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Rackspace Hosting, Inc. (NYSE:RAX)

Goldman Sachs Communacopia Conference (Transcript)

September 25, 2013 04:35 PM ET

Executives

Jason Luce - Vice President of Finance

Bryan McGrath - Director of Finance

Analyst

Scott Goldman – Goldman Sachs & Co.

Question-and-Answer Session

Scott Goldman – Goldman Sachs & Co.

Already started on me so already behind by a minute or two. Thank you everybody for joining. I’m Scott Goldman from the communication services team here at Goldman Sachs. Pleased to be here for the final start of day two with Rackspace. To my right we have VP of Finance, Jason Luce and Director of Finance Bryan McGrath, thank you guys both for joining to yet another Communacopia.

Jason Luce

Thanks Scott.

Scott Goldman – Goldman Sachs & Co.

Just [another] pretty high level industry working and we’ll dig a little bit deeper into some of Rack specific, but it give us a 30,000 foot view in terms of cloud computing, the market adoption for cloud computing, obviously an industry that’s still probably somewhere in its infancy, but what have you guys seen over the past year in terms of penetration and willingness of enterprises to adopt cloud computing service in their IT?

Jason Luce

Okay. Good question. So I think I’d prefer to take it back several more years. If you think about going back to sort of 2007, Rackspace had build call a $400 million revenue business, helping companies run applications on dedicated environments on either a Linux or a Windows’ deck. And we internally, we had we were monitoring this thing called cloud computing that Amazon had invented effectively. And we were scratching our heads wondering is this thing real. And at some point in time it was very obvious that it was real. It was a new technology and what it basically did the attributes that sort of completely changed, turned the world on its head were it was not only could you now go and run an application with a provider and turn it on and turn it off so that’s not only did you, you didn’t have to the goal then was to sort of own the valley and rent the peak, you didn’t have to own anything. And you could turn 100% of what was a CapEx budget into OpEx.

And instead going with the dedicated world, the other attribute that was incredible is that you could spin it up immediately. You could go and get the equivalent power of a mainframe with five minutes in the credit card. And in scaling problems if I think about some of our e-commerce providers that would call us up in September and say, hey look we are going to need a double capacity going into the holiday season for October, November and December. We could plan and go do that and probably do it better than they could do it and that allowed them to sort of rent the peak if you will, but kind of on a per month basis. With the could technology you can rent it on a per minute basis.

And so there were those attributes, those are fascinating things to us not only because it sort of made this idea of not running IT yourself more compelling and I think that (Inaudible) Amazon does an incredible job of angelizing it. It means that so much more work can be done. And there is an analogy drawn to think about what iOS did to the app world, right, Blackberry was sold this week didn’t really sort of adopt that strategy iOS and Android obviously have and now there is millions of apps.

And so at least in their mind and I think we would agree that it means that the world is going to do that much more. And incremental applications and incremental and new companies are going to be born on the web and a large part of what they are going to use is the cloud.

So our response when we realize that this was real, this technology was real, our answer to that was we went out and we bought a company called (Inaudible) at the end of ‘08, which was intended to be sort of our answer to equivalent for the compute, the compute offer equivalent to EC2 and we bought a company and combined with a company called (Inaudible) some of the software that we developed called Cloud FiOS and that was our answer to S3.

And we put those businesses together and we actually moved in out of our headquarters and we put another building and we said incubate and develop and everything went really well. As you know that business was launch in the beginning of 2009 and it was grown at a 100% and doing really well and we were adding 10,000 plus customers net a quarter and we knew Amazon was doing really well. In our minds we were convinced that like the 10 years prior of our existent that there was the part of the market that wanted to, there was a DIY part of market that like to go to in a co-location company as our other providers where you could just abstract sort of some of the inputs of running IT, but was it was still on you to run it and there was a part of the market that wanted to go to a service provider. So there was a company that would manage everything and then a company that would provide some of the inputs.

And so we thought like our competitive position was really strong. And then I think probably sometime in early 2009, some of our strategic I said we have a problem. And, but so what do you mean, the business is going at 100% and no one is going at scale and it's more profitable, user economics are better, we got a great brand and makes a (Inaudible) here is the problem. The problem is that we have some technological limitations with our software platform primarily scale. So you think about companies several years ago that sort of drill upon the web drop box, box, pinterest, instagram, you can, risk goes on and on.

Amazon, they have a 100% market share of those companies. And those are just companies those are popular company names that we know. You think about apps that were born on the web, within enterprise, big enterprise customers they are operating HCL as well. If those aren’t running in house, up-to-date Amazon has a 100% share of those.

And so the problem was not that Amazon had lowered price 27 times what I (Inaudible) the prior two years, it's not that the world didn't want no longer cared about sort of a service provider model versus DIY model. The issue was that the scale tipped, their platform was so technologically richer than ours from the feature and function standpoint that you had to go with them, right? And so what we decided to do initially was (Inaudible) hire 100 developers and we’ll innovate our way through this, we'll close the gap.

Well the reality is we didn't grow up as a dead shop. So that wasn't really our core G&A that wasn't our strength. And so we had to make a board trade off and the trade off was the only chance, the only possibility that we will have a chance to qualify for this opportunity set is the deal is to open source our code. So give it away and to rely on the open source community to help us close that gap. And so we did that alongside with NASA. What we did was we found OpenStack and we brought our sort of cloud storage, sourcecode; they brought their cloud computing sourcecode, we put them together and we launched this thing that was originally intended as a defensive move from a competitive landscape perspective to close the gap with Amazon. And then OpenStack just started gaining traction like a wildfire. The ecosystem grew like crazy and pretty much everyone that was after some of the profit pools of running IT has developed a strategy around it. And so as you know, we've been sort of through the last year as we made OpenStack really our number one sort of aggressive strategic priority. And so where we are today, I think we are, I think that this technology that Amazon develops is here, it's real, it's massive. A 100% of the Fortune 1000s, have they are compelled to have a strategy around it that is cloud. And but I think it’s going to change the world of computing over the next decades.

Scott Goldman – Goldman Sachs & Co.

So piggybanking off of that, it's just coming upon, actually a little over a year ago when you guys introduced OpenStack and obviously that has pretty big implications for the business via the couple of quarters prior to that and as you sort of prepared for that. So you sort of reflect back on the last 13, 14 months. How does that play out relative to your internal expectations at a time and what sort of have you learned that you have to adapt to over that time since you get where you are today?

Jason Luce

Well, we've learned a lot. It’s in a process of discovery. I can remember sort of sitting here this time last year and we have just gone through the summer, where the primary question was, will OpenStack win, will OpenStack proliferate as the standard alternative, the open source standard alternative to mainly VMware on sort of the on-premise private cloud side and Amazon, the clear leader on the public cloud side? And that box, I think 75% of everyone’s mind had been checked. And so the question here at between the copia conference last year is, will Rackspace be able to develop the tools and features that needs to harden a production ready OpenStack version and then will Rackspace be able to roll on to that harden version and publish performance metrics telling the world that look at here it’s ready, right it’s ready.

And in November, we were sort of able to do that, we were fully rolled 100% of everything incremental and the cloud storage network and compute side was on OpenStack, and then going into the winner/ spring the question was okay, where is the adoption? We want to see some names. And on the February call, we were able to talk about HubSpot, which is a great sort of reference win for us, a prior Amazon customer, who solve the benefits of optimizing sort of the price to performance equation through a hybrid architecture and they move on to OpenStack. And when I say great reference customer, I mean they’ve been very vocal about sort of the benefits that they receive through utilizing a hybrid architecture on OpenStack supported by Rackspace and they’ve joined the market with us helping to talk to sort of other prospects.

And then we were at the Portland Summit, the OpenStack this spring where you heard Best Buy, Comcast, Bloomberg, Stern etcetera talk about how they are running sort of production workloads on OpenStack and then this last call was great, we were able to announce even more customers which still when I think about the last 13 or 14 months, I mean that’s how things have developed. We are and so which leads to the next question was, when are we going to see, when are you going to achieve your stated goal of revenue reacceleration?

But one other things that, one of the -- some of the things that, some of the learning that have come out of the last year and half if you will that I think are our word of sharing are look we probably ruled, we probably went from limited availability to general availability and rolled on to a harden version of OpenStack six plus months longer than -- it took six plus months longer than we thought it would, why? Well because we were conservative, I mean our risk threshold was pretty darn high when it came to making sure that it worked. And there were all sorts of characteristics just in attributes that went into that multi variable sort of thought process of, are we ready? And there we had to make sure that it worked because if it didn’t work, that would probably have been the worst thing in terms of ensuring sort of long-term adoption.

And I think that’s ironic because I think in our mind probably when we put together our 2013 revenue growth plan, we kind of thought that as soon as we rolled on to everyone (inaudible) right, but there is some irony in that right because now it’s taking folks a little bit longer than we might have expected. And I just think that, when you think about running really important things on effectively a brand new virtually untested platform, it just takes a little more time than I think we will probably helpful for.

The other thing before we get to that question that clearly the whole reason why we’re here, one of the other earnings, one of the unintended consequences of making these payoffs was we sort of we talked about, we make the big organizational changes in order to push this agenda and some of the unintended consequences are that our same store sales on the dedicated side, they kind of got cut in half and the reality is that by refocusing our sales force on, really on OpenStack and sort of the cloud technology and getting the technology use to sell that. They lost some focus on sort of the bread and butter and we flush our pipeline and that was an unintended consequence.

I think looking back would we make that trade-offs? Yes. Was that a plan trade-off? No. And so we’ve been rebuilding that and that’s really the second part. So wins revenue reacceleration is going to take place requires two things, one it requires more of this large revenue opportunity proof of concepts going from pilot to commitment to production to revenue, okay, and predicting when that will happen, I can already tell you that we gotten it wrong, okay.

Scott Goldman – Goldman Sachs & Co.

I imagine it would be a pretty hard thing to predict, right.

Jason Luce

It's hard to predict.

Scott Goldman – Goldman Sachs & Co.

Every enterprise have taken their our own different approach on time, looking at different applications right. I mean, there is no sort of single view as to how long that could take right.

Jason Luce

If it were one thing Scott, right if there were a whole sort of the networking product, it would be really easy to sort of focus all forces on fixing that one problem, you are exactly right. It's not easy to predict.

And the other thing that's been more difficult to predict for us is, how long does it take to rebuild the pipeline? So that it hits kind of on month over month in a consistent manner. And look so I think that on the May call, when we realized that we had sort of missed a couple of these predictions that we decided that looking this and the times where you have unintended consequences you go to a platform shift, you’re optimistic about the future. But you don't know exactly when things are going to hit that we decided for the first time in five years to give revenue guidance.

And I'll tell you that, sort of the qualitative message that we wanted to communicate with the guidance and everyone knows the numbers are where the numbers are. But the qualitative message that we wanted to communicate was not worse, because we thought we got a good handle on, the moving parts the way just don't -- we don’t want to be unhooked for saying when it's going to get better with the very stated obvious goal of better. And when I say better, just to be clear, we measure better on a revenue growth, sequential growth rate.

Scott Goldman – Goldman Sachs & Co.

Right. Understood. So I would just say step backward (inaudible) right. So, I mean, if you sort of look back, I mean you talked about OpenStack providing the scalability right, and I think you can easily make the argument that OpenStack with the development community behind it has been able you to get a lot of products to market that might have been challenging under the (inaudible) platform or required a lot more internal development of your own to sort of get there.

So are you seeing release of the proof of concepts in what you are seeing around OpenStack today and people that are deploying with you? Is it delivering the desire result in terms of the size of the deals? Is it delivering the expectations that I can put applications on OpenStack and maybe somebody test it for six months and tell me, but people are putting those production applications on OpenStack and feel comfortable doing that?

Jason Luce

What we have, we have a couple of wins under our belt that suggest yes and we're part of a ton of conversations which infer yes. I mean the proof is in a putting. Even though, we sort of like I said, tapped out, I'll call it a $30,000 month spend on public cloud with the prior software framework. We are now being invited to participate in conversations where companies are spending $2 million plus a month with Amazon and you can probably figure out who some of those are and look the proof will be in a putting, is the platform ready? Well, we will all know, right, but we won't.

Scott Goldman – Goldman Sachs & Co.

So just touching on the revenue question, I am not looking for quantitative answers here, but obviously we all know sort of where your growth was a couple of years ago. Do you think with the pieces you have in place today that you can sort of get back to that level of revenue growth or do you need to roll out further products to narrow the gap maybe with Amazon or others out there? How do you guys think about what that opportunity is with the products that you are able to (inaudible)?

Jason Luce

I guess I’ll take the -- okay so can we grow 30%? Again, the good news is I don’t have to answer to that, but I shall because somebody asked it on the conference call and I think you can go back and read what Lanham said.

But it’s inferred something along the lines, look there is no reason to think that we can’t, we have removed the most significant barrier that would have imputed our growth over the next several years, now it’s time to go execute. Our sites on 30% right now, no. Our sites are, I won’t tell you what our next hurdle is, but it’s better. And then what I think will happen kind of as we did when we learned sort of facing this sort of this technology sort of difference was we operate on a continuous improvement framework so you study our numbers for four years kind of aggregate when we went public and it was always better with no sort of never an autocratically imposed step function. Right now we are kind of operating on the same, right? So it’s better.

I can tell you that I do think that and this sort of gets into what else you need to do, I will just transition that into what I am sure our questions (inaudible) when you think about the competitive landscape. You are right, Amazon, when you think about the competitive landscape number one is in-house, still 80% of all IT is run within a corporate datacenter. And even though a majority of new applications are being written to the web, it’s still IP’s buyers to run it themselves, okay. That’s just a shift that none of us would be here if we didn’t believe was taking place and so that's still sort of the number one sort of share when you think about share, competitive issue.

Second, I would say we spend 95% of our time thinking about AWS and 5% of our time thinking about all the other names IBM, VMware, Microsoft, Google, Red Hat, right? And the competitive threat again is on look Amazon is not stopping, they are going to continue to innovate on their platform and rollout a ton of features I mean obviously an incredibly one of the most talented (Inaudible) shops of all time. And the real threat is there more work to do on our side, absolutely. And we are actually we are loading multiple lines of code every single day.

The threat is that OpenStack were for some reason to lose momentum. And we weren’t able to leverage the open source community of developers then I think they could pull away again. I think that standing where we are right I feel like OpenStack’s got a lot of momentum. And I feel like we are in a good spot. I think it’s less about product development right now in terms of getting that growth rate back higher to where we want it to be than it is just sales and marketing execution.

Scott Goldman – Goldman Sachs & Co.

I mean it’s interesting that you say you focus now you probably (Inaudible) AWS because I mean the message or strategy that we are hearing now and frankly I think it’s probably one that I agree with is all about Hybrid and AWS, but I don’t know that they necessarily have sort of a direct hybrid offering to sort of compete on that front and I think OpenStack provide a path for probably more seamless hybrid approach. Was hybrid always the intended solution, I mean I think we all sort of go back a year I think it always just about Public Cloud that was a 75% growth there. Was hybrid always the intended solution or it was something that you said hey guys this is a great opportunity and by the way talking to CIOs this is where everybody kind of go because they want stuff staying in the Private Cloud and they want stuff going into the Public Cloud.

Jason Luce

Yeah, so one the reason why we spend most of our time thinking about Amazon is because the way we think about the world and we think that the way the buyer thinks about the world whether it’s IT department or the guess. If you want to someone to run the [plumbing] where you put your application there is really only us in them. For a company that grew up on the web that operate web speed, it’s kind of us in them. I mean Google, it could be Google, but they’re not in the game, it’s not, IBM didn’t grow up on the web, IBM (Inaudible) Microsoft Group in the world shipping strength to that software, not on the web. And so I think that when you think about sort of your alternatives for running your applications on someone else’s [planning] then I think it’s really us, it’s us in Amazon.

When it comes to really Red Hat, Red Hat doesn’t run planning, Red Hat sells software, VMware doesn’t run pluming, yet they sell software. And so that’s why I think we spend most of our time thinking about Amazon. When it comes to why hybrid now, what I heard, why is it now relevant? Have you think about the fact that, so hybrid what that means is running a combination of probably (Inaudible) non-virtualized dedicated servers that had a certain attributes that match to certain types of applications best, but dedicated environment that’s virtualized same deal attributes the map and then public cloud.

The reason why it’s more relevant today is because if you think about the public cloud part which is a major component of hybrid and our public cloud part only would scale to $30,000 a month then it’s kind of irrelevant because the type of workload that benefits from optimizing around hybrid is a big one. So if it's a big workload and very important component of the hybrid only scales at $30,000 a month, it's kind of, it's not relevant.

And so what was competing with sort of cloud-only, if you wanted a hybrid solution that means you have to develop your own. Thanks Facebook. Yeah, so I think that's actually, we developed a product called RackConnect a couple of years ago, which effectively made running a dedicated environment in our multi-tenant cloud environment inter operable. The reality is that the people that would really benefit from that would be large workloads, but at the cloud part could only fill to a certain extent, it wasn't really a viable offering.

Scott Goldman – Goldman Sachs & Co.

So who do you see is a real viable competitor in a hybrid cloud world?

Jason Luce

In-house? I mean today, I mean if you think about, you could or so let's think about what are options are. We can run, I think that (Inaudible) which is another sort of

Scott Goldman – Goldman Sachs & Co.

With Amazon.

Jason Luce

With Amazon?

Scott Goldman – Goldman Sachs & Co.

What about VMware and some of the announcements, I mean and I would….

Bryan McGrath

I don't know, I would probably, they obviously had line shares sort of the private side.

Jason Luce

They have the line share with the private side, but VMware is not compatible with AWS. I don't, I mean I had heard a lot of buzz that was going to be the announcement of VMware a couple of weeks ago, but I dint hear it. So I don't know, right now I think that, I think right now, right now I think Rackspace is sort of we really think about the public cloud component side, there is really only two. There is Amazon who has the majority of the market share and us. So if that's an important component of hybrid cloud.

Scott Goldman – Goldman Sachs & Co.

Just in interest of time I want to hit a few other topics and open up to the audience for questions. Manage hosting, I guess Dedicated cloud side as you guys would now, obviously big focus from the investor base, I would think that the push into hybrid side would obviously have positive implications for that side of the business. But can you talk a little bit about what's been sort of the driver of that business and what the outlook for that business is or the key drivers that we should be looking for that business going forward?

Bryan McGrath

You touched on, I mean, hybrid would be a key driver, but what drives that business with that form factor relative to all the cloud that comes down to couple of factors, but more along lines of what app is running. So like you are coming to us and you want us to run a big database for you, high performance database, we're going to steer you towards dedicated infrastructure. The database is simply run better when there are high IO intensive apps and they run way better on dedicated boxes that are virtualized.

Games are another app that run much better dedicated infrastructure. So the gaming companies who we run gaming forward with them, they want to wrench out every last drop of performance out of the box. And so by doing that they want to configure the operating system, they want a (Inaudible) operating system, they don’t want to have a hyper (inaudible) tax, so that type of app goes into dedicated versus a very web front-only app that has a lot of variable demand that is better off going over into public cloud. That is the biggest kind of decider of where it goes.

Again we talked about a little bit, but we deemphasize that business a little bit, (inaudible) over the last couple of years because we're so focused on getting the new public cloud getting up and running and up and up and having no outages and letting everyone in the world know that we have a very competitive offering.

Management potential and focus kind of got shifted away from the dedicated business, but look it’s, this is a we believe statement, but we believe we can improve the growth rate of that simply by running the old kind of bread and milk type plays of closing running databases, running games, running more the same. And then hybrid being a new kind of new go-to-market strategy, that will then pull across demand for dedicated as well.

Scott Goldman – Goldman Sachs & Co.

I think you mentioned earlier too that there is some change in incentives around what you guys are trying to sell right after sort of got OpenStack up and running and maybe trying to push the cloud a bit more aggressively. Has that all been sort of addressed and how it had compensated today to sort of?

Unidentified Speaker

It’s all been addressed, but the reality is that once you save put the all favourite (inaudible) together you goes all (inaudible) and you say go, and the reality is it just takes time to rebuild the pipeline in order to start to see consistent results.

Scott Goldman – Goldman Sachs & Co.

And as just on that topic, one last one on that. As you sort of focus on larger deal sizes, I mean is it fair to expect that you can get sort of that consistent pipeline like you were seeing previously when people are spending $300,000 a month as opposed to $20,000 to $30,000 a month, is that realistic to think about?

Unidentified Speaker

I mean on a dedicated side, it’s just, I mean anecdotal sort of examples of guys that would go to Fortune 500 and just sell share points to that next department of a retail provider, that's just execution, right. And that's not like, well this is a bigger deal so this looks like a different animal, it’s just we took our attention away from that, so I just think that's a matter of time.

When I think about, get really excited about the new opportunities that we qualify for these, I mean talk about like the kind of marquee customer that can really shorten the time to sort of market acknowledgement that would really sort of speed up the flywheel, that’s a totally different animal, that’s not a sales person interfacing with someone in IT department who is running a (inaudible), that’s a team of engineers interfacing with a team of engineers. And so we are right now, there is science around this, but we are having to pull some of our best and brightest engineers off of basically interfacing with the command line in a green screen all day to sitting in conference rooms helping to architect transitions, right.

I mean, so that’s -- at some point that would be a good problem to have if we had to figure out how to maximize that balance. The reality is that’s the different animal. When you think about going to get a multimillion dollar a month web app to move to go from sort of a cloud only to on to a brand new -- with the brand new platform and supported by Rackspace on OpenStack, that’s not a sales person, I mean that’s a team of architects that are helping to do that. The good news is that we are having those conversations and we weren’t even part of the conversation set six months ago.

Scott Goldman – Goldman Sachs & Co.

I certainly have one more question, I want to ask one more before we open up to the audience. One thing I think we have noticed is you recently added a Chief Marketing Officer to the mix you hired a new Head of North American sales.

Jason Luce

No, just Head of Sales, we haven’t had a Head of Sales in nine months.

Scott Goldman – Goldman Sachs & Co.

So I really thought those probably have within the last few months or maybe little bit premature, but any initial thoughts on how they may be looking at the business or directions that they may be taking business that you can share with?

Jason Luce

Hire, look, I mean, so these are two great hires for us, Todd Cione and Rick Jackson, I think they are learning from us, they are learning, so what was the (inaudible) first 10 years, what did you do, what have you done over the last 18 to 24 months and how do we get this train back on the tracks and now that we’ve accomplished are sort of at least preliminary objectives around OpenStack and look these guys are new, so I am sure they are feeling a lot of pressure right to produce results now, right or yesterday. And I think and I hope that we will do the right thing which is integrate them properly, give them the time that they need so that they can [continue] approach for us. And I think that’s a number one priority, that is a very important priority when I want to comes integrating those guys, so I am confident in that.

Scott Goldman – Goldman Sachs & Co.

I do want to open up to audience, I certainly have other questions, but if there is questions in the audience, people want to ask feel free to raise your hands. The one right here (inaudible) the microphone.

Unidentified Analyst

For new initiatives like the expansion to Australia and other areas, how much of the cost structure right now approximately which says no revenues associated with, in other words how much can you potentially probably accelerate from some of those investments?

Jason Luce

So I don't have a numbers answer for you, but I'll have sort of a better way to understand kind of what's going on in terms of excess capacity, okay. We are carrying more excess capacity in terms of OpEx and CapEx right now than we have in past years. The reason why is when we put our growth, every year we put together a growth plan based on a calendar year. And we build an operating and costs model behind that.

So if I need to add whatever a $100 to achieve my growth rate target for the next year, then when I say build an operating at a cost plan behind it, I know how many quarter bearing sales reps I need to handle the lead funnel and making assumptions around conversion rate in order to get that revenue. And so I know how many heads I need, I don't have any support people I need in order to sort of support that amount of new work. So I know how many heads I need there. I know how many more servers I'm going to need because the co-relation between sort of hardware, servers, firewalls, load [dozers], storage devices, I need to support that amount of revenue, because I have got a 10-year track record doing that.

And then so that capital and then space power connectivity all the inputs, I know what I need. And so this year because we a couple of predictions that I think we were, maybe I would just say hopeful on that we got wrong, which were more of these deals going from pilot to production revenue are taking a little bit longer and the realizing the fruits of rebuild the pipeline are taken a little bit longer. We were off to revenue plan. And so the only other time in the six years I have been at Rackspace, it were of the revenue plan was in 2009.

And as soon as we realized we're off the revenue plan, which was just kind of like January 1, we changed the cost plan right to correlate to the revenue plan and so we said stop hiring at a 30% growth rate. We're not growing 30% in 2009. This year is different. So even though we're off the revenue plan, we decided to stick with the same cost plan, in other words, the same hiring plan, the same capital plan. And the reason why is, it's not because we're hopeful that these things will materialize, it's that we believe it's a matter of time, okay. So even though we build the budget, January to December calendar year, it's just not the way the world is working as we go through this shift.

So right now what you will see is at the beginning, we always said, think about margin structure similar to last year. That was in February when we realized we're off the revenue plan. In May we said, we actually we're going to stick with the cost plan. So we're going to take a little bit of a hit in the near-term on the margin side and whenever you take a hit on the margin side, you take a hit on the return side.

So and the question is, when will you get back on track and the answer is when the revenue comes. So right now we're carrying more excess capacity. We haven't changed our economic model. So we haven't decided to accept lower incremental returns in order to be competitive. And I think some of the statements we made on the record is, does that publish target model still apply and the answer is yes. So the reason why we opened an Australia facility is not because we were hoping that customers would come to us if we had a facility in Australia.

The reality is that we opened a Hong Kong facility five years ago and most of our customers come from Australia. So that we finally capitulated to their want of, we would actually like for our data to reside in Australia not Hong Kong. So that's why we did that. And we also like we spend capital opening up sort of a cloud facility (inaudible), Virginia campus and the reason why is because customers want us there.

And the other thing I want to talk about on the capital side is a lot of these proof of concepts that we are running, I mean we buy the servers for the customer, and then they pay us, we may recoup our cost of capital for that (inaudible) life of the server, but they are not paying us for management.

When they go from proof of concept to production and we manage it, then they pay us for management, so obviously the turns on capital to revenue look dramatically different when it goes from production to management. I mean I think of you study sort of the relationship between capital and incremental revenue for our business, it’s all pretty darn success based and pretty tightly correlated. I mean datacenter is being long lead items even though there is sort of operating leases now. Servers being basically like short lead inventory items.

Scott Goldman – Goldman Sachs & Co.

We started a minute or so wait for one other quick question from the audience. We probably have time to accommodate that. Right, well, guys thanks so much. Great, we appreciate you being here and closing out day number two for us.

Jason Luce

Yeah. Thanks for inviting us back.

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Source: Rackspace Hosting's Management Presents at Goldman Sachs Communacopia Conference (Transcript)
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