Rackable Systems Gets Crushed

The shares tumble to a new 52-week low as tough competition in the server area dents the company's profits

Only a couple years ago, Rackable Systems(RACK) was just a small outfit coming up with innovative ways to help fast-growing Internet companies run their servers more efficiently. Now tough competition is already denting profits. Investors sold Rackable Systems shares Apr. 5, after the Milpitas, Calif. company said it expects to have a net loss during the first quarter ended March 31.

"Intense competitive conditions for business at our largest customers continued throughout the first quarter of 2007, which negatively impacted our gross margin and bottom line," CEO Tom Barton said in a press release Apr. 4.

Rackable Systems thinks its gross margin for the first quarter will be around 30% lower than previously forecast, given the intensity of competition in the company's largest accounts. A customer canceled its order during the first quarter. Rackable Systems also expects to take hits on sales and "use tax exposures from past sales to various customers," according to the statement. Meanwhile the company is paying severance to former staffers, after having completed an internal reorganization in January.

After the announcement, the stock plunged 15.6% to $14.24 on the Nasdaq Apr. 5, after touching a new 52-week low of $13.95 during the session. It reached a 52-week high of $55.75 a year ago.

First Albany analyst Hugh Mai noted that the computer giant Dell (DELL) recently decided to target Rackable Systems' niche, by replicating the practice of custom-building servers optimized to customers' applications. Given that companies like Dell and network computing services giant Sun Microsystems (SUNW) can replicate Rackable Systems' capabilities much more cheaply in-house, the analyst doubts speculation that either of the two companies might buy their rival instead.

CEO Barton pointed out in the Apr. 4 statement that his company won the bulk of opportunities on which they bid this quarter. March quarter revenue is still expected to be in the previously projected $70 million to 75 million range.

"While we were faced with significant challenges in the first quarter, we remain optimistic that our position within our top customers is strong," Barton said. He also promised to come up with more innovative and operational efficiency improvements.

Founded in 1999, Rackable Systems got its start building servers for Google (GOOG), then just a startup itself. Rackable Systems' customers eventually included others such as the search portal Yahoo! (YHOO)

(see BusinessWeek.com, 1/24/05, "At Last, a Hardware IPO").

(Lisa Bissell contributed to this report.)

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