Rackable Systems Announces Fourth Quarter and Fiscal-Year 2007 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 fourth quarter and fiscal year 2007. Total revenue for the fourth quarter of 2007 was $111.7 million, up 4.5% compared to $106.9 million in the fourth quarter of 2006. Total revenue for the fiscal year 2007 was $353.2 million compared to $360.4 million in fiscal year 2006. GAAP gross margin for the fourth quarter of 2007 was 25.1%, compared to 18.8% in the fourth quarter of 2006. Non-GAAP gross margin for the fourth quarter of 2007 was 21.7%, compared to 19.8% in the fourth quarter of 2006. GAAP gross margin for fiscal year 2007 was 13.9%, compared to 21.4% in fiscal 2006. Non-GAAP gross margin for fiscal 2007 was 18.4%, compared to 22.4% in fiscal year 2006. GAAP net loss per share was ($0.65) for the fourth quarter of 2007, compared to GAAP net income of $0.02 per diluted share in the fourth quarter of 2006. Non-GAAP net income per diluted share was $0.18 in the fourth quarter of 2007, compared to $0.19 in the fourth quarter of 2006. GAAP net loss per share was ($2.42) for fiscal year 2007, compared to GAAP net income of $0.40 per diluted share in fiscal year 2006. Non-GAAP net income per diluted share was $0.17 for fiscal year 2007, compared to $0.94 in fiscal 2006. During the fourth quarter, the company recorded a preliminary pre-tax goodwill impairment charge of $ 23.9 million. The GAAP net loss from operations and GAAP net loss reported for the fourth quarter of 2007 and for fiscal year 2007 both included this goodwill impairment charge. "We are very pleased with our Q4 2007 execution, achieving our strongest quarter ever in revenues and a significant increase in gross margins,” said Mark J. Barrenechea, President and Chief Executive Officer of Rackable Systems. "2007 was a breakthrough year for innovation, demonstrated by the launch of our award-winning ICE Cube modular data center and numerous advancements in our broad range of server and storage products. We took the necessary steps to streamline our day-to-day operations, and our focus remains strong on providing energy efficient, Eco-Logical data center solutions for our growing customer base.” Rackable Systems ended the fourth quarter of 2007 with $198.1 million of cash, cash equivalents and short-term investments compared to $160.5 million as of December 30, 2006, representing an increase of 23% during the period. Business 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 - $ 388 million Annual GAAP Gross Margin is projected to be in the range of 16.5% to 19.5% Annual Non-GAAP gross margin is projected to be in the range of 17% - 20% Positive non-GAAP EPS for the full year 2008 Non-GAAP financial measures disclosed in this press release exclude excess and obsolete inventory charges associated with next-generation technology shifts and related recoveries; goodwill impairment; stock-based compensation; severance costs associated with executive management departures; write-off of in-process research and development; amortization of intangible assets related to the Terrascale acquisition; amortization of patents and customer lists; quarterly payout related to the Terrascale acquisition; and related adjustments to tax provision, including a valuation allowance charge. The reconciliation between GAAP and non-GAAP financials is provided in the tables accompanying this press release. Conference Call Information Rackable Systems will discuss these financial results and its outlook for 2008 in a conference call at 2:00 p.m. PST 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 4367486. Cautionary Statement Regarding Forward Looking Statements The statements in this press release regarding 2008 projected financial results and primary operational focus are forward-looking statements. Actual results may differ materially 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 could have a significant negative effect on Rackable Systems' financial performance for the quarter; 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; new products by competitors may come on the market, which would decrease the demand for Rackable Systems' products. Detailed information about 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 February 28, 2007 and further updated in the latest Quarterly Report on Form 10-Q under the caption "Risks Factors," in Part II, Item 1A of that report, filed with the SEC on November 8, 2007 and available at the SEC's Web site at www.sec.gov. 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 margin discussed in this press release excludes stock-based compensation expense and excess and obsolete inventory charges related to next-generation technology shifts and related recoveries. Non-GAAP operating income (loss) discussed in this press release excludes stock-based compensation expense, goodwill impairment, excess and obsolete inventory charges related to next-generation technology shifts and related recoveries, severance costs associated with executive management departures, write-off of in-process research and development, amortization of intangibles recorded in connection with the Terrascale acquisition, amortization of patents and customer list in connection with the acquisition of the company's predecessor and cash payments related to the Terrascale acquisition. Non-GAAP net income and net income 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, as well as exclude the financial impact of other events affecting the company such as the operational ramifications of excess and obsolete inventory charges 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. In addition, the charges for excess and obsolete inventory associated with next-generation technology platform shifts reflects operational decisions and purchases by the company in a previous period that resulted in a cash outlay that the company will not be able to recover, but the ramifications of this operating decision are not reflected in the non-GAAP financial measures. 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™ 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®, Inc. RACKABLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands) (Unaudited)     December 29, December 30,   2007   2006 ASSETS CURRENT ASSETS: Cash and cash equivalents $ 49,897 $ 30,446 Short-term investments 148,215 130,025 Accounts receivable, net 49,957 104,070 Inventories 53,138 68,137 Deferred income taxes 499 7,408 Deferred cost of sales 456 2,375 Prepaids and other current assets   18,967   12,934 Total current assets 321,129 355,395 PROPERTY AND EQUIPMENT — Net 8,285 5,372 GOODWILL - 22,871 INTANGIBLE ASSETS — Net 22,732 14,007 OTHER ASSETS   922   9,125 TOTAL $ 353,068 $ 406,770   LIABILITIES AND STOCKHOLDERS’ EQUITY CURRENT LIABILITIES: Accounts payable $ 48,390 $ 61,102 Accrued expenses 16,382 19,894 Income taxes payable - 247 Deferred revenue   5,190   5,972 Total current liabilities 69,962 87,215 DEFERRED INCOME TAXES 3,031 431 DEFERRED RENT 868 23 DEFERRED REVENUE   3,089   3,412 Total liabilities 76,950 91,081   STOCKHOLDERS’ EQUITY   276,118   315,689 TOTAL $ 353,068 $ 406,770 RACKABLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share and per share amounts) (Unaudited)         Three Months Ended For the Year Ended December 29, December 30, December 29, December 30,   2007     2006     2007     2006   REVENUE $ 111,650 $ 106,876 $ 353,155 $ 360,376 COST OF REVENUE   83,620     86,756     304,183     283,400   GROSS PROFIT   28,030     20,120     48,972     76,976   OPERATING EXPENSES: Research and development 7,327 5,518 26,281 16,485 Sales and marketing 9,143 8,742 34,245 27,051 General and administrative 7,661 7,293 36,152 21,893 Goodwill impairment   23,872     -     23,872     -   Total operating expenses   48,003     21,553     120,550     65,429   INCOME (LOSS) FROM OPERATIONS (19,973 ) (1,433 ) (71,578 ) 11,547   OTHER INCOME — Net:   2,386     2,065     8,588     8,297     INCOME (LOSS) BEFORE INCOME TAX PROVISION (17,587 ) 632 (62,990 ) 19,844 INCOME TAX PROVISION   (1,370 )   (69 )   (6,567 )   (8,372 ) NET INCOME (LOSS) $ (18,957 ) $ 563   $ (69,557 ) $ 11,472     NET INCOME (LOSS) PER SHARE Basic   ($0.65 ) $ 0.02   $ (2.42 ) $ 0.43   Diluted   ($0.65 ) $ 0.02   $ (2.42 ) $ 0.40     SHARES USED IN NET INCOME (LOSS) PER SHARE Basic   29,233,217     28,012,081     28,785,807     26,947,888   Diluted   29,233,217     29,452,182     28,785,807     28,618,309       Stock-based compensation is included in the following cost and expense categories by period (in thousands):   Three Months Ended For the Year Ended December 29, December 30, December 29, December 30,   2007     2006     2007     2006     Cost of revenue $ 285 $ 1,042 $ 2,152 $ 3,583 Research and development 1,098 2,067 4,887 5,069 Sales and marketing 794 2,197 5,465 6,245 General and administrative   1,926     2,482     10,731     5,858   Total $ 4,103   $ 7,788   $ 23,235   $ 20,755   RACKABLE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)     For the Year Ended December 29, 2007   For the Year Ended December 30, 2006 CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (69,557 ) $ 11,472 Adjustments to reconcile net income (loss) to net cash used in operating activities: Depreciation and amortization 7,392 3,566 Loss on disposal of fixed assets 73 - Impairment loss on fixed assets 188 - Impairment of goodwill 23,872 - Provision for doubtful accounts receivable, net of writeoffs 105 311 Deferred income taxes 12,856 (9,620 ) Write-off of acquired in-process research and development - 2,840 Stock-based compensation 23,235 20,755 Changes in operating assets and liabilities: Accounts receivable 54,008 (53,833 ) Inventories 14,432 (27,197 ) Prepaids and other assets (5,919 ) (8,889 ) Accounts payable and other payables (13,140 ) 32,055 Sales tax payable (103 ) - Accrued expenses (2,563 ) 11,199 Income taxes payable 392 (2,932 ) Deferred cost of sales 1,910 6,200 Deferred revenue   (1,106 )   (3,511 ) Net cash provided by (used in) operating activities   46,075     (17,584 ) CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of marketable securities (584,009 ) (547,017 ) Proceeds from sales and maturities of marketable securities 565,836 442,089 Purchases of property and equipment (4,500 ) (3,938 ) Terrascale acquisition, net of cash acquired (350 ) (31,886 ) Expenditures for intangibles   (9,122 )   (152 ) Net cash used in investing activities   (32,145 )   (140,904 ) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock upon follow on offering — net of issuance costs - 138,452 Excess tax benefit of stock options exercised 1,639 14,971 Repurchased restricted stock (617 ) - Proceeds from issuance of common stock upon exercise of stock options 2,682 4,906 Proceeds from issuance of common stock upon ESPP purchase   1,843     1,541   Net cash provided by financing activities   5,547     159,870     Effect of exchange rate changes on cash and cash equivalents (26 ) (35 ) NET INCREASE IN CASH AND CASH EQUIVALENTS 19,451 1,347   CASH AND CASH EQUIVALENTS — Beginning of period   30,446     29,099   CASH AND CASH EQUIVALENTS — End of period $ 49,897   $ 30,446   RACKABLE SYSTEMS, INC. AND SUBSIDIARIES         RECONCILIATION OF GAAP TO NON-GAAP FINANCIAL MEASURES (In thousands, except share and per share amounts) (Unaudited)   Three Months Ended   For the Year Ended December 29, December 30, December 29, December 30,   2007     2006     2007     2006   GAAP GROSS PROFIT $ 28,030 $ 20,120 $ 48,972 $ 76,976 Add back (deduct): Stock-based compensation 285 1,042 2,152 3,583 Excess and obsolete inventory charges associated with next-generation technology shifts and related (recoveries) of these written-down inventories   (4,129 )     -     13,898       -   Non-GAAP GROSS PROFIT $ 24,186     $ 21,162   $ 65,022     $ 80,559     GAAP GROSS MARGIN 25.1 % 18.8 % 13.9 % 21.4 % Add back (deduct): Stock-based compensation 0.3 % 1.0 % 0.6 % 1.0 % Excess and obsolete inventory charges associated with next-generation technology shifts and related (recoveries) of these written-down inventories   -3.7 %   -     3.9 %   -   Non-GAAP GROSS MARGIN   21.7 %   19.8 %   18.4 %   22.4 %   GAAP INCOME (LOSS) FROM OPERATIONS $ (19,973 ) $ (1,433 ) $ (71,578 ) $ 11,547 Add back (deduct): Stock-based compensation 4,103 7,788 23,235 20,755 Excess and obsolete inventory charges associated with next-generation technology shifts and related (recoveries) of these written-down inventories (4,129 ) - 13,898 - Goodwill impairment 23,872 - 23,872 - Severance costs associated with executive management departures - - 781 - Write-off of in-process research and development and amortization of intangible assets - Terrascale acquisition 1,133 553 2,906 3,530 Amortization of patents and customer list 321 359 1,398 1,436 Quarterly payout related to Terrascale acquisition   1,266     -     5,151     -   Non-GAAP INCOME (LOSS) FROM OPERATIONS (2) $ 6,593   $ 7,267   $ (337 ) $ 37,268     GAAP NET INCOME (LOSS) $ (18,957 ) $ 563 $ (69,557 ) $ 11,472 Add back (deduct): Stock-based compensation 4,103 7,788 23,235 20,755 Excess and obsolete inventory charges associated with next-generation technology shifts and related (recoveries) of these written-down inventories (4,129 ) - 13,898 - Goodwill impairment 23,872 - 23,872 - Severance costs associated with executive management departures - - 781 - Write-off of in-process research and development and amortization of intangible assets - Terrascale acquisition 1,133 553 2,906 3,530 Amortization of patents and customer list 321 359 1,398 1,436 Quarterly payout related to Terrascale acquisition 1,266 - 5,151 - Adjustment to tax provision / benefit (1)   (2,302 )   (3,631 )   3,192     (10,150 ) Non-GAAP NET INCOME (2) $ 5,307   $ 5,632   $ 4,876   $ 27,043     GAAP NET INCOME (LOSS) PER SHARE - DILUTED ($0.65 ) $ 0.02 ($2.42 ) $ 0.40 Add back: Stock-based compensation, excess and obsolete inventory charges associated with next-generation technology shifts and related (recoveries) of these written-down inventories, goodwill impairment, severance costs associated with executive management departures, write-off of in-process research and development and amortization of intangible assets - Terrascale acquisition, amortization of patents and customer list, quarterly payout related to Terrascale acquisition and adjustment to tax provision - benefit. $ 0.83   $ 0.17   $ 2.59   $ 0.54   Non-GAAP NET INCOME PER SHARE - DILUTED $ 0.18   $ 0.19   $ 0.17   $ 0.94     SHARES USED IN COMPUTING NET INCOME (LOSS) PER SHARE DILUTED - GAAP   29,233,217     29,452,182     28,785,807     28,618,309   DILUTED - Non-GAAP   29,468,908     29,452,182     29,356,526     28,618,309     (1) The provision for income taxes used in arriving at the non-GAAP net income was computed using an income tax rate of 40.9% for the three months and year ended December 29, 2007 and includes a $13.2 million valuation charge for the year ended December 29, 2007. The valuation allowance was recorded to adjust the realizability of deferred tax assets at the beginning of the year due to a projected pre-tax loss that will result in a cumulative pre-tax loss position for fiscal years 2007, 2006, and 2005. (2) Non-GAAP net income and non-GAAP net loss from operations for the year ended December 29, 2007 includes $1.3M of charges related to an order cancellation by one customer, $0.8M of charges related to severance payments and $1.9M of charges related to sales & use tax. All of these were recorded in the three months ended March 31, 2007. RACKABLE SYSTEMS, INC. AND SUBSIDIARIES     RECONCILIATION FROM NON-GAAP TO GAAP FINANCIAL PROJECTIONS (in millions except for per share amounts)   Revenue and Gross Margin Projections FY 2008 Low High Estimated revenues $ 353.0 $ 388.0 Non-GAAP gross margin 17.0 % 20.0 % Non-GAAP estimated gross profit $ 60.0 $ 77.6   Less: Estimated stock based compensation expense under cost of revenue $ (1.8 ) $ (1.8 ) GAAP estimated gross profit $ 58.2   $ 75.8   GAAP estimated gross margin 16.5 % 19.5 % Percentage difference - Non-GAAP and GAAP gross margin 0.5 % 0.5 %     EPS Projection FY 2008 Estimated GAAP earnings per share $ (0.57 ) Estimated stock based compensation expense $ 0.66 Amortization of intangible assets - Terrascale acquisition $ 0.11 Quarterly payout related to Terrascale acquisition $ 0.08 Estimated tax impact of non-GAAP adjustments and to reconcile GAAP to non-GAAP tax rate $ (0.11 ) Estimated non-GAAP earnings per diluted share (1) $ 0.17   Estimated number of diluted shares (in millions)   30.2     Footnote: (1) For reconciliation purpose only, the Company has estimated 2008 non-GAAP EPS of $0.17 or flat year over year.