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Rackspace Hosting, Inc. (NYSE:RAX)

February 14, 2013 2:00 pm ET

Executives

Bryan McGrath

Jason Luce

Analysts

Scott Goldman - Goldman Sachs Group Inc., Research Division

Scott Goldman - Goldman Sachs Group Inc., Research Division

Okay, great. Thank you, everybody, for joining us in what I think is the final slot of the conference. So thank you, everybody, who stayed around. I'm always pleased to have the guys from Rackspace. Joining me up on stage, we have Jason Luce, VP of Finance; Bryan McGrath, Director of Finance at Rackspace. And I think the plan for today was, really, you guys reported earnings on Tuesday so I want to talk a little bit about that. Obviously, a lot of discussion in the marketplace around that. Moving to some of the more higher-level OpenStack type of questions, certainly, I want to leave time for the audience to ask questions if they will.

Question-and-Answer Session

Scott Goldman - Goldman Sachs Group Inc., Research Division

And I think probably to no surprise to you guys, I mean, I think, the place to start is going to be on the growth side of things. And the question we hear most often from investors is around the path for top line growth at Rackspace. We went through a period last year. We had a deceleration at the beginning of the year that seemed to perpetuate with the migration to OpenStack may be delaying some decision-making. The OpenStack migration came on in August 1, and I think we're at this stage now where there's a lot of companies trialing it, but maybe not dipping their feet in all the way on that front. So maybe just talk a little bit about what you've seen out of growth in the past few quarters? And I know you guys don't give quantitative guidance on a forward-looking basis. But how should investors think about the growth, having seen what just occurred in 2012, and where you guys are in the OpenStack development?

Bryan McGrath

Yes, so I guess, we can probably start by reviewing what happened in 2012. And so in 2012, I mean, yes, we grew 28% on the year, and it was really a year when we operationally were kind of inward-focused on essentially -- or just switching out the infrastructure behind our cloud business platform, right, and moving it on to the OpenStack cloud, and that was the #1 goal for the year operationally. We finally completed it. We completed the last elements of rolling out that new platform in late October, right? And so at that point, we had a brand-new platform out there. And now, the onus was on us to go out there and see what we can do with it. So what we did is we laid out 2 main goals that we've kind of put on the table: number one was to get some really large reference-able complex enterprise-size workloads to sit on our cloud; and two, to reaccelerate the growth in that cloud business. And really, we are still -- we're kind of in prove it mode, right? We've got the new platform out. The onus is now on us to go out and sell it, to go get deployments, go convince big customers and big companies that our cloud is ready for prime time, get them to deploy in our cloud and then prove that we can have them up and running, and then tell the world about it. That's kind of where we're at. And when we get those big deployments or we'll be the -- our team will be the first to go out and tell everyone about it, but that will be kind of step 3 in the process. So step 1 is just getting the product out, getting conversations with customers, and then moving into pilots. We're kind of in that mode now. We have a good amount of pilots with very large companies that we think -- we're very ambitious that it will turn into large workloads, but then the next step is actually converting those into workloads. And then the step after that will actually be revenue from them so that's where we're at. We're in proving mode. And when it happens, we don't know when it's going to happen, but we know obviously we're focused on it, and that is the #1 two goals.

Scott Goldman - Goldman Sachs Group Inc., Research Division

In that regard, I mean, you said you don't really know when it's going to happen, but I mean, obviously, companies in proof of concept at some point that hopefully is to transition then to revenue-generating. So I guess question one is do you have any sense for how long these proof of concepts, based on your discussions you've had, how long does it take? What milestones are these companies looking for before they're going to say, "Okay, this is -- this product works the way I expect it to work, and we're ready to go in full on?" Or at what point do you just cut them off and say, "Okay, you can't just have this thing going for 12 months and using this?"

Bryan McGrath

Some of the pilots and many of them, the ones that I know about are paid pilots so they're still paid. I mean, it's a relatively small point where they're getting used to the -- they're getting used to -- getting familiar with the technology, but they're -- you get to a certain time you just opt to pay for that. I wish we had a better answer. We have never done this before so we don't exactly know, but I mean I get the sense we're somewhat close in months with some of the guys. I mean, some of them are further along than others. It depends on the company. Some companies are more risk-averse than others. I mean, we have some of what we call -- call these things Web 2.0 these days, which means Web 2.0 companies that are pretty far along in adopting the new technology. And so those are, call it, months, at least, from my sense sitting in finance, and then others from very large companies that are very risk-averse. I mean, they're probably happy to be the #10 big deployment on our cloud. They don't -- they have no interest in being the first or second, and so something like that is kind of a chicken and egg. We're going to have to have a lot of work, existing workloads and cases that we can point to before they get comfortable.

Scott Goldman - Goldman Sachs Group Inc., Research Division

Right. It seems to me like a lot of these discussions centers around the enterprise side of things and some of the larger-type deployments, which OpenStack was really designed to help you guys address, right? But what about sort of the smaller -- you're still pretty highly leveraged in the small business side of things. And so I would think that there's a base of those, and it could be a good base of those, that you don't really even worry about what the technology is behind the cloud, right? And what they want is somebody who can give them a server with x parameters attached to it, and they have choices where they can go, and they've always -- many of them have gone to Racks over time. Have you guys focused less on getting those? Has OpenStack delayed some of their decision-making? I mean, is that contributing to some of the deceleration we've seen?

Bryan McGrath

Yes, so just going back a little bit, the cloud business that we had on some of the old platform was a fast-growing business and was predominately, I mean, almost exclusively we called relatively small workloads, but I mean, so that was -- it was a perfect platform for that. But we did have customers get to the point where they couldn't get any bigger, and they would have to either do some kind of unnatural things to get their workload to get bigger or move in to dedicated or maybe have to leave, and we wanted to be able to have much bigger workloads in the cloud. That would be reason for upgrading the technology, right? I mean, our biggest customers, I mean, we're paying at somewhere in the $30,000 to $40,000 range, and there was just a handful of customers that got that big versus we know that Amazon has customers -- we don't know, but we're pretty confident Amazon has customers that pay them millions of dollars a month, right? And so we wanted to be able to go compete for those workloads, and that was the reason we switched out the infrastructure, but there is still our cloud. The fact that we have new infrastructure doesn't make it in any way less attractive to that customer who wants a more simple, call it, a simple cloud deployment. And I think a lot of people would argue that it makes it a lot better, right? The experience is better. The ability to scale-up in case you need it is better. And then the features, I mean, we have embedded databases in the new cloud. We have better monitoring tools. The experience is better, and so it's not -- because it's more geared or more able to handle larger workloads doesn't make it any way less good for kind of the smaller, simpler workloads.

Scott Goldman - Goldman Sachs Group Inc., Research Division

Okay. The last one just on the revenue side of things, and I think historically, we've always looked at trying to back into revenue ranges, using the customer gear CapEx. I think it's probably no stranger to you guys. We sort of do the same math. If you used last year's efficiency metrics, you get to sort of a 20% to 27%, 28% growth, I think, based on the range of customer to your CapEx. I mean, is that still a fair way to think about looking at what range or revenue outcomes could be for 2013? And if not, why not?

Bryan McGrath

Yes, so one of the -- as a company, we don't ever -- we don't provide specific financial guidance like a lot of companies do. Kind of as a trade-off to that, to not giving specific numbers, what we try -- our flux is we want to give you the metrics or give you the data behind the data, the data that we use to forecast the business so that you can have -- you can use -- have an informed way of forecasting how revenue is going to be. And so we provide a lot of data around the installed base growth, which is like a same-store sales metrics as far as the different businesses. And another thing that we provide is our capital budget, and then our CapEx spend between the different -- the major buckets that we spend, right, and gear, and so you can -- over time, you can look and there's a relationship between how much we spent, how much we invest, if you will, in customer gear CapEx, and then at what rates do we turn that into revenue. And of course, the goal is to get better, right, is to get more and more yield out of every, call it, investment dollar that you spend. And that's a relationship that you guys have picked up on over time and it's -- the problem is it doesn't -- it's not a perfect metric. It doesn't -- it obviously jumps around. It doesn't work very well on a quarterly basis, and it works better on a year-over-year basis, but it's more of a smoothing thing you need to smooth out over time so it's -- the relationship is still there. Big onus on us is to get it better, and we've gotten better over time, and it's not going to get -- it doesn't improve every single year. But the trend has been more yield out of the CapEx investment dollar, and so that's our -- the goal is have that continue.

Scott Goldman - Goldman Sachs Group Inc., Research Division

So we should think about that as a guide. It's not a perfect metric, by any means to do, but it does help frame something along the lines of what expectations could look like.

Bryan McGrath

Yes, it helps.

Scott Goldman - Goldman Sachs Group Inc., Research Division

You mentioned, and this is probably the last one, I think, on earnings before we jump to other things. But you mentioned the installed base growth, and I think that was another metric that came in a little bit lower than we were anticipating, perhaps, others on the Street. And I think Lanham talked about macro and some execution issues. I mean, can -- to what extent is this being macro driven? To what extent is this OpenStack migration and maybe some delays by some of your installed base not taking things?

Bryan McGrath

Yes, so the metrics we provided is the installed base growth, and that's our same-store sales, right? It's a measurement of how much of our growth comes from existing customers. And then in addition to that, we provide kind of the 2 big buckets behind it, the drivers of it, and one is churn. So when customers leave, obviously, that doesn't help the installed base growth number, and we provide -- we measure that for you, and then net upgrades. And so if you look at on a quarter-to-quarter basis, the installed base growth metric was lower than what it was in Q3, and really, that's all -- the biggest driver was the upgrade fees because churn stays, actually got even a little bit better. And so we saw less upgrade activity in the fourth quarter relative to the third. Now that number does bounce around. It was just one quarter. One quarter was materially lower, I think, than we were all expecting. The number tends to move around. And I mean, we dug into the data and there wasn't any answer, right? There wasn't like close rates really extended over the last quarter or we had -- there was no upgrades whatsoever or certain customers that normally upgrade didn't all of a sudden. There was no discernible, this is the reason. And so when reflecting on it, I think our feeling as a company is that the focus, and I talked -- touched on this early in 2012. We've put a lot of focus, a lot of attention around cloud, rolling a new platform, talking about it, and maybe some of that came with the expense of the some attention we should have kept on the dedicated business, which represents roughly 3/4 of our revenue, and so it's a big -- it has a big influence over the installed base growth number, but that's our feeling, but there wasn't any one thing to point to, and it was just the one -- we saw it last quarter, so I think it would be cavalier to say with macro or anything like that.

Scott Goldman - Goldman Sachs Group Inc., Research Division

Okay, good. I want to step out and approach this from a much higher level now, because I don't know if it's a reflection of investors newer to the story or trying to take a different look at Rackspace. But one of the more common questions we get asked or had been asked as of late has been what the total addressable market is for Rackspace, right? And I'm sure it's probably something you've heard over and over again. But can you share for everybody here today, how do you think about what your addressable market is? And if you can break that down between sort of the dedicated cloud/hosting side of the things and the public cloud sort of hosting things.

Bryan McGrath

Yes, it sounds like a great exercise for a financial analysts. We don't -- this may sound surprising, but we really don't spend much time thinking about it, and so it's not a reflection of us being derelict. It's more of confidence, and we think it's a really, really big opportunity, and we're good with 2 really, and really, really big is good enough for us, but you can start triangulating, right? So essentially, what -- at a very high level, what we do is we offer -- or a service provider for applications, and we run applications on servers, and so you can get an idea. You can get numbers around how many servers ship per year, and Gartner puts it out. I think IDG puts it out. You guys probably have forecasts around it, and I don't know what the number is. It's 7 million to 8 million, 9 million of those things shipped per year. And on a very high level, our message to the industry is rather than have those servers go from the manufacturer to you, to the end user, to your data center, to your server closet, right, let us run whatever applications are going on those servers for you. We don't know this number, but I'm pretty confident that high 90% of those go from the manufacturer to the end user, and we add about 10,000, 12,000 servers a year. And so that's one way of getting at the total addressable market is what is the overall demand for compute? Measure the servers and then how much of that have we already addressed or is being addressed by service providers, and then how much should be addressed by service providers. I mean, like there's lots of room for you that you can put your own assumptions in there.

Jason Luce

I would also add, up til now, basically, we've built $1 billion business, serving some fraction of that 10%, okay, of servers that don't fit inside the corporate data center. Now we're able to service the applications that do sit inside corporate data center. With the OpenStack download, customers can download the software as long as they're on sort of reference architecture. And then Rackspace will write a Service Level Agreement to do the ongoing support for that application. So almost to the order of magnitude bigger, right, than kind of what we've been addressing today.

Scott Goldman - Goldman Sachs Group Inc., Research Division

And I mean that's very helpful because it leads in which -- my next question, which is sort of how does private cloud change the equation? And I think you just talked about it, opening up, say, the other 90%. How do the economics differ in that model where the corporate in-house is downloading and then implementing the OpenStack, and then relying on Rackspace for the services side of things versus you guys doing it yourself is, I mean, is it -- you've increased your addressable market by 9x, but on a dollar basis, this increased by 5x because the economics are a little bit different?

Bryan McGrath

So just to go back, what we're talking about is -- private cloud is a relatively new thing for us. So call it almost every single dollar of revenue we have today is for an application that sits in our data center on our infrastructure. And with the rollout of OpenStack or the kind of the adoption of that technology, it opens up an opportunity for us to provide service and manage a workload that doesn't have to be in our data center. If there's a customer, for whatever reason, doesn't want something to leave their data center, but they want an expert to manage this OpenStack deployment, we can write a Service Level Agreement for that deployment. That's a new initiative for us, and we talked about it. You've heard us talk about things as our businesses layer cakes, and so this would be another potential layer. And we certainly have a few paying customers and we have a -- it's a new, very new initiative for us. But you asked what the economics are, well, the economics are better in that. We don't had to provide capital, right? When we build a workload on a dedicated infrastructure, obviously, we go buy all that gear, right, and then we manage it, and we bill our customer for that. And part of that bill is to recoup the capital investment that we've made. Whereas, in a private cloud, obviously, we would not have to do that. We wouldn't have to bill for recouping the capital because we wouldn't have to outlay the capital. And the best way of looking what the economics look like is Red Hat. Because, essentially, what Red Hat does for Linux, the services that they provide are much smaller than the services that we would provide. They would -- they call it support. We would call it active management, but that's the best kind of existing model today to show what that business will look like standalone.

Scott Goldman - Goldman Sachs Group Inc., Research Division

Okay. I want to switch gears a little bit and talk about OpenStack itself. You rolled it out in August. You rolled out a number of new products throughout the back half of last year or after the migration took place. So where are we now in terms of the development from a product perspective? Is there still more you need to do to narrow the gap with where you want it to be? Or are you guys comfortable with the product set, and it's really just a matter of increasing the awareness and...

Bryan McGrath

Yes, that's right. So last year was more -- was about closing the feature function gap and relative to Amazon, right, but it was an improvement in technology. Again, all sorts of bottleneck to growth. From a scalability standpoint, we couldn't hold a candle to what Amazon has, and last year was about changing all that so rolling out the OpenStack code and turning it on was about narrowing the feature gap, and so -- but you're never done, right? This has been ongoing to the OpenStack as the technology continues to evolve, and so our cloud will continue to evolve with it. But it's -- we address the low-hanging fruit as far as the features go. So there's no major glaring hole that we have now that we haven't closed, but that wasn't true 9 months ago. So we didn't have block storage, but you're not going to -- I mean, no one's going to do a material big web deployment without block storage, right? You have to link you storage to compute. It just doesn't make sense from an economic and from an infrastructure standpoint. We didn't have that, and now we do. We have a -- just from a scalability standpoint, the compute piece can scale much, much -- I don't even know what the limit is. I don't know if anyone's hit it yet. Whereas, the other one, we knew it would prove its worth. A new cloud has an embedded database, right? If you wanted a database in the old cloud, you had to spin up a server and then deploy the database yourself. Now we have one that's already pre-configured, already deployed. You just need to go subscribe to it, and there's a network and everything else. So features are done. It will continue to get enhanced as the OpenStack code improves.

Scott Goldman - Goldman Sachs Group Inc., Research Division

Okay. What's been the customer response to date on OpenStack? Obviously, you've had a number of your existing Sytos [ph] customers migrate over. If you can share any feedback you've heard from them or any of even the newer businesses you've been able to court? And is there a difference between sort of the small business and the large enterprise in terms of how they're working at OpenStack and what they're able to do with it?

Bryan McGrath

The difference between large -- I mean, large businesses that are attracted to it, and some of those are in the pilots that we're talking about are -- I mean, the feedback has been pretty positive. I don't want to take a victory lap yet because we haven't gotten one closed and deployed yet, right? So far, I mean, we're feeling pretty confident, but we don't have one -- we don't have a trophy to talk about yet. So give us a little time on that, but there are some very big -- like Instagram, for example, Instagram was on Amazon. It's not on our platform, but that would be a small business that we would love to get, right? That's a huge deployment, right? And so it doesn't necessarily have to be a big company for us to be happy about it. I mean, it can be a small company with a really large deployment, and I think there are somewhat like -- I guess, like we talked about earlier, some of these Web 2.0 companies are -- have been quicker, faster adopters of the technology versus some of the big companies with large IT organizations who are still kind of testing it out and seeing what it will be useful for, how are they going to use it internally.

Scott Goldman - Goldman Sachs Group Inc., Research Division

Right, okay. I want to switch over to -- well, you know what, in the interest of time, I want to see if there's audience questions, and I certainly have a bunch. But we have a bunch up here in the front already so we have a microphone coming. Take your pick.

Unknown Analyst

I had a question. Actually, I was less surprised by growth in the quarter and more surprised by the capital intensity of the business. I was wondering if you could speak to, exactly speak to, the capital intensity of if you -- maybe not in terms of the different buckets, but just as a total CapEx number, if you think about CapEx divided by kind of your installed base of servers over time? Basically, I'm wondering if this isn't really more of an ongoing expense that you have to fund to keep the business up and running versus an investment in future business because I think I was somewhat surprised by the big growth in depreciation in the quarter, which led to an EBITDA beat and an earnings miss.

Bryan McGrath

Yes, as long as the business is growing, there's going to be capital to invest. I mean, you can look at it over the last few years and you can look at the capital intensity. We brought all the numbers so you can do it. We've gotten much better at capital intensity. We measure it a bunch of different ways, but I mean, I don't know, free cash flow would be one way to measure it. Return on capital is another one. Capital returns is another one, and we've gotten better, and our belief and our goal is to continue to get better. Now capital, if you look at it in any one quarter and I think you should look at it on an annual basis, one quarter may fool you and it's not -- we don't get capital improvements and capital efficiency on a quarter-over-quarter basis. It moves around on a quarter, but over time, over a year, it's gotten better. I think it's going to continue to get better.

Unknown Analyst

How do you feel about the cloud orchestration configuration automation space like RightScale and Stratus, those types of players? I think the reason why I'm asking about it is because I support your thought about service provider for apps, and you guys are not going to manage more and more servers over time. But your enterprise customers who want some sort of control there, do you see that as a space where independent players blossom? Or do you see it as a necessary evil that you guys will manage and the independents will face -- will fade, rather?

Bryan McGrath

Yes, certainly, right now, we think, I mean, RightScale is partner of ours as are others, and so right now, we certainly believe there are plenty of room for independents and for other guys to add value around the platform and around what we do. But I mean, how that looks in 5 years, I mean, I'll be candid that we don't know, and we don't know how that can change, but RightScale does a great -- they're good partners. They do great service. They have good reviews from all their customer so I certainly don't see anything like that changing in the near term.

Unknown Analyst

How are you preparing to service the large enterprise customers? Are you segmenting your service sort of team to do that? How will you pay for it? Are you ready for it?

Bryan McGrath

Yes.

Jason Luce

We're already doing it. I mean, if you go back, I don't know, 8 or 9 years, we divided the service organization into something called managed and intensive. And basically, the intensive is just the more robust Service Level Agreement. It's a more concentrated service team. And then that iterated into something called Critical Sites, which is even more concentrated. So in other words, fewer customers per dedicated support team. So we're already doing it. I would say the beginning of 2009, we formed an organization internally called RES, which is RackSpace Enterprise Services, and that had its own support team, and it would support enterprise customers. The thing to know is that what we're running is a general-purpose technology. So we run web apps on x86 servers, and to us, they pretty much all look the same. So I don't think we have to change our service organization dramatically to serve these bigger deals. We just have to make it more concentrated. And the conversations, the conversation is obviously a little bit different, but the enterprise customers, because they're more sophisticated, right, so the shared responsibility looks different, right, with an organization that has good technological skill capabilities than it does with a start-up. It doesn't have that.

Scott Goldman - Goldman Sachs Group Inc., Research Division

Question over here?

Unknown Analyst

Yes, I have a couple questions. First one was the hosted email business that you have, if you wouldn't mind just reminding us which bucket that is in the public cloud, on the dedicated cloud. And then second question is around your hosted service, your hosted cloud service, the OpenStack business. The people you have in trials and in the pipeline, could you give us a little bit of color what other providers they are evaluating. Is it other OpenStack providers? Is it CloudStack? Is it Eucalyptus? Is it Amazon, Google, Microsoft? Be useful to understand that a little bit.

Bryan McGrath

So I mean, I don't -- in my experiences with the guys, the pilot companies, I didn't ask who they have mostly evaluated. But I think it's pretty safe to assume they evaluated Amazon because they're the kind of -- the ones who've kind of invented the space. And everyone's aware of Eucalyptus and open -- or CloudStack. Well, I assume they must have evaluated it, but I didn't ask. HP has a cloud so I mean they're probably aware of that. But hadn't asked them that question so I don't know. And then the hosted emails is in -- included in the public cloud revenue stream.

Scott Goldman - Goldman Sachs Group Inc., Research Division

Do we have other audience questions? Okay. One of the question that just came up got me thinking about the scalability of the business, right? You guys have obviously made it known, and we see it in the metrics around the hiring that takes place in any given quarter in the year and so forth, but how do we think about how well the business scales, whether it's at this growth level, whether it's at the 30% growth level from a people perspective and being able to service and manage the accounts that you have?

Bryan McGrath

Yes, so it's -- this is definitely -- you've seen the scaling that we've done over the past few years, and I've called it a relatively high-growth environment, and so it's the easy one -- it's easier to scale when the growth slows, right, because you don't to build and add capacity ahead of time both from a capital standpoint and from a people standpoint. And so we certainly believe there's lots of room for this business to continue to scaling. Not a lot of scale is going to come on the gross margins front because the gross margins is where the techs reside, but that's where we add the most value is in the support organization. They go in there, but there's room for sales and marketing to scale over time, especially if you're not growing, and there's certainly room for G&A to scale. And then the other assumptions are which piece of the business is going to be, how big is cloud going to be relative to dedicated? How big is offering this cloud going to be relative to dedicated to figure out how much you would scale on the capital side? So we don't know that, but we know -- but one thing we know is it's better. We just don't know what the absolute limits are.

Scott Goldman - Goldman Sachs Group Inc., Research Division

And as a follow-up to that, if you look out at your business models, right now, you're 75%, 70% dedicated, 30% public. I think most people in the industry would probably agree hybrid is where everybody settles in some form or another, but do you see the public cloud ultimately become -- did you see these numbers reversing ultimately, and then we get this 70%, 80% public and only 20% dedicated? Is it more of a 50-50 proposition? And how do we think about the margins of the business within those 2? I mean, are you better off having a 100% public cloud from a margin perspective?

Jason Luce

Well, there's some things that we can do to shape demand, pricing, et cetera. It's ultimately up to the world to decide how they want to consume IT. So I think it's a great topic for debate. I'll tell you, there are folks inside of our shop that think it will be the inverse. Primarily, and somebody that evangelizes on this [indiscernible] at AWS, Amazon Web Services. It really makes this point salient there are so many things that you can do, workloads that you can run now that virtually anyone with a credit card has access to the equivalent of a mainframe. And so that's what -- on the public side, we'll make it -- has the potential to make it so much bigger or the inverse, if you will. It's impossible to know. We know that it's growing faster than sort the private cloud world. But the cadence, it's just too early to predict the cadence. And then look, if we're right and it is the inverse, our business model is going to look better because the margins, particularly, the capital turns and their incremental returns are higher on the public cloud side and what you -- so what you've seen for us, as you've seen our turns go up, over the last few years, you have seen our return on capital go up. You've seen our cash flow margins go up. The last 3 quarters, we've generated more cash than we have in our company's history. And that's really being driven by the fact that the public cloud portion of the business is becoming a larger part of the mix.

Scott Goldman - Goldman Sachs Group Inc., Research Division

We have a question over here.

Unknown Analyst

I'm trying to understand the impact that the OpenStack deployment has had on customers that would have been or still are dedicated hosting customers. And I guess my question really is, is the deployment of OpenStack making a former dedicated customer more likely to become a cloud hosting customer than he would have been before, again, pre-OpenStack?

Bryan McGrath

I think the answer's no, but a little bit more color. So with the decision -- 4 years ago, we didn't have or 5 years ago, we didn't have a cloud business. We had -- we only had -- if you wanted us to run something for you, it can be on a dedicated infrastructure. And then over last few years, we've introduced the cloud business, which created a decision, right, should you use cloud or should you use dedicated? And so that decision process hasn't really changed. I'm not sure if it's changed at all now that the cloud is powered by OpenStack relative to the old platform. There is still that decision. There is still workloads where you're better off using dedicated than cloud, and obviously, the reverse is true, and so that -- but that hasn't been changed or altered just because we've deployed OpenStack.

Jason Luce

Yes, I think -- I mean, that's a great innovator's dilemma sort of question. And a few years ago, when Bryan said we'll launch our cloud business, we thought, is this going to cannibalize the dedicated business? And we just thought, well, if someone's going to eat it, we might as well eat our own. The reality, and this was a big topic of conversation, I'm sure as you guys can remember, kind of back in '09, 2010. And what we found out is very few customers take existing workloads and move them from a dedicated world to the public cloud multi-tenant virtualized world. And for a while, it was like a 150 customers a month. So we would actually talk about that in the call as we go back and read past transcripts. That trend hasn't changed, but as Bryan alluded, it's that sort of single server type workload that 5 years ago when it showed up, they didn't have a choice, okay? Those deals now, out of the gate, are choosing cloud.

Scott Goldman - Goldman Sachs Group Inc., Research Division

There's a question over here.

Unknown Analyst

You didn't give formal guidance for 2013, but some folks took your CapEx guidance to be indicative of where you think the top line growth will be. But there seem to be some different interpretations around whether or not you were trying to signal something there? Is there clarity you could offer?

Bryan McGrath

Yes, so we, as a company, have made a decision not to provide specific financial guidance, but we do provide very explicit ranges around what capital or our capital budget is going to be. And so you can take that data, right, and you can see generally or you could back into or how much yield, if you want to call it that, how much -- what kind of yield do we get on capital expenditures, and you can see how that has trended over time. And so you can use that to get a relative range of -- you can keep those historical ratios in place so you get a range of what you think revenue growth will be, and so a lot of the -- I mean, the financial community is doing that.

Scott Goldman - Goldman Sachs Group Inc., Research Division

Okay, any other questions? One right here.

Unknown Analyst

If I look at just your sort of depreciation in 2012, would you consider that to be a good proxy for maintenance CapEx in terms of -- if you were to not gain or lose any cloud customers or managed hosting customers, going forward, how much would you have to spend to just keep them satisfied with the service?

Bryan McGrath

Yes, that's a good question. If that happens, so we were just in the space, add no more customers, going forward, I think I would expect depreciation, or call it maintenance CapEx, to be roughly 10% of revenue, and D&A trends at about 19%, 20% right now, but we're growing high 20%.

Jason Luce

And we actually published in our -- we have a target model that you can get on our website that sort of has this hypothetical steady-state. Let's hope we don't see that in our time. But at that hypothetical steady-state, we published that sort of 10%. So a lot of -- the 19% to 20%, a lot of that depreciation is for growth, right, that we spent last year, right? If we were to stop growing, then you can basically triangulate around this. If you look at some of our really slow -- let's go back to 2009, right, when growth basically hit 0 in the first quarter and look at how much we were spending, you'll get closer to the 10%.

Scott Goldman - Goldman Sachs Group Inc., Research Division

I think we have time for one very last quick question.

Unknown Analyst

On the call the other night, Lanham mentioned that you would be making some more investments of your own into OpenStack, effectively trying to assert more control, if I heard him correctly. Could you just talk a little bit about what's different year-over-year and what areas you're trying to get more active in?

Bryan McGrath

Yes, I think controls a dirty word in the open source community. So stepping out from that, we'll continue to make investments in the OpenStack. So a lot of the software development we do, part of that will be for furthering the code, right? We're a big contributor to the code. There are other things from a marketing standpoint, doing events, being more -- being a bigger sponsor and being more -- taking a lead in some of the events around the OpenStack community, things like that. Those are all things you can expect us to do more of this year, but not -- no real giant sea change than what we've done in the past, just some more.

Scott Goldman - Goldman Sachs Group Inc., Research Division

Okay. Well, I think, we are out of time. Jason and Bryan, thanks so much for joining us. It's always a pleasure to have you guys.

Bryan McGrath

Thanks, Scott.

Jason Luce

Yes, thanks a lot, Scott.

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Source: Rackspace Hosting, Inc. Presents at Goldman Sachs Technology & Internet Conference 2013, Feb-14-2013 11:00 AM
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