Analyst Conference Summary

conference date: October 25, 2007 @ 2:00 PM Pacific Time
for quarter ending: September 30, 2007 (3rd quarter)

Forward-looking statements

Overview: Second quarter of sequential revenue gains, and reached break-even. Entered Q4 with largest backlog of orders in company history.

Basic data:

Revenue was $87.2 million, up 6.1% sequentially from $82.2 million and up 8.4% from $80.5 million year-earlier.

Net income was zero (0), up from a $40.4 million loss in Q2 2007, and up from a loss of $389 thousand year-earlier.

EPS was zero (0), up from a loss of $1.42 in Q2 2007, and up 1 cent from a loss of 1 cent year-earlier.

Guidance:

2007 annual revenue between $340 and $360 million. GAAP gross margin between 10 and 12%. Non-GAAP gross margin between 16 and 18%. Non-GAAP EPS to be positive.

Conference Highlights:

Reached break-even with solid quarter. Had share gains in key accounts and added a fourth large customer.

"Enabling the ecological datacenter" is the new brand. Good relations with AMD and Intel. Supporting new AMD quad core processors. Feedback is very positive. V-series of virtualization optimized servers using VMWare. Icecube container solutions now available and 3 were shipped for validation to existing customers. We expect to ship 3 more to federal customers by mid 2008. See an up to 80% reduction in cooling costs.

Non-GAAP EPS was $0.09 per share.

Improved storage and management systems brought to market. RapidScale 2.2 OS was released. Have had repeat buys from current customer and got a design win at a leading telco and a major data provider.

A new R&D facility will be open in China by Q1 2008, which will lower costs. Rackable Labs began functioning in Q3.

Cost of revenue was $68.4 million. Gross profit $18.8 million. R&D $6.0 million. S&M $8.0 million. G&A $7.6 million. Total operating expenses $21.5 million. Loss from operations was $2.7 million. Other income was $2.3 million. Income tax benefit was $332 thousand.

Cash from operating activities was $28.1 million. Cash and equivalents ended at $178.8 million, down $1.8 million sequentially. Inventories ended at $50.8 million.

Gross margin was 19.2% (non-GAAP).

Microsoft, Facebook, Amazon and Yahoo were our top 4 customers. Created a partnership with Raytheon. 57% of revenues came from top 3 customers. 83% of revenue came from top 10 accounts.

In Q4 we enter with a good backlog. Seeding market with evaluation units.

Goal is to grow revenue, expand margins, and operate profitably in 2008.

Non-GAAP items: $4.9 stock based-compensation; recovery of inventory from prior write-down $2.6 million; amortization of intangibles $1.1 million; payout for Terrascale acquisition $1.3 million.

Expansion of base markets and supply chain efficiency were main contributors to gross margin improvement.

Headcount 326.

Believe is time to invest in supply chain to be ready for 2008. Hiring. So operating expenses will increase noticeably in Q4.

Q&A:

Record bookings in quarter? Yes. Record book-to-bill in Q3.

Facebook relationship? Very positive; we are the strategic platform for them.

Will you show net income in Q4? We are not providing guidance for Q4 due to uniqueness of situation including need to invest in sales and engineering.

Market changes? Q3 buying decisions were made on platforms and architecture rather than pricing. Containerized solutions are moving to production; we are one of only two vendors with a solution.

Virtualization? Works well with build to order because of complexity of networking and heat generation.

Google patent effect on data centers? Reviewed it and appears to be unrelated to us. We are confident we do not infringe, nor do they infringe on us.

Component costs? Not so much an issue in Q3, like it was for memory earlier.

Blade servers? Our density does well against comparable blade servers.

Storage? Less than 10% of revenues in Q3. Still believe in RapidScale, and had good design wins in Q3.

Federal vertical, we have the partnership with Raytheon.

Budgets for 2008 from customers? We have not heard any change in the market dynamic.

International? Continue to service U.S. customers as they expand internationally. We are looking for a partner to originate international business.

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