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Rackable serves up $13.4m in losses

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If the rising and falling fortunes of niche server maker Rackable Systems are any indication, the economy might be stabilizing. Sales were up sequentially from the fourth quarter and losses shrank a bit. But even with that, the year-on-year numbers look pretty bad for Rackable and show that it has a long way to go to get back to the kinds of numbers it was posting a year ago.

In its first quarter of fiscal 2009 ended April 4, Rackable's sales fell by 34.6 per cent to $44.3m. Even with keeping a cap on research and development spending (which was possible because a lot of the R&D associated with supporting Intel's "Nehalem EP" Xeon 5500 processors was done last year, when the chips should have shipped) and slashing sales and marketing expenses, the company had rising general and administrative costs even as it cut the payroll, and that pushed Rackable to a $13.4m loss in fiscal Q1.

The company had sales of $67.8m and a loss of $766,000 in the year-ago quarter, and by comparison, those look like good times. But Q1 2009 is not as bad as the fourth quarter ended January 3, when the economic meltdown hammered Rackable just like it hit every server maker, with sales off 65.1 per cent to $38.8m and a net loss of $18.2m (that's from continuing operations, by the way).

Rackable sold two of its ICE containerized data centers in the quarter (they had no made any money until now) and launched 30 different server configurations based on Intel's Nehalem EPs. The company also said that it shipped evaluation units of its CloudRack C2 "cookie sheet" servers, which offer high density and low metal content. The company's fledgling storage business accounted for 25 per cent of product sales in the quarter (up 164 per cent sequentially and up 29 per cent year-on-year), and spending at two large accounts (Amazon and Yahoo) improved in fiscal Q1 as well.

Rackable exited the quarter with $173.8m in cash with no short-term investments, down from $155.2m in cash and $43m in investments it had a year ago. But despite the losses in fiscal Q1, Rackable added $1.9m to its cash pile and has more than enough money to pay $42.5m for the carcass of supercomputer maker Silicon Graphics, which it received approval for last Friday.

In a conference call with Wall Street analysts, Mark Barrenechea, Rackable's chief executive officer, said that the auction process required by the New York court is what compelled Rackable to shell out $42.5m in cash to buy most of the assets of SGI compared to the original $25m that SGI's board of directors agreed to accept when the acquisition was first announced back on April 1. He did not say if there were any other competitive bidders for SGI's patents and customer base, but presumably there were.

So what is Rackable buying, precisely, for that $42.5m? Rackable is soaking up the equity of SGI's overseas subsidiaries as well as for its U.S. federal systems business. Rackable is also getting receivables, real estate, core patents, cash on hand, inventories of servers and storage, and a 5,000-strong global customer list that would take Rackable a decade to build on its own (if it could survive that long without such a customer list, given the competition in the server space these days).

Rackable is assuming the costs of employee benefits, warranties on SGI systems, and accounts payables under the deal, and it says that it will cut the SGI employee base by 10 per cent as it eliminates redundancies. After the acquisition is completed, the new Rackable will have about 1,250 employees. At the end of fiscal Q1, Rackable had 276 employees of its own, down from 348 a year ago.

Rackable is not providing any sort of revenue guidance for fiscal 2009's second quarter or for the full year, given the state of the economy and the pending SGI deal, which should close in a few days. But the company is targeting $500m in sales and gross margins "in the 20s" for fiscal 2010. The company has not talked about product roadmaps, but that is surely coming as soon as the acquisition closes.

Barrenechea said that Rackable would be one of the first companies to use the new FAS 141R purchase accounting rules, which will compel it to book costs of a merger in the quarter the deal is done and wipe out any deferred revenue that SGI had on the books. ®

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