Cheap Stocks Net/Net Research

March 13, 2009

Rackable Systems $3.62

Fremont, California based Rackable Systems, Inc. designs and Company Information
manufactures high capacity, low-cost servers, storage and data center Ticker: RACK
solutions. The company’s flagship product is the half-depth server which Price: $3.62
is a high density, rack mounted system utilized by large scale data centers, Shares Outstanding: 29.79 million
and designed to reduce server floor space requirements. Nearly all Market Cap: $108 million
revenue, 94% is generated within the U.S. Current Assets: $265.6
Total Liabilities: $54
Background
Composition of Current Assets
Rackable Systems is yet another technology company that has been stung by the Cash: $172.0
recession and market pullback to the point that it now trades below its net current Inventory: $50.1
asset value. What’s intriguing about Rackable is the company’s current cash Receivables: $27.8
position relative to both current assets and the company’s market cap. Other: $15.8

Recent Results Composition of Total Liabilities

Short Term Debt: $0
The company recently reported 2008 revenue of $247.4 million, down 29% from last Long Term Debt: $0
year’s $350.7 million; while the bottom line” improved” to a loss of $54.2 million, from
a loss of $69.6 million. Included in the losses for both years were substantial losses
from discontinued operations; $22.9 million in 2008, and $29.5 million in 2007.
Net/Net Analysis
Net Current Asset Value: $211.6
Fourth quarter results reflect the continuing challenges facing not only this company, NCAV/Market Cap: .51
but many others, given the pullback in spending coming as a result of major Cash/NCAV: .81
economic difficulties. For the quarter, revenue fell 65%, to $38.8 million, from $111.3
million last year. Although the bottom lines were similar (-$ 19.5 million versus -$19 Valuation
million), last year’s fourth quarter included a loss of $23.6 million from discontinued PE Ratio (TTM): NM
operations, and net income from continuing operations was $4.7 million. Forward PE: NM
Book Value/Share: $7.77
Net/Net Analysis Tangible Book Value/Share: $7.65
Price/Book: .47
Despite the extremely challenging environment and very poor recent results, Price/Tangible Book: .47
Rackable System’s balance sheet remains very solid, and the company’s stock price Price/Sales: .44
has suffered dramatically, adding it to an ever-growing list of companies trading
below their net current asset value (NCAV). Financial Strength/Liquidity
Current Ratio: 5.4
Quick Ratio: 4.4
Debt/Equity: NA
Net Profit Margin: NM

Major Holders (12/31/2008)

Artis Capital Mgmt: 8.98%
Renaissance Technologies: 7.89%
Sun Life Financial: 7.19%
Systematic Financial Mgmt: 6.34%
Barclays Global Inv UK: 5.62%
FMR LLC: 5.15%
Dimensional Fund Adv: 4.65%
Rothschild Asset Mgmt: 4.29%
Vanguard Group: 3.11%
State Street Corp: 2.79%

Recent Price Return Data

52 week high: $14.48
52 week low: $3.42
YTD Return: -5%
1 Year Return: -59%
2008 Return: -59%

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The company ended Q4 with $265.6 million in current assets, the majority of which, $172 million, or $5.77 per share, was in
cash. Inventories accounted for $50.2 million, flat versus last year, while accounts receivable fell from $50 million to $27.8
million. All else being equal, this is a great balance sheet for a net/net. When it comes to net/net current asset composition,
cash is highly preferable to any of the other current asset accounts. While inventories needs to be stored and may be worth
cents on the dollar in the event of liquidation, and accounts receivable need to be collected in order to have value and there
are no guarantees here, the value of cash on the books cannot be disputed; and barring accounting malfeasance, cannot be
worth less than its stated value.

On the other side of the balance sheet, current liabilities were $49.3 million, reflecting no short-term debt, $21.6 million in
accounts payable, and $27.7 million in other current liabilities ($10.9 million in accrued expenses, and $16.8 million in
deferred revenue.) On the long side, Rackable had just $4.7 million in long-term liabilities, and no long-term debt.

With current assets of $265.6 million, the bulk of which is cash, and $54 million in total liabilities, Rackable Systems NCAV is
$211.6 million, or $7.10 per share, versus the current market of $108 million, and price of $3.62. Rackable is currently
trading at just .51 times NCAV.

Long Term Assets

When analyzing net/nets, long-tem assets are not figured into the calculation. In other words, long term assets are viewed
as “thrown in for free”; a sweetener or margin of safety of sorts. In Rackable Systems’ case, long term assets are listed on
the books at $19.9 million, or $.67 per share. Of course, not all long-term assets are created equal, and intangibles, such as
goodwill, should be viewed with skepticism. The assets that matter include long term investments, $8.7 million in Rackable’s
case, and property and equipment, at $6.9 million. The long-term investments represent auction rate securities, which may
be subject to further write down. Assuming, however, that they are “money good”, that the fixed assets are worth stated
book value, and that the intangibles are worthless, the value of long term assets is $15.6 million, or $.52 per share.

The Future

The environment has been horrible for Rackable Systems, and depending on the timing of an economic recovery, losses
may persist into the future. Currently covered by just 3 analysts, consensus estimates call for revenue of just $162 million in
2009, and a loss of $.45 per share, and revenue of $196 million, and a loss of $.29 per share in 2010. Fortunately, the
company has a boatload of cash, and should be able to weather the storm. Of course, the most pertinent question is how
much cash will the company burn before it begins to show signs of recovery. If recovery happens more quickly than is
currently expected, the share price should respond favorably. In the current environment, the company is practically priced
for bankruptcy, with the assumption that much, if not all of the cash will be spent before a recovery scenario begins to unfold.

Recent Developments

Last month, the company announced a stock repurchase program for up to $40 million. At the current price, such an effort
could considerably reduce shares outstanding, and depending on timing and magnitude of repurchases, could affect share
price, as a buyer with substantial resources enters the market. The repurchase program is open-ended in terms of
completion date.

Summary

Rackable System’s current situation is the epitome of a textbook technology net/net: long on cash, but short on hope for the
future. For the current price of $3.62, theoretically buyers receive $5.77 in cash, $.52 in long-term investments, property
and equipment, and a free call option on the business.

Judging by the company’s current discount to net current assets, and especially cash, the market is betting that Rackable
won’t recover anytime soon, and will eat through its relatively large cash balance, leaving investors with little but a struggling
business with dwindling cash. Any positive surprises here, such as glimpses of an improving economy, and improving
operating business, could be rewarding to patient, risk-seeking buyers.

Jonathan M. Heller, CFA

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IMPORTANT DISCLOSURE INFORMATION

Jonathan Heller holds no positions, long or short, in Rackable Systems.
This report is based on publicly available information, but no representation is made regarding either its accuracy or
completeness. This report is neither an offer nor solicitation to buy or sell securities. All expressions of opinion reflect
judgment at this date, and are subject to change. The author will disclose ownership or lack thereof in any securities
mentioned. Reproduction of this report is strictly prohibited.

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