Silicon Graphics International (SGI) 10-Q/A 2008 Q3 Quarterly report (amended)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q/A

Amendment No. 1

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 29, 2008

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                    to                    

Commission file number: 0-51333

RACKABLE SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

Delaware	32-0047154
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

46600 Landing Parkway

Fremont, California 94538

(Address of principal executive offices including zip code)

(510) 933-8300

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No  x

As of May 5, 2008, there were 29,634,189 shares outstanding of the Registrant’s Common Stock, $0.001 par value per share.

QUARTERLY REPORT ON FORM 10-Q/A

For the fiscal quarter ended March 29, 2008

EXPLANATORY NOTE

Rackable Systems, Inc. (“the Company”) is filing this Amendment No. 1 on Form 10-Q/A, Amendment No. 1 (the “Amendment”) to its Quarterly Report on Form 10-Q for the three months ended March 29, 2008, which was originally filed on May 8, 2008, (the ”Original Form 10-Q”) , restating our condensed consolidated balance sheet as of March 29, 2008 and the related condensed consolidated statements of operations and cash flows for the three months ended March 29, 2008, including the condensed consolidated footnotes.

Subsequent to the original filing, the Company concluded that errors existed in the Original Form 10-Q related to the accounting of favorable material variances which affected inventory and cost of revenue. Following disclosure of the error to the Audit Committee of the Rackable Systems Board of Directors (“Audit Committee”) at a meeting held on May 27, 2008, management concluded, and the Audit Committee agreed, that the financial statements of Rackable Systems for the three months ended March 29, 2008, should no longer be relied upon and that the previously issued financial statements should be restated. The overall impact of the adjustments was a decrease in cost of revenue and an increase in inventory of $1.5 million. This restatement also includes the correction of other errors that were considered immaterial and not included in our Original Form 10-Q, which resulted in a reduction of $0.3 million of loss before income taxes. These errors resulted from a miscalculation of an inventory reserve, incorrect adjustments to certain accrued liabilities and reserves and miscellaneous reclassification entries. The overall tax impact of the adjustments set forth above resulted in an increase in the benefit for income taxes of $0.3 million.

The restatement did not affect our disclosures in any items of the Original Form 10-Q other than Items 1 and 2 of Part I and, accordingly, the unaffected items of the Original Form 10-Q are not repeated herein. The errors causing the restatement occurred in areas of material weakness in our internal controls that were previously disclosed in Item 4, Part I of the Original Form 10Q. The Company believes that the errors prompting the restatement are related to the lack of sufficient precision in the review of inventory valuations, and therefore encompassed by Item 4, Part I of the Company’s previously disclosed material weakness as set forth in the Original Form 10-Q. In particular, work orders related to product that shipped for the three months ended March 29, 2008 were not closed timely, resulting in inventory values being relieved in excess of actual cost.

For more detailed information about the restatement, please see Note 2, “Restatement of condensed consolidated financial statements as of and for the three months ended March 29, 2008” in the accompanying condensed consolidated financial statements and “Restatement of Previously Issued Financial Results” in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this quarterly report.

This Form 10-Q/A does not reflect events occurring after the filing of the Original Form 10-Q, other than the restatement for the matter discussed above.

Also attached to this Amendment is an exhibit index disclosing the filing of the certifications required to be filed as exhibits to this Amendment, as well as such certifications.

This quarterly report on Form 10-Q/A should be read in conjunction with our Form 10-K for our fiscal year ended December 29, 2007.

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INDEX

		Page
	PART I FINANCIAL INFORMATION
Item 1.	Financial Statements	4
	Condensed Consolidated Balance Sheets as of March 29, 2008 (restated) and December 29, 2007 (unaudited)	4
	Condensed Consolidated Statements of Operations for the Three Months Ended March 29, 2008 (restated) and March 31,2007 (unaudited)	5
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 29, 2008 (restated) and March 31, 2007 (unaudited)	6
	Notes to the Condensed Consolidated Financial Statements (unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 4.	Controls and Procedures	32

SIGNATURES

“Rackable Systems,” “Eco-Logical”, “OmniStor,” “RapidScale,” “Roamer”, “Concentro”, “ICE Cube” and the Rackable Systems logo are trademarks or registered trademarks of Rackable Systems, Inc. All other trademarks or service marks appearing in this report are trademarks or service marks of their respective owners.

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PART I—FINANCIAL INFORMATION

ITEM 1. Financial Statements

RACKABLE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share amounts)

(Unaudited)

	March 29, 2008			December 29, 2007
	(As restated) (1)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	155,215		$	49,897
Short-term investments		43,005			148,215
Accounts receivable, net of allowance for doubtful accounts of $454 and $434		34,664			49,957
at March 29, 2008 and December 29, 2007, respectively
Inventories		37,899			52,528
Deferred income taxes		499			499
Deferred cost of sales		54			456
Prepaids and other current assets		12,192			19,000
Total current assets		283,528			320,552
PROPERTY AND EQUIPMENT, Net		8,030			8,285
LONG-TERM INVESTMENTS		8,729			—
INTANGIBLE ASSETS, Net		21,854			22,732
OTHER ASSETS		2,849			889
TOTAL	$	324,990		$	352,458
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	22,391		$	47,780
Accrued expenses		11,603			16,382
Income taxes payable		20			—
Deferred revenue		5,205			5,190
Total current liabilities		39,219			69,352
DEFERRED INCOME TAXES		2,864			3,031
DEFERRED RENT		992			868
DEFERRED REVENUE		2,882			3,089
Total liabilities		45,957			76,340
COMMITMENTS AND CONTINGENCIES (NOTE 11)
STOCKHOLDERS’ EQUITY:
Preferred stock, $0.001 par value; 12,000,000 shares authorized and none outstanding		—			—
Common stock, $0.001 par value; 120,000,000 shares authorized; 29,631,036 and 29,525,561 shares issued and outstanding at March 29, 2008 and December 29, 2007, respectively		30			29
Additional paid-in capital		444,787			440,725
Accumulated other comprehensive loss		(393	)		(11	)
Accumulated deficit		(165,391	)		(164,625	)
Total stockholders’ equity		279,033			276,118
TOTAL	$	324,990		$	352,458

(1) See note 2 restatement of condensed consolidated financial statements of the condensed consolidated financial statements

See notes to these unaudited condensed consolidated financial statements.

4

RACKABLE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except for share and per share amounts)

(Unaudited)

	Three months ended
	March 29, 2008			March 31, 2007
	(As restated) (1)
REVENUE	$	67,966		$	72,023
COST OF REVENUE		50,245			62,999
GROSS PROFIT		17,721			9,024
OPERATING EXPENSES:
Research and development		7,096			6,836
Sales and marketing		6,475			8,722
General and administrative		7,041			11,340
Total operating expenses		20,612			26,898
LOSS FROM OPERATIONS		(2,891	)		(17,874	)
Total other income, net		2,030			1,803
LOSS BEFORE INCOME TAXES		(861	)		(16,071	)
INCOME TAX BENEFIT		95			5,914
NET LOSS	$	(766	)	$	(10,157	)
NET LOSS PER SHARE
Basic	$	(0.03	)	$	(0.36	)
Diluted	$	(0.03	)	$	(0.36	)
WEIGHTED SHARES USED IN NET LOSS PER SHARE
Basic		29,352,438			28,220,970
Diluted		29,352,438			28,220,970

(1) See note 2 restatement of condensed consolidated financial statements of the condensed consolidated financial statements

See notes to these unaudited condensed consolidated financial statements.

5

RACKABLE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

	Three months ended
	March 29, 2008			March 31, 2007
	(As restated) (1)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(766	)	$	(10,157	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		1,723			1,298
Provision for doubtful accounts receivable		20			145
Deferred income taxes		(166	)		(6,198	)
Share-based compensation expense		3,457			7,888
Changes in operating assets and liabilities:
Accounts receivable		15,273			34,782
Inventories		13,114			(391	)
Prepaids and other assets		6,807			(2,572	)
Accounts payable		(25,438	)		(12,803	)
Accrued expenses and deferred rent		(4,656	)		(2,396	)
Income taxes payable		20			949
Deferred cost of sales		263			2,043
Deferred revenue		(191	)		(2,223	)
Net cash provided by operating activities		9,460			10,365
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of marketable securities		(25,500	)		(124,331	)
Proceeds from sales and maturities of marketable securities		121,632			136,848
Purchases of property and equipment		(719	)		(2,028	)
Terrascale acquisition, net of cash acquired		—			(150	)
Expenditures for intangible assets		6			(36	)
Net cash provided by investing activities		95,419			10,303
CASH FLOWS FROM FINANCING ACTIVITIES:
Excess tax benefit of stock options exercised		—			(430	)
Restricted shares retired to cover taxes		(285	)		(51	)
Proceeds from issuance of common stock upon exercise of stock options		80			966
Proceeds from issuance of common stock upon ESPP purchase		677			1,065
Net cash provided by financing activities		472			1,550
Effect of exchange rate changes on cash and cash equivalents		(33	)		(12	)
NET INCREASE IN CASH AND CASH EQUIVALENTS		105,318			22,206
CASH AND CASH EQUIVALENTS—Beginning of period		49,897			30,446
CASH AND CASH EQUIVALENTS—End of period	$	155,215		$	52,652
NON CASH INVESTING AND FINANCING ACTIVITIES:
Fixed asset expenditures in accounts payable	$	49		$	—
Unrealized loss, net on investments	$	(349	)	$	(57	)
SUPPLEMENTAL DISCLOSURE OF OTHER CASH FLOW INFORMATION:
Cash paid (refund) for income taxes	$	(472	)	$	510

(1) See note 2 restatement of condensed consolidated financial statements of the condensed consolidated financial statements

See notes to these unaudited condensed consolidated financial statements.

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RACKABLE SYSTEMS, INC. AND SUSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. BUSINESS

Rackable Systems, Inc. (“Rackable Systems”, “we”, “our” or the “Company”) was incorporated in the state of Delaware in December 2002 in connection with the acquisition of substantially all the assets and liabilities of Rackable Systems’ predecessor company referred to herein as Old Rackable. The Company has subsidiaries in Canada, Hong Kong and Ireland. The Company’s headquarters is located in Fremont, California. The principal business of the Company is the design, manufacture and implementation of highly scalable compute servers and high-capacity storage systems, which are sold to customers such as large internet businesses, and companies in vertical markets such as semiconductor design, enterprise software, federal government, entertainment, financial services, oil and gas, biotechnology and pharmaceuticals.

2. RESTATEMENT OF CONDENSED CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE THREE MONTHS ENDEDMARCH 29, 2008

Subsequent to the original filing, the Company’s Form 10Q for the three months ended March 29, 2008 (“Original Filing”) the Company concluded that errors existed in the Original Filing related to the accounting of favorable material variances which affected inventory and cost of revenue. As a result, the Company has restated the accompanying condensed consolidated financial statements as of and for the three months ended March 29, 2008. The overall impact of the adjustments to correct these errors was a decrease in cost of revenue and an increase in inventory of $1.5 million.

This restatement also includes the correction of other errors that were considered immaterial. These resulted in an additional decrease in cost of revenue and an increase in inventory of $0.2 million, as well as a decrease of $0.1 million to general and administrative expenses. The errors resulted from a miscalculation of an inventory reserve, incorrect adjustments to certain liabilities and reserves and miscellaneous reclassification entries.

The Company recorded the tax impact of the restated adjustments listed above which resulted in an increase in the benefit for income taxes of $0.3 million. The overall impact of the total restated adjustments set forth above was a cumulative decrease of net loss and accumulated deficit by approximately $2.1 million.

7

The following sets forth the effect of the restatement on the applicable line items in the Company’s condensed consolidated balance sheet for the three months ended March 29, 2008 (in thousands, except share amounts):

	March 29, 2008
	(as reported)			(adjustments)			(as restated)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	155,215		$	—		$	155,215
Short-term investments		43,005			—			43,005
Accounts receivable, net of allowance for doubtful accounts		34,664			—			34,664
Inventories		36,234			1,665			37,899
Deferred income taxes		499			—			499
Deferred cost of sales		54			—			54
Prepaids and other current assets		12,324			(132	)		12,192
Total current assets		281,995			1,533			283,528
TOTAL	$	323,457		$	1,533		$	324,990
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	22,397		$	(6	)	$	22,391
Accrued expenses		11,909			(306	)		11,603
Income taxes payable		301			(281	)		20
Deferred revenue		5,205			—			5,205
Total current liabilities		39,812			(593	)		39,219
Total liabilities		46,550			(593	)		45,957
STOCKHOLDERS’ EQUITY:
Preferred stock, $0.001 par value; 12,000,000 shares authorized and none outstanding.		—			—			—
Common stock, $0.001 par value; 120,000,000 shares authorized; 29,631,036 outstanding at March 29, 2008		30			—			30
Additional paid-in capital		444,787			—			444,787
Accumulated other comprehensive loss		(393	)		—			(393	)
Accumulated deficit		(167,517	)		2,126			(165,391	)
Total stockholders’ equity		276,907			2,126			279,033
TOTAL	$	323,457		$	1,533		$	324,990

8

The following sets forth the effect of the restatement on the applicable line items in the Company’s condensed consolidated statement of operations for the three months ended March 29, 2008 (in thousands, except share and earnings per share amounts):

	Three months ended March 29, 2008
	(as reported)			(adjustments)			(as restated)
REVENUE	$	67,966		$	—		$	67,966
COST OF REVENUE		51,976			(1,731	)		50,245
GROSS PROFIT		15,990			1,731			17,721
OPERATING EXPENSES:
Research and development		7,096			—			7,096
Sales and marketing		6,475			—			6,475
General and administrative		7,155			(114	)		7,041
Total operating expenses		20,726			(114	)		20,612
LOSS FROM OPERATIONS		(4,736	)		1,845			(2,891	)
Total other income, net		2,030			—			2,030
LOSS BEFORE INCOME TAXES		(2,706	)		1,845			(861	)
INCOME TAX (PROVISION)/BENEFIT		(186	)		281			95
NET LOSS	$	(2,892	)	$	2,126		$	(766	)
NET LOSS PER SHARE
Basic	$	(0.10	)	$	0.07		$	(0.03	)
Diluted	$	(0.10	)	$	0.07		$	(0.03	)
WEIGHTED SHARES USED IN NET LOSS PER SHARE
Basic		29,352,438			29,352,438			29,352,438
Diluted		29,352,438			29,352,438			29,352,438

9

The following sets forth the effect of the restatement on the applicable line items in the Company’s condensed consolidated statement of cash flows for the three months ended March 29, 2008 (in thousands):

	Three months ended March 29, 2008
	(as reported)			(adjustments)			(as restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(2,892	)	$	2,126		$	(766	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		1,723			—			1,723
Provision for doubtful accounts receivable		20			—			20
Deferred income taxes		(166	)		—			(166	)
Share-based compensation expense		3,457			—			3,457
Changes in operating assets and liabilities:
Accounts receivable		15,273			—			15,273
Inventories		14,779			(1,665	)		13,114
Prepaids and other assets		6,675			132			6,807
Accounts payable		(25,432	)		(6	)		(25,438	)
Accrued expenses and deferred rent		(4,350	)		(306	)		(4,656	)
Income taxes payable		301			(281	)		20
Deferred cost of sales		263			—			263
Deferred revenue		(191	)		—			(191	)
Net cash provided by operating activities		9,460			—			9,460
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash provided by investing activities		95,419			—			95,419
CASH FLOWS FROM FINANCING ACTIVITIES:
Net cash provided by financing activities		472			—			472
Effect of exchange rate changes on cash and cash equivalents		(33	)		—			(33	)
NET INCREASE IN CASH AND CASH EQUIVALENTS		105,318			—			105,318
CASH AND CASH EQUIVALENTS—Beginning of period		49,897			—			49,897
CASH AND CASH EQUIVALENTS—End of period	$	155,215		$	—		$	155,215

There was no impact to net cash provided by operating activities, net cash provided by investing activities and net cash provided by financing activities for the three months ended March 29, 2008.

The following notes to the condensed consolidated financial statements have been restated to reflect the correction of the accounting errors described above: Note 4. Balance Sheet, Note 5. Earnings Per Share, Note 10. Income Taxes and Note 11. Commitments and Contingencies.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated financial statements included herein have been prepared by the Company in accordance with the published rules and regulations of the U.S. Securities and Exchange Commission (“SEC”) applicable to interim financial information. Certain information and footnote disclosures included in financial statements prepared in accordance with the generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been omitted in these interim statements as allowed by such SEC rules and regulations. However, management believes that the disclosures herein are adequate to make the information presented not misleading. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements of the Company for the fiscal year ended December 29, 2007, which are included in the Company’s Annual Report on Form 10-K filed with the SEC on March 13, 2008.

Fiscal Year. The Company has a 52-week fiscal year ending on the Saturday nearest to December 31, with 13 week quarters ending on the last Saturday of the period. Fiscal 2008 will have a 53-week fiscal year, with 13 week quarters ending on the last Saturday of the period, except the fourth quarter which will have 14 weeks and will end on January 3, 2009. The first quarter of fiscal 2008 ended on March 29, 2008 and the first quarter of fiscal 2007 ended on March 31, 2007. The latest fiscal year ended on December 29, 2007.

Basis of Consolidation. The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All material intercompany balances and transactions have been eliminated.

10

Foreign Currency Transactions. The Company uses the U.S. dollar as its functional currency for its Ireland and Hong Kong subsidiaries and therefore re-measurement of its financial statements is not required. Currency transaction gains (losses) are recognized in current operations resulting from translating its financial statements at the reporting date. The Company uses the Canadian dollar as its functional currency for its Canada subsidiary. Assets and liabilities denominated in non-U.S. dollars are re-measured into U.S. dollars at the rates of exchange in effect at the balance sheet dates. Revenue and expenses are translated at average exchange rates in effect during each period. Translation adjustments are included in stockholders’ equity in the consolidated balance sheet as a component of accumulated other comprehensive income (loss).

Use of Estimates. The preparation of financial statements in accordance with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the Company’s consolidated financial statements and accompanying notes. Management bases its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based on management’s best knowledge of current events and actions that may impact the Company in the future, actual results may be different from the estimates. The Company’s critical accounting policies are those that affect the Company’s financial statements materially and involve difficult, subjective or complex judgments by management. Those policies are revenue recognition, inventory valuation, warranty, share-based compensation, intangible assets and accounting for income taxes.

Cash and Cash Equivalents. The Company classifies highly liquid investments as cash equivalents. Cash and cash equivalents consist of cash deposited in checking and money market accounts.

Marketable Securities. The Company accounts for short-term marketable securities in accordance with the Financial Accounting Standards Board (“FASB”), Statement of Financial Accounting Standard (“SFAS”) No. 115,Accounting for Certain Investments in Debt and Equity Securities. The Company classifies marketable securities as available-for-sale at the time of purchase and re-evaluates such designation as of each consolidated balance sheet date. Our marketable securities include commercial paper, corporate bonds, government securities and auction rate securities. Auction rate securities are securities that are structured with short-term interest rate reset dates of generally less than ninety days but with contractual maturities that can be well in excess of ten years.

Our marketable securities are reported at fair value with the related unrealized gains and losses included in accumulated other comprehensive income (loss), a component of shareholders’ equity, net of tax. Realized gains or losses on the sale of marketable securities are determined using the specific-identification method and were not material for the three months ended March 29, 2008 and March 31, 2007, respectively. We evaluate our investments periodically for possible other-than-temporary impairment by reviewing factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer and our ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery of market value. We record an impairment charge to the extent that the carrying value of our available for sale securities exceeds the estimated fair market value of the securities and the decline in value is determined to be other-than-temporary.

Effective December 30, 2007, the Company adopted the provisions of SFAS No. 157,Fair Value Measurements (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements required under other accounting pronouncements. SFAS No. 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. SFAS No. 157 also requires that a fair value measurement reflect the assumptions market participants would use in pricing an asset or liability based on the best information available. Assumptions include the risks inherent in a particular valuation technique (such as a pricing model) and/or the risks inherent in the inputs to the model. The adoption of SFAS No.157 did not have a significant impact on the Company’s condensed consolidated financial statements.

SFAS No.157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value hierarchy under SFAS No. 157 are described below:

• Level 1 Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

• Level 2 Quoted prices in markets that are not active or financial instruments for which all significant inputs are observable, either directly or indirectly; and

• Level 3 Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

11

A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

Further information about the application of SFAS No. 157 may be found in Note 12 below.

Accounts Receivable. Accounts receivable are recorded at the invoiced amount and do not bear interest. Our accounts receivable have been reduced by an allowance for doubtful accounts, which is our best estimate of the amount of probable credit losses in our existing accounts receivable. We determine the allowance based on customer specific experience and the aging of our receivables, among other factors.

Inventories. Inventories, consisting primarily of server chassis, hard drives, microprocessors, memory chips, cooling fans and other equipment used in the manufacture of networking servers, are stated at the lower of first-in, first-out cost or market. Cost components include materials, labor and manufacturing overhead costs.

We assess the valuation of our inventory, including demonstration inventory, on a quarterly basis based upon estimates about future demand and actual usage. To the extent that we determine that we are holding excess or obsolete inventory, we write down the value of our inventory to its net realizable value. Such write-downs are reflected in cost of revenue.

In our inventory valuation analysis, we also include inventory that we could be obligated to purchase from our suppliers based on our production forecasts. To the extent that our committed inventory purchases exceed our forecasted production needs, we write down the value of those inventories by taking a charge to our cost of products and increasing our supplier liability.

Property and Equipment. Property and equipment are stated at cost and are depreciated on a straight-line basis over their estimated useful lives (generally two to seven years). Leasehold improvements and assets acquired under capital leases are amortized using the straight-line method over the shorter of the estimated useful lives of the respective assets or the lease term. When assets are retired or disposed of, the assets and related accumulated depreciation and amortization are removed from our general ledger and the resulting gain or loss is reflected in the statement of operations.

Maintenance and repairs are charged to expense as incurred and improvements and betterments that enhance the life of the asset are capitalized. When assets are retired or otherwise disposed of, the cost and accumulated depreciation and amortization are removed.

Intangible Assets. The Company accounts for intangible assets in accordance with SFAS No. 142Goodwill and Other Intangible Assets, (“SFAS No. 142”). The Company periodically evaluates its intangible assets. Intangible assets are carried at cost less accumulated amortization. Amortization is computed using the straight-line method over the economic lives of the respective assets, generally two to seven years.

The process of evaluating the potential impairment of intangibles is highly subjective and requires significant judgment. We estimate expected future cash flows then compare the carrying value of intangibles to the discounted future cash flows. If the total of future cash flows is less than the carrying amount of the assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets.

Impairment of Long-Lived Assets. The Company accounts for its long-lived assets in accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”). The Company evaluates its long-lived assets for indicators of possible impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss may be recognized when undiscounted future cash flows expected to result from the use of an asset and its eventual disposition are less than its carrying amount. Impairment, if any, is measured using discounted cash flows.

Revenue Recognition. The Company accounts for its revenues under the provisions of Staff Accounting Bulletin (“SAB”) No. 104,Revenue Recognition in Financial Statements(“SAB No. 104”), FASB Technical Bulletin No. 90-1,Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts (“FTB 90-1”) and Statement of Position No. 97-2, Software Revenue Recognition(“SOP 97-2”).

Under the provisions of SAB No. 104, the Company recognizes revenues from sales of products when persuasive evidence of an arrangement exists, shipment has occurred and title has transferred, the sales price is fixed and determinable, collection of the resulting receivable is reasonably assured, and all significant obligations have been met. Generally, this occurs at the time of shipment when risk of loss and title has passed to the customer.

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Service revenue includes hardware maintenance and installation. Pursuant to SAB No. 104, the Company recognizes revenue from the sale of its products prior to completion of these services, as the Company’s product sales are not dependent on these services to be functional. Under FTB 90-1, revenue from hardware maintenance contracts, which are sold and invoiced separately, is recognized ratably over the contract term, generally one to three years. Installation services are typically requested by the Company’s new customers who have limited history with the products. Installation and related services are usually performed within one day after product delivery.

Where software is integrated with hardware and sold as a hardware appliance the Company provides unspecified software updates and enhancements to the software through service contracts. As a result, the Company accounts for revenue in accordance with SOP 97-2 for transactions involving the sale of software. Revenues earned on software arrangements involving multiple-elements are allocated to each element based on Vendor Specific Objective Evidence (“VSOE”) of fair value. The VSOE of fair value of the undelivered elements (maintenance and support services) is generally determined based on the price charged for the undelivered element when sold separately or renewed. If VSOE cannot be obtained to determine fair value of the undelivered elements, revenue from the entire arrangement would be deferred and recognized as these elements are delivered.

On occasion, when a customer informs the Company that a product is defective, the Company will ship a replacement product at the customer’s request prior to the customer returning the defective product for repair. This enables the customer to use the replacement product until the defective product is repaired and returned to the customer. Generally, the Company does not charge for this service unless the customer fails to return the defective product, in which case the customer is billed for the replacement product and revenue is recognized at that time.

Estimated sales returns and warranty costs, based on historical experience, changes in customer demand, and other factors, are recorded at the time product revenue is recognized in accordance with SFAS No. 48,Revenue Recognition When Right of Return Exists and SFAS No. 5,Accounting for Contingencies, respectively.

Deferred Revenue. Deferred revenue is primarily comprised of extended warranty, revenue deferred for installations yet to be completed, and advanced billing and customer deposits for service, support and maintenance agreements as well as product revenue for which performance obligations or customer acceptance is required. Deferred revenue is recorded when products or services provided are invoiced prior to the Company’s completion of the related performance obligations or customer acceptance. Deferred revenue is not recognized as revenue until the completion of those performance and acceptance criteria. Extended warranty and service support and VSOE deferrals are recognized ratably over the prerequisite service period.

Product Warranty. The Company’s warranty period for its products is generally one to three years. The Company accrues for estimated warranty costs concurrent with the recognition of revenue. The initial warranty accrual is based upon the Company’s historical experience and is included in accrued expenses and cost of revenue.

Share-based Compensation.The Company accounts for its employee stock purchase and stock incentive plans under the provisions of SFAS No. 123 (revised 2004),Share-Based Compensation, (“SFAS No. 123R”). SFAS No. 123R requires the recognition of the fair value of share-based compensation in net income. The fair values of the Company’s stock options and employee stock purchase plan awards are estimated using the Black-Scholes valuation model. Prior to January 1, 2006, the Company accounted for share-based employee compensation arrangements in accordance with APB No. 25, Accounting for Stock Issued to Employees, (“APB No. 25”), and related interpretations, as permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation, (“SFAS No. 123”.) Under APB No. 25, compensation cost was recognized based on the difference, if any, between the fair value of the Company’s common stock on the date of grant and the amount an employee must pay to acquire the stock. Compensation cost was recorded in accordance with FIN 28, using the multiple-option approach. Under SFAS No. 123R, compensation expense for those options prior to the adoption of SFAS No. 123R continue to be expensed on the same basis as they were prior to its adoption, reduced for estimated forfeitures.

Research and Development. Costs related to research, design and development of our products are charged to research and development expense as they are incurred.

Accounting for Income Taxes. The Company records a tax provision for the anticipated tax consequences of the reported results of operations. In accordance with SFAS No. 109, “Accounting for Income Taxes” (“SFAS No. 109”), the provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carry-forwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled.

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The Company is required to assess the realization of deferred tax assets and the need for a valuation allowance. This assessment requires that management makes judgments and assesses the weight of positive and negative evidence in accordance with the requirements of SFAS No. 109 for purposes of concluding whether it is more likely than not that deferred tax assets will be realized. The effective tax rate varies based on a variety of factors, including overall profitability, the geographical mix of income before taxes and the related tax rates in the jurisdictions where the Company operates, restructuring and other one-time charges, as well as discrete events, such as settlements of future audits. The Company is subject to audits and examinations of tax returns by tax authorities in various jurisdictions, including the Internal Revenue Service. The Company regularly assesses the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.

In June 2006, the FASB issued interpretation No. 48,Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109(“FIN 48”). The Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation also provides guidance on de-recognition, classification, interest and penalties, accounting for interim periods, disclosure and transition. FIN 48 was adopted by the Company in the first quarter of fiscal 2007. The cumulative effect of applying FIN 48 was recorded as an adjustment to retained earnings as of the beginning of the period of adoption. The adoption of FIN 48 did not have a material impact on the Company’s condensed consolidated statements of operations, balance sheet and cash flows.

Recently Issued Accounting Pronouncements.

In December 2007, the FASB issued SFAS No. 141 (revised 2007),Business Combinations (“SFAS No. 141(R)”). SFAS No. 141(R) establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. SFAS No. 141(R) also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. SFAS No. 141(R) is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008. The Company expects to adopt SFAS No. 141(R) in the beginning of fiscal year 2009 and is currently evaluating the potential impact, if any, of the adoption of SFAS No. 141(R) on its consolidated results of operations and financial condition.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115,(“SFAS No. 159”), which is effective for fiscal years beginning after November 15, 2007. This statement permits an entity to choose to measure many financial instruments and certain other items at fair value at specified election dates. Subsequent unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. The Company has elected not to apply the fair value option to these instruments, which is permitted under SFAS No. 159.

4. BALANCE SHEET

Short-and Long-Term Investments

At March 29, 2008 and December 29, 2007, all of the Company’s marketable debt securities were classified as available-for-sale and were carried at fair market value. Auction rate securities are securities that are structured with short-term interest rate reset dates of generally less than ninety days but with contractual maturities that can be well in excess of ten years. At the end of each reset period, which occurs every seven to thirty-five days, investors can sell or continue to hold the securities at par subject to a successful interest rate reset. In the first quarter of fiscal year 2008, certain auction rate securities failed auction due to sell orders exceeding buy orders. Our auction rate securities consist of investments that are backed by pools of student loans ultimately guaranteed by the U.S. Department of Education. We believe that the credit quality of these securities is high based on these guarantees. Based on an analysis of other-than-temporary impairment factors, we recorded a temporary impairment within other accumulated comprehensive loss of approximately $0.4 million at March 29, 2008 related to these auction rate securities. The Company intends and has the ability to hold these securities until the value of such securities recovers. The funds associated with failed auctions will not be accessible until a successful auction occurs, a buyer is found outside of the auction process, the underlying securities have matured or the securities are recalled by the issuer. Given the recent disruptions in the credit markets and the fact that the liquidity for these types of securities remains uncertain, we have classified all of our auction rate securities ($8.7 million, net of unrealized loss), that were not liquidated subsequent to March 29, 2008 as long-term assets in our condensed consolidated balance sheet as our ability to liquidate such securities in the next 12 months is uncertain. The Company utilized the guidance and procedures as provided by SFAS No. 157 in determining the current fair value. The unrealized gains (losses) on available-for-sale securities are recorded in accumulated other comprehensive income (loss). Short- and long-term investments consisted of the following (in thousands):

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	Purchase/ Amortized Cost		Gross Unrealized Gain		Gross Unrealized Loss			Aggregate Fair Value
March 29, 2008
Corporate notes and bonds	$	10,246	$	50				$	10,296
Federal agency notes		21,030		25		—			21,055
Commercial paper		11,632		22		—			11,654
Total short-term investments		42,908		97		—			43,005
Auction rate securities		9,125		—		(396	)		8,729
Total long-term investments		9,125		—		(396	)		8,729
Total investments	$	52,033	$	97	$	(396	)	$	51,734
December 29, 2007
U.S. notes and bonds	$	10,206	$	25	$	—		$	10,231
Federal agency notes		50,437		37		—			50,474
Commercial paper		22,969		—		(13	)		22,956
Auction rate securities		64,554		—		—			64,554
Total short-term investments	$	148,166	$	62	$	(13	)	$	148,215

Accounts Receivable, net

Accounts receivable from Amazon, Facebook and You Tube, Inc. accounted for 42%, 16% and 10%, respectively, of total accounts receivable at March 29, 2008. Accounts receivable from Microsoft and Facebook accounted for 49% and 18%, respectively, of total accounts receivable at December 29, 2007.

Revenue from customers representing 10% or more of total revenue was as follows:

	Three months ended
	March 29, 2008		March 31, 2007
Amazon	24	%	17	%
Facebook	17	%	*
Microsoft	15	%	30	%
You Tube	12	%	*
Yahoo	*		15	%

* indicates less than 10% for the period.

A summary of the activity in the reserves relating to doubtful accounts receivable and sales returns is as follows (in thousands):

	Beginning Balance		Additions		Reductions			Ending Balance
Allowance for Doubtful Accounts
Year ended December 29, 2007	$	328	$	299	$	(193	)	$	434
Three months ended March 29, 2008	$	434	$	20	$	—		$	454
Sales Return Reserve
Year ended December 29, 2007	$	137	$	1,284	$	(1,091	)	$	330
Three months ended March 29, 2008	$	330	$	66	$	(224	)	$	172

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Inventories

Inventories consist of the following (in thousands):

	March 29, 2008		December 29, 2007
	(restated)
Finished goods	$	3,807	$	5,820
Work in process		7,647		16,385
Raw materials		26,445		30,323
Total inventories	$	37,899	$	52,528

Property and Equipment, net

Property and equipment consist of the following (in thousands):

	March 29, 2008			December 29, 2007
Leasehold improvements	$	1,503		$	1,484
Manufacturing equipment		3,643			3,303
Furniture and fixtures		1,134			1,127
Computer equipment		6,940			6,858
Construction in progress		512			362
Vehicles		117			118
		13,849			13,252
Less accumulated depreciation and amortization		(5,819	)		(4,967	)
Property and equipment, net	$	8,030		$	8,285

Depreciation and amortization expense of property and equipment for the three months ended March 29, 2008 and March 31, 2007 was $0.9 million and $0.6 million, respectively.

Intangible Assets, net

Intangible assets are recorded at cost, less accumulated amortization. The following tables present details of the Company’s intangible assets, as of March 29, 2008, (dollars in thousands):

	Useful Life (Years)	Gross		Prior Amortization		Period Amortization		Accumulated Amortization		Net
Rackable Systems
Patents	5.00	$	572	$	307	$	27	$	334	$	238
Other intangibles	3.00		25		17		2		19		6
			597		324		29		353		244
Terrascale Acquisition
Existing technology	7.00		8,256		1,540		295		1,835		6,421
DPE	7.00		13,097		1,404		468		1,872		11,225
Customer relationships	4.00		633		207		40		247		386
Maintenance contracts	6.00		35		8		1		9		26
Non-compete agreements	2.00		313		209		39		248		65
			22,334		3,368		843		4,211		18,123
Tradename			3,487		—				—		3,487
Total		$	26,418	$	3,692	$	872	$	4,564	$	21,854

In December 2002, as a part of the acquisition of Old Rackable, the Company recorded an intangible asset allocated to tradename in the amount of $3.5 million. This intangible asset is not amortizable.

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Long-lived intangible assets with determinable economic life are tested for recoverability whenever events or circumstances indicate that their carrying amounts may not be recoverable. The Company determined the recoverability of long-lived intangible assets was not impaired at March 29, 2008 and December 29, 2007.

In the three months ended March 29, 2008 and March 31, 2007, amortization of intangible assets was $0.9 million and $0.8 million, respectively. Amortization is computed using the straight-line method over the estimated useful life of the intangible asset. The Company expects that the future amortization of acquired intangible assets will be as follows (in thousands):

2008 (remainder)	$	2,583
2009		3,339
2010		3,183
2011		3,056
2012		3,054
2013 and beyond		3,152
Total amortization	$	18,367

Accrued Expenses

Accrued expenses consist of the following (in thousands):

	March 29, 2008		December 29, 2007
	(restated)
Accrued commission	$	1,184	$	2,137
Accrued payroll and related expenses		3,570		5,754
Accrued warranty		2,361		2,038
Accrued sales and use tax		1,972		3,828
Other accrued expenses		2,516		2,625
Total accrued expenses	$	11,603	$	16,382

Accumulated Other Comprehensive Loss

Comprehensive loss consists of the following (in thousands):

	Accumulated Other Comprehensive Loss
December 29, 2007	$	(11	)
Change in unrealized loss on investments		(349	)
Change in cumulative translation adjustment		(33	)
March 29, 2008	$	(393	)

	Accumulated Other Comprehensive Loss
December 30, 2006	$	(3	)
Change in unrealized loss on investments		(57	)
Change in cumulative translation adjustment		(11	)
March 31, 2007	$	(71	)

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5. EARNINGS PER SHARE

In accordance with SFAS No.128,Earnings Per Share, basic net income (loss) per common share has been computed by using the weighted average number of shares of common stock outstanding during the period, less the shares subject to repurchase. The following table sets forth the computation of basic and diluted net income (loss) per share (in thousands, except share and per share data):

	Three months ended
	March 29, 2008			March 31, 2007
	(restated)
Numerators:
Net loss	$	(766	)	$	(10,157	)
Denominators:
Weighted-average shares - Basic		29,352,438			28,220,970
Weighted-average shares - Diluted		29,352,438			28,220,970
Net loss per common share - Basic	$	(0.03	)	$	(0.36	)
Net loss per common share - Diluted	$	(0.03	)	$	(0.36	)

For the three months ended March 29, 2008 and March 31, 2007 the Company had stock options outstanding which could potentially dilute basic earnings per share in the future, but the incremental shares from the assumed exercise of these stock options were excluded in the computation of diluted net loss per share, as their effect would have been anti-dilutive. The number of such outstanding stock options consisted of the following:

	Three months ended
	March 29, 2008	March 31, 2007
Stock options	2,882,150	5,199,981

6. SHARE BASED COMPENSATION

Share-Based Benefit Plans

In 2005, the Company’s Board of Directors adopted and its stockholders approved the Company’s 2005 Equity Incentive Plan (the “2005 Plan”), 2005 Non-Employee Directors’ Stock Option Plan and 2005 Employee Stock Purchase Plan (the “2005 ESPP”).

The Company’s Board of Directors adopted the 2006 New Recruit Equity Incentive Plan (the “New Recruit Plan”) in January 2006 which allows the Company to grant non-statutory stock awards to employees newly hired by the Company as an inducement to join the Company. No grants may be made under the New Recruit Plan to persons who are continuing employees of the Company, or to directors. The New Recruit Plan provides for the grant of the following stock awards: (i) non-statutory stock options, (ii) stock purchase awards, (iii) stock bonus awards, (iv) stock appreciation rights, (v) stock unit awards, and (vi) other stock awards.

Adoption of SFAS 123R

On January 1, 2006, the Company adopted the provisions of SFAS 123R requiring the Company to recognize expenses related to the fair value of the Company’s share-based compensation awards. The Company elected to use the modified prospective application method. Under this method, SFAS 123R is applied to new awards and to awards modified, repurchased, or cancelled after the effective date. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered (such as unvested options) that was outstanding as of the date of adoption is recognized as the remaining requisite services are rendered. The compensation cost relating to unvested awards at the date of adoption is based on the grant-date fair value of those awards as calculated for pro forma disclosures under the original SFAS 123. Additionally, under SFAS 123R, the 2005 ESPP is considered a compensatory plan, which requires the recognition of compensation cost for grants made under the ESPP. The Company recognizes compensation expense for all share-based payment awards over the requisite service period for each separately vesting portion of the award as if the awards were, in-substance, multiple awards. As required by SFAS 123R, management made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.

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Tender Offer

On June 11, 2007, in order to address the lack of retention and incentive effect that the Company’s “out-of-the-money” stock options were having on the Company’s employees, the Company filed a tender offer on Schedule TO (“Tender Offer”) with the SEC under which holders of options with exercise prices greater than $16.00 per share could tender their options in exchange for restricted stock unit awards granted under the 2005 Equity Incentive Plan. On June 11, 2007, the closing price per share was $13.23. The tender offer was based upon the following exchange ratios:

Exercise Price Range	Stock Options Shares per Restricted Stock Unit
$16.00—$24.99	2 to 1
$25.00—$34.99	3 to 1
$35.00 and above	3.5 to 1

The restricted stock unit awards are subject to vesting in equal quarterly installments through August 15, 2009 (if the grant date of the option being tendered was prior to October 1, 2006) or August 15, 2010 (if the grant date of the option being tendered was after October 1, 2006). The Company completed the Tender Offer on July 10, 2007. As a result, the Company accepted for exchange options to purchase an aggregate of 2,238,883 shares of the Company’s common stock from 187 eligible participants, representing 87% of the shares subject to options that were eligible to be exchanged in the Offer to Exchange as of May 31, 2007. Upon the terms and subject to the conditions set forth in the Tender Offer to Exchange, the Company issued restricted stock unit awards covering an aggregate of 893,828 shares of the Company’s common stock in exchange for the options surrendered pursuant to the Tender Offer to Exchange.

The fair value of the restricted stock unit awards was measured as the total of the unrecognized compensation cost of the original options tendered and the incremental compensation cost of the restricted stock unit awards on July 10, 2007, the date of cancellation. The incremental compensation cost was measured as the excess of the fair value of the restricted stock unit awards over the fair value of the options immediately before cancellation based on the share price and other pertinent factors at that date. The unrecognized compensation cost of the 2,238,883 options cancelled was $17.1 million. The incremental cost of exchange for the 893,828 restricted stock unit awards was approximately $145,000. The total fair value of the restricted stock unit awards on July 10, 2007 was $17.2 million and the cost will be amortized over the service period of the restricted stock unit awards. The service period of the restricted stock unit awards is longer than the service period of the options tendered.

Determining Fair Value

The fair value of share-based awards was estimated using the Black-Scholes model with the following weighted-average assumptions for the following periods.

	Three months ended
	March 29, 2008			March 31, 2007
Option Plan Shares
Dividend yield		—			—
Risk-free interest rate		2.8	%		4.7	%
Volatility		59.9	%		62.1	%
Weighted average expected life (in years)		5.27			5.47
Estimated annual forfeitures		11.6	%		10.5	%
Weighted average fair value	$	12.83		$	12.41
ESPP shares
Dividend yield		—			—
Risk-free interest rate		2.0	%		5.0	%
Volatility		52.7	%		54.0	%
Weighted average expected life (in years)		1.25			1.25
Weighted average fair value	$	9.35		$	7.00

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The computation of expected life is based on an analysis of the relevant industry sector post-vest termination rates and the exercise factors. The expected volatility is based on a combination of the implied and historical volatility for both the Company and its peer group. The interest rate is based on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term. Where the expected term of the Company’s share-based awards do not correspond with the terms for which interest rates are quoted, the Company performed a straight-line interpolation to determine the rate from the available term maturities. The estimated forfeiture rate was based on an analysis of the Company’s pre-vest termination rate, as the Company believes that its historical forfeiture rates are representative of future expectations.

Share-Based Compensation Expense

The following table shows total share-based compensation expense included in the condensed consolidated statement of operations (in thousands):

	Three months ended
	March 29, 2008		March 31, 2007
Cost of revenue	$	302	$	669
Research and development		807		1,936
Selling and marketing		649		2,014
General and administrative		1,699		3,269
Total	$	3,457	$	7,888

As required by SFAS 123R, management made an estimate of expected forfeitures and is recognizing compensation costs only for those equity awards expected to vest.

Stock Options and Restricted Stock Awards Activity

A summary of stock option activity for the three months ended March 29, 2008 is as follows:

	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual term in years	Aggregate Intrinsic Value
Balance at December 29, 2007	2,892,480		$	13.13	8.61	$	1,064,809
Options granted	347,500			8.85
Options exercised	(27,365	)		2.94
Options cancelled	(330,465	)		12.09
Balance at March 29, 2008	2,882,150		$	12.83	8.56	$	821,432
Vested and expected to vest at March 29, 2008	2,519,318		$	12.85	8.47	$	781,951
Exercisable at March 29, 2008	679,307		$	12.92	7.05	$	467,219

The total intrinsic value of options exercised for the three months ended March 29, 2008 and March 31, 2007 was $0.2 million and $1.8 million, respectively.

As of March 29, 2008, there was $20.8 million of total unrecognized compensation cost related to non-vested stock options. That cost is expected to be recognized over a weighted average period of 1.5 years.

The following table summarizes the Company’s restricted stock awards (“RSA”) activity for the three months ended March 29, 2008:

	Number of Shares		Weighted Average Grant Date Fair Value
Balance at December 29, 2007	239,534		$	16.03
Awarded	—			—
Released	(15,312	)		16.02
Forfeited	(35,314	)		19.67
Balance at March 29, 2008	188,908		$	15.34

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As of March 29, 2008, there was $4.4 million of total unrecognized compensation cost related to RSA. That cost is expected to be recognized over a weighted average period of 3.0 years.

The following table summarizes the Company’s restricted stock units (“RSU”) activity for the three months ended March 29, 2008:

	Shares		Aggregate Intrinsic Value
Balance at December 29, 2007	800,249		$	7,787,314
Awarded	1,050,000
Released	(73,545	)
Forfeited	(204,246	)
Balance at March 29, 2008	1,572,458		$	14,120,673
Vested and expected to vest at March 29, 2008	1,287,978

As of March 29, 2008, there was $17.2 million of total unrecognized compensation cost related to RSU. That cost is expected to be recognized over a weighted average period of 3.3 years.

During the three months ended March 29, 2008, 32,886 shares of RSA and RSU were delivered to the Company in payment of $285,762 of withholding tax obligations arising from the release of RSA and RSU. The withholding tax obligations were based upon the fair market value of the Company’s common stock on the vesting date.

At March 29, 2008, the total compensation cost related to options to purchase the Company’s common stock under the 2005 ESPP but not yet recognized was approximately $1.1 million. This cost will be amortized on a straight-line basis over periods of up to 2.0 years.

The following table shows the shares issued, and their respective weighted-average purchase price per share, pursuant to the 2005 ESPP during the three months ended March 29, 2008 and March 31, 2007.

	March 29, 2008		March 31, 2007
Shares issued		85,433		91,155
Weighted-average purchase price per share	$	9.35	$	11.68

7. EMPLOYEE BENEFIT PLANS

Defined Contribution Plans—Effective September 1, 2003, Rackable Systems established a 401(k) retirement plan covering substantially all employees. The plan provides for voluntary salary reduction contributions up to the maximum allowed under Internal Revenue Service rules. The Company can make annual contributions to the plan at the discretion of the Board of Directors. The Company contributed $0.1 million and $0.0 million for the three months ended March 29, 2008 and March 31, 2007, respectively.

8. DEFERRED REVENUE AND DEFERRED COST OF GOODS SOLD

At March 29, 2008, the Company had total deferred revenue of $8.1 million, this deferred revenue includes deferred product revenue of $0.9 million. These product deferrals are related to shipments to customers pending acceptance or deferrals related to sales which did not qualify for immediate revenue recognition. The remaining deferred revenue of $7.2 million pertains to revenue from maintenance and extended warranty arrangements that are recognized ratably over the contract period and professional support services which had not been completed as of the balance sheet date. Deferred product costs associated with deferred revenue were $0.3 million at March 29, 2008.

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At December 29, 2007, the Company had total deferred revenue of $8.3 million, this deferred revenue includes deferred product revenue of $1.1 million. These product deferrals are related to shipments to customers pending acceptance or deferrals related to sales which did not qualify for immediate revenue recognition. The remaining deferred revenue of $7.2 million pertains to revenue from maintenance and extended warranty arrangements that are recognized ratably over the contract period and professional support services which had not been completed as of the balance sheet date. Deferred product costs associated with deferred revenue were $0.5 million at December 29, 2007.

9. ENTERPRISE AND RELATED GEOGRAPHIC INFORMATION

The Company is managed by its executive officers in Fremont, California. The Company’s chief operating decision maker is the Chief Executive Officer (“CEO”). Based on the financial information reviewed by the CEO, the Company has determined that it operates in a single reportable segment. Revenue from both domestic and international customers and on a percentage basis by country (based on the address of the customer on the invoice) was as follows (in thousands, except percentage amounts):

	Three months ended
	March 29, 2008			March 31, 2007
Domestic revenue	$	62,954		$	71,527
International revenue		5,012			496
Total revenue	$	67,966		$	72,023
Revenue by country:
United States		93	%		99	%
Ireland		5	%		—
Republic of China		1	%		—
Others		1	%		1	%
Total		100	%		100	%

Sales revenue for the high-density compute server and high-capacity storage system were as follows (in thousands):

	Three months ended
	March 29, 2008		March 31, 2007
Compute servers	$	55,172	$	63,326
Storage systems		12,794		8,697
Total revenue	$	67,966	$	72,023

Over 90% of the Company’s property, plant and equipment was located in the United States for the periods ended March 29, 2008 and March 31, 2007.

10. INCOME TAXES

The Company recorded a tax benefit of $95,000 for the three months ended March 29, 2008. The effective tax rate used to record the tax benefit differed from the combined federal and net state statutory income tax rate for the three months ended March 29, 2008 due primarily to an increase in the valuation allowance for domestic deferred tax assets.

The Company recorded a tax benefit for the three months ended March 31, 2007 based on a projected 36.8% annual effective tax rate. The effective tax rate of 36.8% used to record the tax benefit differed from the combined federal and net state statutory income tax rate for the three months ended March 31, 2007 due primarily to certain share-based compensation expenses for which tax benefits and related deferred tax assets are not recorded in accordance with SFAS 123R.

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The Company’s foreign subsidiaries file income tax returns in the countries in which they have operations. Generally, these countries have statutes of limitations ranging from 4 to 6 years. Years still open to examination by foreign tax authorities in the Company’s major filing jurisdiction of Canada are 2003 through 2007. The Company’s Canadian subsidiary was recently notified that it will be subject to audit by the Quebec tax authorities for the 2003 to 2005 pre-acquisition tax years. As of March 29, 2008, there are no unrecorded tax benefits associated with these years that are subject to the tax audit.

11. COMMITMENTS AND CONTINGENCIES

Future minimum lease payments under operating leases are as follows (in thousands):

Nine Months ending January 3, 2009	$	1,465
Year ending December 30, 2009		2,009
Year ending December 29, 2010		1,698
Year ending December 31, 2011		1,625
Year ending December 30, 2012		1,660
Year ending December 29, 2013		1,643
Total	$	10,100

Total rent expense for the three months ended March 29, 2008 and March 31, 2007 was approximately $0.7 million and $0.4 million, respectively.

Product Warranty—Rackable Systems’ warranty period for its products is generally one to three years. Rackable Systems accrues for estimated warranty costs concurrent with the recognition of revenue. The initial warranty accrual is based upon Rackable Systems’ historical experience and is included in accrued expenses and cost of revenue. The amounts charged and accrued against the warranty reserve for three months were as follows (in thousands):

	March 29, 2008			March 31, 2007			December 29, 2007
	(restated)
Balance—beginning of period	$	2,038		$	868		$	868
Current period accrual		428			712			3,117
Warranty expenditures charged to accrual		(105	)		(692	)		(1,947	)
Balance—end of period	$	2,361		$	888		$	2,038

Purchase Commitments—In connection with supplier agreements, the Company agreed to purchase certain units of inventory and non inventory items through 2008. As of March 29, 2008, these remaining commitments were approximately $18.9 million and $2.2 million, respectively.

Indemnification Agreements—The Company enters into standard indemnification agreements with its customers and certain other business partners in the ordinary course of business. These agreements include provisions for indemnifying the customer against any claim brought by a third party to the extent any such claim alleges that the Company’s product infringes a patent, copyright or trademark, or misappropriates a trade secret, of that third party. The agreements generally limit the scope of the available remedies in a variety of industry- standard methods, including, but not limited to, product usage and geography-based limitations, a right to control the defense or settlement of any claim, and a right to replace or modify the infringing products to make them non-infringing. The Company has not incurred significant expenses related to these indemnification agreements and no material claims for such indemnifications were outstanding as of March 29, 2008. As a result, the Company believes the estimated fair value of these indemnification agreements, if any, to be de minimus; accordingly, no liability has been recorded with respect to such indemnifications as of March 29, 2008.

12. FAIR VALUE MEASUREMENTS

The financial assets of the Company measured at fair value on a recurring basis are cash equivalents, short-term and long-term investments. The Company’s cash equivalents and short-term investments are generally classified within level 1 of the fair value hierarchy because they are valued using quoted market prices, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. The Company’s long-term investments are classified within Level 3 of the fair value hierarchy because they are valued using unobservable inputs, due to the fact that observable inputs are not available, or situations in which there is little, if any, market activity for the asset or liability at the measurement date.

• Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

23

• Level 2: Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability; or

• Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and are unobservable.

The following table sets forth the Company’s cash equivalents, short- and long-term investments as of March 29, 2008, which are measured at fair value on a recurring basis by level within the fair value hierarchy. As required by SFAS No. 157, these are classified based on the lowest level of input that is significant to the fair value measurement.

(In thousands)	Level 1		Level 2	Level 3		Assets at fair value
Money market	$	143,261	—		—	$	143,261
Corporate notes/bonds		10,296	—		—		10,296
Federal agency notes		21,055	—		—		21,055
Commercial paper		11,654	—		—		11,654
Auction rate securities			—		8,729		8,729
Total	$	186,266	—	$	8,729	$	194,995

The above table excludes $12.0 million of cash held by us.

The Company’s Level 3 assets consist of long-term auction rate securities for which the Company used a discounted cash flow model to value these investments.

The following table provides a summary of changes in the fair value of the Company’s Level 3 financial assets as of March 29, 2008 (in thousands):

	Auction Rate Securities
December 29, 2007	$	—
Total unrealized loss included in other comprehensive loss		(396	)
Transfers in Level 3		9,125
March 29, 2008	$	8,729
Total loss for the period attributed to the change in unrealized loss at March 29, 2008	$	(396	)

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q/A contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements included or incorporated by reference in this Form 10-Q/A other than statements of historical fact, are forward-looking statements. Investors can identify these and other forward-looking statements by the use of words such as “estimate,” “may,” “will,” “could,” “anticipate,” “expect,” “intend,” “believe,” “continue” or the negative of such terms, or other similar expressions. Forward-looking statements also include the assumptions underlying or relating to such statements.

Our actual results could differ materially from those projected in the forward-looking statements included herein as a result of a number of factors, risks and uncertainties, including, among others, the risk factors set forth in,” Part I, Item 2—”Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in “Part II, Item 1A—Risk Factors” in this Form 10-Q/A and elsewhere in this Form 10-Q/A, and in “Part II, Item 1A-Risk Factors” in the original Form 10-Q, as well as, the risks detailed from time to time in Rackable Systems, Inc.’s future U.S. Securities and Exchange Commission reports. The information included in this Form 10-Q/A is as of the filing date with the Securities and Exchange Commission and future events or circumstances could differ materially from the forward-looking statements included herein. We assume no duty to update any of the forward-looking statements after the date of this report or to conform these statements to actual results except as required by law. Accordingly, we caution readers not to place undue reliance on such statements. We expressly disclaim any obligation to update or alter our forward-looking statements, whether, as a result of new information, future events or otherwise.

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“Rackable Systems,” “Eco-Logical”, “OmniStor,” “RapidScale,” “Roamer”, “Concentro”, “ICE Cube” and the Rackable Systems logo are trademarks or registered trademarks of Rackable Systems, Inc. All other trademarks or service marks appearing in this report are trademarks or service marks of their respective owners.

The following discussion and analysis should be read in conjunction with the condensed financial statements and notes thereto in Item 1 above and with our financial statements and notes thereto for the year ended December 29, 2007, contained our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 13, 2008.

Restatement of Previously Issued Financial Results

We have restated our condensed consolidated balance sheet as of March 29, 2008, and the related condensed consolidated statement of income and cash flows for the three months ended March 29, 2008, including the applicable notes as reflected in this Form 10-Q/A. For additional information about the restatement, please see the Explanatory Note to this report and Note 2 of notes to condensed consolidated financial statements, “Restatement of condensed consolidated financial statements for the three months ended and as of March 29, 2008.”

The following discussion and analysis of our financial condition and results of operations incorporates the restated amounts.

Company Overview

We develop, market and sell compute server, storage systems and data center infrastructure purpose-built for large-scale data center deployments. Recently, enterprises have begun to deploy large-scale computing and storage farms by aggregating large numbers of relatively inexpensive, open-standard modular computing and storage systems. These systems typically run low-cost operating systems such as Linux and Windows and, we believe, enable enterprises to meet their computing and storage requirements at a lower total cost of ownership and provide enterprises with greater flexibility and scalability.

We have developed innovative technologies in the areas of chassis and cabinet design, power distribution techniques and hardware-based remote management technology. We offer compute servers using our half-depth design, enabling back-to-back mounting for higher server density and improved thermal management. In August 2004, we expanded our product line of compute servers, which we designed to further increase density levels, improve thermal management, and enhance cable management and system serviceability. We also offer a number of storage solutions. In the third quarter of 2006, we acquired Terrascale Technologies, Inc. and market its products as our RapidScale storage appliance and in April 2007 we completed our acquisition of the rights of Distributed Parity Engine (“DPE”) from the former shareholders of Terrascale. Our RapidScale products provide scalable shared storage solutions. RapidScale permits all stored data to reside under a single namespace and be simultaneously accessed by thousands of servers. The solution delivers high performance while improving capacity and performance scalability, ease of data management, and capacity utilization. RapidScale appliances leverage our own hardware in addition to our proprietary RapidScale file system appliance software. In September of 2007, we released the newest generation of our modular data center products, known as “ICE Cube”, designed to augment or replace traditional brick-and-mortar data centers of any size and are ideal for data centers facing power and space limitations. We also sell low-cost, high-capacity storage servers, which leverage many of our core compute server technologies, to help enterprises cost-effectively meet their increasing data storage requirements. Our storage servers represented approximately 19% of our revenue in three months ended March 29, 2008 and 12% for the three months ended March 31, 2007. In addition, we selectively use reseller and OEM relationships to provide additional compute server and storage offerings that our customers may request from time to time. Service revenues were approximately 3% of total revenues in the three months ended March 29, 2008 and approximately 2% for the three months ended March 31, 2007.

We market our systems primarily through our direct sales force predominantly to enterprises within the United States. In the three months ended March 29, 2008 and March 31, 2007, international sales were approximately 7% and 1% of our revenues, respectively. In fiscal 2007, international sales represented 6% of our total sales. We are in the early stages of developing an international sales and operational presence, focusing initially on Europe and China. We focus our sales and marketing activities on enterprises that typically purchase hundreds of servers and tens or hundreds of terabytes of storage per year. To date, we have sold our products to over 500 customers. We have concentrated our marketing efforts on leading Internet companies, as well as customers with high-performance computing requirements in vertical markets such as semiconductor design, enterprise software, federal government, media, financial services, oil and gas exploration, biotechnology and pharmaceuticals.

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Share-based Compensation

In July 2007, we completed a tender offer to exchange 893,828 restricted stock unit awards for 2,238,883 employee stock options. (See Note 6 of the condensed consolidated financial statements.) More than 87% of the eligible employees representing more than 92% of the eligible stock options participated. The incremental accounting charge for the restricted stock unit awards was approximately $145,000, which reflects the difference between the unrecognized compensation costs of the options cancelled ($17.1 million) and the total value of the restricted stock unit awards on July 10, 2007 ($17.2 million). The total value of the restricted stock unit awards is amortized over the vesting period of the restricted stock unit awards which is longer than the remaining vesting period of the options tendered.

Beginning with the tender offer discussed above and continuing into 2008, we have moved away from the use of stock option awards and more to the issuance of restricted stock awards (“RSA”) and restricted stock units (RSU”) for our equity compensation. The following table represents the grants outstanding by type and percent of possible dilution as of the dates set forth below:

	March 29, 2008	As a % of common outstanding		March 31, 2007	As a % of common outstanding
Common stock outstanding	29,631,036	100.0	%	28,596,263	100.0	%
Stock option awards	2,882,150	9.7		5,199,981	18.2
Restricted stock units	1,572,458	5.3		—	—
Total grants outstanding	4,454,608	15.0		5,199,981	18.2
Fully diluted	34,085,644	115.0	%	33,796,244	118.2	%

The following table represents the share-based compensation expenses for the respectively periods (in thousands, except percentages):

	Three months ended
	March 29, 2008		March 31, 2007		Change
					$			%
Cost of revenue	$	302	$	669	$	(367	)	(55	)%
Research and development		807		1,936		(1,129	)	(58	)
Selling and marketing		649		2,014		(1,365	)	(68	)
General and administrative		1,699		3,269		(1,570	)	(48	)
Total	$	3,457	$	7,888	$	(4,431	)	(56	)%

The significant reduction in share-base compensation in the three months ended March 29, 2008 is the result of several factors, among them fewer awards outstanding due to the departure of several senior executives, lower fair value at grant date and changes in assumptions in 2008. Changes in the assumptions that are used to calculate expense were the volatility percentage, which was reduced to 60% in the first quarter of 2008 from 62% during 2007 and the estimated forfeiture rate for unvested awards, which increased to 11.6% in the first quarter of 2008 from 10.5% during 2007. Also contributing to the reduced expense was the declining grant date fair value over the past year, which results in lower future expense.

Fiscal Periods

Beginning with the first quarter of calendar 2003, we have a 52-week fiscal year ending on the Saturday nearest to December 31, with 13 week quarters ending on the last Saturday of the period. The first quarter of our fiscal year 2008 ended on March 29, 2008. The first quarter of our fiscal year 2007 ended on March 31, 2007. Fiscal year 2007 ended on December 29, 2007.

Critical Accounting Policies

Our critical accounting policies are discussed in our Annual Report on Form 10-K for our fiscal year ended December 29, 2007, and there have been no significant changes.

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Significant Judgments and Estimates

The preparation of financial statements in conformity with US GAAP requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses. These estimates and judgments are based on historical experience and on various other assumptions that we believe are reasonable under the circumstances, as well as management’s knowledge about current events and expectation about actions that we may undertake in the future. Actual results could differ materially from those estimates.

Results of Operations

The following table sets forth our financial results for the three months ended March 29, 2008, and March 31, 2007, as a percentage of revenue.

	Three months ended
	March 29, 2008		March 31, 2007
	(restated)
REVENUE	100	%	100	%
COST OF REVENUE	74	%	87	%
GROSS PROFIT	26	%	13	%
OPERATING EXPENSES:
Research and development	10	%	9	%
Sales and marketing	10	%	12	%
General and administrative	10	%	16	%
Total operating expenses	30	%	37	%
LOSS FROM OPERATIONS	(4	)%	(24	)%
Total other income, net	3	%	2	%
LOSS BEFORE INCOME TAXES	(1	)%	(22	)%
INCOME TAX BENEFIT	0	%	8	%
NET LOSS	(1	)%	(14	)%

Comparison of the three months ended March 29, 2008 and March 31, 2007

Revenue.

	Three months ended
	March 29, 2008		March 31, 2007		Change
					$			%
	(in thousands, except percentages)
Revenue	$	67,966	$	72,023	$	(4,057	)	(6	)%

The decline in revenue for the three months ended March 29, 2008 as compared to the three months ended March 31, 2007 was due to timing of customer orders and smaller size purchase commitments, as well as seasonality, that occurred in the first quarter of our fiscal year over the past several years. In the three months ended March 29, 2008, revenue from our historical top three customers was approximately $26.8 million, or 40% of revenue as compared to $44.6 million, or 62% of revenue, in the three months ended March 31, 2007. The number of units sold in the three months ended March 29, 2008 declined to approximately 16,831 units as compared to 19,760 units during the same period in 2007. However, the decline in units shipped was partially offset by a 10.8% increase in the average selling price per unit in the three months ended March 29, 2008 as compared to the three months ended March 31, 2007 due to the change in customer mix and the increased storage revenue as a percent of total revenue. We expect price competition to continue, particularly in our historical top three accounts, and the future changes in average selling price per unit will largely be dependent upon the customer and product mix.

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Cost of revenue and gross profit.

	Three months ended
	March 29, 2008			March 31, 2007			Change
							$			%
	(restated)
	(in thousands, except percentages)
Cost of revenue	$	50,245		$	62,999		$	(12,754	)	(20	)%
Gross profit	$	17,721		$	9,024		$	8,697		96	%
Gross margin		26.1	%		12.5	%		n/a		109	%

Gross profit increased approximately $8.7 million due primarily to a $12.8 million decrease in cost of revenues, partially offset by a $4.0 million decrease in revenue. The decrease in the cost of revenue was primarily due to a decrease of $13.7 million in the cost of materials, partially offset by an increase of $2.3 million related to excess and obsolete inventory in the quarter. The decrease in the cost of material was the result of better supply chain management and decreases in the prices of commodities during the year, such as memory and motherboards. The increase in excess and obsolete inventory charges consisted of a $4.5 million charge for excess and obsolete inventory identified in the quarter, offset by $2.2 million from the sale of inventory written down in prior periods.

Changes in customer and product mix and commodity prices, that comprise a significant portion of cost of revenue, significantly impact our gross margin from period to period. In addition, significant shifts in technology may expose us to excess and obsolete inventory write-downs.

Operating expenses.

	Three months ended
	March 29, 2008		March 31, 2007		Change
					$			%
	(restated)
	(in thousands, except percentages)
OPERATING EXPENSES:
Research and development	$	7,096	$	6,836	$	260		4	%
Sales and marketing	$	6,475	$	8,722	$	(2,247	)	(26	)%
General and administrative	$	7,041	$	11,340	$	(4,299	)	(38	)%

Research and development expense.

The increase in research and development expenses in the three months ended March 29, 2008, as compared to the same period in 2007, was due primarily to:

• The increased compensation and compensation related expenses of $0.9 million was due to the addition of 19 new employees, and

• Amortization expense increased by $0.5 million due primarily to the acquisition of the DPE technology in April 2007.

These increases were offset by the following decreases:

• Reduced share-based compensation of $1.1 million due to the changes described in the Company overview under share-based compensation, above and

• Lower material expenses of $0.2 million than in the three months ended March 31, 2007 due to lower costs for prototype activities based on the stage of various development projects

We expect research and development expense to increase, in absolute dollars, in future periods as we intend to increase our engineering activities in the areas of storage, remote management and power systems.

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Sales and marketing expense.

The decrease in sales and marketing expenses in the three months ended March 29, 2008 as compared to the three months ended March 31, 2007, was due to:

• Reduced share-based compensation of $1.4 million due to the changes described in the Company overview under share-based compensation, above,

• Decreased commission expense of $0.2 million due to lower revenue and

• The three months ended March 31, 2007 included, a settlement of a customer dispute that resulted in a $0.7 million charge

We expect sales and marketing expense to increase, in absolute dollars, in future periods as we expect to expand our sales presence in the United States and internationally.

General and administrative expense.

The reduction of general and administrative expense in the three months ended March 29, 2008 as compared to the same period in 2007 consisted of the following:

• Reduced share-based compensation of $1.6 million due to the changes described in the Company overview under share-based compensation, above,

• Decreased legal expenses of $0.3 million due in large part to resolving the litigation with Super Micro in the three months ended March 31, 2007 which had associated expenses of $0.8 million, partially offset with $0.5 million higher other legal expenses in the three months ended March 29, 2008,

• The three months ended March 31, 2007 included a $1.9 million expense associated with delinquent sales and use tax filings that were resolved in 2007,

• In the 2007 period, we resolved a customer dispute that resulted in a $0.6 million charge in the period and

• Reduced expense related to the amortization of intangibles recognized in connection with the Old Rackable transaction became fully amortized in 2007 resulting in $0.4 million reduction in amortization expense.

These decreases in general and administrative expense in the three months ended March 29, 2008 as compared to March 31, 2007 were partially offset by:

• Increased compensation and compensation related expenses of $0.3 million due to the addition of 8 employees in general and administrative activities

We expect our general and administrative expenses will be relatively constant in terms of absolute dollars, but may vary as percentage of revenue, for the remainder of the year.

Other income, net.

	Three months ended
	March 29, 2008		March 31, 2007		Change
					$		%
	(in thousands, except percentages)
Other income, net:	$	2,030	$	1,803	$	227	13	%

Other income increased primarily due to currency translation gains in the three months ended March 29, 2008 related to certain receivables which were denominated in Euros. Interest income in the three months ended March 29, 2008 was consistent when compared to the 2007 period, even though our average cash available for investment was higher in the 2008 period, the lower interest rates resulted in a lower yield.

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Provision for income taxes.

	Three months ended
	March 29, 2008		March 31, 2007		Change
					$			%
	(restated)
	(in thousands, except percentages)
Tax benefit	$	95	$	5,914	$	(5,819	)	(98	)%

We recorded a tax benefit of $95,000 for the three months ended March 29, 2008. The effective tax rate used to record the tax benefit differed from the combined federal and net state statutory income tax rate for the three months ended March 29, 2008 due primarily to an increase in the valuation allowance for domestic deferred tax assets.

We recorded a tax benefit for the three months ended March 31, 2007 based on a projected 36.8% annual effective tax rate. The effective tax rate of 36.8% used to record the tax benefit differed from the combined federal and net state statutory income tax rate for the three months ended March 31, 2007 due primarily to certain share-based compensation expenses for which tax benefits and related deferred tax assets are not recorded in accordance with SFAS 123R.

Liquidity and Capital Resources

Liquidity

Cash, cash equivalents and investments totaled $206.9 million at March 29, 2008, an increase of $8.8 million compared to $198.1 million at December 29, 2007. We expect to finance our operations for the next twelve months primarily through cash, cash equivalents and short term investment balances and cash flow from operations. A large portion of our available cash is invested in highly liquid, short-term investment grade government and agency debt securities and commercial paper with maturities of less than three months.

The following table summarizes our statement of cash flows for the following periods (in thousands):

	Three months ended
	March 29, 2008			March 31, 2007
Consolidated Statements of Cash Flows Data:
Net cash provided by operating activities	$	9,460		$	10,365
Net cash provided by investing activities		95,419			10,303
Net cash provided by financing activities		472			1,550
Effect of exchange rate changes on cash and cash equivalents		(33	)		(12	)
Net increase in cash and cash equivalents		105,318			22,206
Cash and cash equivalents - beginning of period		49,897			30,446
Cash and cash equivalents - end of period	$	155,215		$	52,652

Operating Activities

Cash provided by operating activities was $9.5 million in the three months ended March 29, 2008. Reductions in accounts receivable contributed $15.3 million, as we continued to have strong collection efforts totaling $89.7 million, combined with the lower revenue, during the period. The reduction in inventory of $13.1 million was the result of better supply chain management efforts, as well reduced inventory levels, as a result of lower revenue during the period. With reductions in prepaid and others assets contributing an additional $6.8 million, related to lower prepaid taxes, rebates receivable and sales tax receivable during the period. Also contributing was the non-cash item of share based compensation of $3.5 million. Offset against these increases in cash provided by operations were reductions in account payable of $25.4 million, due in large part to the lower inventory levels as a result of the lower revenue, combined with the improved supply chain management. As well as accrued expenses and deferred rent of $4.7 million, combined with the net loss of $0.8 million.

Cash provided by operating activities in the three months ended March 31, 2007 was $10.4 million, even though we had a $10.2 million net loss in the three months ended March 31, 2007. The primary contributor to the net cash provided by operating activities was the collection of approximately $109.0 million of accounts receivable in the quarter. The collections in the three months ended March 31, 2007 consisted of $95.2 million of our outstanding accounts receivable balance at December 30, 2006 and the remainder was from collections of revenues from sales in the quarter ended March 31, 2007.

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Investing Activities

Cash provided by investing activities was $95.4 million for the three months ended March 29, 2008. Cash provided by investing activities consisted primarily of sales and maturities of our short-term marketable securities of $121.6 million, partially offset by purchases of short-term marketable securities of $25.5 million.

Cash provided by investing activities was $10.3 million for the three months ended March 31, 2007. Cash provided by investing activities consisted primarily of purchases of short-term marketable securities of $124.3 million, offset by sales and net maturities of our short-term marketable securities of $136.8 million.

In general, we are not a capital intensive company. However, we do expect capital investments to increase moderately in future periods.

Financing Activities

Net cash provided from financing activities during the three months ended March 29, 2008 was $0.5 million. The primary source of the cash provided was proceeds from the employee stock purchase plan and the exercise of employee stock options.

Net cash provided from financing activities during the three months ended March 31, 2007 was $1.6 million. The primary source of the cash provided was proceeds from the employee stock purchase plan and the exercise of employee stock options.

In order to execute our business strategy, we expect to experience growth in our operating expenses for the foreseeable future. This increase in operating expenses may not result in an increase in our revenue and our anticipated revenue may not be sufficient to support these increased expenditures. Our operating expenses and working capital could constitute a material use of our cash resources. However, we believe our current cash and short-term investments are adequate to support our funding of our operating expenses and working capital requirements for the next twelve months.

Contractual Obligations and Contingent Liabilities and Commitments

The following are contractual commitments at March 29, 2008, associated with debt obligations, lease obligations, and contractual commitments (in thousands):

	Payments due by period
	Total		Less than 1 year		1 -3 years		3 -5 years		More than 5 years
Operating leases	$	10,100	$	2,037	$	3,543	$	3,312	$	1,208
Purchase obligations		21,107		21,107		—		—		—
Total	$	31,207	$	23,144	$	3,543	$	3,312	$	1,208

In connection with agreements with our suppliers, we agreed to purchase certain units of inventory through 2008. As of March 29, 2008, there was a remaining commitment of $18.9 million through the end of 2008.

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ITEM 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, including our chief executive officer and chief financial officer, has evaluated the effectiveness of our disclosure controls and procedures that are designed to ensure that the information included in reports we file under the Securities Exchange Act of 1934, as amended, or the Exchange Act, is processed and reported within the appropriate time periods. As discussed in more detail below, our management, including our chief executive officer and chief financial officer, has concluded that these disclosure controls and procedures were ineffective as of March 29, 2008 due to material weaknesses that we identified in our internal control over financial reporting, specifically related to inventory valuation and accounting for income taxes.

As reported in our Annual Report on Form 10-K for our fiscal year ended December 29, 2007, our management identified two material weaknesses in internal control over financial reporting as of December 29, 2007, which continue to be material weaknesses as of March 29, 2008, as follows:

Inventory Valuation

Our management concluded that the controls over our accounting for inventory valuation did not operate effectively as of December 29, 2007 and continued to be a material weakness as of March 29, 2008. In particular, errors were detected in the inventory valuation for the annual and interim financial statements resulting from: (i) items relating to the calculation of purchase price variances and excess and obsolete inventory reserve adjustments and; (ii) reviews of inventory valuations not being performed with sufficient precision. Due to the number and magnitude of the errors identified resulting from these internal control deficiencies and the absence of mitigating controls, management concluded that these internal control deficiencies constitute a material weakness in our internal control over financial reporting because there is a reasonable possibility that a material misstatement of the annual and interim financial statements would not have been prevented or detected on a timely basis.

Accounting for Income Taxes

Our management concluded that the controls over our accounting for income taxes did not operate effectively as of December 29, 2007. In particular, errors were detected in the tax calculations for the annual financial statements resulting from: (i) current period tax calculations not being accurately prepared, and (ii) reviews of tax calculations not being performed with sufficient precision. Due to the magnitude of the error identified resulting from these internal control deficiencies and the absence of mitigating controls, management concluded that these internal control deficiencies constitute a material weakness in our internal control over financial reporting because there is a reasonable possibility that a material misstatement of the annual financial statements would not have been prevented or detected on a timely basis.

Changes in Internal Control over Financial Reporting

We commenced a number of efforts to remediate the two material weaknesses noted above. These efforts will continue throughout 2008 and include the following:

Inventory Valuation

During the three months ended March 29, 2008, we continued the remediation process commenced last quarter, for the material weakness in accounting for inventory valuation, as reported in Item 9A of our Annual Report on Form 10-K filed March 13, 2008. For example, we hired, during the period following the filing of our Annual Report, two experienced cost analysts.

We will continue to make changes as necessary through automation, recruiting and enhancing the training of high quality personnel, in order to provide us with the infrastructure and processes necessary to remediate the inventory valuation material weakness, and to ensure operating effectiveness and improved internal controls over financial reporting.

Accounting for Income Taxes

During the three months ended March 29, 2008, we continued the remediation process commenced last quarter, for the material weakness in accounting for income taxes, as reported in Item 9A of our Annual Report on Form 10-K filed March 13, 2008. For example, we recruited, during the period following the filing of our Annual Report, an additional accounting professional to support tax accounting.

We will continue to make changes as necessary through automation, recruiting and enhancing the training of high quality personnel, and improving the quality and timing of our accounting close process to allow for increased review time, in order to provide us with the infrastructure and processes necessary to remediate the income tax accounting material weakness, and to ensure operating effectiveness and improved internal controls over financial reporting.

Management expects to complete our remediation efforts during fiscal 2008; however, the ultimate remediation of these material weaknesses is contingent upon our ability to test the internal controls related to the material weaknesses once the remediation efforts described above are complete.

Inherent Limitation on the Effectiveness of Internal Controls

The effectiveness of any system of internal control over financial reporting, including ours, is subject to inherent limitations, including the exercise of judgment in designing, implementing, operating, and evaluating the controls and procedures, and the inability to eliminate misconduct completely. Accordingly, any system of internal control over financial reporting, including ours, no matter how well designed and operated, can only provide reasonable, not absolute assurances. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. We intend to continue to monitor and upgrade our internal controls as necessary or appropriate for our business, but cannot assure you that such improvements will be sufficient to provide us with effective internal control over financial reporting.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

RACKABLE SYSTEMS, INC.
By:	/s/ James D. Wheat
	James D. Wheat
	Chief Financial Officer
	(Duly authorized and principal financial officer)

Dated: July 17, 2008

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Exhibit Index

		Incorporated by Reference
Exhibit Number	Exhibit Description	Form	Ex. No	File No.	Filing Date	Filed Herewith
31.1	Certification required by Rule 13a-14(a) or Rule 15d-14(a).					X
31.2	Certification required by Rule 13a-14(a) or Rule 15d-14(a).					X
32.1*	Certifications required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350)					X

* The certification attached as Exhibit 32.1 accompanies the Annual Report on Form 10-K pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed “filed” by Rackable Systems, Inc. for purposes of Section 18 of the Securities Exchange

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