Data Storage IPO: Highlights from Isilon Systems' S-1 Filing

Isilon Systems, a provider of clustered storage systems for digital content, filed recently to go public on Nasdaq with the ticker ISLN. Highlights from the company's S-1 filing are excerpted below:

Proposed Ticker: (ISLN)

Underwriters: Morgan Stanley, Merrill Lynch, RBC, Needham

Maximum Offering Size: $86.25 million

Business Overview:

We are the leading provider of clustered storage systems for digital content. As more information is recorded and communicated in images and pictures rather than text and words, the volume of digital content — which includes video, audio, digital images, computer models, PDF files, scanned images, reference information, test and simulation data and other unstructured data — is growing rapidly. Enterprises are utilizing this digital content to create new products and services, generate new revenue streams, accelerate research and development cycles and improve their overall competitiveness. Recognizing the growth and importance of this type of data, we designed and developed our clustered storage systems specifically to address the needs of storing and managing digital content. Our systems are comprised of three or more nodes, with each node a self-contained, rack-mountable device that contains industry standard hardware, including disk drives, central processing unit, or CPU, memory and network connections, and is integrated with our proprietary OneFS® operating system software, which unifies a cluster of nodes into a single shared resource. To date, we have sold our clustered storage systems to more than 200 customers across a wide range of industries. [...]

The worldwide market for external disk storage systems will grow from approximately $17.4 billion in 2005 to approximately $22.7 billion in 2010, according to estimates from International Data Corporation, or IDC. The market for storage systems dedicated to digital content is estimated to grow at a much faster rate. According to the Enterprise Strategy Group, or ESG, certain industries including multimedia, oil and gas, scientific research, healthcare, personal Internet services and software development will experience rapid growth in file-based storage capacity. For example, in disk-based digital archiving, which is one portion of the market our systems address, ESG forecasts that the demand for storage capacity will grow from 377 petabytes in 2005 to nearly 11,000 petabytes in 2010, representing a 96% compound annual growth rate, with the substantial majority of this stored information comprised of unstructured content, such as office documents, web pages, digital images and audio and video files.

Financial Highlights: For the first half of the year, revenue grew 245% over H1 05 from $6.9 million to $23.8 million. In this period, the company's two largest customers accounted for 32% of revenue. The company grew the channel business significantly during the first half of the year: in H1 06, 44% of revenue was from indirect channels, compared to 16% in the same period of 2005. International revenue grew from 13% to 21% of revenues in this time. Revenue for 2005 increased 175% over 2004 from $7.7 million to $21.1 million. Channel revenues got a real boost in 2005 to 27% of revenues, up from 6% of revenues in 2004.

While the bulk of the company's revenues are from product, the margin for product and service sales do not differ substantially (51% and 57% respectively for the first half of 2006). Total gross margin grew from 48% in H1 05 to 52% in H1 06. For the first half of 2006, S&M expenses were the largest opex item (44% of revenue) followed by R&D (31%) and G&A (13%). The company recorded a net loss of $10 million for H1 06, up from a $9.3 million loss in H1 05. From 2004 to 2005, the company's net loss grew from $8.3 million to $12.5 million.

In the beginning of July, the company had just under $11 million in cash and $23.5 million in contractual obligations including $7.5 million in long term debt and $12.7 million in operating lease obligations.

Customers: The company has over 200 customers varying from single site companies to large corporations. Kodak was the company's largest customer in 2005 (20% of sales), and H1 06 (17%); Comcast was the second largest customer (15% of H1 06 sales).

Use of Proceeds: The company plans to repay its debt with the financing, including $6.2 million to pay principal and accrued interest to Horizon Technology Funding. They also may repay their credit facility with Silicon Valley Bank. The rest of the funding is earmarked to general corporate purposes.

Competition: In addition to privately held companies, Isilon's competitors include:

EMC Corporation (EMC)

Hewlett-Packard Company (HPQ)

Hitachi Data Systems, a Hitachi subsidiary (HIT)

IBM (IBM)

Network Appliance, Inc. (NTAP)

and Sun Microsystems, Inc. (SUNW)

Employees and Management: Isilon had 232 employees worldwide at the beginning of September: 93 each in R&D and S&M, 31 in operations and 15 in support and services. Steven Goldman is the company's CEO:

Steven Goldman has served as our President and Chief Executive Officer since August 2003 and as a director since September 2003. Prior to joining us, from 1997 to August 2003, Mr. Goldman served in various senior executive capacities in sales, marketing and services at F5 Networks, Inc., an application traffic management company, most recently as Senior Vice President, Sales and Services. From 1996 to 1997, Mr. Goldman served as Vice President of Enterprise Sales and Services for Microtest, Inc., a maker of network testing products that acquired Logicraft Information Systems, a network CD-ROM server company. From 1995 to 1996, Mr. Goldman served as Executive Vice President of North American Operations for Logicraft Information Systems. From 1983 to 1995, Mr. Goldman served in various positions for Virtual Microsystems, a communications software company, most recently as Vice President of Sales. Mr. Goldman received a B.A. in economics from the University of California at Berkeley.

Note that Goldman has baggage from his days at F5 (FFIV):

Mr. Goldman, who, prior to joining us, served in various senior executive positions in sales, marketing and services at F5 Networks, Inc., 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.

Current Ownership: There are four institutional investors currently in the company: Atlas (28.4%), Sequoia (22.4%), Madrona (19.3%), and Lehman Brothers (7.7%). The CEO holds 3.6%.

Conclusion: This is a classic tech IPO for a company operating in a hot space with an apparently clean operating history and top tier private investors, as well as a solid IP portfolio. Two teensy issues: this is a case where hot and crowded go hand in hand, and the timing of the entry of lower cost competitors and product commoditization are key. Then there's that minor question of lack of profitability visibility.