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Rackspace Hosting Reports Fourth Quarter 2010 Results
For the quarter ended December 31, 2010:
  • Net revenue of $214.7 million grew 26.7% year-over-year and 7.5% from Q3 2010
  • Adjusted EBITDA (1) of $72.0 million grew 28.7% year-over-year and 5.2% from Q3 2010
  • Achieved adjusted EBITDA margin of 33.5%, up from 33.0% year-over-year and down from 34.3% in Q3 2010
  • Net income of $13.5 million grew 49.9% year-over-year and 14.6% from Q3 2010
  • Generated $5.6 million of Adjusted Free Cash Flow for the quarter and $34.2 million for the 2010 year

SAN ANTONIO, Feb 10, 2011 (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 December 31, 2010.

Net revenue for the fourth quarter of 2010 was $214.7 million, up 7.5% from the previous quarter and 26.7% from the fourth quarter of 2009. Net revenue for the fourth quarter of 2010 was positively impacted by currency exchange rates when compared to the third quarter of 2010, but was negatively impacted when compared to the fourth quarter of 2009.

Changes in currency exchange rates had a positive impact on net revenue of $1.1 million quarter-over-quarter, and a negative impact on net revenue of $1.7 million on a year-over-year basis.

Managed hosting revenue for the quarter increased to $183.3 million, up from $172.9 million in the prior quarter. Cloud revenue increased to $31.4 million in the quarter, up from $26.8 million in the previous quarter.

Total server count increased to 66,015, up from 63,996 servers at the end of the third quarter of 2010, and total customers increased to 130,291, up from 118,732 at the end of the previous quarter.

"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 the year completed, I am very pleased to report that we delivered on all three objectives," said Bruce Knooihuizen, chief financial officer.

Adjusted EBITDA for the quarter was $72.0 million, a 5.2% increase compared to the third quarter of 2010 and a 28.7% increase compared to the fourth quarter of 2009. The adjusted EBITDA margin for the quarter was 33.5%, down from 34.3% in the previous quarter and up from 33.0% in the fourth quarter of 2009. Adjusted EBITDA and adjusted EBITDA margin were negatively impacted by a non-cash charge of $2.9 million for the quarter relating to operating leases.

Net income was $13.5 million for the quarter, up 14.6% from the previous quarter and 49.9% from the fourth quarter of 2009. Net income margin for the quarter was 6.3% compared to 5.9% for the previous quarter and 5.3% in the fourth quarter of 2009.

"While we are pleased that we achieved our goals for 2010, we have even more ambitious plans for 2011 that are designed to position us to succeed well in the future," said Lanham Napier, president and chief executive officer.

Cash flow from operating activities was $74.3 million for the fourth quarter of 2010. Capital expenditures were $63.5 million, including $38.1 million for purchases of customer gear, $9.8 million for data center build outs, $5.1 million for office build outs and $10.5 million for capitalized software and other projects.

Adjusted free cash flow (1) for the quarter was $5.6 million.

At the end of the fourth quarter of 2010, cash and cash equivalents were $104.9 million. Debt obligations totaled $131.7 million consisting of $128.9 million related to capital leases and $2.8 million related to current and non-current debt.

On a worldwide basis, Rackspace employed 3,262 Rackers as of December 31, 2010, up from 3,130 Rackers as of September 30, 2010 and 2,774 Rackers as of December 31, 2009.

Rackspace Developments and Business Highlights

  • "100 Best Companies to Work For": Rackspace was again added to FORTUNE magazine's annual list of the "100 Best Companies to Work For." FORTUNE has now named Rackspace as one of America's top workplaces in three of the past four years.
  • Cloud Infrastructure in UK: To provide customers with a European-based infrastructure for their cloud-based data footprint, Rackspace launched its cloud infrastructure in the UK. The new UK cloud offerings include Rackspace Cloud Files and Cloud Servers.
  • Managed Cloud: Defining a new category in hosting, Rackspace launched Cloud Servers with a managed service level, providing businesses with proactive monitoring, troubleshooting and guidance on how to leverage cloud computing.
  • RackConnect and Critical Sites: Rackspace launched two new products for better serving Enterprise customers. RackConnect offers customers a seamless integration of cloud and dedicated hosting. The new Critical Sites service level provides advanced monitoring for customers who rely on their web applications as mission critical components of their business.
  • Continued Traction with Channel and Enterprise Customers: Rackspace continued to build out its channel business and drive deeper relationships with its channel partner base. As an example, Magento is working with Rackspace for MagentoGO, their new on-demand hosted e-commerce platform for small businesses. During the fourth quarter of 2010, Rackspace added several new enterprise customers to its installed base including Price Waterhouse Coopers, Major League Gaming and Edelman.

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 888-516-2435 from the United States or dial 719-325-2370 from abroad and reference pass code 1074823. 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-K for the year ended December 31, 2010, expected to be filed on or before March 1, 2011. 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

Three Months Ended Year Ended
(Unaudited) (Unaudited)
(In thousands, except per share data) December 31,
2009
September 30,
2010
December 31,
2010
December 31,
2009
December 31,
2010
Net revenue $ 169,516 $ 199,710 $ 214,726 $ 628,987 $ 780,555
Costs and expenses:
Cost of revenue 53,405 64,616 66,747 200,943 249,840
Sales and marketing 20,016 24,651 26,294 79,458 96,207
General and administrative 45,388 49,131 56,748 168,116 199,011
Depreciation and amortization 35,018 39,677 41,529 125,229 155,895
Total costs and expenses 153,827 178,075 191,318 573,746 700,953
Income from operations 15,689 21,635 23,408 55,241 79,602
Other income (expense):
Interest expense (2,096 ) (2,068 ) (1,897 ) (8,950 ) (7,984 )
Interest and other income (expense) 90 (1,263 ) 57 255 (207 )
Total other income (expense) (2,006 ) (3,331 ) (1,840 ) (8,695 ) (8,191 )
Income before income taxes 13,683 18,304 21,568 46,546 71,411
Income taxes 4,648 6,495 8,029 16,328 25,053
Net income $ 9,035 $ 11,809 $ 13,539 $ 30,218 $ 46,358
Net income per share
Basic $ 0.07 $ 0.09 $ 0.11 $ 0.25 $ 0.37
Diluted $ 0.07 $ 0.09 $ 0.10 $ 0.24 $ 0.35
Weighted average number of shares outstanding
Basic 122,891 125,312 126,473 120,570 125,097
Diluted 131,524 133,439 134,786 127,420 133,429

Consolidated Balance Sheets

(In thousands) December 31,
2009
December 31,
2010
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 125,425 $ 104,941

Accounts receivable, net of allowance for doubtful accounts and customer credits of $4,298 as of December 31, 2009 and $2,846 as of December 31, 2010

38,732 47,734
Income taxes receivable 7,509 4,397
Deferred income taxes 9,764 6,416
Prepaid expenses and other current assets 10,239 21,957
Total current assets 191,669 185,445
Property and equipment, net 432,971 495,228
Goodwill 22,329 57,147
Intangible assets, net 10,790 9,675
Other non-current assets 10,886 14,082
Total assets $ 668,645 $ 761,577
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 89,773 $ 111,645
Current portion of deferred revenue 17,113 15,822
Current portion of obligations under capital leases 46,415 59,763
Current portion of debt 4,893 1,912
Total current liabilities 158,194 189,142
Non-current deferred revenue 2,331 2,927
Non-current obligations under capital leases 63,287 69,173
Non-current debt 52,791 879
Non-current deferred income taxes 30,850 35,238
Other non-current liabilities 11,765 25,355
Total liabilities 319,218 322,714
Commitments and Contingencies
Stockholders' equity:
Common stock 124 127
Additional paid-in capital 251,337 296,571
Accumulated other comprehensive loss (10,257 ) (12,416 )
Retained earnings 108,223 154,581
Total stockholders' equity 349,427 438,863
Total liabilities and stockholders' equity $ 668,645 $ 761,577

Consolidated Statements of Cash Flows

(In thousands) Three Months Ended Year Ended
(Unaudited) (Unaudited)
December 31,
2009
September 30,
2010
December 31,
2010
December 31,
2009
December 31,
2010
Cash Flows From Operating Activities
Net income $ 9,035 $ 11,809 $ 13,539 $ 30,218 $ 46,358

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

Depreciation and amortization 35,018 39,677 41,529 125,229 155,895
Loss on disposal of equipment, net 51 295 189 1,027 758
Provision for bad debts and customer credits 1,499 1,592 1,354 10,347 4,330
Deferred income taxes 4,290 9,614 3,806 9,379 6,788
Deferred rent 2,329 1,051 2,893 4,378 7,064
Share-based compensation expense 5,258 7,183 7,087 20,124 26,624
Excess tax benefits from share-based compensation arrangements - 15,453 (2,370 ) - (2,370 )
Changes in certain assets and liabilities

Accounts receivable

(84 ) (2,346 ) (3,790 ) (17,075 ) (12,864 )
Income taxes receivable (3,437 ) (7,633 ) (1,746 ) 4,809 2,606
Prepaid expenses and other current assets 545 (13,811 ) 4,479 (2,313 ) (10,125 )
Accounts payable and accrued expenses 11,921 2,912 3,783 15,168 16,765
Deferred revenue 1,231 (264 ) 2,201 (1,163 ) (488 )
All other operating activities (2,005 ) 1,578 1,316 (3,260 ) 2,894
Net cash provided by operating activities 65,651 67,110 74,270 196,868 244,235
Cash Flows From Investing Activities
Purchases of property and equipment, net (34,652 ) (29,222 ) (46,884 ) (117,292 ) (144,778 )
Acquisitions, net of cash acquired - - (29,854 ) - (29,854 )
Earnout payments for acquisitions - - - (6,822 ) (490 )
Other investing activities - - - - (75 )
Net cash used in investing activities (34,652 ) (29,222 ) (76,738 ) (124,114 ) (175,197 )
Cash Flows From Financing Activities
Principal payments of capital leases (12,167 ) (12,194 ) (14,182 ) (44,680 ) (52,129 )
Principal payments of notes payable (821 ) (684 ) (864 ) (6,729 ) (4,893 )
Payments on line of credit - - (50,000 ) (150,000 ) (50,000 )
Payments for debt issuance costs - - - (367 ) -
Proceeds from employee stock plans 4,759 6,323 3,877 14,489 15,250
Excess tax benefits from share-based compensation arrangements - (15,453 ) 2,370 - 2,370
Net cash used in financing activities (8,229 ) (22,008 ) (58,799 ) (187,287 ) (89,402 )
Effect of exchange rate changes on cash and cash equivalents (295 ) 2,181 (349 ) 1,551 (120 )
Increase (decrease) in cash and cash equivalents 22,475 18,061 (61,616 ) (112,982 ) (20,484 )
Cash and cash equivalents, beginning of period 102,950 148,496 166,557 238,407 125,425
Cash and cash equivalents, end of period $ 125,425 $ 166,557 $ 104,941 $ 125,425 $ 104,941
Supplemental cash flow information:
Acquisition of property and equipment by capital leases $ 12,398 $ 23,208 $ 16,596 $ 64,692 $ 71,363
Acquisition of property and equipment by notes payable - - - 3,690 -
Vendor financed equipment purchases $ 12,398 $ 23,208 $ 16,596 $ 68,382 $ 71,363
Shares issued in business combinations $ - $ - $ - $ 8,680 $ 510
Cash payments for interest, net of amount capitalized $ 1,947 $ 1,846 $ 1,892 $ 8,213 $ 7,743
Cash payments for income taxes $ 3,351 $ 3,822 $ 4,351 $ 8,651 $ 20,112

Key Metrics - Quarter to Date
(Unaudited)

Three Months Ended

(Dollar amounts in thousands, except annualized net revenue per average technical square foot)

December 31,
2009
March 31,
2010
June 30,
2010
September 30,
2010
December 31,
2010
Growth
Managed hosting customers at period end 19,304 19,366 19,433 19,435 19,396
Cloud customers at period end** 71,621 80,080 88,590 99,297 110,895
Number of customers at period end 90,925 99,446 108,023 118,732 130,291
Managed hosting, net revenue $ 152,394 $ 159,536 $ 164,094 $ 172,947 $ 183,311
Cloud, net revenue $ 17,122 $ 19,269 $ 23,220 $ 26,763 $ 31,415
Net revenue $ 169,516 $ 178,805 $ 187,314 $ 199,710 $ 214,726
Revenue growth (year over year) 18.4 % 23.2 % 23.2 % 23.0 % 26.7 %
Net upgrades (monthly average) * 1.4 % 1.1 % 1.6 % 1.6 % 1.6 %
Churn (monthly average) * -0.9 % -0.9 % -1.0 % -1.1 % -1.0 %
Growth in installed base (monthly average) * 0.5 % 0.2 % 0.6 % 0.5 % 0.6 %
Number of employees (Rackers) at period end 2,774 2,905 3,002 3,130 3,262
Number of servers deployed at period end 56,671 59,876 61,874 63,996 66,015
Profitability
Income from operations $ 15,689 $ 16,728 $ 17,831 $ 21,635 $ 23,408
Depreciation and amortization $ 35,018 $ 36,698 $ 37,991 $ 39,677 $ 41,529
Share-based compensation expense
Cost of revenue $ 768 $ 969 $ 1,163 $ 1,305 $ 1,223
Sales and marketing $ 639 $ 880 $ 1,100 $ 1,209 $ 1,052
General and administrative $ 3,851 $ 4,129 $ 4,113 $ 4,669 $ 4,812
Total share-based compensation expense $ 5,258 $ 5,978 $ 6,376 $ 7,183 $ 7,087
Adjusted EBITDA (1) $ 55,965 $ 59,404 $ 62,198 $ 68,495 $ 72,024
Adjusted EBITDA margin (1) 33.0 % 33.2 % 33.2 % 34.3 % 33.5 %
Operating income margin 9.3 % 9.4 % 9.5 % 10.8 % 10.9 %
Income from operations $ 15,689 $ 16,728 $ 17,831 $ 21,635 $ 23,408
Effective tax rate 34.0 % 33.6 % 33.2 % 35.5 % 37.2 %
Net operating profit after tax (NOPAT) (1) $ 10,355 $ 11,107 $ 11,911 $ 13,955 $ 14,700
NOPAT margin 6.1 % 6.2 % 6.4 % 7.0 % 6.8 %
Capital efficiency and returns
Interest bearing debt $ 167,386 $ 169,517 $ 169,847 $ 180,177 $ 131,727
Stockholders' equity $ 349,427 $ 370,425 $ 397,994 $ 413,237 $ 438,863
Less: Excess cash $ (105,083 ) $ (109,840 ) $ (126,018 ) $ (142,592 ) $ (79,174 )
Capital base $ 411,730 $ 430,102 $ 441,823 $ 450,822 $ 491,416
Average capital base $ 413,318 $ 420,916 $ 435,963 $ 446,323 $ 471,119
Capital turnover (annualized) 1.64 1.70 1.72 1.79 1.82
Return on capital (annualized) (1) 10.0 % 10.6 % 10.9 % 12.5 % 12.5 %
Capital expenditures
Purchases of property and equipment, net $ 34,652 $ 39,622 $ 29,050 $ 29,222 $ 46,884
Vendor financed equipment purchases $ 12,398 $ 15,766 $ 15,793 $ 23,208 $ 16,596
Total capital expenditures $ 47,050 $ 55,388 $ 44,843 $ 52,430 $ 63,480
Customer gear $ 28,421 $ 32,488 $ 29,589 $ 36,219 $ 38,052
Data center build outs $ 7,880 $ 16,644 $ 5,955 $ 6,162 $ 9,754
Office build outs $ 5,350 $ 1,220 $ 1,306 $ 1,271 $ 5,145
Capitalized software and other projects $ 5,399 $ 5,036 $ 7,993 $ 8,778 $ 10,529
Total capital expenditures $ 47,050 $ 55,388 $ 44,843 $ 52,430 $ 63,480
Infrastructure capacity and utilization

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

162,848 169,998 169,998 177,148 180,173

Annualized net revenue per average technical square foot ***

$ 4,101 $ 4,298 $ 4,407 $ 4,602 $ 4,807
Utilization rate at period end 65.3 % 66.5 % 69.1 % 68.9 % 72.0 %
* Due to rounding, totals may not equal the sum of the line items in the table above.
** 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 December 31, 2010 excludes 49,575 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.

Key Metrics - Year to Date
(Unaudited)

(Dollar amounts in thousands, except annualized net revenue per average technical square foot) Year Ended
December 31,
2009 2010
Growth
Managed hosting customers at period end 19,304 19,396
Cloud customers at period end** 71,621 110,895
Number of customers at period end 90,925 130,291
Managed hosting, net revenue $ 572,606 $ 679,888
Cloud, net revenue $ 56,381 $ 100,667
Net revenue $ 628,987 $ 780,555
Revenue growth (year over year) 18.2 % 24.1 %
Net upgrades (monthly average) 1.2 % 1.5 %
Churn (monthly average) -1.0 % -1.0 %
Growth in installed base (monthly average) * 0.2 % 0.5 %
Number of employees (Rackers) at period end 2,774 3,262
Number of servers deployed at period end 56,671 66,015
Profitability
Income from operations $ 55,241 $ 79,602
Depreciation and amortization $ 125,229 $ 155,895
Share-based compensation expense
Cost of revenue $ 2,850 $ 4,660
Sales and marketing $ 2,884 $ 4,241
General and administrative $ 14,390 $ 17,723
Total share-based compensation expense $ 20,124 $ 26,624
Adjusted EBITDA (1) $ 200,594 $ 262,121
Adjusted EBITDA margin 31.9 % 33.6 %
Operating income margin 8.8 % 10.2 %
Income from operations $ 55,241 $ 79,602
Effective tax rate 35.1 % 35.1 %
Net operating profit after tax (NOPAT) (1) $ 35,851 $ 51,662
NOPAT margin 5.7 % 6.6 %
Capital efficiency and returns
Interest bearing debt $ 167,386 $ 131,727
Stockholders' equity $ 349,427 $ 438,863
Less: Excess cash $ (105,083 ) $ (79,174 )
Capital base $ 411,730 $ 491,416
Average capital base $ 390,472 $ 445,179
Capital turnover (annualized) 1.61 1.75
Return on capital (annualized) (1) 9.2 % 11.6 %
Capital expenditures
Purchases of property and equipment, net $ 117,292 $ 144,778
Vendor financed equipment purchases $ 68,382 $ 71,363
Total capital expenditures $ 185,674 $ 216,141
Customer gear $ 108,829 $ 136,348
Data center build outs $ 37,208 $ 38,515
Office build outs $ 14,672 $ 8,942
Capitalized software and other projects $ 24,965 $ 32,336
Total capital expenditures $ 185,674 $ 216,141
Infrastructure capacity and utilization
Technical square feet of data center space at period end 162,848 180,173
Annualized net revenue per average technical square foot $ 3,929 $ 4,477
Utilization rate at period end 65.3 % 72.0 %
* Due to rounding, totals may not equal the sum of the line items in the table above.

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

*** Technical square footage as of December 31, 2010 excludes 49,575 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) December 31,

2009

March 31,

2010

June 30,

2010

September 30,

2010

December 31,

2010

Net revenue $ 169,516 $ 178,805 $ 187,314 $ 199,710 $ 214,726
Costs and expenses:
Cost of revenue 53,405 57,007 61,470 64,616 66,747
Sales and marketing 20,016 21,977 23,285 24,651 26,294
General and administrative 45,388 46,395 46,737 49,131 56,748
Depreciation and amortization 35,018 36,698 37,991 39,677 41,529
Total costs and expenses 153,827 162,077 169,483 178,075 191,318
Income from operations 15,689 16,728 17,831 21,635 23,408
Other income (expense):
Interest expense (2,096 ) (2,144 ) (1,875 ) (2,068 ) (1,897 )
Interest and other income (expense) 90 185 814 (1,263 ) 57
Total other income (expense) (2,006 ) (1,959 ) (1,061 ) (3,331 ) (1,840 )
Income before income taxes 13,683 14,769 16,770 18,304 21,568
Income taxes 4,648 4,957 5,572 6,495 8,029
Net income $ 9,035 $ 9,812 $ 11,198 $ 11,809 $ 13,539
Three Months Ended
(Percent of net revenue) December 31,

2009

March 31,

2010

June 30,

2010

September 30,

2010

December 31,

2010

Net revenue 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Costs and expenses
Cost of revenue 31.5 % 31.9 % 32.8 % 32.4 % 31.1 %
Sales and marketing 11.8 % 12.3 % 12.4 % 12.3 % 12.2 %
General and administrative 26.8 % 25.9 % 25.0 % 24.6 % 26.4 %
Depreciation and amortization 20.7 % 20.5 % 20.3 % 19.9 % 19.3 %
Total costs and expenses 90.7 % 90.6 % 90.5 % 89.2 % 89.1 %
Income from operations 9.3 % 9.4 % 9.5 % 10.8 % 10.9 %
Other income (expense):
Interest expense -1.2 % -1.2 % -1.0 % -1.0 % -0.9 %
Interest and other income (expense) 0.1 % 0.1 % 0.4 % -0.6 % 0.0 %
Total other income (expense) -1.2 % -1.1 % -0.6 % -1.7 % -0.9 %
Income before income taxes 8.1 % 8.3 % 9.0 % 9.2 % 10.0 %
Income taxes 2.7 % 2.8 % 3.0 % 3.3 % 3.7 %
Net income 5.3 % 5.5 % 6.0 % 5.9 % 6.3 %
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) December 31,

2009

March 31,

2010

June 30,

2010

September 30,

2010

December 31,

2010

Net revenue $ 169,516 $ 178,805 $ 187,314 $ 199,710 $ 214,726
Income from operations $ 15,689 $ 16,728 $ 17,831 $ 21,635 $ 23,408
Net income $ 9,035 $ 9,812 $ 11,198 $ 11,809 $ 13,539
Plus: Income taxes 4,648 4,957 5,572 6,495 8,029
Plus: Total other (income) expense 2,006 1,959 1,061 3,331 1,840
Plus: Depreciation and amortization 35,018 36,698 37,991 39,677 41,529
Plus: Share-based compensation expense 5,258 5,978 6,376 7,183 7,087
Adjusted EBITDA $ 55,965 $ 59,404 $ 62,198 $ 68,495 $ 72,024
Operating income margin 9.3 % 9.4 % 9.5 % 10.8 % 10.9 %
Adjusted EBITDA margin 33.0 % 33.2 % 33.2 % 34.3 % 33.5 %
Year Ended December 31,
(Unaudited)
(Dollars in thousands) 2009 2010
Net revenue $ 628,987 $ 780,555
Income from operations $ 55,241 $ 79,602
Net income $ 30,218 $ 46,358
Plus: Income taxes 16,328 25,053
Plus: Total other (income) expense 8,695 8,191
Plus: Depreciation and amortization 125,229 155,895
Plus: Share-based compensation expense 20,124 26,624
Adjusted EBITDA $ 200,594 $ 262,121
Operating income margin 8.8 % 10.2 %
Adjusted EBITDA margin 31.9 % 33.6 %

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) December 31,

2009

March 31,

2010

June 30,

2010

September 30,

2010

December 31,

2010

Income from operations $ 15,689 $ 16,728 $ 17,831 $ 21,635 $ 23,408
Effective tax rate 34.0 % 33.6 % 33.2 % 35.5 % 37.2 %
Net operating profit after tax (NOPAT) $ 10,355 $ 11,107 $ 11,911 $ 13,955 $ 14,700
Net income $ 9,035 $ 9,812 $ 11,198 $ 11,809 $ 13,539
Total assets at period end $ 668,645 $ 691,729 $ 720,457 $ 760,198 $ 761,577
Less: Excess cash (105,083 ) (109,840 ) (126,018 ) (142,592 ) (79,174 )
Less: Accounts payable and accrued expenses (89,773 ) (92,828 ) (97,711 ) (101,427 ) (111,645 )
Less: Deferred revenue (current and non-current) (19,444 ) (18,044 ) (16,640 ) (16,685 ) (18,749 )
Less: Other non-current liabilities and deferred income taxes (42,615 ) (40,915 ) (38,265 ) (48,672 ) (60,593 )
Capital base $ 411,730 $ 430,102 $ 441,823 $ 450,822 $ 491,416
Average total assets $ 646,988 $ 680,187 $ 706,093 $ 740,328 $ 760,888
Average capital base $ 413,318 $ 420,916 $ 435,963 $ 446,323 $ 471,119
Return on assets (annualized) 5.6 % 5.8 % 6.3 % 6.4 % 7.1 %
Return on capital (annualized) 10.0 % 10.6 % 10.9 % 12.5 % 12.5 %
Year Ended December 31,
(Unaudited)
(Dollars in thousands) 2009 2010
Income from operations $ 55,241 $ 79,602
Effective tax rate 35.1 % 35.1 %
Net operating profit after tax (NOPAT) $ 35,851 $ 51,662
Net income $ 30,218 $ 46,358
Total assets at period end $ 668,645 $ 761,577
Less: Excess cash (105,083 ) (79,174 )
Less: Accounts payable and accrued expenses (89,773 ) (111,645 )
Less: Deferred revenue (current and non-current) (19,444 ) (18,749 )
Less: Other non-current liabilities and deferred taxes (42,615 ) (60,593 )
Capital base $ 411,730 $ 491,416
Average total assets $ 647,493 $ 720,521
Average capital base $ 390,472 $ 445,179
Return on assets (Net income/Average total assets) 4.7 % 6.4 %
Return on capital (NOPAT/Average capital base) 9.2 % 11.6 %

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

Year Ended
(In thousands) December 31,

2010

December 31,

2010

(Unaudited)
Adjusted EBITDA $ 72,024 $ 262,121
Non-cash deferred rent 2,893 7,064
Total capital expenditures (63,480 ) (216,141 )
Cash payments for interest, net (1,828 ) (7,551 )
Cash payments for income taxes, net (3,989 ) (11,265 )
Adjusted free cash flow $ 5,620 $ 34,228

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 December
31, 2010
(Unaudited)
Obligations under capital leases $ 128,936
Debt 2,791
Total debt $ 131,727
Less: Cash and cash equivalents (104,941 )
Net debt $ 26,786
Adjusted EBITDA (trailing twelve months) $ 262,121
Net leverage 0.1x

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