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Rackable swings to loss on lower sales

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Server maker Rackable Systems reported its financial results for the third quarter on Monday, saying that sales had dropped by 25.2 per cent to $65.3m.

The company reported a minuscule profit in the year ago quarter ($5,000, to be precise, thanks to a tax benefit that wiped out its losses), but this time around, it had a loss of just under $6m even with a little help from the tax man. That worked out to 20 cents per share. Interestingly, the losses come as Rackable has cut research and development expenses by 23.4 per cent, sales and marketing by 65.1 per cent, and general and administrative costs by 47.9 per cent.

Three weeks ago, Rackable, which went public in June 2005, warned Wall Street that it didn't expect to be profitable in 2008 because of tightening budgets at the high-end data centers where it sells its rack-based servers. Rackable is one of the boutique server makers that specializes in making energy-efficient, highly dense servers and related storage; Amazon, Yahoo, and Microsoft were early customers of the company, which has tried to push into more data centers as energy becomes a larger issue.

Back as recently as August, Rackable was expecting sales for 2008 to come in between $353m and $374m with some profits, but now the company says it will only bring in $275m to $300m, with a loss for the year in the range $1.26 to $1.45 per share. Those losses will be driven in part from stock-based compensation, restructuring charges, amortization of assets relating to its acquisition of Terrascale, and a few other items, but these would not have been important if sales were not down by between $75m and $78m, as the company now says they will be for the full year.

In 2007, Rackable had sales of $353.1m and had a net loss of just under $63m, but was profitable in 2005 and 2006. Sales were actually higher in 2006, at $360.4m, but the company was most profitable with $23.6m dropping to the bottom line in 2005 from $215m in sales. Clearly, the high-end, high-density, hyperscale server business is a lumpy one, but Rackable's main problems in this quarter seem to be the global economic meltdown, increasing competition from IBM and Dell (which just got the deal to build out Microsoft's Azure cloud computing hardware platform) and plain old product transitions coming at a bad time.

"We executed on a very robust product roadmap, introducing two leading-edge products in the quarter, and we have several more in the pipeline," explained Mark Barrenechea, Rackable's president and chief executive officer in a statement accompanying its financial results. He was referring to the C2005 modular rack servers announced a few weeks ago and the CloudRack topless and fanless machines. "Our latest release, the CloudRack, is a dramatic departure from conventional server design and delivers best-in-class compute and storage densities.

"During this time of economic uncertainty, we will continue to manage costs and drive operational efficiencies, while maintaining our strong balance sheet. We are confident that our solid financial position will help us invest for long-term growth."

Rackable had $184.6m in cash and equivalents in the bank at the end of September, so it is not doing poorly even though its stock has been hammered (just as every other stock has been these days). At its current trading price of $6.88 per share, Rackable has nearly enough money to take itself private, since it only has a market capitalization of $212m. In early 2006, Rackable's shares were trading at $55 a pop. This was when Rackable had a substantial edge over the competition in the server racket and that, of course, is what brought in the competition.

Rackable says that it is going to introduce a leasing program for its customers to help them get financing and to offer them more flexibility in their technology upgrades. The company is also planning to offer a "lifetime" warranty, which will designate an effective service life for each rack server setup and then guarantee the working of the product so long as it remains with the original buyer. What Rackable really needs is a boom in cloud computing, and it is doing everything it can to foster one - just like all the other server makers are. Just how real this cloud computing thing is (or isn't) is a open for debate. ®

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