Rackspace Hosting Earnings Call Nuggets: Growth Versus Profitability and Expanding Head Count

On Monday, Rackspace Hosting, Inc. (NYSE:RAX) reported its fourth quarter earnings and discussed the following topics in its earnings conference call. Take a look.

Growth Versus Profitability

Christopher Larsen – Piper Jaffray: Revenues were strongest in the quarter, but I think what really stood out was the margins for the material move up in the margins. Lanham can you just talk a little bit how you are going to manage growth versus profitability especially as we see the installed base now above 1% for the first time, I think since ’07. How sustainable and how should we think about that as we go in to 2012. Are both those installed based growth and the margin profile?

Lanham Napier – President and CEO: Generally if you look at our business the most profitable customers we serve are existing customers. The longer we serve them the more valuable and profitable they become for us. So when we look at installed base growth climbing there is absolutely a tailwind for us in terms of profitability. The more growth we get from the installed base, the more likely it is that we have an ability to increase our profitability as a Company. In our prepared remarks we talked about our desire to invest incremental profit back into the business for the long-term. When we think about building Rackspace, we really are trying to build a great company, a company that last for generations and so we see it first as we want to invest back in the business to provide great service and outcomes for customers. We want to build a corporate culture where Rackers can volunteer their best, so all of these investment activities will continue and we protest those activities here inside the Company when we look at our investment frameworks in our annual plans. So, we will continue to have that focus. What we saw here in the fourth quarter was some nice results here in a couple of different ways. We had a good growth quarter as you mentioned. The installed base growth certainly helped with that from a growth point of view, it also helped with the profitability point of view. As we look at the business, we care more about the long-term trends in any given quarter. So you go back and look at some of the targeted models that we provided within our IR presentations, we’ve been tracking pretty clearly within one of those columns with growth rates between 25% and 30% over the past couple of years, the margins have fallen within that range and what we’ve been able to do through the investments in our cloud business is improve the capital efficiency along the way as well. I think as we look out at 2012, we feel like we are hitting 2012 with a great (financial) position in the marketplace. We have some serious execution to do this year with respect to our product work on OpenStack, the systems work to get the foundation in place to support a much larger company and the traction and sales opportunities inside of our enterprise business. So, the faster we grow, there are some trade-offs to take place between high growth and margins. The slower we grow, the more levers we have to pull to improve margin in a quicker time period, so we look at the business as we are executing towards a set of metrics. We share many of those metrics in our key metric page. We think we’re building that company in a sustainable manner and we look at it over the long-term. So, inside this Company, we don’t get too excited about any great quarter and we don’t get too down if the quarter is a little bit soft. We anticipate there will be future bumps as we go through the year. We’re confident we’ll continue to execute at a good level and build the service leader on cloud computing. So, as I guess to summarize as we look at 2012, we just think we’re running at the same play. There are a few different variables this year in 2012 compared to a year ago, but we’re going to stick with our playbook here and keep our head down and execute.

Christopher Larsen – Piper Jaffray: If I could ask second question on the cap spend, how does the moving of OpenStack to public domain impact your spending on software? Will we see in those — what difference in that? I know is that you gave us guidance for that, but how do you think about that as it goes forward?

Lanham Napier – President and CEO: Great question. If you think about how our business is evolving, we can dissect the CapEx into a few buckets, the hardware bucket in terms of customer geared CapEx that we purchase as we build out a dedicated and cloud environment or a multi-tenant Public Cloud environment or software CapEx as we’re constructing the next-generation service tools and capabilities on top of these environments. Over the past couple of years, looking at the trend line, one can see we’ve increased our software CapEx. This software CapEx is really our new product and service capability development functions as we become a larger cloud player or CapEx mix is shifting away from exclusively hardware-based to more than mix between hardware and software and this is great news for our stockholders and for our Company as we invest in more software capability, we can actually increase our capital turns on the hardware itself. So, the code that we’re writing today has a nice long life to it. We believe this code enhances our ability to drive superior customer outcomes, and so I think you’ll see this mix continued to shift towards software as we are building out the intellectual property around running a large global cloud.

Expanding Head Count

James Breen – William Blair: Just a couple of questions; one, Lanham on the third quarter call you talked about sort of the hiring practices throughout 2011 and that – you know, there was a challenge frankly to sort of continue to hire the right people given the growth profiles. Can you talk to us a little bit about that now and where you are positioned from a workforce in terms of growing it throughout 2012? That secondly your thoughts just on the hard asset side of the data center build out and so forth, sort of where the theory is now or where your strategy is with the result of those?

Lanham Napier – President and CEO: Okay. Sure. Let’s start with the hiring practices; on the (indiscernible) exactly the call but on the call for the third quarter, we talked about how we hired fewer people in the third quarter than we wanted to and the gist of that was, we were being selective in the process and hadn’t lined up all the skills we wanted and our organizational bias is basically to – we would rather limp than hire the wrong Racker in here. If the wrong Racker is a cancer to our culture, so we’d rather be really selective in that. The good news here on the fourth quarter is that we were able to increase our hiring and are very comfortable with hires that we made and we are confident about the decisions we made there, and as recently as last week, I was visiting with the rookies in our rookie orientation class and we had 100 plus folks in there going through it and you can feel the energy and the talent in the room. So, if you look at the Q4 hiring numbers, we feel good about that outcome and are optimistic about their future with us. In terms of the data center question, our strategy there with the data center remains the same in that we will continue to lease data center space. We are in continuous, I would say, conversations with multiple parties out there about future capacity, we believe we have a long-term growth trend that we are capitalizing on inside of our business as we build the service leader in cloud computing that that the world wants fanatical support. So we are going to need more data center capacity going forward. If you look over the past year we entered into some transactions with DuPont Fabros, as well as Digital Realty. We believe we’ve got good performance in our partnerships with those companies, we believe those companies will continue to be there for us and continue to do good work for us as we grow. So our perspective on data centers is that we have a wholesale purchase of data center space. We transform that input into our business into a world-class technology experience with fanatical support. Though data center space will continue to be an input to our business, we will run data centers in consumer space ourselves. We’ll also through OpenStack and other opportunities in the long run do more work federating our data centers with our customers’ on-premise facilities. So our model continued to evolve overtime as we endeavor to generate better customer outcomes and higher capital efficiency, but I think the mappings of the play and our strategy are already documented and noted at this point. I just think we’re going to do more of it.

James Breen – William Blair: Just one follow-up with respect to the customers that you added this quarter. Any real change in terms of small medium large and are you seeing different trends across the different groups?

Lanham Napier – President and CEO: Yes, another good question. We haven’t seen much of a difference. One of the themes for our Company here over the past, call it, in the past year has been the traction of our enterprise business. We continue to have great traction with enterprise customers and the one I would reference is Red Bull. So if you go out to the web today we run all the Red Bulls, marketing apps for their production environments and this is a customer that uses our RackConnect technology that linked together a dedicated environment to our public cloud, so that’s an example of what’s happening in the business in terms of our enterprise customers. We continue to see that trend go and then the nice thing is if you look at our installed base growth, the big drivers in installed base growth in our historical calls have been enterprise and cloud that we are starting to see a bit of a lift here with SMBs as well. Now our historical pattern is with installed base growth, if you look back over the past couple of years, it has been one step forward, one step back, and that metric really is proxy for what’s happening in the economy. So as macro conditions improve, we still think that number has some upside to it, but we’re pleased with where we were in the fourth quarter and I think the last thing I’d say in our prepared remarks we talk about managed cloud and the success we’ve had there with that offering and that really enforces to us from a competitiveness perspective is our ability to increase the SLA on this technology form factors, deliver better value for customers and capture it because that’s really our long-term strategy around differentiation. We want to expand our set of products and services, we want to generate incredible customer outcomes, we measure this customer loyalty through the Net Promoter Score and in the process we want to generate great economics, so the success of the managed cloud offering speaks to our ability to differentiate within the cloud world relative to other offerings out there in the marketplace.