Rackspace Shares Decline on Earnings Report

Shares of Rackspace Hosting declined sharply today after the cloud computing provider's earnings fell just short of analyst expectations. Rackspace (RAX) said its first-quarter profit rose to 17 cents per share, up from 10 cents in the year-earlier period, as revenue improved 31 percent to $301 million. Analysts polled by Thomson Reuters were expecting 18 cents and $300 million.

Rackspace shares closed at $52.63 Tuesday, a decline of $5.17 (8.9 percent)  in trading on the New York Stock Exchange, after being off as much as 13 percent earlier in the day. While that seems like a large decline, it leaves RAX shares at the same level as in mid-February.

So why are investors having such a strong reaction to a narrow earnings miss? One reason may be the recent climb in Rackspace shares, which rose by 34 percent in the first quarter of 2012. With those gains, investors may have been seeking an opportunity to take profits. RAX also has set high expectations with a series of reports in which it surpassed Wall Street's expectations.

Rackspace's profit margins shrank on a quarter-to-quarter basis, primarily due to increased hiring to help the company build out a suite of new products for its OpenStack cloud computing platform.

Investing in 'Massive Opportunity'

"We are making huge investments across the company to strengthen our competitive position in the market, solidify our position as the service leader in the cloud, and seize the massive opportunity that the cloud computing market provides us," said Rackspace CEO Lanham Napier in the company's annual earnings call with analysts. "We are increasing investments across the company to bolster our systems, products, and service capabilities in order to help our customers make the transition to the cloud."

The change also reflects seasonal elements, according to CFO Karl Pichler.

"We do see a decline (in profit margin) relative to Q4, but the Q4 results were extraordinarily high, and margins were not expected to remain at those levels," said Pichler. "Our first quarter has traditionally been front-loaded with costs. If you look back over our history, you can see that. The main driver for that is our sales and marketing muscle that we usually increase in the first two quarters, but primarily in the first quarter."

Seasonal Hiring, Revenue Trends

Napier said the fourth quarter results were boosted by Internet retailers scaling up their resources to handle holiday shopping. He also noted that it is much easier to hire staff in the early months of the yar.

"We tend to have more luck hiring Rackers at the beginning of the year than we do the second half of the year," said Napier. "People don’t like to move in the fourth quarter because of the holidays. People like to get their moves done by the summertime before school starts again in the third quarter. So we tend to focus more of our hiring activity in the first half of the year."

Some reports cited increased data center costs as serving as a drag on Rackspace's performance. Data center spending $9.47 million in the first quarter, up slightly from $7.1 million in the year-ago period but well below spending of $17.5 million and $16.7 million, respectively, in the second and third quarters of 2011. Total capital expenditures of $82.3 million followed a similar trend.