The increasing reliance by enterprises on information technology for everyday operations is driving the need for cost-effective, high-performance computing and high-capacity storage systems. Recently, enterprises have begun to deploy large-scale computing and storage infrastructures by aggregating large numbers of relatively inexpensive, open-standard modular computing and storage systems, known as “scale out” systems. Scale out compute servers generally run Linux or Windows operating systems, which increasingly are being used for enterprise computing and storage applications. These operating systems tend to feature a lower total cost of ownership relative to proprietary operating systems, such as UNIX variants. The broad adoption of these lower-cost operating systems has driven extensive support from software and hardware vendors. Linux- and Windows-based servers are expected to be the two fastest growing operating system segments of the server market. International Data Corporation, or IDC, estimates that the market for Linux-based servers will grow from $3.3 billion in 2003 to $9.1 billion in 2008, representing a compounded annual growth rate of 22.8%. IDC also estimates that the market for Windows-based servers will grow from $15.6 billion in 2003 to $23.4 billion in 2008, representing a compounded annual growth rate of 8.5%.

The Internet, data-intensive applications and digital content such as audio, graphics and video files are driving the rapid growth of data storage. According to IDC, the capacity of disk storage systems shipped has increased from 584 petabytes in 2002 to 831 petabytes in 2003, and is expected to grow to 5,444 petabytes by 2008. As data storage requirements have grown over the past decade, enterprises have turned to networked storage systems to address their storage needs. Networked storage systems enable storage to be shared by many users on a network instead of being captive to individual users or servers. This shared access to data has provided dramatic productivity benefits to enterprises. Despite the widespread adoption of networked storage systems, the evolution to modular storage systems based on open-standard operating systems and industry-standard components has trailed the evolution of the open standard modular compute server market.

The Company introduced its Foundation Series compute server line in early 2000. The Foundation Series adheres to rack-mount standards, but increases density levels and improves serviceability when deployed in the Company’s proprietary, purpose-built cabinet. The Company currently offers Foundation Series compute servers for single or dual processor motherboards supporting Intel and AMD 32- and 32/64-bit processors such as the Intel Pentium 4, the Intel Xeon, the Intel Xeon EM64T, or “Nocona,” and the AMD Opteron. The Company also offers Foundation Series compute servers for two processor motherboards supporting the 64-bit Intel Itanium 2 processor, and for four processor motherboards supporting the 32/64-bit AMD Opteron 800 Series processors.

The Company’s Scale Out Series server was introduced in August 2004 and utilizes a proprietary server form factor that is approximately half the width, half the depth and twice the height of a traditional 1U server. The Company mounts the servers back-to-back and side-by-side in its proprietary, purpose-built cabinet. The Company is able to offer essentially any compute server configuration that is supported in its C1000 series, with the additional benefits and feature sets offered by the Scale Out Series.

The Company’s Foundation Series storage server was introduced in 2000. The storage servers are available in a number of 3U half-depth and full-depth configurations supporting from six to 16 disk drives.

The Company offers a range of service and support packages, primarily associated with hardware break-fix support and onsite hardware service. The Company offers several standard levels of warranty support that vary depending on specific services, response times, coverage hours and duration.

The Company offers a range of professional services such as onsite cabling assistance and installation of third-party software such as grid, clustering and utility computing applications.

Cost of revenue increased $9.6 million, or 64%, to $24.6 million for the three months ended March 31, 2005, compared to $15.0 million for the three months ended March 31, 2004.

Research and development expense increased $206,000, or 145%, to $348,000 for the three months ended March 31, 2005, compared to $142,000 for the three months ended March 31, 2004.

Sales and marketing expense increased $1.2 million, or 65%, to $3.0 million for the three months ended March 31, 2005, compared to $1.8 million for the three months ended March 31, 2004.

Interest expense increased $214,000, or 38%, to $782,000 for the three months ended March 31, 2005, compared to $568,000 for the three months ended March 31, 2004.