The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q. The information in this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. For example, words such as "may," "will," "should," "estimates," "predicts," "potential," "continue," "strategy," "believes," "anticipates," "plans," "expects," "intends" and similar expressions are intended to identify forward-looking statements. Our actual results and the timing of certain events may differ significantly from the results discussed in the forward-looking statements. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those discussed elsewhere in this Form 10-Q in the section titled "Risk Factors." Except as required by law, we undertake no obligation to publicly release any revisions to the forward-looking statements after the date of this Form 10-Q.

Overview

We were founded in October 2001 with a mission to develop breakthrough compression technology for disk-based deduplication storage. We began shipping our appliances in February 2004 to address the backup and network-based disaster recovery needs of enterprises. We sell our appliances to enterprises worldwide in a variety of industries, including defense, education, entertainment, finance, government, healthcare, technology, legal, media and retail. As of September 30, 2008, our appliances had been purchased by over 2,500 customers worldwide.

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

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

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

We sell our appliances through a network of channel partners and through our direct sales force. In the three and nine months ended September 30, 2008 and the year ended December 31, 2007, approximately 88%, 87% and 86%, respectively, of our revenue was generated by sales through indirect channels. As of September 30, 2008, we had over 450 channel partners, and we expect that we will continue to sell a substantial majority of our appliances through our channel partners. We consider the continued development of indirect sales channels in domestic and international markets important to future revenue growth and widespread acceptance of our products.

Growth of our product revenue will depend on our ability to attract new customers and to make additional sales to existing customers. Our growth will also depend on our ability to introduce and achieve market acceptance of new products with higher capacity and deduplication throughput performance and develop new products designed to serve other sectors of the storage market beyond protection storage that we believe will benefit from deduplication technology. Revenue from existing customers increased as a percentage of total revenue, a trend we expect to generally continue. It is important to note, however, that our revenue, including our revenue from existing customers, may be impacted by the timing of large orders which tend to have a longer sales cycle and are more difficult to forecast. The recent downturn of the global economy could negatively impact the timing of these large orders and spending by our customers' IT departments generally. We also expect growth in international markets to be a significant factor contributing to our revenue growth in future periods. International revenue accounted for approximately 21% of our total revenue in both the three months ended September 30, 2008 and 2007, and 23% and 25% of our total revenue in the nine months ended September 30, 2008 and 2007, respectively. Even though international revenue was lower as a percentage of total revenue during the nine months ended September 30, 2008 compared to the nine months ended September 30, 2007, over time, we expect international revenue to increase in absolute dollars and as a percentage of our total revenue, though our international revenues will also be susceptible to any further deterioration in global economic conditions. Our growth in support and services revenue will depend upon increasing the number of systems under support and services contracts. Any such increases will depend on a growing customer base and renewal of existing support and services contracts. To date, no individual customer has accounted for greater than 10% of our total revenue in any quarter or year.

Our ability to sustain profitability will also be affected by the extent to which we incur additional expenses to expand our sales, marketing, product development and general and administrative capabilities. Personnel costs constitute the largest component of our operating expenses. Personnel costs consist of salaries, benefits, incentive compensation, including commissions for sales personnel, and stock-based compensation expense. As we expand internationally, we may incur additional costs to conform our products to comply with local laws or local product specifications and to sell, support and ship our products to our international customers.

We believe our operations are more efficient and flexible because we outsource manufacturing of our products, and because we subcontract with third parties to provide onsite hardware repair and replacement services for our appliances, except in those instances where channel partners provide these services directly to our customers.

As a consequence of the rapidly evolving nature of our business and our limited operating history, we believe that period-to-period comparisons of revenue and operating results, including gross margin and operating expenses as a percentage of total revenue, are not necessarily meaningful and should not be relied upon as indications of future performance. Although we have experienced significant growth in our total revenue, you should not assume that our historical growth rates are indicative of future growth. Additional detail of the composition of revenue, cost of revenue and operating expenses can be found in our Annual Report on Form 10-K for the year ended December 31, 2007 that we filed with the SEC on February 29, 2008.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles, or GAAP. These accounting principles require us to make certain estimates and judgments that can affect the reported amounts of assets and liabilities as of the date of the condensed consolidated financial statements, as well as the reported amounts of revenue and expenses during the periods presented. We believe that the estimates and judgments upon which we rely are reasonable based upon information available to us at the time that these estimates and judgments are made. To the extent there are material differences between these estimates and actual results, our condensed consolidated financial statements will be affected. The accounting policies that reflect our more significant estimates and judgments and that we believe are the most critical to aid in fully understanding and evaluating our reported financial results include revenue recognition, stock-based compensation, inventory valuation, warranty reserve, short-term and long-term investments and allowance for doubtful accounts. Other than the adoption of SFAS No. 157, Fair Value Measurements, as discussed in further detail in Note 1 to the Notes to our Condensed Consolidated Financial Statements, there were no significant changes to our critical accounting policies since the filing of our Annual Report on Form 10-K for the year ended December 31, 2007 with the SEC on February 29, 2008.

Results of Operations

Three and Nine months ended September 30, 2008 Compared to the Three and Nine months ended September 30, 2007:

Revenue

The following table sets forth each of our sources of revenue for the specified
periods and as a percentage of our total revenue for those periods.

                                                   Three Months Ended                       Nine Months Ended
                                           September 30,        September 30,       September 30,       September 30,
(dollars in thousands)                          2008                2007                2008                2007
Total revenue                              $       75,030      $        32,025     $       188,856     $        78,742
Total revenue by type:
Product                                    $       63,872      $        27,992     $       161,062     $        69,470
Support and services                               11,135                4,000              27,718               8,975
Ratable product and related support and                23                   33                  76                 297
services
% of revenue by type:
Product                                                85 %                 87 %                85 %                88 %
Support and services                                   15 %                 13 %                15 %                12 %
Ratable product and related support and                -  %                 -  %                -  %                -  %
services
Total revenue by geography:
North America                              $       59,328      $        25,143     $       146,000     $        59,202
Europe, Africa, Middle East and Other               9,290                4,775              29,956              14,216
Japan and Asia                                      6,412                2,107              12,900               5,324
% of revenue by geography:
North America                                          79 %                 79 %                77 %                75 %
Europe, Africa, Middle East and Other                  12 %                 15 %                16 %                18 %
Japan and Asia                                          9 %                  6 %                 7 %                 7 %

For the three months ended September 30, 2008, product revenue increased $35.9 million to $63.9 million from the $28.0 million reported for the three months ended September 30, 2007. For the nine months ended September 30, 2008, product revenue increased $91.6 million to $161.1 million from the $69.5 million reported for the nine months ended September 30, 2007. These increases were due to an increase in the number of units sold to new and existing customers, facilitated by an increase in the number of personnel in our sales organization, an increase in the number of our channel partners and the introduction of new products. These products, which have higher capacity and higher performance, were sold at higher average sales prices. We expect to continue to release new products with higher capacity, higher performance and higher average selling prices.

For the three months ended September 30, 2008, support and services revenue increased $7.1 million to $11.1 million from the $4.0 million reported for the three months ended September 30, 2007. For the nine months ended September 30, 2008, support and services revenue increased $18.7 million to $27.7 million from the $9.0 million reported for the three months ended September 30, 2007. These increases were the result of increased product sales and, to a lesser extent, an increase in the renewal of support and services contracts by existing customers. Substantially all of our customers purchase support and services contracts when they purchase our appliances. As our customer base grows, we expect the revenue we generate from support and services will continue to grow at a faster rate than our product revenue, as a result of both an increase in new contracts and higher renewal of existing contracts.

International revenue was 21% of total revenue for both the three months ended September 30, 2008 and 2007, and 23% and 25% of total revenue for the nine months ended September 30, 2008 and 2007, respectively. Although revenue outside North America increased in the three and nine months ended September 30, 2008 in absolute amounts, the percentage of total revenue it represented in such periods was flat for the three months ended September 30, 2008 and 2007, and declined in the nine months ended September 30, 2008 and 2007 due to the higher growth rate of sales in North America as new sales personnel were added more rapidly and became productive more quickly in North America than elsewhere. As we continue to expand into international locations and introduce our products in new markets, we expect international revenue to increase in absolute dollars and as a percentage of revenue.

Cost of Revenue, Gross Profit and Gross Margin

The following table sets forth each of our costs of revenue, gross profit and
gross margin for the specified periods.

                                                    Three Months Ended                       Nine Months Ended
                                            September 30,        September 30,       September 30,       September 30,
(in thousands)                                   2008                2007                2008                2007
Total revenue                              $         75,030     $        32,025     $       188,856     $        78,742
Cost of product                                      16,739               8,176              41,808              20,467
Cost of support and services                          4,226               1,330               9,851               3,033
Cost of ratable product and related                       1                   3                   3                 100
support and services
Total cost of revenue                                20,966               9,509              51,662              23,600
Gross profit                               $         54,064     $        22,516     $       137,194     $        55,142
Gross margin                                             72 %                70 %                73 %                70 %

For the three months ended September 30, 2008, cost of product revenue increased $8.5 million to $16.7 million from the $8.2 million reported for the three months ended September 30, 2007. This increase was due to increased aggregate product costs associated with an increased volume of shipments of our appliances to our customers and, to a lesser extent, increased amortization of evaluation units and increased personnel costs. Salaries and employee related benefits accounted for $527,000 of the increase in cost of product revenue and stock-based compensation accounted for $124,000 of the increase. For the nine months ended September 30, 2008, cost of product revenue increased $21.3 million to $41.8 million from the $20.5 million reported for the nine months ended September 30, 2007. As noted above, this increase was due to increased aggregate product costs associated with an increased volume of shipments of appliances to our customers, increased amortization of evaluation units and increased personnel costs, partially offset by lower warranty costs due to the $450,000 and $1.6 million charges we recorded in the three and nine months ended September 30, 2007, respectively, for the field replacement program to replace a circuit board used in some of our appliances that we initiated in the second quarter of 2007 and expanded in the third quarter of 2007. Salaries and employee related benefits accounted for $1.1 million of the increase and stock-based compensation accounted for $419,000 of the increase. We expect the cost of product revenue to continue to increase for the remainder of 2008.

For the three months ended September 30, 2008, cost of support and services revenue increased $2.9 million to $4.2 million from the $1.3 million reported for the three months ended September 30, 2007. This increase was due to increases in installation costs and in our support personnel headcount from 18 at September 30, 2007 to 47 at September 30, 2008, which increased our salary expense and employee-related benefits by $782,000. Included in the overall increase is stock-based compensation which accounted for $193,000 of the increase and increased outside service costs of $1.3 million related to third party logistics support of the larger installed base of our products. For the nine months ended September 30, 2008, cost of support and services revenue increased $6.9 million to $9.9 million from the $3.0 million reported for the nine months ended September 30, 2007. As noted above, this increase was due to increases in installation costs and in our support personnel headcount from 18 at September 30, 2007 to 47 at September 30, 2008, which increased our salary expense and employee-related benefits by $2.3 million. Included in the overall increase is stock-based compensation which accounted for $372,000 of the increase, and increased outside service costs of $2.4 million related to logistics support of the larger installed base of our products. We expect the cost of support and services revenue to continue to increase for the remainder of 2008 as our installed base continues to grow.

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

Sales and Marketing Expenses

                                                    Three Months Ended                        Nine Months Ended
                                            September 30,        September 30,        September 30,        September 30,
(in thousands)                                   2008                2007                 2008                 2007
Sales and marketing expenses               $         32,150     $        15,831     $          82,867     $        36,933
Percent of total revenue                                 43 %                49 %                  44 %                47 %
Headcount at end of period                              406                 199                   406                 199

For the three months ended September 30, 2008, sales and marketing expenses increased $16.4 million to $32.2 million from the $15.8 million reported for the three months ended September 30, 2007. This increase was primarily due to the increase in the number of our sales and marketing employees, including the addition of 58 employees associated with our international operations. The increase in employees resulted in higher salary expense, employee-related benefits expense and fees for recruitment of new employees. In addition, commission expenses increased due to the substantial increase in our total bookings and revenue and the higher number of employees on commission plans. The total of the increase from the above factors was $10.9 million. Stock-based compensation accounted for $1.2 million of the increase and the remainder was the result of increased costs from travel, tradeshow, facility and promotional activities.

For the nine months ended September 30, 2008, sales and marketing expenses increased $46.0 million to $82.9 million from the $36.9 million reported for the nine months ended September 30, 2007. As noted above, this increase was primarily due to the increase in the number of our sales and marketing employees. The increase in employees resulted in higher salary expense, employee-related benefits expense and fees for recruitment of new employees. In addition, commission expenses increased due to the substantial increase in our total bookings and revenue and the higher number of employees on commission plans. The total of the increase from the above factors was $29.4 million. Stock-based compensation accounted for $5.5 million of the increase and the remainder was the result of increased costs from travel, tradeshow, facility and promotional activities.

We anticipate that sales and marketing expenses will increase in absolute dollars during the remainder of 2008, but remain relatively stable as a percentage of our total revenue, due to our plans to continue to expand our sales force, both domestically and internationally, and to make significant investments in our direct marketing campaigns.

Research and Development Expenses

                                                    Three Months Ended                        Nine Months Ended
                                            September 30,        September 30,        September 30,        September 30,
(in thousands)                                   2008                2007                 2008                 2007
Research and development                   $         10,318     $         6,111     $          28,681     $        16,273
Percent of total revenue                                 14 %                19 %                  15 %                21 %
Headcount at end of period                              165                 104                   165                 104

For the three months ended September 30, 2008, research and development expenses increased $4.2 million to $10.3 million from the $6.1 million reported for the three months ended September 30, 2007. Salaries, employee-related benefits and fees for recruitments accounted for $2.3 million of the increase as the result of increased headcount. Also contributing to the increase were increases in stock-based compensation of $482,000, and facility related costs for equipment and depreciation on capitalized equipment of $1.2 million. These increases were the direct result of hiring additional personnel to support new product introductions and broaden our product line.

For the nine months ended September 30, 2008, research and development expenses increased $12.4 million to $28.7 million from the $16.3 million reported for the nine months ended September 30, 2007. Salaries, employee-related benefits and fees for recruitments accounted for $6.5 million of the increase as the result of increased headcount. Also contributing to the increase were increases in stock-based compensation of $2.2 million, and facility related costs for equipment and depreciation on capitalized equipment of $3.2 million. These increases were the direct result of hiring additional personnel to support new product introductions and broaden our product line.

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

General and Administrative Expenses

                                                    Three Months Ended                       Nine Months Ended
                                            September 30,        September 30,       September 30,        September 30,
(in thousands)                                  2008                 2007                 2008                2007
General and administrative                 $         6,028      $         2,816     $         17,354     $         6,904
Percent of total revenue                                 8 %                  9 %                  9 %                 9 %
Headcount at end of period                              63                   31                   63                  31

For the three months ended September 30, 2008, general and administrative expenses increased $3.2 million to $6.0 million from the $2.8 million reported for the three months ended September 30, 2007. This increase was primarily the result of increases in personnel costs associated with increased headcount, which accounted for $1.5 million of the increase. Professional service fees accounted for $416,000 of the increase, stock-based compensation accounted for $555,000 and the remainder of the increase was from increased consulting and facility costs.

For the nine months ended September 30, 2008, general and administrative expenses increased $10.5 million to $17.4 million from the $6.9 million reported for the nine months ended September 30, 2007. This increase was primarily the result of increases in personnel costs associated with increased headcount, which accounted for $4.2 million of the increase. Professional service fees accounted for $1.8 million of the increase, stock-based compensation accounted for $1.8 million and the remainder of the increase was from increased consulting and facility costs.

For both periods, the additional personnel and professional service fees were the result of our ongoing efforts to build our legal, finance, human resources, recruiting and information technology functions, and additional professional service fees were necessitated by our public company status. We expect the absolute amount of our general and administrative expenses to increase in the future as we expand our finance function to manage our expected growth and as we incur additional costs associated with being a public company, but our aggregate general and administrative expenses should remain relatively stable as a percentage of our total revenue.

Other Income (Expense), Net

                                                  Three Months Ended                       Nine Months Ended
                                           September 30,       September 30,       September 30,       September 30,
(in thousands)                                  2008                2007                2008                2007
Interest income                              $        1,318      $       1,614       $        4,998      $       1,950
Other income (expense), net                          (1,049 )               68                   74                (41 )
Total other income (expense), net            $          269      $       1,682       $        5,072      $       1,909

For the three months ended September 30, 2008, total other income (expense), net decreased $1.4 million to $269,000 from the $1.7 million reported for the three months ended September 30, 2007. This decrease was the result of the unfavorable revaluation of foreign exchange transactions during the period as well as a decrease in the interest rate earned from our cash equivalents, short-term and long-term investments from 5.2% in the three months ended September 30, 2007 to 2.2% in the three months ended September 30, 2008. This was partially offset by increased interest earned in the three months ended September 30, 2008 resulting . . .