Analyst Conference Summary

conference date: July 26, 2007 @ 2:00 PM Pacific Time
for quarter ending: June 30, 2007 (2nd quarter)

Forward-looking statements

Overview: Turned around in quarter; revenues heading back up, cash positive, but heavy GAAP earnings losses. With enough one-time items they were able to claim a small non-GAAP profit.

Basic data:

Revenue was $82.2 million, up sequentially 14% from $72.0 million but down 7% from $88.6 million year earlier.

GAAP net income was a loss of $40.4 million, down sequentially from a loss of $ million in Q1 and down from a gain of $5.3 million in Q2 2006.

EPS loss of $1.42.

Ended with $180.6 million in cash and equivalents, up $10.5 million sequentially.

Guidance:

For 2007 now expects annual revenue of $340 to $360 million, flat to down 5%; GAAP gross margin between 9.0 and 11.4%; non-GAAP gross margin of 16% to 18%.

For second half of 2007 expects positive non-GAAP EPS; possibly for full year.

Expect growth rate to increase in 2nd half. Operating expense will increase but will do in a way to insure non-GAAP positive EPS.

2008 should see results of investments in 2007.

Conference Highlights:

Fundamental constraint is connecting prospects to products. Rackable is unique with build to order model; can deal effectively with low volume orders; TCO (total cost of ownership) approach to products; ecological benefits; speed of new technology to market. Fixed in place service model.

Believes market for products is large and Internet segment is growing at 20% per year. Needs to build a channel business and seek specialty partners in verticals. Set up an advanced research organization. Realligned management structure.

Remains strategic supplier of 3 top accounts. Settled patent dispute with SuperMicro.

GAAP Gross margin was negative 8.4%. Non-GAAP gross margin, which excludes inventory charges and stock-based compensation expense, was 17.5%. Non GAAP EPS was $0.02.

Cash flow from operations was $30.4 million, up from $9.4 million year earlier.

There was a charge (included in GAAP figures) of $20.6 million for obsolete inventory. Non-GAAP figures also exclude $6.3 million in stock-based compensation. Severance charge was $781,000. Terrascale acquisition costs $2.4 million.

Cost of revenue was $89.2 million, exceeding revenue. This includes the $20.6 million charge for obsolete inventory. Operating expenses were $24.1 million. Loss from operations was $31.0 million. Other income was $2 million.

Obsolete inventory was due to platform shift (AMD to Intel) and cost of components issue. Some weak planning (revenue lower than expected). Has new CRM system integrated to ERP to help avoid this in future. DDR1 inventory was key component. AMD motherboards and CPUs were also a problem. Should be some tax benefit from this.

Historical top 3 customers were 62% of revenues. 81% from top 10 customers. Internet business was 77%. 9 customers over 1 million in revenues. Storage was 10% of revenues. International 6%. Channel greater than 10%.

306 employees end of quarter. Engineering headcount increased 20%. Also expanding sales team.

New AMD motherboard certification will be a major focus in Q3. Oracle released record database functionality on a Rackable server. Virtualization server line to be introduced in Q3. Containerized datacenter project has customer pipeline.

Q&A:

3 to 5 large new customers missing? Smaller accounts (base) are growing, did above 20% growth in first half. New clients will come on board in second half, not as big. Business from larger customers is expected to grow as they grow.

RapidScale? Integration took longer than expected. Released 2.2 version. Added subject matter experts. Execution was not there for prior projections. Did have RapidScale business this quarter; expects some growth going forward, but no specific projection.

Q1 versus Q2 for base account growth? Sees even better growth in second half of year.

Competitive environment? Base market value proposition is very compelling. On large accounts the usual suspects (Dell and HP) compete. Dell is still low price provider and will be hyperaggressive on cost. HP has not gotten its build-to-order model together yet but is trying.

R&D costs going forward? Will increase gradually as percent of revenue. So will sales force growth. But will spend to remain EPS non-GAAP positive.

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