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Rackspace Hosting Reports Third Quarter 2010 Results
For the quarter ended September 30, 2010:
  • Net revenue of $199.7 million grew 23.0% year-over-year and 6.6% from Q2 2010
  • Adjusted EBITDA (1) of $68.5 million grew 33.2% year-over-year and 10.1% from Q2 2010
  • Achieved adjusted EBITDA margin of 34.3%, up from 31.7% year-over-year and 33.2% in Q2 2010
  • Net income of $11.8 million grew 55.3% year-over-year and 5.5% from Q2 2010
  • Generated $11.7 million of Adjusted Free Cash Flow for the quarter and $28.6 million for the first nine months of 2010

SAN ANTONIO, Nov 08, 2010 (BUSINESS WIRE) --

Rackspace(R) Hosting, Inc. (NYSE: RAX), the world's leader in the hosting and cloud computing industry, announced financial results for the quarter ended September 30, 2010.

Net revenue for the third quarter of 2010 was $199.7 million, up 6.6% from the previous quarter and 23.0% from the third quarter of 2009. Net revenue for the third quarter of 2010 was positively impacted by currency exchange rates when compared to the second quarter of 2010, but was negatively impacted when compared to the third quarter of 2009.

Changes in currency exchange rates had a positive impact on net revenue of $1.8 million quarter-over-quarter, and a negative impact on net revenue of $2.9 million on a year-over-year basis.

Managed hosting revenue for the quarter increased to $172.9 million, up from $164.1 million in the prior quarter. Cloud revenue increased to $26.8 million in the quarter, up from $23.2 million in the previous quarter.

Total server count increased to 63,996, up from 61,874 servers at the end of the second quarter of 2010, and total customers increased to 118,732, up from 108,023 at the end of the previous quarter.

"Our efforts to improve the business model are working. We have been making investments to enhance the capital efficiency of our business, and we are beginning to see the early returns on those investments now," said Lanham Napier, president and chief executive officer.

Adjusted EBITDA for the quarter was $68.5 million, a 10.1% increase compared to the second quarter of 2010 and a 33.2% increase compared to the third quarter of 2009. The adjusted EBITDA margin for the quarter was 34.3%, up from 33.2% in the previous quarter and 31.7% in the third quarter of 2009. Adjusted EBITDA and adjusted EBITDA margin were negatively impacted by a non-cash charge of $1.1 million for the quarter relating to operating leases.

Net income was $11.8 million for the quarter, up 5.5% from the previous quarter and 55.3% from the third quarter of 2009. Net income margin for the quarter was 5.9% compared to 6.0% for the previous quarter and 4.7% in the third quarter of 2009.

"At the beginning of the year we outlined our objectives for 2010, to grow faster than 2009, while maintaining margins and investing in our business. We also said that we expected adjusted free cash flow to be positive at growth rates below 35%. With 3 out of 4 quarters complete, we believe that we will achieve these objectives for 2010," said Bruce Knooihuizen, chief financial officer.

Cash flow from operating activities was $67.1 million for the third quarter of 2010. Capital expenditures were $52.4 million, including $36.2 million for purchases of customer gear, $6.2 million for data center build outs, $1.3 million for office build outs, and $8.8 million for capitalized software and other projects. For the full year of 2010, the company continues to expect total capital expenditures of $185 to $235 million.

Adjusted free cash flow (1) for the quarter was $11.7 million.

At the end of the third quarter of 2010, cash and cash equivalents were $166.6 million. Included in that amount are investments in money market funds in the amount of $60.7 million. Debt obligations totaled $180.2 million consisting of $126.5 million related to capital leases and $53.7 million related to current and non-current debt. $50.0 million of non-current debt is related to borrowings on the company's line of credit. The company has an additional $194.4 million available for future borrowings on the company's line of credit.

On a worldwide basis, Rackspace employed 3,130 Rackers as of September 30, 2010, up from 3,002 Rackers as of June 30, 2010 and 2,730 Rackers as of September 30, 2009.

Rackspace Developments and Business Highlights

  • General availability of Cloud Servers(TM) for Windows: In August, Rackspace announced the launch of its Cloud Servers for Windows offering. The new service delivers a highly scalable environment ideal for Windows-based hosting, testing and developing applications and supporting the high levels of traffic required for launching online gaming platforms or the next social networking phenomenon. Cloud Servers for Windows provides a full suite of features supported by an industry leading Service Level Agreement (SLA) and Rackspace's hallmark customer service, Fanatical Support(R).
  • Continued Traction with Enterprise Customers: During the third quarter of 2010, Rackspace added several new enterprise customers to its installed base including CA Technologies. Additionally, Anheuser-Busch expanded its partnership with Rackspace to manage key distributor applications in addition to their public facing websites.

Conference Call and Webcast

Management will host a conference call to discuss the results starting today at 4:30 p.m. ET.

To access the conference call, please dial 888-286-2314 from the United States or dial 719-325-2355 from abroad and reference pass code 9910374. A live webcast and a replay of the conference call will be available on Rackspace's website, located at ir.rackspace.com.

About Rackspace Hosting

Rackspace Hosting is the world leader in hosting. The San Antonio-based company provides its customers Fanatical Support(R) in their portfolio of hosted IT services, including Managed Hosting, Cloud Computing and Email and Apps. For more information, visit www.rackspace.com.

Forward Looking Statements

This press release contains forward-looking statements that involve risks, uncertainties and assumptions. If such risks or uncertainties materialize or such assumptions prove incorrect, the results of Rackspace Hosting could differ materially from those expressed or implied by such forward-looking statements and assumptions. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including any statements concerning expected operational and financial results, long term investment strategies, growth plans, expected results from the integration of technologies and acquired businesses, the performance or market share relating to products and services; any statements of expectation or belief; and any statements or assumptions underlying any of the foregoing. Risks, uncertainties and assumptions include infrastructure failures, the continuation or further deterioration of the current difficult economic conditions or further fluctuations, disruptions, instability or downturns in the economy, the effectiveness of managing company growth, technological and competitive factors, regulatory factors, and other risks that are described in Rackspace Hosting's Form 10-K for the year ended December 31, 2009, filed with the SEC on February 26, 2010 and in Rackspace Hosting's Form 10-Q for the quarter ended September 30, 2010, expected to be filed on November 9, 2010. Except as required by law, Rackspace Hosting assumes no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

Consolidated Statements of Income

(Unaudited)

Three Months Ended Nine Months Ended
September 30, June 30, September 30, September 30, September 30,
(In thousands, except per share data) 2009 2010 2010 2009 2010
Net revenue $ 162,399 $ 187,314 $ 199,710 $ 459,471 $ 565,829
Costs and expenses:
Cost of revenue 53,093 61,470 64,616 147,538 183,093
Sales and marketing 19,860 23,285 24,651 59,442 69,913
General and administrative 43,622 46,737 49,131 122,728 142,263
Depreciation and amortization 32,696 37,991 39,677 90,211 114,366
Total costs and expenses 149,271 169,483 178,075 419,919 509,635
Income from operations 13,128 17,831 21,635 39,552 56,194
Other income (expense):
Interest expense (2,147 ) (1,875 ) (2,068 ) (6,854 ) (6,087 )
Interest and other income (expense) 523 814 (1,263 ) 165 (264 )
Total other income (expense) (1,624 ) (1,061 ) (3,331 ) (6,689 ) (6,351 )
Income before income taxes 11,504 16,770 18,304 32,863 49,843
Income taxes 3,900 5,572 6,495 11,680 17,024
Net income $ 7,604 $ 11,198 $ 11,809 $ 21,183 $ 32,819
Net income per share
Basic $ 0.06 $ 0.09 $ 0.09 $ 0.18 $ 0.26
Diluted $ 0.06 $ 0.08 $ 0.09 $ 0.17 $ 0.25
Weighted average number of shares outstanding
Basic 121,501 124,592 125,312 119,788 124,633
Diluted 129,160

132,660

133,439 125,849 132,824

Consolidated Balance Sheets

(In thousands) December 31, September 30,
2009 2010
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 125,425 $ 166,557

Accounts receivable, net of allowance for doubtful accounts and customer credits of $4,298 as of December 31, 2009 and $2,774 as of September 30, 2010

38,732 44,826
Income taxes receivable 7,509 2,823
Deferred income taxes 9,764 4,234
Prepaid expenses and other current assets 10,239 24,827
Total current assets 191,669 243,267
Property and equipment, net 432,971 474,320
Goodwill 22,329 23,329
Intangible assets, net 10,790 6,658
Other non-current assets 10,886 12,624
Total assets $ 668,645 $ 760,198
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 89,773 $ 101,427
Current portion of deferred revenue 17,113 14,278
Current portion of obligations under capital leases 46,415 57,266
Current portion of debt 4,893 2,340
Total current liabilities 158,194 175,311
Non-current deferred revenue 2,331 2,407
Non-current obligations under capital leases 63,287 69,255
Non-current debt 52,791 51,316
Non-current deferred income taxes 30,850 29,538
Other non-current liabilities 11,765 19,134
Total liabilities 319,218 346,961
Commitments and Contingencies
Stockholders' equity:
Common stock 124 126
Additional paid-in capital 251,337 283,086
Accumulated other comprehensive loss (10,257 ) (11,017 )
Retained earnings 108,223 141,042
Total stockholders' equity 349,427 413,237
Total liabilities and stockholders' equity $ 668,645 $ 760,198

Consolidated Statements of Cash Flows

(Unaudited)

(In thousands) Three Months Ended Nine Months Ended
September 30, June 30, September 30, September 30, September 30,
2009 2010 2010 2009 2010
Cash Flows From Operating Activities
Net income $ 7,604 $ 11,198 $ 11,809 21,183 32,819

Adjustments to reconcile net income to net cash provided by operating activities

Depreciation and amortization 32,696 37,991 39,677 90,211 114,366
Loss on disposal of equipment, net 489 126 295 976 569
Provision for bad debts and customer credits 2,466 848 1,592 8,848 2,976
Deferred income taxes (214 ) (4,911 ) 9,614 5,103 2,982
Deferred rent 1,925 1,316 1,051 2,049 4,171
Share-based compensation expense 5,612 6,376 7,183 14,866 19,537
Other non-cash compensation expense 190 105 140 599 349
Excess tax benefits from share-based compensation arrangements - (8,438 ) 15,453 - -
Changes in certain assets and liabilities
Accounts receivables (4,133 ) (5,362 ) (2,346 ) (16,991 ) (9,074 )
Income taxes receivable 9,281 8,215 (7,633 ) 8,246 4,352
Accounts payable and accrued expenses (9,434 ) 6,454 2,772 2,620 12,633
Deferred revenue (1,602 ) (1,351 ) (264 ) (2,394 ) (2,689 )
All other operating activities (2,524 ) (605 ) (12,233 ) (4,112 ) (13,026 )
Net cash provided by operating activities 42,356 51,962 67,110 131,204 169,965
Cash Flows From Investing Activities
Purchases of property and equipment, net (26,024 ) (29,050 ) (29,222 ) (82,640 ) (97,894 )
Earnout payments for acquisitions (1,200 ) (490 ) - (6,822 ) (490 )
Other investing activities - (75 ) - - (75 )
Net cash used in investing activities (27,224 ) (29,615 ) (29,222 ) (89,462 ) (98,459 )
Cash Flows From Financing Activities
Principal payments of capital leases (11,591 ) (12,957 ) (12,194 ) (32,513 ) (37,947 )
Principal payments of notes payable (1,381 ) (2,505 ) (684 ) (5,908 ) (4,029 )
Payments on line of credit (50,000 ) - - (150,000 ) -
Payments for debt issuance costs (39 ) - - (367 ) -
Proceeds from employee stock plans 3,513 2,788 6,323 9,743 11,373
Excess tax benefits from share-based compensation arrangements - 8,438 (15,453 ) - -
Net cash used in financing activities (59,498 ) (4,236 ) (22,008 ) (179,045 ) (30,603 )
Effect of exchange rate changes on cash and cash equivalents (561 ) (912 ) 2,181 1,846 229
Increase (decrease) in cash and cash equivalents (44,927 ) 17,199 18,061 (135,457 ) 41,132
Cash and cash equivalents, beginning of period 147,877 131,297 148,496 238,407 125,425
Cash and cash equivalents, end of period $ 102,950 $ 148,496 $ 166,557 $ 102,950 $ 166,557
Supplemental cash flow information:
Acquisition of property and equipment by capital leases $ 16,974 $ 15,793 $ 23,208 $ 52,294 $ 54,767
Acquisition of property and equipment by notes payable 3,690 - - 3,690 -
Vendor financed equipment purchases $ 20,664 $ 15,793 $ 23,208 $ 55,984 $ 54,767
Shares issued in business combinations $ 6,800 $ 510 $ - $ 8,680 $ 510
Cash payments for interest, net of amount capitalized $ 1,908 $ 1,861 $ 1,846 $ 6,266 $ 5,851
Cash payments for income taxes $ 2,362 $ 8,525 $ 3,822 $ 5,300 $ 15,761

Key Metrics - Quarter to Date

(Unaudited)

Three Months Ended
(Dollar amounts in thousands, except annualized September 30, December 31, March 31, June 30, September 30,
net revenue per average technical square foot) 2009 2009 2010 2010 2010
Growth
Managed hosting customers at period end 19,328 19,304 19,366 19,433 19,435
Cloud customers at period end** 61,616 71,621 80,080 88,590 99,297
Number of customers at period end 80,944 90,925 99,446 108,023 118,732
Managed hosting, net revenue $ 147,065 $ 152,394 $ 159,536 $ 164,094 $ 172,947
Cloud, net revenue $ 15,334 $ 17,122 $ 19,269 $ 23,220 $ 26,763
Net revenue $ 162,399 $ 169,516 $ 178,805 $ 187,314 $ 199,710
Revenue growth (year over year) 17.4 % 18.4 % 23.2 % 23.2 % 23.0 %
Net upgrades (monthly average) * 1.3 % 1.4 % 1.1 % 1.6 % 1.6 %
Churn (monthly average) * -1.1 % -0.9 % -0.9 % -1.0 % -1.1 %
Growth in installed base (monthly average) * 0.1 % 0.5 % 0.2 % 0.6 % 0.5 %
Number of employees (Rackers) at period end 2,730 2,774 2,905 3,002 3,130
Number of servers deployed at period end 54,655 56,671 59,876 61,874 63,996
Profitability
Income from operations $ 13,128 $ 15,689 $ 16,728 $ 17,831 $ 21,635
Depreciation and amortization $ 32,696 $ 35,018 $ 36,698 $ 37,991 $ 39,677
Share-based compensation expense
Cost of revenue $ 778 $ 768 $ 969 $ 1,163 $ 1,305
Sales and marketing $ 826 $ 639 $ 880 $ 1,100 $ 1,209
General and administrative $ 4,008 $ 3,851 $ 4,129 $ 4,113 $ 4,669
Total share-based compensation expense $ 5,612 $ 5,258 $ 5,978 $ 6,376 $ 7,183
Adjusted EBITDA (1) $ 51,436 $ 55,965 $ 59,404 $ 62,198 $ 68,495
Adjusted EBITDA margin (1) 31.7 % 33.0 % 33.2 % 33.2 % 34.3 %
Operating income margin 8.1 % 9.3 % 9.4 % 9.5 % 10.8 %
Income from operations $ 13,128 $ 15,689 $ 16,728 $ 17,831 $ 21,635
Effective tax rate 33.9 % 34.0 % 33.6 % 33.2 % 35.5 %
Net operating profit after tax (NOPAT) (1) $ 8,678 $ 10,355 $ 11,107 $ 11,911 $ 13,955
NOPAT margin 5.3 % 6.1 % 6.2 % 6.4 % 7.0 %
Capital efficiency and returns
Interest bearing debt $ 167,976 $ 167,386 $ 169,517 $ 169,847 $ 180,177
Stockholders' equity $ 330,392 $ 349,427 $ 370,425 $ 397,994 $ 413,237
Less: Excess cash $ (83,462 ) $ (105,083 ) $ (109,840 ) $ (126,018 ) $ (142,592 )
Capital base $ 414,906 $ 411,730 $ 430,102 $ 441,823 $ 450,822
Average capital base $ 402,188 $ 413,318 $ 420,916 $ 435,963 $ 446,323
Capital turnover (annualized) 1.62 1.64 1.70 1.72 1.79
Return on capital (annualized) (1) 8.6 % 10.0 % 10.6 % 10.9 % 12.5 %
Capital expenditures
Purchases of property and equipment, net $ 26,024 $ 34,652 $ 39,622 $ 29,050 $ 29,222
Vendor financed equipment purchases $ 20,664 $ 12,398 $ 15,766 $ 15,793 $ 23,208
Total capital expenditures $ 46,688 $ 47,050 $ 55,388 $ 44,843 $ 52,430
Customer gear $ 28,705 $ 28,421 $ 32,488 $ 29,589 $ 36,219
Data center build outs $ 4,028 $ 7,880 $ 16,644 $ 5,955 $ 6,162
Office build outs $ 5,432 $ 5,350 $ 1,220 $ 1,306 $ 1,271
Capitalized software and other projects $ 8,523 $ 5,399 $ 5,036 $ 7,993 $ 8,778

Total capital expenditures

$ 46,688 $ 47,050 $ 55,388 $ 44,843 $ 52,430
Infrastructure capacity and utilization

Technical square feet of data center space at period end ***

167,821 162,848 169,998 169,998 177,148

Annualized net revenue per average technical square foot ***

$ 3,764 $ 4,101 $ 4,298 $ 4,407 $ 4,602
Utilization rate at period end 62.3 % 65.3 % 66.5 % 69.1 % 68.9 %

* Prior quarter averages have been updated to reflect a change in our methodology, which was revised to include the full impact of our utility business. Previously, results from our utility business were only included as part of the total revenue number from which the percentages for growth in installed base were calculated. For additional details relating to this methodology, please refer to our third quarter Form 10-Q for the period ended September 30, 2010, expected to be filed with the SEC on November 9, 2010. Due to rounding, totals may not equal the sum of the line items in the table above. The table below is a comparison of our installed base growth metric over the last five quarters using our old methodology compared to what it would have been if we had been using our new methodology:

Three Months Ended
September 30,

2009

December 31,

2009

March 31,

2010

June 30,

2010

September 30,

2010

Net upgrades (monthly average)
New Methodology 1.3 % 1.4 % 1.1 % 1.6 % 1.6 %
Old Methodology 1.2 % 1.3 % 1.1 % 1.4 % 1.4 %
Difference 0.1 % 0.1 % 0.0 % 0.2 % 0.2 %
Churn (monthly average)
New Methodology -1.1 % -0.9 % -0.9 % -1.0 % -1.1 %
Old Methodology -1.1 % -0.8 % -0.9 % -0.9 % -1.0 %
Difference 0.0 % -0.1 % 0.0 % -0.1 % -0.1 %
Growth in installed base (monthly average)
New Methodology 0.1 % 0.5 % 0.2 % 0.6 % 0.5 %
Old Methodology 0.1 % 0.4 % 0.2 % 0.5 % 0.4 %
Difference 0.0 % 0.1 % 0.0 % 0.1 % 0.1 %

** Amounts include SaaS customers for Jungle Disk using a Rackspace storage solution. Jungle Disk customers using a third party storage solution are excluded.

*** Technical square footage as of September 30, 2010 excludes 24,400 square feet and 3,300 square feet for unused portions of the Chicago and Northern Virginia facilities, respectively.

(1) See discussion and reconciliation of our Non-GAAP financial measures to the most comparable GAAP measures.

Consolidated Quarterly Statements of Income

(Unaudited)

Three Months Ended
(In thousands) September 30,

2009

December 31,

2009

March 31,

2010

June 30,

2010

September 30,

2010

Net revenue $ 162,399 $ 169,516 $ 178,805 $ 187,314 $ 199,710
Costs and expenses:
Cost of revenue 53,093 53,405 57,007 61,470 64,616
Sales and marketing 19,860 20,016 21,977 23,285 24,651
General and administrative 43,622 45,388 46,395 46,737 49,131
Depreciation and amortization 32,696 35,018 36,698 37,991 39,677
Total costs and expenses 149,271 153,827 162,077 169,483 178,075
Income from operations 13,128 15,689 16,728 17,831 21,635
Other income (expense):
Interest expense (2,147 ) (2,096 ) (2,144 ) (1,875 ) (2,068 )
Interest and other income (expense) 523 90 185 814 (1,263 )
Total other income (expense) (1,624 ) (2,006 ) (1,959 ) (1,061 ) (3,331 )
Income before income taxes 11,504 13,683 14,769 16,770 18,304
Income taxes 3,900 4,648 4,957 5,572 6,495
Net income $ 7,604 $ 9,035 $ 9,812 $ 11,198 $ 11,809
Three Months Ended
(Percent of net revenue) September 30,

2009

December 31,

2009

March 31,

2010

June 30,

2010

September 30,

2010

Net revenue 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Costs and expenses
Cost of revenue 32.7 % 31.5 % 31.9 % 32.8 % 32.4 %
Sales and marketing 12.2 % 11.8 % 12.3 % 12.4 % 12.3 %
General and administrative 26.9 % 26.8 % 25.9 % 25.0 % 24.6 %
Depreciation and amortization 20.1 % 20.7 % 20.5 % 20.3 % 19.9 %
Total costs and expenses 91.9 % 90.7 % 90.6 % 90.5 % 89.2 %
Income from operations 8.1 % 9.3 % 9.4 % 9.5 % 10.8 %
Other income (expense):
Interest expense -1.3 % -1.2 % -1.2 % -1.0 % -1.0 %
Interest and other income (expense) 0.3 % 0.1 % 0.1 % 0.4 % -0.6 %
Total other income (expense) -1.0 % -1.2 % -1.1 % -0.6 % -1.7 %
Income before income taxes 7.1 % 8.1 % 8.3 % 9.0 % 9.2 %
Income taxes 2.4 % 2.7 % 2.8 % 3.0 % 3.3 %
Net income 4.7 % 5.3 % 5.5 % 6.0 % 5.9 %
Due to rounding, totals may not equal the sum of the line items in the table above.

(1) Non-GAAP Financial Measures

Adjusted EBITDA (Non-GAAP financial measure)

We define Adjusted EBITDA as Net Income, plus Income Taxes, Total Other Income (Expense), Depreciation and Amortization, and non-cash charges for share-based compensation.

Adjusted EBITDA is a metric that is used in our industry by the investment community for comparative and valuation purposes. We disclose this metric in order to support and facilitate the dialogue with research analysts and investors.

Note that Adjusted EBITDA is not a measure of financial performance under accounting principles generally accepted in the United States (GAAP) and should not be considered a substitute for net income, which we consider to be the most directly comparable GAAP measure. Adjusted EBITDA has limitations as an analytical tool, and when assessing our operating performance, you should not consider Adjusted EBITDA in isolation, or as a substitute for net income or other consolidated income statement data prepared in accordance with GAAP. Other companies may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure. See our Adjusted EBITDA to net income reconciliations in the table below.

Three Months Ended
(Unaudited)
(Dollars in thousands) September 30,

2009

December 31,

2009

March 31,

2010

June 30,

2010

September 30,

2010

Net revenue $ 162,399 $ 169,516 $ 178,805 $ 187,314 $ 199,710
Income from operations $ 13,128 $ 15,689 $ 16,728 $ 17,831 $ 21,635
Net income $ 7,604 $ 9,035 $ 9,812 $ 11,198 $ 11,809
Plus: Income taxes 3,900 4,648 4,957 5,572 6,495
Plus: Total other (income) expense 1,624 2,006 1,959 1,061 3,331
Plus: Depreciation and amortization 32,696 35,018 36,698 37,991 39,677
Plus: Share-based compensation expense 5,612 5,258 5,978 6,376 7,183
Adjusted EBITDA $ 51,436 $ 55,965 $ 59,404 $ 62,198 $ 68,495
Operating income margin 8.1 % 9.3 % 9.4 % 9.5 % 10.8 %
Adjusted EBITDA margin 31.7 % 33.0 % 33.2 % 33.2 % 34.3 %

Return on Capital (ROC) (Non-GAAP financial measure)

We define Return on Capital (ROC) as follows:

ROC = Net Operating Profit After Tax (NOPAT)

Average Capital Base

NOPAT = Income from operations x (1 - Effective tax rate)

Average Capital Base = Average of (Interest bearing debt + stockholders' equity - excess cash) = Average of (Total assets - excess cash - accounts payables and accrued expenses - deferred revenues - other non-current liabilities and deferred income taxes); calculated on a quarterly basis.

We define excess cash as the amount of cash and cash equivalents that exceeds our operating cash requirements, which is calculated as three percent of our annualized net revenue for the three months prior to period end. We will periodically review the calculation and adjust it to reflect our projected cash requirements for the upcoming year.

We believe that ROC is an important metric for investors in evaluating a company's performance. ROC relates after-tax operating profits with the capital that is placed into service. It is therefore a performance metric that incorporates both the Statement of Income and the Balance Sheet. ROC measures how successfully capital is deployed within a company.

Note that ROC is not a measure of financial performance under GAAP and should not be considered a substitute for return on assets, which we consider to be the most directly comparable GAAP measure, and may not be comparable to similarly titled measures reported by other companies. See our ROC reconciliation to return on assets below.

Three Months Ended
(Unaudited)
(Dollars in thousands) September 30,

2009

December 31,

2009

March 31,

2010

June 30,

2010

September 30,

2010

Income from operations $ 13,128 $ 15,689 $ 16,728 $ 17,831 $ 21,635
Effective tax rate 33.9 % 34.0 % 33.6 % 33.2 % 35.5 %
Net operating profit after tax (NOPAT) $ 8,678 $ 10,355 $ 11,107 $ 11,911 $ 13,955
Net income $ 7,604 $ 9,035 $ 9,812 $ 11,198 $ 11,809
Total assets at period end $ 625,330 $ 668,645 $ 691,729 $ 720,457 $ 760,198
Less: Excess cash (83,462 ) (105,083 ) (109,840 ) (126,018 ) (142,592 )
Less: Accounts payable and accrued expenses (77,108 ) (89,773 ) (92,828 ) (97,711 ) (101,427 )
Less: Deferred revenue (current and non-current) (18,222 ) (19,444 ) (18,044 ) (16,640 ) (16,685 )
Less: Other non-current liabilities and deferred income taxes (31,632 ) (42,615 ) (40,915 ) (38,265 ) (48,672 )
Capital base $ 414,906 $ 411,730 $ 430,102 $ 441,823 $ 450,822
Average total assets $ 641,062 $ 646,988 $ 680,187 $ 706,093 $ 740,328
Average capital base $ 402,188 $ 413,318 $ 420,916 $ 435,963 $ 446,323
Return on assets (annualized) 4.7 % 5.6 % 5.8 % 6.3 % 6.4 %
Return on capital (annualized) 8.6 % 10.0 % 10.6 % 10.9 % 12.5 %

Adjusted Free Cash Flow (Non-GAAP financial measure)

We define Adjusted Free Cash Flow as Adjusted EBITDA plus non-cash deferred rent, less total capital expenditures (including vendor financed equipment purchases), cash payments for interest, net, and cash refunds (payments) for income taxes, net.

We believe that Adjusted Free Cash Flow is an important metric for investors in evaluating how a company is currently using cash generated, and may indicate its ability to generate cash that can potentially be used by the business for capital investments, acquisitions, reduction of debt, payment of dividends, etc. Note that Adjusted Free Cash Flow is not a measure of financial performance under GAAP and may not be comparable to similarly titled measures reported by other companies. See our Adjusted Free Cash Flow reconciliation to Adjusted EBITDA below, as well as our reconciliation of Net income to Adjusted EBITDA provided above.

Three Months

Ended

Nine Months

Ended

(In thousands) September 30,

2010

September 30,

2010

(Unaudited)
Adjusted EBITDA $ 68,495 $ 190,097
Non-cash deferred rent 1,051 4,171
Total capital expenditures (52,430 ) (152,661 )
Cash payments for interest, net (1,795 ) (5,723 )
Cash payments for income taxes, net (3,577 ) (7,276 )
Adjusted free cash flow $ 11,744 $ 28,608

Net Leverage (Non-GAAP financial measure)

We define Net Leverage as Net Debt divided by Adjusted EBITDA (trailing twelve months).

We believe that Net Leverage is an important metric for investors in evaluating a company's liquidity. Note that Net Leverage is not a measure of financial performance under GAAP and may not be comparable to similarly titled measures reported by other companies. See our Net Leverage calculation below.

(Dollars in thousands) As of September 30,
2010
(Unaudited)
Obligations under capital leases $ 126,521
Debt 53,656
Total debt $ 180,177
Less: Cash and cash equivalents (166,557 )
Net debt $ 13,620
Adjusted EBITDA (trailing twelve months) $ 246,062
Net leverage

0.06

x

SOURCE: Rackspace Hosting

Rackspace Hosting
Investor Relations:
Bryan McGrath, 210-312-5230
ir@rackspace.com
or
Corporate Communications:
Rachel Ferry, 210-312-3732
rachel.ferry@rackspace.com
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