UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

þ		Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

o		Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number 001-33685

COMPELLENT TECHNOLOGIES, INC.

(Exact name of Registrant as specified in its charter)

Delaware		37-1434895
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

     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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

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

     As of October 29, 2010, 31,862,966 shares of the registrant’s common stock, $0.001 par value, were outstanding.

 

 

COMPELLENT TECHNOLOGIES, INC.

FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2010

INDEX

		Page
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements			1
Condensed Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009			1
Condensed Consolidated Statements of Operations for the Three and Nine months ended September 30, 2010 and 2009			2
Condensed Consolidated Statements of Cash Flows for the Nine months ended September 30, 2010 and 2009			3
Notes to the Condensed Consolidated Financial Statements			4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			11
Item 3. Quantitative and Qualitative Disclosures About Market Risk			18
Item 4. Controls and Procedures			19
PART II -— OTHER INFORMATION
Item 1. Legal Proceedings			19
Item 1A. Risk Factors			20
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			32
Item 3. Defaults Upon Senior Securities			32
Item 4. (Removed and Reserved)			32
Item 5. Other Information			32
Item 6. Exhibits			33
Signatures			34
EX-31.1
EX-31.2
EX-32.1

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

COMPELLENT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)

		September 30,				December 31,
		2010				2009
		(unaudited)
Assets
Current assets
Cash and cash equivalents		$	26,070			$	29,155
Short-term investments			33,815				35,218
Accounts receivable, net			38,257				36,702
Inventories, net			9,151				4,750
Other current assets			4,742				3,497
Total current assets			112,035				109,322
Long-term investments			78,912				59,472
Property and equipment, net			8,838				5,153
Total assets		$	199,785			$	173,947
Liabilities and stockholders’ equity
Current liabilities
Accounts payable		$	9,957			$	8,968
Accrued liabilities			2,200				1,261
Accrued compensation			7,666				5,489
Deferred revenues, current			32,910				25,668
Total current liabilities			52,733				41,386
Deferred revenues, non-current			18,325				12,529
Commitments and contingencies			—				—
Stockholders’ equity
Common stock, $0.001 par value, 300,000,000 shares authorized; 31,839,999 and 31,674,940 shares issued and outstanding as of September 30, 2010 and December 31, 2009			32				32
Additional paid in capital			170,772				164,885
Accumulated deficit			(42,702	)			(45,062	)
Accumulated other comprehensive income			625				177
Total stockholders’ equity			128,727				120,032
Total liabilities and stockholders’ equity		$	199,785			$	173,947

See accompanying notes to condensed consolidated financial statements.

COMPELLENT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except per share amounts)

		For the Three Months Ended								For the Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Revenues
Product		$	28,866			$	22,987			$	74,323			$	64,564
Support and services			13,199				9,225				36,063				24,437
Total revenues			42,065				32,212				110,386				89,001
Cost of revenues
Product			14,409				10,957				38,026				32,089
Support and services			4,141				2,825				11,818				8,232
Total cost of revenues			18,550				13,782				49,844				40,321
Gross profit			23,515				18,430				60,542				48,680
Operating expenses
Sales and marketing			13,228				11,386				38,594				32,052
Research and development			5,075				3,276				13,912				9,160
General and administrative			2,165				1,680				6,387				4,630
Total operating expenses			20,468				16,342				58,893				45,842
Operating income			3,047				2,088				1,649				2,838
Other income, net			423				465				1,139				1,380
Income before income taxes			3,470				2,553				2,788				4,218
Income tax expense			158				294				428				699
Net income		$	3,312			$	2,259			$	2,360			$	3,519
Net income per weighted average share, basic		$	0.10			$	0.07			$	0.07			$	0.11
Net income per weighted average share, diluted		$	0.10			$	0.07			$	0.07			$	0.11
Weighted average shares, basic			31,827				30,818				31,770				30,732
Weighted average shares, diluted			32,818				31,944				32,803				31,682

See accompanying notes to condensed consolidated financial statements.

COMPELLENT TECHNOLOGIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)

		For the Nine Months Ended
		September 30,
		2010				2009
Operating activities
Net income		$	2,360			$	3,519
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization			2,640				1,700
Stock-based compensation expense			4,570				3,033
Changes in operating assets and liabilities:
Accounts receivable, net			(1,555	)			(11,497	)
Inventories, net			(4,401	)			(591	)
Other current assets			(1,245	)			(1,496	)
Accounts payable			989				4,236
Accrued liabilities			946				(55	)
Accrued compensation			2,177				518
Deferred revenues			13,038				11,158
Net cash provided by operating activities			19,519				10,525
Investing activities
Purchases of property and equipment			(6,325	)			(2,902	)
Purchases of investments			(96,371	)			(81,614	)
Proceeds from sales of investments			61,893				39,807
Proceeds from maturities of investments			16,911				13,536
Net cash used in investing activities			(23,892	)			(31,173	)
Financing activities
Proceeds from issuance of common stock			1,288				951
Net decrease in cash and cash equivalents			(3,085	)			(19,697	)
Cash and cash equivalents, beginning of period			29,155				51,989
Cash and cash equivalents, end of period		$	26,070			$	32,292
Supplemental cash flow disclosure:
Cash paid for income taxes		$	341			$	567
Supplemental non-cash disclosure:
Vesting of restricted common stock		$	29			$	87

See accompanying notes to condensed consolidated financial statements.

COMPELLENT TECHNOLOGIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. Nature of Business, Basis of Presentation and Recent Accounting Pronouncements

Nature of Business

     Compellent Technologies, Inc., individually or in any combination with its consolidated subsidiaries, “we”, “us”, or “our”, was incorporated in March 2002. We develop, market and service enterprise-class network storage solutions, which include software and hardware. We sell products through an all-channel assisted sales model. Corporate headquarters are in Eden Prairie, Minnesota, and we have channel partners and end users located in the United States and certain international markets.

Basis of Presentation

     The accompanying condensed consolidated balance sheet as of December 31, 2009, which has been derived from audited financial statements, and the unaudited interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America, or U.S. GAAP, for interim financial information, pursuant to the rules and regulations of the Securities and Exchange Commission, or the SEC. Pursuant to such rules and regulations, certain financial information and footnote disclosures normally included in the financial statements have been condensed or omitted. However, in the opinion of management, the financial statements include all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. Operating results for these interim periods are not necessarily indicative of results expected for the entire fiscal year or any future operating periods. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009 as filed with the SEC on March 5, 2010.

     Preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The items in our condensed consolidated financial statements requiring significant estimates and judgment are revenue recognition, allowance for doubtful accounts, inventory valuations, stock-based compensation and income taxes.

     Certain reclassifications have been made to prior years’ notes to the condensed consolidated financial statements to conform to the current year presentation. The reclassifications were deemed immaterial to the financial statements as they had no effect on net income, total stockholders’ equity, total assets or cash flows.

Recent Accounting Pronouncements

     In October 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition (ASC Topic 605) — Multiple-Deliverable Revenue Arrangements, a consensus of the FASB Emerging Issues Task Force.” 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.

     In October 2009, the FASB issued ASU No. 2009-14, “Software (ASC Topic 985) — Certain Revenue Arrangements That Include Software Elements, a consensus of the FASB Emerging Issues Task Force.” This guidance modifies the scope of ASC Subtopic 985-605 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 and as such 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.

     In January 2010, the FASB issued ASU No. 2010-06, “Fair Value Measurements and Disclosures (ASC Topic 820) — Improving Disclosures about Fair Value Measurements.” This guidance requires new disclosures about significant transfers in and out of Level 1 and Level 2 categories and separate disclosures about purchases, sales, issuances, and settlements of Level 3 fair value measurements. This update is effective for interim and annual reporting periods beginning after December 15, 2009, except for new disclosures of Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. We have adopted the portion of this update related to Level 1 and Level 2 fair value measurements on January 1, 2010, but it did not have a material impact on our financial condition or results of operations. We do not expect the portion of this update related to Level 3 fair value measurements to have a material impact on our financial condition or results of operations when it is adopted on January 1, 2011.

2. Fair Value Measurements and Investments

Fair Value Measurements

     Fair value is defined as the amount that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants as of the measurement date. A hierarchy for inputs used in measuring fair value is in place to maximize the use of observable inputs and minimize the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs market participants would use in valuing the asset or liability developed based on market data obtained from sources independent of us. Unobservable inputs are inputs that reflect our assumptions about the factors market participants would use in valuing the asset or liability developed based upon the best information available in the circumstances.

     The following table presents information about our financial assets included in our condensed consolidated balance sheets that are measured at fair value on a recurring basis for the periods presented, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value. The hierarchy is broken down into three levels. Level 1 inputs are unadjusted quoted prices in active markets that are accessible at the measurement date for identical assets or liabilities. Level 2 inputs are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, or model-based valuation techniques for which all significant assumptions are observable in the market. Level 3 inputs are generated from model-based techniques that use significant assumptions not observable in the market. On June 30, 2010, we transferred our corporate debt securities, with a fair value of $55.2 million, from Level 1 to Level 2. We use significant observable inputs to value our corporate debt securities, which more closely align with the definition of Level 2 inputs provided above. We recognize transfers into and out of the fair value hierarchy levels at the end of a reporting period.

						Fair Value Measurements Using
		September 30,								(in thousands)
Description		2010				Level 1				Level 2				Level 3
Assets:
Cash (1)		$	3,870			$	3,870			$	—			$	—
Corporate debt securities (2)			59,725				—				59,725				—
U.S. agency securities (3)			31,744				—				31,744				—
Municipal bonds (2)			7,582				—				7,582				—
Commercial paper (4)			16,985				—				16,985				—
Certificates of deposit (2)			1,691				—				1,691				—
Money market funds (1)			17,200				17,200				—				—
Total		$	138,797			$	21,070			$	117,727			$	—

						Fair Value Measurements Using
		December 31,								(in thousands)
Description		2009				Level 1				Level 2				Level 3
Assets:
Cash (1)		$	1,276			$	1,276			$	—			$	—
Corporate debt securities (2)			50,172				50,172				—				—
U.S. agency securities (2)			27,394				—				27,394				—
Municipal bonds (2)			5,925				—				5,925				—
Commercial paper (5)			2,998				—				2,998				—
Certificates of deposit (5)			1,396				—				1,396				—
Variable rate demand notes (5)			6,806				—				6,806				—
Money market funds (1)			27,878				27,878				—				—
Total		$	123,845			$	79,326			$	44,519			$	—

     Available-for-sale investments included in the Level 2 category above are based on significant observable inputs, such inputs include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and other reference data.

Investments

     The amortized cost, gross unrealized gains and losses and fair values of available-for-sale investments for the periods presented consist of the following (in thousands):

						Gross Unrealized
At September 30, 2010		Cost				Gains				Losses				Fair Value
Corporate debt securities		$	59,097			$	635			$	(7	)		$	59,725
U.S. agency securities			31,694				50				—				31,744
Municipal bonds			7,584				12				(14	)			7,582
Commercial paper			16,985				—				—				16,985
Certificates of deposit			1,691				—				—				1,691
Money market funds			17,200				—				—				17,200
Total		$	134,251			$	697			$	(21	)		$	134,927

						Gross Unrealized
At December 31, 2009		Cost				Gains				Losses				Fair Value
Corporate debt securities		$	49,972			$	323			$	(123	)		$	50,172
U.S. agency securities			27,399				34				(39	)			27,394
Municipal bonds			5,915				13				(3	)			5,925
Commercial paper			2,998				—				—				2,998
Certificates of deposit			1,396				—				—				1,396
Variable rate demand notes			6,806				—				—				6,806
Money market funds			27,878				—				—				27,878
Total		$	122,364			$	370			$	(165	)		$	122,569

     All of our securities in an unrealized loss position as of September 30, 2010 had been in an unrealized loss position for less than twelve months. We intend to hold these securities until maturity and the possibility that we will be required to sell these securities

prior to the recovery of their amortized cost basis is remote. Based on a review of all relevant information such as revised estimates of cash flows and specific conditions affecting the investment, we expect to recover the entire amortized cost basis of these securities. Therefore, there was no other-than-temporary impairment charges recorded during the first nine months of 2010 or 2009.

     The amortized cost and fair value of available-for-sale investments by contractual maturity at September 30, 2010 are as follows (in thousands):

		Cost				Fair Value
Due in one year or less		$	55,987			$	56,015
Due between one year to five years			78,264				78,912
Total		$	134,251			$	134,927

     Securities classified as available-for-sale are carried at estimated fair value with unrealized gains and losses, net of tax if applicable, recorded as a component of accumulated other comprehensive income. Upon the sale of a security classified as available-for-sale, the amount reclassified out of accumulated other comprehensive income into other income, net is based on the specific identification method.

     Our proceeds from sales and maturities of available-for-sale investments were $30.0 million and $22.3 million for the three months ended September 30, 2010 and 2009, respectively. Our proceeds from sales and maturities of available-for-sale investments were $78.8 million and $53.3 million for the nine months ended September 30, 2010 and 2009, respectively. By identifying the specific cost of each security that has been sold or that has matured, we realized gross gains of $78,000 and $69,000 on our sales and maturities in the three months ended September 30, 2010 and 2009, respectively. We realized gross gains of $121,000 and $82,000 on our sales and maturities in the nine months ended September 30, 2010 and 2009, respectively. We realized gross losses of $95,000 for the nine months ended September 30, 2010 and had no realized losses for the three months ended September 30, 2010 and 2009 or the nine months ended September 30, 2009. Gross realized gains and losses are recognized in other income, net on the condensed consolidated statement of operations.

3. Inventories

     Inventories consist of the following (in thousands):

		September 30,				December 31,
		2010				2009
Component materials		$	4,668			$	2,045
Finished systems			4,483				2,705
Total		$	9,151			$	4,750

4. Property and Equipment

     Property and equipment consist of the following (in thousands):

		September 30,				December 31,
		2010				2009
Computer equipment		$	13,720			$	8,855
Computer software			981				951
Office furniture and fixtures			1,422				1,200
Leasehold improvements			2,402				1,217
			18,525				12,223
Accumulated depreciation and amortization			(9,687	)			(7,070	)
Total		$	8,838			$	5,153

5. Comprehensive Income

     Comprehensive income consists of our net income, foreign currency translation adjustments and unrealized holding gains and losses from available-for-sale securities. The components of and changes in other comprehensive income are as follows (in thousands):

		For the Three Months								For the Nine Months
		Ended September 30,								Ended September 30,
		2010				2009				2010				2009
Net income		$	3,312			$	2,259			$	2,360			$	3,519
Net changes in other comprehensive income:
Cumulative translation adjustment			(4	)			—				(22	)			(12	)
Unrealized gain on investments, net			173				78				470				174
Total comprehensive income		$	3,481			$	2,337			$	2,808			$	3,681

6. Stock-Based Compensation

Option Activity

     A summary of option activity for the 2002 Stock Option Plan, or 2002 Plan, and 2007 Equity Incentive Plan, or 2007 Plan, for the nine months ended September 30, 2010 are as follows:

						Weighted				Weighted
						Average				Average
						Exercise				Remaining
		Number of				Price per				Contractual
		Shares				Share				Life
Options outstanding at December 31, 2009			3,374,061			$	9.19				6.00
Granted			973,789				15.69				—
Exercised			(95,943	)			5.50				—
Cancelled			(89,811	)			13.15				—
Options outstanding at September 30, 2010			4,162,096			$	10.71				5.51
Options exercisable at September 30, 2010			2,076,109			$	7.79				5.28

Stock-Based Compensation Expense

     Stock-based compensation expense for the 2002 Plan, 2007 Plan, and Employee Stock Purchase Plan included in the condensed consolidated statements of operations is as follows (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Cost of product		$	19			$	10			$	52			$	36
Cost of support and services			49				18				138				156
Sales and marketing			699				405				2,071				1,298
Research and development			353				139				956				552
General and administrative			488				386				1,353				991
Total stock-based compensation expense		$	1,608			$	958			$	4,570			$	3,033

     As of September 30, 2010, there is $13.5 million of total unrecognized compensation costs related to non-vested stock-based compensation arrangements granted under our stock option plans. This expense will be amortized on a straight-line basis over a weighted-average period of 2.7 years.

7. Net Income Per Share

     The following table sets forth the computation of net income per common share (in thousands, except per share amounts):

		For the Three Months								For the Nine Months
		Ended September 30,								Ended September 30,
		2010				2009				2010				2009
Basic weighted-average shares outstanding			31,827				30,818				31,770				30,732
Dilutive effect of stock options and unvested restricted common stock			991				1,126				1,033				950
Diluted weighted-average shares outstanding			32,818				31,944				32,803				31,682
Net income		$	3,312			$	2,259			$	2,360			$	3,519
Net income per weighted average share, basic and diluted		$	0.10			$	0.07			$	0.07			$	0.11

     For the three months ended September 30, 2010 and 2009, we had 2.1 million and 1.1 million options outstanding, respectively, that were excluded from the computations of diluted net income per share because including them would have had an anti-dilutive effect. For the nine months ended September 30, 2010 and 2009, we had 1.8 million and 1.5 million options outstanding, respectively, that were excluded from the computations of diluted net income per share because including them would have had an anti-dilutive effect

8. Income Taxes

     Income tax expense was $158,000 and $294,000 for the three months ended September 30, 2010 and 2009, respectively. Income tax expense was $428,000 and $699,000 for the nine months ended September 30, 2010 and 2009, respectively. Income tax expense for both the three and nine months ended September 30, 2010 and 2009 primarily consists of federal AMT and state income tax expense. Federal AMT was provided on the portion of our AMT income which could not be entirely offset by the available alternative net operating loss, or NOL, carryforwards.

     In assessing the realization of deferred tax assets, we have considered whether it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Based on the level of projected future taxable income over the periods in which the deferred tax assets are deductible and our history of losses, we believe that it is more likely than not that we will not realize the benefits of these deductible differences. Accordingly, we have provided a full valuation allowance against our deferred tax assets as of September 30, 2010 and December 31, 2009, respectively.

     We recognize the financial statement effects of a tax position when it is more likely than not that the position will be sustained upon examination. 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 recognize interest and penalties related to uncertain tax provisions as part of our provision for income taxes. We have not currently reserved for any interest or penalties for such reserves. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

Balance at December 31, 2009		$	430
Increase related to current year tax positions			18
Balance at September 30, 2010		$	448

     We are subject to U.S. federal income tax as well as state income tax in multiple jurisdictions. The typical statute of limitations is three years from the filing of the federal income tax return. However, due to NOL carryforwards from prior periods and the utilization of those NOL carryforwards on current and future income tax returns, the statute remains open for the Internal Revenue Service and the appropriate state income taxing authorities to review the losses from 2002 to 2009. We are also subject to income tax in two foreign jurisdictions which have open tax years varying by jurisdiction that range from 2007 to 2009. We do not expect the amount of unrecognized tax benefits to significantly change within the next twelve months.

9. Commitments and Contingencies

Indemnification Obligations

     We have agreements with our channel partners and end users, which generally include certain provisions for indemnifying the channel partners and end users against liabilities if our products infringe a third party’s intellectual property rights. To date, we have not incurred any material costs as a result of such indemnification provisions and have not accrued any liabilities related to such obligations in our condensed consolidated financial statements. As permitted under Delaware law and to the maximum extent allowable under that law, we have certain obligations to indemnify our executive officers, directors and may indemnify other employees for certain events or occurrences while the executive officer, director or employee is or was serving at our request in such capacity. These indemnification obligations are valid as long as the executive officer, director or employee acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal proceeding, had no reasonable cause to believe his or her conduct was unlawful. The maximum potential amount of future

payments we could be required to make under these indemnification obligations is unlimited; however, we have a director and officer insurance policy that mitigates our exposure and generally enables us to recover a portion of any future amounts paid.

Legal Proceedings

     On April 14 and 15, 2010, respectively, two purported securities class actions were commenced in the U.S. District Court for the District of Minnesota, naming us and certain of our executive officers as defendants. The lawsuits allege that the defendants made materially false or misleading public statements about our business and prospects in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The plaintiffs seek to represent a class of investors who purchased our common stock between October 28, 2009 and April 7, 2010. On September 30, 2010, we moved to dismiss the Consolidated Amended Complaint. We believe that the allegations are without merit and intend to vigorously defend against them.

     In the ordinary course of business, we are also from time to time involved in lawsuits, claims, investigations, proceedings, and threats of litigation consisting of intellectual property, commercial and other matters of this type. While the outcome of these proceedings and claims cannot be predicted with certainty, there are no matters, as of September 30, 2010, that, in the opinion of management, might have a material adverse effect on our financial position, results of operations or cash flows.

10. Segment and Geographic Information

     We operate in one reportable industry segment: the design, marketing, and technical support of enterprise-class network storage solutions. The following table is based on the geographic location of the channel partner or end user who purchased our products. For sales to channel partners, their geographic location may be different from the geographic locations of the end user. Historically, channel partners located in the United States have generally sold our products to end users located in the United States. Revenues by geographic region were as follows (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Revenues
United States		$	36,169			$	27,166			$	93,882			$	73,810
International			5,896				5,046				16,504				15,191
Total		$	42,065			$	32,212			$	110,386			$	89,001

     We did not hold any long-lived assets outside of the United States as of September 30, 2010 and December 31, 2009.

11. Subsequent Events

     We have evaluated all subsequent events through the date the condensed consolidated financial statements were issued. No subsequent events have taken place that meet the definition of a subsequent event that requires further disclosure in this filing.

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This Quarterly Report on Form 10-Q 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 Quarterly Report on Form 10-Q, including, but not limited to, statements about:

	•		our expectations regarding our net income, revenues, gross margin, expenses and earnings per share;
	•		our expectations regarding unfavorable economic and market conditions, including lessening demand in the information technology market;
	•		our ability to compete in our industry;
	•		our ability to maintain and grow our channel partner relationships;
	•		our growth strategy and our growth rate;
	•		our ability to protect our intellectual property rights;
	•		pricing and availability of our suppliers’ products; and
	•		assumptions underlying or related to any of the foregoing.

     In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “can,” “continue,” “could,” “expect,” “intend,” “may,” “plan,” “potential,” “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 Quarterly Report on Form 10-Q in greater detail in Part II, 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 condensed consolidated financial statements and the related notes contained elsewhere in this Quarterly Report on Form 10-Q and in our other Securities and Exchange Commission, or SEC, filings, including our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 5, 2010.

Overview

     We are a leading provider of enterprise-class network storage solutions that automate the movement and management of data at a granular level, enabling organizations to constantly adapt to change. We combine our sophisticated software with standards-based hardware into a single integrated solution. 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 actively and intelligently store, recover and manage large amounts of data with minimal effort, which can allow our customers to reduce costs and easily secure information against downtime or disaster. As of September 30, 2010, Storage Center was installed in 2,303 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 competitive storage systems.

     We developed our Storage Center software and hardware solution to target mid-size and larger enterprises. We believe mid-size and larger 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. Our sales team is spread geographically throughout the United States and in certain international markets. We also employ a virtual manufacturing strategy, which significantly reduces inventory and eliminates the need for in-house and outsourced manufacturing.

Critical Accounting Policies and Estimates

     Our critical accounting policies are more fully described in Note 1 of the audited financial statements for the year ended December 31, 2009, included in our Annual Report on Form 10-K filed with the SEC on March 5, 2010. There have been no material changes in our critical accounting policies during the nine months ended September 30, 2010.

     The discussion of our financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. In preparing the condensed consolidated financial statements, we are required to make various estimates, judgments and assumptions that have a significant impact on the results reported in the condensed consolidated financial statements. We evaluate our estimates on an ongoing basis, including those related to revenue recognition, the allowance for doubtful accounts, inventory valuations, stock-based compensation and income taxes. 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 condensed consolidated financial statements. We have discussed the development, selection and disclosure of these estimates with the audit committee of our board of directors.

Results of Operations

     The following table sets forth a summary of our condensed consolidated statements of operations and the related changes for the periods shown (in thousands):

		Three Months Ended																Nine Months Ended
		September 30,								Change								September 30,								Change
		2010				2009				$				%				2010				2009				$				%
Revenues
Product		$	28,866			$	22,987			$	5,879				25.6	%		$	74,323			$	64,564			$	9,759				15.1	%
Support and services			13,199				9,225				3,974				43.1				36,063				24,437				11,626				47.6
Total revenues			42,065				32,212				9,853				30.6				110,386				89,001				21,385				24.0
Cost of revenues
Product			14,409				10,957				3,452				31.5				38,026				32,089				5,937				18.5
Support and services			4,141				2,825				1,316				46.6				11,818				8,232				3,586				43.6
Total cost of revenues			18,550				13,782				4,768				34.6				49,844				40,321				9,523				23.6
Gross profit			23,515				18,430				5,085				27.6				60,542				48,680				11,862				24.4
Operating expenses
Sales and marketing			13,228				11,386				1,842				16.2				38,594				32,052				6,542				20.4
Research and development			5,075				3,276				1,799				54.9				13,912				9,160				4,752				51.9
General and administrative			2,165				1,680				485				28.9				6,387				4,630				1,757				37.9
Total operating expenses			20,468				16,342				4,126				25.2				58,893				45,842				13,051				28.5
Operating income			3,047				2,088				959				45.9				1,649				2,838				(1,189	)			(41.9	)
Other income, net			423				465				(42	)			(9.0	)			1,139				1,380				(241	)			(17.5	)
Income before income taxes			3,470				2,553				917				35.9				2,788				4,218				(1430	)			(33.9	)
Income tax expense			158				294				(136	)			(46.3	)			428				699				(271	)			(38.8	)
Net income		$	3,312			$	2,259			$	1,053				46.6	%		$	2,360			$	3,519			$	(1,159	)			(32.9	)%

Comparison of Three Months Ended September 30, 2010 and 2009

Revenues

     Revenues and the related changes for the periods shown were as follows (in thousands):

		Three Months Ended September 30,
		2010								2009
						%								%
						of Total								of Total				Change
		$				Revenues				$				Revenues				$				%
Revenues
Product		$	28,866				68.6	%		$	22,987				71.4	%		$	5,879				25.6	%
Support and services			13,199				31.4				9,225				28.6				3,974				43.1
Total revenues		$	42,065				100.0	%		$	32,212				100.0	%		$	9,853				30.6	%

     Product Revenue. Product revenue derived from system sales primarily increased due to an increase in the number of systems sold. While we continued to experience lower revenue per megabyte for disk drives, this was offset by increased revenue from enhanced capacity and complexity of systems purchased by our customers. We also experienced an increase in add-on hardware and software sales due to the ongoing growth in the number of our total customers, which increased to 2,303 as of September 30, 2010 from 1,627 as of September 30, 2009.

     Support and Services Revenues. Support revenue increased 50% primarily due to the renewal of maintenance agreements by existing end users and the growth of our installed base. Services revenue remained consistent due to the increase in the number of installations as a result of the growth of our installed base being offset by the decrease in the average sales price of our installation services due to sales of our lower price self-service installation offering starting in November 2009.

Cost of Revenues and Gross Profit

     Cost of revenues and gross profit and the related changes for the periods shown were as follows (in thousands):

		Three Months Ended September 30,
		2010								2009
						%								%
						of Related								of Related				Change
		$				Revenues				$				Revenues				$				%
Cost of revenues
Product		$	14,409				49.9	%		$	10,957				47.7	%		$	3,452				31.5	%
Support and services			4,141				31.4				2,825				30.6				1,316				46.6
Total cost of revenues		$	18,550				44.1	%		$	13,782				42.8	%		$	4,768				34.6	%
Gross profit							55.9	%							57.2	%

     Cost of Product Revenue. Cost of product revenue increased primarily due to increased component hardware costs associated with the increased number of systems sold.

     Cost of Support and Services Revenues. Cost of support and services revenues increased primarily due to increased salaries and employee benefits expense of $448,000 related to growth in our customer service and technical support headcount to 80 people from 57 people, increased hardware expense and related freight costs of $279,000 due to growth of our installed base, and increased hardware service fees of $502,000 charged by our third-party hardware maintenance provider associated with the continuing growth of our installed base.

     Gross Profit. Gross profit decreased due to the growth of cost of revenues outpacing the growth of revenue.

Operating Expenses

     Operating expenses and the related changes for the periods shown were as follows (in thousands):

		Three Months Ended September 30,
		2010								2009
						%								%
						of Total								of Total				Change
		$				Revenues				$				Revenues				$				%
Operating expenses
Sales and marketing		$	13,228				31.4	%		$	11,386				35.3	%		$	1,842				16.2	%
Research and development			5,075				12.1				3,276				10.2				1,799				54.9
General and administrative			2,165				5.1				1,680				5.2				485				28.9
Total operating expenses		$	20,468				48.7	%		$	16,342				50.7	%		$	4,126				25.2	%

     Sales and Marketing Expenses. Sales and marketing expenses increased primarily due to an increase in sales and marketing headcount to 220 people from 200 people, resulting in a $1.3 million increase in salaries, employee benefits, commissions and stock-based compensation expense. The increase in headcount was partially offset by a change in the classification of our Technical Solutions team, consisting of 15 people, from a sales and marketing expense to a research and development expense as this team evaluates the interoperability of third-party applications with our Storage Center’s technology. An increase in orders billed directly to end users led to an additional $114,000 of expense related to channel partner referral commissions.

     Research and Development Expenses. Research and development expenses increased primarily due to an increase in research and development headcount to 111 people from 68 people, resulting in a $1.4 million increase in salaries, employee benefits and stock-based compensation expense. A portion of the increase in headcount is due to the change in the classification of our Technical Solutions team as discussed previously in the sales and marketing expenses section above. This change resulted in an additional $483,000 in research and development expenses, or 1.1% of total revenues for the three months ended September 30, 2010. Depreciation expense increased $292,000 due to an increase in purchases of lab equipment.

     General and Administrative Expenses. General and administrative expenses increased primarily due to an increase in salaries, employee benefits and stock-based compensation expense of $449,000 due to an increase in staff headcount in finance, information technology, and human resources to 36 people from 21 people and due to an increase in compensation costs for existing employees.

Other Income, Net

     Other Income, Net. Other income, net, decreased $42,000 primarily due to lower interest rates on increased cash and cash equivalents and investment balances.

Income Tax Expense

     Income Tax Expense. Income tax expense, which consists primarily of federal alternative minimum income tax and state income tax expense, decreased $136,000.

Comparison of Nine Months Ended September 30, 2010 and 2009

Revenues

     Revenues and the related changes for the periods shown were as follows (in thousands):

		Nine Months Ended September 30,
		2010								2009
						%								%
						of Total								of Total				Change
		$				Revenues				$				Revenues				$				%
Revenues
Product		$	74,323				67.3	%		$	64,564				72.5	%		$	9,759				15.1	%
Support and services			36,063				32.7				24,437				27.5				11,626				47.6
Total revenues		$	110,386				100.0	%		$	89,001				100.0	%		$	21,385				24.0	%

     Product Revenue. Product revenue derived from system sales primarily increased due to an increase in the number of systems sold. While we continued to experience lower revenue per megabyte for disk drives, this was offset by increased revenue from enhanced capacity and complexity of systems purchased by our customers. We also experienced an increase in add-on hardware and software sales due to the ongoing growth in the number of our total customers, which increased to 2,303 as of September 30, 2010 from 1,627 as of September 30, 2009.

     Support and Services Revenues. Support revenue increased 49% primarily due to the renewal of maintenance agreements by existing end users and the growth of the installed base. Services revenue increased 37% due to an increase in end user and channel partner training programs and an increase in Storage Center installations. These increases were due to an increase in the number of systems sold and our sales and marketing efforts to grow services revenue.

Cost of Revenues and Gross Margin

     Cost of revenues and gross margin and the related changes for the periods shown were as follows (in thousands):

		Nine Months Ended September 30,
		2010								2009
						%								%
						of Related								of Related				Change
		$				Revenues				$				Revenues				$				%
Cost of revenues
Product		$	38,026				51.2	%		$	32,089				49.7	%		$	5,937				18.5	%
Support and services			11,818				32.8				8,232				33.7				3,586				43.6
Total cost of revenues		$	49,844				45.2	%		$	40,321				45.3	%		$	9,523				23.6	%
Gross profit							54.8	%							54.7	%

     Cost of Product Revenue. Cost of product revenue increased due to increased component hardware costs associated with the increased number of systems and additional add-on hardware and software purchased by our customers.

     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 $1.3 million related to growth in our customer service and technical support headcount to 80 people from 57 people, increased hardware expense and related freight costs of $903,000 due to growth of our installed base, increased hardware service fees of $1.0 million charged by our third-party hardware maintenance provider associated with the continuing growth of our installed base, and $192,000 increase in support and services related travel.

     Gross Profit. Gross profit remained consistent as growth of revenues remained consistent with growth of cost of revenues.

Operating Expenses

     Operating expenses and the related changes for the periods shown were as follows (in thousands):

		Nine Months Ended September 30,
		2010								2009
						%								%
						of Total								of Total				Change
		$				Revenues				$				Revenues				$				%
Operating expenses
Sales and marketing		$	38,594				35.0	%		$	32,052				36.0	%		$	6,542				20.4	%
Research and development			13,912				12.6				9,160				10.3				4,752				51.9
General and administrative			6,387				5.8				4,630				5.2				1,757				37.9
Total operating expenses		$	58,893				53.4	%		$	45,842				51.5	%		$	13,051				28.5	%

     Sales and Marketing Expenses. Sales and marketing expenses increased primarily due to an increase in sales and marketing headcount to 220 people from 200 people, resulting in a $5.4 million increase in salaries, employee benefits, commissions and stock-based compensation expense, and a $597,000 increase in sales and marketing related travel and support costs, partially offset by a $166,000 decrease in channel partner referral commissions due to fewer orders being billed directly to end users. The increase in headcount was partially offset by a change in the classification of our Technical Solutions team, consisting of 15 people, from a sales

and marketing expense to a research and development expense as this team evaluates the interoperability of third-party applications with our Storage Center’s technology. Increased marketing efforts led to an additional $307,000 of expense related to partner programs, trade shows and other promotional activities.

     Research and Development Expenses. Research and development expenses increased primarily due to an increase in research and development headcount to 111 people from 68 people, resulting in a $3.9 million increase in salaries, employee benefits and stock-based compensation expense. A portion of the increase in headcount is due to the change in the classification of our Technical Solutions team as discussed previously in the sales and marketing expenses section above. This change resulted in an additional $1.4 million in research and development expenses, or 1.3% of total revenues for the nine months ended September 30, 2010. Depreciation expense increased $642,000 due to an increase in our purchases of lab equipment.

     General and Administrative Expenses. General and administrative expenses increased primarily due to an increase in salaries, employee benefits and stock-based compensation expense of $1.3 million due to an increase in staff headcount in finance, information technology, and human resources to 36 people from 21 people and due to an increase in compensation costs for existing employees. Legal fees increased $210,000 primarily due to legal fees associated with the legal proceedings as discussed in Note 9 of the notes to the condensed consolidated financial statements.

Other Income, Net

     Other Income, Net. Other income, net decreased by $241,000 due to a $95,000 net loss on sale of investments and lower interest rates on increased cash and cash equivalents and investment balances.

Income Tax Expense

     Income Tax Expense. Income tax expense, which consists primarily of federal alternative minimum income tax and state income tax expense, decreased $271,000.

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, 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, commercial paper, federal agency securities, corporate debt securities, municipal bonds, and certificates of deposit.

     Our cash, cash equivalents and short-term investments available to fund current operations were $59.9 million and $64.4 million at September 30, 2010 and December 31, 2009, respectively. Our cash, cash equivalents and short-term investment balances decreased due to transfers of short-term investments to long-term investments that have higher yield rates. We held $78.9 million and $59.5 million of long-term investments at September 30, 2010 and December 31, 2009, respectively.

Cash Flows

     The following table summarizes our cash flows for the periods shown (in thousands):

		Nine Months Ended
		September 30,
		2010				2009
Net cash provided by operating activities		$	19,519			$	10,525
Net cash used in investing activities			(23,892	)			(31,173	)
Net cash provided by financing activities			1,288				951
Net decrease in cash and cash equivalents		$	(3,085	)		$	(19,697	)

Operating Activities

     Cash provided by operating activities was $19.5 million for the nine months ended September 30, 2010. We reported net income of $2.4 million, which included non-cash charges consisting of $2.6 million in depreciation and amortization expenses and $4.6 million in stock-based compensation expense. Cash provided by other operating activities included an increase in deferred revenues of $13.0 million and an increase in accrued compensation of $2.2 million, partially offset by an increase in inventories of $4.4 million and an increase in accounts receivable of $1.6 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 revenue ratably over the term of the agreements. The increase in accounts receivable reflects an overall increase in revenues primarily due to the expansion of our operations. The increase in accrued compensation reflects the timing of payroll and benefit related payments, which is partially offset by a decrease in annual bonuses due to timing. The increase in inventories reflects an increase in spare parts due to the increases in the number of hardware maintenance agreements and in component inventory to meet sales demands.

     Cash provided by operating activities was $10.5 million for the nine months ended September 30, 2009. We reported net income of $3.5 million, which included non-cash charges consisting of $1.7 million in depreciation and amortization expenses and $3.0 million in stock-based compensation expense. Cash provided by other operating activities included an increase in accounts payable of $4.2 million and an increase in deferred revenues of $11.2 million, partially offset by an increase in accounts receivable of $11.5 million and an increase in other current assets of $1.5 million. The increase in accounts payable is primarily due to the timing of inventory purchases and corresponding payments at the end of the quarter. 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 revenue ratably over the term of the agreements. The increase in accounts receivable reflects an overall increase in revenues primarily due to the expansion of our operations. The increase in other current assets is primarily due to an increase in prepayments to third-party hardware maintenance service providers.

Investing Activities

     Cash used in investing activities was $23.9 million for the nine months ended September 30, 2010, which consists of $6.3 million for purchases of property and equipment and $96.4 million for purchases of investments, partially offset by $78.8 million of sales and maturities of investments.

     Cash used in investing activities was $31.2 million for the nine months ended September 30, 2009, which consists of $2.9 million for purchases of property and equipment and $81.6 million for the purchase of investments, partially offset by $53.3 million of sales and maturities of investments.

Financing Activities

     Cash provided by financing activities was $1.3 million for the nine months ended September 30, 2010, which consists of the cash received from the issuance of shares of common stock of $543,000 in conjunction with the exercise of stock options and $745,000 related to our Employee Stock Purchase Plan.

     Cash provided by financing activities was $951,000 for the nine months ended September 30, 2009, which consists of the cash received from the issuance of shares of common stock of $530,000 in conjunction with the exercise of stock options and $421,000 related to our Employee Stock Purchase Plan.

Operating and Capital Expenditure Requirements

     We anticipate using available cash to fund growth in operations and to further investment in human capital and capital equipment. For the remainder of 2010, capital expenditures are expected to be in the range of approximately $1.0 million to $1.5 million, primarily for product development. We believe that 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 12 months. If these sources of cash are insufficient to satisfy our liquidity requirements beyond the next 12 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

     There have been no material changes in our contractual obligations from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC on March 5, 2010, other than scheduled payments through September 30, 2010. Please see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations — Contractual Obligations, contained in Part II of our Annual Report on Form 10-K for the year ended December 31, 2009 for a description of our contractual obligations.

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

     See Note 1 to the notes to condensed consolidated financial statements for a full description of recent accounting pronouncements, including the respective expected dates of adoption and effects on results of operations and financial condition.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     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. Through our money managers, we maintain risk management control systems to monitor interest rate risk. As of September 30, 2010, we had unrestricted cash and cash equivalents and short-term investments of $59.9 million. Due to the short-term nature of these investments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates; however, declines in interest rates would reduce future investment income.

     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.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

     Based on their evaluations as of September 30, 2010, our Chief Executive Officer and Chief Financial Officer, with the participation of management, have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

     There were no changes in our internal control over financial reporting during the quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations of Internal Controls

     Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

     On April 14 and 15, 2010, respectively, two purported securities class actions were commenced in the U.S. District Court for the District of Minnesota, naming us and certain of our executive officers as defendants. The lawsuits allege that the defendants made materially false or misleading public statements about our business and prospects in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The plaintiffs seek to represent a class of investors who purchased our common stock between October 28, 2009 and April 7, 2010. On September 30, 2010, we moved to dismiss the Consolidated Amended Complaint. We believe that the allegations are without merit and intend to vigorously defend against them.

     In the ordinary course of business, we are also 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 of this type, as of September 30, 2010, that, in the opinion of management, might have a material adverse effect on our financial position, results of operations or cash flows.

Item 1A. Risk Factors

     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. The first quarter is generally the slowest sales quarter in the storage industry. We believe our rapid growth in previous periods has masked the cyclicality and seasonality of our business. Our expense levels are relatively fixed in the short term and are based, in part, on our expectations as to future revenues. If revenue 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:

	•		reductions in end users’ budgets for information technology purchases and delays in their budgeting and purchasing cycles, given current macroeconomic conditions;
	•		hardware and software configuration and mix;
	•		fluctuations in demand, including due to seasonality, for our products and services;
	•		changes in pricing by us in response to competitive pricing actions;
	•		the sale of Storage Center in the timeframes we anticipate, including the number and size of orders in each quarter;
	•		our ability to develop, introduce and ship in a timely manner new products and product enhancements that meet end user requirements;
	•		the timing of product releases or upgrades by us or by our competitors;
	•		any significant changes in the competitive dynamics of our market, including new entrants or substantial discounting of products;
	•		our ability to control costs, including our operating expenses and the costs of the components we purchase;
	•		the extent to which our end users renew their service and maintenance agreements with us;
	•		volatility in our stock price, which may lead to higher stock compensation expenses; and

•

general economic conditions in our domestic and international markets.

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 of $4.8 million for the year ended December 31, 2009 and net losses of $416,000 and $7.8 million for the years ended December 31, 2008 and 2007, respectively. We reported net income of $2.4 million for the nine months ended September 30, 2010 and as of September 30, 2010 our accumulated deficit was $42.7 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 sustain profitability on a quarterly or an annual basis, 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 profitability on a quarterly or an annual basis.

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:

	•		our product’s functionality, scalability, performance, ease of use, reliability, availability and cost effectiveness relative to that of our competitors’ products;
	•		our success in utilizing new and proprietary technologies to offer products and features previously not available in the marketplace;
	•		our success in identifying new markets, applications and technologies;
	•		our ability to attract and retain value-added resellers, which we refer to as channel partners;
	•		our name recognition and reputation;
	•		our ability to recruit software engineers and sales and marketing personnel; and
	•		our ability to protect our intellectual property.

     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, NetApp, Inc. and Xiotech Corporation. Some of our competitors, including Dell, HP, 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:

	•		any decline in demand for Storage Center;
	•		the failure of Storage Center to achieve continued market acceptance;
	•		the introduction of products and technologies that serve as a replacement or substitute for, or represent an improvement over, Storage Center;
	•		technological innovations or new communications standards that Storage Center does not address; and
	•		our inability to release enhanced versions of Storage Center on a timely basis.

     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 profitability on a quarterly or an annual basis 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:

	•		lost revenues;
	•		increased costs, including warranty expense and costs associated with end user support;
	•		delays or cancellations or rescheduling of orders or shipments;
	•		product returns or discounts;
	•		diversion of management resources;
	•		damage to our reputation and brand equity;
	•		payment of damages for performance failures;
	•		reduced orders from existing channel partners and end users; and
	•		declining interest from potential channel partners or end users.