Rackable Systems: Winter Storm Warning

In my report dated November 6, I indicated that visibility might not be improving at Rackable Systems (RACK) and that the storm clouds may be on the horizon. Last night the weather turned chilly as RACK warned that they would fall very short on earnings, despite revenues well within Q3 guidance.

The company is projecting a loss of $683,000 to a profit of $194,000, or a loss of 2 cents per share to a profit of a penny per share:

Rackable Systems expects quarterly revenue to range from $105.5 million to $106.8 million.

Excluding certain expenses, such as amortization and stock-based compensation costs, the company expects $4.8 million to $5.3 million in net income, or earnings of 17 cents to 18 cents per share.

The company said its earnings and gross margins were hurt by higher-than-anticipated DDR (double data rate) memory pricing, lower-than-expected sales of RapidScale products and more aggressive pricing on some of its contracts due to increased competition.

In October, the Company gave guidance of $.25-27 per share earnings on revenue of $100-110MM.

I reported that RACK might have these margin pressures. However, it appears that DDR prices were really pretty steady in Q4. RapidScale products, from their recent Terrascale acquisition, were not really expected to help margins until 2007. So, it appears that Q4 margin declines may be mostly from competing with the likes of HP (HPQ), DELL (DELL), Sun Microsystems (SUNW) and a host of foreign companies. Obviously volume is not the answer as RACK is just “buying” business. Low-end servers have become a commodity business.

Despite the cascading margins, the increased sales will allow the Company to cover its stock-based compensation charges for another quarter. So, at least someone is profiting.

The stock is currently trading at $21, down from a close of $32.

The “Rackable Advantage” certainly does not apply to shareholders.

Disclosure: The author currently has no position in RACK or any other stocks mentioned in this report.