Rackable Systems Announces Second Quarter 2008 Financial Results

Rackable Systems, Inc. (NASDAQ:RACK), a leading provider of servers and storage products for large-scale data centers, today announced financial results for the second quarter of fiscal year 2008 and reaffirmed full fiscal year 2008 outlook. Total revenue for the second quarter of 2008 was $76.0 million, compared to $82.2 million in the second quarter of 2007. GAAP gross margin for the second quarter of 2008 was 9.2%, compared to (8.4%) in the second quarter of 2007. Non-GAAP gross margin for the second quarter of 2008 was 9.7%, compared to 17.5 % in the second quarter of 2007. The Company's gross margin was impacted by two independent factors – a single transaction and product shortages – which we expect to be limited to the second quarter. The Company won an important opportunity at lower pricing, which we believe will put us in an advantageous position for more profitable, long-term opportunities. In addition Rackable Systems experienced component shortages, which resulted in higher cost of goods sold. GAAP net loss was ($0.95) per share for the second quarter of 2008, compared to GAAP net loss of ($1.42) per share in the second quarter of 2007. Non-GAAP net loss was ($0.12) per diluted share in the second quarter of 2008, compared to a net income of $0.02 in the second quarter of 2007. Rackable Systems ended the second quarter of 2008 with $206.2 million of cash, cash equivalents and short and long-term investments compared to $198.1 million as of December 29, 2007. "Our business outlook for the second half of 2008 is positive and we are reaffirming our 2008 annual guidance,” said Mark J. Barrenechea, President and Chief Executive Officer of Rackable Systems. "Our new XE series product is in the market, our industry focus is yielding results, and our core Internet market is expanding into cloud computing. We see these as favorable trends for the second half of 2008 and into 2009.” Q2 2008 Business Highlights The Company entered into an agreement with IBM to offer their BladeCenter servers integrated with its ICE Cube™ modular data centers. Keeping a rapid pace of innovation, Rackable Systems introduced five new server solutions that double the compute density of its existing servers while significantly increasing efficiency. These extreme efficiency, high-density products are optimized for Internet, cloud computing and HPC environments. Rackable Systems recently won an ICE Cube contract for the US Federal Government and booked its first business in Japan. Business Outlook for Fiscal Year 2008 The Company reaffirmed its fiscal year 2008 annual outlook based on current business trends. Rackable Systems’ financial projections for FY 2008 are as follows: Annual revenue is projected to be in the range of $353 to $374 million Annual non-GAAP gross margin is projected to be in the range of 18% to 21% Positive non-GAAP EPS for the full year 2008 Increase in year-over-year cash, cash equivalents and investments Conference Call Information Rackable Systems will discuss these financial results in a conference call at 2:00 p.m. PT today. The public is invited to listen to a live web cast of the call on the Investor Relations section of the Company's website at www.rackable.com. A replay of the web cast will be available approximately two hours after the conclusion of the call and remain available until the next earnings call. An audio replay of the conference call will also be made available approximately two hours after the conclusion of the call. The audio replay will remain available for five days and can be accessed by dialing 719-457-0820 and entering the confirmation code 8289401. Cautionary Statement Regarding Forward Looking Statements This press release contains forward-looking statements, including statements regarding Rackable Systems’ projected financial results and business trends. Any statements contained in this press release that are not statements of historical fact may be deemed forward-looking statements. Actual results may differ materially from forward-looking statements due to a number of risks and uncertainties including: Rackable Systems operates in a very competitive market, and increased competition has in the past, and may continue, to cause pricing pressure on Rackable Systems' products, which would negatively affect Rackable Systems' gross and operating margins, as well as other financial measures; a significant portion of the Company's revenues come from a small number of customers, and so the delay in placing an order, or the failure of a significant customer to place additional orders, could have a significant negative effect on Rackable Systems' financial performance; orders for Rackable Systems' products can be received at the end of the quarter, and so a delay in placing an order in the fourth quarter could have a significant negative effect on Rackable Systems' financial performance for the year; the failure of the RapidScale products to achieve market acceptance; Rackable Systems is unable to control component pricing, such as DDR memory pricing as has happened in the past, and as a result component pricing can rise unexpectedly, negatively impacting Rackable Systems' gross margins as well as other financial measures; Rackable Systems may be required to write-off additional significant amounts of excess and obsolete inventory; and new products by competitors may come on the market, which would decrease the demand for Rackable Systems' products. Detailed information about these and other potential factors that could affect Rackable Systems' business, financial condition and results of operations is included in Rackable Systems' Form 10-K under the caption "Risk Factors", in Part I, Item 1A of that report, filed with the Securities and Exchange Commission ("SEC") on March 13, 2008, as updated by Rackable Systems’ subsequent filings with the SEC, all of which are available at the SEC's Web site at www.sec.gov. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this release. Rackable Systems undertakes no responsibility to update the information in this press release. Use of Non-GAAP Financial Measures The non-GAAP financial measures discussed in the text of this press release and accompanying non-GAAP supplemental information are financial measures used by Rackable Systems' management to evaluate the operating performance of the Company and to conduct its business operations. Non-GAAP gross profit and gross margin discussed or presented in this press release exclude stock-based compensation expense and excess and obsolete inventory charges associated with next generation technology shift. Non-GAAP operating loss discussed in this press release excludes stock-based compensation, excess and obsolete inventory charges associated with next generation technology shift, severance costs associated with former executive management, amortization of patents and customer lists, impairment of long-lived assets, restructuring charges and, with respect to the acquisition of Terrascale, amortization of intangible assets and cash payment to former employee shareholders. Non-GAAP net income (loss) and net income (loss) per share excludes the same items as non-GAAP operating income (loss) and, as well, excludes the related tax effects of the applicable items. Management presents non-GAAP financial measures because it considers them to be important supplemental measures of performance. Management believes that the excluded charges are not central to the Company's core operating performance and uses the non-GAAP financial measures for planning purposes, including analysis of the Company's core operating performance against prior periods, the preparation of operating budgets and to determine appropriate levels of operating and capital investments. Management excludes from its non-GAAP gross margin, non-GAAP operating income (loss) and non-GAAP net income (loss) the items cited above, whether or not recurring, to facilitate its review of the comparability of the Company's core operating performance on a period to period basis as well as to better understand the fundamental economics of a specific period's operational and financial performance. Management uses this view of the Company's operating performance for purposes of comparison with its business plan and individual operating budgets and allocations of resources. Management also believes that the non-GAAP financial measures provide additional insight for analysts and investors in evaluating the Company's financial and operational performance in the same way that management evaluates Rackable Systems' financial performance. However, these non-GAAP financial measures have limitations as an analytical tool, as they exclude the financial impact of transactions necessary or advisable for the conduct of the Company's business, such as the granting of equity compensation awards and the acquisition of Terrascale, and are not intended to be an alternative to financial measures prepared in accordance with GAAP. For example, the benefits of having acquired intangible assets may be reflected in the Company's financial performance, but the amortization of those intangibles is not. Hence, to compensate for these limitations, management does not review these non-GAAP financial metrics in isolation from its GAAP results, nor should investors. Pursuant to the requirements of SEC Regulation G, a detailed reconciliation between the Company's GAAP and non-GAAP financial results is provided at the end of this press release. Investors are advised to carefully review and consider this information as well as the GAAP financial results that are disclosed in the Company's SEC filings. About Rackable Systems Rackable Systems, Inc. (NASDAQ:RACK) is a leading provider of Eco-Logical(TM) servers and storage products for large-scale data center deployments. The Company's products are designed to provide benefits in the areas of density, thermal efficiency, serviceability, power distribution, data center mobility and remote management. Founded in 1999 and based in Fremont, California, Rackable Systems is a founding member of The Green Grid and serves Internet, enterprise software, federal government, entertainment, financial services, oil and gas exploration and high performance-computing customers worldwide. Rackable Systems and Eco-Logical are trademarks or registered trademarks of Rackable Systems(R), Inc. RACKABLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited, in thousands)     June 28, December 29, 2008 2007 ASSETS CURRENT ASSETS: Cash and cash equivalents $ 190,778 $ 49,897 Short-term investments 6,668 148,215 Accounts receivable, net 51,487 49,957 Inventories 48,937 52,528 Deferred income taxes 254 499 Deferred cost of revenue 78 456 Prepaids and other current assets   13,078   19,000 Total current assets 311,280 320,552 PROPERTY AND EQUIPMENT—NET 6,705 8,285 LONG-TERM INVESTMENTS 8,729 - INTANGIBLE ASSETS—NET 4,965 22,732 OTHER ASSETS   4,756   889 TOTAL $ 336,435 $ 352,458   LIABILITIES AND STOCKHOLDERS’ EQUITY CURRENT LIABILITIES: Accounts payable $ 55,327 $ 47,780 Accrued expenses 13,479 16,382 Deferred revenue   4,958   5,190 Total current liabilities 73,764 69,352 DEFERRED INCOME TAXES 4,122 3,031 DEFERRED RENT 976 868 DEFERRED REVENUE   2,874   3,089 Total liabilities 81,736 76,340   STOCKHOLDERS’ EQUITY   254,699   276,118 TOTAL $ 336,435 $ 352,458 RACKABLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited, in thousands, except share and per share amounts)           Three Months Ended Six Months Ended June 28, June 30, June 28, June 30,   2008     2007     2008       2007   REVENUE $ 75,964 $ 82,238 $ 143,931 $ 154,262 COST OF REVENUE   68,976     89,172     119,220     152,171   GROSS PROFIT (LOSS)   6,988     (6,934 )   24,711     2,091   OPERATING EXPENSES: Research and development 6,876 6,146 13,974 12,982 Sales and marketing 5,781 8,401 12,255 17,124 General and administrative 6,885 9,561 13,926 20,901 Impairment of long-lived assets 16,856 - 16,856 - Restructuring charges   685     -     685     -   Total operating expenses   37,083     24,108     57,696     51,007   LOSS FROM OPERATIONS (30,095 ) (31,042 ) (32,985 ) (48,916 )   OTHER INCOME — NET:   845     2,038     2,875     3,840     LOSS BEFORE INCOME TAX (29,250 ) (29,004 ) (30,110 ) (45,076 ) INCOME TAX BENEFIT/(PROVISION)     1,319     (11,444 )   1,414     (5,529 ) NET LOSS $ (27,931 ) $ (40,448 ) $ (28,696 ) $ (50,605 )   NET LOSS PER SHARE Basic   ($0.95 )   ($1.42 )   ($0.98 )   ($1.78 ) Diluted   ($0.95 )   ($1.42 )   ($0.98 )   ($1.78 )   SHARES USED IN NET LOSS PER SHARE Basic   29,419,092     28,564,459     29,429,237     28,392,714   Diluted   29,419,092     28,564,459     29,429,237     28,392,714       Stock-based compensation is included in the following cost and expense categories by period (in thousands):   Three Months Ended Six Months Ended June 28, June 30, June 28, June 30,   2008     2007     2008       2007   Cost of revenue $ 368 $ 743 $ 670 $ 1,412 Research and development 938 961 1,745 2,897 Sales and marketing 678 1,621 1,327 3,635 General and administrative   1,774     2,993     3,473     6,262   Total $ 3,758   $ 6,318   $ 7,215   $ 14,206   RACKABLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited, in thousands) Six Months Ended June 28, 2008   June 30, 2007 CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (28,696 ) $ (50,605 ) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 3,588 3,163 Loss on disposal of property and equipment 63 - Impairment on long-lived assets 16,856 188 Provision for doubtful accounts receivable, net 35 235 Deferred income taxes (1,473 ) 12,121 Stock-based compensation 7,215 14,206 Changes in operating assets and liabilities: Accounts receivable (1,565 ) 64,911 Inventories 2,342 25,334 Prepaids and other assets 5,922 (2,852 ) Accounts payable and other payables 7,426 (36,420 ) Accrued expenses (2,818 ) (372 ) Income taxes payable 21 415 Deferred cost of revenue 299 441 Deferred revenue   (446 )   (387 ) Net cash provided by operating activities   8,769     30,378   CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of marketable securities (26,253 ) (281,774 ) Proceeds from sales and maturities of marketable securities 158,632 273,087 Terrascale acquisition, net of cash acquired - (330 ) Purchases of property and equipment (514 ) (3,395 ) Expenditures for intangibles   (35 )   (9,100 ) Net cash provided by (used in) investing activities   131,830     (21,512 ) CASH FLOWS FROM FINANCING ACTIVITIES: Excess tax benefit of stock options exercised - (430 ) Repurchased restricted stock (918 ) - Proceeds from issuance of common stock upon exercise of stock options 528 2,013 Proceeds from issuance of common stock upon ESPP purchase   677     1,065   Net cash provided by financing activities   287     2,648     Effect of exchange rate changes on cash and cash equivalents (5 ) (19 ) NET INCREASE IN CASH AND CASH EQUIVALENTS 140,881 11,495   CASH AND CASH EQUIVALENTS—Beginning of period   49,897     30,446   CASH AND CASH EQUIVALENTS—End of period $ 190,778   $ 41,941   RACKABLE SYSTEMS, INC. AND SUBSIDIARIES RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL MEASURES (Unaudited, in thousands, except percentage, share and per share amounts)         Three Months Ended Six Months Ended June 28, June 30, June 28, June 30,   2008     2007     2008     2007     GAAP GROSS PROFIT/(LOSS) $ 6,988 $ (6,934 ) $ 24,711 $ 2,091 Add back: Stock-based compensation 368 743 670 1,412 Excess and obsolete inventory charges associated with next-generation technology shifts   -     20,589     -     20,589   NON-GAAP GROSS PROFIT $ 7,356   $ 14,398   $ 25,381   $ 24,092     GAAP GROSS MARGIN 9.2 % (8.4 )% 17.2 % 1.4 % Add back: Stock-based compensation 0.5 % 0.9 % 0.4 % 0.9 % Excess and obsolete inventory charges associated with next-generation technology shifts   -     25.0 %   -     13.3 % NON-GAAP GROSS MARGIN   9.7 %   17.5 %   17.6 %   15.6 %   GAAP LOSS FROM OPERATIONS $ (30,095 ) $ (31,042 ) $ (32,985 ) $ (48,916 ) Add back: Stock-based compensation 3,758 6,318 7,215 14,206 Excess and obsolete inventory charges associated with next-generation technology shifts - 20,589 - 20,589 Severance costs associated with executive management departures - 781 - 781 Amortization of intangible assets - Terrascale acquisition 843 699 1,686 1,074 Amortization of patents and customer lists - 359 - 718 Impairment of long-lived assets 16,856 - 16,856 - Restructuring charges 685 - 685 - Quarterly payout related to Terrascale acquisition   1,266     1,295     2,532     2,590   NON-GAAP LOSS FROM OPERATIONS $ (6,687 ) $ (1,001 ) $ (4,011 ) $ (8,958 )   GAAP NET LOSS $ (27,931 ) $ (40,448 ) $ (28,696 ) $ (50,605 ) Add back/(deduct): Stock-based compensation 3,758 6,318 7,215 14,206 Excess and obsolete inventory charges associated with next-generation technology shifts - 20,589 - 20,589 Severance costs associated with executive management departures - 781 - 781 Amortization of intangible assets - Terrascale acquisition 843 699 1,686 1,074 Amortization of patents and customer lists - 359 - 718 Impairment of long-lived assets 16,856 - 16,856 - Restructuring charges 685 - 685 - Quarterly payout related to Terrascale acquisition 1,266 1,295 2,532 2,590 Adjustment to tax benefit/(provision) (1)   1,070     11,020     (949 )   7,622   NON-GAAP NET INCOME/(LOSS) $ (3,453 ) $ 613   $ (671 ) $ (3,025 )   GAAP NET LOSS PER SHARE - DILUTED ($0.95 ) ($1.42 ) ($0.98 ) ($1.78 ) Add back: Stock-based compensation, excess and obsolete inventory charges associated with next-generation technology shifts, severance costs associated with executive management departures, amortization of intangible assets - Terrascale acquisition, amortization of patents and customer lists, impairment of long-lived assets, restructuring charges, quarterly payout related to Terrascale acquisition and adjustment to tax benefit/(provision) (1). $ 0.83   $ 1.44   $ 0.96   $ 1.67   NON-GAAP NET INCOME/(LOSS) PER SHARE - DILUTED   ($0.12 ) $ 0.02     ($0.02 )   ($0.11 )   SHARES USED IN COMPUTING NET INCOME (LOSS) PER SHARE DILUTED - GAAP   29,419,092     28,564,459     29,429,237     28,392,714   DILUTED - Non-GAAP   29,419,092     29,127,784     29,429,237     28,392,714       (1) The provision of income taxes used in arriving at the non-GAAP net income (loss) was computed using an income tax rate of 40.9% for the three and six months ended June 28, 2008 and June 30, 2007. RACKABLE SYSTEMS, INC. AND SUBSIDIARIES     RECONCILIATION FROM NON-GAAP TO GAAP FINANCIAL PROJECTIONS (in millions, except for percentages and per share amounts)   Revenue and Gross Margin Projections   FY 2008 Low High Estimated revenues $ 353.2 $ 374.4 Non-GAAP gross margin 18.0 % 21.0 % Non-GAAP estimated gross profit $ 63.6 $ 78.6   Less: Estimated stock based compensation expense under cost of revenue $ (1.2 ) $ (1.2 ) GAAP estimated gross profit $ 62.4   $ 77.4   GAAP estimated gross margin 17.7 % 20.7 % Percentage difference - Non-GAAP and GAAP gross margin 0.3 % 0.3 %     EPS Projection FY 2008 Estimated GAAP loss per share $ (0.95 ) Estimated stock based compensation expense $ 0.42 Amortization of intangible assets - Terrascale acquisition $ 0.10 Impairment of long-lived assets $ 0.57 Restructuring charges $ 0.02 Quarterly payout related to Terrascale acquisition $ 0.08 Estimated tax impact of non-GAAP adjustments and to reconcile GAAP to non-GAAP tax rate $ (0.23 ) Estimated non-GAAP earnings per diluted share (1) $ 0.01   Estimated number of diluted shares (in millions)   29.8     Footnote: (1) The Company has projected a non-GAAP positive EPS for the year. For reconciliation purpose only, the Company is using $0.01 of non-GAAP EPS as starting point.