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Investors hammer Rackable back near IPO level

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Super-volatile shares of Rackable Systems dived more than 18 per cent during Friday's trading after the company disappointed investors with its fourth quarter results.

Rackable notched its first ever $100m quarter with revenue rising 29 per cent to $107m. Investors, however, fixated on Rackable's year-over-year net income dip to $563,000 from $7.6m in 2005. The server maker also posted earnings per share of 2 cents in this fourth quarter versus 33 cents in last year's fourth quarter.

The sell off started the instant Rackable flashed these figures in front of investors. At the time of this report, Rackable's shares have dropped 19 per cent to $16.50. In April of 2006, Rackable enjoyed a high of $56 per share, but it's now drawn much closer to its 2005 IPO of $12 per share.

Rackable did take a few stock options and acquisition related charges, although the primary pressure on its Q4 profits come from sickly gross margins and brute force sales tactics by HP and Dell. CEO Tom Barton complained that rivals were taking losses on major deals to undercut Rackable, making it very tough for the smaller company to remain competitive in some accounts.

"We now believe that the competitive intensity is escalating more rapidly than we anticipated," Barton said.

A spike in DDR1 memory prices also hurt Rackable during the fourth quarter, as did the failure to close a large deal before the end of the quarter.

Rackable has turned blaming memory prices, unclosed deals and competitive pressure into a tradition for explaining poor quarters.

The server start-up gained fame for claiming the scalps of Yahoo!, Microsoft and Amazon - three accounts the Tier 1 server vendors would love to dominate. It has always promised to name new, large customers that will help lend some consistency to Rackable's results, making it less dependent on the Big Three. Such customers have yet to arrive despite Barton's suggestions that Q4 could be a good showcase for new clients.

Full the full year, Rackable showed an impressive 68 per cent rise in revenue to $360m. It also boosted net income to $12m from $9m in 2005.

Management is now looking to a new fleet of storage gear to push margins higher and make Rackable more of a balanced operation.

It exited 2006 with 286 staff - up from 254 in 2005. One notable departure, however, was VP of sales Tom Gallivan. Rackable said painfully little to explain Gallivan's exit, although our sources have disclosed that Gallivan had a very serious disagreement with Rackable's brass. Rackable is still searching for Gallivan's replacement. ®

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