Rackspace Hosting Management Discusses Q3 2013 Results - Earnings Call Transcript

Nov.11.13 | About: Rackspace Hosting, (RAX)

Rackspace Hosting (NYSE:RAX)

Q3 2013 Earnings Call

November 11, 2013 4:30 pm ET

Executives

Jason Luce

A. Lanham Napier - Chief Executive and Executive Director

Karl Pichler - Chief Financial Officer, Senior Vice President and Treasurer

Analysts

James D. Breen - William Blair & Company L.L.C., Research Division

Gray Powell - Wells Fargo Securities, LLC, Research Division

Jonathan A. Schildkraut - Evercore Partners Inc., Research Division

Lisa Lam - Morgan Stanley, Research Division

Kash G. Rangan - BofA Merrill Lynch, Research Division

Timothy K. Horan - Oppenheimer & Co. Inc., Research Division

Patrick D. Walravens - JMP Securities LLC, Research Division

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Colby Synesael - Cowen and Company, LLC, Research Division

Operator

Good afternoon, ladies and gentlemen, and welcome to Rackspace Q3 Earnings Release 2013 Conference Call. As a reminder, this call is being recorded. [Operator Instructions] It is now my pleasure to introduce Jason Luce, Vice President of Finance for Rackspace. Mr. Luce, you may begin.

Jason Luce

Hello, everyone. Welcome to Rackspace's Third Quarter 2013 Earnings Conference Call. We hope that you have had a chance to read our press release, which we issued earlier today. If you don't have a copy of the press release, please visit our Investor Relations page of our website at ir.rackspace.com. This call is also being webcast online and can be accessed through our Investor Relations site.

For Rackspace on the call today will be Lanham Napier, Chief Executive Officer; and Karl Pichler, Chief Financial Officer.

I need to remind you that some of the comments we will make today are forward-looking statements, including statements regarding expected operations and business results; our growth plans and expectations; the impact of new platforms, products or services; and our expected level of capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. These risks and uncertainties include things like: one, continued market acceptance of our public cloud platform and products; two, the continued adoption of OpenStack as the open source cloud computing platform standard; three, increasing competition in our industry; four, unfavorable economic conditions; and last, other risks that are described in our SEC filings. Please note that these forward-looking statements reflect our opinions only as of the date of this presentation and we undertake no obligation to revise or publicly release the results of any revisions to these forward-looking statements in light of new information or future events. Please also note that certain financial measures we will use during this call, such as adjusted EBITDA, are expressed on a non-GAAP basis. And that our GAAP results and GAAP to non-GAAP reconciliation can be found on our earnings release, which is currently posted on the Investor page of our website. After our prepared remarks this afternoon, we will be happy to take your questions.

I will now turn the call over to Lanham. Lanham?

A. Lanham Napier

Good afternoon, and thank you for joining us today. Let's start the call by reviewing the path we've traveled towards building Rackspace into one of the greatest cloud computing companies in the industry. Just a few short years ago, we made the decision to open source our cloud technology and create the OpenStack project alongside our friends at NASA. Initially, creating OpenStack was a move to create an open source cloud operating system to speed innovation and allow customers to ensure that their data would remain their data, free from vendor lock-in. We felt that such an open system would compete well against the proprietary alternatives in the market. Open sourcing our cloud and launching OpenStack was a bold move because there was no guarantee that a critical mass of developers and companies would join the movement, participate in the project or adopt the technology for production use. As it turned out, thousands of them did. At the latest count, the OpenStack foundation has attracted more than 9,500 individual members from 850 different organizations. And at last count, the OpenStack technology is approaching 2 million lines of code.

OpenStack created a new technology to provide a powerful and innovative alternative to establish technology, such as VMware, Eucalyptus and CloudStack. And for about 12 to 18 months after its conception, it was unclear which project was going to emerge as the dominant open source cloud platform. As it turned out, OpenStack did.

Now that the success of OpenStack is widely understood in the market, the question is whether Rackspace will benefit from the technology. Within the 4 walls of Rackspace, there is no doubt that OpenStack's the game-changer for our business. However, we don't believe we've yet proven this to the market.

We began addressing the issue roughly 12 months ago, when we completed the rollout of our OpenStack public cloud products. The completion of this project represented the largest, most strategic technology investment that Rackspace has ever made. By the time the rollout was complete, our strategy had shifted from simply minimizing our deficiencies to expanding our addressable market by competing for large, complex workloads. This is an important segment of the market that is growing rapidly, and at the time, a segment in which Rackspace wasn't competitive given the limitations of our prior software platform.

We believe OpenStack changed that dynamic. And we said that if we successfully executed on our strategy, that we would be able to serve these larger customer workloads and ultimately improve our growth rate. In the first quarter, we talked about HubSpot as a customer with multiple, large and complex workloads. In the second quarter, we talked about CERN, Emerson Electric, Fidelity, Mazda and Sony PlayStation. We've had more good wins in the third quarter including Cloudant, Map My Fitness, Sherry-Lehmann Wine & Spirits, Spencer Gifts, theCHIVE.com, Xero and YETI Coolers.

We've said throughout 2013 that our #1 financial objective has been to accelerate our growth rate. We believe we are making significant progress toward this objective. We guided to sequential growth of 2% to 3.5% for the third quarter and we were able to grow 3.4%. Based on what we know today, we believe revenue will grow between 3% and 5% sequentially in the fourth quarter. Although the data points we study indicate that the trajectory of our business has begun to turnaround, there's no guarantee that the revenue growth rate improvement will be a step function.

Let's touch on some of the areas that are driving the improved traction in the business and that give us confidence heading into next year. As discussed on prior calls, we've made a number of investments that we believe will pay off in future periods, but not all of these investments have delivered growth in the short term. We've also told you about a series of organizational leadership changes we've made. And we feel these changes are beginning to reinvigorate the business. Market awareness of our OpenStack capabilities, including our public cloud products, continue to gain momentum. In the pipeline of our Managed Hosting services, largely driven by enterprise demand and installed base growth, is rebuilding nicely.

One new public cloud customer that we'd like to highlight is Xero. Xero is a fast-growing accounting Software-as-a-Service company. Rackspace provides the critical infrastructure necessary to deliver 24/7 global application uptime, which is fundamental to their SaaS business model. Xero is adding roughly 200 customers a day and, by leveraging the capabilities of our public cloud, Xero is able to handle this rate of growth while scaling its operations team and maintaining availability of its application to its installed base.

As we continue to hone our strategy and through continued work with some of the largest and fastest growing web companies, one common theme that has emerged is the importance of world-class performance. The combination of our hybrid cloud portfolio and suite of managed services delivers powerful performance for our customers. When customers select Rackspace, they have a specific application in mind that needs to perform to a high spec. And the deciding framework skews to the provider, who can run the customer's application with the highest performance capability, not just for today, but also for the next 10 million or 100 million users that will demand even greater performance. For some workloads, unit price will be the most important attribute in selecting that company's cloud provider. Rackspace does not intend to pursue markets where the cloud provider strategy is to lead with unit price. Instead, our strategy is to serve customer workloads when performance is the most important attribute in the decision-making process.

We understand that economics will always impact the performance to total cost equation, so we will remain competitive on total costs while keying in on the segment of the market that values performance derived from infrastructure and services more than anything else. Delivering optimum performance through the right combination of software platforms, hardware platforms and the best technical expertise with Fanatical Support creates great outcomes for customers. As the technology adoption cycle continues to develop rapidly, our work to innovate is ongoing. Focusing on innovating around world-class performance is an advantage we hold today and that we're building upon.

Earlier this year, we reemphasized the benefits of our hybrid cloud capabilities and the way in which Rackspace is able to help customers optimize performance by finding the best fit for each of their workloads on hybrid architecture. As you know, Rackspace is a customer-centric company and we have learned from our customers that they architect their applications in 2 distinct ways. Many new applications are architected at inception to take advantage of the public cloud, using API as an open technologies, including dynamic languages like Python and Ruby.

Other customer applications, including many of our Fortune 1000 customers, are architected in more traditional client server manner. We have a Managed Hosting offer that is ideal for traditional client server applications and a hybrid cloud offer that is targeted to new cloud applications. These 2 offers form the foundation of our portfolio. We're uniquely positioned in the market because we have the capability to manage traditional client server apps and public cloud apps. The technology market is going through a big shift and it's to our advantage that we can manage so many different types of applications for our customers.

One new hybrid cloud customer example is Map My Fitness. Map My fitness provides a group of websites that make up the world's largest community for fitness content, interactive tools, calculators and mapping technologies for personal athletic pursuits. By leveraging Rackspace's hybrid cloud solutions, Map My Fitness was able to capture and process the data in realtime, analyze trends and ultimately deliver a more compelling user experience. The company uses our Cloud Servers product to host a database that processes more than 200,000 transactions per day for more than 16 million registered members.

A few e-commerce customer examples include Spencer's Gifts, YETI Coolers and Sherry-Lehmann Wine & Spirits. Spencer Gifts relies on Rackspace's hybrid cloud service to handle its e-commerce storefront. Online sales are growing at a much quicker rate than its brick-and-mortar establishments. The company leverages our hybrid architecture to handle day-to-day traffic and uses our public cloud for bursting during high-traffic periods, such as Halloween and the holiday season. So just inside traffic can reach 1,000x the chain's normal activity. And our infrastructure provides Spencer Gifts with the flexibility to meet the varying demand.

YETI Coolers manufactures the highest quality coolers on the market, providing unsurpassed durability and insulation. YETI utilizes the Rackspace hybrid cloud offering to run its implementation of e-based Magento, a software-based e-commerce platform. Sherry-Lehmann Wine & Spirits, the renown wine and spirits retailer, an iconic name within the wine industry, has partnered with Rackspace for our hybrid cloud solution. Sherry-Lehmann has been a customer of Rackspace since 2008, utilizing a private cloud for their e-commerce site.

In 2013, Sherry-Lehmann with the support of Rackspace successfully migrated to a hybrid cloud. The hybrid cloud allowed Sherry-Lehmann to immediately gain the flexibility of the cloud while maintaining a secure environment for credit card transactions and realizing significant cost savings.

Another hybrid example is Resignation Media, a family of web properties including their flagship website, theCHIVE.com. For those of you not familiar, theCHIVE happens to be the world's largest photo entertainment website. theCHIVE uses both our public and Dedicated Cloud servers to support its mobile properties that receive more than 15 million visitors per month.

Lastly, we'd like to highlight Cloudant, a Y Combinator-funded, next-generation database provider and new Rackspace customer. Cloudant runs a Database-as-a-Service offering and is using Rackspace as their middle infrastructure to help support its applications in a large-scale distributed system.

Our hybrid cloud offer is aimed at customers who take an API-driven utility billing approach to IT. We have learned that public cloud has its limitations, particularly with large complicated apps running at scale. While many new applications start out on a public cloud, as the applications grow, customers have to engage in costly over-provisioning to achieve the level of performance that they need. That's when the benefits of a hybrid cloud become compelling.

Another strategic step aimed at delivering superior performance was our recent launch of the Rackspace Performance Cloud Servers product. By improving architecture, the hardware infrastructure layer, including the use of solid-state drives, 10-gigabit Ethernet and powerful Intel Xeon processors, Performance Cloud Servers delivers up to 5,000% higher disk I/O performance than the Standard Cloud Servers with spinning disks. Our Performance Cloud Servers are designed to deliver enhanced levels of application performance with greater speed, throughput and reliability. This capability makes our cloud offering extremely attractive for a variety of workloads, ranging from high-traffic websites to large-scale NoSQL data stores like MongoDB, Hadoop and Cassandra.

Our customers benefit from the increased efficiency and performance of their applications and ultimately, greater revenue for their businesses. By offering Performance Cloud Servers across every flavor and configuration of cloud server we sell, we have redefined the standard of performance. Performance Cloud Servers are currently available out of our Northern Virginia data center. In the coming weeks, we plan to make performance servers available in our Dallas-Fort Worth, Chicago and London Data Centers as well.

This new offering strengthens our hybrid cloud capabilities. And as the name suggests, it's all about performance. With our hybrid cloud offer supercharged by Performance Cloud Servers, we are able to offer the best value in the industry for customers who demand consistent high performance.

We can also improve performance in our hybrid cloud through the optimization of open technologies on our platform that speed innovation, avoid vendor lock-in and ensure that the customer maintains ownership of their data. And of course, we will layer on Fanatical Support enabling customers to benefit from our superior technical expertise.

The combination of our unmatched portfolio of hybrid cloud services, our commitment to open technologies and our technical service expertise is what differentiates us from the rest of the technology industry. We intend to pursue this strategy relentlessly.

In closing, I'd to take a moment to thank all of the Rackers for their hard work this year. We got off to a difficult start this year, but we stayed in the battle and all those efforts are beginning to bear fruit. I'm proud of the way Rackers respond to adversity. The work we're doing to refine our strategy in hybrid cloud offering is a once-in-a-lifetime opportunity for all of us. And I'm excited about changing the world with all of you.

I will now turn the call over to Karl to review our detailed financial statements. Karl?

Karl Pichler

Thank you, Lanham. Despite revenue growth in the third quarter falling within the range of our guidance, our aspiration is to grow at a higher rate, but that continues to be our primary focus. As Lanham indicated in his prepared remarks, for the fourth quarter, we expect our sequential revenue growth to range between 3% and 5%, which would result in revenues between $400 million and $408 million, with $404 million falling in at the midpoint of the range. We're currently working through our 2014 growth plans and we'll share those with you on the February call next year.

Now let's move onto the specific results. Total revenue for the quarter was $389 million, representing 3.4% sequential growth and 16% growth compared to the third quarter of 2012. Exchange rates had a positive impact on revenue by approximately $900,000 compared to the second quarter of 2013 and a negative impact of $1.8 million compared to the third quarter of 2012.

Dedicated revenue increased to $280 million in the third quarter, representing 1.2% sequential growth and 9.2% growth on a year-over-year basis. Public cloud revenue for the quarter was $108 million, representing 9.5% sequential and 36.5% growth on a year-over-year basis. Installed base growth was 0.7% in the quarter, just the same as the prior quarter.

We have talked about our work on rebuilding the dedicated pipeline for several months now and that we expect for the dedicated growth rate to rebound. The pipeline rebuilding is going well and we have factored that into our total revenue guidance for the fourth quarter.

Moving on to profitability. Adjusted EBITDA for the quarter was $125 million, a 1.9% increase compared to the second quarter, and a 3% increase compared to the third quarter of 2012. The adjusted EBITDA margin for the quarter was 32.3% compared to 32.8% in the previous quarter and 36.2% for the third quarter of 2012.

Consistent with our goal to reaccelerate revenue growth, our decision to invest aggressively in hiring technical talent and in research and development have depressed margins this year compared to 2011 and 2012. Even though our growth estimates for the fourth quarter are slightly higher than the past few quarters, we expect margins to remain near the 30% range for the time being.

Depreciation, amortization expense came to $81 million in the quarter, representing 20.8% of revenue. Net income was $16 million for the quarter, down 27% from the previous quarter and down 40% from the third quarter of 2012. Net income margin for the quarter was 4.2% compared to the 6% for the previous quarter and 8.1% in the third quarter of 2012.

Earnings per share came to $0.11 on a fully diluted basis in the quarter. Capital expenditures totaled $118 million for the quarter. Of this amount, we spent approximately $74 million on customer gear, $12 million on data center build-outs, $7 million on our office facility and $25 million in capitalized software development and other projects. Total server count increased to 101,967 in the quarter, up from 98,884 servers in the previous quarter.

Adjusted free cash flow for the quarter was $8 million. Return on capital was 8.0% in the third quarter compared to 11.9% in the prior quarter and 16% in the third quarter of 2012. Capital turnover in the third quarter slightly decreased to 1.89 from 1.93 in the prior quarter. Our returns are similarly being depressed while we invest ahead of our ambition to achieve higher growth rates.

This completes -- concludes the review of our third quarter results. Operator, please open up to the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We will go first to James Breen with William Blair.

James D. Breen - William Blair & Company L.L.C., Research Division

Just around the revenue trajectory. When I look at the guidance for the fourth quarter, it's the first time the guidance range has ticked up. We have 5% at the high end of the range. So it seems like you're seeing some form of re-acceleration there back toward that 20% level you targeted. What gives you confidence in that? What can you point to that's going well that makes you believe that the top end of that range is achievable now?

A. Lanham Napier

This is Lanham. I'll take this one. When we work on our guidance, we try to take into account everything we know about the business. The process we follow looks at what's going on in our existing customer base, it looks at what's going on in the market around us, it looks at what's happening internationally and new initiatives we have coming up. As we looked at it here recently to provide this guidance range, there are a few things that I'd highlight that are giving us confidence. I think the first is that we feel the results improving in our traditional Managed Hosting business. That when we look at the trajectory there, we see our pipeline rebuilding. We think things are firming up there based on some of the investments we made so we feel good about that dedicated business, that Managed Hosting business improving. As you look across that, I would say our churn is pretty darn stable. Historically, when you look at our company, churn will bounce around a little bit. When you look at the metrics we just published, it's pretty stable right now, so that's another thing that gives us confidence. We also believe that our cloud is advancing. When we look at the results we're delivering for customers, we believe the customer outcomes we're delivering are better today in the cloud than they were a year ago. We think the new performance server launch is the next advance in those customer outcomes that we generate. We like the traction that we are receiving at hybrid. In the prepared remarks, many of those examples were hybrid cloud customers utilizing multiple form factors here at Rackspace. So I guess, I'd say hybrid's got good traction and we like the product advances that we have. OpenStack just had a big summit last week over in Hong Kong. We've recently launched the Hadoop service here. We just launched Performance Servers, we're making additional investments in our products, in our Managed Hosting business. So I think we see things firming in managed hosting, we see improved results in our cloud and we believe we have more interesting offers and customer outcomes coming in the future, so that's why we're taking it up a little bit.

James D. Breen - William Blair & Company L.L.C., Research Division

Just on the cloud side of the equation, margins did come down a little bit as you led people to talk about in the second quarter call and you hired another 200-or-so employees this quarter. Just can you talk about the trends there? As revenue, you're setting up for that revenue growth, what's the reasoning?

A. Lanham Napier

Well, the way to -- this as Lanham again, by the way. The way to think about what we're doing right now as a company is that we are in an investment phase. The ultimate outcome of these investments is to accelerate our growth. We are making those investments ahead of the growth today. So as we look at our business internally, we go through the thought exercise we -- I just described on the forecast, the guidance itself here going forward. And then, we look at the investments we need to make to accelerate from there. If you look at our margins, what's driving it, it's all the investment that we're doing right now that's just -- the timing is such that it's coming ahead of the growth. If you look at the investments we made this year, we made investments around data centers, we've made investment in a compute platform, which we just launched here recently called Performance Servers. We've made investments in new offers that haven't yet launched. We've also made investment in human capital, which you referenced in the question with the people that we've hired. As we distill all that down, I think some of the hires we've made here, specifically in sales and marketing, with Rick Jackson and Todd Cione, we would -- those are having an impact on the company now. And we also think the offers and the investments we've made around the technology capability and the offers for customers are having an impact. And you see some of that in the -- you see that in the costs today, before we have all the growth from it. I think that, back to your previous question, the confidence we have and the visibility we have in the pipeline is making us feel better today about that guidance range. And what you're seeing in the cost bar that you're asking about now is really the aggregate impact of all those investments we've made. And now we're going to push real hard moving forward around the growth.

Operator

Our next question will come from Gray Powell with Wells Fargo.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Just a couple, if I may. So cloud revenue growth reaccelerated back to 9.5% sequentially, which was good to see. Can you talk about what the main driver was there? And just what needs to happen for cloud to get back to sort of the 10% to 12% quarter-over-quarter growth that we saw back in 2012?

A. Lanham Napier

The way you started the question, I thought you had a couple coming, is that the only one?

Gray Powell - Wells Fargo Securities, LLC, Research Division

Yes, I got another one, too, but I'll -- maybe I'll just go one at a time?

A. Lanham Napier

Just stage [ph] them out. Okay.

Gray Powell - Wells Fargo Securities, LLC, Research Division

If that's okay with you guys?

A. Lanham Napier

All right. Well, thank you, Jeff [ph]. Okay. So first, we'll deal with the cloud revenue growth rate. So I -- the question about what does it take to get back to 10% to 12%? What's causing the reacceleration? Here we are sitting at 9.5%, so I would say we're chipping away at it. I mean our mental attitude is we're going to keep pounding the rock. And the rock here, with respect to cloud growth, comes down to really a pretty simple thing. And that's the job we do for customers. When we look at the job we do for customers, we think there are a few areas there to go down: one is just a base infrastructure performance; and another is the value of the services that we put on top of the infrastructure. As we've discussed on prior calls, we've made investments in managed services like Managed Cloud. We -- on the last call, we talked about some of our DevOps thinking. These are examples of moving up the stack, which we continue to invest in, which will have a positive impact on that sequential growth rate that you just mentioned. The other thing we've done here recently with the performance servers launch is deepen the focus at the infrastructure layer itself in terms of the capability in the job they can do for customers. Specifically, we want the infrastructure to be able to run larger, more complicated workloads. Larger and more complicated workloads have a higher performance specification and tend to come in larger chunks, therefore, larger revenue. So that when we think about the job to be done by customers it's how do we improve that infrastructure and have it -- performance itself and how do we add more value in the service layer. Then we end up with targeting customers in particular segments where we can do great job. When we think about customer segments that we can do a great job, we think about people that value performance with respect to the infrastructure and the service. We talked about that in our prepared remarks. And we also look for those customers that are in a high-growth area. The customers we mentioned on the call today were all customers that are growing at a pretty darn good rate in their businesses. In our mind, if we get the job, if we do a great job for customers at the infrastructure and service level and we do a great job in the go-to-market around targeting customers with a high growth rate, we believe this is how we ultimately continue to drive higher and higher performance out of our cloud offer. The great news here is that we are playing in a category, in the cloud computing category, that's growing at a really fast rate, so it's on us to execute well. We've made some steps there, we just have more steps to go. So we love our position. Our confidence is increasing and we can see what we got to do, we just got to go do it. And it's a combination of doing the right job for customers and targeting customers that have a good growth rate themselves.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Got it. Okay. No, that makes sense. And you actually kind of hit on my second question. Specifically, can you just talk about the new high-performance server offering? What do you expect to see from initial customer demand standpoint? And is there even like a -- is there even a way to ballpark how it increases your adjustable market?

A. Lanham Napier

Well, sure. Let's talk about that a little bit. In terms of ball-parking the adjustable market, I think everybody here on the call or listening in that's going to review the transcript and everything is buying into the fact that the cloud is a big addressable market. I would say we have pretty high confidence on that dimension and that we are fishing in a pond with a whole lot of fish that we have a great opportunity ahead of us. When we think about the workloads and the type of performance that we get out of this offer and what customers should be doing it and how do we think about what customers will be taking this up, we had a pretty extensive and rigorous beta program with customers for this offering. And we specifically wanted to push and understand the dimensions around more complex, high-performance workloads. That's why we put it on our prepared remarks. If you go out to the website and you watch the video testimonials of some of the beta customers, you'll see in that, that they were running complex things. Historically, when we first launched our cloud, our cloud was great for very simple workloads in use cases. What held us up in winning some of these more -- these larger cloud customers was that the functionality and the performance just wasn't there in terms of getting the job done for customers who had more complicated requirements. Our open cloud launch started the work last year. We believe the Performance Server, where this year is the next step in that, as we do more DevOps services capability, that's another step in it. The great news here is that our market is dynamic and growing rapidly, so we have plenty of opportunity to rollout additional offers. What we are focused on is increasing our capability to serve more complex workloads with customers because they come with a higher ARPU, they come with a higher revenue upside, particularly when we target high-growth customer segments in the marketplace. So I would think what we're trying to do is skew to that edge of the market, where we have a bigger revenue opportunity because we're doing a better job for customers. They value what we bring between infrastructure and services. They want Fanatical Support and they have high growth requirements themselves.

Operator

Next, we'll hear here from Jonathan Schildkraut with Evercore.

Jonathan A. Schildkraut - Evercore Partners Inc., Research Division

Three questions. First, just in terms of the margin commentary from Karl. Karl, I think you said during your prepared remarks, you expected margins to be in the 30% range. But the last 2 quarters, you've sort of been in the 32% to 33% range. And so I just want to make sure I understand what you meant about the 30% range versus what we've seen over the last 2 quarters. The second question is just about new customer or revenue growth from new customers. It seems like you guys have done a really nice job sort of rebuilding the IBG pipeline, which has been a little weak -- was a little weak in the first quarter. But we also have seen revenue growth from new customers sort of slide down. I'm just trying to understand how those 2 dynamics play against each other. And then last quarter, you talked about a record number of new customer wins. I was wondering if we can get some color commentary. And then finally, just in terms of your prepared remarks today, you spent a lot of time really emphasizing the progress you've made in the hybrid cloud. And I'm wondering how far are we away from a point in time where you don't break out dedicated and cloud-based revenue because their solutions are reaching across both of those groups?

Karl Pichler

Okay. This is Karl. Let me take the first one around the way we think about margins. Thanks for the question. I think this is a good one iterating for everybody on the call. So basically, there are 2 things that are going on at the same time. One is, we're constantly working on making our core business more efficient. That is an ongoing operational requirement that we impose on ourselves. And then the funds that we generate through that are basically then available to us for reinvestment. And I think Lanham and -- through the prepared remarks, we have pointed what those investment areas are. When you boil it down to basically cost items, you're talking about headcount and data center infrastructure and equipment. Those are the 2 areas. And you can basically see through all the P&L and the key metrics how they -- how those investments are affecting those key metrics. So we have a underlying margin uplift from operating at a higher scale and from delivering margin in our core business. And then we take those dollars and more this year and basically fund those investment areas that we have done. So on the data center side, for example, we have built up more capacity. So our data center utilization has come down slightly. With those data center infrastructures, we have also invested into launch capital to launch performance cloud all over the place in Europe and in the U.S. U.S. already launched. Europe will launch in the next couple of days. And thereafter, we're going to launch Hong Kong and Sydney as well. So all of these are the investments that Lanham referred to that are being made ahead of the revenue. And that's why you see these aberrations in the margin. And when we say 30% minimum, what we simply mean is that even if we are super opportunistic and fund everything that is interesting to us, we still believe that we have enough power in the underlying model to fund everything that we want at a minimum margin of 30%. That doesn't mean that we just go out and spend it and that's why we have the -- why we're floating right now at around 32%.

A. Lanham Napier

All right. So let's talk about progress in the hybrid cloud and revenue growth from new customers. With respect to the revenue growth from new customers, I would just say it's sequential when we phase things around here. In your question, Jonathan, you referenced the IBG, you mentioned how that's improved. We had a low point of that earlier this year and we've rebounded nicely from that. Clearly, we made IBG and existing customers a big focus because that's today's work. Ultimately, the growth of the company going forward is driven as more by the base today than it is by tomorrow's acquisition of a single customer. Up to this point, we've done that work, appreciate you recognizing that in the metrics. And now the work that we're talking about in terms of further acceleration, there is a lot of acquisition efforts in there. I would just say we're getting to that now. This is where, in my remarks earlier, I talked about the addition of Todd Cione and Rick Jackson, some other folks we've hired into our sales and marketing efforts. We have acquisition on our mind now. First things first was just the installed base. Now, we're doing more acquisition. We believe we have a lot of room for improvement in there and therefore, a whole lot of opportunity to help ourselves. The last question you had was around progress in the hybrid cloud and at what point do the metrics here really blur between single-tenant and multi-tenant architecture and form factors. Great observation. I mean, we're getting there. It's something we've wrestled with internally about when we should think about changing those metrics or how we would communicate with people. I don't think we've arrived there yet, but as the business progresses, we can all envision a world where through a control panel or a series of commands, customers call on single-tenant and multi-tenant architecture, particularly when you think about these customers running large, complex workloads. I mean, these people are running large workloads like that, they want to tap into different forms of architecture based on providing the best fit for their application performance. With this in mind, it gets really hard to think about classifying revenue at a customer level when they use the form factors and how should we do that. Up to this point in our development, people tend to use vast majority one way or the other today. Going forward, at some point in time, I think that's much more of a mix. When it's more of a mix, we have to figure out how we want to convey that to investors, so you guys can understand the results of the company, know where we're headed and understand how we're performing. I think that will be a conversation for future periods. I don't think it's something we have to delve into deeply today because, right now, the metrics today hold pretty well.

Operator

Next we'll hear from Simon Flannery with Morgan Stanley.

Lisa Lam - Morgan Stanley, Research Division

This is Lisa for Simon. Can we talk a little bit more about your CapEx with how you're seeing that for the remainder of the year? I know that CapEx this quarter ticked up a bit relative to -- with previous 2 quarters.

Karl Pichler

Yes, absolutely. This is Karl. So we have talked about this capital investment for the year, throughout the year. And we have shared with you the CapEx range in the past. And we will come in above the high end of the range. We will probably spend around $460 million to $510 million on total CapEx for the year, all-inclusive. That's year-to-date including the fourth quarter. And we basically have deviations on the high end for 2 reasons. They are on the customer gear side on the DC build-out gear -- on the DC build-out side, and it's all related to the investment areas that we've talked about. There are a couple of outliers that are worth mentioning. One, we bought a piece of land in the U.K. that is adjacent to the piece of land on which Digital will build our data center, and we've acquired that land for flexibility and optionality purposes. That's north of $10 million acquisition of land. And we have also spent more than we originally anticipated on accelerating and globalizing the launch of our performance cloud, which had additional capital requirements on the equipment side and on the data center upgrade side. And those are the main drivers why we're above the range. On the office build-out and software and other, we're exactly checking -- tracking along the original plans.

Operator

Next, we'll go to Kash Rangan with Merrill Lynch.

Kash G. Rangan - BofA Merrill Lynch, Research Division

And Karl, this goes back to several years back, at the time of the IPO. We talked about the return on capital as a very important yardstick for the company. Curious to get your thoughts on where do you think we should be thinking about your return on capital as your target as we emerge from this investment cycle? Since I remember that for quite some time, with your return on capital accelerating, you're able to grow the business sustainably at a higher pace. But if the return on capital were to go in the other direction, I would imagine that it takes a lot more capital to reaccelerate your revenue growth. So I guess, the question for you is where do we get that acceptable cutoff point where your return on capital can start to expand that will allow the company to grow without diluting its margins? Sorry for the financial question, but that's all I had.

Karl Pichler

Sure. Okay, so I think it's worthwhile distinguishing between 2 things. One is the economics on a unit perspective and then the economics on a company perspective. The economics on the unit perspective continue to be very healthy. That is where all the analytical discipline goes into and where operationally we're executing along that discipline. And we are very confident that in all our product categories, whether they're growing very fast or very modestly, that they are generating healthy economics. And when I say healthy economics, what I specifically mean, given that you're asking a finance question, a return profile that clearly covers any hurdle rates that we are applying ourselves. And so that is kind of the economic engine that drives the business. And my remark before, too, that we have uplift in our margin structure from our core business is related to that, is that we have those unit economics that are very powerful and that we're managing those very, very carefully and deliberately. Then the second piece is what do you do with those excess returns and how much do you take and reinvest in the business? And if you look at our last 5 years, if you want to take the long-term view, what you've seen is that we have invested along the way, all the time and have filled the business and have grown the business quite substantially. And this is kind of the first year really, if you take that long-term view, where we've invested more than the underlying business has generated. And this is drives -- this is what drives the wedge between the corporate economics and the unit economics and basically takes those margins and returns down. If you decompose the return differentials, they are really to 80% due to the changes that happens in the margin. If you take the margin, it all happens in the area of really headcount and people-related cost that is largely attributable to building the product, development capabilities that we focused on over the last 12 to 18 months. And then the small impact you have on the capital earned side is all around infrastructure deployments and investments that we make there. You can also see that our utilization metrics, for example, they fluctuate a little bit. This year, they were a little bit down. From a watt perspective, from the Key Metrics table at the very bottom, and that is another indicator that we're investing ahead of our revenue, which is driving the overall turns perspective down. All of this infrastructure that is deployed, that does not provide revenue yet and, therefore, depresses turns and margins, is revenue capacity. So as soon as that infrastructure gets monetized, we will basically have a very high flow-through, i.e. incremental revenue without any incremental cost.

Operator

Next, we'll hear from Tim Horan with Oppenheimer.

Timothy K. Horan - Oppenheimer & Co. Inc., Research Division

When do you expect that flow-through to really start kicking on the revenue front? Obviously, it's a good quarter, but you are obviously adding a huge amount of capacity in the front of that. Is this kind of a year out, is it a quarter out? Just a little color on there would be great. And then maybe what do you think the main kind of customer bottleneck is at this point or why are -- why they're waiting to adopt? And then lastly, can you just talk about what you're paying on a per megawatt basis on the data center side? Is that changing all that much? Is it going up and squeezing margins? Is it going down?

A. Lanham Napier

This is Lanham. I'll start with the first couple and then Karl can address the dollar-per-megawatt question that you had. In terms of the -- I would categorize your question really around when is it going to accelerate, how's that acceleration going to take place, what's holding you back and that leads to flow-through timing and customer bottleneck question, et cetera. As we think about it, we're sitting here today and we think that Q4 is going to be higher in terms of sequential growth for the first time in a year. That basically, with our guidance range that we set forth, we feel like we're taking the first good step here. What's led to this has been a lot of work on the product side, which we've covered in the call, and some work on the sales and marketing side, which we've covered in the call. I think to continue the progress, we set to keep that work going. The first half of this year was characterized with the product work we were doing and getting the right people on the bus and some of these sales and marketing moves that we've made. We've now done that, so now it's more about accelerating that activity and getting it to work. With respect to customer behavior and any bottlenecks we see, some of the bottlenecks we've seen, I touched on earlier about our ability to run more complex, larger workloads. When you envision Rackspace running some of the largest web properties in our cloud, up until recently, we really weren't able to do that super effectively. And I think now our hybrid capability repositions us. And this is why we have some of the wins we talked about on the call earlier today. I believe one win begets another, that it takes a little bit of time and as we continue to execute, you'll see us do this faster than we have up to this point. But there are still plenty of work to do. So I see it as there's product and service work that we've done a lot and we'll continue to do a lot more. There's go-to-market work, which we have done for the base. We have more work to do on the base and we have more opportunity in the marketplace with new customers. As we do that work, I think you'll see customer adoption increase. We become more relevant to our customers, we can do a better job for customers, the volume of Fanatical Support increases as we move up the stack. So I think all of these things enhance our chances and give us a better opportunity. I'd also add to that, our viewpoint here is a long-term view. When Karl talks about the investments that we want to make, we think we have a tiger by the tail here that we are operating at the intersection of some incredible opportunities in tech; that cloud computing's changing the world and we feel blessed to have the opportunity to participate in that, as you may have [ph] built out this platform. And therefore, we want to make the investments that build long-term power for the company; we want to prove it to you on a short-term basis. We believe the first step here with Q4 guidance increasing is that we're demonstrating to you that the investments we made earlier this year are starting to bear fruit. We have other long-term investments that we think will bear fruit later on. That's how I would incorporate the -- your first 2 questions that we see the opportunity, we're doing the work. We just have to keep after it. Karl, why don't you address the...?

Karl Pichler

Yes, let me take a stab at addressing the other question. I think it's probably time to reeducate a little bit on what our data center strategy has in terms of implications on the cost structure. So I think, traditionally, what we've had is we've taken on a piece of data center or a fit data center facility and we had an initial fit-out that basically allowed us to take this facility live. And this was traditionally in the range of $3 million to $5 million in terms of initial CapEx over and above the simple data center electricity kind of environment with cooling and power and connectivity. So what has happened over time, obviously, is that we have done 2 things. One is we have focused on operating larger and larger facilities. So most notably in the U.S., we're building out more and more facilities, which means that the build-out comes with different economics, not in these millions of megawatts chunks. And then at the same time, we went from a lease and build-out ourselves -- to a basically, to wholesale lease caller model, which is much better for us as a company. And so I think the simple rules of thumb, they just don't apply anymore. We basically, when you want to study our data center economics, you would have to look at the DC cost elements that are flowing through the P&L and in the cost of revenue section with respect to the rent. And then you have the capital that's associated with the DC build-outs that we break out as a category as well. And that gives you the complete cost picture in terms of what we incur. And you have the megawattage as well listed on the key metrics, so you can infer look at it how you want. Obviously, as a company, our goal is by partnering with the right partners and by operating at the largest scale in concentrated and specialized facilities that we bring the TCO down over time as in relation to the megawatts or the revenue that we generate against it.

Operator

We'll hear next with Pat Walravens with JMP Securities.

Patrick D. Walravens - JMP Securities LLC, Research Division

Lanham, I was surprised to see that Dedicated Cloud decelerates just 1.2%, and I think some investors probably are, too. Can you just provide some deeper perspective as to the challenges that you're facing there?

A. Lanham Napier

Sure. Thanks for the question, Pat. Yes, I don't -- I wouldn't characterize it as deeper challenges so much as we feel like we have good visibility there and we see the pipeline rebuilding. There's a longer sales cycle on these deals. They tend to skew more enterprise in nature. I think we've touched on that in prior calls. So where we sit today, it's a matter of the net upgrades and what are we doing to accelerate net upgrades in that business. We've made the sales and marketing investments in terms of human capital. We are also make -- rolling out the sales and marketing investments in terms of programs and account management for those customers. So I guess, to give you more color around the challenges, the challenges we've had up to this point are getting all those things in place. We haven't -- we just didn't have all that in place earlier this year. And I think what you're seeing here in Q3 is the low point in that business for the year. And when we talked about it on calls earlier, we said we were getting to work on it, but we didn't have near-term acceleration there. And I think now we're at the point where when we look at our guidance range going forward, we are feeling better about that business. And that's contributing to that range changing. Why do we feel better about the business? It's really a result of the investments we've made, the sales and marketing investments on the human capital and program side. There's also an investment that we've made on some product work over there. We talked about hybrid traction. And hybrid does have a drag-along effect with dedicated gear as we make that business move more cloud-like, if we can use that term. I just think that we are now feeling better about it and that we worked really hard the first half of the year to get that turned around. And we have pretty good visibility in that business. And today, we're feeling better about the growth of that business here over the next 90 days.

Operator

Our next question comes from Frank Louthan with Raymond James.

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

Just a couple of quick questions. First, on the longer-term vision of the business, as hybrid cloud's become much more of a focus than, I think, was sort of the original thought or intention, has that changed the long-term trajectory of your CapEx and play any -- into the return on capital discussion from earlier? And then, I'm looking at the new heads of sales and marketing, any -- can you be more specific about what sort of changes you may have made in the last few months to your sales team and some of the maybe -- maybe some of the process you're executing on trying to get the sales force revamped?

A. Lanham Napier

Yes, sure. This is Lanham again. So when you think about the business model with hybrid cloud, the value prop here is really about providing best fit application performance for customers. And hybrid is really powerful there. Our ability to integrate single-tenant and multi-tenant resources is pretty darn unique in the marketplace and provides a better application performance than either one of those resources on their own. A lot of the customer examples we provided to you this year basically demonstrate that performance attribute to the customers. The next thing to talk about then is, okay, given outcome for customers, what's the economic outcome for Rackspace stockholders? I think that what we're seeing and what we believe will continue is that hybrid cloud positions us to handle larger, more complex workloads. And with larger, more complex workloads, there tends to be a higher SLA, a higher service content -- higher service requirement rather, for those applications. And because it is a bigger, more valuable bundle, the Rackspace business model is better with those customers. And we have an opportunity to capture more margin and create more value with a larger complex workload that has a high service level and infrastructure performance requirement than we can a simple workload like a blog. All right. When there's more at stake for a customer, when things are more mission-critical, customers will set the bar on a higher performance level, we can add more value in that level. And because we're integrating these different form factors, we can capture that value and just deliver better outcome for customers and have pretty darn good economics for ourselves. When we look at the microeconomics, which Karl touched on earlier, we believe hybrid cloud positions us very well to capture these economics going forward. If you take the view that Karl talked about, a 5-year view of our company's economic model, you can see how we've demonstrated a really good ability to drive margin up. And as we drive margin up, return on capital follows. We're in an investment cycle right now where we've deliberately pushed margin down to fund for these investments. Earlier on the call, we had a question about, well you were saying -- I think it's from Jonathan Schildkraut, we were saying 30%, the numbers are coming closer to 32%. How do we think about that? I thought Karl had a wonderful answer on that, in that we've got pretty darn good control over the investments we're making. We're thoughtful about those investments. Now not all those investments are going to pay off like we think. We do not bat a thousand around here. But we are very thoughtful about these investments and we believe the investments position us for the great long-term growth. We think we've demonstrated our ability in the past to increase margin and we believe we can do it again. Right now we're in a phase where, man, we see an incredible opportunity coming our way. We have excellent investment opportunities around our hybrid cloud portfolio to drive better outcomes for customers, so we want to go do that stuff. And we're happy to describe microeconomics for investors so that they can get a comfort level in what we're doing and how to assess our improvement. It's just right now we think it's go time. We think the market is forming, that we're uniquely positioned with hybrid. So we want to make those investments going forward. I think that as you evaluate the business model there and what happens with the return on capital, right now our capital turns are still pretty close to where they were a year ago, the difference is margin. And we've demonstrated an ability to control margin going forward. Does that help you with that?

Frank G. Louthan - Raymond James & Associates, Inc., Research Division

That's great. And any thoughts on changes with the sales force in that direction?

A. Lanham Napier

Sure. I think that -- let's just break them down here a little bit. With Rick Jackson joining us as Chief Marketing Officer, he was prior -- prior to Rackspace, he was Chief Marketing Officer at VMware. I think Rick brings a enterprise understanding to us that our company didn't have prior to his arrival. I think he also has a marketing focus and thought process around hitting the right segments in the marketplace that's superior to what we had before his arrival. So I think that's one thing that's happened in our thinking around here. And I referenced this earlier in our remarks and I talked about high-growth customer segments, combining that thinking with some of our product offer thinking, a lot of that's really Rick's voice. I'm just taking credit for it here on this call, all right? So that's what I would say is happening in marketing resource and he's just -- in our marketing thinking rather. And Rick's just -- Rick's talented. He has enterprise perspective that's superior to what our company had before his arrival. I think Todd Cione brings an enterprise perspective -- who's leading sales based on his experience at Microsoft. And he also brings a nuts-and-bolts sales force understanding that's excellent as well. And I think what Todd's doing in the sales force is just getting people aligned and focused around customer targets, around specific offers in the marketplace and increasing our game from an account management point of view in the sales process with these customers whether they're in the installed base or in the acquisition side of things. Earlier, we talked about our progress in installed base. I think we're feeling good there, but we also have upside in that number. And I think we have a lot of upside in our acquisition number right now. So I think that's some of the stuff that's changing. It's a focus change, it's a depth of understanding change, it's a customer segmentation change, it's an organizational and execution change across our sales and marketing teams today.

Operator

And with that, we are out of time for today. We will take our final question from Colby Synesael with Cowen and Company.

Colby Synesael - Cowen and Company, LLC, Research Division

I have 2. One, as it relates to hybrid, it seems like the focus is obviously in that area but it's just taking a little bit to show up in the numbers. Is there anything that you could do to help accelerate the on-boarding, such as providing some type of framework that can be used from customer to customer to help in that direction? And then the second question just have to do with seasonality. Can you remind us how much seasonality you typically see in the business? And how much, if any of that, is reflected in the fourth quarter guidance?

A. Lanham Napier

Okay, this is Lanham. I'll take the first one and then Karl to the -- for the second one. With the question around what can we do to accelerate customer adoption? Is there a framework that we can utilize to help customers along the path. We are investing in lots of these areas. If you -- I'll give an example. If you go out to our developers on Rackspace.com site, we're talking to developers about best practice ways to use our OpenStack power cloud. Yes, and there's a framework and a reference architecture out there to do that. When we're talking about complex web apps and workloads and how they can utilize our infrastructure through our SE efforts, we are providing best practices and reference architectures around how customers can utilize our infrastructure and make this happen sooner and make it easier for them to adopt what we're doing. The way we think about it is it's our job to deliver incredible outcomes for customers, that's job #1. And we've got to get them to a point where it's easy for them to do that. Now as we roll out these new products, we have a documentation strategy with that. We have a communication strategy with it. We update the way our SEs interact with customers. We update our training for our reps and account managers around the company. We'll continue to do all this stuff because obviously, a big part of our job to help humanity and customers go through these technology shift is to educate them on the possibilities of it. Therefore, a lot of our investments are about how do we educate them on how to use these things. It's exactly, I think, the guts of your question around what framework and how do we help people accelerate the decisions. We're doing that, we're not doing it perfectly but we're doing some really good stuff and I think we'll invest more in it to keep it going. Karl, why don't you take the last one?

Karl Pichler

Yes, sure. On the seasonality, there is a, certainly, from an activity standpoint, we do see seasonality around December and January. Traditionally, if you look at the numbers, I think, the Q3 and Q4 quarters have traditionally been stronger than the first half of the year. Last year, for example, our Q4 quarter was actually a little bit slower than our Q3 quarter from a sequential growth perspective. So sometimes, you see the seasonality if it's affecting December to kind of affect a little bit to the Q4 number. And as far as what we know, based on what we know, we factored in everything that, as Lanham mentioned, into the guidance range. But the real impact, if any, of true seasonality year-end cycle is really going to be in our first quarter number. And we will certainly talk about that in our next call in February and factor it into the guidance then.

Operator

And with that, gentlemen, I'd like to turn the call back over to you for any final and closing remarks.

A. Lanham Napier

Okay. This is Lanham. I want to thank everybody for tuning in. Today also happens to be Veteran's Day. We have a number of Rackers that have served in the Armed Forces. And we want to thank the Rackers for their service and for all our other active armed service members today. Thank you for what you're doing. We've got a lot of work here at Rackspace, building out this hybrid cloud and high performance, so we're going to get back to work. Thank you.

Karl Pichler

Thank you.

Operator

And with that, ladies and gentlemen, once again, that does conclude today's call. Thank you for your participation and have a great day.

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