Isilon Systems 10-Q 2007 Q2 Quarterly report

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

For the quarterly period ended July 1, 2007

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                    to                    

Commission File Number 001-33196

Isilon Systems, Inc.

(Exact name of registrant as specified in its charter)

Delaware	91-2101027
(State or other jurisdiction of	(IRS Employer
incorporation or organization)	Identification No.)
3101 Western Ave
Seattle, WA	98121
(Address of principal executive offices)	(Zip code)

Registrant’s telephone number, including area code:
206-315-7500

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. Yesþ Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filero           Accelerated filero           Non-accelerated filerþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yeso Noþ

As of August 3, 2007, 61,922,131 shares of the registrant’s Common Stock were outstanding.

TABLE OF CONTENTS

Part I – Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Statements of Operations for the three and six months ended July 1, 2007 and July 2, 2006	3
Condensed Consolidated Balance Sheets as of July 1, 2007 and December 31, 2006	4
Condensed Consolidated Statements of Cash Flows for the six months ended July 1, 2007 and July 2, 2006	5
Notes to Condensed Consolidated Financial Statements (unaudited)	6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3. Quantitative and Qualitative Disclosures About Market Risk	20
Item 4T. Controls and Procedures	20
Part II – Other Information
Item 1. Legal Proceedings	21
Item 1A. Risk Factors	21
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	32
Item 3. Defaults Upon Senior Securities	32
Item 4. Submission of Matters to a Vote of Security Holders	32
Item 5. Other Information	32
Item 6. Exhibits	32
Signatures	36
EXHIBIT 10.31
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

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PART I – FINANCIAL INFORMATION

ITEM 1.Financial Statements

Isilon Systems, Inc.

Condensed Consolidated Statements of Operations

(unaudited)

(in thousands, except per share data)

	Three Months Ended						Six Months Ended
	July 1,			July 2,			July 1,			July 2,
	2007			2006			2007			2006
Revenue:
Product	$	21,654		$	11,696		$	40,271		$	20,708
Services		3,462			1,718			6,452			3,129
Total revenue		25,116			13,414			46,723			23,837
Cost of revenue:
Product		10,237			5,735			18,566			10,085
Services (1)		1,762			660			3,270			1,336
Total cost of revenue		11,999			6,395			21,836			11,421
Gross profit		13,117			7,019			24,887			12,416
Operating expenses:
Research and development (1)		4,730			3,894			9,404			7,454
Sales and marketing (1)		9,956			5,685			19,227			10,501
General and administrative (1)		3,183			1,777			5,883			3,070
Total operating expenses		17,869			11,356			34,514			21,025
Loss from operations		(4,752	)		(4,337	)		(9,627	)		(8,609	)
Other income (expense), net
Interest income and other		1,167			22			2,331			66
Interest expense		—			(345	)		—			(456	)
Warrant revaluation expense		—			(765	)		—			(944	)
Loss on disposal of property and equipment		—			(72	)		—			(72	)
Total other income (expense), net		1,167			(1,160	)		2,331			(1,406	)
Loss before income tax expense		(3,585	)		(5,497	)		(7,296	)		(10,015	)
Income tax expense		(36	)		—			(75	)		—
Net loss	$	(3,621	)	$	(5,497	)	$	(7,371	)	$	(10,015	)
Net loss per common share, basic and diluted	$	(0.06	)	$	(0.89	)	$	(0.12	)	$	(1.69	)
Shares used in computing basic and diluted net loss per common share		61,148			6,177			60,940			5,943

(1) Includes stock-based compensation as follows:

Cost of revenue	$	25	$	—	$	44	$	1
Research and development		222		33		321		38
Sales and marketing		398		28		550		32
General and administrative		371		44		559		48
Total stock-based compensation	$	1,016	$	105	$	1,474	$	119

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Isilon Systems, Inc.

Condensed Consolidated Balance Sheets

(unaudited)

(in thousands, except per share data)

	As of
	July 1,			December 31,
	2007			2006
ASSETS
Current assets:
Cash and cash equivalents	$	73,648		$	99,899
Marketable securities		20,859			—
Trade receivables, net of allowances of $873 and $501, respectively		29,261			24,388
Inventories		5,744			3,587
Other current assets		4,405			1,939
Total current assets		133,917			129,813
Property and equipment, net		10,258			7,158
Total assets	$	144,175		$	136,971
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	14,428		$	6,777
Accrued liabilities		2,697			2,869
Accrued compensation and related benefits		4,210			3,463
Deferred revenue and customer deposits		9,050			7,611
Total current liabilities		30,385			20,720
Deferred revenue, net of current portion		5,223			3,308
Deferred rent, net of current portion		3,493			2,186
Total liabilities		39,101			26,214
Stockholders’ equity:
Preferred stock, par value $0.00001: 10,000 shares authorized no shares issued and outstanding		—			—
Common stock, par value $0.00001: 250,000 authorized; 61,807 and 61,519 shares issued and outstanding		1			1
Additional paid-in capital		187,689			185,947
Accumulated other comprehensive loss		(137	)		(83	)
Accumulated deficit		(82,479	)		(75,108	)
Total stockholders’ equity		105,074			110,757
Total liabilities and stockholders’ equity	$	144,175		$	136,971

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Isilon Systems, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited)

(in thousands)

	Six Months Ended
	July 1,			July 2,
	2007			2006
Cash flows from operating activities
Net loss	$	(7,371	)	$	(10,015	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		2,447			1,683
Realized gain on sale of marketable securities		—			(8	)
Non-cash interest expense		—			78
Excess and obsolete inventory expense		271			92
Amortization of discount on marketable securities		(30	)		—
Stock-based compensation expense		1,474			119
Loss on disposal of property and equipment		—			80
Warrant revaluation expense		—			944
Changes in operating assets and liabilities:
Accounts receivable, net		(4,761	)		(6,726	)
Inventories		(2,428	)		(2,785	)
Other current assets		(2,360	)		(329	)
Accounts payable		7,018			5,644
Accrued liabilities, compensation payable and deferred rent		775			1,312
Deferred revenue and customer deposits		3,203			2,302
Net cash used in operating activities		(1,762	)		(7,609	)
Cash flows from investing activities
Purchases of property and equipment		(3,183	)		(2,845	)
Purchases of marketable securities		(20,832	)		(691	)
Sales of marketable securities		—			2,008
Proceeds from sale of property and equipment		—			21
Net cash used in investing activities		(24,015	)		(1,507	)
Cash flows from financing activities
Proceeds from issuance of common stock		203			577
Proceeds from notes payable		—			24,862
Repurchases of unvested common stock		(78	)		—
Payments of offering costs		(600	)		—
Payments of notes payable and capital lease obligations		—			(16,711	)
Net cash (used in) provided by financing activities		(475	)		8,728
Effect of exchange rate changes on cash and cash equivalents		1			3
Net decrease in cash and cash equivalents		(26,251	)		(385	)
Cash and cash equivalents at beginning of period		99,899			10,853
Cash and cash equivalents at end of period	$	73,648		$	10,468

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Isilon Systems, Inc

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Organization and Significant Accounting Policies

Organization

     Isilon Systems, Inc. (the “Company”) was incorporated in the State of Delaware on January 24, 2001. The Company designs, develops and markets clustered storage systems for storing and managing digital content and unstructured data. The Company began selling its products and services in January 2003. The Company sells systems that generally include a software license, hardware, post-contract customer support and, in some cases, additional elements.

Significant Accounting Policies

Accounting Principles

     The consolidated financial statements and accompanying notes were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements include the accounts of Isilon Systems, Inc. and its wholly owned foreign subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. Certain information and disclosures normally included in financial statements prepared in conformity with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).

     These financial statements reflect all adjustments, consisting only of normal, recurring adjustments that, in the opinion of the Company’s management, are necessary for a fair statement of the financial position, results of operations and cash flows for the periods presented. Operating results for the three and six months ended July 1, 2007, are not necessarily indicative of the results that may be expected for any subsequent quarter or for the year ending December 30, 2007. The Company operates on a 52/53-week fiscal year ending on the Sunday closest to December 31. Accordingly, the Company’s fiscal year 2007 ends on December 30, 2007 and its fiscal year 2006 ended on December 31, 2006. The fiscal year 2007 quarters end on April 1, July 1, and September 30, 2007.

Use of Estimates

     The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates are inherent in the preparation of the consolidated financial statements and include accounting for revenue recognition, the allowance for doubtful accounts, obsolete and excess inventory, the valuation allowance on deferred tax assets and the valuation of preferred stock warrants and stock-based compensation. Some of these estimates require difficult, subjective or complex judgments about matters that are uncertain. Actual results could differ from those estimates.

Concentration of Risk

     The Company’s cash and cash equivalents are invested with financial institutions in deposits that may exceed federally insured limits. The Company has not experienced any losses on its deposits of cash and cash equivalents. Management believes that the institutions are financially sound and, accordingly, that minimal credit risk exists.

     The Company does not require collateral to support credit sales. Allowances are maintained for potential credit losses. Customer concentrations of greater than 10% were as follows:

	Three Months Ended						Six Months Ended
	July 1,			July 2,			July 1,			July 2,
	2007			2006			2007			2006
% of Total Revenue
Eastman Kodak Company		17	%		17	%		16	%		15	%
Comcast Corporation (1)	less than 10%				18		less than 10%				17

(1) Comcast Corporation purchases through one of the Company’s resellers.

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Isilon Systems, Inc

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(unaudited)

	As of
	July 1,			December 31,
	2007			2006
% of Gross Accounts Receivable
Eastman Kodak Company		12	%		18	%

     The Company is dependent on a single contract manufacturer, and some of the key components in the Company’s products come from single or limited sources of supply.

Revenue Recognition

     The Company derives its revenue from sales of its products and services. Product revenue consists of revenue from sales of systems and software. Shipping charges billed to customers are included in product revenue and the related shipping costs are included in cost of product revenue.

     The Company’s software is integrated with industry standard hardware and is essential to the functionality of the integrated system product. The Company provides unspecified software updates and enhancements related to its products through service contracts. Accordingly, the Company recognizes revenue in accordance with the guidance provided under AICPA Statement of Position (“SOP”) No. 97-2,Software Revenue Recognition, or SOP 97-2, and SOP No. 98-9,Modification of SOP No. 97-2, Software Revenue Recognition, with Respect to Certain Transactions, or SOP 98-9, for all transactions involving the sale of software. Product revenue is recognized once a legally binding arrangement with a customer has been evidenced, delivery has occurred, fees are fixed or determinable and free of contingencies and significant uncertainties, and collection is probable. The Company’s fees are considered fixed or determinable at the execution of an agreement, which comprises the final terms of sale including the description, quantity and price of each product purchased. Substantially all of the sales under the Company’s arrangements with customers, including value-added resellers and distributors, do not include rights of return, acceptance provisions, rebates or other incentives. The Company assesses the ability to collect from its customers based on a number of factors, including credit worthiness of the customer and past transaction history of the customer. If the customer is deemed not credit worthy, all revenue from the arrangement is deferred until payment is received and all other revenue recognition criteria have been met.

     Substantially all of the Company’s products have been sold in combination with services, which primarily consist of hardware and software support. Software support provides customers with rights to unspecified software updates and to maintenance releases and patches released during the term of the support period. Hardware support includes repair or replacement of hardware in the event of breakage or failure, and telephone and Internet access to technical information and support personnel during the term of the support period. Installation services when provided are also included in services revenue.

     Substantially all of the sales through indirect channels and reorders through the Company’s direct sales force consist of product and support services. The Company has established vendor specific objective evidence (“VSOE”) for the fair value of the Company’s support services as measured by the renewal prices offered to and paid by its customers. Accordingly, the Company uses the residual method, as allowed by SOP 98-9, to determine the amount of product revenue to be recognized. Under the residual method, the fair value of the undelivered element, support services, is deferred and the remaining portion of the sales amount is recognized as product revenue. This product revenue is recognized upon shipment, based on freight terms, assuming all other criteria for recognition discussed above have been met and, in the case of all indirect channel sales, persuasive evidence of the identity of the end-user customer is obtained. The fair value of the support services is recognized as services revenue on a straight-line basis over the term of the related support period, which is typically one to three years.

Accounting for Stock-Based Compensation

     On January 2, 2006, the Company adopted SFAS No. 123(R),Share-Based Payment, or SFAS 123(R), using the prospective transition method. Under this method, the Company’s stock-based compensation costs recognized during 2006 were comprised of compensation costs for all share-based payment awards granted subsequent to January 1, 2006, based on their grant-date fair value estimated using the Black-Scholes model, in accordance with the provisions of SFAS 123(R).

     The Company chose the straight-line method of allocating compensation cost over the requisite service period of the related award under SFAS 123(R). The Company calculated the expected term based on the provisions outlined in SFAS 123(R), which, for options granted in the three and six months ended July 1, 2007, resulted in an expected term of approximately four years. The Company based its estimate of expected volatility on the estimated volatility of similar entities whose share prices are publicly available.

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Isilon Systems, Inc

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(unaudited)

     During the three and six months ended July 1, 2007, and July 2, 2006, the Company recorded non-cash stock-based compensation expense of $1.0 million and $105,000, and $1.5 million and $119,000, respectively. As of July 1, 2007, and December 31, 2006, the Company’s total unrecognized compensation cost related to stock-based awards granted since January 2, 2006, was $18.8 million and $6.3 million, respectively, which will be recognized over the weighted-average remaining requisite service period of approximately 3.0 years. The Company recorded no tax benefit related to these options during the three and six months ended July 1, 2007, since the Company currently maintains a full valuation allowance on its net deferred tax assets. In future periods, stock-based compensation expense will increase as the Company records expense related to previously issued stock-based compensation awards and issues additional equity-based awards to continue to attract and retain key employees.

Recent Accounting Pronouncements

     In February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115, or SFAS 159. SFAS No. 159 permits entities to choose to measure eligible items at fair value at specified election dates and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. If the Company elects the fair value option provided for in this standard, it would be effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company has not yet determined whether it will elect the option provided for in this standard, or the impact that the elective adoption may have on its consolidated results of operations or financial position.

2. Initial Public Offering

     On December 14, 2006, the Company completed its initial public offering selling 8,940,717 shares of common stock at $13.00 per share generating net proceeds of approximately $105.7 million. Simultaneous with its initial public offering, the Company’s shares of mandatorily redeemable convertible preferred stock were automatically converted into 43.5 million shares of common stock, and 409,478 warrants to purchase mandatorily redeemable convertible preferred stock were converted into warrants to purchase common stock.

3. Net Loss Per Common Share

     Basic and diluted net loss per common share was the same for all periods presented as the impact of all potentially dilutive securities outstanding was anti-dilutive. Basic net loss per share is calculated by dividing net loss by the weighted-average shares of common stock outstanding during the period that are not subject to vesting provisions. The following table presents the potentially dilutive securities outstanding that were excluded from the computation of diluted net loss per common share for the periods presented because their inclusion would have had an anti-dilutive effect:

	As of
	July 1,		July 2,
	2007		2006
Options to purchase common stock		8,837,388		6,325,210
Common stock subject to vesting provisions		332,074		1,384,472
Common stock purchaseable under Employee Stock Purchase Plan		27,535		—
Mandatorily redeemable convertible preferred stock		—		41,788,922
Warrants to purchase mandatorily redeemable convertible preferred stock		129,992		409,478
		9,326,989		49,908,082

4. Comprehensive Loss

     Comprehensive loss for the three months ended July 1, 2007, and July 2, 2006, was $3.7 million and $5.5 million, respectively, and for the six months ended July 1, 2007, and July 2, 2006 was $7.4 million and $10.0 million, respectively. The other components of comprehensive loss in the first and second quarters ended 2007 and 2006, aside from net loss for the periods reported, were net unrealized gains on marketable securities and foreign currency translation adjustments.

5. Marketable Securities

     At their date of acquisition, the Company’s marketable securities are classified into categories in accordance with the provisions of statement of Financial Accounting Standards (“SFAS”) No. 115,Accounting for Certain Investments in Debt and Equity Securities.During

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Isilon Systems, Inc

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(unaudited)

the periods presented, the Company had securities classified as available-for-sale, which were reported at fair value with the related unrealized gains and losses included as a separate component in stockholders’ equity. Realized gains and losses and declines in value of securities judged to be other than temporary are included in other income (expense), net. Realized and unrealized gains and losses are based on the specific identification method. The Company’s investments in marketable securities are diversified among high-credit quality securities in accordance with the Company’s investment policy.

     Marketable securities totaled $20.9 million at July 1, 2007. There were no realized gains or losses on the sales of marketable securities for the three and six months ended July 1, 2007. Gross unrealized gains and losses at July 1, 2007 were not significant.

6. Inventories

     The Company outsources the manufacturing of its products to a contract manufacturer that assembles each product to the Company’s specifications. As protection against component shortages and to provide replacement parts for its service teams, the Company also stocks limited supplies of certain key product components. The Company reduces inventory to its estimated net realizable value by reserving for excess and obsolete inventories determined primarily based on historical usage, forecasted demand and evaluation unit conversion rate and age. Inventories have been reduced by $1.2 million and $1.1 million as of July 1, 2007, and December 31, 2006, respectively.

     Inventories consisted of the following:

	As of
	July 1,		December 31,
	2007		2006
	(in thousands)
Finished goods	$	2,460	$	1,530
Evaluation units		3,284		2,057
	$	5,744	$	3,587

7. Property and Equipment

     Property and equipment, net, consisted of the following:

	As of
	July 1,			December 31,
	2007			2006
	(in thousands)
Software and computer equipment	$	10,787		$	8,569
Furniture, office equipment and other		5,227			3,581
Leasehold improvements		4,992			3,308
		21,006			15,458
Less: accumulated depreciation and amortization		(10,748	)		(8,300	)
	$	10,258		$	7,158

     Depreciation and amortization expense was $1.3 million and $2.4 million, and $1.1 million and $1.7 million, for the three and six months ended July 1, 2007, and July 2, 2006, respectively.

8. Stockholders’ Equity

Warrants

          On June 29, 2005, the FASB issued Staff Position No. 150-5,Issuer’s Accounting under FASB Statement No. 150 for Freestanding Warrants and Other Similar Instruments on Shares That Are Redeemable, or FSP 150-5. FSP 150-5 affirms that warrants to purchase shares of

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Isilon Systems, Inc

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(unaudited)

the Company’s mandatorily redeemable convertible preferred stock are subject to the requirements in FSP 150-5 and requires the Company to classify these warrants as liabilities and revalue them to fair value at the end of each reporting period. For the six months ended July 2, 2006, the Company recorded a charge of $944,000, reflecting the increase in fair value between January 2, 2006, and July 2, 2006. The Company revalued the warrants through December 20, 2006, the date of the closing of the Company’s initial public offering and conversion of preferred stock to common stock. Subsequent to December 20, 2006, the warrants no longer were marked to market because they were converted into warrants to purchase common stock.

     The Company’s common stock warrants consisted of the following:

					Number of Shares
					Subject to Warrants
		Exercise		Expiration	July 1,		December 31,
	Issue Date	Price		Date	2007		2006
Warrants to purchase common stock	March 2006	$	2.3078	March 2016		129,992		129,992

Stock Options and Unvested Common Stock

     The Company accounts for cash received for the purchase of unvested shares of common stock or the early-exercise of unvested stock options as a current liability, included as a component of accrued liabilities in the Company’s consolidated balance sheets. As of July 1, 2007, and December 31, 2006, there were 332,074 and 921,292 unvested shares, respectively, of the Company’s common stock outstanding and $259,000 and $506,000, respectively, of the related recorded liability.

     Detail related to activity of unvested shares of common stock is as follows:

	Number of			Weighted-Average
	Unvested Shares			Exercise/Purchase
	Outstanding			Price
Balance as of January 1, 2007		921,292		$	0.55
Issued		—		$	—
Vested		(419,942	)	$	0.39
Repurchased		(169,276	)	$	0.47
Balance as of July 1, 2007		332,074		$	0.78

     Detail related to stock option activity is as follows:

				Weighted-
	Number of			Average
	Shares			Exercise
	Outstanding			Price
Balance as of January 1, 2007		6,753,969		$	1.77
Options granted		2,962,894		$	13.55
Options exercised		(457,270	)	$	0.44
Options forfeited		(422,205	)	$	2.89
Balance as of July 1, 2007		8,837,388		$	5.73

     The total intrinsic value for options exercised during the six months ended July 1, 2007, was $6.2 million, representing the difference between the estimated fair value of the Company’s common stock underlying these options at the dates of exercise and the exercise prices paid.

     The fair value of each employee option on the date of grant was estimated using the Black-Scholes option pricing model under SFAS 123(R). The following assumptions were used for the valuations of options granted to employees during the three and six months ended July 1, 2007, and July 2, 2006:

	Three Months Ended						Six Months Ended
	July 1,			July 2,			July 1,			July 2,
	2007			2006			2007			2006
Risk-free interest rate		4.5% - 5.1	%		4.9% - 5.1	%		4.5% - 5.1	%		4.6% - 5.1	%
Expected term	4 years			4 years			4 years			4 years
Dividend yield	None			None			None			None
Volatility		40 - 41%			47%			39 - 41%			47%

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Isilon Systems, Inc

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(unaudited)

     The Company estimated its expected volatility based on reported market value data for a group of publicly traded companies, which were selected from certain market indices, that the Company believed were relatively comparable after consideration of their size, industry, stage of lifecycle, profitability, growth, and risk and return on investment.

     The estimated weighted-average grant date fair value of options granted during the six months ended July 1, 2007, with exercise prices that equaled the estimated per share fair value of the Company’s common stock at the date of grant, was $5.18. The estimated weighted-average grant date fair value of options granted during the six months ended July 2, 2006, with exercise prices less than the estimated per share fair value of the Company’s common stock at the date of grant, was $0.80.

     The Company adopted an Employee Stock Purchase Plan (the “2006 ESPP”) in the fourth quarter of 2006. A total of 750,000 shares of the Company’s common stock have been reserved for sale under the 2006 ESPP. Under the 2006 ESPP, employees may purchase shares of common stock through payroll deductions at a price per share that is 85% of the fair market value of the Company’s common stock on the applicable purchase date. The first purchase period commenced in February 2007 and the related discount was included in stock-based compensation expense. The total liability for the 2006 ESPP, including the related 15% discount, is $412,000 as of July 1, 2007, and is included in accrued compensation and related benefits in the company’s condensed consolidated balance sheet.

10. Income Taxes

     As of July 1, 2007, the Company had total net operating loss carryforwards for federal and state income tax purposes of $44.6 million. Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the Company’s gross deferred tax assets have been fully offset by a valuation allowance. If not utilized, these net operating loss carryforwards will expire for federal purposes between 2021 and 2027. Utilization of these net operating loss carryforwards is subject to an annual limitation due to provisions of the Internal Revenue Code of 1986, as amended. Events that cause limitations in the amount of net operating losses that the Company may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined, over a three-year period.

     The Company’s effective tax rate differs from the U.S. federal statutory rate as follows:

	Three Months Ended						Six Months Ended
	July 1,			July 2,			July 1,			July 2,
	2007			2006			2007			2006
Income tax at statutory rate		34.0	%		34.0	%		34.0	%		34.0	%
State taxes, net of federal benefit		2.1			2.4			2.1			2.4
Permanent difference		(0.9	)		—			(0.8	)		—
Stock compensation		(2.6	)		—			(2.4	)		—
Other		0.8			(0.1	)		0.4			(0.1	)
Change in valuation allowance		(34.4	)		(36.3	)		(34.3	)		(36.3	)
Total		(1.0	)%		—	%		(1.0	)%		—	%

     On January 1, 2007, the Company adopted FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes, or FIN 48. FIN 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. The Company elected to include interest on tax positions as a component of interest expense. The adoption of FIN 48 did not have a material impact on the Company’s consolidated results of operations or financial position.

     As of January 1, 2007, we were open to examination in the U.S. federal tax jurisdiction for the 2004 to 2006 tax years and various foreign, state and local jurisdictions for the 2003 to 2006 tax years.

11. Segment Information

     SFAS No. 131,Disclosures About Segments of an Enterprise and Related Information, establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise for which separate financial information is available and evaluated regularly by the chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company is organized as, and operates in, one reportable segment: the development and sale of clustered storage solutions. The Company’s chief operating decision-maker is its chief executive officer. The Company’s chief executive officer reviews

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Isilon Systems, Inc

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(unaudited)

financial information presented on a consolidated basis, accompanied by information about revenue by geographic region, for purposes of evaluating financial performance and allocating resources. The Company and its chief executive officer evaluate performance based primarily on revenue in the geographic locations in which the Company operates. Revenue is attributed by geographic region based on the location of the end customer. The Company’s assets are primarily located in the United States of America and not allocated to any specific region; therefore, geographic information is presented only for total revenue.

The following presents total revenue by geographic region:

	Three Months Ended				Six Months Ended
	July 1,		July 2,		July 1,		July 2,
	2007		2006		2007		2006
	(in thousands)				(in thousands)
United States of America	$	17,265	$	10,786	$	33,738	$	18,812
Asia		3,861		1,390		6,867		2,770
EMEA		3,745		556		5,569		1,505
Other		245		682		549		750
Total	$	25,116	$	13,414	$	46,723	$	23,837

12. Commitments and Contingencies

     The Company maintains, with Sanmina-SCI Corporation (“Sanmina”), a rolling 90-day firm order for products it manufactures for the Company, and these orders may only be rescheduled or cancelled by Sanmina under certain limited conditions and, even then, with certain restrictions and penalties up to the full cost of the product. The amount of the open purchase orders with Sanmina and other partners and suppliers at July 1, 2007, was approximately $4.6 million.

     The Company is party to various legal proceedings arising in the ordinary course of its business. The Company is not currently a party to any legal proceedings that management believes would have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company.

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

     This Quarterly Report onForm 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Act”) and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to them. In some cases you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential,” and similar expressions intended to identify forward-looking statements. Examples of these statements include, but are not limited to, statements regarding our competitive environment, the anticipated growth of digital content, the expected demand for and benefits of our storage products, our future business plans and growth strategy, our ability to improve existing products and to develop new and future products, our anticipated revenue and expenses, our ability to add value-added resellers and distributors and to sell our products internationally, our ability to realize operating leverage and realize efficiencies in our sales model by leveraging partners and selling to existing customers, anticipated results of potential or actual litigation, the anticipated sufficiency of our current office space and ability to find additional space as needed, anticipated development or acquisition of intellectual property and resulting benefits, expected impacts of changes in accounting rules, including the impact on deferred tax benefits, the impact of governmental regulation, employee hiring and retention, including anticipated reductions in force and headcount, the future payment of dividends, use of cash, cash needs and ability to raise capital, and potential liability from contractual relationships. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us and described in Part II, Item 1A of this Quarterly Report onForm 10-Q and our other filings with the SEC. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report onForm 10-Q . You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. Except as required by law, we assume no obligation to update these forward-looking statements, whether as a result of new information, future events, or otherwise.

     The following discussion and analysis should be read in conjunction with the unaudited financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Overview

     We were founded in January 2001 specifically to create a solution that addressed the unique challenges associated with the storage and management of digital content and unstructured data. From January 2001 to January 2003, we were focused on designing and developing our OneFS™ operating system software used in all of our storage systems. We began commercial shipments of our first systems in January 2003, and since then we have been focused on optimizing our solution to meet our customers’ needs and establishing development, manufacturing and marketing partnerships. Today, our solution includes a suite of systems, software and services.

     We believe we are the leading provider of clustered storage systems for digital content and unstructured data. We sell clustered storage systems that consist of three or more storage nodes. Each node is comprised of our proprietary OneFS™ operating system software and industry standard hardware components integrated into a self-contained, 3.5-inch or 1.75-inch high, rack-mountable chassis. Customers can scale our clustered storage systems incrementally as their needs grow by purchasing additional nodes or clusters of nodes from us to enhance storage capacity, performance or both. Our future revenue growth will depend upon further penetration of our existing customers as well as expansion of our customer base in existing and other industries that depend upon digital content. We consider the development of direct and indirect sales channels in domestic and international markets a key to our future revenue growth and the global acceptance of our products. We also are dependent on the development, adoption and acceptance of new software and systems to increase our overall margins and achieve profitability.

     Our product revenue growth rate will depend significantly on continued growth in our target industries and our ability to continue to attract new customers in those industries. Our growth in services revenue will depend upon increasing the number of systems under service contracts. Any such increases will depend on a growing customer base and on our customers renewing existing service contracts.

Key Business Metrics

     We monitor a number of key metrics to help forecast growth, establish budgets, measure the effectiveness of our sales and marketing efforts, and measure operational effectiveness.

     New Customers and Repeat Sales Orders.Our goal is to attract a significant number of new customers and to encourage existing customers to purchase additional products, specifically our higher margin software applications, SyncIQ, SnapshotIQ, SmartConnect, Migration IQ, and SmartQuotas. A majority of our customers buy our storage systems and later add additional nodes or software applications as the need arises under our ‘pay-as-you-grow’ model.

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     Channel Leverage.We are actively growing our relationships with channel partners to further penetrate our targeted markets domestically and internationally. We track our sales orders by direct or indirect customers with the goal of increasing revenue from channel partners.

     Gross Margin.Our goal is to grow our gross margin to increase the profitability of our business. Some of the key factors affecting our gross margin are average sales prices of our systems, the revenue attributable to software applications as a percentage of total revenue, the rate at which our customers adopt our higher margin products, the timing of component cost reductions through product redesign, the timing of supplier cost reductions, and overall market conditions. We also expense items such as customer service and inventory obsolescence through cost of revenue. We consider our ability to monitor and manage these factors to be a key aspect of attaining and expanding our profitability.

     Operating Cash Flow.We closely monitor operating cash flow as a measure of our business performance. Some of the key factors affecting operating cash flows are our ability to generate net income and manage working capital. Increasing inventory turns and reducing days sales outstanding in accounts receivable are both contributors to improving working capital. Our goal is to maximize cash flows while continuing to invest in our business. Our close tracking of operating cash flow allows us to better manage the cash needs of our business.

Critical Accounting Policies and Estimates

     Our consolidated financial statements are prepared in accordance with United States generally accepted accounting principles, or GAAP. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the dates of the consolidated financial statements, the disclosure of contingencies as of the dates of the consolidated financial statements, and the reported amounts of revenue and expenses during the periods presented. Although we believe that our estimates and judgments are reasonable under the circumstances, actual results may differ from those estimates. These critical accounting policies are consistent with those disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.

     We believe the following to be our critical accounting policies because they are important to the portrayal of our financial condition and results of operations and they require critical management estimates and judgments about matters that are uncertain: revenue recognition, allowance for doubtful accounts, stock-based compensation, estimation of fair value of warrants to purchase convertible preferred stock, inventory valuation, and accounting for income taxes. If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operations for future periods could be materially affected. See “Risk Factors” for certain matters that may affect our future financial condition or results of operations.

Results of Operations

     The following discussion and analysis should be read in conjunction with our consolidated financial statements, related notes and risk factors included elsewhere in this Quarterly Report on Form 10-Q.

     Revenue.We derive our revenue from sales of our products and services. Our customers typically purchase a cluster of our storage devices comprised of three or more nodes and related support services. Each node includes our OneFS™ operating system software and industry standard hardware. In addition, customers may purchase separate additional software applications for enhanced functionality.

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	Three Months Ended						Six Months Ended
	July 1,			July 2,			July 1,			July 2,
	2007			2006			2007			2006
	(dollars in thousands)
Revenue by type:
Product	$	21,654		$	11,696		$	40,271		$	20,708
Services		3,462			1,718			6,452			3,129
Total revenue	$	25,116		$	13,414		$	46,723		$	23,837
% revenue by type:
Product		86	%		87	%		86	%		87	%
Services		14			13			14			13
Total		100	%		100	%		100	%		100	%
Revenue by geography:
Domestic	$	17,265		$	10,786		$	33,738		$	18,812
International		7,851			2,628			12,985			5,025
Total revenue	$	25,116		$	13,414		$	46,723		$	23,837
% revenue by geography:
Domestic		69	%		80	%		72	%		79	%
International		31			20			28			21
Total		100	%		100	%		100	%		100	%
Revenue by sales channel:
Direct	$	10,613		$	7,412		$	19,519		$	13,231
Indirect		14,503			6,002			27,204			10,606
Total revenue	$	25,116		$	13,414		$	46,723		$	23,837
% revenue by sales channel:
Direct		42	%		55	%		42	%		56	%
Indirect		58			45			58			44
Total		100	%		100	%		100	%		100	%

     Total revenue increased 87% and 96% for the three and six months ended July 1, 2007, from the comparable periods in the prior year. This growth was primarily due to an increase in our customer base and expanded product offerings offset by a decrease in average order sizes. The number of new customers added for the three and six months ended July 1, 2007, was 91 and 168, representing a 117% and 124% increase over the number of new customers added in the comparable periods in the prior year. New customer growth was driven by penetration in our target markets, our expanded sales force and continued traction in international markets. A wider range of product offerings and greater overall acceptance of the clustered storage category contributed to both initial and repeat orders from customers. The decrease in average order sizes year-over-year is attributable to increased diversification of customers and product mix, specifically a greater number of new customers purchasing our entry level IQ 200 system. We experience seasonality in our revenue growth based on historical customer demand and therefore expect revenue growth to be higher during the second and fourth quarters of the fiscal year.

     The increase in indirect channel revenue was due to the growing market for our products and our increased focus on expanding our indirect channel sales by hiring dedicated sales managers and expanding our group of value-added resellers. Computer Design and Integration LLC is the only reseller that accounted for more than 10% of our total revenue during the first half of 2006. No reseller accounted for more than 10% of our revenue during the first half of 2007. We plan to continue to expand our relationships with channel partners and over time expect the percent of revenue generated through the channel to grow.

     The percentage of our total revenue derived from support services was 14% for both the three and six months ended July 1, 2007, and 13% for both the three and six months ended July 2, 2006. As our installed customer base continues to grow, we expect our proportion of services revenue to continue to increase over time in proportion with of our total revenue.

     Cost of Revenue and Gross Margin.Cost of product revenue consists primarily of amounts paid to Sanmina, our contract manufacturer, in connection with the procurement of hardware components and assembly of those components into our systems, costs of shipping and logistics, and valuation reserves taken for excess and obsolete inventory. Cost of services revenue is primarily comprised of salaries and employee benefits and third-party costs in providing technical support. Our gross margin has been and will continue to be affected by a variety of factors, including average sales prices of our systems, the revenue attributable to sales of software applications as a percentage of total revenue, the rate at which our customers adopt our higher margin products and software applications, the timing of component cost reductions, the timing of supplier cost reductions, and overall market conditions.

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	Three Months Ended						Six Months Ended
	July 1,			July 2,			July 1,			July 2,
	2007			2006			2007			2006
	(dollars in thousands)
Cost of revenue:
Product	$	10,237		$	5,735		$	18,566		$	10,085
Services		1,762			660			3,270			1,336
Total cost of revenue	$	11,999		$	6,395		$	21,836		$	11,421
Gross margin:
Product		52.7	%		51.0	%		53.9	%		51.3	%
Services		49.1			61.6			49.3			57.3
Total gross margin		52.2			52.3			53.3			52.1

     Overall gross margin decreased 10 basis points and increased 120 basis points for the three and six months ended July 1, 2007, respectively, from the comparable periods in the prior year.

     Gross margin for product revenue increased 170 basis points and 260 basis points for the three and six months ended months ended July 1, 2007, respectively, from the comparable periods in the prior year. These increases were primarily due to customer adoption of our new generation of software applications together with a reduction in component costs. Since the third quarter of 2006, we expanded from a single software application, SyncIQ, to create a suite of five applications including the additions of SnapshotIQ, SmartConnect, Migration IQ, and SmartQuotas. All of our software applications carry a higher gross margin than our overall product margin. In the first half of 2007, approximately 50% of our new customers purchased one or more of our five software applications.

     Overall gross margin decreased 230 basis points sequentially from the first to second quarter of 2007. The decrease was primarily due to a large transaction with Kodak, one of our oldest and largest high-volume customers, in which we provided our products to them at a price point that placed downward pressure on gross margin for the second quarter of 2007.

     We expect to continue to experience pricing pressures within our industry as the price per megabyte of storage decreases year-over-year. This downward pricing pressure is primarily due to the decreasing prices of disk drives and other industry standard hardware components. Depending on the product type, disk drives can represent approximately one-fourth of our material cost. Historically, disk drives have decreased in price approximately 30% from year to year. Thus, the decline in product prices that we experienced was more than offset by a greater percentage decrease in cost of product revenue on a per node basis resulting in an overall increase in product gross margin the first half of 2007 compared with the first half of 2006.

     Gross margin for services revenue decreased 1250 basis points and 800 basis points for the three and six months ended months ended July 1, 2007, respectively, from the comparable periods in the prior year. Services revenue includes support services for both our software and our hardware products. Software support provides customers with software updates, maintenance releases and patches, which have minimal costs. Hardware support includes Internet access to our technical knowledge database and to technical support personnel, and third-party costs in providing technical support. During the first half of 2007, we continued to make investments in our customer service and support structure to support the growth in our customer base. As a result, gross margin for services revenue for the second quarter and first half of 2007 decreased from the comparable period in the prior year.

     As our customer base continues to grow, it will be necessary for us to continue to make significant upfront investments in our customer service and support structure to support this growth. The rate at which we add new customers will affect the amount of these upfront investments. The timing of these additional expenditures could materially affect our cost of revenue, both in absolute dollars and as a percentage of total revenue, in any particular period. This could cause downward pressure on services and total gross margins. However, we expect overall gross margin to increase to approximately 60%-64% over the long term. We believe that we will experience increases in gross margin as software revenue, which has a higher gross margin, increases as a percent of our total revenue.

     Research and Development Expenses.Research and development expenses primarily include personnel costs, prototype expenses, facilities expenses and depreciation of equipment used in research and development. In addition to our United States development teams, we use an offshore development team from a third-party contract engineering provider in Moscow, Russia. Research and development expenses are recorded when incurred. We are devoting substantial resources to the development of additional functionality for existing products and the development of new systems and software products. We intend to continue to invest significantly in our research and development efforts because we believe they are essential to maintaining and improving our competitive position. Accordingly, we expect research and development expenses to continue to increase in total dollars although we expect these expenses to decrease as a percentage of total revenue to approximately 11%-16% over the next several years.

	Three Months Ended											Six Months Ended
	July 1,			July 2,								July 1,			July 2,
	2007			2006			$ change		% change			2007			2006			$ change		% change
	(dollars in thousands)											(dollars in thousands)
Research and development expenses	$	4,730		$	3,894			836		21	%	$	9,404		$	7,454			1,950		26	%
Percent of total revenue		19	%		29	%							20	%		31	%

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     Research and development expenses increased primarily due to an increase in employee headcount to 105 at July 1, 2007, from 90 at July 2, 2006. The absolute dollar increases period-to-period were primarily due to an increase in salaries and benefits, professional services, and stock-based compensation expense. Stock-based compensation expense related to research and development increased to $222,000 in the second quarter of 2007 from $33,000 in the second quarter of 2006 and to $321,000 in the first half of 2007 from $38,000 in the first half of 2006.

     Sales and Marketing Expenses.Sales and marketing expenses primarily include personnel costs, sales commissions, professional services fees, trade shows, marketing programs, facilities and depreciation expenses, and bad debt expense. We plan to continue to invest heavily in sales and marketing by increasing the size of our field sales force and the number of our channel partners to allow us to expand into existing and new geographic and vertical markets. We also plan to continue to invest in expanding our domestic and international sales and marketing activities and building brand awareness. We expect that sales and marketing expenses will increase in absolute dollars and grow at a faster rate than our research and development expenses and thus remain our largest expense category. However, we expect sales and marketing expenses to decrease as a percentage of total revenue in the future due to our expected revenue growth and attainment of economies of scale. Over the next several years, we expect sales and marketing expenses to be in the high 20% to low 30% of total revenue. Generally, sales personnel are not immediately productive and thus sales and marketing expenses do not immediately result in revenue. Hiring additional sales personnel reduces short-term operating margins until the sales personnel become fully productive. Accordingly, the timing of sales personnel hiring and the rate at which they become productive will affect our future performance.

	Three Months Ended											Six Months Ended
	July 1,			July 2,								July 1,			July 2,
	2007			2006			$ change		% change			2007			2006			$ change		% change
	(dollars in thousands)											(dollars in thousands)
Sales and marketing expenses	$	9,956		$	5,685			4,271		75	%	$	19,227		$	10,501			8,726		83	%
Percent of total revenue		40	%		42	%							41	%		44	%

     Sales and marketing expenses increased primarily due to an increase in employee headcount to 133 at July 1, 2007, from 78 at July 2, 2006. The absolute dollar increases period-to-period were primarily due to an increase in salaries and benefits, trade shows, marketing programs and sales commissions. Stock-based compensation expense related to sales and marketing increased to $398,000 in the second quarter of 2007 from $28,000 in the second quarter of 2006 and to $550,000 in the first half of 2007 from $32,000 in the first half of 2006.

     General and Administrative Expenses.General and administrative expenses primarily include personnel costs, facilities expenses related to our executive, finance, human resources, information technology and legal organizations, and fees for professional services such as legal, accounting, compliance and information systems. Since our initial public offering, we have incurred and will continue to incur significant additional accounting, legal and compliance costs, as well as additional insurance, investor relations, and other costs associated with being a public company. Accordingly, we expect general and administrative expenses to continue to increase in total dollars although we expect these expenses to decrease as a percentage of total revenue to 6-10% over the next several years.

	Three Months Ended											Six Months Ended
	July 1,			July 2,								July 1,			July 2,
	2007			2006			$ change		% change			2007			2006			$ change		% change
	(dollars in thousands)											(dollars in thousands)
General and administrative expenses	$	3,183		$	1,777			1,406		79	%	$	5,883		$	3,070			2,813		92	%
Percent of total revenue		13	%		13	%							13	%		13	%

     General and administrative expenses increased primarily due to an increase in employee headcount to 43 at July 1, 2007, from 28 at July 2, 2006. The absolute dollar increases period-to-period were primarily due to an increase in salaries and benefits, stock-based compensation, facilities and depreciation expenses, and insurance costs. The additional personnel and professional services fees were primarily the result of our efforts to build our legal, financial, human resources and information technology functions required of a public company. We expect to continue to incur significant additional expenses as a result of operating as a public company, including costs to comply with the Sarbanes-Oxley Act of 2002 and other rules and regulations applicable to public companies. However, we expect total general and administrative costs to decrease as a percentage of revenue over time. Stock-based compensation expense related to general and administrative increased to $371,000 in the second quarter of 2007 from $44,000 in the second quarter of 2006 and to $559,000 in the first half of 2007 from $48,000 in the first half of 2006.

     Other Income (Expense), Net.Other income (expense), net primarily includes interest income on cash, cash equivalents and marketable securities balances and interest expense on our outstanding debt. In addition, the three months ended July 2, 2006, included the warrant revaluation expense adjustment to record our preferred stock warrants at fair value in accordance with FSP 150-5. We adopted FSP 150-5 and accounted for the related cumulative effect of the change in accounting principle on July 4, 2005.

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	Three Months Ended							Six Months Ended
	July 1,		July 2,					July 1,		July 2,
	2007		2006			$ change		2007		2006			$ change
	(in thousands)							(in thousands)
Interest income and other	$	1,167	$	22		$	1,145	$	2,331	$	66		$	2,265
Interest expense		—		(345	)		345		—		(456	)		456
Warrant revaluation expense		—		(765	)		765		—		(944	)		944
Loss on disposal of property and equipment		—		(72	)		72		—		(72	)		72
Other income (expense), net	$	1,167	$	(1,160	)	$	2,327	$	2,331	$	(1,406	)	$	3,737

     Other income (expense), net increased by $2.3 million due to a $1.1 increase in interest income related to our higher average cash, cash equivalents and marketable securities balances during the second quarter of 2007 from the comparable period in the prior year and a reduction in interest and warrant revaluation expense of $1.1 million. The higher average cash and cash equivalents balance during the first half of 2007 resulted from the proceeds received from our initial public offering in December 2006.

Liquidity and Capital Resources

     As of July 1, 2007, our principal sources of liquidity consisted of cash, cash equivalents and marketable securities of $94.5 million and net accounts receivable of $29.3 million.

     The following table shows our working capital and cash and cash equivalents as of the stated dates:

	As of
	July 1,		December 31,
	2007		2006
	(in thousands)
Working capital	$	103,532	$	109,093
Cash, cash equivalents and marketable securities		94,507		99,899

     The following table shows our cash flows from operating activities, investing activities and financing activities for the stated periods:

	Six Months Ended
	July 1,			July 2,
	2007			2006
	(in thousands)
Net cash used in operating activities	$	(1,762	)	$	(7,609	)
Net cash used in investing activities		(24,015	)		(1,507	)
Net cash (used in) provided by financing activities		(475	)		8,728

Cash Flows from Operating Activities

     Net cash used in operating activities was $1.8 million and $7.6 million during the six months ended July 1, 2007 and July 2, 2006. Net cash used in operating activities during the first half of 2007 consisted primarily of our net loss of $7.4 million, offset by net changes in current assets and liabilities of $1.4 million, depreciation and amortization expense of $2.4 million and stock-based compensation expense of $1.5 million.

     Net cash used in operating activities during the first half of 2006 primarily consisted of our net loss of $10.0 million and a use of $582,000 related to net changes in our operating assets and liabilities, reduced by depreciation and amortization expense of $1.7 million and warrant revaluation expense of $944,000.

Cash Flows from Investing Activities

     Cash flows from investing activities primarily relate to capital expenditures to support our growth. Net cash used in investing activities during the six months ended July 1, 2007, was $24.0 million, comprised of $20.8 million of purchases of marketable securities and $3.2 million of capital expenditures, primarily related to improvements for additional leased space for our headquarters and increased research and development lab equipment. Net cash used in investing activities during the six months ended July 2, 2006, was $1.5 million, comprised of $2.8 million in capital expenditures offset by net sales of marketable securities of $1.3 million.

Cash Flows from Financing Activities

     Net cash used in financing activities was $475,000 during the six months ended July 1, 2007, compared with net cash provided by financing activities of $8.7 million during the six months ended July 2, 2006. In the first half of 2007, the net cash used in financing activities primarily related to payments of previously accrued public offering costs of $600,000, offset by $200,000 in proceeds from issuance of common stock. In

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the first half of 2006, the net cash provided by financing activities of $8.7 million was primarily due to net borrowings of $8.2 million under our line of credit facilities and $577,000 in proceeds from issuance of common stock.

     We believe that our $94.5 million of cash, cash equivalents and marketable securities at July 1, 2007, will be sufficient to fund our projected operating requirements for at least twelve months. However, we may need to raise additional capital or incur additional indebtedness to continue to fund our operations in the future. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of our expansion into new territories, the timing of introductions of new products and enhancements to existing products, potential acquisitions of new businesses, and the continuing market acceptance of our products.

Contractual Obligations

     As of July 1, 2007, our principal commitments consisted of obligations outstanding under operating leases. We lease our facilities under operating leases that expire at various dates through 2014. There have been no material changes in our principal lease commitments compared to those discussed in our Annual Report on Form 10-K for the year ended December 31, 2006.

     We outsource the manufacturing of our products with Sanmina-SCI Corporation in which we maintain a rolling 90-day firm order based on production forecast. These orders may only be rescheduled or cancelled by Sanmina under certain limited conditions and, even then, with certain restrictions and penalties up to the full cost of the product. The remaining amount on the open purchase order with Sanmina and other partners and suppliers at July 1, 2007, was approximately $4.6 million.

Off-Balance Sheet Arrangements

     During the periods presented, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Recent Accounting Pronouncements

     In February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115,or SFAS 159. SFAS No. 159 permits entities to choose to measure eligible items at fair value at specified election dates and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. If we elect the fair value option provided for in this standard, it would be effective for financial statements issued for fiscal years beginning after November 15, 2007. We have not yet determined whether we will elect the option provided for in this standard, or the impact that the elective adoption may have on our consolidated results of operations or financial position.

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ITEM 3.Quantitative and Qualitative Disclosures About Market Risk

     Management believes there have been no material changes to our quantitative and qualitative disclosures about market risk during the three months ended July 1, 2007, compared to those discussed in our Annual Report on Form 10-K for the year ended December 31, 2006.

ITEM 4T.Controls and Procedures

     As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of our management, including our chief executive officer and chief financial officer (together, our “certifying officers”), of the effectiveness of the design and operation of our disclosure controls and procedures. Disclosure controls and procedures are controls and other procedures designed to ensure that information required to be disclosed by us in our periodic reports filed with the Security and Exchange Commission (“SEC”) is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and SEC reports, and that the information is accumulated and communicated to our management, including the chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. Based on their evaluation, our certifying officers concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report.

     We believe that a controls system, no matter how well designed and operated, is based in part upon certain assumptions about the likelihood of future events, and therefore can only provide reasonable, not absolute, assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected.

     There were no changes in our internal control over financial reporting during the quarter ended July 1, 2007, that our certifying officers concluded materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

     This Quarterly Report on Form 10-Q does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of our independent registered public accounting firm due to a transition period established by rules of the SEC for newly public companies. At the end of the fiscal year 2007, Section 404 of the Sarbanes-Oxley Act will require our management to provide an assessment of the effectiveness of our internal control over financial reporting, and our independent registered public accounting firm will be required to audit management’s assessment. We are in the process of performing the system and process documentation, evaluation and testing required for management to make this assessment and for its independent auditors to provide its attestation report. We have not completed this process or its assessment, and this process will require significant amounts of management time and resources. In the course of evaluation and testing, management may identify deficiencies that will need to be addressed and remediated.

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PART II – OTHER INFORMATION

ITEM 1.Legal Proceedings

     From time to time, we may become involved in legal proceedings arising in the ordinary course of our business. We are not presently a party to any legal proceedings the outcome of which, if determined adversely to us, would individually or in the aggregate have a material adverse effect on our business, operating results, financial condition or cash flows.

ITEM 1A.Risk Factors

Risks Related to Our Business and Industry

We have a history of losses, and we may not achieve profitability in the future.

     We have not been profitable in any fiscal period since we were formed. We experienced a net loss of $3.6 million and $7.4 million for the three and six months ended July 1, 2007, and $5.5 million and $10.0 million for the three and six months ended July 2, 2006. As of July 1, 2007, our accumulated deficit was $82.5 million. We expect to make significant expenditures related to the development of our products and expansion of our business, including expenditures for additional sales and marketing and research and development personnel. We may encounter unforeseen difficulties, complications and 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 revenue to achieve profitability. Our revenue growth trends in prior periods are not likely to be sustainable. Accordingly, we may not be able to achieve or maintain profitability and we may continue to incur significant losses in the future.

We face intense competition and expect competition to increase in the future, which could reduce our revenue and customer base.

     The storage market is highly competitive and we expect competition to intensify in the future. This competition could make it more difficult for us to sell our products, and result in increased pricing pressure, reduced profit margins, increased sales and marketing expenses and failure to increase, or the loss of, market share, any of which would likely seriously harm our business, operating results and financial condition. For instance, the decrease in the price of disk drives and other industry standard hardware components has resulted in increased pricing pressure and a reduction in the price per megabyte of storage.

     Currently, we face competition from a number of established companies, including EMC Corporation, Hewlett-Packard Company, Hitachi Data Systems Corporation, International Business Machines Corporation, Network Appliance, Inc. and Sun Microsystems, Inc. We also face competition from a large number of private companies and recent market entrants. Many of our current competitors have, and some of our potential competitors could have, longer operating histories, greater name recognition, larger customer bases and significantly greater financial, technical, sales, marketing and other resources than we have. Potential customers may prefer to purchase from their existing suppliers rather than a new supplier regardless of product performance or features.

     We expect increased competition from other established and emerging companies, including companies such as networking infrastructure and storage management companies that provide complementary technology and functionality. In addition, third parties currently selling our products could market products and services that compete with ours. Some of our competitors, including EMC and Network Appliance, have made acquisitions of businesses that allow them to offer more directly competitive and comprehensive solutions than they had previously offered. Our current and potential competitors may also establish cooperative relationships among themselves or with third parties. If so, new competitors or alliances that include our competitors may emerge that could acquire significant market share. We expect these trends to continue as companies attempt to strengthen or maintain their market positions in an evolving industry. In addition, large operating system and application vendors, such as Microsoft Corporation, have introduced and may in the future introduce products or functionality that include some of the same functions offered by our products. In the future, further development by these vendors could cause our products to become obsolete. In addition, we compete against internally developed storage solutions as well as combined third-party software and hardware solutions. Any of these competitive threats, alone or in combination with others, could seriously harm our business, operating results and financial condition.

Our operating results may fluctuate significantly, which makes our future results difficult to predict and could cause our operating results to fall below expectations.

     Our operating results may fluctuate due to a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. In addition, a significant portion of our quarterly sales typically occurs near the end of the quarter. As a result, small

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delays can make our operating results difficult to predict. If our revenue or operating results fall below the expectations of investors or any securities analysts that follow our company, the price of our common stock would likely decline.

     Factors that may affect our operating results include:

• the timing and magnitude of shipments and timing of installations of our products in each quarter;

• our ability to build and expand our direct sales operations and reseller distribution channels;

• our ability to build sales backlogs and improve sales linearity;

• reductions in customers’ budgets for information technology purchases, delays in their purchasing cycles or deferments of their product purchases in anticipation of new products or updates from us or our competitors;

• the rates at which customers purchase additional storage systems from us and renew their service contracts with us;

• the timing of recognizing revenue as a result of revenue recognition rules;

• fluctuations in demand, sales cycles and prices for our products and services;

• our ability to develop, introduce and ship in a timely manner new products and product enhancements that meet customer requirements;

• the timing of product releases or upgrades or announcements by us or our competitors;

• any change in competitive dynamics, including new entrants or discounting of product prices;

• our ability to control costs, including our operating expenses and the costs of the components we use in our products;

• the possibility of seasonality of demand for our products;

• volatility in our stock price, which may lead to higher stock compensation expenses pursuant to Statement of Financial Accounting Standards No. 123(R),Share-Based Payment, or SFAS 123(R), which first became effective for us in the first quarter of 2006 and requires that employee stock-based compensation be measured based on its fair value on the grant date and recorded as an expense in our financial statements over the recipient’s service period;

• future accounting pronouncements and changes in accounting policies; and

• geopolitical events such as war or incidents of terrorism.

Our limited operating history in an emerging market sector makes it difficult to evaluate our current business and future prospects, and may increase the risk of your investment.

     Our company has only been in existence since January 2001. We first began shipping products in January 2003 and much of our growth has occurred since October 2005. Our limited operating history in an emerging market sector makes it difficult to evaluate our current business and our future prospects. We have encountered and will continue to encounter risks and difficulties frequently experienced by growing companies in rapidly changing industries, such as the risks described in this report. If we do not address these risks successfully, our business will be harmed.

Our future financial performance depends on growth in the storage of unstructured, digital content. If growth in the storage of unstructured, digital content does not continue at the rate that we forecast, our operating results would be materially and adversely impacted.

     Our products are designed to address the growth in storage of unstructured, digital content. This is a new and emerging category. Accordingly, our future financial performance will depend in large part on growth in this new category and on our ability to adapt to emerging demands. Changes in technologies could adversely affect the demand for storage systems. For example, advances in file compression technology could result in smaller file sizes and reduce the demand for storage systems. A reduction in demand for storage of unstructured, digital content caused by lack of customer acceptance, weakening economic conditions, competing technologies and products, decreases in corporate spending or otherwise, would result in decreased revenue or a lower revenue growth rate. We cannot assure you that growth in the storage of unstructured, digital content will continue or that we will be able to respond adequately to changes in the future.

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If we are unable to maintain or replace our relationships with customers or to increase the diversification of our customer base, it would be more difficult to maintain or grow our revenue and our growth might be limited.

     Historically, a significant portion of our total revenue has come from a limited number of customers in a small number of industries, particularly media and entertainment and Internet companies. For example, our largest customer for the three and six months ended July 1, 2007, Eastman Kodak Company, accounted for approximately 17% and 16% of our total revenue, respectively, and our two largest customers for the three and six months ended July 2, 2006, Comcast Corporation, which purchased through one of our resellers, and Eastman Kodak Company, accounted for approximately 35% and 32% of our total revenue, respectively. Because of concentrated purchases by certain new and existing customers, our largest customers have historically varied from quarter to quarter. As a consequence of the concentrated nature of our customers’ purchasing patterns, the proportion of our total revenue derived from a small number of customers may be even higher in any future quarter. We cannot provide any assurance that we will be able to sustain our revenue from these customers because our revenue has largely been generated in connection with these customers’ decisions to deploy large-scale storage installations and their capacity requirements may have been met. In addition, our customers, including Comcast Corporation and Eastman Kodak Company, generally buy systems on a purchase order basis and generally do not enter into long-term contracts or minimum purchase commitments. If we are unable to sustain our revenue from these customers or to replace it with revenue from new or existing customers, our growth may be limited. If economic conditions change for the industries in which our largest customers do business, or if we are unable to attract significant numbers of customers in other targeted industries, including government, oil and gas, and life sciences, our ability to maintain or grow our revenue would be adversely affected.

If we are unable to develop and introduce new products and respond to technological changes, if our new products do not achieve market acceptance or if we fail to manage product transitions, we may fail to increase, or may lose, market share.

     Our future growth depends on the successful development and introduction of new systems and software products. Due to the complexity of storage systems, these products are subject to significant technical risks that may impact our ability to introduce these products successfully. Our new products also may not achieve market acceptance. In addition, our new products must respond to technological changes and evolving industry standards. If we are unable, for technological or other reasons, to develop and introduce new products in a timely manner in response to changing market conditions or customer requirements, or if these products do not achieve market acceptance, our operating results could be materially and adversely affected.

     Product introductions by us in future periods may also reduce demand for our existing products. As new or enhanced products are introduced, we must successfully manage the transition from older products in order to minimize disruption in customers’ ordering patterns, avoid excessive levels of older product inventories and ensure that sufficient supplies of new products can be delivered to meet customer demand.

We rely on value-added resellers and other distribution partners to sell our products, and disruptions to, or our failure to develop and manage, our distribution channels and the processes and procedures that support them could result in these resellers and partners discontinuing the marketing and distribution of our products and services.

     Our future success is highly dependent upon establishing and maintaining successful relationships with a variety of value-added resellers and other distribution partners, which we collectively refer to as channel partners. A significant portion of our total revenue is currently derived through our channel partners. Therefore, our ability to maintain or grow our revenue will likely depend, in part, on our ability to maintain our arrangements with our existing channel partners and to establish and expand arrangements with new channel partners, and any failure to do so could have a material adverse effect on our future revenue. Additionally, by relying on channel partners, we may have less contact with the ultimate users of our products, thereby making it more difficult for us to establish brand awareness, ensure proper delivery and installation of our products, service ongoing customer requirements and respond to evolving customer needs.

     Recruiting and retaining qualified channel partners and training them in our technology and product offerings require significant time and resources. In order to develop and expand our distribution channel, we must continue to scale and improve our processes and procedures that support our channel partners, including investments in systems and training. Those processes and procedures may become increasingly complex and difficult to manage.

     We typically enter into non-exclusive, written distribution agreements with our channel partners that generally have a one-year term, have no minimum sales commitment and do not prohibit them from offering products and services that compete with ours. Accordingly, our channel partners may choose to discontinue offering our products and services or may not devote sufficient attention and resources toward selling our products and services. Our competitors may provide incentives to our existing and potential channel partners to use or purchase their products and services or to prevent or reduce sales of our products and services. Some of our channel partners possess significant resources and advanced technical abilities and may, either independently or jointly with our competitors, develop and market products and related services that compete with our offerings. If this were to occur, these channel partners might discontinue marketing and distributing our products and services. In addition, these channel partners would have an advantage over us when marketing their competing products and related services because of their existing customer relationships. The occurrence of any of these events would likely materially adversely affect our business, operating results and financial condition.

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Claims by others that we infringe their proprietary technology could cause us to incur substantial costs, distract our management and, if these claims are successful, require us to pay substantial damages or prevent us from offering our products.

     Third parties could claim that our products or technologies infringe their proprietary rights. The data storage 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. We expect that infringement claims may further increase as the number of products and competitors in our market increases. Although we have not to date been involved in any litigation related to intellectual property, we received a letter on July 31, 2006, from counsel to SeaChange International, Inc., a supplier of video-on-demand digital server systems and software to the television industry, suggesting that our products may be using SeaChange’s patented technology. We sent a response letter to SeaChange on August 7, 2006, to convey our good faith belief, based on our initial review of SeaChange’s patents, that the SeaChange patents are not relevant to Isilon’s products. We have exchanged additional correspondence with SeaChange’s legal counsel, who, among other things, alleged infringement and requested a meeting to discuss SeaChange’s concerns. We have investigated these allegations with the assistance of counsel, and we believe that we do not infringe. If we are unable to reach an amicable resolution of this dispute, it is possible that litigation with SeaChange may result. The outcome of any litigation is inherently unpredictable, and accordingly, we cannot assure you that, in the future, a court would not find that our products infringed these patents. 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.

     Any claim of infringement by a third party, even one without merit, could cause us to incur substantial costs defending against the claim, and could distract our management from our business. Further, a party making such a claim, if successful, could secure a judgment that requires us to pay substantial damages. A judgment could also include an injunction or other court order that could prevent us from offering our products. In addition, we might be required to seek a license for the use of the infringed intellectual property, which might not be available on commercially reasonable terms or at all. Alternatively, we might be required to develop non-infringing technology, which could require significant effort and expense and might ultimately be unsuccessful. Any of these events could seriously harm our business, operating results and financial condition. Third parties may also assert infringement claims against our customers and channel partners. Any of these claims would require us to initiate or defend potentially protracted and costly litigation on their behalf, regardless of the merits of these claims, because we generally indemnify our customers and channel partners from claims of infringement of proprietary rights of third parties. If any of these claims succeeds, we might be forced to pay damages on behalf of our customers or channel partners, which could have a material adverse effect on our business, operating results and financial condition.

Our sales cycles can be long and unpredictable, and our sales development efforts require considerable time and expense. As a result, our sales are difficult to predict and may vary substantially from quarter to quarter, which may cause our operating results to fluctuate significantly.

     The timing of our revenue is difficult to predict. Our sales efforts involve building and expanding our direct sales operations and reseller distribution channels, improving our ability to build sales backlogs and improve sales linearity, and educating our customers about the use and benefits of our products, including their technical capabilities and potential cost savings to an organization. Customers typically undertake a significant evaluation process that in the past has resulted in a lengthy sales cycle, in some cases more than 12 months. We spend substantial time and resources on our sales efforts without any assurance that our efforts will produce any sales. In addition, product purchases are frequently subject to budget constraints, multiple approvals and unplanned administrative, processing and other delays. If we do not realize expected sales from a specific customer for a particular quarter in that quarter or at all, our business, operating results and financial condition could be harmed.

We derive substantially all of our total revenue from sales of our Isilon IQ product family and related services, and a decline in demand for our Isilon IQ product family would cause our revenue to grow more slowly or to decline.

     We derive substantially all of our total revenue from sales of our Isilon IQ product family and customer and technical support services associated with this product family. As a result, we are vulnerable to fluctuations in demand for this product family, whether as a result of competition, product obsolescence, technological change, customer budgetary constraints or other factors. If demand for our Isilon IQ product family were to decline, our financial condition would be harmed.

If we are unable to continue to create valuable innovations in software, we may not be able to generate additional high-margin revenue to increase our gross margins.

     Our industry has a history of declining storage hardware prices as measured on a cost per gigabyte of storage capacity basis. In order to maintain or increase our gross margins, we will need to continue to create valuable software that is included with our clustered storage systems and/or sold as separate standalone software applications. Any new feature or application that we develop or acquire may not be introduced in a timely or cost-effective manner and may not achieve the broad market acceptance necessary to help increase our overall gross margin. If we are unable to successfully develop or acquire, and then market and sell, additional software functionality, such as our recently introduced SmartConnect, SnapshotIQ, Migration IQ, and SmartQuotas software applications, in addition to our previously released SyncIQ software application, our ability to maintain or increase our high-margin revenue and gross margin will be adversely affected.

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We currently rely on a single contract manufacturer to assemble our products, and our failure to forecast demand for our products accurately or manage our relationship with our contract manufacturer successfully could negatively impact our ability to sell our products.

     We currently rely on a single contract manufacturer, Sanmina-SCI Corporation, to assemble our products, manage our supply chain and, alone or together with us, negotiate component costs. Our reliance on Sanmina reduces our control over the assembly process, exposing us to risks, including reduced control over quality assurance, production costs and product supply. If we fail to manage our relationship with Sanmina effectively, or if Sanmina experiences delays, disruptions, capacity constraints or quality control problems in its operations, our ability to ship products to our customers could be impaired and our competitive position and reputation could be harmed. If we and Sanmina are unable to negotiate with suppliers for reduced component costs, our operating results would be harmed. Additionally, Sanmina can terminate our agreement for any reason upon 120 days’ notice or for cause upon 30 days’ notice. If we are required to change contract manufacturers or assume internal manufacturing operations, we may lose revenue, incur increased costs and damage our customer relationships. Qualifying a new contract manufacturer and commencing volume production are expensive and time-consuming. We are required to provide forecasts to Sanmina regarding product demand and production levels. If we inaccurately forecast demand for our products, we may have excess or inadequate inventory or incur cancellation charges or penalties, which could adversely impact our operating results.

     We intend to introduce new products and product enhancements, which could require us to achieve volume production rapidly by coordinating with Sanmina and component suppliers. We may need to increase our component purchases, contract manufacturing capacity, and internal test and quality functions if we experience increased demand. The inability of Sanmina to provide us with adequate supplies of high-quality products, or an inability to obtain adequate quantities of components, could cause a delay in our order fulfillment, and our business, operating results and financial condition would be adversely affected.

We rely on a limited number of suppliers, and in some cases single-source suppliers, and any disruption or termination of these supply arrangements could delay shipments of our products and could materially and adversely affect our relationships with current and prospective customers.

     We rely on a limited number of suppliers for several key components utilized in the assembly of our products. We purchase several of our required components, such as chassis and disk drives, from a single supplier. This reliance on a limited number of suppliers involves several risks, including:

• supplier capacity constraints;

• price increases;

• timely delivery; and

• component quality.

     Component quality is particularly significant with respect to our suppliers of disk drives. In order to meet product capacity requirements, we must obtain disk drives of extremely high quality and capacity. We cannot assure you that we will be able to obtain enough of these components in the future or that prices of these components will not increase. In addition, problems with respect to yield and quality of these components and timeliness of deliveries could occur. Disruption or termination of the supply of these components could delay shipments of our products and could materially and adversely affect our relationships with current and prospective customers. These delays could also materially and adversely affect our operating results.

If we fail to manage future growth effectively, we may not be able to market and sell our products and services successfully.

     We have expanded our operations significantly since inception and anticipate that further significant expansion will be required. Our future operating results depend to a large extent on our management’s ability to manage expansion and growth successfully, including, but not limited to, hiring, training and developing our sales personnel to become productive and generate revenue, forecasting revenue, controlling expenses, implementing and enhancing infrastructure, systems and processes, addressing new markets and expanding international operations. A failure to manage our growth effectively could materially and adversely affect our ability to market and sell our products and services.

Our products incorporate components that are obtained in spot markets, and, as a result, our cost structure and our ability to respond in a timely manner to customer demand are sensitive to volatility in the market prices for these components.

     A significant portion of our expenses is directly related to the pricing of commoditized components utilized in the manufacture of our products, such as memory chips, disk drives and CPUs. As part of our procurement model, we do not enter into long-term supply contracts for these components, but instead have our contract manufacturer purchase these components on our behalf. In some cases, our contract manufacturer does so in a competitive-bid purchase order environment with suppliers or on the open market at spot prices. As a result, our cost structure is affected by price volatility in the marketplace for these components, especially for disk drives. This volatility makes it difficult to predict expense levels and operating results and may cause them to fluctuate significantly. Furthermore, if we are successful in growing our

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business, we may not be able to continue to procure components on the spot market, which would require us to enter into contracts with component suppliers to obtain these components. This could increase our costs and decrease our gross margins.

We maintain relatively low inventory and acquire components only as needed; as a result, if shortages of these components arise, we may not be able to secure enough components to build new products to meet customer demand.

     We maintain relatively low inventory and acquire components only as needed, and neither we nor our contract manufacturer enter into long-term supply contracts for these components. As a result, our ability to respond to customer orders efficiently may be constrained by the then-current availability or 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. For example, disk drives can represent a significant portion of our cost of revenue, and both the price and availability of various kinds of disk drives are subject to substantial volatility in the spot market. In the past, we have encountered situations where we paid higher prices than we had anticipated for disk drives or had to use a larger-size drive as a replacement. Likewise, the industry recently experienced a shortage of selected memory chips, which caused some of our motherboard suppliers to reduce or suspend shipments to us. This delayed our ability to ship selected configurations to some of our customers, and in some cases accelerated a transition by us to other components. In addition, new generations of disk drives are often in short supply and are subject to industry allocations that may limit our ability to procure these disk drives. Many of the other components required to build our systems are occasionally in short supply and subject to industry allocations. If shortages or delays arise, the prices of these components may increase or the components may not be available at all. We may not be able to secure enough components at reasonable prices or of acceptable quality to build new products to meet customer demand, which could adversely affect our business, operating results and financial condition.

If we lose key personnel, if key personnel are distracted or if we are unable to attract and retain highly-qualified personnel on a cost-effective basis, it would be more difficult for us to manage our existing business operations and to identify and pursue new growth opportunities.

     Our future performance depends on the continued service of our key technical, sales, services and management personnel. We rely on our executive officers and senior management to manage our existing business operations and to identify and pursue new growth opportunities. The loss of key employees could result in significant disruptions to our business, and the integration of replacement personnel could be time-consuming, cause additional disruptions to our business or be unsuccessful. In addition, key personnel may be distracted by activities unrelated to our business. For instance, prior to joining us, Steven Goldman, our President and Chief Executive Officer, served in various senior executive positions in sales, marketing and services at F5 Networks, Inc. Mr. Goldman has been named, together with other former and current officers and directors of F5 Networks, as a co-defendant in a number of federal and state derivative lawsuits that have been filed since May 2006. The plaintiffs in these actions are seeking to bring derivative claims on behalf of F5 Networks against the defendants based on allegations of improper stock option pricing practices. Mr. Goldman has engaged his own counsel to represent him in these actions and believes that he has meritorious defenses to all claims against him. We currently carry key-person life insurance covering only Mr. Goldman, and this insurance may not be able to compensate us adequately for the loss of Mr. Goldman’s services in the event of his death. The loss of the services, or distraction, of Mr. Goldman or other key executives for any reason could adversely affect our business, operating results and financial condition.

     Our future success also depends on our continued ability to attract and retain highly-qualified technical, sales, services and management personnel. In particular, our ability to enhance and maintain our technology requires talented software development engineers with specialized skills in areas such as distributed computing, file systems and operating systems. If we are not able to recruit and retain these engineers, the quality and speed with which our products are developed would likely be seriously compromised, and our reputation and business would suffer as a result. Competition for these and the other personnel we require, particularly in the Seattle metropolitan area, is intense, and we may fail to retain our key technical, sales, services and management employees or to attract or retain other highly-qualified technical, sales, services and management personnel in the future.

Our ability to sell our products is highly dependent on the quality of our service offerings, and our failure to offer high-quality service offerings would have a material adverse effect on our ability to market and sell our products and services.

     After our products are deployed within our customers’ networks, our customers depend on our services organization to resolve issues relating to our products. High-quality support services are critical for the successful marketing and sale of our products. If we or our channel partners do not effectively assist our customers in deploying our products, succeed in helping our customers to resolve post-deployment issues quickly, and provide ongoing support, it would adversely affect our ability to sell our products to existing customers and could harm our prospects with potential customers. In addition, as we expand our operations internationally, our services organization will face additional challenges, including those associated with delivering services, training and documentation in languages other than English. As a result, our failure to maintain high-quality support services could have a material adverse effect on our business, operating results and financial condition.

Our products are highly technical and may contain undetected software or hardware defects, which could cause data unavailability, loss or corruption that might, in turn, result in liability to our customers and harm to our reputation and business.

     Our storage products are highly technical and complex and are often used to store information critical to our customers’ business operations. Our products have contained and may contain undetected errors, defects or security vulnerabilities that could result in data unavailability, loss or corruption or other harm to our customers. Some errors in our products may only be discovered after they have been installed and used by customers. Any errors, defects or security vulnerabilities discovered in our products after commercial release, as well as any computer virus or human error on the part of our customer support or other personnel resulting in a customer’s data unavailability, loss or corruption could result

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in a loss of revenue or delay in revenue recognition, a loss of customers or increased service and warranty costs, any of which could adversely affect our business, operating results and financial condition. In addition, we could face claims for product liability, tort or breach of warranty, including claims relating to changes to our products made by our channel partners. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may be difficult to enforce. Defending a lawsuit, regardless of its merit, would be costly and might divert management’s attention and adversely affect the market’s perception of us and our products. In addition, if our business liability insurance coverage proves inadequate with respect to a claim or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely impacted.

Our international sales and operations and offshore development initiative subject us to additional risks that may adversely affect our international operations and reduce our international sales.

     We derived approximately 31% and 28% and of our total revenue from customers outside the United States during the three and six months ended July 1, 2007, respectively, and 20% and 21% during the three and six months ended July 2, 2006, respectively. We have sales and technical support personnel in several countries worldwide. We expect to continue to add personnel in additional countries. In addition, we use an offshore software development team from a third-party contract engineering provider in Moscow, Russia, and we may expand our offshore development effort within Russia and possibly in other countries. Our various international operations subject us to a variety of risks, including:

• the difficulty of managing and staffing international offices and the increased travel, infrastructure and legal compliance costs associated with multiple international locations;

• difficulties in enforcing contracts and collecting accounts receivable, and longer payment cycles, especially in emerging markets;

• the challenge of managing development teams in geographically disparate locations;

• tariffs and trade barriers and other regulatory or contractual limitations on our ability to sell or develop our products in various foreign markets;

• increased exposure to foreign currency exchange rate risk;

• the ability of our third-party contract engineering provider in Moscow, Russia to terminate our agreement for any reason upon 90 days’ notice;

• reduced protection for intellectual property rights in some countries, including Russia; and

• political and economic instability.

     As we expand our business globally, our success will depend, in large part, on our ability to anticipate and effectively manage these risks. Our failure to manage any of these risks successfully could harm our international operations and reduce our international sales, adversely affecting our business, operating results and financial condition.

If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.

     Our success is dependent in part on obtaining, maintaining and enforcing our patent and other proprietary rights. We rely on trade secret, patent, copyright and trademark laws and confidentiality agreements with employees and third parties, all of which offer only limited protection. The steps we have taken to protect our proprietary rights may not be adequate to prevent misappropriation of our proprietary information or infringement of our intellectual property rights, and our ability to prevent this misappropriation or infringement is uncertain, particularly in countries outside of the United States. Further, with respect to patent rights, we do not know whether any of our pending patent applications will result in the issuance of a patent or whether the examination process will require us to narrow our claims. To date, we have obtained one issued United States patent and this patent, as well as any additional patents that may be issued to us may be contested, circumvented, found unenforceable or invalidated, and we may not be able to prevent third parties from infringing them. Moreover, the rights granted under any issued patents may not provide us with proprietary protection or competitive advantages, and, as a result, our competitors may be able to develop technologies similar or superior to ours.

     Protecting against the unauthorized use of our products, trademarks and other proprietary rights is expensive and difficult. Litigation may be necessary in the future to enforce or defend our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Any such litigation could result in substantial costs and diversion of management resources, either of which could harm our business, operating results and financial condition. Further, many of our current and potential competitors have the ability to dedicate substantially greater resources to enforcing their intellectual property rights than we have. Accordingly, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property.

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Our use of open source and third-party software could impose unanticipated conditions or restrictions on our ability to commercialize our products.

     We incorporate open source software into our products. Although we monitor our use of open source software to avoid subjecting our products to conditions we do not intend, the terms of many open source licenses have not been interpreted by United States courts, and there is a risk that these licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. 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 discontinue the sale of our products if re-engineering could not be accomplished on a timely basis, any of which could adversely affect our business, operating results and financial condition.

     We may also find that we need to incorporate certain proprietary third-party technologies, including software programs, into our products in the future. However, licenses to relevant third-party technology may not be available to us on commercially reasonable terms, or at all. Therefore, we could face delays in product releases until equivalent technology can be identified, licensed or developed, and integrated into our current products. These delays, if they occur, could materially adversely affect our business, operating results and financial condition.

Our products must interoperate with many software applications that are developed by others and if we are unable to devote the necessary resources to ensure that our products interoperate with those applications, we may fail to increase, or we may lose, market share and we may experience a weakening demand for our products.

     Our products must interoperate with many software applications that are developed by others. When new or updated versions of these software applications are introduced, we must sometimes develop updated versions of our software so that they interoperate properly with these applications. We may not accomplish these development efforts quickly, cost-effectively or at all. These development efforts require substantial capital investment and the devotion of substantial employee resources. For example, our products currently interoperate with a number of data protection applications marketed by vendors such as Symantec Corporation and EMC. If we fail to maintain compatibility with these applications, our customers may not be able to protect adequately the data resident on our products and we may, among other consequences, fail to increase, or we may lose, market share and experience a weakening in demand for our products, which would adversely affect our business, operating results and financial condition.

Our products must interoperate with various data-access protocols and, if we are unable to ensure that our products interoperate with these protocols, our products might become less competitive.

     Our products interoperate with servers and software applications predominantly through the use of protocols, many of which are created and maintained by independent standards organizations. However, some of these protocols that exist today or that may be created in the future are or could be proprietary technology and therefore require licensing the proprietary protocol’s specifications from a third party or implementing the protocol without specifications, which might entail significant effort on our part. If we fail to obtain a license to these specifications from third-party vendors on reasonable terms or at all, and we are not able to implement the protocol in the absence of these specifications, our products might become less competitive, which would harm our business. For example, Microsoft Corporation maintains and enhances the Common Internet File System, or CIFS, a proprietary protocol that our products use to communicate with the Windows operating system, the most popular computer operating system in the world. Although our products are currently compatible with CIFS, at present we do not license the specifications to this proprietary protocol. If we are not able to continue to maintain adequate compatibility with CIFS or if we are not able to license adequate specifications to this protocol on reasonable terms, our products would likely be less competitive in the marketplace, which would adversely affect our business, operating results and financial condition.

If our products do not interoperate with our customers’ networks, servers or software applications, installations would be delayed or cancelled.

     Our products must interoperate with our customers’ existing infrastructure, specifically their networks, servers and software applications. This infrastructure often utilizes multiple protocol standards, products from multiple vendors and a wide range of storage features. If we find, as we have in the past, defects in the existing software or hardware used in our customers’ infrastructure or an incompatibility or deficiency in our software, we may have to modify our software so that our products will interoperate with our customers’ infrastructure. This could cause longer sales and implementation cycles for our products and could cause order cancellations, either of which would adversely affect our business, operating results and financial condition.

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 customers, 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, increase our expenses and adversely impact our business, operating results and financial condition. 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.

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Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and affect our reported results of operations.

     A change in accounting standards or practices can have a significant effect on our operating results and may affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of existing accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. For example, as a result of SFAS 123(R), our results of operations in 2006 reflect expenses that are not reflected in prior periods, making it more difficult for investors to evaluate our 2006 results of operations relative to prior periods.

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements could be impaired, which could adversely affect our operating results, our ability to operate our business and investors’ views of us.

     Ensuring that we have adequate internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. We are in the process of documenting, reviewing and, if appropriate, improving our internal controls and procedures as we are subject to Section 404 of the Sarbanes-Oxley Act of 2002, which will for fiscal 2007, require annual management assessments of the effectiveness of our internal control over financial reporting and a report by our independent registered public accounting firm addressing these assessments. Both we and our independent registered public accounting firm have begun the process of testing our internal controls as we are subject to Section 404 requirements and, as part of that documentation and testing, are working to identify areas for further attention and improvement. Implementing any appropriate changes to our internal controls may entail substantial costs in order to modify our existing financial and accounting systems, take a significant period of time to complete, and distract our officers, directors and employees from the operation of our business. These changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or a consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In addition, investors’ perceptions that our internal controls are inadequate or that we are unable to produce accurate financial statements may seriously affect our stock price.

Our business is subject to increasingly complex environmental legislation that has increased both our costs and the risk of noncompliance.

     We face increasing complexity in our product design and procurement operations as we adjust to new and upcoming requirements relating to the materials composition of many of our products. The European Union, or EU, has adopted certain directives to facilitate the recycling of electrical and electronic equipment sold in the EU, including the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment, or RoHS, directive. The RoHS directive restricts the use of lead, mercury and certain other substances in electrical and electronic products placed on the market in the EU after July 1, 2006.

     In connection with our compliance with these environmental laws and regulations, we could incur substantial costs, including reserves taken for excess component inventory, and be subject to disruptions to our operations and logistics. In addition, we will need to ensure that we can manufacture compliant products and that we can be assured a supply of compliant components from suppliers. Similar laws and regulations have been proposed or may be enacted in other regions, including in the United States, China and Japan. Other environmental regulations may require us to reengineer our products to utilize components that are compatible with these regulations, and this reengineering and component substitution may result in additional costs to us. We cannot assure you that existing laws or future laws will not have a material adverse effect on our business.

We are subject to governmental export and import controls that could impair our ability to compete in international markets.

     Because we incorporate encryption technology into our products, our products are subject to United States export controls and may be exported outside the United States only with the required level of export license or through an export license exception. In addition, various countries regulate the importation of certain encryption technology and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries. Changes in our products or changes in export and import regulations may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products throughout their global systems or, in some cases, prevent the export or import of our products to certain countries altogether. Any change in export or import regulations or related legislation, shift in approach to the enforcement or scope of existing regulations or change in the countries, persons or technologies targeted by these regulations could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations.

If we need additional capital in the future, it may not be available to us on favorable terms, or at all.

     We have historically relied on outside financing and customer payments to fund our operations, capital expenditures and expansion. We may require additional capital from equity or debt financing in the future to fund our operations or respond to competitive pressures or strategic opportunities. We may not be able to secure timely additional financing on favorable terms, or at all. The terms of any additional financing may place limits on our financial and operating flexibility. If we raise additional funds through further issuances of equity, convertible debt securities or other securities convertible into equity, our existing stockholders could suffer significant dilution in their percentage ownership of our company, and any new securities we issue could have rights, preferences and privileges senior to those of holders of our common stock. If we are unable to obtain adequate financing or financing on terms satisfactory to us, if and when we require it, our ability to grow or support our business and to respond to business challenges could be significantly limited.

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Our business is subject to the risks of earthquakes and other natural catastrophic events, and to interruption by man-made problems such as computer viruses or terrorism.

     Our corporate headquarters are located in Seattle, Washington, an area that is at heightened risk of earthquake and volcanic events. We may not have adequate business interruption insurance to compensate us for losses that may occur from any such significant events. A significant natural disaster, such as an earthquake or volcanic eruption, could have a material adverse impact on our business, operating results and financial condition. Also, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. In addition, acts of terrorism could cause disruptions in our or our customers’ business or the economy as a whole. To the extent that these disruptions result in delays or cancellations of customer orders or the deployment of our products, our business, operating results and financial condition would be adversely affected.

Risks Related Ownership of Our Common Stock

The trading price of our common stock is likely to be volatile.

     The trading prices of the securities of technology companies have been highly volatile. Further, our common stock has a limited trading history. Since our initial public offering in December 2006 through August 6, 2007, our stock price has fluctuated from a low of $9.12 to a high of $28.50. Factors affecting the trading price of our common stock, some of which are outside our control, include:

• variations in our operating results or those of our competitors;

• announcements of technological innovations, new products or product enhancements, strategic alliances or significant agreements by us or by our competitors;

• the gain or loss of significant customers;

• the level of sales in a particular quarter;

• lawsuits threatened or filed against us;

• the recruitment or departure of key personnel;

• changes in the estimates of our operating results or changes in recommendations by any securities analysts who elect to follow our common stock;

• market conditions in our industry, the industries of our customers and the economy as a whole;

• the adoption or modification of regulations, policies, procedures or programs applicable to our business; and

• the expiration of lock-up agreements.

     In addition, if the market for technology stocks or the stock market in general experiences loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, operating results or financial condition. The trading price of our common stock might also decline in reaction to events that affect other companies in our industry even if these events do not directly affect us. Each of these factors, among others, could have a material adverse effect on an investment in our common stock. Some companies that have had volatile market prices for their securities have had securities class actions filed against them. If a suit were filed against us, regardless of its merits or outcome, it would likely result in substantial costs and divert management’s attention and resources. This could have a material adverse effect on our business, operating results and financial condition.

If there are substantial sales of common stock, our stock price could decline.

     If our existing stockholders sell a large number of shares of common stock or the public market perceives that existing stockholders might sell shares of common stock, the market price of our common stock could decline significantly.

If securities or industry analysts cease publishing research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

     The trading market for our common stock depends in part on any research and reports that securities or industry analysts publish about us or our business. In the event one or more of these analysts downgrade our stock, cease publishing or publish inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.

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Insiders continue to have substantial control over us and will be able to influence corporate matters.

     As of July 1, 2007, our directors and executive officers and their affiliates beneficially own, in the aggregate, approximately 53.1% of our outstanding common stock. As a result, these stockholders will be able to exercise significant influence over all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, such as a merger or other sale of our company or its assets. This concentration of ownership could limit other stockholders’ ability to influence corporate matters and may have the effect of delaying or preventing a third party from acquiring control over us.

Provisions in our certificate of incorporation and bylaws and Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.

     Our certificate of incorporation and bylaws contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change in control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions:

• establish a classified board of directors so that not all members of our board are elected at one time;

• provide that directors may only be removed “for cause;”

• authorize the issuance of “blank check” preferred stock that our board of directors could issue to increase the number of outstanding shares and to discourage a takeover attempt;

• eliminate the ability of our stockholders to call special meetings of stockholders;

• prohibit stockholder action by written consent, which has the effect of requiring all stockholder actions to be taken at a meeting of stockholders;

• provide that the board of directors is expressly authorized to make, alter or repeal our bylaws; and

• establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.

     In addition, Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control of our company by prohibiting stockholders owning in excess of 15% of our outstanding voting stock from merging or combining with us unless certain approvals are obtained.

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ITEM 2.Unregistered Sales of Equity Securities and Use of Proceeds

None.

ITEM 3.Defaults Upon Senior Securities

None.

ITEM 4.Submission of Matters to a Vote of Security Holders

We held our annual meeting of stockholders on May 22, 2007. At the meeting, stockholders elected two nominees to the Board of Directors. The results of voting were as follows:

	For		Withheld
William D. Ruckelshaus		50,621,866		70,770
Gregory L. McAdoo		50,607,793		84,843

     There were no abstentions or broker non-votes with respect to the election of directors.

     At the annual meeting, stockholders ratified the appointment of PricewaterhouseCoopers LLP as our independent registered public accounting firm for the fiscal year ending December 30, 2007. The vote was 50,663,848 for ratification, 18,501 against ratification, and there were 10,287 abstentions and no broker non-votes.

ITEM 5.Other Information

     Our insider trading policy, allows directors, officers and other employees covered under the policy to establish, under limited circumstances contemplated by Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, written programs that permit automatic trading of Isilon Systems stock or trading of Isilon Systems stock by an independent person (such as a broker or an investment bank) who is not aware of material, nonpublic information at the time of the trade. As of May 31, 2007, a majority of our executive officers established a 10b5-1 plan under the Exchange Act, which provided that any such trading would only commence after August 15, 2007. The transactions under these plans will be disclosed publicly through Form 4 and, if applicable, Form 144 filings with the Securities and Exchange Commission.

     Rule 10b5-1 allows corporate officers and directors to adopt written, pre-arranged stock trading plans when they do not have material, non-public information. Once the plan is in place, the executive does not retain or exercise any discretion over shares traded under the plan, although the executive may later amend or terminate the plan. The broker administering the plan is authorized to trade Isilon Systems stock in volumes and at times determined independently by the broker, subject to the limitations set forth in the trading plan. Using these plans, insiders can gradually diversify their investment portfolios, can spread stock trades out over an extended period of time to reduce any market impact and can avoid concerns about whether they had material, non-public information when they sold their stock.

ITEM 6.Exhibits

     The following exhibits are incorporated by reference or filed herewith.

		Incorporation by Reference Herein
Exhibit
Number	Description	Form	Date
3.1	Amended and Restated Certificate of Incorporation of the registrant.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
3.2	Amended and Restated Bylaws of the registrant.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
4.1	Form of registrant’s common stock certificate.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 24, 2006
4.2	Fourth Amended and Restated Investors’ Rights Agreement between the registrant and certain of its security holders dated July 19, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006

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		Incorporation by Reference Herein
Exhibit
Number	Description	Form	Date
10.1	Form of Indemnification Agreement.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.2	Amended and Restated 2001 Stock Plan.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.3	Form of Stock Option Agreement under the Amended and Restated 2001 Stock Plan.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.4	2006 Equity Incentive Plan.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 24, 2006
10.5	Form of Stock Option Agreement under the 2006 Equity Incentive Plan.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 24, 2006
10.6	2006 Employee Stock Purchase Plan.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 24, 2006
10.7	Form of Subscription Agreement under the 2006 Employee Stock Purchase Plan.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 24, 2006
10.8	Offer Letter with Steven Goldman dated July 17, 2003.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.9	Offer Letter with Eric J. Scollard dated October 4, 2002.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.10	Offer Letter with Mark L. Schrandt dated October 3, 2003.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.11	Offer Letter with Brett G. Goodwin dated March 10, 2002.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.12	Offer Letter with John W. Briant dated September 29, 2004.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.13	Offer Letter with Stuart W. Fuhlendorf dated March 29, 2004.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.14	Offer Letter with Thomas P. Pettigrew dated December 22, 2003.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.15†	Manufacturing Services Agreement between the registrant and Sanmina-SCI Corporation dated February 17, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	December 14, 2006
10.16	Office Lease between the registrant and Selig Holdings Company dated November 11, 2005.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.17	First Amendment to Office Lease between the registrant and Selig Holdings Company dated December 2, 2005.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006

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		Incorporation by Reference Herein
Exhibit
Number	Description	Form	Date
10.18	Second Amendment to Office Lease between the registrant and Selig Holdings Company dated August 4, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.19	Venture Loan and Security Agreement between the registrant and Horizon Technology Funding Company LLC dated March 22, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.20	Amendment to Venture Loan and Security Agreement between the registrant and Horizon Technology Funding Company LLC dated July 18, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.21	Loan and Security Agreement between the registrant and Silicon Valley Bank dated June 24, 2004.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006

10.22	Amendment to Loan and Security Agreement between the registrant and Silicon Valley Bank dated March 10, 2005.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.23	Amendment to Loan and Security Agreement between the registrant and Silicon Valley Bank dated March 21, 2005.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.24	Amendment to Loan and Security Agreement between the registrant and Silicon Valley Bank dated June 29, 2005.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.25	Amendment to Loan Documents between the registrant and Silicon Valley Bank dated March 22, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.26	Amendment to Loan Documents between the registrant and Silicon Valley Bank dated July 18, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.27	Warrant to Purchase Stock issued by registrant to Horizon Technology Funding Company III LLC, dated March 22, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	October 10, 2006
10.28	Warrant to Purchase Stock issued by registrant to Horizon Technology Funding Company III LLC, dated March 22, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	October 10, 2006
10.29	Offer Letter with Gwen Weld dated June 5, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 9, 2006
10.30	Offer Letter with James Richardson dated October 2, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 9, 2006
10.31*†	Offer Letter with Steven D. Fitz dated April 11, 2007

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		Incorporation by Reference Herein
Exhibit
Number	Description	Form	Date
31.1*	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2 *	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1 ‡	Section 1350 Certification of Chief Executive Officer.
32.2 ‡	Section 1350 Certification of Chief Financial Officer.

†	Portions of the agreement are subject to confidential treatment.
*	Filed herewith.
‡	Furnished herewith.

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SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	ISILON SYSTEMS, INC.
Date: August 8, 2007	By:	/s/ Steven Goldman
		Steven Goldman
		President, Chief Executive Officer and Director (Principal Executive Officer)
	By:	/s/ Stuart W. Fuhlendorf
		Stuart W. Fuhlendorf
		Chief Financial Officer and Vice President of Finance (Principal Accounting and Financial Officer)

- 36 -

INDEX TO EXHIBITS

		Incorporation by Reference Herein
Exhibit
Number	Description	Form	Date
3.1	Amended and Restated Certificate of Incorporation of the registrant.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
3.2	Amended and Restated Bylaws of the registrant.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
4.1	Form of registrant’s common stock certificate.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 24, 2006
4.2	Fourth Amended and Restated Investors’ Rights Agreement between the registrant and certain of its security holders dated July 19, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.1	Form of Indemnification Agreement.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.2	Amended and Restated 2001 Stock Plan.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.3	Form of Stock Option Agreement under the Amended and Restated 2001 Stock Plan.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.4	2006 Equity Incentive Plan.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 24, 2006
10.5	Form of Stock Option Agreement under the 2006 Equity Incentive Plan.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 24, 2006
10.6	2006 Employee Stock Purchase Plan.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 24, 2006
10.7	Form of Subscription Agreement under the 2006 Employee Stock Purchase Plan.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 24, 2006
10.8	Offer Letter with Steven Goldman dated July 17, 2003.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.9	Offer Letter with Eric J. Scollard dated October 4, 2002.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006

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		Incorporation by Reference Herein
Exhibit
Number	Description	Form	Date
10.10	Offer Letter with Mark L. Schrandt dated October 3, 2003.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.11	Offer Letter with Brett G. Goodwin dated March 10, 2002.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.12	Offer Letter with John W. Briant dated September 29, 2004.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.13	Offer Letter with Stuart W. Fuhlendorf dated March 29, 2004.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.14	Offer Letter with Thomas P. Pettigrew dated December 22, 2003.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.15†	Manufacturing Services Agreement between the registrant and Sanmina-SCI Corporation dated February 17, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	December 14, 2006
10.16	Office Lease between the registrant and Selig Holdings Company dated November 11, 2005.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.17	First Amendment to Office Lease between the registrant and Selig Holdings Company dated December 2, 2005.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.18	Second Amendment to Office Lease between the registrant and Selig Holdings Company dated August 4, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.19	Venture Loan and Security Agreement between the registrant and Horizon Technology Funding Company LLC dated March 22, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.20	Amendment to Venture Loan and Security Agreement between the registrant and Horizon Technology Funding Company LLC dated July 18, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.21	Loan and Security Agreement between the registrant and Silicon Valley Bank dated June 24, 2004.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006

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		Incorporation by Reference Herein
Exhibit
Number	Description	Form	Date
10.22	Amendment to Loan and Security Agreement between the registrant and Silicon Valley Bank dated March 10, 2005.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.23	Amendment to Loan and Security Agreement between the registrant and Silicon Valley Bank dated March 21, 2005.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.24	Amendment to Loan and Security Agreement between the registrant and Silicon Valley Bank dated June 29, 2005.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.25	Amendment to Loan Documents between the registrant and Silicon Valley Bank dated March 22, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.26	Amendment to Loan Documents between the registrant and Silicon Valley Bank dated July 18, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	September 1, 2006
10.27	Warrant to Purchase Stock issued by registrant to Horizon Technology Funding Company III LLC, dated March 22, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	October 10, 2006
10.28	Warrant to Purchase Stock issued by registrant to Horizon Technology Funding Company III LLC, dated March 22, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	October 10, 2006
10.29	Offer Letter with Gwen Weld dated June 5, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 9, 2006
10.30	Offer Letter with James Richardson dated October 2, 2006.	Registration Statement on Form S-1, as amended (File No. 333-137078)	November 9, 2006
10.31*���	Offer Letter with Steven D. Fitz dated April 11, 2007
31.1*	Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2 *	Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1 ‡	Section 1350 Certification of Chief Executive Officer.
32.2 ‡	Section 1350 Certification of Chief Financial Officer.

†	Portions of the agreement are subject to confidential treatment.
*	Filed herewith.
‡	Furnished herewith.

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