Rackspace Hosting, Inc. Earnings: Incremental Improvements

By Anders BylundMarketsFool.com

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Rackspace (NYSE: RAX) reported second-quarter results on Monday night. At the same time, the cloud computing specialist also announced the sale of its Cloud Sites operations to privately held Liquid Web.

Let's dig into these important news items together.

Rackspace's Q2 results: The raw numbers

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Data source: Rackspace. YOY = year over year.

What happened with Rackspace this quarter?

The company is tightening all sorts of nuts and bolts these days. The changes may seem mundane at a glance, but they add up to a solid business trend:

  • Sales increased 8.2% year over year on a constant currency basis. Take that currency-adjusted figure and back out the effect of recent business line spin-offs, and the revenue gain rises to 8.9%.
  • The average revenue per Rackspace-managed server now stands at $1,513 per month, up 7% from $1,416 per month a year earlier.
  • Rackspace's transition away from hosted services and into providing high-quality support for other cloud platforms is making a big difference to the company's cash costs. Capital expenses fell 46% year over year, and cash spent on customer gear plunged 60% lower. As a result, free cash flows multiplied many times over, rising from $18.2 million to $161.5 million.

Management provided guidance ranges for the third quarter and full year of 2016. The midpoints of these ranges were as follows:

  • Revenue should stop at roughly $513 million in the third quarter, a mere 1% increase over the year-ago period. Adjusted for divestitures and currency effects, sales growth should be approximately 6%.
  • For the full year, sales are seen rising 7% when adjusted for the same items as the third-quarter forecast, landing at $2.07 billion.
  • Adjusted EBITDA profit margins are expected to stop near 34%, and capital expenses should work out to 17% of revenues for the full year.

What management had to say

Rackspace CEO Taylor Rhodes underscored strong client demand for the company's trademarked Fanatical Support services, where the company offers paid technical support for cloud platforms hosted by Microsoft (NASDAQ: MSFT), Amazon.com (NASDAQ: AMZN), and others:

Microsft Azure and Amazon's AWS do sell their own support packages for their market-leading cloud services, but even these technology titans don't necessarily measure up to the street cred of Rackspace's award-winning alternative. It's a win-win-win for everyone involved; as end users walk away with top-notch support, Amazon and Microsoft can step away from this niche to focus on other opportunities, and Rackspace can explore its own unique market.

RAX Return on Capital Employed (TTM) data by YCharts.

Looking ahead

The Cloud Sites sale is not going to move mountains. The unit and the sale price were small enough that neither the press release nor Rackspace's SEC filings provided real numbers. When the deal closes in the third quarter, it won't cause any significant changes to Rackspace's top or bottom lines.

Meanwhile, Rackspace is becoming a leaner and meaner competitor by shedding less-important business units. Return on assets increased from 6.4% in the year-ago quarter to 7.1% in this report, and return on capital rose from 11.8% to 16.4%.

As a Rackspace shareholder myself, I find these management efficiency trends reassuring. Both of the highlighted metrics still have a long way to go before healing the damage done in 2013 and 2014, when the support service shift started in earnest. Still, things are moving in the right direction.

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Anders Bylund owns shares of Rackspace Hosting. The Motley Fool owns shares of and recommends Amazon.com. The Fool also owns shares of Microsoft. Finally, the Fool recommends Rackspace Hosting. Try any of our Foolish newsletter services free for 30 days.

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