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EX-32.2 - EXHIBIT 32.2 SECTION 906 CERTIFICATION OF PFO - RACKSPACE HOSTING, INC.rax32-2.htm
EX-31.2 - EXHIBIT 31.2 SECTION 302 CERTIFICATION OF PFO - RACKSPACE HOSTING, INC.rax31-2.htm
EX-32.1 - EXHIBIT 32.1 SECTION 906 CERTIFICATION OF PEO - RACKSPACE HOSTING, INC.rax32-1.htm
EX-31.1 - EXHIBIT 31.1 SECTION 302 CERTIFICATION OF PEO - RACKSPACE HOSTING, INC.rax31-1.htm
EX-10.1 - FIRST AMENDMENT TO LEASE AGREEMENT BY AND BETWEEN GRIZZLY VENTURES LLC AND RACKSPACE US, INC. - RACKSPACE HOSTING, INC.ex10-1.htm




UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
 
(Mark one)
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
þ
 EXCHANGE ACT OF 1934  
For the quarterly period ended September 30, 2009.
   
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (No Fee Required)
 
For the transition period from ______ to ______.
 
Commission file number 001-34143
 
 
RACKSPACE HOSTING, INC.
(Exact Name of Registrant as Specified in its Charter)
 
     
Delaware
 
74-3016523
(State or Other Jurisdiction of
Incorporation or Organization)
 
(IRS Employer
Identification No.)

5000 Walzem Rd.
San Antonio, Texas 78218
(Address of principal executive offices, including Zip Code)
(210) 312-4000
(Registrant’s Telephone Number, Including Area Code)
 
    Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   þ    No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes  o     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer, large accelerated filer and a smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o
 
Accelerated filer o
 
Non-accelerated filer þ
 
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o    No þ  
 
On November 6, 2009, 122,508,591 shares of the registrant’s Common Stock, $0.001 par value, were outstanding.

 

 

RACKSPACE HOSTING, INC.
TABLE OF CONTENTS
 
Part I – Financial Information
 
Item 1.
Financial Statements:
 
 
Consolidated Balance Sheets as of December 31, 2008 and September 30, 2009 (unaudited)
3
 
Unaudited Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2008 and 2009
4
 
Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2009
5
 
Notes to Unaudited Consolidated Financial Statements
6
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
18
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
32
Item 4.
Controls and Procedures
33
     
Part II – Other Information
 
Item 1.
Legal Proceedings
34
Item 1A.
Risk Factors
34
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
46
Item 3.
Defaults Upon Senior Securities
46
Item 4.
Submission of Matters to a Vote of Securities Holders
46
Item 5.
Other Information
46
Item 6.
Exhibits
47
     
Signatures
 
48
 
 
 

 

PART I – FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

RACKSPACE HOSTING, INC. AND SUBSIDIARIES—
CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)
 
December 31,
   
September 30,
 
   
2008
   
2009
 
         
(Unaudited)
 
ASSETS
           
Current assets:
           
    Cash and cash equivalents
  $ 238,407     $ 102,950  
    Accounts receivable, net of allowance for doubtful accounts and
               
    customer credits of $3,295 as of December 31, 2008,
               
    and $5,184 as of September 30, 2009
    30,932       39,902  
    Income taxes receivable
    12,318       4,072  
    Prepaid expenses and other current assets
    10,838       14,056  
    Total current assets
    292,495       160,980  
                 
Property and equipment, net
    362,042       419,454  
Goodwill
    6,942       22,329  
Intangible assets, net
    15,101       12,344  
Other non-current assets
    8,681       10,223  
       Total assets
  $ 685,261     $ 625,330  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities:
               
    Accounts payable and accrued expenses
  $ 71,387     $ 77,108  
    Current portion of deferred revenue
    16,284       15,338  
    Current portion of obligations under capital leases
    38,909       46,408  
    Current portion of debt
    5,944       4,850  
    Total current liabilities
    132,524       143,704  
                 
Non-current deferred revenue
    3,883       2,884  
Non-current obligations under capital leases
    50,781       63,063  
Non-current debt
    204,779       53,655  
Non-current deferred income taxes
    13,398       19,665  
Other non-current liabilities
    10,212       11,967  
       Total liabilities
    415,577       294,938  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
Stockholders' equity:
               
    Common stock, $0.001 par value per share: 300,000,000 shares
               
    authorized; 117,154,094 shares issued and outstanding
               
    as of December 31, 2008, 122,426,741 shares issued and
               
    outstanding as of September 30, 2009
    117       122  
    Additional paid-in capital
    207,589       241,355  
    Accumulated other comprehensive income (loss)
    (16,027 )     (10,273 )
    Retained earnings
    78,005       99,188  
    Total stockholders’ equity
    269,684       330,392  
       Total liabilities and stockholders’ equity
  $ 685,261     $ 625,330  
                 

See accompanying notes to the unaudited consolidated financial statements.

 
- 3 -

 

RACKSPACE HOSTING, INC. AND SUBSIDIARIES—
CONSOLIDATED STATEMENTS OF INCOME – (Unaudited)
 
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
(In thousands, except per share data)
 
2008
   
2009
   
2008
   
2009
 
                         
Net revenue
  $ 138,354     $ 162,399     $ 388,796     $ 459,471  
Costs and expenses:
                               
Cost of revenue
    45,499       53,093       127,564       147,538  
Sales and marketing
    21,462       19,860       58,876       59,442  
General and administrative
    38,729       43,622       110,470       122,728  
Depreciation and amortization
    23,174       32,696       63,862       90,211  
Total costs and expenses
    128,864       149,271       360,772       419,919  
    Income from operations
    9,490       13,128       28,024       39,552  
Other income (expense):
                               
Interest expense
    (1,912 )     (2,147 )     (5,076 )     (6,854 )
Interest and other income (expense)
    (144 )     523       276           165  
Total other income (expense)
    (2,056 )     (1,624 )     (4,800 )     (6,689 )
    Income before income taxes
    7,434       11,504       23,224       32,863  
Income taxes
    2,199       3,900       8,365       11,680  
    Net income
  $ 5,235     $ 7,604     $ 14,859     $ 21,183  
                                 
Net income per share
                               
Basic
  $ 0.05     $ 0.06     $ 0.14     $ 0.18  
Diluted
  $ 0.04     $ 0.06     $ 0.13     $ 0.17  
                                 
Weighted average number of shares outstanding
                               
Basic
    111,231       121,501       105,698       119,788  
Diluted
    118,724       129,160       112,796       125,849  
                                 
 
See accompanying notes to the unaudited consolidated financial statements.

 
- 4 -

 

RACKSPACE HOSTING, INC. AND SUBSIDIARIES—
CONSOLIDATED STATEMENTS OF CASH FLOWS – (Unaudited) 

(In thousands)
 
Nine Months Ended September 30,
 
   
2008
   
2009
 
Cash Flows From Operating Activities
           
Net income
  $ 14,859     $ 21,183  
Adjustments to reconcile net income to net cash provided by operating activites
               
    Depreciation and amortization
    63,862       90,211  
    Loss on disposal of equipment, net
    2,277       976  
    Provision for bad debts and customer credits
    2,340       8,848  
    Deferred income taxes
    10,486       5,103  
    Share-based compensation expense
    10,873       14,866  
    Deferred rent
    419       2,049  
    Other non-cash compensation expense
    212       599  
    Excess tax benefits from share-based compensation arrangements
    (3,212 )     -  
Changes in certain assets and liabilities
               
    Accounts receivable
    (5,446 )     (16,991 )
    Income taxes receivable
    (10,837 )     8,246  
    Accounts payable and accrued expenses
    17,665       2,620  
    Deferred revenue
    2,114       (2,394 )
All other operating activities
    (3,399 )     (4,112 )
Net cash provided by operating activities
    102,213       131,204  
                 
Cash Flows From Investing Activities
               
Purchases of property and equipment, net
    (132,849 )     (82,640 )
Earnout payments for acquisitions
    -       (6,822 )
    Net cash used in investing activities
    (132,849 )     (89,462 )
                 
Cash Flows From Financing Activities
               
Principal payments of capital leases
    (22,881 )     (32,513 )
Principal payments of notes payable
    (5,521 )     (5,908 )
Borrowings on line of credit
    200,000       -  
Payments on line of credit
    (57,301 )     (150,000 )
Payments for debt issuance costs
    (158 )     (367 )
Proceeds from sale leaseback transactions
    1,543       -  
Proceeds from issuance of common stock at IPO net of offering expenses of $13,555
    145,195       -  
Proceeds from issuance of common stock, net
    548       -  
Exercise of warrants
    278       -  
Proceeds from exercise of stock options
    1,964       9,743  
Excess tax benefits from share-based compensation arrangements
    3,212       -  
Net cash provided by (used in) financing activities
    266,879       (179,045 )
                 
Effect of exchange rate changes on cash and cash equivalents
    (862 )     1,846  
                 
Increase (decrease) in cash and cash equivalents
    235,381       (135,457 )
                 
Cash and cash equivalents, beginning of period
    24,937       238,407  
                 
Cash and cash equivalents, end of period
  $ 260,318     $ 102,950  
                 
Supplemental cash flow information:
               
Acquisition of property and equipment by capital leases
  $ 58,708     $ 52,294  
Acquisition of property and equipment by notes payable
    11,934       3,690  
    Vendor financed equipment purchases
  $ 70,642     $ 55,984  
                 
Shares issued in business combinations
  $ -     $ 8,680  
Cash payments for interest, net of amount capitalized
  $ 5,676     $ 6,266  
Cash payments for income taxes
  $ 6,075     $ 5,300  
 
See accompanying notes to the unaudited consolidated financial statements.

 
- 5 -

 

RACKSPACE HOSTING, INC. AND SUBSIDIARIES—
 
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Overview and Basis of Presentation
Nature of Operations

As used in this report, the terms “Rackspace”, “Rackspace Hosting”, “we”, “our company”, “the company”, “us,” or “our” refer to Rackspace Hosting, Inc. and its subsidiaries.  Rackspace Hosting, Inc., through its operating subsidiaries, provides hosting services and cloud computing solutions, including managed hosting, cloud hosting, as well as email and application hosting.   We focus on providing a service experience for our customers, which we call Fanatical Support®.

Rackspace Hosting, Inc. was incorporated in Delaware on March 7, 2000. However, our operations began in 1998 as a limited partnership which became our subsidiary through a corporate reorganization completed on August 21, 2001.

We operate consolidated subsidiaries which include, among others, Rackspace US, Inc., our domestic operating entity, and Rackspace Limited, our United Kingdom operating entity.

In October 2008, we completed the acquisition of Jungle Disk, Inc., a company specializing in cloud storage.  Also in October 2008, we completed the acquisition of Slicehost LLC, a company specializing in cloud hosting.  Accordingly, their operating results have been included in our consolidated financial statements since the date of acquisition.

Basis of Consolidation

The consolidated financial statements include the accounts of our wholly owned subsidiaries located in the United States of America (U.S.), the United Kingdom (U.K.), the Netherlands, and Hong Kong. Intercompany transactions and balances have been eliminated in consolidation.
 
Basis of Presentation
 
The accompanying consolidated financial statements as of September 30, 2009, and for the three and nine months ended September 30, 2008 and 2009, are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all financial information and disclosures required by GAAP for complete financial statements and certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted.  The unaudited interim consolidated financial statements have been prepared on the same basis as the annual consolidated financial statements and in the opinion of management, reflect all adjustments, which include normal recurring adjustments, necessary for a fair statement of our financial position as of September 30, 2009, our results of operations for the three and nine months ended September 30, 2008 and 2009, and our cash flows for the nine months ended September 30, 2008 and 2009.
 
These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto as of December 31, 2008 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 2, 2009, as amended.  The results of the three and nine months ended September 30, 2009 are not necessarily indicative of the results to be expected for the year ending December 31, 2009, or for any other interim period, or for any other future year.

Certain reclassifications have been made to prior year balances in order to conform to the current year’s presentation.
 
Use of Estimates
 
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions 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 during the reporting period. Actual results could differ from those estimates. On an ongoing basis, we evaluate our estimates, including those related to accounts receivable and customer credits, property and equipment, fair values of intangible assets and goodwill, useful lives of intangible assets, fair value of stock options, contingencies, and income taxes, among others. We base our estimates on historical experience and on other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. We engaged third party valuation consultants to assist management in the purchase price allocation of significant acquisitions.  We also engaged third party valuation consultants to assist management in the valuation of our common stock price, which affected transactions recorded in our consolidated financial statements prior to Rackspace becoming a public company.
 
- 6 -

2. Summary of Significant Accounting Policies
 
The accompanying financial statements reflect the application of certain significant accounting policies. There have been no material changes to our significant accounting policies that are disclosed in our audited consolidated financial statements and notes thereof as of December 31, 2008 included in our Annual Report on Form 10-K, as amended.
 
Recently Adopted Accounting Pronouncements
 
    In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162.  U.S. GAAP will no longer be issued in the form of an “accounting standard,” but rather as an update to the applicable “topic” or “subtopic” within the codification. As such, accounting guidance will be classified as either “authoritative” or “nonauthoritative” based on its inclusion or exclusion from the codification.  The codification will be the single source of authoritative U.S. accounting and reporting standards, except for rules and interpretive releases of the SEC under authority of federal securities laws, which are sources of authoritative GAAP for SEC registrants.  The codification of U.S. GAAP became effective for interim and annual periods ending after September 15, 2009.  This statement did not have a material impact on our consolidated financial statements.

Recent Accounting Pronouncements

In June 2009, the FASB issued SFAS 167, Amendments to FASB Interpretation No. 46(R), which is to be included in Accounting Standards Codification (ASC) Topic 810, Consolidation.  This guidance amends FASB Interpretation No. 46 (revised December 2003) to address the elimination of the concept of a qualifying special purpose entity. SFAS 167 also replaces the quantitative-based risks and rewards calculation for determining which enterprise has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity and the obligation to absorb losses of the entity or the right to receive benefits from the entity. Additionally, SFAS 167 provides more timely and useful information about an enterprise’s involvement with a variable interest entity. SFAS 167 will become effective in the first annual reporting period that begins after November 15, 2009 and for interim periods within that first annual reporting period.  It will become effective for Rackspace in the first quarter of 2010. We are currently evaluating the impact of this standard on our consolidated financial statements.

In September 2009, the FASB issued two Accounting Standards Updates (ASU): (i) ASU 2009-13 (EITF 08-1), Multiple-Deliverable Revenue Arrangements, and (ii) ASU 2009-14 (EITF 09-3), Certain Revenue Arrangements that Include Software Elements, which will be effective prospectively for revenue arrangements, entered into or materially modified in fiscal years beginning on or after June 15, 2010.  ASU 2009-13 amends ASC Subtopic 605-25 to eliminate the requirement that all undelivered elements in a multiple-element revenue arrangement have vendor-specific objective evidence (VSOE) or third-party evidence (TPE) before an entity can recognize the portion of an overall arrangement fee that is attributable to items that already have been delivered.  In the absence of VOSE or TPE of the standalone selling price for one or more delivered or undelivered elements in a multiple-element arrangement, entities will be required to estimate the selling prices of those elements.  The overall arrangement fee will be allocated to each element (both delivered and undelivered items) based on their relative selling prices, regardless of whether those selling prices are evidenced by VSOE or TPE or are based on the entity’s estimated selling price.  Application of the “residual method” of allocating an overall arrangement fee between delivered and undelivered elements will no longer be permitted upon adoption.  ASU 2009-14 amends ASC Subtopic 985-605 to exclude from its scope tangible products that contain both software and non-software components that function together to deliver a product’s essential functionality.  We are currently evaluating the impact of these standards on our consolidated financial statements.
 
 
- 7 -

 

3. Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share:
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
(In thousands, except per share data)
 
2008
   
2009
   
2008
   
2009
 
                         
Basic net income per share:
                       
Net income
  $ 5,235     $ 7,604     $ 14,859     $ 21,183  
                                 
Weighted average shares outstanding:
                               
Common stock
    110,729       121,501       104,722       119,788  
Preferred stock
    502       -       976       -  
    Number of shares used in per share computations
    111,231       121,501       105,698       119,788  
                                 
    Earnings per share
  $ 0.05     $ 0.06     $ 0.14     $ 0.18  
Diluted net income per share:
                               
Net income
  $ 5,235     $ 7,604     $ 14,859     $ 21,183  
                                 
Weighted average shares outstanding:
                               
Common stock
    110,729       121,501       104,722       119,788  
Stock options and awards
    7,391       7,659       6,900       6,061  
Preferred stock
    502       -       976       -  
Stock warrants
    102       -       198       -  
    Number of shares used in per share computations
    118,724       129,160       112,796       125,849  
                                 
    Earnings per share
  $ 0.04     $ 0.06     $ 0.13     $ 0.17  
                                 

    We excluded 4.9 million and 0.5 million potential common shares from the computation of dilutive earnings per share for the three months ended September 30, 2008 and 2009, respectively, and 5.7 million and 5.3 million potential shares for the nine months ended September 30, 2008, and 2009, respectively, because the effect would have been anti-dilutive.
 
As a result of our initial public offering (IPO) in August 2008, all outstanding stock warrants were exercised, resulting in an issuance of 268,750 shares of common stock, and all shares of our outstanding preferred stock were automatically converted to shares of common stock; thus subsequent to the IPO, the impact of these transactions on the weighted average shares outstanding was reflected in common stock.

4. Cash and Cash Equivalents

Cash and cash equivalents consisted of:
 
   
December 31,
   
September 30,
 
(In thousands)
 
2008
   
2009
 
             
Cash deposits
  $ 37,787     $ 42,250  
Money market funds
    200,620       60,700  
    Cash and cash equivalents
  $ 238,407     $ 102,950  
                 
    Our available cash and cash equivalents are held in bank deposits, overnight sweep accounts, and money market funds. We actively monitor the third-party depository institutions that hold our deposits. Our emphasis is primarily on safety of principal while secondarily maximizing yield on those funds.  In March 2009 and July 2009, we repaid $100.0 million and $50.0 million, respectively, on our revolving credit facility with our money market funds.

Our money market mutual funds invest exclusively in high-quality, short-term securities that are issued or guaranteed by the U.S. government or by U.S. government agencies.
 
- 8 -

5.  Fair Value Measurements
 
We adopted the full provisions of ASC Subtopic 820-10 (formerly SFAS 157), Fair Value Measurements and Disclosures.  Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There is a three-tier fair value of hierarchy, which prioritizes the inputs used in measuring fair value as follows:
 
Level 1 – Observable inputs such as quoted prices in active markets for identical assets or liabilities;
 
Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
 
Level 3 – Unobservable inputs that are supported by little or no market activity, which require management judgment or estimation.
 
We measure applicable assets and liabilities at fair value. Our money market funds are classified within Level 1 because they are valued using quoted market prices.  Our interest rate swap is classified within Level 2 as the valuation inputs are based on quoted prices and market observable data of similar instruments.
 
The carrying values of cash deposits, accounts receivable, prepaid expenses and other assets, accounts payable and accrued expenses are reasonable estimates of their fair values due to the short maturity of these financial instruments and are classified within Level II.
 
Assets and liabilities measured at fair value on a recurring basis are summarized by level below.  The table does not include assets and liabilities which are measured at historical costs or any other basis other than fair value.
 
(In thousands)
 
December 31, 2008
 
   
Quoted Prices in Active Markets for Identical Assets (Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
   
Total Assets/Liabilities at Fair Value
 
Assets:
       
 
         
 
 
Money market funds (1)
  $ 200,620     $ -     $ -     $ 200,620  
     Total
  $ 200,620     $ -     $ -     $ 200,620  
                                 
Liabilities:
                               
Interest rate swap agreement (1)
  $ -     $ 2,901     $ -     $ 2,901  
Deferred compensation (2)
    296       -       -       296  
     Total
  $ 296     $ 2,901     $ -     $ 3,197  
                                 
 
(In thousands)
 
September 30, 2009
 
   
Quoted Prices in Active Markets for Identical Assets (Level 1)
   
Significant Other Observable Inputs
(Level 2)
   
Significant Unobservable Inputs
(Level 3)
   
Total Assets/Liabilities at Fair Value
 
Assets:
       
 
         
 
 
Money market funds (1)
  $ 60,700     $ -     $ -     $ 60,700  
Rabbi trust (3)
    574       -       -       574  
     Total
  $ 61,274     $ -     $ -     $ 61,274  
                                 
Liabilities:
                               
Interest rate swap agreement (1)
  $ -     $ 2,201     $ -     $ 2,201  
Deferred compensation (2)
    559       -       -       559  
     Total
  $ 559     $ 2,201     $ -     $ 2,760  
                                 
(1) Money market funds are classified in cash and cash equivalents and the interest rate swap agreement is classified in other non-current liabilities.
 
(2) Obligations to pay benefits under a non-qualified deferred compensation plan that are classified in other non-current liabilities.
         
(3) Investments in marketable securities held in a Rabbi Trust associated with a non-qualified deferred compensation plan located in other non-current assets.
 
 
Our Rabbi Trust was established in January 2009 and we elected the fair value option under FASB ASC Subtopic 825-10, Financial Instruments, which allows for the recognition of gains and losses to be recorded in the statement of income in the same period as the gains and losses are incurred as part of the non-qualified deferred compensation plan.  For the three and nine months ended September 30, 2009, we recognized a net gain of $44 thousand and $92 thousand, respectively, as interest and other income (expense).

- 9 -

6. Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consisted of:

   
December 31,
   
September 30,
 
(In thousands)
 
2008
   
2009
 
             
Prepaid expenses
  $ 5,481     $ 7,938  
Current deferred taxes
    3,050       3,265  
Other current assets
    2,307       2,853  
Prepaid expenses and other current assets
  $ 10,838     $ 14,056  
 
7. Property and Equipment, net
 
Property and equipment consisted of:
 
(In thousands)
 
Estimated Useful Lives
   
December 31,
2008
   
September 30,
2009
 
                   
Computers, software and equipment
 
1-5 years
    $ 350,697     $ 482,218  
Furniture and fixtures
 
7 years
      12,856       19,208  
Buildings and leasehold improvements
 
2-30 years
      61,839       110,849  
Land
   --       13,860       13,860  
Property and equipment, at cost
            439,252       626,135  
    Less accumulated depreciation and amortization
            (188,300 )     (269,561 )
    Work in process
            111,090       62,880  
    Property and equipment, net
          $ 362,042     $ 419,454  
 
Depreciation and leasehold amortization expense, not including amortization expense for intangible assets, was $21.8 million and $31.0 million for the three months ended September 30, 2008 and 2009, respectively, and $61.0 million and $85.4 million for the nine months ended September 30, 2008 and 2009, respectively.
 
At December 31, 2008, the work in process balance consisted of build outs of $47.0 million for office facilities and $53.5 million for data centers, and $10.6 million for capitalized software and other projects.  At September 30, 2009, the work in process balance consisted of build outs of $55.3 million for office facilities and $2.8 million for data centers, and $4.8 million for capitalized software and other projects.
 
Capitalized interest was $0.5 million and $0.2 million for the three months ended September 30, 2008 and 2009, respectively and $1.7 million and $0.7 million for the nine months ended September 30, 2008 and 2009, respectively.

8. Business Combinations and Goodwill
 
In October 2008, we acquired two companies with a total purchase price of $28.0 million, which were accounted for as business combinations.  The initial purchase price of the combined acquisitions was $11.5 million paid in cash and stock, with up to $16.5 million in additional payouts of cash and stock based on certain earnout provisions.  For the nine months ended September 30, 2009, earn-outs totaling $15.5 million were achieved and paid in both cash and stock, of which $8.0 million was achieved in the three months ended September 30, 2009.  If the remaining $1.0 million in additional earn-out is achieved, the payment will be accounted for as additional goodwill.
 
The following table provides a roll forward of our goodwill balance.
 
Balance at December 31, 2008
  $ 6,942  
    Earn-out payments for acquisitions
    15,502  
    Purchase accounting adjustments
    (115 )
Balance at September 30, 2009
  $ 22,329  
 
- 10 -

9. Accounts Payable and Accrued Expenses
 
Accounts payable and accrued expenses consisted of:
 
   
December 31,
   
September 30,
 
(In thousands)
 
2008
   
2009
 
             
Trade payables
  $ 23,459     $ 23,661  
Accrued compensation and benefits
    19,462       20,049  
Foreign income taxes payable
    324       6,068  
Vendor accruals
    19,984       19,257  
Other liabilities
    8,158       8,073  
    Accounts payable and accrued expenses
  $ 71,387     $ 77,108  
 
10. Debt
 
Debt outstanding consisted of:
 
   
December 31,
   
September 30,
 
(In thousands)
 
2008
   
2009
 
             
Revolving credit facility
  $ 200,000     $ 50,000  
Notes payable
    10,723       8,505  
Total debt
    210,723       58,505  
    Less current portion of debt
    (5,944 )     (4,850 )
    Total non-current debt
  $ 204,779     $ 53,655  
                 
 
Revolving Credit Facility
 
Our revolving credit facility includes an aggregate commitment of $245.0 million.  The facility provides for letters of credit up to $25.0 million. The interest is based on a floating rate, generally the London Interbank Offered Rate (LIBOR) plus a margin spread, which changes ratably from 0.675% to 1.55% dependent on the total funded debt to adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) ratio. We are required to pay a facility fee of 0.2% per annum on the full amount committed under the facility and a quarterly administrative fee. The facility has a 5-year term and matures in August 2012, and is fully secured by our assets and governed by financial and non-financial covenants.  Financial covenants under our facility include a minimum fixed charge coverage ratio and a maximum total funded debt to EBITDA ratio. As of September 30, 2009, we were in compliance with all of the covenants under our facility.

In June 2009, we amended the revolving credit facility agreement to provide us with the ability to borrow under our credit facility in Pounds Sterling and Euros, rather than only allowing our borrowings in U.S. dollars. We have the ability to borrow up to $75 million in alternate currencies. In addition, the amendment provides for changes in regard to certain other items in the credit agreement, including but not limited to (i) the calculation to determine our “Minimum Fixed Charge Coverage Ratio”, (ii) our banking account maintenance, and (iii) requirements for access to collateral located at our various real property locations. These changes were made in order to provide clarifications that reflected compliance expectations that already existed among the parties. We incurred fees of $367 thousand in connection with the amendment which have been capitalized and are being amortized over the remaining term of the revolver. As of September 30, 2009 we did not have any borrowings on our credit facility in alternate currencies.

In July 2009 we repaid $50.0 million, reducing our borrowings on the facility to $50.0 million.

As of September 30, 2009, the amount outstanding under the facility was $50.0 million, with an outstanding letter of credit of $0.7 million, and an additional $194.3 million available for future borrowings.
 
- 11 -

Interest Rate Swap
 
We have a cash flow hedge to limit our exposure that may result from the variability of floating interest rates. Effective December 10, 2007, we entered into an interest rate swap agreement with a notional amount of $50.0 million.  The interest rate swap  hedges the first $50.0 million of our outstanding floating-rate debt. This swap converts floating rate interest based on the LIBOR into fixed-rate interest as part of the arrangement with our primary lender and expires in December 2010.
 
We are required to pay the counterparty a stream of fixed interest payments at a rate of 4.135%, and in turn, receive variable interest payments based on 1-month LIBOR.  The margin spread as of September 30, 2009 was 1.05% resulting in an effective fixed rate of 5.185%.  The net receipts or payments from the swap are recorded as interest expense. The swap is designated and qualifies as a cash flow hedge under FASB ASC Topic 815, Derivatives and Hedging. As such, the swap is accounted for as an asset or a liability in the accompanying consolidated balance sheets at fair value. We are utilizing the dollar offset method to assess the effectiveness of the swap. Under this methodology, the swap was deemed to be highly effective for the nine month periods ended September 30, 2008 and September 30, 2009. There was no hedge ineffectiveness recognized in earnings for either period.  If the hedge becomes ineffective, or if certain terms of the facility change, the facility is extinguished, or if the swap is terminated prior to maturity, the fair value of the swap and subsequent changes in fair value may be recognized in the accompanying consolidated statements of income.  The fair value of the swap was estimated based on the yield curve as of December 31, 2008 and September 30, 2009, and represents its carrying value.
 
The following table presents the impact of the interest rate swap on the consolidated balance sheets:
 
   
December 31,
   
September 30,
 
(In thousands)
 
2008
   
2009
 
Other non-current liabilities
  $ 2,901     $ 2,201  
Accumulated other comprehensive income
   (loss), net of tax
  $ (1,886 )   $ (1,431 )
 
   
Three Months Ending September 30,
   
Nine Months Ending September 30,
 
(In thousands)
 
2008
   
2009
   
2008
   
2009
 
Effective gain (loss) recognized in accumulated
   other comprehensive income, net of tax
  $ (77 )   $ 130     $ (220 )   455  
 
    Our counterparty is also the primary lender on our revolving credit facility and we actively monitor the potential credit risk.  As of September 30, 2009, we were in a liability position to our primary lender and therefore had limited counterparty credit risk.
 
 
- 12 -

 

 
11. Other Non-Current Liabilities
 
Other non-current liabilities consisted of:
 
   
December 31,
   
September 30,
 
(In thousands)
 
2008
   
2009
 
             
Texas Enterprise Fund Grant
  $ 5,000     $ 5,000  
Other
    5,212       6,967  
Other non-current liabilities
  $ 10,212     $ 11,967  
                 
    In August 2007, we entered into an agreement with the State of Texas (Texas Enterprise Fund Grant) under which we may receive up to $22.0 million in state enterprise fund grants on the condition that we meet certain employment levels in the State of Texas paying an average compensation of at least $56,000 per year (subject to increases). To the extent we fail to meet these requirements, we may be required to repay all or a portion of the grants plus interest.  In September 2007, we received the initial installment of $5.0 million from the State of Texas, which was recorded as a non-current liability.
 
    In July 2009, the Texas Enterprise Fund Grant agreement was amended to modify the job creation requirements. Under the amendment, the grant was divided into four separate tranches. The first tranche, called “Basic Fund” in the amendment, is $8.5 million with a target of 1,225 new jobs created in the state of Texas by December 31, 2012. We already have drawn $5.0 million of this tranche. We can draw an additional $3.5 million when we reach the target. While we expect to meet the job target requirements, if we do not create these jobs by December 31, 2012 and maintain them through December 31, 2021, we will be required to repay portions of the grant (clawback), with the maximum clawback being the amounts we have drawn plus 3.4% interest on such amounts per year. The remaining three tranches are at our option and provide for additional draws up to $13.5 million, which are also subject to clawbacks.

12. Commitments and Contingencies
 
Legal Proceedings
 
    We are party to various legal and administrative proceedings, which we consider routine and incidental to our business. In addition, on October 22, 2008, Benjamin E. Rodriguez D/B/A Management and Business Advisors vs. Rackspace Hosting, Inc. and Graham Weston, was filed in the 37th District Court in Bexar County Texas by a former consultant to the company, Benjamin E. Rodriguez. The suit alleges breach of an oral agreement to issue Mr. Rodriguez a 1% interest in our stock in the form of options or warrants for compensation for services he was engaged to perform for us. We believe that the plaintiff’s position is without merit and intend to vigorously defend this lawsuit. We do not expect the results of this claim or any other current proceeding to have a material adverse effect on our business, results of operations or financial condition.
 
Contingent Liability
 
    We previously recorded a $­­­2.1 million charge to cost of revenue related to an unresolved contractual issue with a vendor. We recorded a loss contingency liability with respect to this matter in accordance with FASB ASC Topic 450, Contingencies (formerly SFAS 5).   Due to the uncertainty regarding the interpretation of certain contractual terms, it is possible the ultimate loss may exceed or be less than the amount currently accrued.
 
- 13 -

13. Share-Based Compensation
 
In January 2009, our board of directors approved an additional 5.5 million shares for future grant under the Amended and Restated 2007 Stock Plan.  As of September 30, 2009, the total number of shares authorized under all of our plans was 42.8 million shares, of which approximately 6.3 million shares were available for future grants.
 
Outstanding stock awards were as follows:
 
   
December 31,
 2008
   
September 30,
2009
 
Restricted stock units
    50,000       2,050,000  
Stock options
    19,255,644       17,944,547  
Total outstanding awards
    19,305,644       19,994,547  
                 
 
The following table summarizes our restricted stock unit activity for the nine months ended September 30, 2009:
 
   
Number of Units
 
Outstanding at December 31, 2008
    50,000  
    Units granted
    2,000,000  
    Units vested
    -  
    Units cancelled
    -  
Outstanding at September 30, 2009
    2,050,000  
         
 
    On February 25, 2009, our board approved grants of restricted stock units (RSUs) to our chief executive officer and another member of the executive team. A total of 2,000,000 RSUs were granted. The vesting of the RSUs are dependent on the company’s total shareholder return (TSR) on its common stock compared to other companies in the Russell 2000 Index. In addition, the company’s TSR must be positive for vesting to occur. Of the total RSUs granted, 1,050,000 have a measurement period at the end of three years, and the remainder at the end of five years.  The fair value of these awards was $7.0 million at the date of grant using a Monte Carlo pricing model, and are being amortized over their service periods.
- 14 -

   The following table summarizes the activity under our stock plans:
 
   
Number of Shares
   
Weighted Average Exercise Price
   
Weighted Average Remaining Contractual Life
   
Aggregate Intrinsic Value (in thousands)
 
Outstanding at December 31, 2008
    19,255,644     $ 4.94       7.01     $ 34,050  
Granted
    3,927,850     $ 5.46                  
Exercised
    (4,398,980 )   $ 2.22                  
Cancelled
    (839,967 )   $ 7.40                  
Outstanding at September 30, 2009
    17,944,547     $ 5.61       7.64     $ 205,481  
                                 
Vested and exercisable at September 30, 2009
    6,722,666     $ 3.22       6.28     93,030  
                                 
Vested and exercisable at September 30, 2009            
 
                 
   and expected to vest thereafter *
    16,517,907     $ 5.45       7.53     $ 191,732  
* Includes reduction of shares outstanding due to estimated forfeitures
 
 
On February 25, 2009, our board approved the grant of 3.7 million stock options for certain employees with an exercise price of $5.09. The shares vest 25% at the end of each year over a four-year period and expire after ten years. The fair value of these stock options was $2.97 per option using the Black-Scholes option pricing model.
 
The total pre-tax intrinsic value of the stock options exercised during the three months ended September 30, 2008 and 2009, was $4.2 million and $12.5 million, respectively and $12.4 million and $31.9 million for the nine months ended September 30, 2008 and 2009, respectively.
 
The weighted average fair value of stock options issued for the three months ended September 30, 2008 and 2009 was $8.52 and $9.03 respectively, and $7.96 and $3.19 for the nine months ended September 30, 2008 and 2009, respectively, using the Black-Scholes option pricing model with the following assumptions:
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2008
   
2009
   
2008
   
2009
 
                         
Expected stock volatility
    60% - 61%       59%       60% - 65%       59% - 61%  
Expected dividend yield
    0.0%       0.0%       0.0%       0.0%  
Risk-free interest rate
    3.30% - 3.45%       3.03%       2.71% - 3.45%       2.24% - 3.03%  
Expected life
    6.25 - 6.50 years      
6.25 years
      6.25 - 6.50 years      
6.25 years
 
                                 
    As of September 30, 2009, there was $44.6 million of total unrecognized compensation cost related to non-vested stock options granted under our various plans, which will be amortized using the straight line method over a weighted average period of 2.2 years.
 
Share-based compensation expense was recognized as follows:

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
(in thousands)
 
2008
   
2009
   
2008
   
2009
 
                         
Cost of revenue
  $ 819     $ 778     $ 1,788     $ 2,082  
Sales and marketing
    612       826       1,546       2,245  
General and administrative
    2,886       4,008       7,539       10,539  
Pre-tax share-based compensation
    4,317       5,612       10,873       14,866  
    Less: Income tax benefit
    (1,356 )     (1,913 )     (3,916 )     (5,284 )
Total share-based compensation
                         
    expense, net of tax
  $ 2,961     $ 3,699     $ 6,957     $ 9,582  
                                 

- 15 -

14. Income Taxes
 
We are subject to U.S. federal income tax and various state, local, and international income taxes in numerous jurisdictions. Our domestic and international tax liabilities are subject to the allocation of revenue and expenses in different jurisdictions and the timing of recognizing revenue and expenses. Additionally, the amount of income taxes paid is subject to our interpretation of applicable tax laws in the jurisdictions in which we file.
 
We currently file income tax returns in the U.S., the U.K., the Netherlands and Hong Kong, which are periodically under audit by federal, state, and international tax authorities. These audits can involve complex matters that may require an extended period of time for resolution. The Internal Revenue Service completed an examination of our consolidated U.S. Federal income tax returns through fiscal year 2004 with no changes to the tax return. We remain subject to U.S. federal and state income tax examinations for the tax years 2005 through 2008, and to U.K. income tax examinations for the years 2002 through 2007. There are no income tax examinations currently in process. Although the outcome of open tax audits is uncertain, in management’s opinion, adequate provisions for income taxes have been made. If actual outcomes differ materially from these estimates, they could have a material impact on our financial condition and results of operations. Differences between actual results and assumptions, or changes in assumptions in future periods are recorded in the period they become known. To the extent additional information becomes available prior to resolution, such accruals are adjusted to reflect probable outcomes. Our effective tax rate is impacted by earnings being realized in countries where we have lower statutory rates.
 
During the three and nine months ended September 30, 2009 we received federal income tax refunds totaling $7.5 million and $10.1 million, respectively, related to the 2008 tax period.  We experienced a taxable loss in 2008 primarily as a result of the accelerated depreciation allowed under the 2008 Economic Stimulus Act passed in February 2008.
 
15. Comprehensive Income
 
    Total comprehensive income was as follows:
 
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
(In thousands)
 
2008
   
2009
   
2008
   
2009
 
                         
Net income
  $ 5,235     $ 7,604     $ 14,859     $ 21,183  
Derivative instrument, net of deferred taxes of $64 and $(70) for the three months ended September 30, 2008 and 2009, and $142 and $(245) for the nine months ended September 30, 2008 and 2009.
    (77 )     130       (220 )     455  
Foreign currency cumulative translation adjustmment, net of taxes of $986 and $109 for the three months ended September 30, 2008 and 2009, $985 and $(1,588) for the nine months ended September 30, 2008 and 2009.
    (4,160 )     (2,176 )     (4,168 )     5,299  
    Total other comprehensive income (loss)
    (4,237 )     (2,046 )     (4,388 )     5,754  
Total comprehensive income
  $ 998     $ 5,558     $ 10,471     $ 26,937  
                                 
 
(In thousands)
 
Derivative Instrument
   
Translation Adjustment
   
Accumulated other comprehensive income (loss)
 
Balance at December 31, 2008
  $ (1,886 )   $ (14,141 )   $ (16,027 )
2009 changes in fair value
    455       -       455  
2009 translation adjustment
    -       5,299       5,299  
Balance at September 30, 2009
  $ (1,431 )   $ (8,842 )   $ (10,273 )
                         

- 16 -

16. Segment Information
 
FASB ASC Topic 280, Segment Reporting (formerly SFAS 131), establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise for which separate financial information is available and evaluated regularly by the chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Our chief operating decision-maker is our chief executive officer. Our chief executive officer reviews financial information presented on a consolidated basis, accompanied by information by business unit and geographic region for purposes of evaluating financial performance and allocating resources.  We are organized as, and operate two business units: managed hosting and cloud computing services, which includes cloud hosting, as well as email and application hosting.  We have evaluated the criteria for aggregation by products and services, and by geography, and determined we have one reportable segment, which we describe as Hosting.  Revenue is attributed by geographic location based on the Rackspace Hosting operating location that enters into the contractual relationship with the customer, either the U.S. or outside U.S., primarily the U.K.  Our long-lived assets are primarily located in the U.S. and U.K., and to a lesser extent Hong Kong.
 
Total net revenue by geographic region was as follows:
 
   
Three Months Ending September 30,
   
Nine Months Ending September 30,
 
(In thousands)
 
2008
   
2009
   
2008
   
2009
 
                         
United States
  $ 99,173     $ 119,896     $ 276,120     $ 343,769  
Outside United States
    39,181       42,503       112,676       115,702  
Total net revenue
  $ 138,354     $ 162,399     $ 388,796     $ 459,471  
                                 
 
Long-lived assets by geographic region were as follows:
 
   
December 31,
   
September 30,
 
(In thousands)
 
2008
   
2009
 
             
United States
  $ 322,949     $ 373,261  
Outside United States
    68,930       89,236  
Total long-lived assets
  $ 391,879     $ 462,497  
                 

17. Related Party Transactions
 
We lease some facilities from a partnership controlled by our chairman of the board of directors. For these leases, we recognized $166 thousand and $180 thousand of rent expense on our consolidated statements of income for the three months ended September 30, 2008 and 2009, respectively, and $443 thousand and $546 thousand for the nine months ended September 30, 2008 and 2009, respectively.
 
18. Subsequent Events
 
In connection with the preparation of the consolidated financial statements and in accordance with FASB ASC Topic 855, Subsequent Events, (formerly SFAS 165) we evaluated events after the balance sheet date of September 30, 2009 through November 12, 2009, the day the consolidated financial statements were issued.

 
- 17 -

 

 
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

References to “we,” “our,” “our company,” “us,” “the company,” “Rackspace Hosting,” or “Rackspace” refer to Rackspace Hosting, Inc. and its consolidated subsidiaries.  We have made forward-looking statements in this Quarterly Report on Form 10-Q that are subject to risks and uncertainties. Forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section and Section 21E of the Securities Exchange Act of 1934, as amended, are subject to the “safe harbor” created by those sections.  The forward-looking statements in this report are based on our management’s beliefs and assumptions and on information currently available to our management. In some cases, you can identify forward-looking statements by terms such as “anticipates,” “aspires,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “seeks,” “should,” “will” or “would” or the negative of these terms and similar expressions intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this document in greater detail under the heading “Risk Factors.” We believe it is important to communicate our expectations to our investors. However, there may be events in the future that we are not able to predict accurately or over which we have no control. The risks described in “Risk Factors” included in this report, as well as any other cautionary language in this report, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. You should be aware that the occurrence of the events described in “Risk Factors” and elsewhere in this report could harm our business.
 
Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this filing. You should read this document completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify our forward-looking statements by these cautionary statements. Except as required by law, we assume 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.
 
The following discussion should be read in conjunction with our consolidated financial statements and the related notes contained elsewhere in this document.
 
Overview of our Business

Rackspace Hosting, Inc. is the world leader in hosting and cloud computing. Our growth is the result of our commitment to serving our customers, known as Fanatical Support®, and our exclusive focus on hosting and cloud computing. We have been successful in attracting and retaining thousands of customers and in growing our business. We are a pioneer in an emerging category, hybrid hosting, which combines the benefits of both traditional dedicated hosting and cloud computing. We are committed to maintaining our service-centric focus and will follow our vision to be considered one of the world’s greatest service companies.

Rackspace offers a full suite of hosting services, including managed hosting, cloud hosting, as well as email and application hosting.  The equipment required (servers, routers, switches, firewalls, load balancers, cabinets, software, wiring, etc.) to deliver services is typically purchased and managed by us.

We sell our services to small and medium-sized businesses as well as large enterprises. For the nine months of 2009, 25.2% of our net revenue was generated by our operations outside of the U.S., mainly from the U.K. Late in 2008, we also began operations of a Hong Kong data center and a sales office, which generated minimal revenue in 2008 and the first nine months of 2009.  Our growth strategy includes, among other strategies, targeting international customers as we plan to expand our activities in continental Europe and Asia. For the first nine months of 2009, no individual customer accounted for greater than 2% of our net revenue.
 
Key Metrics

We carefully track several financial and operational metrics to monitor and manage our growth, financial performance, and capacity. Our key metrics are structured around growth, profitability, capital efficiency, infrastructure capacity, and utilization. The following data should be read in conjunction with the consolidated financial statements, the notes to the financial statements and other financial information included in this Quarterly Report on Form 10-Q.
 
 
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     Three Months Ended  
   
(Unaudited)
 
(Dollar amounts in thousands, except annualized net
 
September 30,
   
December 31,
   
March 31,
   
June 30,
   
September 30,
 
revenue per average technical square foot)
 
2008
   
2008
   
2009
   
2009
   
2009
 
Growth
                             
Managed hosting customers at period end
    18,012       18,480       19,048       19,363       19,328  
Cloud customers at period end*
    18,173       34,820       43,030       51,440       61,616  
Number of customers at period end
    36,185       53,300       62,078       70,803       80,944  
                                         
Managed hosting, net revenue
  $ 131,908     $ 134,275     $ 134,204     $ 138,943     $ 147,065  
Cloud, net revenue
  $ 6,446     $ 8,862     $ 10,873     $ 13,052     $ 15,334  
Net revenue
  $ 138,354     $ 143,137     $ 145,077     $ 151,995     $ 162,399  
                                         
Revenue growth (year over year)
    44.0 %     34.2 %     21.3 %     16.2 %     17.4 %
                                         
Net upgrades (monthly average)
    1.8 %     1.4 %     0.9 %     1.2 %     1.2 %
Churn (monthly average)
    -1.2 %     -1.3 %     -1.1 %     -1.0 %     -1.1 %
Growth in installed base (monthly average)
    0.6 %     0.1 %     -0.2 %     0.2 %     0.1 %
                                         
Number of employees (Rackers) at period end
    2,536       2,611       2,661       2,648       2,730  
Number of servers deployed at period end
    45,231       47,518       50,038       52,269       54,655  
                                         
Profitability
                                       
Income from operations
  $ 9,490     $ 12,125     $ 13,021     $ 13,403     $ 13,128  
Depreciation and amortization
  $ 23,174     $ 26,310     $ 27,804     $ 29,711     $ 32,696  
Share-based compensation expense
                                       
Cost of revenue
  $ 819     $ 678     $ 629     $ 675     $ 778  
Sales and marketing
  $ 612     $ 595     $ 698     $ 721     $ 826  
General and administrative
  $ 2,886     $ 2,871     $ 2,910     $ 3,621     $ 4,008  
Total share-based compensation expense
  $ 4,317     $ 4,144     $ 4,237     $ 5,017     $ 5,612  
Adjusted EBITDA (1)
  $ 36,981     $ 42,579     $ 45,062     $ 48,131     $ 51,436  
                                         
Adjusted EBITDA margin
    26.7 %     29.7 %     31.1 %     31.7 %     31.7 %
                                         
Operating income margin
    6.9 %     8.5 %     9.0 %     8.8 %     8.1 %
                                         
Income from operations
  $ 9,490     $ 12,125     $ 13,021     $ 13,403     $ 13,128  
Effective tax rate
    29.6 %     27.7 %     36.6 %     36.2 %     33.9 %
Net operating profit after tax (NOPAT) (1)
  $ 6,681     $ 8,766     $ 8,255     $ 8,551     $ 8,678  
NOPAT margin
    4.8 %     6.1 %     5.7 %     5.6 %     5.3 %
                                         
Capital efficiency and returns
                                       
Interest bearing debt
  $ 297,933     $ 300,413     $ 201,507     $ 210,284     $ 167,976  
Stockholders' equity
  $ 269,008     $ 269,684     $ 282,880     $ 308,823     $ 330,392  
Less: Excess cash
  $ (235,421 )   $ (200,620 )   $ (117,611 )   $ (129,638 )   $ (83,462 )
Capital base
  $ 331,520     $ 369,477     $ 366,776     $ 389,469     $ 414,906  
Average capital base
  $ 316,245     $ 350,499     $ 368,127     $ 378,123     $ 402,188  
Capital turnover (annualized)
    1.75       1.63       1.58       1.61       1.62  
                                         
Return on capital (annualized) (1)
    8.5 %     10.0 %     9.0 %     9.0 %     8.6 %
                                         
Capital expenditures
                                       
Purchases of property and equipment, net
  $ 45,328     $ 32,547     $ 25,589     $ 31,027     $ 26,024  
Vendor financed equipment purchases
  $ 23,009     $ 14,848     $ 11,683     $ 23,637