Rackable Systems Disappoints, Promises

Rackable Systems (RACK) reported Q2 revenues that were up 12% over Q1 ($76 million v. $68 million). There are high expectations for Rackable, so the impressive sequential increase was not enough to compensate for the poor bottom line. Even on a non-GAAP basis there was a net loss of $3.5 million, or $0.12 per share. The GAAP loss was amplified by an impairment charge of $16 million to $28 million or negative $0.95 per share. [See my Rackable (RACK) analyst conference summary for August 4, 2008 for a full report]

The impairment charge was because they are "looking at strategic options" for their RapidScale storage technology, which they acquired only a few years ago, and which was supposed to help them grow into a much larger company. Obviously they expect to sell the division for less than they acquired it for, hence the write-down.

The sequential increase in revenue was marred by a single sale where management decided to make a substantial price cut to get the business. They would not name a client or a dollar amount, but they believe this one-time transaction will lead to future profitable sales.

There are, however, reasons for optimism. Management did not lower the guidance for 2008. They expect revenues of at least $353 million, which implies that Q3 and Q4 revenues will be over $100 million each, which would be quite a jump.

They have some reasons for this optimism. In a bull market the bulls would be swarming all over these "forward looking statements." The backround is their claim, upheld by independent researchers, that their technology is far more energy efficient than that of their competitors (Sun, HP, IBM, etc.). In addition to their standard data center and Internet server farm technologies, they have a product called the ICE Cube, which is a portable server farm in a standard storage container. They have been talking about this for well over a year now, and they finally completed their first sale after Q2 ended. At least as important, IBM has decided to partner with them on the ICE Cube by supplying its own blade servers (BladeCenter); presumably IBM will do the marketing on this joint product. Raytheon is also partnered with Rackable to sell ICE Cube technology to the government; it is particularly attractive for military applications.

For their standard servers (the Eco-Logical line), they had their first sale in the energy (petroleum) vertical market. About 65% of revenues were generated with sales to their current major clients, Amazon, Yahoo, and Microsoft.

And even the RapidScale debacle has its upside. They expect to announce a new, global storage partnership soon. So they don't need RapidScale as badly as some giant computer corporation needs their server farm technology.

They even made their first sale in Japan. Rackable has had weak international sales, but is working on that problem with partners.

I own Rackable stock; I am certainly not selling it at this point. Rackable has disappointed investors over the past two years, and profitability has been elusive. If you don't own the stock you might want to wait until Q3 results are in, to see if management can make good on its promises.

As always, keep diversified.

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