Microsoft, Yahoo Slash Server Spending

Rackable Systems (RACK) said yesterday that Microsoft and Yahoo spent $114 million less on the company's servers and storage products in 2008 than they did in 2007, with the brunt of that decline coming in the fourth quarter. Rackable's revenue for the fourth quarter was $38.8 million compared to $111.3 million in the same quarter in 2007.

Microsoft slashed its capital spending on data centers by $300 million in October, citing the impact of the U.S. economic crisis, and last month said that it would lay off 1,500 workers, halt one major data center project and slow construction on two others. Yahoo has also been focused on cost-cutting, announcing a 10 percent staff reduction in December amid a broader restructuring that brought in a new CEO, Carol Bartz.

Rackable's business has been highly concentrated among the largest Internet companies. Orders from Microsoft (MSFT), Yahoo (YHOO) and Amazon (AMZN)  accounted for 65 percent of the company’s revenues during the second quarter of 2008. In October Rackable slashed its revenue guidance for the year, citing an "abrupt slowdown" in corporate purchasing.

While Rackable didn't explicitly name the customers that had altered spending, it said orders from its two largest customers plunged $100 million, and that the delay of large-scale construction projects had hurt servers sales, and had a specific negative impact on Rackable's data center container business. The three largest buyers during the fourth quarter were identified as Amazon, Conoco Phillips and Microsoft, with no mention of Yahoo.

Not all of Rackable's 65 percent sales plunge in the fourth quarter can be blamed on the economy, as competitors also gained traction, with Dell winning a key piece of business with Microsoft. In October Dell said that its Data Center Solutions division is providing the server and storage hardware powering Windows Azure, Microsoft’s cloud services platform. Dell says it has developed “highly-customized server platforms for Microsoft tailored to their physical facility, operating processes and application workload.” In December Dell said Microsoft would use its new double-decker containers in its Chicago data center.

It's not clear that either of these opportunities is generating substantial sales at the moment. Azure remains in a technology preview phase, which allows developers to access an Azure installation in Microsoft's Quincy, Washington data center. Meanwhile, the company's planned Chicago container farm is in a holding pattern, and will be briought online “as customer demand warrants” based on quarterly reviews of data center capacity.

Rackable president and CEO Mark Barrenechea insisted that the sales drop was "primarily market driven, and not driven by market share shift." Barrenechea said Rackable remained committed to the Internet sector, but will continue on ongoing effort to diversify its customer base, especially in the financial sector and the oil and gas industry, which each are large users of high-density computing applications.

"Excluding sales to these two customers, our revenues for fiscal 2008 were up 5 percent compared to fiscal year 2007, our storage sales were up 23 percent year over year, our service business grew more than 40 percent," said Barrenechea.

Rackable touted the potential for its new line of Microslice servers, which come with a price tag below $500. But its key strategic move yesterday was a $40 million share buyback. Rackable has $180 million in cash and a market capitalization of about $120 million.