Mail Stop 4-6
April 22, 2005
Mr. Thomas K. Barton
Chief Executive Officer
Rackable Systems, Inc.
1933 Milmont Drive
Milpitas, California 95035
Re: Rackable Systems, Inc.
Amendment No. 1 to Registration Statement on Form S-1 filed
March 30, 2005
File No. 333-122576
Dear Mr. Barton:
We have reviewed your amended filing and have the following
comments.
Inside Front Cover Page
1. Please note that our comments with respect to your graphic
artwork
will be provided to you in a telephone discussion.
Prospectus Summary
2. We note your response to our prior comment no. 4. In each
market
in which you hold a leading position, please supplementally inform
us
of the number of competitors from which you have been ranked
against.
Further, in light of your inability to neither cite to IDC in your
prospectus nor provide us with written materials in order to
support
your assertion that you are "a leading provider of high-density
compute servers," please qualify your assertion on the basis that
it
is your belief.
3. We note your response to our prior comment no. 5. Please
disclose
the basis for WebEx`s inclusion as a representative customer in
your
summary discussion.
Risk Factors
Our business depends on decisions by potential customers to adopt
our
modular, open standard-based products and to replace their legacy
server systems with our products, p. 13
4. We note your revised disclosure in response to our prior
comment
no. 16. Please clarify the extent to which you and the market for
Linux will be affected by an adverse result in the Linux
litigation.
We note that the open-source aspect of Linux is key to the
attractiveness of Linux to customers and that the Linux litigation
would essentially end this aspect of Linux. As a result, it would
appear that an adverse ruling would potentially affect your
prospects
in the Linux market greater than limiting your ability to sell
Linux
servers or slowing the growth of the market.
If we fail to maintain or expand our relationships with our
suppliers, we may not have adequate access to new or key
technology..., p. 15
5. Please briefly explain to us the terms and purpose of the
evaluation agreement that you entered into with Advanced Micro
Devices as well as your reason for concluding that such an
agreement
is not material to you.
We depend on our Foundation Series compute servers for
substantially
all of our revenues..., pp. 15-16
6. Please quantify the share of your revenues that the Foundation
Series compute servers represented.
Special Note Regarding Forward-looking Statements
7. We note your revised disclosure in this section. You have
provided industry data by IDC to assist investors in understanding
your industry, business and potential market. As presented, this
market data receives fairly prominent discussion in your
registration
statement, such as in business. As you know, market data included
in
your registration statement must be based on reasonable and sound
assumptions. We note, however, that you have not independently
verified the information from IDC. Please revise the text as
necessary so that you do not suggest that you could lack a
reasonable
belief as to the accuracy and completeness of the market data you
elect to include in the filing.
Capitalization
8. We have further considered the nature, terms and timing of
various
transactions surrounding your offering. To provide investors with
a
better understanding of your capital structure immediately prior
to
the offering, consider revising your filing as follows:
* Revise your "pro forma" capitalization to reflect the conversion
of
the Series A preferred shares to Series B preferred and common
shares;
* Revise your "pro forma" capitalization to remove the impact of
using offering proceeds to redeem Series B preferred shares;
* Revise your "pro forma as adjusted" capitalization to reflect
the
application of your offering proceeds; and
* Revise your balance sheet to include pro forma columns
reflecting
your capitalization subsequent to the conversion of the Series A
preferred shares and prior to the completion of your offering and
the
application of any resulting proceeds.
Selected Financial Data
9. Footnote 2 to your presentation of selected financial data
indicates, in part, that pro forma net loss is adjusted to
reflecting
the accretion of the Series A preferred shares to the Series B
redemption amount. As the Series A and B stock will be converted
or
redeemed at the offering, it does not appear that this accretion
will
have a continuing impact. In view of this, explain why you
believe
this adjustment is appropriate.
Management`s Discussion and Analysis of Financial Condition and
Results of Operations
Overview
Revenues and Expenses, pp. 32-33
10. We note your response to our prior comment no. 25. Please
explain why your agreement with Yahoo! and any prospective
agreement
with Microsoft would not be material to your business in light of
the
fact that, despite the lack of any purchase obligations, the
agreement(s) govern the terms and conditions of relationships that
account for a significant share of your revenue. Such an
agreement
may include terms for payment, warranty, etc. that may be
construed
as material components of your relationship. We note on page 52
that
under your agreement with Yahoo! you are obligated to spend
$250,000
in marketing with them. We further note that your disclosure on
page
F-22 suggests that your marketing obligation is conditioned upon a
purchase commitment of at least $14 million by Yahoo!. Please
clarify and reconcile.
Cost of Revenues, pp. 33-34
11. We note your response to our prior comment no. 27. If
material,
please disclose the percentage of your price for which the cost of
DRAM constituted, for example, in fiscal year 2004. In addition,
we
note your disclosure in the first paragraph on page 42 that your
decrease in gross margin for the year ended December 31, 2004 was
attributable to system pricing pressures. Please expand your
disclosure to discuss these system pricing pressures and any
material
trends related to such pressures. Do you expect competitive
market
conditions to continue? What are these market conditions?
Critical Accounting Policies, Significant Judgments and Estimates
Allocation of Rackable Purchase Pursuant to Purchase Accounting
and
Valuation of Intangible Assets and Goodwill, pp. 37-38
12. You disclose that you operate in two segments and have one
reporting unit. Supplementally, clarify for us what you intend to
convey with this statement and how it impacts your accounting for
goodwill. As part of your response, explain how the
identification
of your reporting unit(s) complies with SFAS 142, par. 30. In
this
regard, note that a reporting unit is an "operating segment or one
level below an operating segment."
Results of Operations
Comparison of the Years Ended December 31, 2004 and 2003, pp. 41-
43
13. With reference to our prior comment no. 28, please confirm
that
you have quantified the impact of each identified source for
material
changes from period to period in line items of your financial
statements. For instance, we note that you disclosed headcount
increases with respect to your research and development expense,
sales and marketing expense and general and administrative expense
without quantifying the impact of such changes.
Business
Industry Background
The High-Capacity Storage Market, p. 59
14. We refer you to your industry data statement regarding the
growth
in storage capacity by petabytes. It would appear that if a
petabyte
is 1,024 terabytes, then your supplemental support reflecting
830,986
terabytes in 2003 would equate to 812 petabytes rather than the
831
petabytes that you disclose, for example. Please clarify.
Manufacturing and Operations, p. 73
15. We note your response to our prior comment no. 26. Please
provide additional disclosure with respect to the reason why
Sanmina-
SCI no longer manufactures a majority of your products. Please
also
confirm to us whether a master agreement governing your
relationship
with Sanmina-SCI exists. We note that such agreements are in
place
with respect to E-Cycle and Synnex. Despite not containing
purchase
obligations, such agreements contain other material terms and
conditions with respect to the relationship such as payment,
confidentiality and warranty terms. In light of Sanmina-SCI`s
large
share of your manufacturing, please disclose the material terms
and
conditions of your relationship. Further, please discuss whether
certain products are divided among your various contract
manufacturers and whether one manufacturer acts as the sole
manufacturer of a particular product. Please also disclose the
share
of your manufacturing that each contract manufacturer represented
in
2004 and, to the extent possible, the share represented by each
contract manufacturer currently and going forward.
Certain Relationships and Related Party Transactions
Indebtedness of Management, pp. 93-94
16. We note your response to our prior comment no. 47. Please
reconcile your statement in your disclosure that the deferred
compensation agreements were entered into with Messrs. Barton and
Ford in consideration for the services they provided in connection
with your acquisition of Predecessor with your response and
revised
disclosure on page 95 stating that compensation was paid to
Callero
Partners for services provided by Messrs. Barton and Ford. It
appears that compensation was paid in two instances for the
services
of Messrs. Barton and Ford or that Messrs. Barton and Ford
provided
services to both Predecessor and New Rackable concurrently.
Please
explain. We also note your use of two terms with respect to GNJ,
Inc.-Old Rackable and Predecessor. For purposes of clarity,
please
consider using only one term for GNJ, Inc. in your disclosure.
Underwriting
17. We note your response to our prior comment no. 52. Please
make
disclosure similar to your response in your prospectus.
Financial Statements
Revenue Recognition, pp. F-10 to F-11
18. We note that you have entered into a reseller agreement with
Hewlett-Packard for the purpose of providing equipment to
Microsoft,
who accounted for 36% of your 2004 revenue. We further note your
disclosure indicating that you expect to expand your sales through
resellers and other indirect channels. In view of these factors,
consider revising your disclosure under this note to identify any
differences in the terms of your direct and indirect sales
arrangements. Similarly, consider explaining how your revenue
recognition policies reflect any such differences.
Note 17. Stock Based Compensation, pp. F-27 to F-29
19. We have considered your responses to prior comments nos. 63
and
64 and do not believe the method used to determine the fair value
of
shares underlying stock options awarded is appropriate. In this
regard, we note that the values of shares of common stock
underlying
the stock options granted were determined based on a straight-line
progression of value between December 2003 and February 2005.
This
method does not appear to be objectively supportable or based on
generally accepted valuation methodologies. In view of this,
supplementally tell us whether or not you considered the guidance
provided in the AICPA publication "Valuation of Privately-Held-
Company Equity Securities Issued As Compensation."
20. For the stock option awards identified in your response to our
prior comment no. 63, supplementally provide, with a view towards
additional disclosure in your filing, the information contemplated
by
par. 182 of the AICPA valuation guide. Additionally, tell us how
you
considered the disclosures recommend in pars. 179 through 181 of
the
AICPA valuation guide.
21. Supplementally tell us whether your independent auditor
consulted
with their national office with respect to the valuation of shares
of
common stock underlying your stock option awards. If so, please
provide the name of the person with whom they consulted.
* * * *
As appropriate, please amend your registration statement in
response to these comments. You may wish to provide us with
marked
copies of the amendment to expedite our review. Please furnish a
cover letter with your amendment that keys your responses to our
comments and provides any requested supplemental information.
Detailed cover letters greatly facilitate our review. Please
understand that we may have additional comments after reviewing
your
amendment and responses to our comments.
You may contact Stathis Kouninis at (202) 942-2883, or Brad
Skinner, Branch Chief - Accounting, at (202) 942-1922, if you have
questions or comments on the financial statements and related
matters. Please contact Daniel Lee at (202) 942-1871 with any
other
questions. If you need further assistance, you may contact me at
(202) 942-1800.
Sincerely,
Barbara Jacobs
Assistant Director
cc: Via Facsimile
Timothy J. Moore, Esq.
Brett D. White, Esq.
Cooley Godward LLP
Five Palo Alto Square
3000 El Camino Real
Palo Alto, California 94306
Telephone: (650) 843-5000
Facsimile: (650) 843-5191