Rackspace Hosting, Inc (RAX)

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Rackspace Hosting, Inc. (RAX)

Q3 2011 Earnings Call

November 7, 2011 4:30 pm ET

Executives

Jason Luce – Vice President, Finance

A. Lanham Napier – President and Chief Executive Officer

Karl Pichler – Acting Chief Financial Officer, Principal Financial Officer and Treasurer

Analysts

Scott Goldman – Goldman Sachs Group Inc.

Christopher Larsen – Piper Jaffray Companies

James Breen – William Blair

Jonathan Atkin – RBC Capital Markets

Jonathan Schildkraut – Evercore Partners Inc.

Mitesh Dhruv – Bank of America/Merrill Lynch

Simon Flannery – Morgan Stanley

Frank Louthan – Raymond James

Presentation

Operator

Good evening, ladies and gentlemen, and welcome to the Rackspace Hosting Quarter Three Earnings Release 2011 Conference Call. As a reminder, this call is being recorded; at this time all lines are in listen-only mode to prevent background noise. After the prepared remarks, there will be a question-and-answer session. (Operator Instructions) It is now my pleasure to introduce Jason Luce, Vice President of Finance for Rackspace. Mr. Luce, you may begin.

Jason Luce

Good afternoon. Thank you for joining Rackspace's Third Quarter 2011 Earnings Call. I'm here today with Lanham Napier, our CEO; and Karl Pichler, our CFO.

We issued a press release after the close of the market today with our unaudited financial results for the third quarter of 2011. If you do not have a copy, please visit the Investors section of our website at rackspace.com where this call is also being webcast. The primary purpose of today's call is to discuss the third quarter results. However, some of our comments today are forward-looking statements that involve risks, uncertainties and assumptions. If the risks or uncertainties materialize or assumptions prove incorrect, our results could differ materially from those expressed or implied by the forward-looking statements and assumptions.

All statements other than historical facts are statements that could be deemed forward-looking statements. These risks, uncertainties and assumptions are described in Rackspace Hosting's Form 10-K for the year ended December 31, 2010, filed with the SEC on February 22, 2011, and in Rackspace Hosting's Form 10-Q for the quarter ended September 30, 2011, expected to be filed shortly.

These forward-looking statements speak as of today. Except as required by law, we assume no obligation to update these forward-looking statements publicly even if new information becomes available in the future. During today's discussion, we will be using GAAP as well as non-GAAP financial measures, such as adjusted EBITDA.

Our GAAP results and GAAP to non-GAAP reconciliations can be found in the earnings release we issued earlier today, which is posted on our website as mentioned previously. Following our prepared remarks today, we will open the call for your questions. Okay, let’s get started Lanham?

A. Lanham Napier

Thanks, Jason. Good afternoon, and thank you for joining our third quarter earnings call. In the third quarter, we improved upon the solid results that we delivered in the first and second quarters by continuing on our strong pace of revenue growth while boosting margins and returns. In short, Q3 was the strongest quarter so far in 2011.

Here are the highlights. First, our revenue growth rate adjusted for currency improved to 7.3% sequentially, and 31.3% year-over-year, several factors have enabled us to increase growth in 2011 including continued rapid growth in our public cloud business, which grew 89% year-over-year in Q3, improved traction in serving large enterprises, customers leveraging our enhanced portfolio of products and services, and a significant pick up in sales to existing customers.

Monthly installed base growth remained at 0.9% per month for the quarter, although we’re not at pre-recession levels on installed base growth, which was approximately 1.5% per month on average. Our rate of 0.9% for the first nine months of 2011 is higher than the 0.2% that we achieved in 2009, and the 0.5% that we have averaged in 2010. Our second highlight for Q3, is that both adjusted EBITDA margins and net income margins improve sequentially.

Our final highlight is that, revenue per server increased for the ninth consecutive quarter, and our fully burden return on capital increased for the eighth consecutive quarter to 14.8%. As you all aware, the results we’ve generated in the first nine months of 2011 have occurred during a time of tremendous macroeconomic uncertainty, punctuated by the fear of a double dip recession, and a decline in the overall demand environment. We’ve heard these concerns first hand throughout the year in meetings with customers and prospects as well as investors. And one of our biggest concerns with that at some point, the persistent fear of recession would become so fulfilling.

With nine months of the year behind us, we’re not seeing any significant slowdown in demand for our services. We’re successfully executing on our internal growth and profit plan. So today, demand for cloud computing backed by Fanatical Support is not our constrain for growth.

We believe that cloud computing era represents the biggest market opportunity in all of tech, more and more corporations are discovering that using a specialized service provider is the faster, cheaper, more affective way to address their IT needs. Basically, pay less and get more.

We are beneficiary, so the math is secular shift towards cloud computing, and believe it can represent a multi-billion dollar revenue stream for Rackspace. What accounts for our success is the Fanatical Support that our employees called Rackers deliver to our customers.

We believe that our strategy to be the dominant service leader on cloud computing market will drive sustained growth. Ruining mission critical IT systems requires a complex combination of computing hardware, software management tools and a technical staff that has expertise in diverse range of technologies, and is obsessed with customer service.

Fanatical Support combines these ingredients to deliver the best technology service results in the industry to our customers. In short, Fanatical Support changes the way businesses consume IT. Instead of buying this simply in all the various IT inputs, Rackspace customers can purchase IT as an output as a service.

This service delivery strategy is the core of our differentiation. It is a complex business process that offers us a sustainable competitive advantage. We will continue to invest in this core and improve the value delivered to customers. We believe the investments we make today will help us take full advantage of the huge market opportunity in cloud computing.

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