UNITED STATES DISTRICT COURT WESTERN DISTRICT OF...

COMPLAINT FOR VIOLATION OF THE FEDERAL SECURITIES LAWS

LOVELL MITCHELL BARTH LLP 11542 NE 21st Street, Bellevue, Washington 98004

Telephone: 425/452-9800 • Fax: 425/452-9801

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UNITED STATES DISTRICT COURT

WESTERN DISTRICT OF WASHINGTON

AT SEATTLE

MARCEL YOUAKIM, Individually and on Behalf of All Others Similarly Situated,

Plaintiff,

vs.

ISILON SYSTEMS, INC., WILLIAM D. RUCKELSHAUS, STEVEN S. GOLDMAN, SUJAL M. PATEL, STUART W. FUHLENDORF, ELLIOTT H. JURGENSEN, JR., BARRY J. FIDELMAN, GREGORY L. McADOO, MATTHEW S. McILWAIN, JAMES G. RICHARDSON, MORGAN STANLEY & CO. INCORPORATED, MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED, NEEDHAM & COMPANY, LLC and RBC CAPITAL MARKETS CORP.,

Defendants.

) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) )

No.

CLASS ACTION


DEMAND FOR JURY TRIAL


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NATURE OF THE ACTION

1. This is a class action on behalf of all persons or entities who purchased or otherwise

acquired the common stock of Isilon Systems, Inc. (“Isilon” or the “Company”) between December

14, 2006 and October 3, 2007, inclusive (the “Class Period”), against Isilon and certain of its officers

and directors for violations of the Securities Exchange Act of 1934 (the “1934 Act”), and on behalf

of all persons or entities who acquired the common stock of Isilon pursuant and/or traceable to the

Company’s false and misleading Registration Statement and Prospectus (collectively, the

“Registration Statement”) issued in connection with its December 14, 2006 initial public offering

(“IPO”), seeking to pursue remedies under the Securities Act of 1933 (“1933 Act”).

2. Isilon is a provider of clustered storage systems for digital content. The Company has

designed and developed its clustered storage systems specifically to address the needs of storing and

managing digital content. Isilon’s systems include three nodes, with each node a self-contained,

rack-mountable device that contains industry standard hardware, including disk drives, a central

processing unit, memory chips and network interfaces, integrated with its OneFS operating system

software, which unifies a cluster of nodes into a single shared resource.

3. On December 14, 2006, Isilon completed its IPO of 8.9 million shares at $13.00 per

share (including 590,717 shares sold as part of an over-allotment) for net proceeds of approximately

$105.7 million, pursuant to the Registration Statement.1 The Registration Statement failed to

disclose the truth about Isilon’s business operations, finances, business metrics, and future business

and financial prospects.

4. Due to defendants’ positive, but false statements in the Registration Statement,

Isilon’s stock immediately soared – its shares closing up over 77% on its first day of trading in the

best debut of a technology IPO in more than six years. Isilon’s stock continued to climb closing as

high as $27.37 per share on December 29, 2006.

1 Certain selling shareholders sold an additional 661,783 shares as part of the over-allotment.


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5. During the Class Period, certain of the defendants issued materially false and

misleading statements regarding the Company’s business and financial results. As a result of

defendants’ false statements, Isilon stock traded at artificially inflated prices during the Class Period.

6. On October 3, 2007, after the market closed, Isilon announced preliminary results for

its 3Q 2007, in a press release which stated:

Isilon Systems, the leader in clustered storage, today announced preliminary results for the third quarter of 2007 ended September 30, 2007. Based on preliminary estimates, total revenue is expected to be in the range of $23.2 million to $23.7 million, down approximately 6 percent to 8 percent sequentially from the second quarter of 2007 and up approximately 30 percent to 33 percent from the same period one year ago. Previously, on the company’s second quarter conference call on July 26, 2007, the company stated it expected total revenue in the range of $25 million to $27.5 million for the third quarter of 2007.

Based on preliminary revenue estimates for the third quarter of 2007, Isilon expects GAAP gross margin to be in the range of 54.4 percent to 56.4 percent and non-GAAP gross margin in the range of 54.6 percent to 56.6 percent. Based on preliminary revenue and gross margin estimates, Isilon expects GAAP net loss per share to be in the range of ($0.10) to ($0.12) and non-GAAP net loss per share to be in the range of ($0.08) to ($0.10). . . .

“We are disappointed with our Q3 results,” said Steve Goldman, president and chief executive officer. “Despite the fact that our recent growth rate has not been matching our expectations, continued spending by an ever broadening range of new and existing customers underscores the strong value proposition of Isilon clustered storage.”

Isilon’s preliminary third quarter results are subject to review by the company as well as its independent auditors. The company’s final results for the third quarter of 2007 will be announced on October 25, 2007 after the close of market.

(Footnote omitted.)

7. On this news, Isilon’s stock price collapsed from $7 per share on October 3, 2007 to

close at $5.66 per share on October 4, 2007 – a decline of over 19% on volume of 3 million shares

(over five times the average previous trading volume for the stock). This closing price represented

an all-time trading low for Isilon.

8. The true facts, which were omitted from the Registration Statement or were known by

certain of the defendants but concealed from the investing public during the Class Period, were as

follows:


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(a) The Company was not on track, nor would it be able, to reach profitability by

the second half of 2007.

(b) The Company’s clustered storage solutions did not provide a competitively

differentiated business model which would enable the Company to effectively compete against the

dominant players in the traditional storage market such as EMC and Network Appliance. The

Company’s main competitors were larger, more established and better capitalized, which enabled to

them to engage in aggressive pricing to the detriment of Isilon.

(c) The Company’s past results were not indicative of its future operations,

including the amount of revenue it derived from its large customers, such as the Eastman Kodak

Company (“Kodak”),2 the Company’s ability to continue to sustain quarter over quarter revenue

growth, and its ability to manage its cost structure.

(d) Despite being able to grow and significantly diversify its overall customer

base, the Company would remain highly dependent upon Kodak.

(e) Given that the clustered network attached storage market in which the

Company operates is a highly competitive, high-growth emerging market, the Company had no

reasonable basis to make projections about its 2007 results.

JURISDICTION AND VENUE

9. Certain of the claims asserted herein arise under and pursuant to §§10(b) and 20(a) of

the 1934 Act and Rule 10b-5 promulgated thereunder by the SEC [17 C.F.R. §240.10b-5]. Certain

of the other claims asserted herein arise under and pursuant to §§11 and 15 of the 1933 Act [15

U.S.C. §§77k and 77o].

10. This Court has jurisdiction over the subject matter of this action pursuant to §27 of

the 1934 Act as well as 28 U.S.C. §1331 and §22 of the 1933 Act.

2 Kodak was one of the selling shareholders in the Company’s IPO selling 416,736 shares of Isilon stock at $13 per share as part of the over-allotment.


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11. Venue is proper in this District pursuant to §27 of the 1934 Act and 28 U.S.C.

§1391(b), because the defendants maintain an office in this District and many of the acts and

practices complained of herein occurred in substantial part in this District. Isilon’s principal

executive offices are located at 3101 Western Avenue, Seattle, Washington.

12. In connection with the acts alleged in this complaint, defendants, directly or

indirectly, used the means and instrumentalities of interstate commerce, including, but not limited to,

the mails, interstate telephone communications and the facilities of the national securities markets.

PARTIES

13. Plaintiff Marcel Youakim acquired the common stock of Isilon pursuant or traceable

to the IPO, as set forth in the accompanying certification, and has been damaged thereby.

14. Defendant Isilon is headquartered in Seattle, Washington. Its stock trades in an

efficient market on the NASDAQ.

15. Defendant William D. Ruckelshaus (“Ruckelshaus”) is Chairman of the Board of

Directors of Isilon. During the Class Period, Ruckelshaus was responsible for the Company’s false

financial statements and signed or authorized the signing of the false and misleading Registration

Statement.

16. Defendant Steven S. Goldman (“Goldman”) is Chief Executive Officer (“CEO”),

President and a director of Isilon. During the Class Period, Goldman was responsible for the

Company’s false financial statements and signed or authorized the signing of the false and

misleading Registration Statement.

17. Defendant Sujal M. Patel (“Patel”) is co-founder of Isilon. Patel is Chief Technology

Officer and a director of Isilon. During the Class Period, Patel was responsible for the Company’s

false financial statements and signed or authorized the signing of the false and misleading

Registration Statement.

18. Defendant Stuart W. Fuhlendorf (“Fuhlendorf”) is Chief Financial Officer (“CFO”)

and Vice President, Finance of Isilon. During the Class Period, Fuhlendorf was responsible for the


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Company’s false financial statements and signed or authorized the signing of the false and

misleading Registration Statement.

19. Defendant Barry J. Fidelman (“Fidelman”) is a director of Isilon. Fidelman signed or

authorized the signing of the false and misleading Registration Statement.

20. Defendant Elliott H. Jurgensen, Jr. (“Jurgensen”) is a director of Isilon. Jurgensen

signed or authorized the signing of the false and misleading Registration Statement.

21. Defendant Gregory L. McAdoo (“McAdoo”) is a director of Isilon. McAdoo signed

or authorized the signing of the false and misleading Registration Statement.

22. Defendant Matthew S. McIlwain (“McIlwain”) was a director of Isilon until his

resignation in April 2007. McIlwain signed or authorized the signing of the false and misleading

Registration Statement.

23. Defendant James G. Richardson (“Richardson”) is a director of Isilon. Richardson

signed or authorized the signing of the false and misleading Registration Statement.

24. The defendants referenced above in ¶¶15-23 are referred to herein as the “Individual

Defendants.”

25. The defendants referenced above in ¶¶15-17 and 19-23 are referred to herein as the

“Director Defendants.”

26. Defendant Morgan Stanley & Co. Incorporated (“Morgan Stanley”) is a global

financial services firm that, through its subsidiaries and affiliates, provides its products and services

to customers, including corporations, governments, financial institutions and individuals. Morgan

Stanley assists public and private corporations in raising funds in the capital markets (both equity

and debt), as well as in providing strategic advisory services for mergers, acquisitions and other

types of financial transactions. Morgan Stanley acted as an underwriter in the sale of corporate

securities and acted as financial advisor to Isilon in connection with the IPO, helping to draft and

disseminate the offering documents.


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27. Defendant Merrill Lynch, Pierce, Fenner & Smith Incorporated (“Merrill Lynch”)

provides capital markets services, investment banking and advisory services, wealth management,

asset management, insurance, banking and related products and services on a global basis. Merrill

Lynch acted as financial advisor to Isilon in connection with the IPO, helping to draft and


28. Defendant Needham & Company, LLC (“Needham”) is an investment banking and

asset management firm that focuses on serving emerging growth industries and their investors.

Needham’s principal activities are public and private financings; corporate finance advisory services,

including mergers, acquisitions and divestitures; equity research; sales and trading primarily for

institutional investors; and asset management through public and private funds. Needham acted as

financial advisor to Isilon in connection with the IPO, helping to draft and disseminate the offering

documents.

29. Defendant RBC Capital Markets Corporation (“RBC”) is an international corporate

and investment bank that provides products and services to institutions, corporations, governments

and high net worth clients around the world, and acts as an underwriter in the sale of corporate

securities. RBC acted as financial advisor to Isilon in connection with the IPO, helping to draft and


30. The defendants referenced above in ¶¶26-29 are referred to herein as “Underwriter

Defendants.”

CLASS ACTION ALLEGATIONS

31. Plaintiff brings this action as a class action pursuant to Federal Rule of Civil

Procedure 23(a) and (b)(3) on behalf of a Class, consisting of all those who purchased or otherwise

acquired Isilon common stock between December 14, 2006 and October 3, 2007, inclusive,

including all persons or entities who acquired shares of Isilon common stock pursuant and/or

traceable to the Company’s false and misleading Registration Statement for its IPO and who were

damaged thereby. Excluded from the Class are defendants, the officers and directors of the


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Company, at all relevant times, members of their immediate families and their legal representatives,

heirs, successors or assigns and any entity in which defendants have or had a controlling interest.

32. The members of the Class are so numerous that joinder of all members is

impracticable. Isilon stock was actively traded on the NASDAQ. While the exact number of Class

members is unknown to plaintiff at this time and can only be ascertained through appropriate

discovery, plaintiff believes that there are hundreds of members in the proposed Class. Record

owners and other members of the Class may be identified from records maintained by Isilon or its

transfer agent and may be notified of the pendency of this action by mail, using the form of notice

similar to that customarily used in securities class actions. Isilon has more than 61.9 million shares

of stock outstanding.

33. Plaintiff’s claims are typical of the claims of the members of the Class as all members

of the Class are similarly affected by defendants’ wrongful conduct in violation of federal law that is

complained of herein.

34. Plaintiff will fairly and adequately protect the interests of the members of the Class

and has retained counsel competent and experienced in class and securities litigation.

35. Common questions of law and fact exist as to all members of the Class and

predominate over any questions solely affecting individual members of the Class. Among the

questions of law and fact common to the Class are:

(a) whether the federal securities laws were violated by defendants’ acts as

alleged herein;

(b) whether statements made by certain of the defendants to the investing public

in the Registration Statement misrepresented material facts about the business, operations and

management of Isilon;

(c) whether statements made by the defendants to the investing public during the

Class Period misrepresented material facts about the business, operations and management of Isilon;

(d) whether defendants acted with the required state of mind; and


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(e) to what extent the members of the Class have sustained damages and the

proper measure of damages.

36. A class action is superior to all other available methods for the fair and efficient

adjudication of this controversy since joinder of all members is impracticable. Furthermore, as the

damages suffered by individual Class members may be relatively small, the expense and burden of

individual litigation make it impossible for members of the Class to individually redress the wrongs

done to them. There will be no difficulty in the management of this action as a class action.

BACKGROUND

37. Isilon is a provider of clustered storage systems for digital content. The Company has

designed and developed its clustered storage systems specifically to address the needs of storing and

managing digital content. Isilon’s systems include three nodes, with each node a self-contained,

rack-mountable device that contains industry standard hardware, including disk drives, a central

processing unit, memory chips and network interfaces, integrated with its OneFS operating system

software, which unifies a cluster of nodes into a single shared resource. The Company’s product

family consists of clustered storage systems and related software applications, which includes Isilon

IQ Accelerator, Isilon EX 6000, SyncIQ replication software, SmartConnect load-balancing software

and SnapshotIQ protection software.

THE FALSE AND DEFECTIVE REGISTRATION STATEMENT AND PROSPECTUS

38. On or about December 14, 2006, Isilon filed with the SEC a Form S-1/A (the “IPO

Registration Statement”) for the IPO.

39. On or about December 15, 2006, the Company filed its Prospectus for the IPO (the

“IPO Prospectus”), which forms part of the IPO Registration Statement and which became effective

on December 14, 2006, and at least 9.6 million shares of Isilon common stock were sold to the

public at $13 per share (including 1.25 million shares sold as part of an over-allotment); 8.9 million

shares were sold by the Company with the remaining shares being sold by certain selling

shareholders. The Company received approximately $105.7 million in net proceeds from the IPO.


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40. The IPO Registration Statement and IPO Prospectus were negligently prepared and,

as a result, contained untrue statements of material facts or omitted to state other facts necessary to

make the statements made not misleading and were not prepared in accordance with the rules and

regulations governing their preparation.

41. The IPO Registration Statement and IPO Prospectus represented the following about

Isilon’s business and operations:

Overview

We believe we are the leading provider of clustered storage systems for digital content, based on customer adoption, breadth of product offerings and technology capabilities. 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. Each node is a self-contained, rack-mountable device that contains industry standard hardware, including disk drives, a central processing unit, or CPU, memory chips and network interfaces, 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 300 customers across a wide range of industries. We sell our products indirectly through a channel partner program that includes over 100 value-added resellers and distributors, and directly through our field sales force.

* * *

Our Intelligent Clustered Storage Solutions

We believe we are the leading provider of clustered storage solutions for storing and managing digital content, based on customer adoption, breadth of product offerings and technology capabilities. We designed our storage solutions, based on our OneFS operating system software, to take advantage of the benefits of clustered systems built with industry standard hardware. We believe our clustered storage solutions enable data-intensive enterprises to manage digital content more efficiently and cost effectively than traditional storage systems.

Our Isilon IQ storage systems combine our proprietary OneFS operating system software with industry standard hardware, including a storage server, a CPU, memory chips and network interfaces, in a self-contained, 3.5-inch high, rack-mountable chassis. Our proprietary OneFS operating system software combines the three distinct layers of a traditional storage architecture, which typically consist of a file system, a volume manager and a redundant array of independent disks, or RAID,


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into a single unified software layer. As a result, Isilon IQ nodes automatically work together to aggregate their collective computing power into a single, unified storage system that is designed to withstand the failure of any piece of hardware, including disks, switches or even entire nodes. In addition, we provide platform extension products that enable customers to scale either performance or capacity incrementally based on their then-current needs.

Key benefits of our Isilon IQ clustered storage systems include:

• Scalability and Performance. We believe our systems provide industry-leading scalability and performance. Our OneFS operating system software can currently combine up to 96 separate nodes and up to 1,000 terabytes, or one petabyte, of storage capacity in a single cluster, and can deliver total data throughput of 10 gigabytes per second from a single file system and single pool of storage, providing linear scalability in both storage capacity and performance. Our systems support either Gigabit Ethernet or high-performance InfiniBand interconnect for low-latency, high-bandwidth, intra-cluster communication. We are continually seeking to increase the storage capacity and throughput of our systems.

• Reliability. Our clustered storage systems have data protection capabilities, built-in redundancy and self-healing capabilities. Each Isilon IQ storage system is designed to withstand the failure of multiple disks or entire nodes so that a customer does not lose access to any files. Each node in an Isilon IQ cluster is a peer, and any node can handle a request from any application server to provide the file requested. Our OneFS operating system software allocates, or stripes, files and meta-data across all nodes in a cluster so that, if one node or multiple nodes fail, any other node can perform the requested function, thereby preventing any single point of failure. In the event of one or more disk or node failures, OneFS automatically rebuilds files in parallel across all of the existing distributed free space in the cluster, eliminating the need to have the dedicated “hot spare drives” required with most traditional storage systems. We believe our Isilon IQ storage systems can utilize this free space, while also drawing on the multiple microprocessors and aggregate computing power of the cluster, to rebuild data from failed drives five to ten times faster than traditional storage systems, enabling a more reliable storage solution.

• Reduced Storage Cost. Our customers can purchase our Isilon IQ storage systems on a “pay-as-you-grow” model that allows them to expand their storage capacity and performance commensurate with their needs. In contrast, traditional storage systems typically require the purchase of excess performance and capacity, which remains underutilized until an enterprise grows into it. Our modular product architecture enables each customer to purchase an initial combination


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of performance and capacity tailored to its current needs, and to add performance, capacity or both in incremental quantities to support the growth in its digital content. In contrast to traditional storage systems, our systems, which utilize industry standard hardware, can significantly lower the initial capital expenditures required for storage, as well as the cost of acquiring additional storage capacity or performance.

• Increased IT Operating Efficiency. Our clustered storage systems enable customers to manage their growing amounts of digital content in an automated and efficient manner that is more cost-effective than traditional storage systems. Our Isilon IQ storage systems automatically balance data across nodes to enhance performance and optimize utilization, eliminating the need for the planned storage outages that are common during the manual data-balancing processes required with traditional storage systems. The simplicity, ease of use and automation of our Isilon IQ storage systems have enabled individual customers to scale deployments from a few terabytes to more than 2,000 terabytes without any additional investment in IT staff. Each Isilon IQ storage system has been designed to interface with existing Ethernet networks, and our “plug and store” design automates many of the tasks that must be performed manually to deploy traditional storage systems. As a result, once installed in a rack, a 100 terabyte cluster can typically be configured and operational in less than 15 minutes. Additionally, capacity can typically be added to existing clusters in less than 60 seconds, without any downtime.

• Enhanced Business Processes and Revenue Opportunities. By providing faster data access, faster data processing and streamlined workflows, our systems enable customers to manage the rapid growth in their digital content, capitalize on new products and service models for delivering digital content and unlock new revenue opportunities. For example, NBC used Isilon IQ solutions to store, access and edit more than 1,200 broadcast hours over six networks during the 17 days of events at the 2004 Summer Olympics, providing immediate access to all programming and tripling the number of broadcast hours compared with previous Olympics. Similarly, using our Isilon IQ storage system, a major aerospace and defense company unified its engine test results from previously disparate data sources into one large pool of storage, greatly improving the efficiency, speed and cost of its test operations.

• Complementary to Existing Solutions for Structured Data. Our customers typically deploy our solutions specifically for digital content while maintaining their existing storage systems for


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structured data. Our use of industry standard hardware and standard file sharing protocols greatly eases integration with existing enterprise systems and substantially reduces the need to change existing data center infrastructures or use proprietary tools or software. In addition, our software enables our storage systems to be adaptable to technology that exists in our customers’ data center environments.

Our Strategy

Our strategic focus is to enhance our position as a leading provider of clustered storage solutions for digital content. Key elements of this strategy include:

• Focus on High-Growth, Data-Intensive Markets. We believe the market for clustered storage is in its early stages. We intend to expand our customer base by focusing on markets where the storage and management of digital content are critical to the success of many enterprises. To date, our solutions have been deployed by customers in industries such as media and entertainment, Internet, cable and telecommunications, oil and gas, life sciences and manufacturing, and by the federal government. We intend to invest in our direct sales force and channel partners to further penetrate these and other markets domestically and internationally.

• Continue to Enhance OneFS and Deliver Additional Software Applications. Our OneFS operating system software is the core of our Isilon IQ clustered storage architecture. We intend to continue to enhance our OneFS operating system software with greater levels of automation, functionality and performance and to add new software applications in areas such as archiving, data protection and storage management.

• Leverage Trends in Commodity Hardware to Improve Price-Performance Attributes of Our Systems. Our software-based architecture is designed to allow us to integrate quickly and easily into our systems technology improvements, including those in components such as CPUs, disk drives and memory chips. Our systems are built using industry standard hardware rather than proprietary hardware, enabling us to address our customers’ needs in a cost-effective manner. As a result, our customers benefit as the price-performance attributes of these components improve over time. We intend to proactively incorporate advances in computing, storage and networking technologies into our storage systems.

• Optimize Repeat Order Business Model. Because of the modular nature of our clustered storage systems, our customers have typically


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deployed our systems in an incremental fashion. We intend to continue to design our systems to take advantage of our modular architecture, enabling our customers to scale deployments in step with their growing capacity and performance needs.

• Utilize Channel Partners to Expand Global Market Penetration. We received 41% of our total revenue for the first nine months of 2006 through indirect channels. We have established a distribution channel program that, as of October 1, 2006, had over 100 value-added resellers and distributors worldwide. We believe the ease of use and installation of our systems makes them well-suited for distribution by channel partners. We believe the international opportunity for our systems is significant and we have expanded the number of our channel partners in Asia-Pacific and Europe. We intend to continue adding value-added resellers and distributors to expand the global distribution of our systems.

• Realize Operating Leverage. We intend to realize operating leverage from the flexibility of our business model. By leveraging partners, including value-added resellers and distributors, offshore third-party software development teams, contract manufacturers, providers of international back-office support and providers of support services, we intend to maintain a flexible cost structure and focus on our core competencies. We are also able to benefit from our contract manufacturing partner’s purchasing power, lowering our costs of components. In addition, by selling to our existing customers, we believe we can realize efficiencies in our sales model.

42. Additionally, in connection with the offering, management made oral statements to

analysts concerning the Company’s business model and future projections, including making

projections that the Company would be able to reach bottom-line profitability by the second half of

2007. Several analysts repeated these statements into the market through analyst reports after the

IPO but prior to the time defendants issued Isilon’s 4Q 2006 results.

43. The true facts, which were omitted from the Registration Statement, were as follows:






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including the amount of revenue it derived from its large customers, such as Kodak, the Company’s

ability to continue to sustain quarter over quarter revenue growth, and its ability to manage its cost

structure.






DEFENDANTS’ FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD

44. On or about December 14, 2006, Isilon filed its IPO Registration Statement.

45. On or about December 15, 2006, Isilon filed its Prospectus for the IPO. Due to the

positive, but false statements in the Registration Statement, Isilon’s stock immediately soared – its

shares closing up over 77% on its first day of trading in the best debut of a technology IPO in more

than six years. Isilon’s stock continued to climb closing as high as $27.37 per share on

December 29, 2006.

46. On February 7, 2007, Isilon issued a press release entitled “Isilon Systems Announces

Financial Results for Fourth Quarter and Full Year 2006; Q4 Revenue Increases 137% Year-over-

Year to $20.7 Million; Full Year 2006 Revenue Increases 195% to $62.3 Million.” The press release

stated in part:

Isilon Systems, Inc., the leader in clustered storage, today reported financial results for the fourth quarter and year ended December 31, 2006. Revenue for the fourth quarter was $20.7 million, an increase of 137 percent from $8.7 million in the fourth quarter of 2005, and an increase of 16 percent sequentially compared with $17.8


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million in the prior quarter. Revenue for the year ended December 31, 2006 was $62.3 million, up 195 percent from $21.1 million in 2005.

“Our strong fourth quarter performance caps another year of rapid top-line revenue growth, driven by record new customer acquisition and a high rate of repeat business from our existing customers,” said Steve Goldman, president and chief executive officer. “This year we broadened our portfolio of clustered storage systems and software products, and our results demonstrate how our value proposition resonates with customers across a broad range of industries. In 2006, Isilon established itself and clustered storage as a compelling new alternative in the storage industry, providing solutions that address the unique challenges created by the exponential growth of digital content and that leverage the broad paradigm shift to clustered computing.”

Fourth Quarter and 2006 Highlights

Isilon’s focus on delivering clustered storage solutions that provide “pay-as-you-grow” scalability, ease-of-use and simplicity, and high levels of performance and reliability, resulted in a number of business highlights:

− Isilon acquired 88 new customers in the fourth quarter of 2006, nearly doubling the number acquired in the same quarter the prior year, resulting in a total customer base of 371. Year-over-year, Isilon increased the size of its customer base by 152 percent.

− Isilon generated more than half of its fourth quarter and full year revenue through reorders from existing customers.

− Isilon expanded gross margins to 54.2 percent in the fourth quarter of 2006, up from 51.7 percent in the same period of 2005, marking the fifth consecutive quarter of margin growth.

− Isilon continued to grow its reseller channel with 45 percent of sales in 2006 coming through the channel compared with 27 percent in 2005.

− Isilon further expanded geographically with international sales accounting for 24 percent of revenue in 2006 compared with 17 percent in 2005.

− Isilon introduced OneFS® 4.5, the latest version of its clustered operating system software, creating an innovative clustered storage system that delivers one Petabyte of capacity and 10 gigabytes per second of performance in a single file system and single volume. Additionally, Isilon was awarded a patent for core technology of its OneFS operating system.

− Isilon released SnapshotIQ™ and SmartConnect™, which, in addition to SyncIQ™, deliver a next-generation suite of clustered storage software applications for the enterprise. More than one in three new customers in the fourth quarter purchased one or more of Isilon’s new software applications.


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− Isilon began shipping the new Isilon IQ 200 clustered storage system, which combines the benefits of high-end enterprise clustered storage in an affordable and compact solution.

− Isilon successfully completed its initial public offering on December 20, 2006, raising $105.7 million net of underwriting discounts, commissions and offering expenses.

Financial Summary

* * *

− Net loss for the fourth quarter of 2006 was $10.4 million, or $0.72 per share, compared with net loss of $4.1 million, or $0.78 per share, in the same period of 2005. On a non-GAAP basis, net loss for the fourth quarter of 2006 was $3.3 million, or $0.06 per share, compared with net loss of $4.1 million, or $0.09 per share, in the same period of 2005.

− Net loss for 2006 was $25.4 million, or $3.02 per share, compared with net loss of $19.2 million, or $3.95 per share, in 2005. On a non-GAAP basis, net loss for 2006 was $16.4 million, or $0.33 per share, compared with net loss of $19.1 million, or $0.44 per share, in 2005.

− Loss from operations for the fourth quarter of 2006 was $2.9 million compared with $4.0 million in the same period of 2005. On a non-GAAP basis, loss from operations for the fourth quarter of 2006 was $2.6 million compared with $4.0 million in the same period of 2005.

− Loss from operations for 2006 was $15.4 million compared with $19.0 million in 2005. On a non-GAAP basis, loss from operations for 2006 was $14.7 million compared with $19.0 million in 2005.

− At December 31, 2006, deferred revenue was $10.9 million, compared with $3.1 million at the end of 2005; in the fourth quarter of 2006 inventory turns were 11, compared with 8 in the third quarter of 2006; in the fourth quarter of 2006 days sales outstanding (DSOs) were 106, compared with 97 in the third quarter of 2006.

− At December 31, 2006, cash and cash equivalents were $99.9 million, including proceeds from the December initial public offering, and the company had no outstanding debt.

Outlook

Isilon expects total revenue for the first quarter of 2007 to be in the range of $21.0 million to $23.0 million. For the full year 2007, the company expects total revenue to be in the range of $115 million to $125 million. In 2007, the company


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expects operating expenses to continue to grow in absolute dollars as the company invests in its business, but to decrease as a percentage of total revenue. If revenue and operating expense expectations are met, Isilon expects to reach breakeven and profitability on a non-GAAP basis in the second half of 2007.

47. This was the first in a series of partial disclosures and revelations concerning the truth

about Isilon’s business operations, finances, business metrics and future business and financial

prospects. Nonetheless, Isilon’s stock continued to trade at artificially inflated levels, as this

revelation, along with the ones made during the remainder of the Class Period, was accompanied by

denials and continued misrepresentations by certain of the defendants. Upon this partial disclosure,

Isilon’s stock took a hit, closing down sharply at $20.83 per share on February 8, 2007 – a one-day

decline of $4.48 per share or 18% on extremely high volume.

48. On April 25, 2007, Isilon issued its results for 1Q 2007 in a press release which

stated:

Isilon Systems, Inc. , the leader in clustered storage, today reported financial results for the 2007 first quarter ended April 1, 2007. Revenue for the first quarter was $21.6 million, an increase of 107 percent from $10.4 million in the first quarter of 2006.

Recent announcements of strategic partner and customer agreements with a broad range of industry leading companies, including Schlumberger, NBC Universal, NASA, Second Life and XM Satellite Radio, reflect strong continued growth in Isilon’s customer base, which increased 149 percent from 180 customers at the end of the first quarter of 2006 to 448 customers at the end of the first quarter of 2007. Underscoring its focus on maximizing the significant market opportunity created by the broad-scale shift to clustered storage, Isilon also today announced (see separate press release) that it has expanded its management team with storage industry executives with proven track records of scaling business and managing large, worldwide organizations.

“Our year over year growth in revenue and customers reflects the solid underlying fundamentals in Isilon’s business,” said Steve Goldman, president and chief executive officer. “Also, during the first quarter, Isilon made significant progress in laying the foundation for future growth by expanding its line of clustered storage systems and software, growing the company’s worldwide channel business and continuing to garner industry awards and recognition for Isilon’s product innovation and market leadership.”

2007 Highlights

• Isilon acquired 77 new customers in the first quarter of 2007, an increase of 133 percent over the 33 new customers in the first quarter of 2006 and


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representing the second best quarter of new customer growth in the company’s history.

• Isilon continued to leverage its customer base and unique modular “pay as you grow” clustered architecture, with reorders from existing customers accounting for more than half of total revenue, in line with historical trends.

• Isilon expanded non-GAAP gross margins to 54.6 percent in the first quarter of 2007 up from 51.8 percent in the same period of 2006.

• Isilon continued to leverage its global system of resellers and distributors, generating 59 percent of first quarter sales with its channel partners, compared with 44 percent a year ago and 51 percent in the 2006 fourth quarter.

• Isilon expanded its suite of licensable software with the February launch of its fourth software application, MigrationIQ™, which enables automated data migration between multiple tiers of Isilon clustered storage. Isilon also introduced the latest version of its replication software, SyncIQ™ 2.0.

• Isilon expanded its line of award-winning clustered storage systems with the launch of the Isilon IQ 200 in January, bringing the benefits of clustered storage to the widest range of businesses in an extremely compact and affordable solution that runs all of Isilon’s software.

• Isilon received numerous awards and recognition for its products and leadership in clustered storage, including Gartner Research naming Isilon as a “cool vendor” in its “Cool Vendors in Storage Systems” 2007 report, Isilon IQ clustered storage systems named “Best of FOSE 2007” by Government Computer News Editors for the Top Honor in Storage Category at the world’s largest government information technology event, and receiving a “Broadcast Engineering Pick Hit Award” for innovative technology demonstrated at the National Association of Broadcasters 2007 show.

Financial Summary

* * *

• Revenue for the first quarter of 2007 was $21.6 million, compared with $10.4 million in the same period of 2006.

• Net loss for the first quarter of 2007 was $3.8 million, or $0.06 per share, based on 60.7 million shares outstanding. This compares with net loss of $4.5 million in the same period of 2006, or $0.79 per share, based on 5.7 million shares outstanding. On a non-GAAP basis, net loss for the first quarter of 2007 was $3.3 million, or $0.05 per share, based on 60.7 million shares


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outstanding. This compares with net loss of $4.3 million, or $0.09 per share, based on 47.5 million shares outstanding in the same period of 2006.

• Loss from operations for the first quarter of 2007 was $4.9 million compared with $4.3 million in the same period of 2006. On a non-GAAP basis, loss from operations for the first quarter of 2007 was $4.4 million compared with $4.3 million in the same period of 2006.

• At April 1, 2007, cash and cash equivalents were $99.4 million, compared with $99.9 million at the end of 2006, and the company had no outstanding debt.

Outlook

Isilon expects total revenue for the second quarter of 2007 to be in the range of $24.5 million to $27.5 million. For the full year 2007, the company expects total revenue to be in the range of $115 million to $125 million, the same range provided in February. In 2007, the company expects operating expenses to continue to grow in absolute dollars as the company invests in its business, but to decrease as a percentage of total revenue if revenue expectations are met. If revenue and operating expense expectations are met, Isilon expects to reach breakeven and profitability on a non-GAAP basis in the second half of 2007.

49. Upon this partial disclosure, Isilon’s again stock took a hit, closing down sharply at

$12.86 per share on April 26, 2007 – a one-day decline of $5.25 per share or 29% on extremely high

volume.

50. On July 26, 2007, the Company announced its 2Q 2007 results in a press release

which stated:

Isilon Systems, Inc., the leader in clustered storage, today reported financial results for the 2007 second quarter and six-month period ended July 1, 2007. Revenue for the second quarter was $25.1 million, an increase of 87 percent from $13.4 million in the second quarter of 2006, and an increase of 16 percent sequentially from $21.6 million in the first quarter of 2007. Revenue for the six-month period ended July 1, 2007 was $46.7 million, up 96 percent compared with $23.8 million in the same period of 2006.

“Isilon’s results reflect strong revenue growth, a record quarter of customer acquisition and a rapid pace of product innovation that is extending Isilon’s leadership in clustered storage,” said Steve Goldman, president and chief executive officer. “As Isilon’s business continues to grow and scale at an impressive rate, the company’s biggest challenge is to hire and bring new people up to speed as quickly as possible so we can capture the large market opportunity in front of us.”


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Highlights

• Isilon acquired 91 new customers in the second quarter of 2007, an increase of 117 percent over the 42 new customers acquired in the second quarter of 2006, representing the best quarter of new customer growth in the company’s history. Isilon’s total customer base grew to 539, successfully crossing the 500th customer milestone during the quarter (see separate press release).

• Isilon continued to leverage its growing customer base and unique modular “pay as you grow” clustered architecture, with reorders from existing customers accounting for more than half of total revenue, in line with historical trends. A particularly large reorder from an existing customer impacted gross margin for the quarter, but otherwise pricing remained consistent with prior quarters.

• Isilon expanded its line of award winning clustered storage systems with the introduction of the new Isilon IQ 9000 and EX 9000 systems products, delivering the industry’s first and only storage system to scale up to 1.6 Petabytes of capacity in a single file system and single volume, achieving scalability levels 100 times that of traditional NAS and SAN storage systems.

• Isilon expanded its enterprise-class software line with its SmartQuotas software application, enabling customers to partition a single, highly scalable, shared pool of storage into smaller allocations assigned to individual users or groups and providing thin provisioning capability to optimize utilization. With the introduction of SmartQuotas, Isilon’s suite of licensable software increased to five applications.

• Isilon continued to leverage its global channel of trained resellers and distributors, generating 58 percent of second quarter sales with its channel partners compared with 45 percent in the same period a year ago.

• Isilon IQ clustered storage systems were named “Best of Show” at Bio- IT World Conference and Expo in the event’s Information Technology (IT) Infrastructure category in recognition of new products that demonstrate exceptional technology innovation across the life sciences research, discovery and clinical trials process.

Financial Summary

* * *

• Revenue for the second quarter of 2007 was $25.1 million, compared with $13.4 million in the same period of 2006.

• Gross margin for the second quarter of 2007 was 52.2 percent, compared with 52.3 percent in the same period of 2006. On a non-GAAP basis, gross


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margin for the second quarter of 2007 was 52.3 percent, compared with 52.3 percent in the same period of 2006.

• Net loss for the second quarter of 2007 was $3.6 million, or $0.06 per share, based on 61.1 million shares outstanding. This compares with net loss of $5.5 million in the same period of 2006, or $0.89 per share, based on 6.2 million shares outstanding. On a non-GAAP basis, net loss for the second quarter of 2007 was $2.6 million, or $0.04 per share, based on 61.1 million shares outstanding. This compares with net loss of $4.6 million, or $0.10 per share, based on 48.0 million shares outstanding in the same period of 2006.

• Loss from operations for the second quarter of 2007 was $4.8 million, compared with $4.3 million in the same period of 2006. On a non-GAAP basis, loss from operations for the second quarter of 2007 was $3.7 million, compared with $4.2 million in the same period of 2006.

• At July 1, 2007, cash, cash equivalents and marketable securities were $94.5 million, compared with $99.9 million at the end of 2006, and the company had no outstanding debt.

Outlook

Isilon expects total revenue for the third quarter of 2007 to be in the range of $25 million to $27.5 million, representing year over year growth in the range of 40 percent to 54 percent. Based on results for the first half of 2007, Isilon is lowering guidance for total revenue for the full year 2007, and now expects total revenue to be in the range of $98 million to $105 million, which represents year over year growth in the range of 57 percent to 69 percent.

51. Upon this partial disclosure, Isilon’s again stock took a hit, closing down sharply at

$9.54 per share on July 27, 2007 – a one-day decline of $5.37 per share or 36% on extremely high

volume.

52. Then, on October 3, 2007, after the market closed, Isilon announced preliminary 3Q

2007 results, in a press release which stated:

Isilon Systems, the leader in clustered storage, today announced preliminary results for the third quarter of 2007 ended September 30, 2007. Based on preliminary estimates, total revenue is expected to be in the range of $23.2 million to $23.7 million, down approximately 6 percent to 8 percent sequentially from the second quarter of 2007 and up approximately 30 percent to 33 percent from the same period one year ago. Previously, on the company’s second quarter conference call on July 26, 2007, the company stated it expected total revenue in the range of $25 million to $27.5 million for the third quarter of 2007.

Based on preliminary revenue estimates for the third quarter of 2007, Isilon expects GAAP gross margin to be in the range of 54.4 percent to 56.4 percent and


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non-GAAP gross margin in the range of 54.6 percent to 56.6 percent. Based on preliminary revenue and gross margin estimates, Isilon expects GAAP net loss per share to be in the range of ($0.10) to ($0.12) and non-GAAP net loss per share to be in the range of ($0.08) to ($0.10). . . .

“We are disappointed with our Q3 results,” said Steve Goldman, president and chief executive officer. “Despite the fact that our recent growth rate has not been matching our expectations, continued spending by an ever broadening range of new and existing customers underscores the strong value proposition of Isilon clustered storage.”

Isilon’s preliminary third quarter results are subject to review by the company as well as its independent auditors. The company’s final results for the third quarter of 2007 will be announced on October 25, 2007 after the close of market.

(Footnote omitted.)

53. On this news, Isilon’s stock price collapsed from $7 per share on October 3, 2007, to

close at $5.66 per share on October 4, 2007 – a decline of over 19% on volume of 3 million shares

(over five times the average previous trading volume for the stock).

54. The true facts, which were known by certain of the defendants but concealed from the

investing public during the Class Period, were as follows:









including the amount of revenue it derived from its large customers, such as Kodak, the Company’s

ability to continue to sustain quarter over quarter revenue growth, and its ability to manage its cost

structure.




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LOSS CAUSATION/ECONOMIC LOSS

55. By misrepresenting Isilon’s financial outlook, the defendants presented a misleading

picture of the Company’s business and prospects. Thus, instead of truthfully disclosing during the

Class Period that Isilon’s business was not as healthy as represented, Isilon falsely reported its

financial outlook and its actual business prospects going forward.

56. These claims of profitability caused and maintained the artificial inflation in Isilon’s

stock price throughout the Class Period and until the truth was revealed to the market.

57. Defendants’ false and misleading statements had the intended effect and caused Isilon

stock to trade at artificially inflated levels throughout the Class Period, reaching as high as $27.37

per share on December 29, 2006.

58. The truth about Isilon’s business operations, finances, business metrics, and future

business and financial prospects began to enter the market with a series of partial disclosures and

revelations which were accompanied by denials and continuing misrepresentations by defendants.

As a result, the artificial inflation in Isilon’s stock price did not come out of the stock all at once,

rather the artificial price inflation came out over time, in bits, pieces, and spurts as the stock

continued to trade at artificially inflated, albeit lower, prices through October 2007.

59. As a direct result of defendants’ admissions and the public revelations regarding the

truth about Isilon’s financial outlook and its actual business prospects going forward, Isilon’s stock

price plummeted 79%, falling from $27.37 per share on December 29, 2006 – its all time high – to

$5.66 per share on October 4, 2007 – a drop of $21.71 per share. This closing price of $5.66

represented an all-time trading low for Isilon.


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COUNT I

For Violation of §10(b) of the 1934 Act and Rule 10b-5 Against Defendant Isilon and the Individual Defendants

60. Plaintiff incorporates ¶¶1-59 by reference.

61. During the Class Period, defendants disseminated or approved the false statements

specified above, which they knew or deliberately disregarded were misleading in that they contained

misrepresentations and failed to disclose material facts necessary in order to make the statements

made, in light of the circumstances under which they were made, not misleading.

62. Defendants violated §10(b) of the 1934 Act and Rule 10b-5 in that they:

(a) employed devices, schemes and artifices to defraud;

(b) made untrue statements of material facts or omitted to state material facts

necessary in order to make the statements made, in light of the circumstances under which they were

made, not misleading; or

(c) engaged in acts, practices and a course of business that operated as a fraud or

deceit upon plaintiff and others similarly situated in connection with their purchases of Isilon

common stock during the Class Period.

63. Plaintiff and the Class have suffered damages in that, in reliance on the integrity of

the market, they paid artificially inflated prices for Isilon common stock. Plaintiff and the Class

would not have purchased Isilon common stock at the prices they paid, or at all, if they had been

aware that the market prices had been artificially and falsely inflated by defendants’ misleading

statements.

COUNT II

For Violation of §20(a) of the 1934 Act Against Isilon and the Individual Defendants

64. Plaintiff incorporates ¶¶1-63 by reference.

65. The Individual Defendants acted as controlling persons of Isilon within the meaning

of §20(a) of the 1934 Act. By reason of their positions with the Company, and their ownership of


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Isilon stock, the Individual Defendants had the power and authority to cause Isilon to engage in the

wrongful conduct complained of herein. Isilon controlled the Individual Defendants and all of its

employees. By reason of such conduct, defendants are liable pursuant to §20(a) of the 1934 Act.

COUNT III

Violations of Section 11 of the 1933 Act Against All Defendants

66. Plaintiff repeats and realleges ¶¶9-43 set forth above, emphasizing that plaintiff

explicitly excludes any allegation herein that could be construed to allege intentional or reckless

misconduct.

67. This Count is brought pursuant to §11 of the 1933 Act, 15 U.S.C. §77k, on behalf of

the Class, against all defendants.

68. The Registration Statement for the IPO was inaccurate and misleading, contained

untrue statements of material facts, omitted to state other facts necessary to make the statements

made not misleading, and omitted to state material facts required to be stated therein.

69. Isilon is the registrant for the IPO. The defendants named herein were responsible for

the contents and dissemination of the Registration Statement.

70. As issuer of the shares, Isilon is strictly liable to plaintiff and the Class for the

misstatements and omissions.

71. None of the defendants named herein made a reasonable investigation or possessed

reasonable grounds for the belief that the statements contained in the Registration Statement were

true and without omissions of any material facts and were not misleading.

72. By reason of the conduct herein alleged, each defendant violated, and/or controlled a

person who violated, §11 of the 1933 Act.

73. Plaintiff acquired Isilon shares pursuant and/or traceable to the Registration Statement

for the IPO.

74. Plaintiff and the Class have sustained damages. The value of Isilon common stock

has declined substantially subsequent to and due to defendants’ violations.


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75. At the time of their purchases of Isilon shares, plaintiff and other members of the

Class were without knowledge of the facts concerning the wrongful conduct alleged herein and

could not have reasonably discovered those facts prior to October 3, 2007. Less than one year has

elapsed from the time that plaintiff discovered or reasonably could have discovered the facts upon

which this complaint is based to the time that plaintiff filed this complaint. Less than three years

elapsed between the time that the securities upon which this Count is brought were offered to the

public and the time plaintiff filed this complaint.

COUNT IV

Violations of Section 15 of the 1933 Act Against the Individual Defendants

76. Plaintiff repeats and realleges ¶¶9-43 set forth above, emphasizing that plaintiff

explicitly excludes any allegation herein that could be construed to allege intentional or reckless

misconduct.

77. This Count is brought pursuant to §15 of the 1933 Act against the Individual

Defendants.

78. Each of the Individual Defendants was a control person of Isilon by virtue of his or

her position as a director and/or senior officer of Isilon. The Individual Defendants each had a series

of direct and/or indirect business and/or personal relationships with other directors and/or officers

and/or major shareholders of Isilon.

79. Each of the Individual Defendants was a culpable participant in the violations of §11

of the 1933 Act alleged in the Count above, based on their having signed or authorized the signing of

the Registration Statement and having otherwise participated in the process which allowed the IPO

to be successfully completed.

PRAYER FOR RELIEF

WHEREFORE, plaintiff prays for relief and judgment, as follows:

A. Determining that this action is a proper class action and certifying plaintiff as a Class

representative under Rule 23 of the Federal Rules of Civil Procedure;


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B. Awarding compensatory damages in favor of plaintiff and the other Class members

against all defendants, jointly and severally, for all damages sustained as a result of defendants’

wrongdoing, in an amount to be proven at trial, including interest thereon;

C. Awarding plaintiff and the Class their reasonable costs and expenses incurred in this

action, including counsel fees and expert fees;

D. Awarding rescission or a rescissory measure of damages; and

E. Such equitable/injunctive or other relief as deemed appropriate by the Court.

JURY DEMAND

Plaintiff hereby demands a trial by jury

DATED: November 1, 2007 LOVELL MITCHELL BARTH LLP KARL P. BARTH, WSBA #22780

KARL P. BARTH

11542 NE 21st Street Bellevue, WA 98004 Telephone: 425/452-9800 425/452-9801 (fax) [email protected]

COUGHLIN STOIA GELLER RUDMAN & ROBBINS LLP DARREN J. ROBBINS DAVID C. WALTON CATHERINE J. KOWALEWSKI 655 West Broadway, Suite 1900 San Diego, CA 92101 Telephone: 619/231-1058 619/231-7423 (fax)

Attorneys for Plaintiff

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