Analysis

posted on 03 April 2008 17:24

Isilon is in a mess. As well as making a loss equivalent to 35 percent of its revenues for fy 2007 it's had to face up to the fact that its former CEO and CFO were incompetent or worse.

The Audit Committee has restated the company's FY 2007 results and the picture revealed is pretty bleak.

- In FY 2007 Isilon earned $89 million but lost $31.2 million.
- In FY2006 Isilon earned $61.2 million and lost $16.0 million.

If we look at the losses as a percentage of revenue the horror story of losses growing faster than revenue is revealed more starkly:

- FY2006 - 26.1 percent.
- FY2007 - 35.1 percent.

The company has been collecting its revenues with a leaky bucket and the holes are getting bigger.

In December 2006 Isilon went public in a greatly over-subscribed IPO. The prospects were great and shareholders excited, The CEO was ex-F5 man Steve Goldman (pictured), but all that he touched did not turn to gold. The CFO was Stu Fuhlendorf. Co-founder of Isilon, Sujal Patel, was the chief technology officer. Less than ten months later Goldman and Fuhlendorf were history.

It must have been some emergency for the CEO and CFO to be simultaneously ousted. Patel became the CEO. Controller Bill Richter was appointed interim CFO and he went over the books. What he saw was enough to send him to Patel and then the company's Audit Committee. Revenue had been recognised too early. Not only was the company making growing losses but reported revenue figures couldn't be relied on. The company was late filing its figures and lost its Nasdaq listing.

After a lengthy and detailed investigation the Audit Committee restated the company's results and reported that: "revenue was recognized prematurely on certain transactions and that revenue should not have been recognized on certain transactions. In certain instances, revenue was recognized when persuasive evidence of an end-user did not exist, when oral arrangements existed that would have precluded revenue recognition, or when resellers did not have the ability or intent to pay independent of payment by the end-user customer."

There was no-one to actually blame although the committee's finger quivered excitedly as it tried to point somewhere: "Our former Chief Executive Officer, former Chief Financial Officer, and former Vice President of North America Sales participated directly in certain of the transactions for which adjustments are being recorded, but the Audit Committee concluded that the evidence about their roles, knowledge and intent is conflicting, disputed, and ultimately inconclusive."

The restatements of revenue and actual FY 2007 results made Isilon's position clear, and bleak. It seems that Goldman and Fuhlendorf had been running the company into the ground. The company's reputation and standing have suffered greatly. A Federal Securitities class action case is pending. Competitors are suggesting to customers that Isilon is an unreliable company to buy from.

Patel has begun rearranging things. He's promoted Paul Rutherford internally to be the new CTO. Brett Helsel has been recruited to be SVP Engineering, a sign that product development is key. Isilon has to retain its clustered filer product advantages because established players EMC (Hulk/Maui), HP and NetApp will all be trying to enhance their products.

Meanwhile there is the small matter of ensuring that the company doesn't lose another $30+ million this year. The accumulated loss is now at $102 million. The share price has steadily slumped since the IPO. More losses won't help, yet Patel has to spend to develop new products and develop his channel and his own salesforce. There's no guarantee that losses won't continue but, at least, the loss rate has to fall to demonstrate that there is now firm control inside Isilon and that its internal reporting is trustworthy.

A regained Nasdaq listing would help here.

There is still everything to play for. Patel's basic message is: "Have faith. We can turn the company around." They key is going to be execution. With the expertise of ex-ADIC CEO Peter Van Oppen on board, literally, then Patel has a resource available. His company just has to sell more product. It can't cut back - that gives competitors room to come in. The signs are that Isilon is going to have to sell its way out of trouble and rely on its 52 percent gross margin to turn the increased revenue tide towards profit.

Remember the old folk song: "There's a hole in my bucket. ... Well, mend it." This mending is probably going to take a year or two.

^{[Chris Mellor.]}