This Quarterly Report on Form 10-Q 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 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 and elsewhere in this Form 10-Q and 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 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.

"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.

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 is designed to 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 is 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 13% and 11% of our revenue in the six months ended June 28, 2008 and June 30, 2007 respectively. 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% and 2% of total revenues in the six months ended June 28, 2008 and June 30, 2007, respectively.

We market our systems primarily through our direct sales force predominantly to enterprises within the United States. In the six months ended June 28, 2008 and June 30, 2007, international sales were approximately 4% of our revenues. 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.

During the second quarter of 2008 we had several significant events, primary among those were changes in our expectations for the RapidScale product line, which required us to perform an impairment analysis of our intangible and other long-lived assets, as required by SFAS No. 144. This analysis resulted in an impairment of approximately $16.9 million to our intangibles and long-lived assets. As part of our ongoing consolidation of production facilities, we early terminated leases on two properties and recorded a restructuring charge of approximately $0.7 million. Our gross margin in the second quarter was at its lowest level in over two years, due in part to our decision to accept an order from a significant customer with unfavorable pricing. The decision to accept the order was made to protect market position that we believe is important and where we believe we have the ability to improve margin profile in the future. We expect in future quarters that we will be returning to gross margins more in line with earlier periods. For additional information on these events please see our consolidated financial statements in this Form 10-Q, as well as the discussion of our results of operation below.

Share-based Compensation

In July 2007, we completed a tender offer to exchange 2,238,883 employee stock options for 893,828 restricted stock unit awards. See Note 7 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 of $17.1 million and the total value of the restricted stock unit awards on July 10, 2007 of $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 increased the mix of restricted stock awards ("RSA") and restricted stock units (RSU") as compared to stock option awards 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:

                                                        As a percent                     As a percent
                                                         of common                        of common
                                        June 28, 2008   outstanding      June 30, 2007   outstanding
Common stock outstanding                   29,737,860          100.0 %      29,370,632          100.0 %
Stock option awards                         3,059,148           10.3         4,883,356           16.6
Restricted stock units                      1,410,102            4.7            65,625            0.2

Total grants oustanding                     4,469,250           15.0         4,948,981           16.9
Fully diluted                              34,207,110          115.0 %      34,319,613          116.9 %

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

                                           Three months ended                    Six months ended
                                          June 28,     June 30,    Change      June 28,    June 30,    Change
                                            2008         2007        %           2008        2007        %
Cost of revenue                          $      368    $     743      (50 )%   $     670   $   1,412      (53 )%
Research and development                        938          961       (2 )        1,745       2,897      (40 )
Selling and marketing                           678        1,621      (58 )        1,327       3,635      (64 )
General and administrative                    1,774        2,993      (41 )        3,473       6,262      (45 )

Total                                    $    3,758    $   6,318      (41 )%   $   7,215   $  14,206      (49 )%

The significant reduction in share-base compensation in the three and six months ended June 28, 2008 is the result of several factors, among them fewer awards outstanding due to reorganizing the management team and its responsibilities, which included 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 59% in the second quarter of 2008 from 60% during 2007 and the estimated forfeiture rate for unvested awards, which increased to 11.6% in the second 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

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 second quarter of our fiscal year 2008 ended on June 28, 2008. The second quarter of our fiscal year 2007 ended on June 30, 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.

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 and six
months ended June 28, 2008 and June 30, 2007, as a percentage of revenue.



                                      Three months ended           Six months ended
                                    June 28,      June 30,      June 28,      June 30,
                                      2008          2007          2008          2007
  REVENUE                              100.0 %       100.0 %         100 %         100 %
  COST OF REVENUE                       90.8         108.4          82.8          98.6

  GROSS PROFIT                           9.2          (8.4 )        17.2           1.4
  OPERATING EXPENSES:
  Research and development               9.1           7.5           9.7           8.4
  Sales and marketing                    7.6          10.2           8.5          11.1
  General and administrative             9.1          11.6           9.7          13.6
  Impairment of long lived assets       22.2           0.0          11.7           0.0
  Restructuring charges                  0.9           0.0           0.5           0.0

  Total operating expenses              48.9          29.3          40.1          33.1

  LOSS FROM OPERATIONS                 (39.7 )       (37.7 )       (22.9 )       (31.7 )

  Total other income, net                1.1           2.5           2.0           2.5

  LOSS BEFORE INCOME TAX               (38.6 )       (35.3 )       (20.9 )       (29.2 )
  INCOME TAX BENEFIT/(PROVISION)         1.7         (13.9 )         1.0          (3.6 )

  NET LOSS                             (36.9 )%      (49.2 )%      (19.9 )%      (32.8 )%

Comparison of the three and six months ended June 28, 2008 and June 30, 2007

Revenue.

                   Three months ended                      Six months ended
                  June 28,     June 30,                  June 28,    June 30,
                    2008         2007      $ Change        2008        2007      $ Change
                           (in thousands)                         (in thousands)
       Revenue   $    75,964   $  82,238   $  (6,274 )   $ 143,931   $ 154,262   $ (10,331 )

The decline in revenue for the three months ended June 28, 2008, compared to the three months ended June 30, 2007, was due to a delay in the timing of customer orders and smaller purchases. In the three months ended June 28, 2008, revenue from our historical top three customers remained constant at approximately $51.0 million, or 67% of revenue as compared to $51.0 million, or 62% of revenue, in the three months ended June 30, 2007. The number of units sold in the three months ended June 28, 2008 increased to approximately 25,400 units compared to 23,200 units during the same period in 2007. However, the increase in units shipped was offset by a 15% decrease in the average selling price ("ASP") per unit in the three months ended June 28, 2008 compared to the three months ended June 30, 2007. The decrease in our ASPs is due to several factors, the most significant of which was our decision to accept an order from a significant customer with unfavorable pricing, as well as an increase in the mix of our historic top three customers that purchase high quantities at lower ASPs and the mix of product configurations shipped in the quarter. This resulted in a larger than usual number of lower priced products being sold during the quarter.

The decline in revenue for the six months ended June 28, 2008, compared to the six months ended June 30, 2007, was due to a delay in the timing of customer orders and smaller purchases. In the six months ended June 28, 2008, revenue from our historical top three customers decreased to approximately $78.0 million, or 54% of revenue as compared to $96.0 million, or 62% of revenue, for the six months ended June 30, 2007. The number of units sold in the six months ended June 28, 2008, declined slightly to approximately 42,200 units compared to 43,000 units during the same period in 2007. In addition to the decline in units shipped, there was a 5% decrease in the ASP per unit for the six months ended June 28, 2008 as compared to the six months ended June 30, 2007, as discussed above.

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 configuration mix.

Cost of revenue and gross profit.

                                          Three months ended                               Six months ended
                                       June 28,         June 30,                       June 28,          June 30,
                                         2008             2007         $ Change          2008              2007        $ Change
                                         (in thousands, except percentages)              (in thousands, except percentages)
Cost of revenue                      $     68,976       $  89,172      $ (20,196 )   $    119,220       $  152,171     $ (32,951 )
Gross profit                         $      6,988       $  (6,934 )    $  13,922     $     24,711       $    2,091     $  22,620
Gross margin                                  9.2 %          (8.4 )%         n/a             17.2 %            1.4 %         n/a

Gross profit increased for the three months ended June 28, 2008, compared to the same period in 2007, due largely to the fact that we recorded approximately a $20.6 million charge for excess and obsolete inventory in the three month period ended June 30, 2007, compared to a $3.2 million charge for excess and obsolete inventory in the three months ended June 28, 2008. In the three months ended June 28, 2008 sales of previously written down inventory benefited gross profit by $1.0 million compared to no benefit from sales of previously written down inventory in the three months ended June 30, 2007. Gross profit in the three months ended June 28, 2008, was negatively impacted by a $1.3 million increase in the warranty provision compared to the same fiscal period in 2007 as a result of increasing to a three year product warranty from a one year product warranty. Gross margin was negatively impacted by an order shipped in the quarter to a customer priced at unfavorable gross margins, with the intent of preserving an existing and significant customer relationship. In addition, gross margin was negatively impacted by the increased concentration of revenue from our historic top three customers, which typically purchase product from us at lower margins. While our material and manufacturing cost had reduced in the three months ended June 28, 2008 compared to the three months ended June 30, 2007, the reductions were not enough to offset the decrease in ASPs.

Gross profit increased for the six months ended June 28, 2008, compared to the same period in 2007, due largely to the fact that we recorded approximately a $20.8 million charge for excess and obsolete inventory in the six month period ended June 30, 2007 compared to a $7.6 million charge for excess and obsolete inventory in the six months ended June 28, 2008. In the six months ended June 28, 2008, sales of previously written down inventory benefited gross profit by $3.1 million as compared to no benefit from sales of previously written down inventory in the six months ended June 30, 2007. In addition, as discussed above, in the second half of 2007 we began offering a three year product warranty to our customers, negatively impacting gross profit in the 2008 fiscal period. While ASPs declined 5% in the six months ended June 28, 2008 as compared to the same period in 2007, material and manufacturing cost reductions more than offset that decline.

Changes in customer and product mix, pricing actions by our competitors 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                       Six months ended
                                         June 28,       June 30,                  June 28,    June 30,
                                           2008           2007      $ Change        2008        2007      $ Change
                                                   (in thousands)                          (in thousands)
Research and development                $     6,876    $    6,146   $     730     $  13,974   $  12,982   $     992
Sales and marketing                     $     5,781    $    8,401   $  (2,620 )   $  12,255   $  17,124   $  (4,869 )
General and administrative              $     6,885    $    9,561   $  (2,676 )   $  13,926   $  20,901   $  (6,975 )
Impairment of long-lived assets         $    16,856    $       -    $  16,856     $  16,856   $      -    $  16,856
Restructuring Charges                   $       685    $       -    $     685     $     685   $      -    $     685

Research and development expense.

The increase in research and development expenses in the three and six months ended June 28, 2008, compared to the same periods in 2007, was due to:

• Increased compensation and compensation related expenses of $0.5 million and $1.4 million in the three and six month periods due to the addition of 14 new employees

• Higher amortization expense of $0.1 million and $0.6 million in the three and six month periods due to the acquisition of the DPE technology in April 2007, and

• Increased depreciation expense of $0.1 million and $0.3 million in the three and six month periods as a result of the addition of test systems to support engineering activities.

These increases were offset by the following decreases:

• Reduced share-based compensation of $1.2 million in the six month period in 2008 due to the changes described in the Company overview under share-based compensation, above and

• Lower professional services of $0.2 million and $0.4 million in the three and six month periods as a result of increased internal resources to support those activities.

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.

Sales and marketing expense.

The decrease in sales and marketing expenses in the three and six months ended June 28, 2008 compared to the same periods in 2007, was due to:

• Reduced share-based compensation of $0.9 million and $2.3 million for the three and six month periods in 2008 due to the changes described in the Company overview under share-based compensation, above,

• Decreased commission and sales expense of $1.2 million and $1.1 million for the three and six month periods of 2008 due to lower revenue, and

• Decreased evaluation system charges of $0.1 million and $0.9 million for the three and six month periods in 2008 from being more selective in the deployment of evaluation systems

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 and six months ended June 28, 2008 compared to the same periods in 2007 consisted of the following:

• Reduced share-based compensation of $1.2 million and $2.8 million for the three month and six month periods in 2008 due to the changes described in the Company overview under share-based compensation, above,

• Lower compensation and compensation related expenses of $0.7 million for the three and six month periods in 2008 due to $0.8 million of severance expenses in the 2007 periods related to the termination of two executives; lower management bonus expense of $0.2 million in the three month 2008 period due to performance objectives not having been met; partially offset by increased compensation expense of $0.4 million and $0.7 million in the three and six month periods in 2008 due to the addition of 13 new employees

• Decreased legal expenses of $0.2 million and $0.5 million in the three and six month periods in 2008 due in large part to resolving the litigation with Super Micro in the six months ended June 30, 2007 which had associated expenses of $0.8 million, partially offset by higher legal expense of $0.5 million in the six months ended June 28, 2008 related to SEC filings, and

• Reduced expense related to the amortization of intangibles that became fully amortized during the six months ended June 30, 2007, resulting in $0.4 million reduction in amortization expense.

• The six months ended June 30, 2007 included a $2.1 million expense associated with delinquent sales and use tax filings and a $0.7 million charge associated with a customer dispute.

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.

Impairment of long-lived assets.

We evaluated our long-lived assets with determinable economic life for recoverability due to events that indicated their carrying amounts might not be recoverable as of June 28, 2008. During the quarter ended June 28, 2008, the Company significantly lowered its projected revenue and cash flow from the RapidScale product line. The decrease in projections was due to a change in strategic direction, as well as an inability to license certain third party software on reasonable commercial terms. We determined that certain property and equipment and intangible assets related to our RapidScale product were impaired. The total impairment was $16.9 million.

Restructuring charges.

In the three months ended June 30, 2008, we relocated certain engineering activities that were being performed in our Milmont, California facility, which was under lease through June 30, 2009. We completed the relocation and returned the facility to the lessor prior to June 28, 2008. In addition, we negotiated and completed a lease termination agreement with the lessor, releasing us from any further responsibilities which required that we pay $0.7 million, which is . . .