Analyst Conference Summary

Rackable Systems

conference date: February 6, 2008 @ 2:00 PM Pacific Time
for quarter ending: December 31, 2007 (4th quarter)

Forward-looking statements

Overview: Good quarter with record revenue, but bad GAAP earnings due to large non-cash goodwill impairment charge. Cash generation is good.

Basic data:

Revenue was $111.7 million, up 28% sequentially from $87.2 million and up 4.5% from $106.9 million year-earlier.

Net income was a loss of $19.0 million, worse than $0 million in Q3 and worse than a gain of $0.6 million year-earlier.

EPS was a loss of $0.65, worse than $0.00 in Q3 and worse than a gain of $0.02 year-earlier.


For full year 2008 revenue expected between $353 and $388 million. Gross margin GAAP 16.5% to 19.5%, non-GAAP 17% to 20%. Positive non-GAAP EPS for the full year flat against 2007. Q1 is seasonally weak and we factored that into the annual guidance.

Conference Highlights:

Strongest quarter ever in revenue with a significant gross margin increase. 2007 was a breakthrough year for us. Delivered on plan for 2007. Product differentiation was the heart of ability to win customers. CFO is leaving when replacement is found.

Non-GAAP numbers: gross margin 21.7%. EPS $0.18, down from $0.19 year-earlier. Difference between GAAP and non-GAAP mainly due to TerraScale acquisition goodwill impairment charge of $23.9 million. Stock based compensation charge was $4.1 million. Amortization of intangibles $1.5 million. Recovery of previously written-down inventories $4.2 million benefit. And tax consequences.

GAAP gross margin was 25.1%.

Cash ended at $198.1 million., up from $160.5 million year-earlier. Nearly $20 million was added in Q4.

Inventories ended at $53.1 million, down from $68.1 million year-earlier. But accounts receivable at $50.0 million was way below $104.1 million year-earlier.

Cost of revenue was $83.6 million, leaving $28.0 million gross profit. Operating expenses were $48.0 million including R&D $7.3 million, sales and marketing $9.1 million, general and administrative $7.7 million, and goodwill impairment of $23.9 million. Other income was $2.4 million.

One ICE Cube module went live at Yahoo. Many new customers and products.

Amazon, Microsoft, and Facebook were over 10% customers.

Bookings ended strongly.

378 headcount, up 11 sequentially.

Sales will be expanded in 2008 with product lines, geographies, and large scale partners. International teams are now supporting channel partners. Will extend lead in density, efficiency and power. Shift to quad-core CPUs favors Rackable. Our value proposition helps us do well even in a down economy.

Certain unfavorable revenue streams will be phased out in 2008, hence our projected flat revenues.


Revenue mix transition assumptions? We are focusing on profitable growth. We are not giving details.

Gross margin benefit in Q4? It was a stellar quarter with sales across install base. In 2008 we can only do what is within our control. Deduplification, virtualization and form factors mean new product introductions could get us good gross margins.

Q1 similar to last year? Not giving quarterly guidance. Q1 is always seasonally weak. We re planning EPS positive on annual basis, but flexible for any given quarter.

Are you willing to forego historical customers if pricing is bad? Business means to make sense for both parties. That is across customers and product lines. We surveyed our installed base and have a plan.

Storage? 2007 was disappointing in storage. In 2008 plan is to have it be a 10% to 20% contributor to revenue.

Indirect channel revenue goals? Mid to high teens would be really great for us.

It is all about scaling the business. We had one failed model: direct sales in North America. We are going to international and multiple sales paths. We were X86 compute and we are moving to multiple products. We were single industry, Internet, and we are expanding to other verticals. We are doing real well starting to sell into the federal market in partnership with Raytheon. This is planned for 2008 and lays the investment for 2009.

If you are eliminating low margin products, should not margins go up? To get to high end of range we need new product introductions and excellent execution.

Macroenvironment? There are a couple of very favorable trends. Movement to quad-core and virtualization. There is a fairly healthy demand in Internet and federal, and even in financial sectors. ICE Cube is about selling on value: it cuts cooling cost by 80%, electricity by 50%.

Goodwill impairment charge? Purely a bookkeeping charge forced by decline of market capitalization (FAS 142). We are going forward with storage business.

We are still disproportionately investing in the business, but maintaining profitability discipline. To scale the business we need to invest. That is why the lower estimated non-GAAP EPS for 2008. Facility in China is now operational, and we are going to work the company 24 hours a day, back office costs will be reduced. Growing headcount, but mainly offshore.

Datacenter infrastructure goal? 2008 will be a breakthrough year in containerized datacenters, but it is hard to quantify.

Component pricing benefit in Q4? Was favorable for DRAM pricing, but starting to see some stabilization for DRAM. Motherboards are price stable but longer lead times. All independent motherboard makers have been acquired.

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Copyright 2008 William P. Meyers