in an integrated automated solution. This metadata is used by Storage Center to automatically change how blocks of data are stored within each volume (e.g., by changing disk drive types). We refer to this capability as managing data inside the volume. Because of our innovative approach to managing data within a storage system, Storage Center provides significant cost and time saving feature advantages to our end users and allows them to easily respond to changing business conditions.

 

Storage Center delivers enterprise storage capabilities through an integrated suite of software applications that are offered in a modular fashion, so that enterprises can modify the solution to meet their changing requirements. Building on Compellent’s Fluid Data Architecture, Storage Center software applications intelligently improve data movement and access at the block-level, increasing utilization, automating tiered storage, simplifying replication and speeding data and disaster recovery.

 

Storage Center’s standards-based hardware platform enables flexibility and scalability with a no single point of failure architecture. Storage Center’s architecture is designed to enable rapid deployment and expansion of storage without disruption of service. Furthermore, Compellent’s standards-based approach enables enterprises to be technology neutral, adopting new hardware technologies to adapt to evolving business requirements.

Storage Center Directly Addresses Today’s Storage Challenges

 

We believe Storage Center is a highly sophisticated and easy-to-use system that addresses the challenges faced by today’s storage users in one integrated solution.

 

Simplified Storage Management

 

We designed Storage Center to reduce the complexity associated with traditional storage systems. Our intuitive interface and integrated architecture enables even less sophisticated users to accomplish advanced storage tasks in minutes, by automating manual, time-consuming storage management tasks, such as volume provisioning, tiering, disaster recovery and boot from SAN. This enables enterprises to more efficiently deploy their information technology resources. According to an end user study commissioned by us in 2006 and conducted by Enterprise Strategy Group, an independent third-party consultant, 98% of our end users surveyed were able to manage their SAN in three hours or less per week, while only 31% of other storage system users surveyed were able to do so. We believe that enterprises could purchase and integrate a number of different hardware and software products and still not achieve the functionality of Storage Center.

 

Automated, Cost-Effective Management of Inactive Data

 

Storage Center offers automated tiered storage technology based on the block-level intelligence provided by our Fluid Data Architecture. With information about access frequency at the block level, Storage Center automatically moves inactive blocks of data to lower cost tiers of storage. Our solution allows for automatic movement of blocks of data between tiers of high cost, high performance storage and tiers of lower cost storage based on access frequency and other parameters. Our solution also allows for dynamic placement of blocks of data on the preferred track of each system drive. Traditional storage systems do not gather information about blocks of data that would enable them to implement tiered storage with this level of functionality. As an example, an end user’s entire email database (calendar, inbox, sent items, deleted items, attachments, contacts, etc.) is contained in one single file, yet all of this data does not require equal performance, reliability, and frequency of access. Traditional storage systems store this entire file on one storage tier. With Storage Center, enterprises have the flexibility to put the frequently accessed items (such as the majority of a user’s inbox) on a faster tier of storage, and inactive items (such as almost all of a user’s sent and deleted items) on a less expensive tier of storage.

 

Storage Center users maintain the ability to establish the parameters under which tiering will be performed through a simple intuitive graphical user interface. With over 80% of customers’ data inactive, we believe Storage Center’s automated tiered storage can result in significant cost savings for end users.

 

Rapid Data Recovery

 

Using Storage Center, storage administrators can typically recover and allocate any size volume to any server in seconds, without the constraints of traditional recovery methodologies. Using a simple point-and-click interface, administrators can quickly recover data in the event of disruption. Storage Center’s advanced architecture enables the creation of significantly more snapshots, while consuming minimal storage space as Storage Center only captures data changes at the block level. The time intervals between snapshots on Storage Center are significantly shorter than traditional storage systems, providing many more recovery points and greater recovery precision. Storage Center’s architecture enables enterprises’ storage administrators to use snapshots as the first line of defense in data recovery, reducing the frequency of saving data to tapes.

 

Affordable and Reliable Disaster Recovery

 

We designed our replication technology to consume less disk space and require less bandwidth and management oversight than traditional storage solutions, which we call thin replication. Storage Center’s thin replication application sends only written data during the initial site synchronization process instead of the allocated but unused space sent by other commercially available replication technologies. To save additional time, especially for organizations without dedicated high-speed data transfer links, administrators can utilize Compellent’s Portable Volume solution, a kit with two enterprise-class external hard drives preconfigured for replication synchronization. For ongoing replication, Storage Center’s thin replication application transfers only the changed

data, consuming less space and lowering bandwidth costs. Storage Center eliminates the need for expensive protocol converters, provides the ability to prioritize replication across applications, enables multi-site replication using different hardware configurations and reduces the amount of data that needs to be sent to the replication site. Enterprises using Storage Center can easily set-up a remote replication solution, typically in just a few minutes. The simplicity and robustness of Storage Center’s disaster recovery solution makes it attractive for a range of end users from those with limited technical sophistication to large enterprises with significant technical know-how. One of the most important differentiators of Storage Center is its ability to test disaster recovery systems seamlessly and without disruption of service. We believe Compellent offers the only commercially available SAN solution that provides this level of capability.

 

Efficient Storage Utilization

 

Compellent’s thin provisioning technology is designed to maximize storage utilization. Thin provisioning describes a storage system’s ability to provision (or “allocate” to an application) more storage space than is physically in the system. With thin provisioning, end users can allocate more applications on less physical storage space, which increases the utilization rate of the physical storage space installed and requires fewer disk drives. Because of Fluid Data Architecture, Storage Center only consumes physical disk capacity when data is written by an application or user, as opposed to allocating physical capacity to users and applications upfront. We believe this capability significantly reduces an end user’s total cost of ownership by enabling them to defer or avoid additional spending on storage until the capacity is required, if ever. Storage Center enables end users to allocate capacity at a much more granular level than traditional storage systems. Storage Center also enables power and cooling savings, improved performance, data availability and storage utilization, while automating many of the tasks associated with capacity planning.

 

Enabling the Virtualized Data Center

 

Compellent’s advanced storage virtualization technology enabled by Fluid Data Architecture enables end users to create an efficient shared storage pool. This pool can be comprised of any combination of the disk drive technologies that Storage Center supports and enables any application to access all drives in the system. Storage Center dynamically distributes workloads across the entire pool, automatically improving utilization of storage resources for applications. Application Optimizer allows end users to set the size of data transfers within the SAN to match I/O performance for different applications such as video imaging, e-mail and databases. The result is a significant improvement in storage utilization, performance, flexibility and cost for end users.

 

Compellent’s approach to storage virtualization complements server virtualization technologies. End users realize similar benefits from Compellent’s storage virtualization features as they do from server virtualization, including reduced hardware costs, high utilization of assets and simplified management. While virtual server environments are not dependent on virtualized storage (and vice versa), we believe our storage virtualization leads to a more cost effective, flexible and high performing virtual data center. Virtual datacenters have lower hardware requirements due to higher utilization of both server and storage hardware and simplified management, which can reduce operating expenses.

 

Reducing Technology Risk

 

Compellent’s hardware architecture is designed to mitigate our end users’ technology risk. Storage Center enables users to simultaneously utilize any combination of our various standards-based hardware options and/or connectivity platforms and easily adopt new technologies as they become available. Storage Center offers disk independence, enabling end users to use any combination of Solid State, Fibre Channel, Serial Attached SCSI or Serial ATA disks in one virtualized storage pool. Storage Center’s virtualization engine enables end users to access the full capacity of all the drives in the system, even if they mix drive types. Similarly, Storage Center provides server connectivity independence, supporting both Fibre Channel and iSCSI protocols in the same system, which gives end users more flexibility. As our users’ storage needs expand, Storage Center’s modular design enables them to seamlessly add the appropriate technology without discarding current hardware and software investments.

Highly-Efficient and Scalable Business Model

 

We believe our business model is highly differentiated and gives us a competitive advantage. Key elements of our business model are virtual manufacturing, a standards-based hardware architecture and assisted selling through an all-channel approach. We believe these combined strategies create an efficient and scalable business model that enables us to grow our end user base, significantly reduce operating costs and improve capital efficiency.

 

Virtual Manufacturing

 

Our virtual manufacturing model incorporates standards-based hardware architecture, thereby eliminating the need for in-house or outsourced manufacturing operations. The different standards-based hardware components of our solution are provided by our suppliers. These components are custom configured, shipped from multiple geographic locations to a centralized consolidation point, merged in transit and delivered to the end user as one order. This is the process we call virtual manufacturing. This model significantly reduces our working capital needs and eliminates the need for maintaining assembly facilities, production inventory, warehouses or complex outsourced manufacturing relationships. By working with large suppliers and utilizing standards-based hardware architecture, we are able to scale rapidly with reduced capital outlay.

 

Standards-Based Hardware Architecture

 

Our hardware approach enables us to offer the best industry-standard hardware technology that suits the needs of our end users. Since we use hardware components that are tested extensively and shipped in high volumes by the manufacturers, our end users achieve high quality and low cost. This model enables us to focus our research and development efforts on our software core competencies to design and develop advanced software functionality at reasonable costs.

 

All-Channel Assisted Sales Model

 

We employ an all-channel assisted selling model through value-added resellers, which we refer to as channel partners. Our channel partners generally sign agreements with us outlining the terms of our relationship with them. Provisions within these agreements include a restriction that software is licensed while the hardware is sold, warranty provisions, agreement term (one year with automatic renewal terms of one year terminable without cause upon written notice to the other party), payment terms (generally 30 days), channel partner sales commitments, installation and configuration training requirements, which we may waive at our discretion, and the channel partners’ acknowledgement of the existence of our deal registration process for registering potential system sales to end users. Substantially all of our channel partners sign similar agreements except for sales commitments. Our channel partner agreements do not contain financial penalties for either party. Unlike other enterprise storage vendors who utilize resellers for distribution but may also compete with them through direct sales, our business model motivates our channel partners and significantly reduces our sales expense. By leveraging the customer reach, technical expertise and industry knowledge of our channel partners, we believe that we are able to market to a significantly larger set of end users more effectively and at lower cost than we could with our own direct sales force. We have built a strong internal sales team to assist our channel partners with, among other things, executive sales calls, service and support offerings, product matter expertise, configuration and pricing, joint sales calls, product demonstrations and design assistance. We believe this model provides us high visibility of demand for Storage Center and quick market entry. We further believe our close working relationship with channel partners and end users enables us to better understand end user needs.

 

Our Strategy

 

Our goal is to be the leading provider of feature rich, easy to use and cost effective storage solutions for enterprises of all sizes. Key elements of our strategy include:

 

 

 

Our Technology

 

We have designed a highly scalable, enterprise-class storage solution with an intelligent software architecture, advanced storage virtualization capabilities and a modular, standards-based hardware platform. Storage Center is designed to work with most server operating systems in use today (i.e., Apple, AIX, HP-UX, Linux, NetWare, Solaris and Windows) without installing additional server software. We believe these underlying technologies enable Storage Center to overcome the limitations of traditional storage systems and operate as a fully integrated solution managed through a single, intuitive, user interface.

 

Fluid Data Architecture

 

The foundation of Compellent’s solution is our Fluid Data Architecture, which utilizes block-level intelligence to improve the movement, placement and access of data with a level of functionality that delivers significant improvements in the cost, administration and recovery of data. Fluid Data Architecture enables us to record and track specific information about each block of data in a given system. This information about the data, or metadata, provides Storage Center with intelligence on how each block is being used. The metadata Storage Center gathers can be extensive, including access frequency, performance and availability characteristics. Storage Center combines metadata with our sophisticated data movement engine, enabling enterprises to take a more intelligent approach to storing, recovering and managing data in an integrated automated solution. Because of our innovative approach to managing data within a storage system, Storage Center provides significant cost and time saving feature advantages to our end users.

 

Advanced Storage Virtualization

 

Storage Center accelerates data access by spreading read/write operations across all disk drives, so multiple requests are processed in parallel. This is known as storage virtualization, where the physical drives are abstracted from the logical view of the data that the end user sees. Storage Center removes the limitations of physical drives by

aggregating them into logical, virtual volumes. Storage Center’s advanced virtualization technology manages all disk space, even across disparate technologies, as a centralized pool, and when demand increases, end users can simply add physical drives without downtime. This centralized pool of storage simplifies capacity planning for end users, who no longer need to map physical disk drives to dedicated servers and can provision logical volumes from a single storage pool without restrictions.

 

Storage Center’s virtualization technology removes the concept of dedicated disk drives for servers, applications and users, treating blocks as the basic resource managed by the system and intelligently placing these blocks across disk drives in a virtualized environment. In addition, administrators can virtualize the Fibre Channel and iSCSI connections to simplify configurations and reduce the number of physical I/O ports required in network switches.

 

Standards-Based Hardware Platform

 

Storage Center’s standards-based architecture enables the ongoing adoption of new storage technologies, without forcing enterprises to replace or discard their existing hardware and software investments. This architecture enables end users to mix and match server interfaces and disk drive technologies, simultaneously supporting Fibre Channel and/or iSCSI server connections, and any combination of Solid State, Fibre Channel, Serial Attached SCSI and/or Serial ATA disk drives. As part of a complete storage solution, we also provide switches, host bus adapters, drive enclosures and controllers.

 

Storage Center’s modular hardware architecture enables users to add capacity, connectivity and performance incrementally to match demand, rather than purchasing resources upfront that may never get used. Organizations can scale capacity from one to hundreds of terabytes on a single integrated platform, expanding hardware and upgrading software online without disruption or downtime.

 

We have architected Storage Center for high availability by striping data across all nodes in a cluster so that, if one node fails, the other nodes can perform the requested function, thereby preventing any single point of failure. Dual paths from controllers to disk drives, redundant power and fans, and controller failover support with a single or dual host bus adapters are designed to enable continuous data access. Controllers can be clustered but are connected independently and fail over without additional software, even with a single server connection.

Our Products

 

Building on our Fluid Data Architecture, Storage Center’s integrated suite of software applications dramatically improve utilization, automate tiered storage, streamline storage administration and speed data and disaster recovery. A base configuration of Storage Center typically includes a controller, disk enclosure, disk drives, connectivity hardware, Storage Center Core software and Dynamic Capacity. Most users also purchase Data Instant Replay with their initial order. Based on their capacity or functionality requirements, users can add hardware or software modules to complete their solutions. We believe that Storage Center’s software products offer the following key benefits:

 

 

Single, Intuitive Management Interface

 

All of Storage Center’s software applications are managed through a single unified interface that spans our entire set of technologies, capabilities and configurations. An intuitive point-and-click approach enables rapid set up and installation and reduces the need for training and specialized storage skills.

 

Complex allocation, configuration and administration functions can be easily accomplished with a point and click interface, that we call wizards, which guides the process and expands the capabilities of a single administrator. Storage consumption and usage trends are instantly monitored and displayed. Users can manage individual or multiple systems from the same interface.

We believe Storage Center’s wizard-driven interface is easy to use, speeding both common and complex storage tasks by reducing the time and effort required for many complex functions into a few simple point-and-click steps. Users can accomplish advanced storage tasks in just minutes, including implementing information lifecycle management in a single step, provisioning volumes, automating capacity planning, creating and expiring snapshots, deploying and testing disaster recovery and administering their entire storage environment.

 

Data Progression (Automated Tiered Storage)

 

Storage Center’s Data Progression application automatically classifies and migrates blocks of data based on user selected policies. When combined with our Fast Track application, blocks of data are dynamically placed on the appropriate tracks on each drive within the system. For instance, data can be migrated to the appropriate tier of storage based on usage, retaining frequently accessed data on the fastest portion of high-performance storage and storing infrequently accessed data on lower cost storage. Users can configure storage tiers based on technology, performance redundancy, or other criteria. Storage Center’s block-level intelligence allows blocks of data to move both up and down tiers of storage and across drives for appropriate placement over time based on frequency of access. A good example is medical imaging applications, which are storage intensive. All of the data associated with these applications does not require equal performance, reliability and frequency of access. With Data Progression technology, images are automatically placed, or can be manually placed by end users, on the appropriate tier of storage based on the required level of performance. Active images are stored on Solid State or Fibre-Channel Drives, which offer the highest level of performance. Inactive images can be stored on lower cost storage, Serial Attached SCSI or Serial ATA Drives, which utilize higher density and lower performance.

 

Data Instant Replay (Continuous Snapshots)

 

Storage Center’s Data Instant Replay application creates space-efficient copies of data, called Replays, which enable rapid recovery from data hazards, creation of test environments and duplication of boot volumes. Replays are created without an initial clone and contain only written data, rather than the allocated but unused storage typical in traditional storage systems. After the Replay creation, only the changed data blocks are stored, resulting in greater space savings. End users are able to create and store more Replays without consuming excess storage capacity or negatively impacting performance. Every Replay can be converted to a readable and writeable volume that can be quickly mapped to any server.

 

End users can create Replays at multiple time intervals and keep those Replays as long as required. With Replays, end users are able to create more recovery points, which can reduce potential data loss and dependence on tape backups by allowing recovery to be targeted as close as possible to the time before the failure occurred. Replays automatically expire after a user-specified time and space is automatically returned to the shared storage pool. Storage Center’s intuitive interface typically enables users to create a manual Replay in less than five seconds and recover a Replay in less than ten seconds. Additionally, Replays can be initiated directly by end user applications.

 

Server Instant Replay (Boot from SAN)

 

Storage Center’s Server Instant Replay application integrates with Storage Center’s Data Instant Replay application to provide snapshots of server boot images that are stored and booted from a SAN instead of from local disks. This capability enables end users to deploy diskless servers and significantly simplifies server management. Each new boot image is created by taking a Replay of the initial boot image, which includes pointers to the original “gold” image rather than creating a duplicate copy of equal size. These space-efficient Replays consume significantly less space per boot image as compared to traditional storage systems, reducing overall capacity requirements. An intuitive wizard automates the set-up, management and restoration process, enabling end users to simply provision and recover servers.

 

Remote Instant Replay (Thin Replication)

 

Storage Center’s Remote Instant Replay application creates any number of space-efficient Replays between primary and remote data centers without a pre-allocation of space. This granularity enables shorter recovery intervals, enabling end users near instant recovery from any point in time.

Replication can be synchronous or asynchronous and can be enabled in bi-directional, point-to-point or multi-point configurations. System configurations can be different between primary and remote locations, but all sites are active and available for recovery. Storage Center’s hardware ships with a native iSCSI interface, allowing our system to replicate over long distances using existing Ethernet networks. We support both IP-based and Fibre Channel replication.

 

Remote Instant Replay improves bandwidth utilization by only sending written data during the initial site synchronization process, instead of the allocated but unused space sent by other replication technologies. Remote Instant Replay then transfers only the changed data, consuming less space and lowering bandwidth costs. Replay data de-duplication ensures the same block of data is not sent twice.

 

With Remote Instant Replay’s bandwidth simulation, users can accurately estimate bandwidth requirements upfront based on actual data, improving the initial bandwidth purchase. Ongoing bandwidth shaping enables users to customize transfer rates based on link speed, time of day and replication priority.

 

Storage Center’s intuitive interface also enables users to test and verify disaster recovery online. There is no need to bring systems down to test disaster recovery readiness. A replication can be setup in as few as six clicks and replication templates can be created without complex scripting, reducing overall management requirements. This streamlined replication management is designed to allow recovery from a disaster in seconds with a single click disaster declaration.

 

Portable Volume

 

Compellent’s Portable Volume jumpstarts replication, reducing initial synchronization time to days or even hours without the need for high-speed connections or a duplicate array. Instead of transmitting data via conventional links, end users connect a Portable Volume primed with the replication information needed for the initial synchronization to the primary storage array. Once the data to be replicated is loaded onto the portable disk drive, end users pack the drive in a protective travel case and carry or ship it to the secondary site. At the destination site, Storage Center auto-detects the Portable Volume and begins the replication synchronization process.

 

Dynamic Capacity (Thin Provisioning)

 

Storage Center’s Dynamic Capacity application consumes physical disk space only when data is written by the application, as opposed to traditional storage systems, which require users to allocate potential needed capacity upfront. This enables Storage Center’s end users to reduce storage purchases and add capacity only when needed. With Storage Center, maximum capacity does not have to be fixed on a per volume basis. Volumes can easily be created and expanded online without disruption or downtime. Continual automated monitoring and alerts of allocated, used and physical storage enable administrators to ensure that the appropriate physical storage space is available when it is actually needed.

 

Storage Center’s Thin Import allows users to copy thick provisioned volumes from traditional storage systems onto Storage Center and convert unused space into thin provisioned volumes. In traditional implementations of thin provisioning, the operating system will report deleted files as unavailable space. Storage Center’s Free Space Recovery software identifies and reclaims space that is no longer in use. These advanced thin provisioning features improve the efficiency of Storage Center. Due to Storage Center’s use of Dynamic Capacity’s thin provisioned volumes, Storage Center increases the performance of volume-based operations such as rebuilds, copies, backups and replications.

 

Enterprise Manager (Storage Resource Management)

 

Enterprise Manager is designed to enable all local and remote Storage Center systems to be monitored and managed using a single console, providing a complete, centralized view of all aspects of an enterprise’s storage environment and enabling a single administrator to monitor multiple systems. System reports present storage resource management information, including summaries for capacity utilization, performance, replications and events. Users can view storage capacity utilization and performance on all systems over any period of time, including summaries from the last week, month or year. Hero reports allow users to easily show the cost and power

savings of Storage Center compared to traditional storage systems. Users can also chargeback departments or customer sites for actual storage consumed, associating different costs with multiple storage tiers and charging premiums or discounts based on user defined configurations.

 

Our Services

 

Our Copilot Service is a comprehensive customer service and technical support program that integrates installation services, a single point of contact call center, hardware and software maintenance, and onsite field services to enable reliable service delivery and execution for Storage Center end users. Copilot Service provides the convenience of one contract and a single point of contact to address Storage Center hardware or software issues.

 

Support activities are provided by highly skilled and trained staff, and Compellent’s channel partners can monitor service issues via a secure, online tracking system. Copilot Service utilizes Storage Center’s integrated “PhoneHome functionality” to alert users to potential systems issues via scheduled or event-based notifications. Onsite hardware repair services are delivered through Anacomp, Inc., a third-party hardware maintenance provider with a global field service force of trained technicians, dispatched via a 24-hour call center with access to local exchange parts depots in which we store replacement parts for Storage Center.

 

Our installation services speed time to deployment with on-site configuration and implementation. Our training services improve system understanding and operation through instruction in system administration and management. Our professional service offerings provide access to our technical experts in storage administration, management and troubleshooting, without requiring staff overhead for the end user. These services include regularly scheduled reviews, system health checks and evaluations as well as advanced configuration and software support.

 

End Users

 

As of December 31, 2009, Storage Center was being utilized by 1,812 enterprises worldwide in a variety of industries, including accounting, agriculture, automotive, construction, education, entertainment, financial services, food services, government, healthcare, insurance, legal, manufacturing, media, real estate, retail, scientific, technology, telecommunications, transportation and travel.

 

Distribution Channel and Marketing

 

We currently sell Storage Center to mid-size and large enterprise customers through our all-channel assisted sales model. We provide our end users with SAN solutions through our channel partners, who our end users rely on to address their enterprise-class networking and storage needs. We selectively recruit value-added-resellers to join our channel partner network. We have built a strong internal sales team to train and assist our channel partners with, among other things, executive sales calls, service and support offerings, product matter expertise, configuration and pricing, joint sales calls, product demonstrations and design assistance. In addition, we currently maintain a small team of installation professionals to assist channel partners and end users in installing our products.

 

For 2009, 2008 and 2007, our top ten channel partners accounted for 42%, 47% and 45% of our revenues, respectively. One channel partner, AMEX, Inc., accounted for 15% and 12% of total revenues for the years ended December 31, 2009 and 2008, respectively. Another channel partner, Insight Investments, accounted for 10% and 13% of total revenues for the years ended December 31, 2008 and 2007, respectively.

 

Since January 2008, we have maintained a marketing agreement with AMEX, Inc., an export firm, pursuant to which we granted AMEX exclusive distribution rights to resell Storage Center to resellers and end users internationally, except Canada. AMEX agrees to use its best efforts to further the promotion, marketing and sale of Storage Center. The marketing agreement is renewable on an annual basis each January unless either party notifies the other party in writing of an intention to discontinue the relationship at least 90 days prior to the renewal date. In the event we elect not to renew the marketing agreement, we must continue to pay AMEX a sliding-scale commission based on international sales for a period of two years following termination.

 

Virtual Manufacturing

 

Our virtual manufacturing model incorporates standards-based hardware architecture, thereby eliminating the need for in-house and outsourced manufacturing operations. The different standards-based hardware components of our solution are provided by our suppliers. These components are custom configured, shipped from multiple geographic locations to a centralized consolidation point, merged in transit and delivered to the end user as one order. This is the process we call virtual manufacturing. This virtual manufacturing and integration approach enables us to focus resources on the design, development and marketing of Storage Center.

 

We currently rely on a limited number of suppliers for components such as system controllers, enclosures, disk drives and switches utilized in the assembly of Storage Center and do not have long-term supply contracts. In particular, we rely on Bell Microproducts, Inc., a value added distributor, to provide us with customized system controllers, which Bell Microproducts generally obtains from Supermicro Computer, Inc. We also rely on Xyratex Corporation, a provider of data storage subsystems, to provide us with custom enclosures and disk drives. Xyratex purchases most of the disk drives that it supplies to us from Seagate Technology, Inc. This model significantly reduces our working capital needs and eliminates the need for maintaining assembly facilities, production inventory, warehouses or complex outsourced manufacturing relationships. We work closely with our suppliers to lower component costs and improve quality. By working with large suppliers, we are able to scale rapidly with limited capital expenditures. We generally maintain minimal inventory for repairs, evaluation and demonstration units and acquire components only as needed. We do not enter into long-term supply contracts for these components.

 

Research and Development

 

We believe that our future success depends in part on our ability to introduce enhancements to Storage Center and to develop new applications for both existing and new markets. Our research and development efforts are directed largely to the development of additional enterprise-class network storage solutions demanded by our channel partners and end users. We have assembled a team of highly skilled engineers who have expertise in designing and developing enterprise-class SANs. Our research and development group is located in Eden Prairie, Minnesota. As of December 31, 2009 and 2008, we had 75 and 58 employees in the research and development group. Our research and development expenses were $12.7 million in 2009, $10.1 million in 2008, and $7.6 million in 2007.

 

Competition

 

We compete with numerous domestic and international companies, most of which have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we have. A number of very large corporations have historically dominated the storage market. We consider our primary competitors to be companies that provide SAN products, such as 3Par, Inc., Dell, Inc., EMC Corporation, Hewlett-Packard Company, Hitachi Data Systems Corporation, IBM, NetApp, Inc. and Xiotech Corporation. Some of our competitors, including Dell, EMC and NetApp, have made acquisitions of businesses that allow them to offer more directly competitive and comprehensive solutions than they had previously offered. We expect to encounter new competitors as we enter new markets as well as increased competition, both domestically and internationally, from other established and emerging storage companies, original equipment manufacturers, and from systems and network management companies. In addition, there may be new technologies that are introduced that reduce demand for, or make our, storage solution architecture obsolete.

 

We believe that the principal competitive factors affecting the data storage market include such storage system attributes as:

 

 

We believe that we compete favorably with our competitors on the basis of these factors. However, potential end users may prefer to purchase from their existing suppliers rather than a new supplier regardless of product performance or features. Our success will also depend on utilizing new and proprietary technologies to offer products and features previously not available in the marketplace. If we fail to continue to compete favorably, our business will be harmed.

 

Intellectual Property

 

Our success depends in part upon our ability to protect our core technology and intellectual property. To accomplish this, we rely on a combination of intellectual property rights, including patents, trade secrets, copyrights and trademarks, and contractual protections.

 

As of December 31, 2009, we had five issued patents in the United States and one issued foreign patent in China, expiring between 2024 and 2026. We also had thirteen pending patent applications in the United States, three patent application filed pursuant to the Patent Cooperation Treaty and seventeen pending foreign patent applications. Our pending patent applications relate to Fluid Data Architecture storage processing and other SAN concepts. We focus our patent efforts in the United States, and, when justified by cost and strategic importance, we file corresponding foreign patent applications in strategic jurisdictions such as Asia and Europe. Our patent strategy is designed to provide a balance between the need for coverage in our strategic markets and the need to maintain costs at a reasonable level.

 

We do not know whether any of our pending patent applications will result in the issuance of additional patents or whether the examination process will require us to narrow the scope of our claims. With respect to our issued patents, and to the extent any of our pending applications proceed to issuance as a patent, any such patent or future patent may be opposed, contested, circumvented, designed around by a third party, or found to be invalid or unenforceable. In addition, our future patent applications may not be issued with the scope of the claims sought by us, if at all, or the scope of claims we are seeking may not be sufficiently broad to protect our proprietary technologies. Others may develop technologies that are similar or superior to our proprietary technologies, duplicate our proprietary technologies or design around patents owned or licensed by us. If our products are found to conflict with any patent held by third parties, we could be prevented from selling our products or our patent applications may not result in issued patents.

 

In addition, we generally control access to and use of our proprietary software and other confidential information through the use of internal and external controls, including contractual protections with employees, contractors, end users and channel partners. We rely in part on U.S. and international copyright laws to protect our software. All employees and consultants are required to execute confidentiality agreements in connection with their employment and consulting relationships with us. We also require them to agree to disclose and assign to us all inventions conceived or made in connection with the employment or consulting relationship. We cannot provide any assurance that employees and consultants will abide by the confidentiality or invention assignment terms of their agreements. Despite our efforts to protect our intellectual property through patents, trademarks and confidentiality agreements, unauthorized parties may copy or otherwise obtain and use our software and proprietary technology.

 

Our Storage Center suite of products utilizes eCos, an “open source,” royalty-free, real-time operating system intended for embedded applications. eCos is released under a modified version of the well-known GNU General Public License. Open source software is generally made available to the public by its authors and/or other third parties under licenses, such as the GNU General Public License, which impose certain obligations on licensees in the event such licensees make derivative works of the open source software.

 

Third parties have sent us letters offering to license their patents, and they and others could claim that our products or technologies infringe their proprietary rights. The SAN industry is characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. As the number of products and competitors in our market increases, we face a higher risk of being the subject of intellectual property infringement claims from other third parties. We cannot assure you that we do not currently infringe, or that we will not in the future infringe, upon any third-party patents or other proprietary rights.

Litigation in this industry is often protracted and expensive. Questions of infringement in the SAN industry involve highly technical and subjective analyses. Any claim of infringement from a third-party, even those without merit, could cause us to incur substantial costs defending against such claims, and could distract our management from running 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 selling Storage Center. In the event we receive an adverse result in any litigation, we could be required to pay substantial damages, cease sale of products, expend significant resources to develop alternative technology and discontinue the use of processes requiring the relevant technology. 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.

 

In addition, litigation may become necessary in the future to enforce our intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity, and we may not prevail in any future litigation. The results of any litigation are inherently uncertain. Any successful infringement claim or litigation against us could have a significant adverse impact on our business. Alternatively, we may be required to develop non-infringing technology, which would require significant effort and expense and may ultimately not be successful.

 

We may also be required to seek licenses under patents or intellectual property rights owned by third parties. However, we cannot be certain that third parties will offer licenses to us or that the terms of any licenses offered to us will be acceptable. If we fail to obtain such third-party license for our products, we could incur substantial liabilities or be forced to suspend sales of our products.

 

Backlog

 

We do not believe that backlog as of any particular date is meaningful, as sales of Storage Center are made primarily pursuant to purchase orders for delivery of products. We consider backlog to be approved orders that have not yet been shipped. As of March 3, 2010, we had $2.3 million of backlog and as of March 16, 2009, we had $557,000 of backlog. We do not believe that backlog as of any particular date is indicative of future results.

 

Financial Information by Business Segment and Geographic Data

 

We operate in one reportable industry segment: the design, marketing, and technical support of enterprise-class network storage solutions. Our chief operating decision maker is our chief executive officer. Our chief executive officer reviews financial information, accompanied by information about revenues by geographic region for purposes of allocating resources and evaluating financial performance. The information included in Note 13 of the Notes to Consolidated Financial Statements is hereby incorporated by reference.

 

Employees

 

As of December 31, 2009, we had 387 employees, which included 75 employees in research and development, 212 in sales and marketing, 63 in customer and technical services, 22 in administration and 15 in manufacturing. None of our employees are represented by a labor union and we consider current employee relations to be good.

 

Executive Officers of the Registrant

 

Our executive officers, their ages and their positions as of March 5, 2010, are as follows:

 

Philip E. Soran has served as our Chairman, President and Chief Executive Officer since co-founding Compellent in March 2002. From July 1995 to August 2001, Mr. Soran served as President and Chief Executive Officer of Xiotech Corporation, or Xiotech, a storage area networking company, which Mr. Soran co-founded in July 1995. Xiotech was acquired by Seagate Technology, or Seagate, a disk drive manufacturer, in January 2000. From October 1992 to April 1995, Mr. Soran served as Executive Vice President of Prodea Software Corporation, a data warehousing software company. From 1982 to 1993, Mr. Soran also held a variety of management, sales, marketing and technical positions with IBM. Mr. Soran received a B.A. in Education from the University of Northern Colorado.

 

Lawrence E. Aszmann has served as our Chief Technology Officer and Secretary since co-founding Compellent in March 2002. Mr. Aszmann was a member of our board of directors from March 2002 through June 2003. From July 1995 to August 2001, Mr. Aszmann served as Chief Technology Officer of Xiotech, which Mr. Aszmann co-founded in July 1995. Xiotech was acquired by Seagate in January 2000. From July 1988 to August 1995, Mr. Aszmann served as Director of Intelligent Input/Output Subsystems at Tricord Systems. From December 1981 to June 1988, Mr. Aszmann served as Chief Software Architect of Star Technologies, and Mr. Aszmann previously held various storage-related technology positions with Technalysis Corporation, a consulting company, and Control Data Corporation, a mainframe manufacturing company.

 

Brian P. Bell has served as our Vice President, Worldwide Sales since April 2006. From August 2003 to April 2006, he served as our Director of Business Development. From August 2002 to August 2003, Mr. Bell was with Storage Networks, Inc., an information storage software and services company, as Vice President of Global Services. From July 1999 to August 2002, Mr. Bell served in various positions for Storage Network, Inc. including most recently as Director of Operations. From 1988 to 1999, Mr. Bell served as a commissioned officer in the U.S. Air Force. Mr. Bell received a B.S. in Human Factors from the U.S. Air Force Academy and an M.S. in Human Factors Engineering from the University of Illinois.

 

John P. Guider has served as our Chief Operating Officer and a member of our board of directors since co-founding Compellent in March 2002. From July 1995 to August 2001, Mr. Guider served as Chief Operating Officer of Xiotech, which Mr. Guider co-founded in July 1995. Xiotech was acquired by Seagate in January 2000. From 1987 to 1995, Mr. Guider served as Chief Technology Officer and Senior Vice President of Product Development of Tricord Systems, a high performance server company, which Mr. Guider co-founded in 1987. From December 1982 to January 1987, Mr. Guider served as Director of Hardware Development at Star Technologies, a scientific computer company, and held various management and technical positions with Sperry Corporation, a mainframe systems company. Mr. Guider received a B.S. in Electrical Engineering from the University of Minnesota, Minneapolis.

 

John R. Judd has served as our Chief Financial Officer since June 2006. From October 2003 to July 2006, Mr. Judd served as Chief Financial Officer of ATS Medical, Inc., a medical device manufacturer. From June 2000 to October 2003, Mr. Judd served as Controller of American Medical Systems Holdings, Inc., a medical device manufacturer. From 1997 to 1999, Mr. Judd served as Chief Financial Officer of the Autoglass Division of Apogee Enterprises, Inc., a glass technology company. Mr. Judd received a B.A. and an M.B.A. from the University of St. Thomas.

 

Corporate Information

 

Compellent Technologies, Inc. was formed in Minnesota in March 2002 and reincorporated in Delaware in June 2002. The address of our principal executive office is 7625 Smetana Lane, Eden Prairie, Minnesota 55344, and our telephone number is (952) 294-3300. Our website address is http://www.compellent.com.

 

Available Information

 

Our website address is http://www.compellent.com. Information contained on our website is not incorporated by reference into this Form 10-K unless expressly noted. We file reports with the Securities and Exchange Commission, or the SEC, which we make available on our website free of charge. These reports include annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports, each of which is provided on our website as soon as reasonably practicable after we electronically file such

materials with or furnish them to the SEC. You can also read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains a website (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us. In addition, our Corporate Governance Guidelines, Code of Business Conduct and Ethics and Charters of our Audit, Compensation and Nominating and Corporate Governance Committees are available on our website and are available in print to any stockholder who requests such information.

 

 

We have identified the following additional risks and uncertainties that may have a material adverse effect on our business, financial condition or results of operations. Investors should carefully consider the risks described below before making an investment decision. The risks described below are not the only ones we face. Additional risks not presently known to us or that we currently believe are immaterial may also significantly impair our business operations. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks, and investors may lose all or part of their investment.

 

Risks Related to Our Business

 

Our quarterly operating results may fluctuate significantly, which makes our future results difficult to predict.

 

Our quarterly operating results fluctuate due to a variety of factors, many of which are outside of our control. Our future revenues are difficult to predict. A significant portion of our sales typically occurs during the last month of a quarter. As a result, we typically cannot predict our revenues in any particular quarter with any certainty until late in that quarter. Our storage products typically are shipped shortly after orders are received. As a result, revenues in any quarter are substantially dependent on orders booked and shipped in that quarter. Revenues for any future period are not predictable with any significant degree of certainty. 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. Moreover, spending on storage solutions has historically been cyclical in nature, reflecting overall economic conditions as well as budgeting and buying patterns of business enterprises. We believe our recent rapid growth has masked the cyclicality and seasonality of our business. The third quarter is generally the slowest sales quarter in the storage industry. Our expense levels are relatively fixed in the short term and are based, in part, on our expectations as to future revenues. If revenues levels are below our expectations, we may incur less income and may not sustain profitability on a quarterly or an annual basis. Our operating results may be disproportionately affected by a reduction in revenues because a proportionately smaller amount of our expenses varies with our revenues. As a result, our quarterly operating results are difficult to predict, even in the near term. If our revenues 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 would likely decline substantially.

 

In addition to other risk factors listed in this “Risk Factors” section, factors that may affect our operating results include:

 

 

 

We have a history of losses, and we may not sustain profitability on a quarterly or an annual basis in the future.

 

We achieved profitability on an annual basis for the first time as of December 31, 2009. We had net income (loss) of $4.8 million, ($416,000) and ($7.8) million for the years ended December 31, 2009, 2008 and 2007, respectively. As of December 31, 2009, our accumulated deficit was $45.1 million. We expect to make significant expenditures related to the development of our products and expansion of our business, including sales and marketing, research and development and general and administrative expenses. We may also encounter unforeseen difficulties, complications, product delays and other unknown factors that require additional expenditures. As a result of these increased expenditures, we will have to generate and sustain substantially increased revenues to achieve and maintain profitability, which we may never do. In addition, the percentage growth rates we achieved in prior periods will not be sustainable and we may not be able to increase our revenues sufficiently in absolute dollars to sustain quarterly or annual profitability.

 

Unfavorable economic and market conditions and a lessening demand in the information technology market could adversely affect our operating results.

 

Our operating results may be adversely affected by unfavorable global economic and market conditions as well as a lessening demand in the information technology, or IT, market. Customer demand for our products is intrinsically linked to the strength of the economy. A reduction in demand for storage and data management products caused by weak and/or deteriorating economic conditions and customer decreases in corporate spending, deferral or delay of IT projects, longer time frames for IT purchasing decisions, the inability of customers to obtain credit to finance purchases of our products and generally reduced capital expenditures for IT storage solutions will result in decreased revenues and lower revenues growth rates for us. If the storage and data management markets grow slower than anticipated or if IT spending is reduced, demand for our products could decline and our operating results could be materially and adversely affected.

 

The markets in which we compete are highly competitive and dominated by large corporations and we may not be able to compete effectively.

 

The storage market is intensely competitive and is characterized by rapidly changing technology. This competition could make it more difficult for us to sell our products, and result in increased pricing pressure, reduced gross profit, increased sales and marketing expense and failure to increase, or the loss of, market share or expected market share which would likely result in lower revenues.

 

Our ability to compete depends on a number of factors, including:

 

 

 

Potential end users may prefer to purchase from their existing suppliers rather than a new supplier regardless of product performance or features. In the event a potential end user decides to evaluate a new storage system, the end user may be more inclined to select one of our competitors whose product offerings are broader than just storage systems. In addition, potential end users may prefer to purchase from their existing suppliers rather than a new supplier, regardless of product performance or features. Most of our new end users have installed storage systems, which gives an incumbent competitor an advantage in retaining an end user because it already understands the network infrastructure, user demands and information technology needs of the end user, and also because it is costly and time-consuming for end users to change storage systems.

 

A number of very large corporations have historically dominated the storage market. We consider our primary competitors to be companies that provide Storage Area Network, or SAN products, such as 3Par, Inc., Dell, Inc., EMC Corporation, Hewlett-Packard Company, Hitachi Data Systems Corporation, IBM and NetApp, Inc., and Xiotech Corporation. Some of our competitors, including Dell, EMC and NetApp, have made acquisitions of businesses that allow them to offer more directly competitive and comprehensive solutions than they had previously offered. Most of our competitors have longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we have. We expect to encounter new competitors as we enter new markets as well as increased competition, both domestically and internationally, from other established and emerging storage companies, original equipment manufacturers, and from systems and network management companies. In addition, there may be new technologies that are introduced that reduce demand for, or make our, storage solution architecture obsolete. Our current and potential competitors may also establish cooperative relationships among themselves or with third parties and rapidly acquire significant market share. Increased competition could also result in price reductions and loss of market share, any of which could result in lower revenues and reduced gross profits.

 

We are dependent on a single product, and the lack of continued market acceptance of Storage Center would result in lower revenues.

 

Storage Center accounts for all of our revenues and will continue to do so for the foreseeable future. As a result, our revenues could be reduced by:

 

 

We are particularly vulnerable to fluctuations in demand for storage area network products in general and Storage Center in particular. If the storage markets grow more slowly than anticipated or if demand for Storage Center does not grow as quickly as anticipated, whether as a result of competition, product obsolescence, technological change, unfavorable economic conditions, uncertain geopolitical environments, budgetary constraints of our end users or other factors, we may not be able to increase our revenues sufficiently to sustain quarterly or annual profitability and our stock price would decline.

 

Our products must meet exacting specifications, and defects and failures may occur, which may cause channel partners or end users to return or stop buying our products.

 

Our channel partners and end users generally establish demanding specifications for quality, performance and reliability that our products must meet. However, our products are highly complex and may contain undetected

defects and failures when they are first introduced or as new versions are released. We have in the past and may in the future discover software errors in new versions of Storage Center or new products or product enhancements after their release or introduction, which could result in lost revenues during the period required to correct such errors. Despite testing by us and by current and potential end users, errors may not be found in new releases or products until after commencement of commercial shipments, resulting in loss of or delay in market acceptance. Storage Center may also be subject to intentional attacks by viruses that seek to take advantage of these bugs, errors or other weaknesses. If defects or failures occur in Storage Center, a number of negative effects in our business could result, including:

 

 

In addition, delays in our ability to fill product orders as a result of quality control issues may negatively impact our relationship with our channel partners and end users. Our revenues could be lower and our expenses could increase if any of the foregoing occurs.

 

Our end users utilize Storage Center to manage their data. As a result, we could face claims resulting from any loss or corruption of our end users’ data due to a product defect. Our contracts with end users contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management’s attention and could result in public perception that our products are not effective, even if the occurrence is unrelated to the use of our products or services. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our costs to defend and cover such claims, if any, will increase.

 

We will not sustain our percentage growth rate, and we may not be able to manage any future growth effectively.

 

We have experienced significant growth in a short period of time. Our revenues increased from $3.9 million in 2004 to $125.3 million in 2009. The percentage growth rates we achieved in prior periods will not be sustainable. You should not rely on our operating results for any prior quarterly or annual periods as an indication of our future operating performance. If we are unable to maintain adequate revenues growth in dollars, we may not be able to sustain quarterly or annual profitability and our stock price could decline.

 

Our future operating results depend to a large extent on our ability to successfully manage our anticipated expansion and growth. To manage our growth successfully and handle the responsibilities of being a public company, we believe we must effectively, among other things:

 

 

 

We intend to increase our investment in sales and marketing, research and development and general and administrative and other functions to grow our business. We are likely to recognize the costs associated with these increased investments earlier than some of the anticipated benefits and the return on these investments may be lower, or may develop more slowly, than we expect, which could decrease our annual net income.

 

If we are unable to manage our growth effectively, we may not be able to take advantage of market opportunities or develop new products or enhancements to existing products and we may fail to satisfy end user requirements, maintain product quality, execute on our business plan or respond to competitive pressures, which could result in lower revenues and a decline in our stock price.

 

Our gross profit may vary and such variation may make it more difficult to forecast our earnings.

 

Our gross profit has been and may continue to be affected by a variety of other factors, including:

 

 

Changes in gross profit may result from various factors such as continued investments in our Copilot Services, increases in our fixed costs, changes in the mix between technical support services and professional services, as well as the timing and amount of maintenance agreement initiations and renewals.

 

We receive a substantial portion of our revenues from a limited number of channel partners, and the loss of, or a significant reduction in, orders from one or more of our major channel partners would result in lower revenues.

 

Our future success is highly dependent upon establishing and maintaining successful relationships with a variety of channel partners. We market and sell Storage Center through an all-channel assisted sales model and we derive substantially all of our revenues from these channel partners. We generally enter into agreements with our channel partners outlining the terms of our relationship, including channel partner sales commitments, installation and configuration training requirements, and the channel partners’ acknowledgement of the existence of our sales registration process for registering potential systems sales to end users. These contracts typically have a term of one year and are terminable without cause upon written notice to the other party. Our reseller agreements with our channel partners do not prohibit them from offering competitive products or services. Many of our channel partners also sell our competitors’ products. If our channel partners give higher priority to our competitors’ storage products, we may be unable to grow our revenues and could decrease our annual net income.

 

We receive a substantial portion of our revenues from a limited number of channel partners. For 2009, 2008 and 2007, our top ten channel partners accounted for 42%, 47% and 45% of our revenues, respectively. One channel partner, AMEX, Inc., accounted for 15% and 12% of total revenues for the years ended December 31, 2009 and 2008, respectively. Another channel partner, Insight Investments, accounted for 10% and 13% of total revenues for the years ended December 31, 2008 and 2007, respectively. We anticipate that we will continue to be dependent upon a limited number of channel partners for a significant portion of our revenues for the foreseeable future and, in

some cases, the portion of our revenues attributable to individual channel partners may increase in the future. The loss of one or more key channel partners or a reduction in sales through any major channel partner would reduce our revenues. Further, in order to develop and expand our channels, we must continue to scale and improve our processes and procedures that support our channel partners, including investments in systems and training, and those processes and procedures may become increasingly complex and difficult to manage. If we fail to maintain existing channel partners or develop relationships with new channel partners, our revenue opportunities will be reduced.

 

The loss of any key suppliers or the failure to accurately forecast demand for our products or successfully manage our relationships with our key suppliers could negatively impact our ability to sell our products.

 

We generally maintain minimal inventory for repairs, evaluation and demonstration units and acquire components only as needed. We do not enter into long-term supply contracts for these components. As a result, our ability to respond to channel partner or end user orders efficiently may be constrained by the then-current availability, terms and pricing of these components. Our industry has experienced component shortages and delivery delays in the past, and we may experience shortages or delays of critical components in the future as a result of strong demand in the industry or other factors. If we or our suppliers inaccurately forecast demand for our products, our suppliers may have inadequate inventory, which could increase the prices we must pay for substitute components or result in our inability to meet demand for our products, as well as damage our channel partner or end user relationships.

 

We currently rely on a limited number of suppliers for components such as system controllers, enclosures, disk drives and switches utilized in the assembly of Storage Center. We generally purchase components on a purchase order basis and do not have long-term supply contracts with these suppliers. In particular, we rely on Bell Microproducts, Inc., a value-added distributor, to provide us with customized system controllers, which Bell Microproducts generally obtains from Supermicro Computer, Inc., a server and component manufacturer. We also rely on Xyratex Corporation, a provider of data storage subsystems, to provide us with their custom enclosures and disk drives. Xyratex purchases most of the disk drives that it supplies to us from Seagate Technology, Inc., a disk drive manufacturer. Our reliance on these key suppliers reduces our control over the manufacturing process, exposing us to risks, including reduced control over product quality, production costs, timely delivery and capacity. It also exposes us to the potential inability to obtain an adequate supply of required components, because we do not have long-term supply commitments and generally purchase our products on a purchase order basis. Component quality is particularly significant with respect to our suppliers of disk drives. We have in the past and may in the future experience disk drive failures, which could cause our reputation to suffer, our competitive position to be impaired and our customers to select other vendors. To meet our product performance requirements, we must obtain disk drives of extremely high quality and capacity. In addition, there are periodic supply-and-demand issues for disk drives that could result in component shortages, selective supply allocations and increased prices of such components. We may not be able to obtain our full requirements of components, including disk drives, that we need for our storage products or the prices of such components may increase. If we fail to effectively manage our relationships with our key suppliers, or if our key suppliers increase prices of components, experience delays, disruptions, capacity constraints, or quality control problems in their manufacturing operations, our ability to ship products to our channel partners or end users could be impaired and our competitive position and reputation could be adversely affected. Qualifying a new key supplier is expensive and time-consuming. If we are required to change key suppliers or assume internal manufacturing operations, we may lose revenues and damage our channel partner or end user relationships.

 

If our third-party repair service fails to timely and correctly resolve hardware failures experienced by our end users, our reputation will suffer, our competitive position will be impaired and our expenses could increase.

 

We rely upon Anacomp Inc., or Anacomp, a third-party hardware maintenance provider, which specializes in providing vendor-neutral support of storage equipment, network devices and peripherals, to provide repair services to our end users. We currently have limited capabilities in-house to resolve hardware failures or other issues experienced by our end users. If Anacomp fails to timely and correctly resolve hardware failures or issues

experienced by our end users, our reputation will suffer, our competitive position will be impaired and our expenses could increase. In May 2008, we entered into a five year agreement with Anacomp. Our agreement with Anacomp will automatically renew for successive one-year terms, unless either party notifies the other, in writing, of its intention to terminate or renegotiate the agreement at least 180 days prior to the end of the initial five-year term or any successive one-year term. In addition, either party may immediately terminate the agreement for a material default by the other party that is not cured within 30 days. If our relationship with Anacomp were to end, we would have to engage a new third-party provider of hardware support, and the transition could result in delays in effecting repairs and damage our reputation and competitive position as well as increase our operating expenses.

 

If we are unsuccessful in developing and selling new products, services and product enhancements, our competitive position will be adversely affected and our ability to grow our revenues will be impaired.

 

We operate in a dynamic environment characterized by rapid technological change, changing end user needs, frequent new product introductions and evolving industry standards. The introduction of products embodying new technologies and the emergence of new industry standards could render our existing products obsolete and unmarketable. Our competitiveness and future success depend on our ability to anticipate, develop, market and support new products and product enhancements on a timely and cost effective basis that keep pace with technological developments and emerging industry standards and that address the increasingly sophisticated needs of our end users. We may fail to develop and market products and services that respond to technological changes or evolving industry standards, experience difficulties that could delay or prevent the successful development, introduction and marketing of these products and services, or fail to develop products and services that adequately meet the requirements of the marketplace or achieve market acceptance. Our failure to develop and market such products and services on a timely basis would erode our competitive position and impair our ability to grow our revenues.

 

If our channel partners fail to timely and correctly install and configure our storage systems, or face disruptions in their business, our reputation will suffer, our competitive position could be impaired and we could lose customers.

 

In addition to our small team of installation personnel, we rely upon some of our channel partners to install Storage Center at our end user locations. Our channel partner agreements generally contain provisions requiring installation and configuration training by the channel partners, which we may waive at our discretion. Although we train and certify our channel partners on the installation and configuration of Storage Center, end users have in the past encountered installation and configuration difficulties. In addition, if one or more of our channel partners suffers an interruption in its business, or experiences delays, disruptions or quality control problems in its operations, or we have to change or add additional channel partners, installation and configuration of Storage Center to our end users could be delayed, our revenues could be reduced and our ability to compete could be impaired. As a significant portion of our sales occur in the last month of a quarter, our end users may also experience installation delays following a purchase if we or our channel partners have too many installations in a short period of time. If we or our channel partners fail to timely and correctly install and configure Storage Center, end users may not purchase additional products and services from us, our reputation could suffer and our revenues could be reduced. In addition, we will incur additional expenses to correctly install and configure Storage Center to meet the expectations of our end users.

 

If we fail to attract or retain engineering or sales and marketing personnel or if we lose the services of our founders or key management, our ability to grow our business and our competitive position would be impaired.

 

We believe our future success will depend in large part upon our ability to attract, retain and motivate highly skilled managerial, research and development, sales and marketing personnel. Our management, research and development, sales and marketing personnel represent a significant asset and serve as the source of our business strategy, technological and product innovations, and sales and marketing initiatives. As a result, our success is substantially dependent upon our ability to attract additional personnel for all areas of our organization, particularly in our research and development department and our sales and marketing department. Competition for qualified

personnel is intense, and we may not be successful in attracting and retaining such personnel on a timely basis or on competitive terms. Any failure to adequately expand our management, research and development, sales and marketing personnel will impede our growth. In addition, many qualified personnel are located outside of the Minneapolis geographic area where our headquarters are located, and some qualified personnel that we may recruit may not be interested in relocating. If we are unable to attract and retain the necessary personnel on a cost-effective basis, our ability to grow our business and our competitive position would be impaired.

 

In particular, we are highly dependent on the contributions of our three founders, Philip E. Soran, our Chairman, President and Chief Executive Officer, John P. Guider, our Chief Operating Officer, and Lawrence E. Aszmann, our Chief Technology Officer. The loss of any of our founders could make it more difficult to manage our operations and research and development activities, reduce our employee retention and revenues and impair our ability to compete. If any of our founders were to leave us unexpectedly, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity during the search for and while any such successor is integrated into our business and operations. The loss of any of our founders or the inability to attract, retain or motivate qualified personnel, including research and development and sales and marketing personnel, could delay the development and introduction of, and impair our ability to, sell our products.

 

We expect to face numerous challenges as we attempt to grow our operations, and our channel partner and end user base internationally.

 

Historically, we have conducted only a small portion of our business internationally. We have two international offices and revenues from international sales were 17%, 16% and 11% of our consolidated revenues during 2009, 2008 and 2007, respectively. Although we expect that part of our future revenues growth will be from channel partners and end users located outside of the United States, we may not be able to increase international market demand for Storage Center. In January 2008, we entered into a marketing agreement with AMEX, Inc., an export firm, pursuant to which we granted AMEX exclusive distribution rights to resell Storage Center to resellers and end users internationally, except in Canada. In January 2009, we entered into a new marketing agreement with AMEX containing exclusive distribution rights similar to those contained in the January 2008 agreement. AMEX agrees to use its best efforts to further the promotion, marketing and sale of Storage Center. The marketing agreement is renewable on an annual basis each January unless either party notifies the other party in writing of an intention to discontinue the relationship at least 90 days prior to the renewal date. If AMEX is not successful in helping us expand our international distribution channel, our revenues and our ability to compete internationally could be impaired.

 

We expect to face numerous challenges as we attempt to grow our operations, channel partner relationships and end user base internationally, in particular attracting and retaining channel partners with international capabilities or channel partners located in international markets. Our revenues and expenses could be adversely affected by a variety of factors associated with international operations some of which are beyond our control, including:

 

 

 

In addition, we expect that we may encounter increased complexity and costs of managing international operations, including longer and more difficult collection of receivables, difficulties in staffing international operations, local business and cultural factors that differ from our normal standards and practices, differing employment practices and labor issues, and work stoppages, any of which could result in lower revenues and higher expenses.

 

If we fail to protect our intellectual property rights adequately, our ability to compete effectively or to defend ourselves from litigation could be impaired which could reduce our revenues and increase our costs.

 

We rely primarily on patent, copyright, trademark and trade secret laws, as well as confidentiality and non-disclosure agreements and other methods, to protect our proprietary technologies and know-how. As of December 31, 2009, we have five issued patents in the United States, one international patent and additional patents pending in the United States and in foreign countries. The rights granted to us under our issued patents and, if the pending patent applications are granted, those applications may not be meaningful or provide us with any commercial advantage and they could be opposed, contested, circumvented or designed around by our competitors or be declared invalid or unenforceable in judicial or administrative proceedings. The failure of our patents to adequately protect our technology might make it easier for our competitors to offer similar products or technologies. Foreign patent protection is generally not as comprehensive as U.S. patent protection and may not protect our intellectual property in some countries where our products are sold or may be sold in the future. Many U.S.-based companies have encountered substantial intellectual property infringement in foreign countries, including countries where we sell or intend to sell products. Even if foreign patents are granted, effective enforcement in foreign countries may not be available.

 

Monitoring unauthorized use of our intellectual property is difficult and costly. Although we are not aware of any unauthorized use of our intellectual property in the past, it is possible that unauthorized use of our intellectual property may have occurred or may occur without our knowledge. The steps we have taken may not prevent unauthorized use of our intellectual property. Our failure to effectively protect our intellectual property could reduce the value of our technology in licensing arrangements or in cross-licensing negotiations, and could impair our ability to compete. We may in the future need to initiate infringement claims or litigation. Litigation, whether we are a plaintiff or a defendant, can be expensive, time-consuming and may divert the efforts of our technical staff and managerial personnel, which could result in lower revenues and higher expenses, whether or not such litigation results in a determination favorable to us.

 

Assertions by third parties of infringement by us of their intellectual property rights could result in a significant diversion of management’s time and increased expenses.

 

The storage industry is characterized by vigorous protection and pursuit of intellectual property rights and positions, which has resulted in protracted and expensive litigation for many companies. Litigation can be expensive, lengthy, and disruptive to ordinary business operations. Moreover, the results of complex legal proceedings are difficult to predict. We have received and expect that in the future we may receive communications from various industry participants alleging our infringement of their patents, trade secrets or other intellectual property rights and/or offering licenses to such intellectual property. Any lawsuits resulting from such allegations could subject us to significant liability for damages and invalidate our proprietary rights. Any intellectual property litigation also could force us to do one or more of the following:

 

 

 

We expect that companies in the storage market will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Our channel partners and end users could also become the target of litigation relating to patent and other intellectual property rights of others. This could trigger technical support and indemnification obligations in our licenses and maintenance agreements. These obligations could results in substantial expenses, including the payment by us of costs and damages.

 

If we fail to comply with the terms of our open source software license agreement, we could be required to release portions of our software codes, which could impair our ability to compete and result in lower revenues.

 

Storage Center utilizes a software application called eCos, an “open source,” royalty-free, real-time operating system intended for embedded applications. eCos is licensed to us under a modified version of version 2.0 of the GNU General Public License. Open source software is often made available to the public by its authors and/or other third parties under licenses, such as the GNU General Public License, which impose certain obligations on licensees in the event such licensees re-distribute and/or make derivative works of the open source software. The terms of our license to the eCos application require us to make source code for the derivative works freely available to the public, and/or license such derivative works under a particular type of license, rather than the forms of commercial license customarily used to protect our intellectual property. In addition, there is little or no legal precedent for interpreting the terms of certain of these open source licenses, including the determination of which works are subject to the terms of such licenses. While we believe we have complied with our obligations under the various applicable licenses for open source software to avoid subjecting our proprietary products to conditions we do not intend, in the event the copyright holder of any open source software were to successfully establish in court that we had not complied with the terms of a license for a particular work, we could be required to release the source code of that work to the public, stop distribution of that work and/or recall our products that include that work. In this event, we could be required to seek licenses from third parties in order to continue offering our products, to make generally available, in source code form, proprietary code that links to certain open source modules, to re-engineer our products, or to recall and/or discontinue the sale of our products if re-engineering could not be accomplished on a timely basis, any of which could impair our ability to compete, result in lower revenues and increase our expenses.

 

We may need to raise additional funds in the future, which may not be available to us on terms acceptable to us, or at all.

 

We may need to raise additional funds in the future. Any required additional financing may not be available on terms acceptable to us, or at all. If we raise additional funds by issuing equity securities or convertible debt, investors may experience significant dilution of their ownership interest, and the newly-issued securities may have rights senior to those of the holders of our common stock. If we raise additional funds by obtaining loans from third parties, the terms of those financing arrangements may include negative covenants or other restrictions on our business that could impair our operational flexibility, and would also require us to fund additional interest expense. If additional financing is not available when required or is not available on acceptable terms, we may be unable to successfully develop or enhance our storage products in order to take advantage of business opportunities or respond to competitive pressures, which could result in lower revenues and reduce the competitiveness of our storage product offerings.

We may engage in future acquisitions that could disrupt our business, cause dilution to our stockholders, reduce our financial resources and result in increased expenses.

 

In the future, we may acquire other businesses, products or technologies. We have not made any acquisitions to date. Accordingly, 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 strengthen our competitive position or achieve our goals, or these acquisitions may be viewed negatively by channel partners, end users, financial markets or investors. In addition, any acquisitions that we make could lead to difficulties in integrating personnel, technologies 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 and increase our expenses. Future acquisitions may 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 cannot forecast the number, timing or size of future acquisitions, or the effect that any such acquisitions might have on our operating or financial results.

 

Risks Related to the Ownership of Our Common Stock

 

Our stock price is volatile and purchasers of our common stock could incur substantial losses.

 

The market price of our common stock and the securities of other technology companies has been and may continue to be highly volatile. The market price of our common stock may fluctuate significantly in response to a number of factors, including:

 

 

In addition, the stock market in general, and the market for technology companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may cause the market price of our common stock to decrease, regardless of our actual operating performance. These trading price fluctuations may also make it more difficult for us to use our common stock as a means to make acquisitions or to use options to purchase our common stock to attract and retain employees. In addition, in the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

If securities analysts or industry analysts downgrade our stock, publish negative research or reports, or do not publish reports about our business, our stock price and trading volume could decline.

 

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us, our business and our market. If one or more analysts adversely change their recommendation regarding our stock or our competitors’ stock, our stock price would likely decline. If one or more analysts cease coverage of us or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

 

A limited number of stockholders will have the ability to influence the outcome of director elections and other matters requiring stockholder approval.

 

Our directors and executive officers and their affiliates beneficially own approximately 28.6% of our outstanding common stock, as of February 26, 2010. These stockholders, if they acted together, could exert substantial influence over matters requiring approval by our stockholders, including electing directors, adopting new compensation plans and approving mergers, acquisitions or other business combination transactions. This concentration of ownership may discourage, delay or prevent a change of control of our company, which could deprive our stockholders of an opportunity to receive a premium for their stock as part of a sale of our company and might reduce our stock price. These actions may be taken even if they are opposed by our other stockholders.

 

Delaware law and our amended and restated certificate of incorporation and bylaws contain provisions that could delay or discourage takeover attempts that stockholders may consider favorable and result in a lower market price for our common stock.

 

Provisions in our amended and restated certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:

 

 

In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law. These provisions may prohibit large stockholders, particularly those owning 15% or more of our outstanding voting stock, from merging or combining with us. These provisions in our amended and restated certificate of incorporation and amended and restated bylaws and under Delaware law could discourage

potential takeover attempts, could reduce the price that investors are willing to pay for shares of our common stock in the future and could potentially result in the market price being lower than they would without these provisions.

 

 

None.

 

 

Our principal executive offices are located in leased facilities in Eden Prairie, Minnesota, consisting of approximately 106,000 square feet of office space. Our leases expire at various dates through February 2014. These facilities accommodate our principal engineering, sales, marketing, operations and finance and administrative activities. We do not own any real property. We believe that our leased facilities are adequate for our anticipated future needs.

 

 

In April 2009, Data Network Storage LLC, or Data Networks, filed a lawsuit in the U.S. District Court for the Southern District of California, against us and 14 other storage vendors, alleging, among other things, patent infringement on a universal storage management system for which it holds an exclusive license. Data Networks is seeking unspecified monetary damages and an injunction against further infringement from us and the other defendants. We filed an answer to Data Network’s complaint denying any liability and are vigorously contesting the lawsuit. We have accrued an immaterial amount of what we believe to be the probable costs in connection with this matter.

 

In the ordinary course of business, we are from time to time involved in lawsuits, claims, investigations, proceedings, and threats of litigation consisting of intellectual property, commercial and other matters. While the outcome of these proceedings and claims cannot be predicted with certainty, there are no matters, as of December 31, 2009, that, in the opinion of management, might have a material adverse effect on our financial position, results of operations or cash flows.

 

 

 

Market for our Common Stock

 

Our common stock has been traded on the New York Stock Exchange, or NYSE, under the ticker symbol “CML” since March 23, 2009. Prior to March 23, 2009, our common stock was traded on the NYSE Arca under the ticker symbol “CML” since it began trading on October 10, 2007. The following table sets forth, for the period indicated, the range of high and low sale prices of our common stock, as reported by the NYSE Arca with respect to the period from January 1, 2008 through March 20, 2009 and by the NYSE for the period from March 23, 2009 through December 31, 2009.

 

 

There were 186 stockholders of record of our common stock as of February 26, 2010. In addition, we believe that a significant number of beneficial owners of our common stock hold their shares in street name.

 

Dividend Policy

 

To date, we have not declared or paid any cash dividends on our common stock. We currently expect to retain any future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends on our common stock in the foreseeable future.

Stockholder Return Comparison

 

The following graph shows the cumulative 26-month total return of an investment of $100 on October 10, 2007, the date we became a public company, for our common stock on NYSE (or the NYSE Arca for applicable periods), in the Russell 2000 Index and the NASDAQ Computer Index. The stock price performance shown on the graph is not necessarily indicative of future price performance, and we do not make or endorse any predictions as to future stockholder returns. This graph is not “soliciting material,” is not deemed “filed” with the SEC and is not to be incorporated by reference into any filing of Compellent Technologies, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.

 

COMPARISON OF 26 MONTH CUMULATIVE TOTAL RETURN*
Among Compellent Technologies, Inc., The Russell 2000 Index
And The NASDAQ Computer Index

 

 

 

Unregistered Sales of Equity Securities

 

None.

 

Use of Proceeds from the Sale of Registered Securities

 

Our initial public offering of common stock was effected through a Registration Statement on Form S-1 (File No. 333-144255), that was declared effective by the Securities and Exchange Commission on October 9, 2007. We registered 6,900,000 shares of our common stock with a proposed maximum aggregate offering price of $93.1 million. The offering did not terminate until after the sale of all of the shares registered on the Registration Statement. All of the shares of common stock issued pursuant to the registration statement were sold at a price to the public of $13.50 per share. The managing underwriters were Morgan Stanley & Co. Incorporated, Needham & Company, LLC, Piper Jaffray & Co., RBC Capital Markets and Thomas Weisel Partners LLC.

 

As a result of our initial public offering, we raised a total of approximately $84.6 million in net proceeds after deducting underwriting discounts and commissions of $6.5 million and offering expenses of a $2.0 million. As of February 26, 2010, $5.0 million of the $84.6 million in net proceeds has been utilized as working capital in support of operations, with the remainder included in our investment portfolio. No payments for such offering expenses were made directly or indirectly to (i) any of our officers or directors or their associates, (ii) any persons owning 10% or more of any class of our equity securities, or (iii) any of our affiliates.

 

The following selected financial data should be read in conjunction with our consolidated financial statements and the notes thereto, and with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The consolidated statements of operations data for the years ended December 31, 2009, 2008 and 2007 and the consolidated balance sheet data as of December 31, 2009 and 2008 have been derived from and should be read in conjunction with our audited consolidated financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. The consolidated statements of operations data for the year ended December 31, 2006 and 2005 and the consolidated balance sheet data as of December 31, 2007, 2006 and 2005, are derived from audited consolidated financial statements and the notes thereto which are not included in this Annual Report on Form 10-K.

 

 

 

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that are based on our management’s beliefs and assumptions and on information currently available to our management. Forward-looking statements include all statements other than statements of historical fact contained in this Annual Report on Form 10-K, including, but not limited to, statements about:

 

 

In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” and similar expressions intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Annual Report on Form 10-K in greater detail in Part I, Item IA. “Risk Factors.” Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date hereof. We hereby qualify all of our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

 

The following discussion should be read in conjunction with our consolidated financial statements and the related notes contained elsewhere in this Annual Report on Form 10-K and in our other Securities and Exchange Commission filings.

Overview

 

We are a leading provider of enterprise-class network storage solutions that are highly scalable, feature rich and designed to be easy to use and cost effective. Our Storage Center solution is a Storage Area Network, or SAN, that enables users to intelligently store, recover and manage large amounts of data by combining our sophisticated software with standards-based hardware into a single integrated solution. As of December 31, 2009, Storage Center was being utilized by 1,812 enterprises worldwide, across a wide variety of industries including education, financial services, government, healthcare, insurance, legal, media, retail, technology and transportation. We believe that Storage Center is the most comprehensive enterprise-class network storage solution available today, providing increased functionality and lower total cost of ownership when compared to competing storage systems.

 

We believe our business model is highly differentiated and provides us with several competitive advantages. We sell our products through an all-channel assisted sales model designed to enable us to quickly scale and cost effectively increase sales. We have built a strong internal sales team, which is spread geographically throughout the United States and in certain international markets, to assist our channel partners with, among other things, executive sales calls, service and support offerings, product matter expertise, configuration and pricing, joint sales calls, product demonstrations and design assistance. We also employ a virtual manufacturing strategy, which significantly reduces inventory and eliminates the need for in-house or outsourced manufacturing. We believe these combined strategies create an efficient and scalable business model that enables us to reduce operating costs and improve capital efficiency.

 

Key Financial Measures and Trends

 

Sources of Revenues

 

Revenues are comprised of product revenues, consisting of software and hardware revenues, and support and services revenues. A sale of Storage Center is typically comprised of (a) an upfront fully-paid perpetual end-user license fee, (b) the associated hardware components, (c) a software maintenance arrangement that includes telephone support, bug fixes and potential unspecified product updates, (d) a hardware maintenance agreement that includes telephone support and on-site repairs and replacement and (e) in certain cases, professional services for installation, training and consulting support. Substantially all of our revenues consist of product revenue from sales of Storage Center. We expect that support and services revenues will grow on an absolute basis as our installed base of end users continues to grow, but will remain relatively consistent as a percentage of total revenues.

 

We offer our products and services through value-added resellers, which we refer to as channel partners. Our channel partners purchase our products after they have received a purchase order from an end user, as they do not maintain an inventory of our products in anticipation of sales to end users. For 2009, 2008 and 2007, our top ten channel partners accounted for 42%, 47% and 45% of our revenues, respectively. One channel partner, AMEX, Inc., accounted for 15% and 12% of total revenues for the years ended December 31, 2009 and 2008, respectively. Another channel partner, Insight Investments, accounted for 10% and 13% of total revenues for the years ended December 31, 2008 and 2007, respectively.

 

Our systems are modular and highly configurable. Variations in these configurations affect our average system order size and can significantly impact our overall revenues, cost of revenues and gross profit performance. Our revenues within a particular quarter are often significantly affected by the unpredictable procurement patterns of our end users. Historically, we have generated the majority of our revenues in the final month of each quarter primarily because many of our end users do not finalize their purchasing decisions until the final weeks or days of a quarter. We expect these purchasing patterns to continue in the future.

 

Product Revenues

 

Product revenues consist of license fees for software applications and related hardware sales of disk drives, system controllers, host bus adapters, switches and enclosures. We also derive a portion of our product revenues from software and hardware upgrades, which include new software applications and additional hardware components. We expect that product revenues will increase on an absolute basis if we are able to execute our business strategy.

Support and Services Revenues

 

Support and services revenues consist of software and hardware maintenance contracts, which typically have a duration of one to three years, and professional services for installation, training and consulting support.

 

Maintenance.  We offer software maintenance that includes telephone support, bug fixes and unspecified product updates and hardware maintenance that includes telephone support and on-site repairs and replacement. Revenues are deferred at the time the maintenance agreement is entered into and is recognized ratably over the term of the maintenance agreement. Our historical experience has shown us that substantially all of our end users have renewed their maintenance agreements upon expiration of their existing maintenance agreements. We anticipate that maintenance revenues will grow on an absolute basis as our installed base of end users continues to grow, but will remain relatively consistent as a percentage of total revenues.

 

Professional Services.  We generally sell professional services on a time-and-materials basis and recognize revenues when the services are performed. Professional services include installation, training and consulting support. We expect that professional services revenues will grow on an absolute basis as our installed base of end users continues to grow, but remain relatively consistent as a percentage of total revenues.

 

Cost of Revenues and Gross Profit

 

Cost of revenues is comprised of cost of product revenues and cost of support and services. Cost of product revenues consist primarily of the cost of component hardware charged by our component suppliers, shipping and handling, provisions for excess and obsolete inventory, overhead allocations, and employee salaries, benefits, and stock-based compensation expense. We expect cost of product revenues to increase in absolute dollars, but remain relatively constant as a percentage of total product revenues. Cost of support and services consists of employee salaries, benefits, stock-based compensation expense for our customer service and technical support team and service fees charged by our third-party hardware maintenance provider. We expect cost of support and services revenues to increase as we expand the size of our customer service and technical support team and incur increased third-party services fees associated with anticipated future revenues growth.

 

Our gross profit has been and will be affected by many factors, including:

 

 

We do not expect any material changes to our gross profit, as compared to current levels.

 

Operating Expenses

 

Operating expenses consist of sales and marketing, research and development and general and administrative expenses. Personnel-related costs are the most significant component of each of these expense categories. We expect to continue to hire a significant number of new employees to support our anticipated growth.

 

Our business strategy is to be a leading provider of enterprise-class network storage solutions. For us to achieve our goals, substantial investments in our infrastructure were, and continue to be, necessary to facilitate rapid expansion. Our sales and marketing team geographically covers the entire United States, and certain international

markets, with employees predominately located at either our corporate headquarters or working remotely. With our increased sales and marketing headcount, and the correlating growth in our revenues, we have also expanded our support functions such as sales management, sales operations, information technology, finance and human resources to leverage our corporate structure to further our business strategy.

 

Sales and Marketing.  Sales and marketing expense consists primarily of:

 

 

We expect sales and marketing expense to increase on an absolute basis for the foreseeable future as we increase the number of sales and marketing professionals and, to a lesser extent, increase our marketing activities. We expect sales and marketing expense to decrease as a percentage of revenues if our revenues grow as we anticipate.

 

Research and Development.  Research and development expense consists primarily of:

 

 

To date, all of our research and development expenses have been expensed as incurred. We expect research and development expense to increase on an absolute basis for the foreseeable future as we enhance and expand our product offerings. We expect research and development expense to decrease as a percentage of revenues if our revenues grow as we anticipate.

 

General and Administrative.  General and administrative expense consists primarily of:

 

 

We expect general and administrative expenses to increase on an absolute basis for the foreseeable future as we increase personnel to support growth of our operations. We expect general and administrative expenses to decrease as a percentage of revenues if our revenues grow as we anticipate.

 

Other Income, net

 

Other Income, net.  Other income, net consists primarily of interest income and realized gains and losses on investments.

 

Income Tax Expense

 

Income Tax.  Income tax expense consists primarily of U.S. federal alternative minimum income tax expense, state income tax expenses and foreign income tax expenses.

Critical Accounting Policies and Estimates

 

The discussion of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. In preparing the consolidated financial statements, we are required to make various estimates, judgments and assumptions that have a significant impact on the results reported in the consolidated financial statements. We base our estimates on historical experience and other assumptions that we believed to be reasonable under the circumstances. Changes to these estimates could have a material effect on our consolidated financial statements. We have discussed the development, selection and disclosure of these estimates with the audit committee of our board of directors.

 

Our significant accounting policies can be found in Note 1 of our Notes to the consolidated financial statements. We believe the following accounting policies may include a higher degree of judgment and complexity in their application and are most critical to aid in fully understanding and evaluating our reported financial condition and results of operations.

 

Revenue Recognition

 

We recognize product revenues when:

 

 

We use channel partners to sell our products. Revenues under channel partner arrangements are not recognized until delivery occurs, the fee is fixed and determinable, collectability is probable and supported, and an end user has been identified. We maintain contractual arrangements with our channel partners, which contain provisions that specify that the risk of loss and title transfers upon shipment. In circumstances where we sell directly to an end user, our revenues are the price we charge the end user and revenues are recognized upon delivery.

 

A sale is typically a multiple-element arrangement including software, hardware, software maintenance, hardware maintenance and, in certain cases, services. Our determination of fair value of each element in these multiple-element arrangements is based on vendor-specific objective evidence, or VSOE. We have analyzed all of the elements included in our multiple-element arrangements and have determined that we have sufficient VSOE to allocate revenues to all undelivered elements of a contract. VSOE is evaluated and determined by us based on separate sales of the specific elements. No software products remain undelivered at the inception of the arrangement. Accordingly, assuming all other revenue recognition criteria are met, revenues from software and hardware are recognized upon delivery using the residual method, and revenues from software maintenance and hardware maintenance are recognized ratably over the respective support period. For multiple-element arrangements that include only hardware and hardware maintenance, we have determined that we have objective and reliable evidence of fair value to allocate revenues separately to hardware and hardware maintenance.

 

We generally sell professional services on a time-and-materials basis and recognize revenues when the services are performed.

 

Allowance for Doubtful Accounts

 

In the vast majority of sales, we sell our products to channel partners for resale to end users. In certain limited circumstances, we may sell directly to the end user, primarily due to concerns of the credit worthiness of the channel partner. We perform ongoing evaluations of our channel partners and end users and continuously monitor collections and payments. We record an allowance for doubtful accounts for potentially uncollectible receivables. The allowance is established based on a specific assessment of accounts with known collection exposure, a review of the age of the receivable, the customer’s payment history, the customer’s financial condition and industry and general economic conditions, as well as a general assessment of collection exposure in the remaining receivable population based upon bad debt history. Our actual bad debt exposure could differ significantly from our estimates if the financial condition of our channel partners or end users were to deteriorate, resulting in an impairment of their ability to make payments.

 

Inventory Valuations

 

Inventories are recorded at the lower of cost, determined on the first-in, first-out method, or market value (estimated net realizable value). Each quarter, we evaluate our inventories for obsolescence and excess quantities. We record provisions for excess and obsolete inventory. The amounts of these provisions are based upon our analysis of current inventory levels, expected product lives, historical loss trends and projections of future sales demand. However, our inventory provision may not be sufficient if future demand for our products decreased because of economic or competitive conditions, or if products became obsolete because of technical advancements in the industry or by us. Under these and other circumstances, additional inventory write-downs would be required and would adversely affect income in the period the write-down is made.

 

Stock-Based Compensation

 

We measure and recognize compensation expense for all share-based payment awards made to employees and non-employee directors based on fair value. Determining the appropriate fair value model and calculating the fair value of stock option grants requires the input of highly subjective assumptions. We use the Black-Scholes option pricing model to value our stock option awards. Stock-based compensation expense is significant to our financial statements and is calculated using our best estimates, which involve inherent uncertainties and the application of management’s judgment. Significant estimates include the risk free interest rate, the expected life of the option, stock price volatility, the dividend yield and the forfeiture rate. The risk-free interest rate is based on the yield available on U.S. Treasury zero-coupon bonds at the date of grant with maturity dates approximately equal to the expected life of the options at their grant date. The expected life of the options is based on evaluations of historic expected lives from a selected publicly traded peer group, believed to be comparable after consideration of size, maturity, profitability, growth, risk and return on investment. Volatility is based on historic volatilities from traded shares of the same publicly traded peer group. We have not paid dividends in the past and do not expect to in the foreseeable future. We utilize historical data to estimate pre-vesting forfeitures and record stock-based compensation expense only for those awards that are expected to vest. Any changes in these highly subjective assumptions could significantly impact the amount of stock-based compensation expense recognized, which could have a material impact on our financial statements.

 

Income Taxes

 

We are required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax expense and assessing temporary differences resulting from differing treatment of items for financial statement and income tax purposes. These temporary differences result in deferred tax assets and liabilities, which are included in the consolidated balance sheets. We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. Increases in the valuation allowance result in the recognition of additional income tax expense. Income tax expense could be materially different from actual results because of changes in our expectations regarding future taxable income, the relationship between book and taxable income and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies vary, adjustments to the carrying value of deferred tax assets and liabilities may be required.

We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more likely than not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. We have recorded unrecognized tax benefits of $430,000 at December 31, 2009, which are netted against the corresponding deferred tax assets on the balance sheet.

 

Our deferred tax assets are comprised primarily of net operating loss, or NOL, carryforwards, federal and state research and development credit carryforwards and federal alternative minimum tax, or AMT, credit carryforwards. As of December 31, 2009, we had federal tax NOL carryforwards of approximately $24.2 million. The NOL carryforwards are available to offset taxable income through 2027 and will begin to expire in 2022. Our various state NOL carryforwards are available to offset future state taxable income. These state NOL carryforwards typically will have the same expirations as our federal tax NOL carryforwards. We had approximately $1.6 million of federal research and development credit carryforwards, $578,000 of state research and development credit carryforwards and $278,000 of federal AMT credit carryforwards. The federal and state research and development credit carryforwards will begin to expire in 2022, while the federal AMT credit carryforwards do not have an expiration date. In addition, under the provisions of Section 382 of the Internal Revenue Code of 1986, as amended, substantial changes in our ownership could place limitations on the availability of our NOL carryforwards.

 

Based on the level of projected future taxable income over the periods in which the deferred tax assets are deductible, our past history of losses and the positive and negative evidence available, we have concluded it is more likely than not that we will not realize the benefits of our net deferred tax assets. Accordingly, we have recorded a full valuation allowance against our net deferred tax assets as of December 31, 2009 and 2008 of $14.2 million and $15.1 million, respectively. We continue to evaluate the realization of deferred tax assets and at the point in time when we determine that it is more likely than not that a portion of our deferred tax assets will be realized, we will evaluate our valuation allowance and release an amount that is expected to be realized.

 

Results of Operations

 

The following table sets forth a summary of our Consolidated Statements of Operations and the related changes for the periods indicated (in thousands):

 

 

 

 

Comparison of Years Ended December 31, 2009 and 2008

 

Revenues

 

Revenues and the related changes for the years ended December 31, 2009 and 2008 were as follows (in thousands):

 

 

Product Revenues.  Product revenues derived from system sales primarily increased due to a 39% increase in the number of systems sold. The increase in systems sales was driven by an increase of 107 channel partners, an increase in sales and marketing headcount to 212 people from 163 people, and additional marketing programs. While we continued to experience lower revenues per megabyte for disk drives, this was offset by increased revenues from enhanced capacity and complexity of systems purchased by our end users. Product revenues derived from upgrade sales increased due to the ongoing growth in the number of our total end users, which increased to 1,812 as of December 31, 2009 from 1,278 as of December 31, 2008.

 

Support and Services Revenues.  Support revenues increased 87% primarily due to the renewal of maintenance agreements by existing end users and the growth of the installed base. Services revenues increased 80% due to an increase in end user and channel partner training programs and an increase in Storage Center installations. These increases were due to both an increase in the number of products sold and our efforts to grow services revenues.

 

Cost of Revenues and Gross Profit

 

Cost of revenues and gross profit and the related changes for the years ended December 31, 2009 and 2008 were as follows (in thousands):

 

 

Cost of Product Revenues.  Cost of product revenues increased primarily due to increased component hardware costs associated with the increased number of systems and upgrades purchased by our end users.

 

Cost of Support and Services Revenues.  Cost of support and services revenues increased primarily due to increased salaries, employee benefits and stock-based compensation expense of $2.0 million related to growth in our customer service and technical support headcount to 63 people from 41 people, increased travel expense of $143,000, increased hardware service fees of $2.0 million charged by our third-party hardware maintenance provider associated with the continuing growth of our installed base and $477,000 for allocations of facilities related costs and depreciation expense.

Gross Profit.  Gross profit increased due to revenues increasing faster than cost of revenues as discussed above.

 

Operating Expenses

 

Operating expenses and the related changes for the years ended December 31, 2009 and 2008 were as follows (in thousands):

 

 

Sales and Marketing Expense.  Sales and marketing expense increased primarily due to an increase in sales and marketing headcount to 212 people from 163 people, resulting in a $6.1 million increase in salaries, employee benefits, commissions and stock-based compensation expense, a $479,000 increase in sales and marketing related travel and support costs and a $297,000 increase in channel partner commissions due to increased third-party selling activities. Increased marketing efforts led to an additional $2.6 million of expense related to partner programs, trade shows and other promotional activities.

 

Research and Development Expense.  Research and development expense increased primarily due to an increase in research and development headcount to 75 people from 58 people, resulting in a $2.0 million increase in salaries, employee benefits and stock-based compensation expense. Depreciation expense increased $511,000 due to an increase in our purchases of lab equipment throughout 2009.

 

General and Administrative Expense.  General and administrative expense decreased primarily due to a decrease in professional and compliance fees of $589,000 for outside legal and consulting services from prior year, which pertained predominately to public company reporting and compliance requirements related to our initial public offering in October 2007. In the prior year, we also incurred $778,000 of additional legal and settlement expenses in defense and settlement of claims brought against us. These decreases were somewhat offset by an increase in salaries, employee benefits and stock-based compensation expense of $983,000 due to an increase in staff headcount in finance, information technology, and human resources from 17 people to 22 people and for compensation increases to reflect current market conditions. In addition, our accounting fees increased $182,000 due to an increase in tax services for one-time projects.

 

Other Income, Net

 

Other Income, Net.  Other income, net decreased $984,000 primarily due to decreased interest income resulting from lower interest rates partially offset by interest income on increased cash, cash equivalents and investment balances.

 

Income Tax Expense

 

Income Tax Expense.  Income tax expense of $718,000 for the year-ended December 31, 2009 consisted of $256,000 for U.S. federal alternative minimum income tax expense, $409,000 for state income tax expense and $53,000 for foreign income tax expense. There was no income tax expense or benefit incurred in 2008.

Comparison of Years Ended December 31, 2008 and 2007

 

Revenues

 

Revenues and the related changes for the years ended December 31, 2008 and 2007 were as follows (in thousands):

 

 

Product Revenues.  Product revenues derived from system sales primarily increased due to a 42% increase in the number of systems sold. The increase in systems sales was driven by an increase of approximately 80 channel partners, an increase in sales and marketing headcount to 163 people from 119 people, and additional marketing programs. While we continued to experience lower revenues per megabyte for disk drives, this was offset by increased revenues from enhanced capacity and complexity of systems purchased by our end users. Product revenues derived from upgrade sales increased due to the ongoing growth in the number of our total end users, which increased to over 1,275 as of December 31, 2008 from over 740 as of December 31, 2007.

 

Support and Services Revenues.  Support revenues increased 113% primarily due to the renewal of maintenance agreements by existing end users and the growth of the installed base. Support pricing remained relatively flat with an adjustment for immaterial inflationary price increases. Services revenues increased 204% due to an increase in end user and channel partner training programs and an increase in Storage Center installations. These increases were due to both an increase in the number of products sold and our efforts to grow services revenues.

 

Cost of Revenues and Gross Profit

 

Cost of revenues and gross profit and the related changes for the years ended December 31, 2008 and 2007 were as follows (in thousands):

 

 

Cost of Product Revenues.  Cost of product revenues increased primarily due to increased component hardware costs associated with the increased number of systems and upgrades purchased by our end users.

 

Cost of Support and Services Revenues.  Cost of support and services revenues increased primarily due to increased salaries, employee benefits and stock-based compensation expense of $806,000 related to growth in our customer service and technical support headcount to 41 people from 26 people, increased travel expense of $226,000, increased hardware service fees of $1.1 million charged by our third-party hardware maintenance provider associated with the continuing growth of our installed base and $445,000 of product cost predominately for obligations owed to customers pursuant to terms of our hardware and software maintenance contracts.

Gross Profit.  Gross profit increased due to revenues increasing faster than cost of revenues as discussed above.

 

Operating Expenses

 

Operating expenses and the related changes for the years ended December 31, 2008 and 2007 were as follows (in thousands):

 

 

Sales and Marketing Expense.  Sales and marketing expense increased primarily due to an increase in sales and marketing headcount to 163 people from 119 people, resulting in a $9.8 million increase in salaries, employee benefits, commissions and stock-based compensation expense, a $942,000 increase in sales and marketing related travel and support costs and a $661,000 increase in channel partner commissions due to increased third-party selling activities. Increased marketing efforts led to an additional $624,000 of expense related to partner programs, trade shows and other promotional activities.

 

Research and Development Expense.  Research and development expense increased primarily due to an increase in research and development headcount to 58 people from 48 people, resulting in a $2.0 million increase in salaries, employee benefits and stock-based compensation expense, and an increase of $284,000 in facilities related costs due primarily to our relocation to our new executive headquarters in March 2007.

 

General and Administrative Expense.  General and administrative expense increased primarily due to an increase in finance, information technology, and human resource staff headcount to 17 people from 11 people and compensation increases to reflect current market conditions, resulting in a $893,000 increase in salaries, employee benefits and stock-based compensation expense. Professional and compliance fees increased $1.1 million for outside legal, accounting, and consulting services, pertaining predominately to public company reporting and compliance requirements as we completed an initial public offering in October 2007. We also incurred $778,000 of additional legal and settlement expenses in defense and settlement of claims brought against us.

 

Other Income, Net

 

Other Income, Net.  Other income, net increased primarily due to increased interest income resulting from higher cash and cash equivalent and investment balances following the closing of the initial public offering in October 2007.

 

Liquidity and Capital Resources

 

We completed an initial public offering of our common stock on October 9, 2007 in which we sold 6,900,000 shares of our common stock at $13.50 per share for cash proceeds of $84.6 million, net of underwriting discounts and commissions and offering expenses. We have used these funds for general corporate purposes since our initial public offering and expect to continue to do so. We also completed a secondary offering of our common stock on November 17, 2009 in which we sold 600,000 shares of our common stock at $19.25 per share for cash proceeds of $10.7 million, net of underwriting discounts and commissions and offering expenses. Cash in excess of immediate operating requirements is invested in accordance with our investment policy, primarily with a goal of maintaining liquidity and capital preservation. Our cash, cash equivalents and short and long-term investments are held in highly liquid money market funds, federal agency securities, corporate debt securities, certificates of deposit, and variable rate demand notes.

Our cash, cash equivalents and short-term investments available to fund current operations were $64.4 million and $81.1 million at December 31, 2009 and 2008, respectively. Our cash, cash equivalents and short-term investment balances decreased between periods due to movement of funds into long-term securities to capture higher interest rates. We held $59.5 million and $19.2 million of long-term investments at December 31, 2009 and 2008, respectively. Additionally, cash provided by operating activities for the year ended December 31, 2009 was $14.9 million compared to $7.8 million for the year ended December 31, 2008.

 

Cash Flows

 

The following table summarizes our cash flows for the years ended December 31, 2009, 2008 and 2007 (in thousands).

 

 

Operating Activities

 

Cash provided by operating activities was $14.9 million in 2009. We had net income of $4.8 million, which included non-cash charges consisting of $2.4 million in depreciation and $4.1 million in stock-based compensation expense. Cash provided by other operating activities included an increase in deferred revenues of $17.6 million and an increase in accounts payable of $6.1 million, partially offset by an increase in accounts receivable of $17.5 million. The increase in deferred revenues reflects an increase in our customer base and related increase in the purchase of our maintenance agreements, which are paid for in advance but recorded as revenues ratably over the term of the agreement. The increase in accounts payable relates to increased inventory purchases at the end of the current year as a result of increased sales in the fourth quarter. The increase in accounts receivable reflects an overall increase in revenues primarily due to the expansion of our operations.

 

Cash provided by operating activities was $7.8 million in 2008. We incurred a net loss of $416,000, which included non-cash charges consisting of $1.6 million in depreciation and $2.2 million in stock-based compensation expense related to employees. Cash provided by other operating activities included an increase in deferred revenues of $10.1 million and an increase in accrued compensation and accrued liabilities of $2.2 million, partially offset by an increase in accounts receivable of $5.9 million. The increase in deferred revenues reflects an increase in our customer base and related increase in the purchase of our maintenance agreements, which are paid for in advance but recorded as revenues ratably over the term of the agreement. The increase in accrued compensation and accrued liabilities relates predominately to increased employee costs for salaries, vacation, bonuses and commissions due to increased headcount, timing of payroll, and overall expansion of our operations and customer base. The increase in accounts receivable reflects an overall increase in revenues primarily due to the expansion of our operations.

 

Cash used in operating activities was $3.5 million in 2007. We incurred a net loss of $7.8 million, which included non-cash charges consisting of $1.2 million in depreciation and $642,000 in stock-based compensation expense related to employees. Cash used in other operating activities included an increase in accounts receivable of $5.4 million, more than offset by an increase in deferred revenues of $6.6 million and an increase in accrued compensation and accrued liabilities of $2.1 million. The increase in accounts receivable reflects an overall increase in revenues primarily due to the expansion of our operations. The increase in deferred revenues reflects an increase in our customer base and related increase in the purchase of our maintenance agreements, which are paid for in advance but recorded as revenues ratably over the term of the agreement. The increase in accrued compensation and accrued liabilities relates predominately to increased employee costs for salaries, vacation, bonuses and commissions due to increased headcount, timing of payroll, and overall expansion of our operations and customer base.

Investing Activities

 

Cash used in investing activities was $50.4 million in 2009, consisting primarily of $4.1 million for purchases of property and equipment and $123.4 million for purchases of investments, partially offset by sales and maturities of investments of $77.0 million.

 

Cash used in investing activities was $39.1 million in 2008, consisting primarily of $2.3 million for purchases of property and equipment and $98.5 million for purchases of investments, partially offset by sales and maturities of investments of $61.7 million.

 

Cash used in investing activities was $14.0 million in 2007, consisting primarily of $11.4 million for purchases of short-term investments and $2.9 million for purchases of property and equipment.

 

Financing Activities

 

Cash provided by financing activities was $12.7 million from the issuance of 306,000 shares of common stock in conjunction with the 2007 Employee Stock Purchase Plan and the exercise of stock options with cash proceeds of $2.0 million and from the issuance of 600,000 shares of common stock in conjunction with a secondary offering in November 2009 with cash proceeds of $10.7 million, net of offering expenses.

 

Cash provided by financing activities was $865,000 in 2008, largely from the issuance of common stock in conjunction with the 2007 Employee Stock Purchase Plan and pursuant to the exercise of stock options.

 

Cash provided by financing activities was $84.7 million in 2007, primarily from the issuance of 6,900,000 shares of common stock in conjunction with our initial public offering in October 2007 with cash proceeds of $84.6 million, net of underwriting discounts and commissions and offering expenses.

 

Operating and Capital Expenditure Requirements

 

We anticipate using available cash to fund growth in operations and further investments in human capital and capital equipment. In the next twelve months, capital expenditures are expected to be in the range of approximately $6.5 million to $7.5 million, primarily for product development. We believe our current cash and cash equivalents, investments, and the interest we earn on these balances, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next twelve months. If these sources of cash are insufficient to satisfy our liquidity requirements beyond the next twelve months, we may seek to sell additional equity or convertible debt securities or enter into a credit facility. The sale of additional equity and convertible debt securities may result in dilution to our stockholders. If we raise additional funds through the issuance of convertible debt securities, such securities could have rights senior to those of our common stock and could contain covenants that would restrict our operations. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on reasonable terms, if at all.

 

Contractual Obligations

 

The following table summarizes our outstanding contractual obligations as of December 31, 2009 and the effect those obligations are expected to have on our liquidity and cash flows in future periods (in thousands):

 

 

The table above reflects only payment obligations that are fixed and determinable. Our commitments for operating leases relate to our corporate headquarters in Eden Prairie, Minnesota and office equipment.

 

Off-Balance Sheet Arrangements

 

Since our inception, we have not engaged in any off-balance sheet arrangements, including the use of structured finance, special purpose entities or variable interest entities.

Recent Accounting Pronouncements

 

In June 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2009-01, “Generally Accepted Accounting Principles” (ASC Topic 105), which establishes the FASB Accounting Standards Codification^tm, or the Codification or ASC, and amended the hierarchy of generally accepted accounting principles (GAAP) such that the ASC became the single source of authoritative U.S. GAAP. The ASC did not change current U.S. GAAP, but was intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All previously existing accounting standards were superseded and all other accounting literature not included in the Codification is considered non-authoritative. New accounting standards issued subsequent to June 30, 2009 are communicated by the FASB through Accounting Standards Updates (ASUs). This standard is effective for financial statements issued for interim and annual periods ending after September 15, 2009 and therefore was effective for us in the third quarter of fiscal 2009. The principal impact on our financial statements is limited to disclosures as all future references to authoritative accounting literature will be referenced in accordance with the Codification. The Codification did not have an impact on our financial condition or results of operation.

 

In October 2009, the FASB issued the following ASUs:

 

 

ASU No. 2009-13:  This guidance modifies the fair value requirements of ASC Subtopic 605-25 Revenue Recognition Multiple-Element Arrangements by allowing the use of the “best estimate of selling price” in addition to VSOE and Vendor Objective Evidence (now referred to as third-party evidence, or TPE) for determining the selling price of a deliverable. A vendor is now required to use its best estimate of the selling price when VSOE or TPE of the selling price cannot be determined. In addition, the residual method of allocating arrangement consideration is no longer permitted.

 

ASU No. 2009-14:  This guidance modifies the scope of ASC Subtopic 965-605 Software Revenue Recognition to exclude from its requirements (a) non-software components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible products when the software components and non-software components of the tangible product function together to deliver the tangible product’s essential functionality.

 

These updates require expanded qualitative and quantitative disclosures and are effective for fiscal years beginning on or after June 15, 2010. However, companies may elect to adopt as early as interim periods ended September 30, 2009. We plan to adopt these updates on January 1, 2011 on a prospective basis. We are currently evaluating the impact of adopting these updates on our consolidated financial statements.

 

We are exposed to market risk from changes in interest rates relating to our investment portfolio. The primary objective of our investment activities is to preserve our capital for the purpose of funding operations while at the same time maximizing the income we receive from our investments without significantly increasing risk. This means that a change in prevailing interest rates may cause the principal amount of the investments to fluctuate. By policy, we minimize risk by placing our investments with high quality debt security issuers and limit the amount of credit exposure to any one issuer. To achieve these objectives, our investment policy allows us to maintain a portfolio of cash equivalents and short-term and long-term investments in a variety of securities, including commercial paper, money market funds and corporate debt securities. Our investment policy prohibits investment in derivative instruments. Through our money managers, we maintain risk management control systems to monitor interest rate risk. Our cash and cash equivalents as of December 31, 2009 primarily included liquid money market accounts and are held with high quality financial institutions and at times, such balances may be in excess of insurance limits. Our investments as of December 31, 2009 included federal agency securities, corporate debt securities, certificates of deposit, and variable rate demand notes. Our investments in variable rate demand notes are not subject to auction risk. We performed a sensitivity analysis on our variable and fixed rate financial investments. According to our analysis, if our blended rate of return decreased by 10% in 2009, our interest income for 2009 would have declined by approximately $239,000. While we cannot predict future market conditions or market liquidity, we have taken steps, including regularly reviewing our investments and associated risk profiles, which we believe will allow us to effectively manage the risks of our investment portfolio.

 

We manufacture our products in the United States and sell them worldwide. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since our sales are currently denominated in U.S. dollars, a strengthening of the dollar could make our products less competitive in foreign markets and our accounts receivable more difficult to collect. We do not currently hedge our exposure to foreign currency exchange rate fluctuations. We may, however, hedge such exposure to foreign currency exchange rate fluctuations in the future.

 

We believe that our international entities are subject to risks typical of any international entity, including, but not limited to: differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions and foreign exchange rate volatility. Accordingly, our future results could be materially adversely impacted by changes in these or other factors.

 

Compellent Technologies, Inc.

 

Index to Consolidated Financial Statements