Rackspace^® Hosting, Inc. (NYSE: RAX), the open cloud company, announced financial results for the quarter ended September 30, 2012.

Net revenue for the third quarter of 2012 was $336 million, up 5.3% from the previous quarter and 27% from the third quarter of 2011. Net revenue for the third quarter of 2012 was negatively impacted by currency exchange rates, when compared to the third quarter of 2011, by $1.5 million, and was negatively impacted compared to the previous quarter by $0.1 million.

Total server count increased to 89,051 up from 84,978 servers at the end of the previous quarter, and total customers increased to 197,635, up from 190,958 at the end of the previous quarter.

“We have successfully enhanced our product and services portfolio while managing a rapidly growing business and building a better economic model.  We believe the work we’ve accomplished so far in 2012 increases our competitiveness in this massive cloud opportunity,” said Karl Pichler, chief financial officer.

Adjusted EBITDA for the quarter was $122 million, an 8.8% increase compared to the second quarter of 2012 and a 38% increase compared to the third quarter of 2011. The adjusted EBITDA margin for the quarter was 36.2% compared to 35.1% in the previous quarter and 33.3% for the third quarter of 2011.

Consistent with prior periods, adjusted EBITDA and adjusted EBITDA margin were negatively impacted by a non-cash charge relating to data center operating leases. During the third quarter of 2012, the non-cash data center lease charge was $2.3 million.

Net income was $27 million for the quarter, up 8.2% from the previous quarter and up 36% from the third quarter of 2011. Net income margin for the quarter was 8.1% compared to 7.9% for the previous quarter and 7.6% in the third quarter of 2011.

Cash flow from operating activities was $100 million for the third quarter of 2012. Capital expenditures were $85 million, including $51 million for purchases of customer gear, $5.8 million for data center build outs, $3.4 million for office build outs and $25 million for capitalized software and other projects.

Adjusted free cash flow ⁽¹⁾ for the quarter was $34.1 million. Return on capital ⁽¹⁾ improved to 16.0% in the third quarter, compared to 15.5% in the prior quarter and 14.8% in the third quarter of 2011. Average monthly revenue per server grew for the thirteenth consecutive quarter to $1,287 from $1,270 in the prior quarter and $1,155 in the third quarter of 2011.

At the end of the third quarter of 2012, cash and cash equivalents were $258 million, and debt including capital lease obligations totaled $150 million.

On a worldwide basis, Rackspace employed 4,596 Rackers as of September 30, 2012, up from 4,528 in the previous quarter.

“Rackspace just open sourced the cloud.  We're excited to report that the rollout of our new Open Cloud platform, built on OpenStack, is finally complete.  With the new products now in production, Rackspace offers a better, faster and more valuable cloud experience, built on an open platform that gives our customers true choice and control without the fear of being locked-in to one vendor’s technology.  Rackspace customers can choose how, where, and with whom they deploy applications, as well as the deployment option that best fits their needs – whether that’s public, private or a hybrid cloud infrastructure, all backed by our unmatched culture of customer service, known throughout the industry as Fanatical Support^®,” said Lanham Napier, chief executive officer.

Rackspace Developments and Business Highlights

• Rackspace introduced a suite of open cloud products including Cloud Servers, Cloud Monitoring, Private Cloud Software, and Critical Application Services. The introduction of these open cloud products marks the first time any company has deployed a large-scale open source public cloud powered by OpenStack^®. Customers can now select from private, public or hybrid offerings and have the flexibility to deploy their solutions in a Rackspace data center or another data center of their choice. For the first time, Rackspace’s open cloud products also give application developers and IT organizations in businesses large and small the ability to build, test and deploy applications in the cloud without being locked-in to a single provider.
  
  We announced the release of Rackspace Private Cloud software, powered by OpenStack – making it simple and easy for companies to install, test and run a multi-node OpenStack-based private cloud environment in their own data center, at Rackspace, or in a collocation facility.
  
  Rackspace also extended Critical Application Services to the open cloud, allowing companies to focus on their core business while Rackspace keeps their vital apps running smoothly. To provide this service level, Rackspace uses a unique combination of web-scale engineers, on-going consultation, and performance monitoring through a CA Technologies application performance management solution. Every environment is tailored to the customer’s specific business needs.
  
  Rackspace also announced the release of Rackspace Cloud Monitoring, a flexible and highly scalable solution that empowers customers to track the health of their infrastructure - including websites, ports and protocols. The service provides real-time alerts allowing customers to react quickly and help prevent downtime. With Rackspace Cloud Monitoring, customers can easily monitor their infrastructure whether it’s hosted on-premise or off-premise, with any cloud provider and in any location across the globe.
• Rackspace launched its first Australian data center, located at Erskine Park in Western Sydney. The new multi-million dollar investment will support the company's ongoing growth in Australia. Rackspace can now offer local dedicated hosting and managed virtualization solutions to larger IT customers looking to deploy enterprise grade private cloud solutions based on VMware. Target customers include large enterprises, financial firms, government entities, and other customers who prefer to keep their data onshore. The data center also provides the perfect launch pad for Rackspace's OpenStack-based Open Cloud platform, expected to launch into the local market.
• Rackspace acquired Mailgun to further enhance Rackspace’s product portfolio, making it easy to integrate cloud-based email services into applications and websites within minutes. Mailgun provides a powerful set of APIs that allows users to send, receive, and track email easily from within their applications – without managing an email server or becoming an expert in email setup, operations and deliverability. This full-featured email service allows customers to engage their users and optimize the email capability of their application and websites with all the analytics and data needed to measure the impact.
• Rackspace was included in FORTUNE's fastest growing companies list. We appear at number 67 and are listed among names such as Apple, OpenTable and F5. This recognition is a reflection of the hard work and commitment Rackers put forth every single day. Our company is growing during a time of economic struggle and it’s rewarding to be recognized by a reputable source such as FORTUNE.

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 888-587-0611 from the United States and Canada or dial 719-325-2421 from abroad and reference pass code 1014272. A live webcast and a replay of the conference call will be available on Rackspace’s website, located at http://ir.rackspace.com.

About Rackspace Hosting

Rackspace^® Hosting (NYSE: RAX) is the open cloud company, delivering open technologies and powering more than 190,000 customers worldwide. Rackspace provides its renowned Fanatical Support^® across a broad portfolio of IT products, including Public Cloud, Private Cloud, Hybrid Hosting and Dedicated Hosting. The company offers choice, flexibility and freedom from vendor lock in. Rackspace has been recognized by Bloomberg BusinessWeek as a Top 100 Performing Technology Company and is featured on Fortune’s list of 100 Best Companies to Work For. Rackspace was positioned in the Leaders Quadrant by Gartner Inc. in the “2011 Magic Quadrant for Managed Hosting.” Rackspace is headquartered in San Antonio with offices and data centers around the world. 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, and 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 deterioration of economic conditions or 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, 2011, filed with the SEC on February 17, 2012 and in Rackspace Hosting’s Form 10-Q for the quarter ended September 30, 2012, expected to be filed later this week. 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.

(1) Non-GAAP Financial Measures

Adjusted EBITDA (Non-GAAP financial measure)

We use Adjusted EBITDA as a supplemental measure to review and assess our performance. 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 operating 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.

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 revenue – other non-current liabilities, deferred income taxes, and deferred rent); 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 the 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 our company’s performance. ROC relates to after-tax operating profits with the capital that is placed into service. It is therefore a performance metric that incorporates both the Statement of Comprehensive 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 calculate directly from amounts on the Statement of Comprehensive Income and the Balance Sheet. ROC has limitations as an analytical tool, and when assessing our operating performance, you should not consider ROC in isolation or as a substitute for other financial data prepared in accordance with GAAP. Other companies may calculate ROC differently than we do, limiting its usefulness as a comparative measure. See our ROC reconciliation to return on assets below.

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 non-cash purchases of property and equipment), cash payments for interest, net, and cash 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.

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. We believe that Net Leverage provides an additional indicator when assessing our liquidity, capital structure and leverage and provides insight into a company's ability to assume more debt if and when required. A negative Net Leverage indicates that our cash and cash equivalents is greater than our total debt as of the balance sheet date. See our Net Leverage calculation below.