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OpenStack Journal Authors: Liz McMillan, Elizabeth White, Blue Box Blog, Esmeralda Swartz, Lori MacVittie

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Rackspace Hosting Reports Fourth Quarter 2012 Results

Rackspace® Hosting, Inc. (NYSE: RAX), the open cloud company, announced financial results for the quarter ended December 31, 2012.

Net revenue for the fourth quarter of 2012 was $353 million, up 5.0% from the previous quarter and 25% from the fourth quarter of 2011. Net revenue for the fourth quarter of 2012 was positively impacted by currency exchange rates when compared to the fourth quarter of 2011 by $1.8 million and positively impacted when compared to the previous quarter by $1.4 million.

Total server count increased to 90,524, up from 89,051 servers at the end of the previous quarter, and total customers increased to 205,538, up from 197,635 at the end of the previous quarter.

“We are very pleased with the financial results we have delivered in 2012. Even more importantly, we are excited about the growth opportunities that our new set of open cloud products will provide us in the future,” said Karl Pichler, chief financial officer.

Adjusted EBITDA for the quarter was $130 million, a 6.6% increase compared to the third quarter of 2012 and a 27% increase compared to the fourth quarter of 2011. The adjusted EBITDA margin for the quarter was 36.8% compared to 36.2% in the previous quarter and 36.1% for the fourth quarter of 2011.

Consistent with prior periods, adjusted EBITDA and adjusted EBITDA margin were negatively impacted by a non-cash charge relating to data center operating leases. During the fourth quarter of 2012, the non-cash data center lease charge was $2.9 million.

Net income was $30 million for the quarter, up 10.0% from the previous quarter and up 19% from the fourth quarter of 2011. Net income margin for the quarter was 8.5% compared to 8.1% for the previous quarter and 8.8% in the fourth quarter of 2011.

Cash flow from operating activities was $121 million for the fourth quarter of 2012. Capital expenditures were $88 million, including $60 million for purchases of customer gear, $8 million for data center build outs, $2 million for office build outs and $18 million for capitalized software and other projects.

Adjusted free cash flow(1) for the quarter was $39 million. Return on capital(1) improved to 16.9% in the fourth quarter, compared to 16.0% in the prior quarter and 17.2% in the fourth quarter of 2011. Average monthly revenue per server grew for the fourteenth consecutive quarter to $1,310 from $1,287 in the prior quarter and $1,191 in the fourth quarter of 2011.

At the end of the fourth quarter of 2012, cash and cash equivalents were $292 million, and debt including capital lease obligations totaled $125 million.

On a worldwide basis, Rackspace employed 4,852 Rackers as of December 31, 2012, up from 4,596 in the previous quarter.

“During 2012 we made significant investments across the business to bolster our systems, products, and service delivery capabilities. One of the most important projects we completed in 2012 was the launch of our Open Cloud platform,” said Lanham Napier, chief executive officer.

Rackspace Developments and Business Highlights

  • Rackspace was featured at #34 on FORTUNE Magazine’s “100 Best Companies to Work For” List. This is Rackspace’s fifth time in six years making the list. We were chosen for enhanced pay and leave practices, all while preserving and improving the company’s unique culture, even during growth.
  • Rackspace also enhanced its service offerings for its open cloud platform through Managed and Critical Application Services. Critical Application Services allows companies to focus on their core business while Rackspace keeps their vital applications running smoothly. Rackspace’s Managed Cloud Services became available for seven new products launched during the year as part of the open cloud platform. It offers customers access to a team that can help them plan, deploy, and run websites or applications on the Rackspace open cloud.
  • Rackspace also improved its SharePoint Services, offering a complete end-to-end SharePoint solution that provides design, development, support and training services.
  • Rackspace announced a strategic agreement with Hortonworks, a leader in Apache Hadoop development, implementation, support, operations and training, to empower customers with an enterprise-ready Hadoop platform that is easy to use in the Cloud. Together, Rackspace and Hortonworks will focus on eliminating the complexities that are required for implementing a Big Data solution. The joint effort will pursue an OpenStack-based Hadoop solution for the public and private cloud, which can easily be deployed in minutes.
  • Rackspace expanded its OpenStack® training offering by launching the industry’s first certification program for the open source cloud computing software. Since launching the program for OpenStack in 2011, Rackspace has trained hundreds of students across North America, Europe, Asia, Africa and Australia. Rackspace currently offers a variety of public and private classes in which students learn how to use and operate OpenStack technology both in a public and private cloud environment.
  • Rackspace won the prestigious UK Customer Experience Award for IT & Telecoms. Rackspace was recognized as an outstanding leader among organizations that place customer service at the forefront of their commercial operation, which Rackspace delivers through a service approach we refer to as Fanatical Support®.

Conference Call and Webcast

Management will host a conference call to discuss the results starting today at 4:30 p.m. ET.

To access the conference call, please dial 888-857-6932 from the United States and Canada or dial 719-325-2352 from abroad and reference pass code 9729354. A live webcast and a replay of the conference call will be available on Rackspace's website, located at http://ir.rackspace.com.

About Rackspace Hosting

Rackspace® Hosting (NYSE: RAX) is the open cloud company, delivering open technologies and powering more than 200,000 customers worldwide. Rackspace provides its renowned Fanatical Support® across a portfolio of IT products, including Public Cloud, Private Cloud, Hybrid Hosting and Dedicated Hosting. The company offers choice, flexibility and freedom from vendor lock-in. Rackspace has been recognized by Bloomberg BusinessWeek as a Top 100 Performing Technology Company and was featured on Fortune's list of 100 Best Companies to Work For. Rackspace was positioned in the Leaders Quadrant by Gartner Inc. in the “2011 Magic Quadrant for Managed Hosting.” Rackspace is headquartered in San Antonio with offices and data centers around the world. For more information, visit www.rackspace.com.

Forward Looking Statements

This press release contains forward-looking statements that involve risks, uncertainties and assumptions. If such risks or uncertainties materialize or such assumptions prove incorrect, the results of Rackspace Hosting could differ materially from those expressed or implied by such forward-looking statements and assumptions. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including any statements concerning expected operational and financial results, long-term investment strategies, growth plans, expected results from the integration of technologies and acquired businesses, the performance or market share relating to products and services; any statements of expectation or belief; and any statements or assumptions underlying any of the foregoing. Risks, uncertainties and assumptions include infrastructure failures, the deterioration of economic conditions or fluctuations, disruptions, instability or downturns in the economy, the effectiveness of managing company growth, technological and competitive factors, regulatory factors, and other risks that are described in Rackspace Hosting's Form 10-Q for the quarter ended September 30, 2012, filed with the SEC on November 7, 2012, and in Rackspace Hosting's Form 10-K for the year ended December 31, 2012, expected to be filed by March 1, 2013. Except as required by law, Rackspace Hosting assumes no obligation to update these forward-looking statements publicly or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

       

Consolidated Statements of Income

 
Three Months Ended Year Ended
(Unaudited)       (Unaudited)
(In thousands, except per share data)

December 31,
2011

   

September 30,
2012

   

December 31,
2012

December 31,
2011

December 31,
2012

Net revenue $ 283,261 $ 335,985 $ 352,909 $ 1,025,064 $ 1,309,239
Costs and expenses:
Cost of revenue 82,851 94,731 95,456 309,095 367,479
Sales and marketing 33,452 38,924 41,069 126,505 158,108
General and administrative 72,349 93,028 97,847 270,581 361,066
Depreciation and amortization 54,844   63,972   68,914   195,412   249,845  
Total costs and expenses 243,496   290,655   303,286   901,593   1,136,498  
Income from operations 39,765   45,330   49,623   123,471   172,741  
Other income (expense):
Interest expense (1,304 ) (1,253 ) (991 ) (5,848 ) (4,749 )
Interest and other income (expense) (226 ) 38   245   (1,194 ) 15  
Total other income (expense) (1,530 ) (1,215 ) (746 ) (7,042 ) (4,734 )
Income before income taxes 38,235 44,115 48,877 116,429 168,007
Income taxes 13,188   16,918   18,970   40,018   62,589  
Net income $ 25,047   $ 27,197   $ 29,907   $ 76,411   $ 105,418  
 
Net income per share
Basic $ 0.19   $ 0.20   $ 0.22   $ 0.59   $ 0.78  
Diluted $ 0.18   $ 0.19   $ 0.21   $ 0.55   $ 0.75  
 
Weighted average number of shares outstanding
Basic 131,423   135,946   137,055   129,922   135,279  
Diluted 138,912   141,474   142,549   138,064   141,265  
       

Consolidated Balance Sheets

 
(In thousands) December 31, 2011 December 31, 2012
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 159,856 $ 292,061
Accounts receivable, net of allowance for doubtful accounts and customer credits of $3,420 as of December 31, 2011 and $4,236 as of December 31, 2012 68,709 92,834
Deferred income taxes 9,841 10,320
Prepaid expenses 22,006 25,195
Other current assets 2,953   4,835  
Total current assets 263,365 425,245
 
Property and equipment, net 627,490 724,985
Goodwill 59,993 68,742
Intangible assets, net 26,034 23,802
Other non-current assets 49,600   52,777  
Total assets $ 1,026,482   $ 1,295,551  
 
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 156,004 $ 175,128
Current portion of deferred revenue 14,835 17,265
Current portion of obligations under capital leases 66,031 61,302
Current portion of debt 879   1,744  
Total current liabilities 237,749 255,439
 
Non-current deferred revenue 3,446 3,695
Non-current obligations under capital leases 72,216 60,335
Non-current debt 1,991
Non-current deferred income taxes 68,781 71,081
Non-current deferred rent 23,343 32,293
Other non-current liabilities 21,524   27,070  
Total liabilities 427,059 451,904
 
COMMITMENTS AND CONTINGENCIES
 
Stockholders' equity:
Common stock 132 138
Additional paid-in capital 383,031 515,188
Accumulated other comprehensive loss (14,732 ) (8,089 )
Retained earnings 230,992   336,410  
Total stockholders’ equity 599,423   843,647  
Total liabilities and stockholders’ equity $ 1,026,482   $ 1,295,551  
       

Consolidated Statements of Cash Flows

 
Three Months Ended Year Ended
(Unaudited)       (Unaudited)
(in thousands)

December 31,
2011

   

September 30,
2012

   

December 31,
2012

December 31,
2011

December 31,
2012

Cash Flows From Operating Activities
Net income $ 25,047 $ 27,197 $ 29,907 $ 76,411 $ 105,418
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization 54,844 63,972 68,914 195,412 249,845
Loss on disposal of equipment, net (110 ) 597 624 247 1,586
Provision for bad debts and customer credits 1,451 1,426 1,741 5,913 6,300
Deferred income taxes 4,802 1,120 (4,568 ) 13,991 (775 )
Deferred rent 1,200 2,279 2,930 9,471 9,259
Share-based compensation expense 7,585 12,418 11,244 28,773 41,546
Excess tax benefits from share-based compensation arrangements (8,711 ) (5,145 ) (11,065 ) (20,627 ) (46,046 )
Changes in certain assets and liabilities
Accounts receivable (9,442 ) (9,789 ) (162 ) (26,805 ) (29,265 )
Income taxes receivable 4,397
Prepaid expenses and other current assets 7,494 (18,910 ) 6,127 (2,597 ) (4,903 )
Accounts payable and accrued expenses 15,626 25,027 15,062 38,886 66,268
Deferred revenue 614 (997 ) 2,477 (482 ) 2,185
All other operating activities 888   (190 ) (2,443 ) 1,405   (1,919 )
Net cash provided by operating activities 101,288 99,005 120,788 324,395 399,499
 
Cash Flows From Investing Activities
Purchases of property and equipment (63,385 ) (53,449 ) (82,919 ) (251,214 ) (270,374 )
Acquisitions, net of cash acquired (5,233 ) (952 ) (5,945 )
All other investing activities 63   3   56   168   98  
Net cash used in investing activities (63,322 ) (58,679 ) (82,863 ) (251,998 ) (276,221 )
 
Cash Flows From Financing Activities
Principal payments of capital leases (16,924 ) (17,928 ) (22,958 ) (65,778 ) (75,928 )
Principal payments of notes payable (437 ) (1,032 ) (51 ) (1,913 ) (1,962 )
Payments for debt issuance costs (1,114 )
Payments for deferred acquisition obligations (2,399 ) (1,450 ) (5,299 ) (6,176 )
Proceeds from notes payable 691 691
Receipt of Texas Enterprise Fund Grant 3,500
Proceeds from employee stock plans 8,505 13,671 9,770 36,287 41,284
Excess tax benefits from share-based compensation arrangements 8,711   5,145   11,065   20,627   46,046  
Net cash provided by (used in) financing activities (2,544 ) 547 (3,624 ) (17,190 ) 7,455
 
Effect of exchange rate changes on cash and cash equivalents (246 ) 1,330 109 (292 ) 1,472
         
Increase in cash and cash equivalents 35,176 42,203 34,410 54,915 132,205
Cash and cash equivalents, beginning of period 124,680   215,448   257,651   104,941   159,856  
Cash and cash equivalents, end of period $ 159,856   $ 257,651   $ 292,061   $ 159,856   $ 292,061  
 
Supplemental cash flow information:

Non-cash purchases of property and equipment

$ 15,970 $ 31,934 $ 5,096 $ 93,680 $ 67,308
     

Key Metrics - Quarter to Date

(Unaudited)

 
Three Months Ended
(Dollar amounts in thousands, except average monthly revenue per server)

December 31,
2011

   

March 31,
2012

   

June 30,
2012

   

September 30,
2012

   

December 31,
2012

Growth
Dedicated Cloud, net revenue $ 224,808 $ 236,604 $ 246,417 $ 256,559 $ 265,585
Public Cloud, net revenue $ 58,453   $ 64,751   $ 72,573   $ 79,426   $ 87,324  
Net revenue $ 283,261 $ 301,355 $ 318,990 $ 335,985 $ 352,909
Revenue growth (year over year) 31.9 % 31.0 % 29.0 % 27.0 % 24.6 %
 
Net upgrades (monthly average) 2.0 % 1.5 % 1.7 % 1.6 % 1.2 %
Churn (monthly average)

-0.8

%

-0.8

%

-0.8

%

-0.8

%

-0.7

%

Growth in installed base (monthly average) (2) 1.2 % 0.7 % 1.0 % 0.8 % 0.5 %
 
Number of customers at period end (3) 172,510 180,866 190,958 197,635 205,538
Number of employees (Rackers) at period end 4,040 4,335 4,528 4,596 4,852
 
Number of servers deployed at period end 79,805 82,438 84,978 89,051 90,524
Average monthly revenue per server $ 1,191 $ 1,238 $ 1,270 $ 1,287 $ 1,310
 
Profitability
Income from operations $ 39,765 $ 37,084 $ 40,704 $ 45,330 $ 49,623
Depreciation and amortization $ 54,844 $ 55,151 $ 61,808 $ 63,972 $ 68,914
Share-based compensation expense
Cost of revenue $ 1,047 $ 1,236 $ 1,113 $ 1,282 $ 1,499
Sales and marketing $ 839 $ 1,114 $ 1,393 $ 1,943 $ 1,647
General and administrative $ 5,699   $ 6,159   $ 6,869   $ 9,193   $ 8,098  
Total share-based compensation expense $ 7,585   $ 8,509   $ 9,375   $ 12,418   $ 11,244  
Adjusted EBITDA (1) $ 102,194 $ 100,744 $ 111,887 $ 121,720 $ 129,781
 
Adjusted EBITDA margin 36.1 % 33.4 % 35.1 % 36.2 % 36.8 %
 
Operating income margin 14.0 % 12.3 % 12.8 % 13.5 % 14.1 %
 
Income from operations $ 39,765 $ 37,084 $ 40,704 $ 45,330 $ 49,623
Effective tax rate 34.5 % 35.5 % 35.7 % 38.3 % 38.8 %
Net operating profit after tax (NOPAT) (1) $ 26,046 $ 23,919 $ 26,173 $ 27,969 $ 30,369
NOPAT margin 9.2 % 7.9 % 8.2 % 8.3 % 8.6 %
 
Capital efficiency and returns
Interest bearing debt $ 139,126 $ 143,978 $ 149,226 $ 150,112 $ 125,372
Stockholders' equity $ 599,423 $ 668,436 $ 714,819 $ 781,934 $ 843,647
Less: Excess cash $ (125,865 ) $ (150,368 ) $ (177,169 ) $ (217,333 ) $ (249,712 )
Capital base $ 612,684 $ 662,046 $ 686,876 $ 714,713 $ 719,307
Average capital base $ 607,477 $ 637,365 $ 674,461 $ 700,795 $ 717,010
Capital turnover (annualized) 1.87 1.89 1.89 1.92 1.97
 
Return on capital (annualized) (1) 17.2 % 15.0 % 15.5 % 16.0 % 16.9 %
 
Capital expenditures
Purchases of property and equipment $ 63,385 $ 64,621 $ 69,385 $ 53,449 $ 82,919
Non-cash purchases of property and equipment $ 15,970   $ 17,695   $ 12,583   $ 31,934   $ 5,096  
Total capital expenditures $ 79,355 $ 82,316 $ 81,968 $ 85,383 $ 88,015
 
Customer gear $ 47,376 $ 52,999 $ 53,746 $ 51,026 $ 60,099
Data center build outs $ 6,568 $ 9,473 $ 3,285 $ 5,767 $ 7,768
Office build outs $ 9,915 $ 4,666 $ 4,015 $ 3,413 $ 2,288
Capitalized software and other projects $ 15,496   $ 15,178   $ 20,922   $ 25,177   $ 17,860  
Total capital expenditures $ 79,355 $ 82,316 $ 81,968 $ 85,383 $ 88,015
 
Infrastructure capacity and utilization
Megawatts under contract at period end 48.1 47.8 58.0 58.0 61.1
Megawatts available for use at period end 30.7 32.2 32.7 33.7 36.9
Megawatts utilized at period end 20.9 21.4 22.7 23.5 24.0
Annualized net revenue per average Megawatt of power utilized $ 55,136 $ 56,994 $ 57,867 $ 58,179 $ 59,437
 

(1)

See discussion and reconciliation of our Non-GAAP financial measures to the most comparable GAAP measures.

(2)

Due to rounding, totals may not equal the sum of the line items in the table above.

(3)

Customers are counted on an account basis, and therefore a customer with more than one account with us is included as more than one customer. Furthermore, amounts include SaaS customers for Jungle Disk using a Rackspace storage solution. Jungle Disk customers using a third-party storage solution are excluded.

 
     

Key Metrics - Year to Date

(Unaudited)

 
Year Ended December 31,
(Dollar amounts in thousands, except average monthly revenue per server) 2011     2012
Growth
Dedicated Cloud, net revenue $ 835,877 $ 1,005,165
Public Cloud, net revenue $ 189,187   $ 304,074  
Net revenue $ 1,025,064 $ 1,309,239
Revenue growth (year over year) 31.3 % 27.7 %
 
Net upgrades (monthly average) 1.9 % 1.5 %
Churn (monthly average)

-0.9

%

-0.8

%

Growth in installed base (monthly average) (2) 1.0 % 0.8 %
 
Number of customers at period end (3) 172,510 205,538
Number of employees (Rackers) at period end 4,040 4,852
 
Number of servers deployed at period end 79,805 90,524
Average monthly revenue per server $ 1,157 $ 1,278
 
Profitability
Income from operations $ 123,471 $ 172,741
Depreciation and amortization $ 195,412 $ 249,845
Share-based compensation expense
Cost of revenue $ 4,220 $ 5,130
Sales and marketing $ 2,313 $ 6,097
General and administrative $ 22,240   $ 30,319  
Total share-based compensation expense $ 28,773   $ 41,546  
Adjusted EBITDA (1) $ 347,656 $ 464,132
 
Adjusted EBITDA margin 33.9 % 35.5 %
 
Operating income margin 12.0 % 13.2 %
 
Income from operations $ 123,471 $ 172,741
Effective tax rate 34.4 % 37.3 %
Net operating profit after tax (NOPAT) (1) $ 80,997 $ 108,309
NOPAT margin 7.9 % 8.3 %
 
Capital efficiency and returns
Interest bearing debt $ 139,126 $ 125,372
Stockholders' equity $ 599,423 $ 843,647
Less: Excess cash $ (125,865 ) $ (249,712 )
Capital base $ 612,684 $ 719,307
Average capital base $ 552,328 $ 679,125
Capital turnover 1.86 1.93
 
Return on capital (1) 14.7 % 15.9 %
 
Capital expenditures
Purchases of property and equipment $ 251,214 $ 270,374
Non-cash purchases of property and equipment $ 93,680   $ 67,308  
Total capital expenditures $ 344,894 $ 337,682
 
Customer gear $ 196,096 $ 217,870
Data center build outs $ 49,947 $ 26,293
Office build outs $ 35,752 $ 14,382
Capitalized software and other projects $ 63,099   $ 79,137  
Total capital expenditures $ 344,894 $ 337,682
 
Infrastructure capacity and utilization
Megawatts under contract at period end 48.1 61.1
Megawatts available for use at period end 30.7 36.9
Megawatts utilized at period end 20.9 24.0
Annual net revenue per average Megawatt of power utilized $ 54,065 $ 58,188
 

(1)

See discussion and reconciliation of our Non-GAAP financial measures to the most comparable GAAP measures.

(2)

Due to rounding, totals may not equal the sum of the line items in the table above.

(3)

Customers are counted on an account basis, and therefore a customer with more than one account with us is included as more than one customer. Furthermore, amounts include SaaS customers for Jungle Disk using a Rackspace storage solution. Jungle Disk customers using a third-party storage solution are excluded.

   

Consolidated Quarterly Statements of Income

(Unaudited)

 
Three Months Ended
(In thousands)

December 31,
2011

   

March 31,
2012

   

June 30,
2012

   

September 30,
2012

   

December 31,
2012

Net revenue $ 283,261 $ 301,355 $ 318,990 $ 335,985 $ 352,909
Costs and expenses:
Cost of revenue 82,851 87,240 90,052 94,731 95,456
Sales and marketing 33,452 38,502 39,613 38,924 41,069
General and administrative 72,349 83,378 86,813 93,028 97,847
Depreciation and amortization 54,844   55,151   61,808   63,972   68,914  
Total costs and expenses 243,496   264,271   278,286   290,655   303,286  
Income from operations 39,765   37,084   40,704   45,330   49,623  
Other income (expense):
Interest expense (1,304 ) (1,272 ) (1,233 ) (1,253 ) (991 )
Interest and other income (expense) (226 ) 137   (405 ) 38   245  
Total other income (expense) (1,530 ) (1,135 ) (1,638 ) (1,215 ) (746 )
Income before income taxes 38,235 35,949 39,066 44,115 48,877
Income taxes 13,188   12,769   13,932   16,918   18,970  
Net income $ 25,047   $ 23,180   $ 25,134   $ 27,197   $ 29,907  
 
Three Months Ended
(Percent of net revenue)

December 31,
2011

March 31,
2012

June 30,
2012

September 30,
2012

December 31,
2012

Net revenue 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Costs and expenses:
Cost of revenue 29.2 % 28.9 % 28.2 % 28.2 % 27.0 %
Sales and marketing 11.8 % 12.8 % 12.4 % 11.6 % 11.6 %
General and administrative 25.5 % 27.7 % 27.2 % 27.7 % 27.7 %
Depreciation and amortization 19.4 % 18.3 % 19.4 % 19.0 % 19.5 %
Total costs and expenses 86.0 % 87.7 % 87.2 % 86.5 % 85.9 %
Income from operations 14.0 % 12.3 % 12.8 % 13.5 % 14.1 %
Other income (expense):
Interest expense (0.5 )% (0.4 )% (0.4 )% (0.4 )% (0.3 )%
Interest and other income (expense) (0.1 )% 0.0 % (0.1 )% 0.0 % 0.1 %
Total other income (expense) (0.5 )% (0.4 )% (0.5 )% (0.4 )% (0.2 )%
Income before income taxes 13.5 % 11.9 % 12.2 % 13.1 % 13.8 %
Income taxes 4.7 % 4.2 % 4.4 % 5.0 % 5.4 %
Net income 8.8 % 7.7 % 7.9 % 8.1 % 8.5 %
 
Due to rounding, totals may not equal the sum of the line items in the table above.

(1) Non-GAAP Financial Measures

Adjusted EBITDA (Non-GAAP financial measure)

We use Adjusted EBITDA as a supplemental measure to review and assess our performance. We define Adjusted EBITDA as Net income, plus income taxes, total other (income) expense, depreciation and amortization, and non-cash charges for share-based compensation.

Adjusted EBITDA is a metric that is used in our industry by the investment community for comparative and valuation purposes. We disclose this metric in order to support and facilitate the dialogue with research analysts and investors.

Note that Adjusted EBITDA is not a measure of financial performance under accounting principles generally accepted in the United States (GAAP) and should not be considered a substitute for operating income, which we consider to be the most directly comparable GAAP measure. Adjusted EBITDA has limitations as an analytical tool, and when assessing our operating performance, you should not consider Adjusted EBITDA in isolation or as a substitute for net income or other consolidated income statement data prepared in accordance with GAAP. Other companies may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure. See our Adjusted EBITDA to net income reconciliations in the table below.

   
Three Months Ended
(Dollars in thousands)

December 31,
2011

   

March 31,
2012

   

June 30,
2012

   

September 30,
2012

   

December 31,
2012

Net revenue $ 283,261 $ 301,355 $ 318,990 $ 335,985 $ 352,909
 
Income from operations $ 39,765 $ 37,084 $ 40,704 $ 45,330 $ 49,623
 
Net income $ 25,047 $ 23,180 $ 25,134 $ 27,197 $ 29,907
Plus: Income taxes 13,188 12,769 13,932 16,918 18,970
Plus: Total other (income) expense 1,530 1,135 1,638 1,215 746
Plus: Depreciation and amortization 54,844 55,151 61,808 63,972 68,914
Plus: Share-based compensation expense 7,585   8,509   9,375   12,418   11,244  
Adjusted EBITDA $ 102,194 $ 100,744 $ 111,887 $ 121,720 $ 129,781
 
Operating income margin 14.0 % 12.3 % 12.8 % 13.5 % 14.1 %
 
Adjusted EBITDA margin 36.1 % 33.4 % 35.1 % 36.2 % 36.8 %
   
Year Ended December 31,
(Dollars in thousands) 2011     2012
Net revenue $ 1,025,064 $ 1,309,239
 
Income from operations $ 123,471 $ 172,741
 
Net income $ 76,411 $ 105,418
Plus: Income taxes 40,018 62,589
Plus: Total other (income) expense 7,042 4,734
Plus: Depreciation and amortization 195,412 249,845
Plus: Share-based compensation expense 28,773   41,546  
Adjusted EBITDA $ 347,656 $ 464,132
 
Operating income margin 12.0 % 13.2 %
 
Adjusted EBITDA margin 33.9 % 35.5 %
 

Return on Capital (ROC) (Non-GAAP financial measure)

We define Return on Capital (ROC) as follows:
 

ROC = Net operating profit after tax (NOPAT)

Average capital base
 
NOPAT = Income from operations x (1 – Effective tax rate)

Average capital base = Average of (Interest bearing debt + stockholders’ equity – excess cash) = Average of (Total assets – excess cash – accounts payables and accrued expenses – deferred revenue – other non-current liabilities, deferred income taxes, and deferred rent).

Year-to-date average balances are based on an average calculated using the quarter-end balances at the beginning of the period and all other quarter ending balances included in the period.

We define excess cash as the amount of cash and cash equivalents that exceeds our operating cash requirements, which is calculated as three percent of our annualized net revenue for the three months prior to the period end. We will periodically review the calculation and adjust it to reflect our projected cash requirements for the upcoming year.

We believe that ROC is an important metric for investors in evaluating our company’s performance. ROC relates after-tax operating profits with the capital that is placed into service. It is therefore a performance metric that incorporates both the Statement of Comprehensive Income and the Balance Sheet. ROC measures how successfully capital is deployed within a company.

Note that ROC is not a measure of financial performance under GAAP and should not be considered a substitute for return on assets, which we calculate directly from amounts on the Statement of Comprehensive Income and the Balance Sheet. ROC has limitations as an analytical tool, and when assessing our operating performance, you should not consider ROC in isolation or as a substitute for other financial data prepared in accordance with GAAP. Other companies may calculate ROC differently than we do, limiting its usefulness as a comparative measure. See our ROC reconciliation to return on assets below.

   
Three Months Ended
(Dollars in thousands)

December 31,
2011

   

March 31,
2012

   

June 30,
2012

   

September 30,
2012

   

December 31,
2012

Income from operations $ 39,765 $ 37,084 $ 40,704 $ 45,330 $ 49,623
Effective tax rate 34.5 % 35.5 % 35.7 % 38.3 % 38.8 %
Net operating profit after tax (NOPAT) $ 26,046 $ 23,919 $ 26,173 $ 27,969 $ 30,369
 
Net income $ 25,047 $ 23,180 $ 25,134 $ 27,197 $ 29,907
 
Total assets at period end $ 1,026,482 $ 1,089,393 $ 1,138,728 $ 1,241,765 $ 1,295,551
Less: Excess cash (125,865 ) (150,368 ) (177,169 ) (217,333 ) (249,712 )
Less: Accounts payable and accrued expenses (156,004 ) (153,668 ) (148,091 ) (177,328 ) (175,128 )
Less: Deferred revenue (current and non-current) (18,281 ) (20,195 ) (19,227 ) (18,483 ) (20,960 )
Less: Other non-current liabilities, deferred income taxes, and deferred rent (113,648 ) (103,116 ) (107,365 ) (113,908 ) (130,444 )
Capital base $ 612,684 $ 662,046 $ 686,876 $ 714,713 $ 719,307
 
Average total assets $ 998,580 $ 1,057,938 $ 1,114,061 $ 1,190,247 $ 1,268,658
Average capital base $ 607,477 $ 637,365 $ 674,461 $ 700,795 $ 717,010
 
Return on assets (annualized) 10.0 % 8.8 % 9.0 % 9.1 % 9.4 %
Return on capital (annualized) 17.2 % 15.0 % 15.5 % 16.0 % 16.9 %
   
Year Ended December 31,
(Dollars in thousands) 2011     2012
Income from operations $ 123,471 $ 172,741
Effective tax rate 34.4 % 37.3 %
Net operating profit after tax (NOPAT) $ 80,997 $ 108,309
 
Net income $ 76,411 $ 105,418
 
Total assets at period end $ 1,026,482 $ 1,295,551
Less: Excess cash (125,865 ) (249,712 )
Less: Accounts payable and accrued expenses (156,004 ) (175,128 )
Less: Deferred revenue (current and non-current) (18,281 ) (20,960 )
Less: Other non-current liabilities, deferred income taxes, and deferred rent (113,648 ) (130,444 )
Capital base $ 612,684 $ 719,307
 
Average total assets $ 895,545 $ 1,158,384
Average capital base $ 552,328 $ 679,125
 
Return on assets (Net income/Average total assets) 8.5 % 9.1 %
Return on capital (NOPAT/Average capital base) 14.7 % 15.9 %

Adjusted Free Cash Flow (Non-GAAP financial measure)

We define Adjusted Free Cash Flow as Adjusted EBITDA plus non-cash deferred rent, less total capital expenditures (including non-cash purchases of property and equipment), cash payments for interest, net, and cash payments for income taxes, net.

We believe that Adjusted Free Cash Flow is an important metric for investors in evaluating how a company is currently using cash generated and may indicate its ability to generate cash that can potentially be used by the business for capital investments, acquisitions, reduction of debt, payment of dividends, etc. Note that Adjusted Free Cash Flow is not a measure of financial performance under GAAP and may not be comparable to similarly titled measures reported by other companies. See our Adjusted Free Cash Flow reconciliation to Adjusted EBITDA below, as well as our reconciliation of Net income to Adjusted EBITDA provided above.

       
Three Months Ended Year Ended
(In thousands) December 31, 2012 December 31, 2012
Adjusted EBITDA $ 129,781 $ 464,132
Non-cash deferred rent 2,930 9,259
Total capital expenditures (88,015 ) (337,682 )
Cash payments for interest, net (1,283 ) (4,809 )
Cash payments for income taxes, net (4,706 )   (11,906 )
Adjusted free cash flow $ 38,707 $ 118,994

Net Leverage (Non-GAAP financial measure)

We define Net Leverage as Net Debt divided by Adjusted EBITDA (trailing twelve months).

We believe that Net Leverage is an important metric for investors in evaluating a company’s liquidity. Note that Net Leverage is not a measure of financial performance under GAAP and may not be comparable to similarly titled measures reported by other companies. We believe that Net Leverage provides an additional indicator when assessing our liquidity, capital structure and leverage and provides insight into a company's ability to assume more debt if and when required. A negative Net Leverage indicates that our cash and cash equivalents is greater than our total debt as of the balance sheet date. See our Net Leverage calculation below.

   
As of
(Dollars in thousands) December 31, 2012
Obligations under capital leases $ 121,637
Debt 3,735  
Total debt $ 125,372
Less: Cash and cash equivalents (292,061 )
Net debt $ (166,689 )
Adjusted EBITDA (trailing twelve months) $ 464,132
Net leverage (0.36 ) x

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