<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 22, 2000
REGISTRATION NO. 333-33414
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------------------
RACKSPACE.COM, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 7389 75-2864797
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer Identification
incorporation or organization) Classification Code Number) Number)
</TABLE>
------------------------
RACKSPACE.COM, INC.
425 SOLEDAD, SUITE 500
SAN ANTONIO, TEXAS 78205
TELEPHONE: (210) 892-4000
FACSIMILE: (210) 892-4329
(Address, including zip code, and telephone number, including area code, of the
registrant's principal executive offices)
------------------------------
GRAHAM M. WESTON
CHIEF EXECUTIVE OFFICER
425 SOLEDAD, SUITE 500
SAN ANTONIO, TEXAS 78205
TELEPHONE: (210) 892-4000
FACSIMILE: (210) 892-4329
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
------------------------------
COPIES TO:
<TABLE>
<S> <C>
S. MICHAEL DUNN, P.C. JEFFREY A. CHAPMAN, ESQ.
MICHELLE KWAN MONTOYA, ESQ. SHARON M. COOPER, ESQ.
BROBECK, PHLEGER & HARRISON LLP VINSON & ELKINS L.L.P.
301 CONGRESS AVENUE 2001 ROSS AVENUE
SUITE 1200 3700 TRAMMEL CROW CENTER
AUSTIN, TEXAS 78701 DALLAS, TEXAS 75201-2925
TELEPHONE: (512) 477-5495 TELEPHONE: (214) 220-7700
FACSIMILE: (512) 477-5813 FACSIMILE: (214) 220-7716
</TABLE>
--------------------------
Approximate date of commencement of proposed sale to the public: as soon as
practicable after the effective date of this registration statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended, check the following box. / /
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / /
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
------------------------------
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
------------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SUCH SECTION 8(A), MAY DETERMINE.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>
The information in this preliminary prospectus is not complete and may be
changed. We may not sell these securities until the registration statement filed
with the Securities and Exchange Commission is effective. This preliminary
prospectus is not an offer to sell and is not soliciting an offer to buy these
securities in any jurisdiction where the offer or sale is not permitted.
<PAGE>
Subject to Completion, Dated June 22, 2000
[LOGO]
3,200,000 Shares
Common Stock
This is an initial public offering of common stock of Rackspace.com, Inc. We
anticipate that the initial public offering price will be between $11.00 and
$13.00 per share.
Our common stock has been approved for quotation on the Nasdaq National Market
under the symbol "RACK."
Investing in our common stock involves risks. See "Risk Factors" beginning on
page 7.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Public offering price $ $
Underwriting discounts and commissions $ $
Proceeds, before expenses, to Rackspace.com $ $
</TABLE>
The underwriters have the right to purchase up to an additional 480,000 shares
of common stock from us at the public offering price within 30 days from the
date of this prospectus to cover over-allotments.
Deutsche Banc Alex. Brown Bear, Stearns & Co. Inc.
Thomas Weisel Partners LLC
The date of this prospectus is , 2000
<PAGE>
PROSPECTUS SUMMARY
THIS SUMMARY HIGHLIGHTS INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS.
THIS SUMMARY MAY NOT CONTAIN ALL OF THE INFORMATION THAT YOU SHOULD CONSIDER
BEFORE INVESTING IN OUR COMMON STOCK. YOU SHOULD READ THE ENTIRE PROSPECTUS
CAREFULLY, INCLUDING "RISK FACTORS" AND OUR FINANCIAL STATEMENTS AND THE NOTES
RELATING TO THOSE STATEMENTS, BEFORE MAKING AN INVESTMENT DECISION.
RACKSPACE.COM, INC.
OUR BUSINESS
Rackspace.com is a leading provider of managed Linux-based Internet hosting
services targeted to small- to medium-sized enterprises worldwide. Managed
hosting services enable enterprises to establish and maintain their Internet
operations using the servers, networking facilities and technical support of a
third-party provider, such as Rackspace. We offer our customers
attractively-priced monthly hosting plans, which include configuration of the
server that we supply for the customer, deployment of that server in a data
center within 24 hours of order confirmation, server maintenance, a subscribed
allocation of network data transmission capability, or bandwidth, and
installation and support for select operating system and Internet-based
applications. Our managed hosting services enable small- and medium-sized
enterprises to have access to hardware, software, network facilities and
technical expertise for operating an Internet business that generally are
affordable only for very large enterprises. As of March 31, 2000, we managed an
installed base of over 1,200 servers within our state-of-the-art data center for
more than 900 customers, with approximately 48% of these customers located
outside of the United States in over 50 countries around the world.
We have developed specific expertise in deploying Internet hosting services
based on the Linux operating system, and approximately 80% of our customers have
selected Linux-based hosting services. We believe that many small- to
medium-sized enterprises select Linux-based hosting services due to Linux's
reputation for stability, high performance, ease of remote administration and
cost advantages. We also provide and support managed hosting services based on
Solaris, Windows NT/2000 and other operating systems. In addition, we have
entered into strategic relationships with Red Hat, Perot Systems and Sun
Microsystems, among others, in order to accelerate our market penetration and to
expand our product and service offerings.
OUR SERVICES
Our comprehensive service offerings are designed to aid our customers in
rapidly implementing their Internet operations. To this end, we offer our
customers:
- the ability to configure, price and order our services through the
Rackspace.com Configurator available at our Web site;
- month-to-month, flexible hosting plans that enable our customers to
cost-effectively establish service with us and to adjust their service
without long-term commitment;
- guaranteed deployment of a new customer's hosting service within 24 hours
of order confirmation;
- housing of servers within our state-of-the-art data center where we
provide around-the-clock monitoring, security and technical support;
- rapid upgrades of server hardware and provisioning of additional bandwidth
to cost-effectively support the expansion of our customers' Internet
operations; and
- enhanced services including pre-tested applications that can accelerate a
customer's introduction of new e-commerce initiatives on its Web site.
3
<PAGE>
OUR STRATEGY
Our goal is to become the leading global provider of managed Linux-based
Internet hosting services by capitalizing on the growth in Internet usage and
e-business and the trend towards outsourcing of hosting services. Our strategy
for accomplishing this objective includes:
- establishing ourselves as the leading Linux-based hosting services
provider;
- building global brand awareness of our company and service offerings
through targeted marketing initiatives;
- capitalizing on international market opportunities to provide managed
hosting services;
- utilizing strategic relationships with third parties that select, or
influence the selection of, managed hosting services providers, including
expanding our existing relationships with Red Hat, Perot Systems and Sun
Microsystems, among others;
- expanding our products and enhanced services to address our customers'
needs as their growing Internet operations require more advanced hosting
solutions; and
- continuing to expand and further develop our customer service and
technical support capabilities.
INVESTMENT CONSIDERATIONS
Since we began offering managed hosting services in December 1998, our
business has grown rapidly. However, due to our short operating history within
an emerging industry, our business model continues to evolve and is largely
unproven. We have experienced significant operating losses since December 1998,
including net losses of $2.1 million in the quarter ended March 31, 2000 and
$1.7 million for the year ended December 31, 1999. Moreover, we expect our
operating expenses to increase significantly as we continue to expand our
business. As a result, we expect to continue to operate at a net loss and to
experience negative cash flows for the foreseeable future. For additional
information concerning risks associated with an investment in our company,
please see "Risk Factors" beginning on page 7.
OUR ADDRESS AND TELEPHONE
Our principal executive offices are located at 425 Soledad, Suite 500, San
Antonio, Texas 78205, and our telephone number is (210) 892-4000. Our World Wide
Web address is www.rackspace.com. INFORMATION CONTAINED ON OUR WEB SITE IS NOT
INTENDED TO CONSTITUTE PART OF THIS PROSPECTUS.
4
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common stock offered by Rackspace.com....................... 3,200,000 shares
Common stock to be outstanding after this offering.......... 20,180,868 shares
Use of proceeds............................................. We intend to use the net proceeds to
fund capital expenditures, including
the purchase of computer and networking
hardware, the establishment of new data
centers, the expansion of our sales and
marketing and product development
activities and potential acquisitions,
and for other general corporate
purposes. See "Use of Proceeds" on page
17 for a more detailed description of
our use of proceeds.
Proposed Nasdaq National Market symbol...................... RACK
</TABLE>
Unless otherwise indicated, all information in this prospectus concerning
the common stock outstanding is based on the number of shares outstanding as of
March 31, 2000, on a pro forma basis to give effect to the completion of the
holding company restructuring as if it had occurred on such date and excludes:
- 480,000 shares to be sold by us if the underwriters' over-allotment option
is exercised in full, as described in "Underwriting";
- 480,833 shares of common stock issuable upon exercise of options granted
to employees outstanding as of March 31, 2000, with a weighted average
exercise price of $2.30 per share;
- 380,952 shares of common stock issuable upon the exercise of warrants
outstanding as of March 31, 2000, which were granted to an investor in a
private equity financing in November 1999, with an exercise price of
$2.10 per share;
- shares of common stock issuable upon the exercise of warrants
that were granted to Norwest Venture Partners and Sequoia Capital in a
private equity financing completed in March 2000; and
- shares reserved for issuance under our 2000 Stock Incentive Plan.
References in this prospectus to "Rackspace.com," "Rackspace," "we," "us"
and "our" refer to Rackspace.com, Inc., a Delaware corporation, and, prior to
the reorganization of our corporate structure, Rackspace, Ltd., a Texas limited
partnership. See "Holding Company."
5
<PAGE>
SUMMARY FINANCIAL DATA
The following table sets forth summary financial and operating data for our
predecessor, Cymitar Technology Group, Inc., and our company. You should read
this information together with our financial statements and the notes to those
statements appearing elsewhere in this prospectus. See "Selected Financial Data"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
THE PREDECESSOR THE COMPANY
------------------------------- -----------------------------------------------------------
PERIOD FROM
DECEMBER 29,
PERIOD FROM 1998
JANUARY 1, (INCEPTION) THREE MONTHS ENDED
YEAR ENDED 1998 THROUGH THROUGH YEAR ENDED -------------------------
DECEMBER 31, DECEMBER 28, DECEMBER 31, DECEMBER 31, MARCH 31, MARCH 31,
1997 1998 1998 1999 1999 2000
-------------- -------------- -------------- -------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues.................. $ 72,535 $ 166,632 $ 76 $ 1,700,537 $125,507 $ 1,434,967
Operating expenses:
Cost of revenues.............. 38,895 73,767 -- 513,424 31,232 645,163*
Sales and marketing........... 648 3,615 -- 1,612,071 78,414 1,639,054*
General and administrative.... 47,705 181,260 23 970,155 80,774 994,063*
Product development........... -- -- -- 52,712 7,724 99,818*
Depreciation and
amortization................ 6,912 12,363 262 261,730 20,513 304,442
-------- --------- ----- ----------- -------- -----------
Total operating expenses...... 94,160 271,005 285 3,410,092 218,657 3,682,540
-------- --------- ----- ----------- -------- -----------
Loss from operations........ (21,625) (104,373) (209) (1,709,555) (93,150) (2,247,573)
Other income (expense).......... (3,247) (7,767) (66) (43,243) (3,682) 102,874
-------- --------- ----- ----------- -------- -----------
Net loss.................... $(24,872) $(112,140) $(275) $(1,752,798) $(96,832) $(2,144,699)
======== ========= ===== =========== ======== ===========
</TABLE>
----------------------------------
* Includes $23,000, $129,000, $182,000 and $46,000 of amortization of deferred
stock cash compensation within cost of revenues, sales and marketing,
general and administrative and product development, respectively.
The following table contains a summary of our balance sheet as of March 31,
2000:
- on an actual basis; and
- on a pro forma as adjusted basis to reflect (1) the completion of the
holding company restructuring through the exchange of all limited partner
interests and the general partner interest of Rackspace, Ltd. for an
aggregate of 16,980,868 shares of our common stock and (2) the net
proceeds to us from the sale of 3,200,000 shares of our common stock in
this offering at an assumed initial public offering price of $12.00 per
share.
<TABLE>
<CAPTION>
AS OF MARCH 31, 2000
---------------------------
PRO FORMA
ACTUAL AS ADJUSTED
----------- -------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................................. $12,535,029 $47,497,029
Working capital........................................... 10,853,096 45,815,096
Total assets.............................................. 17,740,590 52,702,590
Total partners' capital/stockholders' equity.............. 15,429,204 50,391,204
</TABLE>
6
<PAGE>
RISK FACTORS
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD
CAREFULLY CONSIDER THE RISKS AND UNCERTAINTIES DESCRIBED BELOW BEFORE YOU
PURCHASE ANY OF OUR COMMON STOCK. WHILE WE HAVE DESCRIBED ALL RISKS AND
UNCERTAINTIES THAT WE BELIEVE ARE MATERIAL TO OUR BUSINESS, OTHER RISKS AND
UNCERTAINTIES THAT AFFECT OUR BUSINESS OPERATIONS MAY ARISE OR BECOME MATERIAL
IN THE FUTURE. IF WE CANNOT ADDRESS THE FOLLOWING RISKS AND UNCERTAINTIES
EFFECTIVELY, WE COULD BE MATERIALLY AND ADVERSELY AFFECTED. IN THIS EVENT, THE
TRADING PRICE OF OUR COMMON STOCK COULD DECLINE AND YOU COULD LOSE ALL OR A PART
OF YOUR INVESTMENT.
THIS PROSPECTUS ALSO CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS
AND UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
ANTICIPATED IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF MANY FACTORS,
INCLUDING THE RISKS AND UNCERTAINTIES DESCRIBED BELOW AND ELSEWHERE IN THIS
PROSPECTUS. SEE "FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS."
RISKS RELATED TO OUR BUSINESS
BECAUSE WE HAVE A LIMITED OPERATING HISTORY AND OUR BUSINESS MODEL IS STILL
EVOLVING, WE MAY BE UNABLE TO ACHIEVE A SIGNIFICANT RATE OF REVENUE GROWTH OR TO
BECOME PROFITABLE IN ACCORDANCE WITH OUR BUSINESS PLAN.
We began offering managed hosting services in December 1998. As a result, we
have a very short operating history and our business model is still evolving. We
may be unable to successfully implement our business plan or adapt it to changes
in the market. Our limited operating history makes it difficult for us to
predict our future results and to evaluate the execution of our business plan
thus far. Our ability to execute our plans must be considered in light of the
risks, expenses and challenges encountered by companies in the rapidly evolving
managed hosting market. Due to these uncertainties, we may be unable to achieve
a significant rate of revenue growth or to become profitable in future periods,
in which case the market price of our common stock may decline.
BECAUSE WE OPERATE IN A NEW AND EVOLVING MARKET WITH UNCERTAIN PROSPECTS FOR
GROWTH, WE MAY BE UNABLE TO SUCCESSFULLY GROW OUR CUSTOMER BASE, WHICH WOULD
IMPEDE OUR FUTURE REVENUES.
Our market is new and rapidly evolving. Growth in demand for, and acceptance
of, managed Linux-based Internet hosting services are highly uncertain.
Businesses may not recognize the benefits of outsourcing their managed hosting
needs or they may find it less expensive, more secure or otherwise preferable to
host their Internet sites internally. Internet technologies, such as e-commerce
applications, which require managed hosting may not grow as rapidly as we
expect. If the market for managed Linux-based Internet hosting services fails to
grow or grows more slowly than we anticipate, we may experience difficulty in
expanding our business, which would impede our future revenues. Growth in the
demand for our products and services may be inhibited and we may be unable to
sustain growth in our customer base for a number of reasons, such as:
- our inability to market our products and services in a cost-effective
manner to new customers;
- the inability of customers to differentiate the services we offer from
those of our competitors;
- the termination of our customer contracts, which are subject to renewal on
a monthly basis;
- our inability to strengthen awareness of our brand; and
- reliability, quality or compatibility problems with our services.
IF THE LINUX OPERATING SYSTEM DOES NOT CONTINUE TO GAIN MARKET ACCEPTANCE, WE
LIKELY WOULD BE UNABLE TO SUSTAIN OUR REVENUE GROWTH AND TO SUCCESSFULLY EXECUTE
OUR BUSINESS PLAN.
The vast majority of our customers elect to base their servers on the Linux
operating system. The Linux operating system has only recently gained broad
market acceptance. Our ability to sustain growth in our revenues and to
successfully execute our business plan depends on the continued development
7
<PAGE>
and enhancement of the Linux operating system, as well as on the continued
adoption of Linux, particularly by small- and medium-sized enterprises.
IF THE NETWORK PROVIDERS UPON WHICH WE RELY FAIL TO PROVIDE ADEQUATE
RELIABILITY, CAPACITY OR PERFORMANCE FOR OUR NETWORK, WE COULD LOSE CUSTOMERS.
Our success partly depends upon the capacity, reliability and performance of
our network infrastructure, including the capacity leased from our
telecommunications network suppliers, consisting of Intermedia, Qwest, SBC
Communications, Time Warner Telecom and UUNET. Our agreements with these network
providers are long-term contracts over two to five years with monthly pricing
based on the amount of network traffic experienced by the respective provider.
We depend on these companies to provide uninterrupted and error-free service
through their telecommunications networks. Some of these providers also are our
competitors. As our customers' usage of telecommunications capacity increases,
we will need to make additional investments in our capacity to maintain adequate
data transmission speeds, the availability of which may be limited or the cost
of which may be on terms unacceptable to us. We currently have network capacity
for 2,000 servers at our primary data center in San Antonio, Texas, and can
upgrade our capacity through our current network providers to handle up to 5,000
servers. If adequate capacity is not available to us as our customers' usage
increases, our network may not be able to achieve or maintain sufficiently high
data transmission capacity, reliability or performance. In addition, our
business would suffer if our network suppliers increased the prices for their
services and we were unable to pass along the increased costs to our customers.
Any failure on our part or the part of our third-party suppliers to achieve or
maintain high data transmission capacity, reliability or performance could
significantly reduce customer demand for our services and damage our business.
WE COULD EXPERIENCE SYSTEM FAILURES, WHICH COULD HARM OUR REPUTATION AND RESULT
IN CUSTOMER DISSATISFACTION OR LOSS.
To succeed, we must be able to operate our data centers and maintain the
operation of our Web site around the clock without interruption or a material
decline in service. Our operations depend upon our ability to protect our
network infrastructure, equipment and customer files against damage from human
error, fire, earthquakes, hurricanes, floods, power loss, telecommunications
failures, physical and electronic break-ins, sabotage, intentional acts of
vandalism and similar events. Our servers and other network equipment are
located in our data centers in San Antonio, Texas and London. We do not have a
comprehensive disaster recovery plan and the occurrence of a natural disaster or
other unanticipated problems at our data center could result in interruptions in
the services that we provide to our customers and in the operation of our Web
site.
We have experienced interruptions in service and at our Web site in the
past. We have experienced partial system failures due to routing problems, hard
drive failures, database corruption and other computer failures. A future
interruption could result in substantial customer dissatisfaction or loss and
could necessitate future customer refunds. Our network is subject to various
points of failure, and a problem with our routers, switches or other equipment
could cause an interruption in the services we provide to some or all of our
customers. Any future interruptions could:
- cause our customers to seek damages for losses incurred;
- require us to replace existing equipment or add redundant facilities;
- damage our reputation as a reliable provider of managed hosting services;
- cause existing customers to cancel or elect to not renew their contracts;
or
- make it more difficult for us to attract new customers.
8
<PAGE>
IF WE DO NOT PREVENT SECURITY BREACHES, WE MAY LOSE CUSTOMERS, SUFFER HARM TO
OUR REPUTATION AND INCUR ADDITIONAL COSTS.
A fundamental requirement for online business transactions and services is
the secure transmission of confidential information over public communications
networks. Unauthorized access, computer viruses, accidents, fraudulent service
plan orders, intentional misconduct by computer "hackers" and other disruptions
can occur. While we have experienced no material security breaches in the past,
any breaches that may occur could result in liability to us, loss of existing
customers, harm to our reputation, deterrence of future customers or increases
in our costs. In addition, we may incur significant costs to prevent breaches in
security or to alleviate problems caused by breaches. We rely on third-party
suppliers to protect our equipment and hardware against breaches in security. We
cannot be certain that they will provide adequate security.
IF WE ARE UNABLE TO EXPAND OUR NETWORK INFRASTRUCTURE TO MEET INCREASING DEMAND,
WE COULD LOSE CUSTOMERS AND OUR ABILITY TO GROW OUR BUSINESS WOULD BE IMPEDED.
We must continue to expand and adapt our network infrastructure to
accommodate, or scale, our network operations to address an increasing number of
customers, larger amounts of information that they wish to transmit and changing
customer requirements. We will continually need to address the challenge of
scaling our network operations to meet increasing managed hosting demands while
maintaining acceptable performance levels. The expansion of our existing data
centers and the establishment of new data centers will require substantial
financial, operational and management resources. If we are required to expand
our network significantly and rapidly, additional stress will be placed upon our
network hardware, traffic management systems and hosting facilities, as well as
our financial, operational and management resources. Due to the limited
deployment of our services to date, the ability of our network to support a
substantially larger number of customers at high transmission speeds is unknown.
THE FORMATION OF STRATEGIC RELATIONSHIPS IS AN IMPORTANT STRATEGY, AND IF WE
FAIL TO ESTABLISH THESE RELATIONSHIPS, OR IF THESE RELATIONSHIPS ARE TERMINATED
OR DO NOT FUNCTION AS WE INTEND, OUR ABILITY TO EXECUTE OUR BUSINESS PLAN AND TO
REMAIN COMPETITIVE IN THE MANAGED HOSTING MARKET COULD BE IMPEDED.
In an effort to enhance our sales, support, sourcing and other business
functions, we form strategic relationships with select partners. We have formed
strategic relationships with Red Hat, Perot Systems and Sun Microsystems. If
these or any future strategic relationships are terminated or impaired, our
ability to execute our business plan could be impeded. Some of our strategic
partners may also provide services that compete with our own, which could
increase competitive pressures on our business.
WE HAVE A HISTORY OF OPERATING LOSSES, AND WE ANTICIPATE THAT WE WILL CONTINUE
TO INCUR SIGNIFICANT OPERATING LOSSES FOR THE FORESEEABLE FUTURE, WHICH MAY
DEPRESS THE MARKET PRICE FOR OUR STOCK.
We have experienced operating losses and negative cash flows from operations
in each quarterly and annual period since we commenced our hosting operations in
December 1998. We experienced a net loss of $2.1 million for the quarter ended
March 31, 2000 and $1.8 million for the year ended December 31, 1999. We expect
our operating expenses to increase significantly as we continue to expand our
business. We believe that we will need to significantly increase our current
staff levels across all areas of our business over the next 12 months. In
addition, we expect to incur significant expenses to establish new data centers,
support and improve our operational and financial systems, pursue additional
channel partners, fund greater levels of research and development and broaden
our customer service and support capabilities. We cannot assure you that we will
ever be profitable on a quarterly or annual basis, or that if we achieve
profitability, it will be sustainable. Recurring losses without the prospect of
future profitability likely will depress the market price for our stock.
9
<PAGE>
THE MARKET FOR MANAGED HOSTING SERVICES IS EXTREMELY COMPETITIVE, AND WE MAY BE
UNABLE TO COMPETE EFFECTIVELY IF WE DO NOT OFFER OUR CUSTOMERS PRICES AND
BENEFITS SUPERIOR TO THOSE OFFERED BY OUR COMPETITORS.
The market for managed hosting services is highly competitive, with few
barriers to entry preventing new competitors from entering this market. We
expect that we will face additional competition from our existing competitors as
well as new market entrants in the future. Many of our current and potential
competitors have substantially greater financial, technical and marketing
resources, larger customer bases, longer operating histories, greater brand
recognition and more established relationships in the industry than we do. As a
result, some of these competitors may be able to:
- develop and expand their network infrastructures and service offerings
more rapidly;
- adapt to new or emerging technologies and changes in customer requirements
more quickly;
- take advantage of acquisition and other opportunities more readily;
- devote greater resources to the marketing and sales of their services; and
- adopt more aggressive pricing policies.
In addition, some of our competitors have entered, and will likely continue
to enter, into joint ventures or other arrangements to provide additional
services competitive with those provided by us. We believe that the managed
hosting market is likely to experience consolidation in the near future, which
could result in larger and more formidable competitors, increased price
competition, the formation of strategic relationships across complementary
industries, including relationships with our suppliers and channel partners that
could limit our access to critical supplies, and other factors that could impair
our ability to compete effectively.
In an effort to gain market share, we expect that competitors will offer
managed hosting services similar to ours at prices lower than ours or with
incentives not matched by us. In addition, some of our competitors may be able
to provide customers with additional benefits that could reduce the overall
costs of their services relative to ours. We may be unable to reduce the pricing
of our services or offer incentives in response to the actions of our
competitors without hindering our business.
For more information about the competition we face in our market, please see
"Business--Competition."
IF WE ARE UNABLE TO ATTRACT AND RETAIN EXPERIENCED INFORMATION TECHNOLOGY
PROFESSIONALS AND SKILLED SALES PERSONNEL, WE MAY BE UNABLE TO SUCCESSFULLY GROW
OUR BUSINESS.
Our success depends on our ability to attract, integrate, motivate, train
and retain highly skilled technical personnel and other employees. In
particular, we need to attract experienced information technology professionals.
We face intense competition for these people and we expect competition to remain
intense as the technology industry continues to grow. Even if we expend
significant resources to recruit, train and retain qualified personnel, we may
not be successful in our efforts.
We also must expand our direct and indirect sales operations to increase
market awareness of our services and generate increased revenues. We plan to
increase our sales force significantly in 2000. Newly-hired employees will
require training and it will take time for them to achieve full productivity. If
we are unable to hire enough qualified individuals in the future or if
newly-hired employees fail to achieve necessary levels of productivity, we would
be unable to effectively expand our business.
10
<PAGE>
IF OUR OPERATING AND FINANCIAL SYSTEMS FAIL TO KEEP PACE WITH THE ANTICIPATED
GROWTH IN OUR BUSINESS, WE MAY EXPERIENCE OPERATING INEFFICIENCIES, CUSTOMER
DISSATISFACTION AND LOST REVENUE OPPORTUNITIES.
The rapid growth of our business and our service offerings has placed, and
is likely to continue to place, a significant strain on our operating and
financial resources. Our future performance will partly depend on our ability to
manage our growth effectively, which will require that we further develop our
operating and financial system capabilities and controls. We are in the process
of implementing new billing and other management information systems. If our
information systems are unable to support the demands placed on them by the
rapid growth in our business, we may be forced to implement new systems which
would be disruptive to our business. If we fail to improve our operational
systems or to expand our customer service capabilities to keep pace with the
growth of our business, we could experience customer dissatisfaction, cost
inefficiencies and lost revenue opportunities. We may be unable to successfully
implement these systems when needed or they may not perform reliably.
IF WE FAIL TO EXPAND DATA CENTER CAPACITY TO MEET OUR CUSTOMERS' NEEDS, OUR
SERVICE OFFERINGS AND ABILITY TO RETAIN CUSTOMERS WOULD BE IMPAIRED.
Continuing to expand data center capacity is critical to achieving our
business strategy. This expansion will include adding new hardware and software,
and further contemplates the opening of additional data centers in the United
States, Europe and Asia. Our ability to do so successfully depends on:
- anticipating and planning for future demand levels;
- having access to sufficient capital; and
- locating and securing satisfactory data center sites and implementing the
build-out of these sites,
all of which may require significant lead time. If we cannot expand capacity
effectively, our service offerings will be impaired and we may be unable to
adequately meet the needs of our customers, which could result in the loss of
customers.
IF OUR THIRD-PARTY SUPPLIERS DO NOT PROVIDE US WITH KEY COMPONENTS OF OUR
NETWORK INFRASTRUCTURE, WE MAY BE UNABLE TO DELIVER OUR SERVICES TO OUR
CUSTOMERS, WHICH MAY RESULT IN CUSTOMER DISSATISFACTION OR LOSS.
We depend on other companies to supply key components of our network
infrastructure. Any failure to obtain needed products or services in a timely
fashion or at an acceptable cost could impair our ability to deliver our
services to our customers. We buy servers, routers and switches on an as-needed
basis and therefore do not carry significant inventories of these items. We also
have no guaranteed supply arrangements with our vendors. If this equipment were
to become unavailable or available only on terms that are not acceptable to us,
we would be forced to find alternative providers of this equipment. The
inability to obtain equipment from our existing suppliers on terms acceptable to
us would require us to expend time and money to select and obtain new equipment,
and to train our personnel to use different equipment and deploy alternative
components.
DISRUPTION OF OUR SERVICES CAUSED BY UNKNOWN SOFTWARE DEFECTS COULD DAMAGE OUR
REPUTATION AND RESULT IN LOST REVENUES AND DELAYED MARKET ACCEPTANCE.
Our service offerings depend on complex software, including software
licensed from third parties. Complex software often contains defects,
particularly when first introduced or when new versions are released. We may not
discover software defects that affect our services until after the software is
deployed. Although we have not experienced any material software defects to
date, it is possible that defects may occur in the future. These defects could
cause service interruptions, which could damage our reputation, increase our
service costs, cause us to lose revenues, delay market acceptance or divert our
development resources.
11
<PAGE>
PROVIDING SERVICES TO CUSTOMERS WITH MISSION-CRITICAL INTERNET SITES AND
WEB-BASED APPLICATIONS COULD POTENTIALLY EXPOSE US TO LAWSUITS FOR CUSTOMERS'
LOST PROFITS OR DAMAGES.
Because our managed hosting services are critical to many of our customers'
businesses, any significant disruption in our services could result in lost
profits or other indirect or consequential damages to our customers. Our
customers are required to sign server order forms which incorporate our standard
terms and conditions. Although these terms disclaim our liability for any
indirect or consequential damages, a customer could still bring a lawsuit
against us claiming lost profits or other consequential damages as the result of
a service interruption or other Internet site or application problems that the
customer may ascribe to us. We cannot assure you that a court would enforce any
limitations on our liability, and the outcome of any lawsuit would depend on the
specific facts of the case and legal and policy considerations. In such cases,
we could be liable for substantial damage awards. These damages might exceed our
liability insurance by unknown but significant amounts, which could seriously
impair our financial condition.
WE HAVE MANY INTERNATIONAL CUSTOMERS, AND, AS A RESULT, OUR ABILITY TO OPERATE
AND EXPAND OUR BUSINESS MAY BE IMPEDED BY GOVERNMENTAL RESTRICTIONS IN FOREIGN
MARKETS.
In the first quarter of 2000 and in the year ended December 31, 1999, 32.5%
and 33.4% of our revenues were derived from customers located outside of North
America. A key element of our strategy is to expand our customer base
internationally and successfully operate data centers in foreign markets.
Because our international sales are denominated in U.S. dollars, currency
fluctuations may deter foreign customers from purchasing our services. In
addition, we face risks in servicing customers in foreign markets, such as:
- different Internet access fees;
- different technology standards;
- different privacy, censorship and service provider liability standards and
regulations; and
- less protective intellectual property laws.
Any of these risks could impair our ability to operate or expand
internationally, which would limit our ability to grow our business.
ANY FAILURE TO PROTECT OUR INTELLECTUAL PROPERTY COULD HINDER OUR ABILITY TO
DELIVER DIFFERENTIATED MANAGED HOSTING SERVICES.
Third parties may infringe or misappropriate our technology or proprietary
rights, which could compromise our competitive position in the managed hosting
market. We rely on a combination of copyright, trademark, service mark and trade
secret laws to protect our intellectual property. We also have internally
developed tools and procedures that are important to our business for which we
have no protection. Our competitors or potential competitors may independently
develop technologies that are equivalent or superior to the technology upon
which we rely. We have entered into contractual arrangements with our employees
and generally with contractors, suppliers, distributors and some of our key
customers in order to limit access to, and any disclosure of, our proprietary
information. However, these measures may not be sufficient to protect our
intellectual property. We may need to take legal action to protect our
intellectual property rights, which could be costly and divert the attention of
our technical and management personnel.
WE MAY BE ACCUSED OF INFRINGING THE PROPRIETARY RIGHTS OF OTHERS, WHICH COULD
SUBJECT US TO COSTLY AND TIME-CONSUMING LITIGATION.
In addition to the technologies we develop or have developed, we license
some technologies from third parties and may license additional technologies in
the future. Although we have not been accused
12
<PAGE>
of infringing the proprietary rights of others in the past, we could become
subject to infringement actions based upon our internally-developed technologies
or technologies licensed from third parties. Any of these claims, with or
without merit, could subject us to costly litigation and divert the attention of
our technical and management personnel. In addition, third parties may change
the terms of their license agreements in ways that would prevent us from using
technologies licensed from them on commercially reasonable terms or that could
prevent us from using them at all. We may be unable to replace those
technologies with technologies that have the same features or functionality on
commercially reasonable terms or at all.
OUR ABILITY TO DEVELOP, INTRODUCE AND SELL OUR SERVICES COULD BE SIGNIFICANTLY
IMPAIRED IF OUR MANAGEMENT TEAM, WHICH HAS WORKED TOGETHER FOR ONLY A BRIEF
TIME, IS UNABLE TO WORK TOGETHER EFFECTIVELY, OR IF WE LOSE THE SERVICES OF KEY
PERSONNEL.
We recently hired key employees and officers, including our Chief Financial
Officer and the Vice President, Product Development and Strategic Planning who
each joined us in April 2000, our Vice President, Sales and Marketing who joined
us in November 1999, our Vice President, Channel Sales and Strategic Alliances
who joined us in December 1999 and our Vice President, Operations who joined us
in November 1999. As a result, our management team has worked together for only
a brief time.
We depend on the continued service of our key technical, sales and senior
management personnel, including Graham M. Weston, our Chief Executive Officer,
Morris A. Miller, our President and Chief Operating Officer, and our founders,
Patrick R. Condon, Dirk J. Elmendorf and Richard K. Yoo. Following this
offering, we will not maintain key-person insurance on any of our employees,
other than Mr. Weston. We do not have employment agreements with any of our key
employees, other than Messrs. Condon, Elmendorf and Yoo, Mr. Lanham Napier, our
Chief Financial Officer and Mr. Lew Moorman, our Vice President, Marketing and
Strategic Planning. The terms of these employment agreements are limited and if
any key personnel are unable or unwilling to continue in their present
positions, our ability to develop, introduce and sell our services could be
significantly impaired.
BECAUSE WE ARE A HOLDING COMPANY, WE MAY BE UNABLE TO PAY DIVIDENDS TO OUR
STOCKHOLDERS OR MAKE DEBT PAYMENTS IF OUR SUBSIDIARIES ARE UNABLE TO PAY
DIVIDENDS OR MAKE DISTRIBUTIONS TO US.
We are a holding company with no operations of our own. Therefore, if our
subsidiaries are unable to pay dividends or make distributions to us, we would
be unable to make dividend payments to our stockholders or pay any future
indebtedness. We do not anticipate paying cash dividends in the foreseeable
future, if ever.
WE HAVE ADOPTED ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN
ACQUISITION OF OUR COMPANY, WHICH MAY DEPRESS THE MARKET PRICE FOR OUR STOCK.
Certain provisions of our certificate of incorporation and bylaws and the
provisions of Delaware law could have the effect of delaying, deferring or
preventing an acquisition of our company, which may depress the market price for
our stock. For example, our board of directors will be divided into three
classes to serve staggered three-year terms, our stockholders will be unable to
take action by written consent and our stockholders will be limited in their
ability to make proposals at stockholder meetings. For more information about
these provisions, you should read "Description of Capital Stock."
WE MAY NEED ADDITIONAL CAPITAL TO FUND OUR OPERATIONS AND FINANCE OUR GROWTH,
AND WE MAY BE UNABLE TO OBTAIN IT ON TERMS ACCEPTABLE TO US, IF AT ALL.
We believe that our existing capital resources, including the anticipated
proceeds of this offering, will enable us to maintain our current and planned
operations for at least the next 12 months.
13
<PAGE>
However, we may require additional funds during or after that 12-month period.
Any required financing may not be available or may be available only on terms
that are not favorable to us. Further, if additional funds are raised through
the issuance of additional equity securities, the percentage ownership of our
stockholders would be diluted. Any new equity securities may have rights,
preferences or privileges senior to those of our common stock.
RISKS RELATED TO OUR INDUSTRY
IF WE ARE UNABLE TO ADAPT TO EVOLVING TECHNOLOGIES AND CUSTOMER DEMANDS IN A
TIMELY AND COST-EFFECTIVE MANNER, OUR ABILITY TO SUSTAIN AND GROW OUR BUSINESS
MAY SUFFER.
Our market is characterized by rapidly changing technology, evolving
industry standards and frequent new product announcements. These characteristics
are magnified by the recent growth of the Internet and the intense competition
in our industry. We also are subject to risks from technological changes in the
way managed hosting solutions are marketed and delivered. To be successful, we
must adapt to our rapidly changing market by continually improving the
performance, features and reliability of our services and modifying our business
strategies accordingly. We could also incur substantial costs if we need to
modify our services or infrastructure in order to adapt to these changes. Our
ability to sustain and grow our business would suffer if we fail to respond to
these changes in a timely and cost-effective manner.
OUR ABILITY TO EXPAND OUR CUSTOMER BASE WILL BE IMPAIRED IF INTERNET USAGE DOES
NOT CONTINUE TO INCREASE, IF THE INTERNET FAILS TO PERFORM RELIABLY OR IF THE
INTERNET PROVES NOT TO BE SECURE.
Use of the Internet for retrieving, sharing and transferring information
among businesses, consumers, suppliers and partners is increasing rapidly. Our
ability to grow our business and expand our customer base depends on continued
growth in the use of the Internet, and this ability would be impaired if
Internet use does not continue to grow, particularly among small- to
medium-sized enterprises. Internet use and growth may be inhibited for a number
of reasons, such as:
- inadequate network infrastructure;
- concerns about the security of confidential information;
- concerns about acts of sabotage, vandalism and other similar events such
as the events that adversely impacted the Web sites of Yahoo! and eBay in
February 2000;
- uncertainty of legal and regulatory issues concerning the use of the
Internet;
- adoption of onerous laws or governmental regulations; and
- lack of availability of cost-effective, reliable, high-speed service.
If Internet usage grows, the Internet infrastructure may not be able to
support the demands placed on it by this growth, or its performance and
reliability may decline. For example, Web sites have experienced interruptions
in service as a result of outages or acts of sabotage, vandalism or other
similar events. If these outages or delays occur frequently, use of the Internet
as a commercial or business medium could in the future grow more slowly or
decline, which would hinder our ability to grow our business. In addition,
because a number of our services include the transmission of confidential
information, we could experience decreased revenues and a loss of customers if
Internet users significantly reduce their use of the Internet due to security or
privacy concerns.
REGULATORY AND LEGAL UNCERTAINTIES COULD RESULT IN SIGNIFICANT COSTS OR
POTENTIAL LIABILITY.
Laws and regulations directly applicable to commerce or communications over
the Internet are becoming increasingly prevalent. However, many laws affecting
the Internet remain largely unsettled. The adoption or modification of laws or
regulations relating to the Internet could impede our ability to execute our
business plan, especially if they impose direct costs on us or if they curtail
the growth of
14
<PAGE>
the Internet. If liability for materials carried on or disseminated through Web
sites on the Internet is imposed on hosting services providers, we would be
required to implement measures to reduce our exposure to liability. These
measures could require us to expend substantial resources or discontinue
offering affected services. In addition, liability issues, including as a result
of lawsuits, legislation and legislative proposals, could divert management's
attention, result in unanticipated expenses and harm our business. If
legislation in the U.S. or abroad is adopted that makes transacting business
over the Internet less favorable, our business would suffer. For instance, if
legislation to tax e-commerce transactions were enacted, the demand for managed
hosting services would likely decrease. See "Business--Government Regulation."
RISKS RELATED TO THIS OFFERING
OUR PRINCIPAL STOCKHOLDERS, DIRECTORS AND EXECUTIVE OFFICERS WILL OWN
APPROXIMATELY 66% OF OUR COMMON STOCK FOLLOWING THIS OFFERING, WHICH MAY ALLOW
THEM TO EXERT INFLUENCE OVER US OR TO PREVENT A CHANGE OF CONTROL.
After this offering, our principal stockholders, directors and executive
officers will beneficially own, in the aggregate, approximately 66% of our
outstanding common stock. These stockholders, acting together, will be able to
exercise significant influence over all matters requiring stockholder approval,
including the election of directors and approval of significant corporate
transactions. This concentration of ownership may also delay or prevent a change
in our control even if beneficial to our stockholders.
SUBSTANTIAL FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET MAY DEPRESS
OUR STOCK PRICE.
Our current stockholders hold a substantial number of shares, which they
will be able to sell in the public market in the near future. Sales of a
substantial number of shares of our common stock, or the perception that such
sales will occur, after this offering could cause our stock price to fall. In
addition, the sale of shares by our stockholders could impair our ability to
raise capital through our sale of newly-issued stock. You should read "Shares
Eligible for Future Sale" for a more complete discussion of shares that may be
sold in the public market in the future.
OUR QUARTERLY AND ANNUAL RESULTS ARE LIKELY TO FLUCTUATE SIGNIFICANTLY AND MAY
FAIL TO MEET OR EXCEED THE EXPECTATIONS OF SECURITIES ANALYSTS OR INVESTORS,
CAUSING OUR STOCK PRICE TO BE VOLATILE AND POTENTIALLY RESULTING IN CLAIMS
AGAINST US.
Our quarterly and annual operating results are likely to fluctuate
significantly due to a number of factors, many of which are outside our control.
If our operating results do not meet the expectations of securities analysts or
investors, our stock price may be volatile. Factors that could cause our
operating results to fluctuate include:
- new customer installations;
- our retention of existing customers;
- fluctuations in data communications costs;
- timing and magnitude of capital expenditures;
- costs relating to the expansion of our operations;
- changes in our pricing policies or those of our competitors; and
- economic conditions specific to the hosting industry, as well as general
economic conditions.
In the past, securities class action litigation often has been brought
against a company following periods of volatility in the market price of its
common stock. We may be the target of similar litigation in the future.
Securities litigation could result in substantial costs and divert management's
attention and resources.
15
<PAGE>
FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS
This prospectus contains forward-looking statements. These statements
include, among others, statements relating to expenditure levels, the adequacy
of capital resources and plans for expansion of our marketing and sales efforts,
risk factors, use of proceeds, liquidity, strategy, sales and technology and
network operations. These statements may be found under "Prospectus Summary,"
"Risk Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business." Forward-looking statements are typically
identified by the use of terms such as "may," "will," "expect," "intend,"
"anticipate," "estimate" and similar words, although some forward-looking
statements are expressed differently. You should be aware that our actual
results could differ materially from those contained in the forward-looking
statements due to a number of factors, including without limitation, changes in
external competitive market factors, changes in our business strategy or an
inability to execute our strategy, unanticipated changes in the hosting industry
or in the economy in general and changes in use of the Internet, particularly by
small- and medium-sized enterprises. We cannot guarantee future results, levels
of activity, performance or achievements. You should also consider carefully the
statements under "Risk Factors" and other sections of this prospectus, which
address additional factors that could cause our actual results to differ from
those set forth in the forward-looking statements.
This prospectus contains estimates of market growth related to the Internet.
These estimates have been included in studies by market research and other firms
including International Data Corporation and Internet Operating System Counter
(leb.net/hzo/ioscount). These estimates have been produced by industry analysts
based on trends to date, their knowledge of technologies and markets, and
customer research, but these are forecasts only and are subject to inherent
uncertainty.
16
<PAGE>
USE OF PROCEEDS
We estimate that the net proceeds from the sale of shares of our common
stock in this offering will be approximately $35.0 million, at an assumed
initial public offering price of $12.00 per share, after deducting the estimated
underwriting discounts and commissions and estimated offering expenses payable
by us. If the underwriters' over-allotment option is exercised in full, we
estimate that the net proceeds will be approximately $40.3 million.
We intend to use approximately $8.0 million of the net proceeds of this
offering to fund capital expenditures associated with the purchase of computer
and networking hardware. We also intend to use approximately $10.0 million to
expand our data center presence in London and to establish a data center
presence in Asia and a second data center presence in the U.S. in the next
18 months. We expect to use the balance of the net proceeds for the expansion of
our sales and marketing and product development activities, working capital and
other general corporate purposes. In addition, we may use some of the net
proceeds for strategic investments or acquisitions; however, we have no current
agreements or commitments with respect to any acquisition or investments of this
type. Our management will have significant flexibility in applying the net
proceeds of this offering and may spend the proceeds from this offering in ways
that the stockholders may not deem desirable.
The timing and amount of our actual expenditures will be based on many
factors, including cash flows from operations and the growth of our business.
Until we use the net proceeds of this offering for the above purposes, we intend
to invest the funds in short-term, investment-grade, interest-bearing
securities. We cannot predict whether the proceeds invested will yield a
favorable return.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our common stock since
inception. We intend to retain any future earnings for developing and expanding
our business and do not anticipate paying any cash dividends in the foreseeable
future.
HOLDING COMPANY
Rackspace, Ltd., a Texas limited partnership, was formed on December 29,
1998, to provide managed Internet hosting services. To establish our initial
business, we acquired substantially all of the assets of Cymitar Technology
Group, Inc., a Texas corporation, in December 1998. In contemplation of this
public offering, we effected a reorganization of our operating structure by
incorporating Rackspace.com, Inc. in Delaware on March 7, 2000 to serve as a
holding company. To complete the holding company restructuring, the holders of
limited partner interests and the general partner interest in Rackspace, Ltd.
have agreed to exchange their respective partnership interests for an aggregate
of 16,980,868 shares of common stock in Rackspace.com, Inc. Contemporaneously
with that exchange, we will contribute the general partner interest and limited
partner interests in Rackspace, Ltd. to two wholly-owned subsidiaries.
17
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of March 31, 2000:
- on an actual basis;
- on a pro forma basis to reflect the completion of the holding company
restructuring through the exchange of all limited partner interests and
the general partner interest of Rackspace, Ltd. for an aggregate of
16,980,868 shares of our common stock; and
- on a pro forma as adjusted basis to additionally reflect the net proceeds
to us from the sale of 3,200,000 shares of our common stock in this
offering at an assumed initial public offering price of $12.00 per share
less estimated underwriting expenses and other estimated offering
expenses.
This information should be read in conjunction with our financial statements
and notes relating to these statements appearing elsewhere in this prospectus.
<TABLE>
<CAPTION>
MARCH 31, 2000
---------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
----------- ----------- -----------
<S> <C> <C> <C>
Cash and cash equivalents............................. $12,535,029 $12,535,029 $47,497,029
=========== =========== ===========
Partners' capital..................................... 15,429,204 -- --
Stockholders' equity:
Preferred stock, $.001 par value, 30,000,000 shares
authorized, no shares issued and outstanding,
actual, pro forma and pro forma as adjusted....... -- -- --
Common stock, $.001 par value, 170,000,000 shares
authorized, no shares issued and outstanding,
actual; 16,980,868 shares issued and outstanding,
pro forma; 20,180,868 shares issued and
outstanding, pro forma as adjusted................ -- 16,981 20,181
Additional paid-in capital............................ -- 16,648,286 51,607,086
Deferred stock compensation........................... (1,236,063) (1,236,063)
----------- ----------- -----------
Total partners' capital/stockholders' equity........ 15,429,204 15,429,204 50,391,204
----------- ----------- -----------
Total capitalization.............................. $15,429,204 $15,429,204 $50,391,204
=========== =========== ===========
</TABLE>
The share information set forth above excludes:
- 480,000 shares to be sold by us if the underwriters' over-allotment option
is exercised in full, as described in "Underwriting";
- 480,833 shares issuable upon the exercise of stock options granted to
employees outstanding as of March 31, 2000, with a weighted average
exercise price of $2.30 per share;
- 380,952 shares of common stock issuable upon the exercise of warrants
outstanding as of March 31, 2000, which were granted to investors in a
private equity financing in November 1999, with an exercise price of $2.10
per share;
- shares of common stock issuable upon the exercise of warrants
outstanding to Norwest Venture Partners and Sequoia Capital which were
granted in a private equity financing completed in March 2000; and
- additional shares of common stock reserved for future issuance under
the 2000 Stock Incentive Plan.
See "Management--2000 Stock Incentive Plan," "Description of Capital Stock"
and Note 7 of notes to our financial statements.
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<PAGE>
DILUTION
Our pro forma net tangible book value at March 31, 2000 was $14.8 million,
or $0.87 per share of common stock. Pro forma net tangible book value per share
represents the amount of our tangible net assets, which is defined as total
assets less intangible assets, less total liabilities, divided by the pro forma
number of shares of common stock outstanding as of March 31, 2000, after giving
effect to the completion of the holding company restructuring through the
exchange of all limited partner interests and the general partner interest of
Rackspace, Ltd. for an aggregate of 16,980,868 shares of our common stock.
Dilution in pro forma net tangible book value per share represents the
difference between the amount per share paid by purchasers of shares of common
stock in this offering and the pro forma net tangible book value per share of
common stock immediately after the completion of this offering. After giving
effect to our sale of 3,200,000 shares of common stock in this offering at an
assumed initial public offering price of $12.00 per share and after deducting
estimated underwriting discounts and commissions and estimated offering expenses
payable by us and the application of the estimated net proceeds from the
offering, our adjusted pro forma net tangible book value at March 31, 2000 would
have been $49.8 million, or $2.47 per share. This amount represents an immediate
increase in pro forma net tangible book value to our existing stockholders of
$1.60 per share and an immediate dilution to new investors of $9.53 per share.
The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............. $12.00
Pro forma net tangible book value per share at March 31,
2000.................................................... $0.87
Increase in pro forma net tangible book value per share
attributable to new investors........................... 1.60
-----
Pro forma net tangible book value per share after this
offering.................................................. 2.47
------
Dilution per share to new investors......................... $ 9.53
======
</TABLE>
If the underwriters exercise their over-allotment option in full, our
adjusted pro forma net tangible book value at March 31, 2000 would have been
$55.2 million, or $2.67 per share, representing an immediate increase in pro
forma net tangible book value to our existing stockholders of $1.80 per share
and an immediate dilution to new investors of $9.33 per share.
The following table summarizes, as of March 31, 2000 and after giving effect
to the pro forma adjustments described above, the differences between the number
of shares of common stock purchased from us, the aggregate cash consideration
paid to us and the average price per share paid by our existing stockholders and
by new investors purchasing shares of common stock in this offering. The
calculation below is based on an assumed initial public offering price of $12.00
per share, before deducting estimated underwriting discounts and commissions and
estimated offering expenses payable by us:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
--------------------- ---------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
---------- -------- ----------- -------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders................ 16,980,868 84.1% $18,846,598 32.9% $ 1.11
New investors........................ 3,200,000 15.9% 38,400,000 67.1% 12.00
---------- ----- ----------- -----
Total.......................... 20,180,868 100% $57,246,598 100%
========== ===== =========== =====
</TABLE>
The tables and calculations above assume no exercise of outstanding options.
At March 31, 2000, there were 480,833 shares of common stock issuable upon
exercise of options granted to employees outstanding with a weighted average
exercise price of $2.30 per share and shares reserved for future issuance
under our 2000 Stock Incentive Plan. In addition, at March 31, 2000, there were
380,952 shares of common stock issuable upon the exercise of warrants issued to
an investor in a private equity financing in November 1999, with an exercise
price of $2.10 per share, and warrants outstanding to purchase an aggregate of
shares issued to Norwest Venture Partners and Sequoia Capital in a private
equity financing completed in March 2000.
To the extent that these options and warrants are exercised, there will be
further dilution to new investors. See "Management--2000 Stock Incentive Plan."
19
<PAGE>
SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and our financial statements and related notes included in this
prospectus. The selected data presented below under the captions "Statement of
Operations Data" and "Balance Sheet Data" as of December 31, 1998 and 1999 and
for the period from December 29, 1998 to December 31, 1998 and the year ended
December 31, 1999, are derived from the financial statements of
Rackspace, Ltd., and the "Statement of Operations Data" for the year ended
December 31, 1997 and the period from January 1, 1998 to December 28, 1998 are
derived from the financial statements of Cymitar Technology Group, Inc., all of
which financial statements have been audited by KPMG LLP, independent certified
public accountants. The selected financial data for Rackspace for the three
months ended March 31, 1999 and March 31, 2000, and the selected financial data
as of December 31, 1996 and for the year ended December 31, 1996 for Cymitar
Technology Group, Inc., have been derived from the unaudited financial
statements for such periods, which financial statements, in the opinion of
management, include all adjustments, consisting only of normal recurring
accruals, necessary to state fairly the data included therein in accordance with
generally accepted accounting principles. Interim results are not necessarily
indicative of financial results expected for the full fiscal year.
The pro forma information regarding net loss per share and weighted average
shares outstanding set forth below gives effect to the exchange of all limited
partner interests and the general partner interest of Rackspace, Ltd. for shares
of our common stock for all periods presented. See our financial statements and
the notes to these statements appearing elsewhere in this prospectus for the
determination of the number of shares used in computing pro forma basic and
diluted net loss per share.
<TABLE>
<CAPTION>
THE COMPANY
THE PREDECESSOR ----------------------------
------------------------------------------ PERIOD FROM
PERIOD FROM DECEMBER 29,
JANUARY 1, 1998
YEAR ENDED 1998 (INCEPTION)
DECEMBER 31, THROUGH THROUGH YEAR ENDED
--------------------------- DECEMBER 28, DECEMBER 31, DECEMBER 31,
1996 1997 1998 1998 1999
------------ ------------ ------------ ------------- ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues................... $33,228 $ 72,535 $ 166,632 $ 76 $ 1,700,537
Operating expenses:
Cost of revenues............... 21,844 38,895 73,767 -- 513,424
Sales and marketing............ 1,387 648 3,615 -- 1,612,071
General and administrative..... 14,237 47,705 181,260 23 970,155
Product development............ -- -- -- -- 52,712
Depreciation and
amortization................. 4,115 6,912 12,363 262 261,730
------- -------- --------- ----------- -----------
Total operating expenses....... 41,583 94,160 271,005 285 3,410,092
------- -------- --------- ----------- -----------
Loss from operations......... (8,355) (21,625) (104,373) (209) (1,709,555)
Other income (expense)........... (227) (3,247) (7,767) (66) (43,243)
------- -------- --------- ----------- -----------
Net loss..................... $(8,582) $(24,872) $(112,140) $ (275) $(1,752,798)
======= ======== ========= =========== ===========
PRO FORMA LOSS PER SHARE:
Net loss................................................................. $ (275) $(1,752,798)
=========== ===========
Basic and diluted net loss per share..................................... $ (0.00) $ (0.16)
=========== ===========
Weighted average shares outstanding used in pro forma basic and diluted
per share calculation.................................................. 10,000,000 10,733,098
=========== ===========
<CAPTION>
AS OF
DECEMBER 31, AS OF DECEMBER 31, AS OF
--------------------------- ------------------- MARCH 31,
1996 1997 1999 1998 2000
------------ --------------------------------------------------------------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents................... 887 $ 19,183 $ 150,000
Working capital (deficit)................... (18,264) 16,548 154,232
Total assets................................ 17,966 38,724 343,161
Total partners' capital/stockholders' equity
(deficit)................................. (3,030) (27,902) 192,094
<CAPTION>
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues................... $ 125,507 $ 1,434,967
Operating expenses:
Cost of revenues............... 31,232 645,163*
Sales and marketing............ 78,414 1,639,054*
General and administrative..... 80,774 994,063*
Product development............ 7,724 99,818*
Depreciation and
amortization................. 20,513 304,442
----------- -----------
Total operating expenses....... 218,657 3,682,540
----------- -----------
Loss from operations......... (93,150) (2,247,573)
Other income (expense)........... (3,682) 102,874
----------- -----------
Net loss..................... $ (96,832) $(2,144,699)
=========== ===========
PRO FORMA LOSS PER SHARE:
Net loss..................... $ (96,832) $(2,144,699)
=========== ===========
Basic and diluted net loss pe $ (0.01) $ (0.14)
=========== ===========
Weighted average shares outst
per share calculation...... 10,000,000 15,035,893
=========== ===========
BALANCE SHEET DATA:
Cash and cash equivalents..... $ 3,794,784 $12,535,029
Working capital (deficit)..... 2,735,337 10,853,096
Total assets.................. 5,863,786 17,740,590
Total partners' capital/stockh
(deficit)................... 4,643,525 15,429,204
</TABLE>
----------------------------------
* Includes $23,000, $129,000, $182,000 and $46,000 of amortization of deferred
compensation within cost of revenues, sales and marketing, general and
administrative and product development, respectively.
20
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION OF THE FINANCIAL CONDITION AND RESULTS OF
OPERATIONS OF RACKSPACE.COM, INC. SHOULD BE READ IN CONJUNCTION WITH THE
FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED ELSEWHERE IN THIS PROSPECTUS.
THIS DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER FROM THOSE ANTICIPATED IN THESE
FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS INCLUDING, BUT NOT
LIMITED TO, THOSE DISCUSSED IN "RISK FACTORS," "FORWARD-LOOKING STATEMENTS AND
ASSOCIATED RISKS," "BUSINESS" AND OTHER SECTIONS OF THIS PROSPECTUS.
OVERVIEW
We provide managed Linux-based Internet hosting services primarily targeted
to small- to medium-sized enterprises worldwide. Through our managed hosting
services, we enable our customers to outsource their Internet operations while
allowing them to rapidly upgrade their server hardware and add bandwidth to
support their needs as they expand. Our service offerings are sold as a complete
hosting service package that can be configured, priced and ordered at our Web
site. All of our service packages include a built-to-order Internet server which
is dedicated for the exclusive use by a specific customer. At our U.S. facility,
we guarantee that a customer's dedicated server will be deployed within
24 hours after order confirmation in our state-of-the-art data center with
around-the-clock monitoring, security and technical support. As of March 31,
2000, we managed an installed base of over 1,200 servers within our data center
for more than 900 customers, with approximately 48% of these customers located
outside of the United States in over 50 countries around the world.
Since inception, we have incurred net losses and experienced negative cash
flow from operations. We intend to continue to invest significant resources to
enhance our brand identity and aggressively build our customer base worldwide.
In addition, we intend to establish additional data centers and expand our
network infrastructure, including our customer service and technical support
capabilities. As a result, we expect to continue to operate at a net loss and to
experience negative cash flows for the foreseeable future. Our ability to
achieve profitability and positive cash flow from operations will be dependent
upon our ability to expand significantly the number of customers for our
services, to retain our customers, to maintain our current prices and to achieve
operating efficiencies over a larger subscriber base.
CORPORATE RESTRUCTURING
Our company, Rackspace.com, Inc., is a newly-formed Delaware corporation
that will serve as the successor-in-interest to the business currently conducted
by Rackspace, Ltd., a Texas limited partnership. Prior to the completion of this
offering, the holders of limited partner interests and the general partner
interest in Rackspace, Ltd., as well as holders of options to acquire limited
partner interests in Rackspace, Ltd., will exchange their equity interests in
Rackspace, Ltd. for shares of our common stock or options, as the case may be.
Our operations will continue to be largely conducted by Rackspace, Ltd., with
two newly-formed, wholly-owned limited liability companies of
Rackspace.com, Inc. serving as its sole limited partner and sole general
partner, respectively. Rackspace, Ltd. originally was formed in December 1998 to
acquire substantially all of the assets of Cymitar Technology Group, Inc., a
Texas corporation that was incorporated in December 1997 and prior to that,
operated as a sole proprietorship beginning in March 1996. Cymitar Technology
Group, Inc. provided information technology consulting services to companies in
the San Antonio region. The asset acquisition was completed on December 29,
1998.
21
<PAGE>
REVENUES
We derive our revenues primarily from recurring monthly subscriptions for
our managed hosting services, which include the provision of an Internet server,
deployment of that server in our data center, an allocated amount of bandwidth,
monitoring, security and technical support provided on an around-the-clock, or
"24X7," basis. In addition, we derive revenues from:
- one-time set-up fees for initial installations;
- sales of upgrades for server system hardware and software;
- charges assessed for bandwidth usage in excess of the allocated amount
under customers' subscription agreements;
- other enhanced services that we offer to customers separately from their
subscription agreements;
- managed colocation services; and
- system management services that are not included in subscription plan
packages.
Monthly subscriptions are invoiced at the outset of the first month's
subscription and on approximately the same day in each successive month that the
subscription is renewed. Set-up fees also are invoiced at the outset of the
monthly subscription. Upgrades, excess bandwidth usage and technical services
are invoiced with the following month's subscription payment.
Because subscription revenues are prepaid on the first day of the monthly
subscription period and because the first day of each subscription period varies
from customer to customer, we defer a pro rata portion of each month's billings
to the following month. Therefore, we recognize only the revenue earned during
the time period in question. Deferred revenue is recorded at the end of each
quarter to reflect invoices billed during the last month of the quarter but not
recognized as revenue during that quarter. Other fees and charges are recognized
at the time the related services and products are provided to the customer.
In 1999, 33.4% of our revenues were derived from customers located outside
of North America. All of our sales to date have been denominated in U.S.
dollars. We believe that a significant portion of our revenues will continue to
be derived from customers outside of the U.S. as our services, and in
particular, our Linux-based services, receive a high level of acceptance in
international markets.
OPERATING EXPENSES
Our operating expenses are comprised of:
- cost of revenues, which consists primarily of the cost of contracting for
lines from telecommunication providers to supply our customers with
bandwidth, as well as compensation and related expense for customer
service and technical support and costs of operating our data centers;
- sales and marketing, which consists primarily of print and Internet
advertising expenses, compensation for sales and marketing personnel and
public relations and other marketing expenses;
- general and administrative, which consists primarily of corporate
compensation and related expenses, professional fees and occupancy costs;
- product development, which consists of employee-related expenses and other
expenses dedicated towards the development of new service and product
offerings for our customers; and
22
<PAGE>
- depreciation and amortization, which consists of depreciation of all of
our physical assets and amortization of costs for licensed software and
goodwill.
RESULTS OF OPERATIONS
The following table sets forth selected financial data for the quarters
ended March 31, 2000 and March 31, 1999, and for the year ended December 31,
1999, set forth as a percentage of total revenues in each period:
<TABLE>
<CAPTION>
YEAR ENDED THREE MONTHS THREE MONTHS
DECEMBER 31, ENDED ENDED
1999 MARCH 31, 1999 MARCH 31, 2000
------------ -------------- --------------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues............................. 100.0% 100.0% 100.0%
Operating expenses:
Cost of revenues......................... 30.2 24.9 45.0
Sales and marketing...................... 94.8 62.5 114.2
General and administrative............... 57.0 64.3 69.3
Product development...................... 3.1 6.2 7.0
Depreciation and amortization............ 15.4 16.3 21.2
------ ----- ------
Total operating expenses............... 200.5 174.2 256.7
------ ----- ------
Loss from operations................. (100.5) (74.2) (156.7)
Other income (expense)..................... (2.5) (2.9) 7.2
------ ----- ------
Net loss............................. (103.0)% (77.1)% (149.5)%
====== ===== ======
</TABLE>
THREE MONTHS ENDED MARCH 31, 2000 COMPARED TO THREE MONTHS ENDED MARCH 31,
1999
REVENUES. Revenues increased ten fold to $1.4 million in the quarter ended
March 31, 2000 from $126,000 in the quarter ended March 31, 1999. This increase
was primarily due to a large increase in the number of customers for our managed
hosting services in the quarter over quarter periods. We anticipate that revenue
growth in future periods will be derived from new customers for our services, as
well as service plan upgrades by our existing customers.
COST OF REVENUES. Cost of revenues increased to $645,000 in the quarter
ended March 31, 2000 from $31,000 in the quarter ended March 31, 1999,
representing 45.0% and 24.9% of total revenues for the respective quarters. Cost
of revenues for the quarter ended March 31, 2000 included $23,000 in
amortization of deferred stock compensation, with no deferred stock compensation
amortized in the quarter ended March 31, 1999. The increase in cost of revenues
in dollar amount and as a percentage of total revenues was primarily due to
costs associated with the expansion of our technical support staff to support
new subscribers and anticipated additional demand for our services, as well as
costs associated with the provisioning of bandwidth in advance of anticipated
demand for our hosting services. During the quarter ended March 31, 2000, we
entered into additional contracts with bandwidth providers to significantly
expand our network capacity in anticipation of future customer demand. These
arrangements were a significant contributor to the increased cost of revenues in
the quarter over quarter comparison. We anticipate that cost of revenues will
increase in both dollar amount and, in the near term, as a percentage of
revenues as we establish additional data centers and enter into additional
bandwidth contracts to offer hosting services in advance of customer demand for
those services. However, in the long term, cost of revenues as a percentage of
revenues should eventually stabilize if we are able to achieve greater economies
of scale by serving a larger customer base through our network infrastructure
and multiple data centers.
23
<PAGE>
SALES AND MARKETING. Sales and marketing expense increased to $1.6 million
in the quarter ended March 31, 2000 from $78,000 in the quarter ended March 31,
1999, representing 114.2% and 62.5% of total revenues for the respective
quarters. Sales and marketing expense for the quarter ended March 31, 2000
included $129,000 in amortization of deferred stock compensation, with no
deferred stock compensation amortized in the quarter ended March 31, 1999. The
increase in sales and marketing expense, both in dollar amount and as a
percentage of revenues, was primarily due to an increase in advertising
expenditures in 2000, as well as an increase in employee-related expenses
associated with a significant increase in the number of marketing-related
personnel and an increase in expenses for other marketing activities conducted
in the first quarter of 2000. Because we intend to significantly expand our
sales and marketing staff and pursue expanded sales and marketing activities in
future periods, sales and marketing expense will continue to increase in dollar
amount, and may increase in the short term as a percentage of revenues as we
develop and expand our marketing initiatives.
GENERAL AND ADMINISTRATIVE. General and administrative expense increased to
$994,000 in the quarter ended March 31, 2000 from $81,000 in the quarter ended
March 31, 1999, representing 69.3% and 64.3% of total revenues for the
respective quarters. General and administrative expense for the quarter ended
March 31, 2000 included $182,000 in amortization of deferred stock compensation,
with no deferred stock compensation amortized in the quarter ended March 31,
1999. The increase in the dollar amount of general and administrative expense
was primarily due to an increase in employee-related compensation and benefits
and, to a lesser extent, an increase in professional fees and allocation of
occupancy expense. The decrease in general and administrative expenses as a
percentage of revenues in the quarter over quarter period was due to the large
increase in revenues in the first quarter of 2000 as compared to the first
quarter of 1999 relative to such expense. We expect that general and
administrative expense will increase in dollar amount in future periods as we
expand our international operations, but we anticipate that it will decrease as
a percentage of revenues to the extent that we are able to achieve a larger
customer base for our services.
PRODUCT DEVELOPMENT. Product development expense increased to $100,000 in
the quarter ended March 31, 2000 from $8,000 in the quarter ended March 31,
1999, representing 7.0% and 6.2% of total revenues for the respective quarters.
Product development expense for the quarter ended March 31, 2000 included
$46,000 in amortization of deferred stock compensation, with no deferred stock
compensation amortized in the quarter ended March 31, 1999. The increase in
product development expense was the result of increased employee-related
expenses in the 2000 period. We anticipate that product development expense will
increase in both dollar amount and as a percentage of revenues in future periods
as a result of our increased emphasis on developing new network and hosting
services for our customer base.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased to $304,000 in the quarter ended March 31, 2000 from $21,000 in the
quarter ended March 31, 1999, representing 21.2% and 16.3% of total revenues for
the respective quarters. The increase in depreciation and amortization expense,
both in dollar amount and as a percentage of revenues, was the result of an
increase in server and networking equipment capital expenditures during 1999 and
the first quarter of 2000 needed to support our expanded customer base.
24
<PAGE>
The amortization of deferred stock compensation recorded during the quarter
ended March 31, 2000, as allocated among our functional departments, was as
follows:
<TABLE>
<CAPTION>
<S> <C>
Cost of revenue............................................. $ 23,000
Sales and marketing......................................... 129,000
General and administrative.................................. 182,000
Product development......................................... 46,000
--------
Total amortization of deferred stock compensation......... $380,000
========
</TABLE>
There were no stock based compensation awards prior to 2000 and,
accordingly, there was no amortization of deferred stock compensation in 1999.
OTHER INCOME (EXPENSE). Other income (expense) increased to $103,000 in the
quarter ended March 31, 2000 from ($3,700) in the quarter ended March 31, 1999.
The increase was due to interest income on the net proceeds received in our
private placement financing in November 1999. We anticipate that income included
in other income (expense) will increase in amount during the second half of 2000
as a result of interest income from interest-bearing investments that are made
with the proceeds of this offering.
COMPARISON OF YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
REVENUES. Revenues increased to $1.7 million in 1999 from $76 in 1998.
Revenues in 1998 represented revenues from operations that commenced on
December 29, 1998 and, therefore, included only three days of operations.
Revenues for 1999 were derived from customers of our managed hosting services.
Comparing the results of our predecessor, Cymitar Technology Group, Inc.,
revenues increased to $167,000 in 1998 from $72,000 in 1997. The increase
resulted from increased demand for Cymitar's consulting services.
We began focusing our efforts on providing managed hosting services in
December 1998. Prior to that, our predecessor was engaged in activities
primarily unrelated to our current operations and, accordingly, comparisons of
Cymitar's operating results for 1997 and 1998 with our operating results for
1999 are not meaningful and, accordingly, have not been made.
COST OF REVENUES. Cost of revenues were $513,000 in 1999, compared to no
such costs in the three-day period of 1998. Bandwidth costs represented the
majority of cost of revenues in 1999, with customer service and technical
personnel-related expenses and data center-related and other expenses
representing the balance. Bandwidth expenses have historically increased from
quarter to quarter and year to year as we have increased our network capacity in
a stair-step fashion. We expect these increases to continue, but should
stabilize as percentage of revenues once we reach a large enough scale within
our operations that incremental network demands are small relative to current
standard bandwidth provisioning sizes. As a percentage of revenues, cost of
revenues represented 30.2% of total revenues in 1999.
Comparing the results of our predecessor, cost of revenues increased to
$74,000 in 1998 from $39,000 in 1997. As a percentage of revenues, cost of
revenues decreased from 44.3% in 1998 from 53.6% in 1997.
SALES AND MARKETING. Sales and marketing expense was $1.6 million in 1999,
as compared to no such expense in the three-day period of 1998. Advertising,
public relations and trade show-related marketing expenditures represented the
majority of this expense in 1999, with compensation and related expenses of our
sales and marketing personnel representing the balance. As a percentage of
revenues, sales and marketing expense represented 94.8% of total revenues.
25
<PAGE>
Comparing the results of our predecessor, sales and marketing expense
increased to $4,000 in 1998 from $1,000 in 1997. As a percentage of revenues,
sales and marketing expense increased to 2.2% in 1998 from 0.9% in 1997.
GENERAL AND ADMINISTRATIVE. General and administrative expense increased
$971,000 in 1999 from $23 in the three-day perod of 1998. General and
administrative expenses were composed primarily of employee-related expenses,
such as salaries and wages. As a percentage of revenues, general and
administrative expense increased 57.0% in 1999 from 30.3% in 1998.
Comparing the results of our predecessor, general and administrative expense
increased to $181,000 in 1998 from $48,000 in 1997. As a percentage of revenues,
general and administrative expense increased to 109.8% in 1998 from 65.8% in
1997.
PRODUCT DEVELOPMENT. Product development expense was $53,000 in 1999, as
compared to no such expense in the three-day period of 1998. Product development
expenses primarily consisted of employee-related expenses. As a percentage of
revenues, product development expense represented 3.1% of total revenues in
1999.
Comparing the results of our predecessor, there were no product development
expenses in 1998 and 1997, as Cymitar's business was focused solely on providing
consulting services.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased to $262,000 in 1999 from $262 in the three-day period of 1998. As a
percentage of revenues, depreciation and amortization expense decreased to 15.4%
in 1999 from 344.7% in 1998.
Comparing the results of our predecessor, depreciation and amortization
expense increased to $12,000 in 1998 from $7,000 in 1997. As a percentage of
revenues, depreciation and amortization expense decreased to 7.4% in 1998 from
9.5% in 1997.
OTHER INCOME (EXPENSE). Other income (expense) increased to ($43,000) in
1999 from ($66) in 1998. As a percentage of revenues, other income (expense)
decreased to (2.5%) in 1999 from (86.8%) in 1998. Other income (expense)
consisted primarily of interest expense on a note that was converted to equity
in the fourth quarter of fiscal 1999 as well as interest earned on cash
holdings.
Comparing the results of our predecessor, other income (expense) increased
to ($8,000) in 1998 and from ($3,000) in 1997. As a percentage of revenues,
other income (expense) increased to (4.7%) in 1998 from (4.5%) in 1997.
INCOME TAXES. No provision for federal income taxes has been recorded as we
have incurred net operating losses from inception through December 31, 1999 as
our operations have been conducted as a limited partnership prior to this
offering. Consequently, we have not accumulated a net operating loss that may be
used to offset future taxable income.
SELECTED QUARTERLY OPERATING RESULTS
The following table sets forth unaudited statement of operations data for
each of the four quarters in 1999 and the first quarter of 2000, as well as the
percentage of our revenues represented by each item. This data has been derived
from unaudited interim financial statements prepared on the same basis as the
audited financial statements contained in this prospectus. The interim financial
statements include all adjustments, consisting of normal recurring adjustments,
that we consider necessary for a fair presentation of this information when
considered in conjunction with our financial statements and
26
<PAGE>
notes appearing elsewhere in this prospectus. The operating results for any
quarter should not be considered indicative of the results for any future
period.
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31,
1999 1999 1999 1999 2000
--------- --------- --------- ----------- -----------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues.................... $125,507 $ 263,483 $ 508,750 $ 802,797 $ 1,434,967
Operating expenses:
Cost of revenues................ 31,232 100,789 104,222 277,181 645,163*
Sales and marketing............. 78,414 253,942 410,300 869,415 1,639,054*
General and administrative...... 80,774 156,736 221,393 511,252 994,063*
Product development............. 7,724 9,960 9,960 25,068 99,818*
Depreciation and amortization... 20,513 43,235 75,354 122,628 304,442
-------- --------- --------- ----------- -----------
Total operating expenses...... 218,657 564,662 821,229 1,805,544 3,682,540
-------- --------- --------- ----------- -----------
Loss from operations........ (93,150) (301,179) (312,479) (1,002,747) (2,247,573)
Other income (expense)............ (3,682) (10,022) (19,528) (10,011) 102,874
-------- --------- --------- ----------- -----------
Net loss.................... $(96,832) $(311,201) $(332,007) $(1,012,758) $(2,144,699)
======== ========= ========= =========== ===========
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31, MARCH 31,
1999 1999 1999 1999 2000
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
AS A PERCENTAGE OF REVENUES:
Total revenues......................... 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Operating expenses:
Cost of revenues..................... 24.9 38.3 20.5 34.5 45.0
Sales and marketing.................. 62.5 96.4 80.6 108.3 114.2
General and administrative........... 64.4 59.5 43.5 63.7 69.3
Product development.................. 6.2 3.8 2.0 3.1 7.0
Depreciation and amortization........ 16.3 16.4 14.8 15.3 21.2
------- -------- ------- -------- --------
Total operating expenses........... 174.3 214.4 161.4 224.9 256.7
------- -------- ------- -------- --------
Loss from operations............. (74.3) (114.4) (61.6) (124.9) (156.7)
Other income (expense)................. (2.9) (3.8) (3.8) (1.2) 7.2
------- -------- ------- -------- --------
Net loss......................... (77.2)% (118.2)% (65.4)% (126.1)% (149.5)%
======= ======== ======= ======== ========
</TABLE>
------------------------
* Includes $23,000, $129,000, $182,000 and $46,000 of amortization of deferred
stock compensation included within cost of revenues, sales and marketing,
general and administrative and product development, respectively.
REVENUES. Revenues increased 93.1% during the quarter ended September 30,
1999, 57.8% during the quarter ended December 31, 1999, and 78.7% during the
quarter ended March 31, 2000, in each case as compared to the preceding quarter,
as a result of significant increases in our customer base during each quarter.
COST OF REVENUES. Cost of revenues increased in each quarter and fluctuated
as a percentage of revenues. Fluctuations in cost of revenues as a percentage of
revenues primarily were attributable to our purchase of additional bandwidth
capacity in advance of customer subscriptions for our hosting services. As
utilization of bandwidth increases, cost of revenues as a percentage of revenues
will tend to decline until we purchase additional bandwidth to support
customers' use of our services at which time the percentage will increase,
reflecting the reduced utilization of our bandwidth as a percentage of our
27
<PAGE>
total available bandwidth. Additionally, cost of revenues increased during the
quarter ended March 31, 2000 as a percentage of revenues as we expanded our
customer service and technical support teams in order to support future growth
in our customer base.
SALES AND MARKETING. Sales and marketing expense increased significantly
during each quarter of 1999 as we increased our sales and marketing staff, as
well as our advertising and promotional expenditures, during the year. Sales and
marketing expenses also increased both in dollar amount from the quarter ended
December 31, 1999 to the quarter ended March 31, 2000 and as a percentage of
revenues. We anticipate that our sales and marketing activities will continue to
increase in dollar amount as we establish our telemarketing presence and expand
our print and Internet advertising.
GENERAL AND ADMINISTRATIVE. General and administrative expense increased
each quarter during 1999 as we significantly increased our general and
administrative staffing. The increase in general and administrative expense from
the quarter ended December 31, 1999 to the quarter ended March 31, 2000 was
primarily the result of increases in recruiting fees and employee-related
expenses in that quarter.
PRODUCT DEVELOPMENT. Product development expense increased from the quarter
ended December 31, 1999 to the quarter ended March 31, 2000 as the result of our
increased emphasis on the development of new products and services.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization expense
increased each quarter during 1999 as the result of additions to our data center
infrastructure and the acquisition of new server equipment. During the quarter
ended March 31, 2000, we aggressively invested in our San Antonio data center.
As a result of our increased data center expenditures combined with our rapid
customer growth, depreciation and amortization expense increased as a percentage
of revenues from 15.3% of revenues in the quarter ended December 31, 1999 to
21.2% of revenues for the quarter ended March 31, 2000.
LIQUIDITY AND CAPITAL RESOURCES
We have used cash in our operating and investing activities during all
periods since inception. Cash used in operating and investing activities has
been funded by permanent contributions to capital, primarily in the form of
private placements of equity and debt. During the quarter ended March 31, 2000
and the year ended December 31, 1999, cash used in operations was $1.0 million
and $439,000, respectively. Net cash used in operating activities was primarily
the result of operating losses and changes in working capital. Net cash used in
investing activities was $2.8 million and $1.8 million, respectively, during the
same time periods. Net cash used in investing activities primarily resulted from
acquisitions of server and related computer hardware as well as network
equipment. Although we have plans to invest significantly in property and
equipment, we have no material commitments for such items at this time. Net cash
flow provided by financing activities during the year ended December 31, 1999
was $5.9 million. As part of our cash flows from financing activities, during
the quarter ended December 31, 1999 $1.6 million of debt was converted to equity
and an additional $4.5 million was raised in a private placement of equity. Net
cash flow provided by financing activities during the quarter ended March 31,
2000 and the year ended December 31, 1999 was $12.6 million and $5.9 million,
respectively. As of December 31, 1999, we had $3.8 million in cash and cash
equivalents.
Since December 31, 1999, we have raised gross proceeds of $12.6 million
through private placements of 2,309,440 limited partner interests in Rackspace,
Ltd. to a group of investors and the payment in full of a $750,000 note that was
issued to us in the November 1999 equity financing. Investors in these
financings included Norwest Venture Partners, Sequoia Capital and Red Hat. As of
March 31, 2000, we had $12.5 million in cash and cash equivalents.
We believe that our cash balances as of March 31, 2000, together with the
proceeds from this offering, will be adequate to meet our funding requirements
over the next 12 months. However, after such time, we may require additional
external financing for working capital and capital expenditures. We anticipate
that further expansion of our operations will cause us to incur negative cash
flows on a
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short-term basis, and therefore require us to use our cash and other liquid
resources to support our growth. Our operating and investing activities on a
long-term basis may require us to obtain additional equity or debt financing.
Although we have no present understandings or commitments with respect to any
acquisition of other businesses, products, services or technologies, we intend
to evaluate potential acquisitions from time to time. In order to consummate
potential acquisitions, we may need additional equity or debt financing in the
future.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (FAS 133), which will be effective for the fiscal year
ending December 31, 2001. This statement establishes accounting and reporting
standards requiring that every derivative instrument, including derivative
instruments embedded in other contracts, be recorded in the balance sheet as
either an asset or liability measured at its fair value. The statement also
requires that changes in the derivative's fair value be recognized in earnings
unless specific hedge accounting criteria are met. Although we have not
evaluated the impact of FAS 133, we believe the adoption of FAS 133 will not
have a material effect on our financial position, results of operations or cash
flows as we have not entered into any derivative contracts.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to interest rate risk primarily through our portfolio of cash
equivalents. We do not believe that we have significant exposure to market risks
associated with changing interest rates as of December 31, 1999 because our
intention is to maintain relatively liquid investments. We do not use derivative
financial instruments in our operations.
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BUSINESS
Rackspace.com is a leading provider of managed Linux-based Internet hosting
services targeted to small- to medium-sized enterprises worldwide. We offer our
customers attractively-priced monthly Internet hosting plans that are packaged
as end-to-end solutions that can be configured, priced and ordered through the
Rackspace.com Configurator at our Web site. Our service offerings are designed
to aid our customers in rapidly implementing their Internet strategies and
e-business initiatives. All of our service packages include a built-to-order
Internet server with pre-installed operating system software and select
Internet-based applications, and multiple connections to the Internet. We
provide each customer with a dedicated server or servers, meaning that each
server is exclusively devoted to the use by that customer. Servers are housed
within a state-of-the-art data center where we provide around-the-clock
monitoring, security and technical support. We guarantee deployment of a new
customer's Internet hosting service within 24 hours of order confirmation.
Additionally, we enable our customers to cost-effectively expand their Internet
operations to support their growing needs by adding bandwidth and rapidly
upgrading their server hardware. We have developed specific expertise in
deploying managed hosting services based on the Linux operating system, and
approximately 80% of our customers have selected Linux-based hosting services.
We believe that customers select the Linux operating system for their Internet
operations due to its reputation for stability, high performance, ease of remote
administration and cost advantages. We also provide and support managed hosting
services based on Solaris, Windows NT/2000 and other operating systems.
We offer flexible, cost-effective managed hosting solutions that can be
customized and rapidly deployed to meet our customers' specific requirements. We
seek to educate small- to medium-sized enterprises worldwide about the benefits
of outsourced Internet hosting services and to accelerate their purchasing
decisions through targeted marketing and our direct and channel sales efforts.
In addition, we have entered into strategic relationships with Red Hat, Perot
Systems and Sun Microsystems, among others, in order to accelerate our market
penetration and to expand our product and service offerings. As of March 31,
2000, we managed an installed base of over 1,200 servers within our data center
for more than 900 customers, with approximately 48% of these customers located
outside of the United States in over 50 countries around the world.
INDUSTRY BACKGROUND
THE NEED FOR A WEB PRESENCE
The Internet has emerged as a global communications medium and traffic on
the World Wide Web continues to explode. International Data Corporation, or IDC,
estimates that the number of Web users worldwide will grow from 142.2 million in
1998 to 502.4 million in 2003. The Internet also has developed into a critical
resource for business. According to IDC, worldwide business-to-business
e-commerce is expected to grow from approximately $50.4 billion in 1998 to
approximately $1.3 trillion in 2003, representing a 92% compound annual growth
rate. To successfully develop an online presence into a competitive advantage,
companies seek to rapidly introduce sophisticated Internet services to improve
communications with customers, suppliers, employees and business partners and to
attract the growing worldwide consumer audience that increasingly uses the
Internet to purchase goods and services. According to IDC, in 2003, businesses
worldwide will spend approximately $1.5 trillion in technology and
non-technology investments to maintain and support the Internet infrastructure.
OUTSOURCING OF INTERNET HOSTING SERVICES
A large number of enterprises initially created their Web sites for
brochure-style marketing and information purposes. Today, enterprises are adding
transaction functionality, e-commerce and other complex applications to their
Internet operations in an effort to derive substantial revenues from their
online activities. The economics of outsourcing hosting services is compelling
for many enterprises. We believe that the costs associated with outsourcing a
small- to medium-sized enterprise's hosting needs
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are a small fraction of the costs involved in establishing in-house hosting
capabilities. In addition, outsourcing of Internet hosting services provides
enterprises with the following benefits:
- high-speed and reliable bandwidth;
- the ability to rapidly adopt evolving Internet technologies and
architectures;
- rapid and efficient scaling of e-commerce and Internet application
initiatives;
- access to qualified and experienced information technology personnel;
- the ability to maintain primary focus on their core business operations
instead of infrastructure requirements;
- cost-effective managed hosting solutions; and
- reduced risk of hardware obsolescence.
Internet hosting services have traditionally been provided in three forms:
- SHARED-SERVER HOSTING. In shared-server hosting, two or more enterprises
share a third party's Internet server, network connections, software and
bandwidth. This method of hosting provides a low-cost means for an
enterprise to maintain an Internet presence. Shared-server hosting is
attractive for enterprises that maintain Web sites with primarily
brochure-style content, as shared-server hosting provides limited storage
and processing capabilities, typically does not offer multiple connections
to the Internet or ready access to additional bandwidth and poses security
risks caused by multiple parties having access to a single server.
- COLOCATION HOSTING. Enterprises that own their own Internet servers and
software can use colocation hosting to house their servers within an
Internet hosting company's shared data center. The enterprise retains
responsibility for the installation, management, upgrading and security of
its Internet operations. For this reason, colocation generally is a
feasible option for enterprises that operate a large number of servers and
maintain a staff of technical support personnel within close proximity of
the data center.
- MANAGED HOSTING. In managed hosting, enterprises are provided a complete
outsourced Internet hosting solution housed at the Internet hosting
company's data center. Managed hosting includes provision of the Internet
server, software, network equipment and services and technical support. In
addition, managed hosting often includes other value-added services such
as server clustering and load balancing, private networking options and
security management solutions.
THE OPPORTUNITY TO PROVIDE INTERNET HOSTING FOR SMALL- TO MEDIUM-SIZED
ENTERPRISES
According to IDC, there were approximately 7.6 million businesses in the
U.S. in 1999, of which 99.9% were categorized as small- to medium-sized firms,
I.E., firms with less than 1,000 employees. In addition, according to IDC, in
1999:
- 52.3% of small businesses and 95.6% of medium-sized businesses were
connected to the Internet;
- 17.0% of small businesses and 73.1% of medium-sized businesses maintained
an active home page; and
- 6.4% of small businesses and 19.9% of medium-sized businesses conducted
business online.
As these small- to medium-sized enterprises increase their activities in the
digital marketplace, Internet hosting services should experience significant
increased demand. To date, the market for Internet hosting services targeted to
small- to medium-sized enterprises has been largely underserved. Neither
shared-server nor colocation hosting effectively addresses these enterprises'
needs for dynamic, but cost-effective, Internet operations, yet this market
represents a significant opportunity. IDC estimates that the market for
colocation hosting and dedicated Web hosting, the latter term of which
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we refer to as managed hosting, will be approximately $13.0 billion in the U.S.
in 2003, and that small-to medium-sized enterprises will represent 90.1%, or
$11.7 billion, of that total.
LINUX AND THE WEB
In assessing their needs for a reliable and cost-effective infrastructure to
support their Internet operations, many enterprises choose to implement hardware
and software products that use an open source operating system software, such as
the Linux system. The term "open source" refers to software which can be copied,
modified and distributed without payment of licensing or associated fees and
with few restrictions on use. As an open source standard for use in computing
systems, or platform, the source code for the Linux operating system can be
downloaded from the Internet and software developers can write and sell
applications based on the Linux software without obligation to pay fees or
royalties to any third party. The Linux code itself is continuously maintained
and improved by large communities of developers who share information, code and
suggestions. Additionally, the open source platform for Linux allows end users
to customize the Linux source code to meet their specific requirements. The
Linux platform offers companies several important benefits, including:
- STABLE AND HIGH PERFORMANCE CHARACTERISTICS. The Linux operating system
has established a reputation as a stable platform that is designed to run
in continuous mode without interruption.
- COST-EFFECTIVE IMPLEMENTATION. Unlike proprietary operating systems, the
operating system for Linux is free to anyone and many core software
products, such as Linux database software, e-mail and Internet server
applications, also are available at no charge.
- GREATER INTEROPERABILITY. Due to Linux's growing popularity, equipment
manufacturers and software developers increasingly introduce products that
are compatible with the Linux platform, which, in turn, provides
enterprises with greater flexibility in selecting the most appropriate
hardware and software for their needs, including from leading vendors such
as IBM, Intel, Oracle, Red Hat and Sun Microsystems.
- REMOTE ADMINISTRATION CAPABILITY. The Linux operating system can be
administered through simple, quickly transmitted instructions, thereby
enabling operators to rapidly administer changes to the server from a
remote site over a modem without physically handling the server.
Linux has emerged as the leading operating system for the Internet. In an
April 1999 survey conducted by Internet Operating System Counter
(leb.net/hzo/ioscount), which polls Web sites for operating system information,
Linux-based operating systems represented 31% of all Web server installations,
making Linux the most commonly used operating system for Web servers. According
to IDC, revenue or paid shipments of Linux grew faster than any other server
operating environment between 1997 and 1998, and again between 1998 and 1999.
THE MARKET OPPORTUNITY
For small- to medium-sized enterprises, the outsourcing of their hosting
needs to a provider of managed hosting services offers a cost-effective means to
establish and maintain dynamic Internet operations. Managed hosting involves the
dedication of a server, or series of connected servers, to a single customer's
Internet operations on an outsourced basis. The customer pays for the use of the
outsourced server or servers and the services provided to it, including
bandwidth, network monitoring, server maintenance and technical support, without
incurring the up-front capital cost for purchasing and deploying the server
hardware and software and the continuing costs for maintaining a staff of
technical personnel. IDC estimates that in the United States the dedicated Web
hosting market will grow from $555.0 million in 1998 to approximately
$13.0 billion in 2003.
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THE RACKSPACE.COM SOLUTION
We provide managed hosting services that offer enterprises a cost-effective
outsourcing solution to deploy and maintain their Internet servers within a
secure, state-of-the-art data center that provides around-the-clock monitoring,
security and technical support. Our month-to-month service plans allow small- to
medium-sized enterprises to rapidly establish their online presence efficiently
and effectively. Our service plans also provide our customers with a flexible
means to scale their Internet server and bandwidth requirements to accommodate
rapid changes in demand or pursue new e-business initiatives. Our solutions
provide our customers with the following benefits:
- FLEXIBLE, COST-EFFECTIVE SOLUTION. We offer end-to-end services that
provide a complete outsourced managed hosting solution at a fraction of
the cost typically associated with the purchase of a server and network
hardware and its deployment within a data center. A purchase of a service
plan typically begins with the prospective customer using the
Rackspace.com Configurator on our Web site to custom configure, price and
order an Internet server and bandwidth package. We offer our services
under month-to-month contracts that permit the customer to adjust its
services without a long-term commitment. The short-term nature of the
customer's commitment can accelerate the customer's initial decision to
outsource its managed hosting service needs to us. Our month-to-month
programs also make it easy for a customer to increase the performance of
its single server or server cluster without incurring disposition fees or
continuing payment obligations on the prior server.
- RAPID DEPLOYMENT. We have designed our managed hosting services to support
rapid deployment, quick upgrades and fast modifications. We guarantee our
new customers that we will configure and launch their Internet servers in
our U.S. data center within 24 hours of order confirmation. Additionally,
we are able to increase a customer's bandwidth upon request, and we
typically complete hardware upgrades within 24 hours. We also offer
applications to streamline the introduction of robust e-commerce features
and functions at our customers' Web sites. In e-commerce, where rapid time
to market is a competitive advantage, our rapid deployment capabilities
enable our customers to move with confidence in establishing and expanding
their Internet operations.
- SCALABLE PRODUCT OFFERINGS. We offer our customers managed hosting
solutions that expand without degradation in performance, or scale, to
accommodate their new e-business initiatives and Web traffic needs.
Through this scalability, our services minimize the costs and capital
risks involved in projecting future managed hosting service needs,
including server obsolescence, bandwidth oversizing and Web site outages.
- LINUX EXPERTISE. Managing the deployment of business-critical Internet
applications requires an in-depth understanding of the underlying
software, hardware and network technologies. We believe that we are the
leading provider of managed hosting services that uses Linux as the
primary operating system for the vast majority of its dedicated servers.
We have broad knowledge of the Linux operating system and Linux-based
applications. We use this expertise to offer comprehensive services,
including installation, configuration and stress testing of hardware and
software, content back-ups and system upgrades.
- HIGH LEVEL OF CUSTOMER SERVICE. We believe that our prospective customers
highly value customer service and technical support when selecting a
hosting provider. We form a support team for each customer to serve as a
single point of contact for that customer. Each team is composed of a
support specialist to handle routine inquiries and system specialists who
are available 24 hours a day, seven days a week, or "24X7." Customer
service and standard technical support are provided through e-mail and
telephone inquiries handled by people, rather than by automated call
answering systems.
- GLOBAL DATA CENTER INFRASTRUCTURE. We maintain a data center in our San
Antonio facility that uses Cisco networking equipment and the services of
multiple providers of the main network
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connections that compose the Internet, which is commonly referred to as
the "Internet backbone," consisting of Intermedia, Qwest, SBC
Communications, Time Warner Telecom and UUNET. Our data center offers
customers ready access to additional bandwidth to accommodate surges or
bursts of data traffic to their servers, which assures them that we will
provide sufficient bandwidth to address rapid, unexpected or continuing
increases in the demand for data from their housed servers. Our data
center provides around-the-clock monitoring, security and technical
support, backup power supply, and high-speed and redundant network
connectivity to help ensure uninterrupted high performance and data
integrity. To further support our global customer base, we recently
established a data center in London and we intend to establish additional
data centers in Europe and Asia, as well as a second data center in the
United States.
STRATEGY
Our goal is to become the leading global provider of managed Linux-based
Internet hosting services by capitalizing on the growth in Internet usage,
e-commerce and the outsourcing of hosting services. Our strategy for
accomplishing this goal includes the following key elements:
ESTABLISH RACKSPACE.COM AS THE LEADING LINUX HOSTING SOLUTION. Our
technicians have particular expertise in the implementation and support of
managed Linux-based Internet hosting services. As Linux continues to receive
broad acceptance as the platform of choice for Internet operations, we believe
that enterprises will increasingly view us as the authoritative provider of
managed hosting solutions using the Linux platform. We intend to continue
focusing significant resources to further develop and expand our technical
proficiency in Linux and firmly establish our position as the authoritative
provider of Linux hosting solutions.
BUILD GLOBAL BRAND AWARENESS. The market for managed hosting services is in
the early stages of its development and we believe this market is both unformed
and uninformed. Therefore, we believe a significant opportunity exists for us,
as a leader in this industry, to build brand identity as the premier provider of
these services. We intend to inform prospective customers about the benefits of
our services by expanding our involvement in trade shows, seminars and
workshops, and by conducting marketing programs with our channel partners to
develop association of our brand name with their more recognizable names. In
this manner, we believe that we will form greater demand for our services that,
in turn, will broaden our customer base worldwide. We also intend to generate
greater awareness of our brand and service offerings by continuing to engage in
technology tradeshows and conferences, outbound telemarketing, direct mail
advertisements, targeted advertisements on Web sites and searches directed at
hosting services, advertisements in business and technology publications and
regional public relations activities. We will pursue these efforts in defined
regions in which Internet adoption by enterprises occurs at a rapid pace, such
as in North America, Western Europe and select Pacific Rim locations, including
Australia, Hong Kong, Japan, Singapore and Taiwan.
CAPITALIZE ON INTERNATIONAL MARKET OPPORTUNITIES. Customers with principal
offices outside of the United States represented 48% of our customers as of
March 31, 2000. Because the Internet infrastructure has been rapidly established
in the U.S. and intense competition among bandwidth providers of Internet
connectivity in the U.S. market has contributed to a relatively lower cost
environment than in other countries, many international enterprises elect to
maintain their Internet servers in the U.S. In addition, because sites
maintained by international enterprises are accessed in significant part by
U.S.-based Internet users, the placement of an Internet server in the U.S.
enables rapid delivery of content to these users. Linux is also a popular
platform for international enterprises due to its ability to be administered
through short commands from any remote site over a modem connected to the
Internet. We recently established a data center presence in London. We intend to
establish additional data centers in markets outside of the U.S. as the Internet
infrastructure becomes more developed, and pricing among providers of Internet
connectivity becomes more competitive, in
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those markets. We believe that our experience in providing managed hosting
services in the U.S., combined with our technical expertise, brand recognition
and focus on Linux, will enable us to compete favorably with other providers of
managed hosting services in local markets across the world.
UTILIZE STRATEGIC RELATIONSHIPS TO EXPAND MARKET OPPORTUNITIES. A key
element of our sales and marketing strategy involves the formation of strategic
relationships with third parties that select, or influence the selection of,
Internet hosting service providers for end-user enterprises. To this end, we
recently established a strategic relationship with Red Hat for proposed joint
marketing and product development and with Perot Systems to co-market our
services and generate referrals. We will continue to aggressively pursue
relationships with other system integrators, e-business consultants, application
service providers, Web designers and independent software vendors, particularly
Linux software vendors. We believe that these relationships will enable us to
promote greater awareness of our products and services with end-user enterprises
through co-marketing arrangements. We intend to continue developing
relationships with channel partners in key markets around the world in a
collaborative and noncompetitive manner.
OFFER A BROAD RANGE OF PRODUCTS AND SERVICES TO SERVE THE GROWING NEEDS OF
OUR CUSTOMERS. Our managed hosting services are designed to accommodate the
needs of our customers as they progress in the development of their Internet
operations. Therefore, we intend to further expand the products and services
that we offer to our global customer base. For example, we intend to establish
an additional data center in the U.S. to support redundant data mirroring and
remote backup. Furthermore, we intend to establish and expand our relationships
with providers of products and services that are complementary to our services
in order to offer our customers additional enhanced services and e-commerce
software applications. To this end, we have established strategic relationships
with Red Hat proposing to provide product development and application testing
expertise; with Trident Data Systems to provide advanced security solutions;
with Cisco Systems to provide enhanced networking solutions; with SiteLite to
provide advanced database administration and monitoring services for Oracle and
Microsoft SQL database applications; and with Mercantec and Akopia to provide
e-commerce solutions.
EXPAND OUR CUSTOMER SERVICE CAPABILITIES. We intend to continue to devote
significant resources to expand and further develop our customer service and
technical support capabilities. We believe that we offer superior customer
service and technical support, which increasingly will be critical factors for
generating new customer referrals, retaining our existing customers and creating
barriers to entry for emerging competitors in our market. We recently launched
the Rackspace.com Wizard at our Web site, which simplifies the process of
setting up a new Internet-domain configuration. We also intend to expand our
online reporting of server performance for our customers so that they can
anticipate the need for a server upgrade or replacement, or an increased
bandwidth service plan, to remain cost-effective in the use of our services as
they grow their online operations.
SERVICES
Our primary service offering consists of comprehensive managed hosting
service packages that are targeted to small- to medium-sized enterprises
enabling them to establish, maintain and expand their Internet operations. Each
managed hosting plan consists of a custom-built outsourced server that is housed
within one of our data centers. Each outsourced server is dedicated to a single
customer for that customer's Internet hosting use. All of our hosting service
plans also include:
- connectivity to a high-speed network designed with multiple redundant
systems;
- customer-selected operating system software and standard Internet
applications, including e-mail, file transfer protocol and Web server
applications;
- around-the-clock, or 24X7, monitoring, security and technical support;
- remote access administration and management reporting tools;
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- sophisticated monitoring and alert notification;
- uninterrupted power supply through a back-up diesel generator that is
capable of supporting the data center's operation should primary power be
unavailable;
- air-conditioned, and humidity- and static-controlled environment; and
- multiple security measures to control physical access to servers within
the data center.
We also offer customers enhanced services separate from our managed hosting
plans. Please see "--Enhanced Services" below for a description of these
services.
EASE OF DEPLOYMENT OF OUR MANAGED HOSTING SERVICES
We have made the configuration of a customized Internet server and the
selection of a managed hosting service package a simple, quick and automated
process. For most of our prospective customers, the process begins with a visit
to our Web site and, in particular, the use of our proprietary Rackspace.com
Configurator. The following is the main screen that a user sees when accessing
the Rackspace.com Configurator for a Linux-based hosting package:
[SCREEN SHOT FROM THE COMPANY'S RACKSPACE.COM CONFIGURATOR WEB PAGE]
As indicated in the pull-down menus shown in the boxes above, a prospective
customer can select from multiple options underlying each category on the
Rackspace.com Configurator set-up page. For example, the customer can select a
microprocessor with performance capability ranging from a single 350 MHz
processor to dual 750 MHz processors. Other hardware specifications,
custom-configured by the customer, include memory requirements, selection of one
or more hard drives, and optional selection of a tape drive or a redundant array
of independent disks, commonly referred to as RAID, configuration. The
Rackspace.com Configurator also allows prospective customers to choose a service
plan consistent with their needs. Service options include the choice of
operating system software, a subscribed allocation of bandwidth ranging from two
gigabytes to five terabytes of data transfer per month with bandwidth above that
amount purchased on an as-used, basis, one or more Internet addresses, system
management services, and tape backup and rotation services. Upon the online
submission of a selected configuration, the Rackspace.com Configurator instantly
generates a price quote for both the monthly service fee and the set-up fee.
Thus, the prospective customer can readily explore various service plan
alternatives to reach a desired price point.
Following confirmation of an order for a service plan in the U.S., a
Rackspace.com technician will custom configure the server in our San Antonio
facility and then install the server in our primary data center. Following
performance testing of the installed server, we notify the customer that its
server is ready for downloading of the customer's software applications. We
guarantee that assembly and deployment will be completed within 24 hours of
order confirmation.
Once deployed, our customer service and technical support personnel provide
server management services to support the uninterrupted operation of the server
within our data centers. Customer service and technical support include
around-the-clock monitoring, technical support, automated interval checking of
system ports and prompt replacement of defective components without additional
charge.
ENHANCED SERVICES
- PRIVATENET. Our PrivateNet service allows customers with multiple servers
to operate their own private internal network among those servers. This
feature enables these multiple servers to exchange data exclusively among
each other, without transmission over the public Internet. PrivateNet
offers a number of benefits to customers with multiple server
configurations, including (1) enhanced security through the separation of
internal traffic from the public Internet, (2) improved server performance
by separating internal processes, such as database access, from external
processes, such as requests for data received over the Internet, and
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(3) reduced cost as there is no charge for bandwidth used for internal
PrivateNet transmissions, in contrast to billable transmissions between
servers and the public Internet.
- LOAD BALANCING. This service provides a higher level of service for
customers with multiple servers. By installing a load-balancing switch
between the Internet backbone connection and a server array, data requests
can be diverted among servers to prevent server overload while providing
redundant storage and processing capability.
- DATABASE MONITORING. Through our relationship with SiteLite, we offer our
customers database administration, monitoring and support services for
Oracle and Microsoft SQL database solutions. Although these enhanced
services are billed by us, SiteLite provides the services directly to the
customer. SiteLite services are offered as an option for our customers
through the Rackspace.com Configurator.
- E-COMMERCE SOLUTIONS. We partner with Mercantec and Akopia to offer our
customers online catalog and ordering software, credit card processing and
other features and functions for their Web sites' e-commerce initiatives.
These e-commerce options are offered to our customers through the
Rackspace.com Configurator.
- SECURITY AUDITING SERVICES. Through our partnership with Trident Data
Systems, we offer customized security auditing services to our customers.
As part of these services, we work with Trident to identify, assess and
propose corrections to security vulnerabilities on the customer's server.
In addition, at the customer's request, we work in conjunction with
Trident to implement solutions to address the identified vulnerabilities.
The enhanced services we provide through our strategic partnerships with
third parties are accounted for in the same manner as our baseline managed
hosting services. We bill our customers up front, but recognize only the portion
of the revenue that was earned during a given calendar time period. We recognize
the gross revenues from these strategic relationships and expense the costs as
either cost of recurring revenues or amortization of licenses.
MANAGED COLOCATION SERVICES
Through our managed colocation services, customers can locate their own
Internet servers within our world-class data center, and outsource the
monitoring and technical support of their servers to us. The selection of a
colocation service plan can be made online at our Web site.
PRICING
Our managed hosting services generally are billed on a monthly basis, with a
one-time initial setup fee charged at the time the server is configured. Our
current customers' monthly service plans range from approximately $200 to $6,500
per month, with the amount varying according to the customer's server
specifications, number of servers, bandwidth requirements and selection of
enhanced services. The sample screen from the Rackspace.com Configurator
presented on page 36 shows typical selections for a small- to medium-sized
enterprise that is commencing Internet operations with a Linux-based server.
To further simplify the purchasing process for our customers, all service
plans, including features and pricing, are described on our Web site. This
enables our customers to evaluate the various service offerings without
contacting one of our sales representatives, which in turn can shorten the sales
cycle, reduce our customer acquisition costs and ultimately enhance customer
satisfaction.
CUSTOMERS
We provide our services to end-user businesses, system integrators, Web site
development firms and other organizations. Our customers are located in over 50
countries around the world, including in North America, Europe and select
Pacific Rim locations. As of March 31, 2000, our primary data
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center housed over 1,200 Internet servers for more than 900 customers. Our
customers are comprised primarily of small- to medium-sized enterprises. As a
result, our top 10 customers, in the aggregate, represented less than 15% of our
revenues in 1999, and no single customer represented more than 4% of our
revenues in 1999.
STRATEGIC RELATIONSHIPS
- RED HAT. In March 2000, we executed a memorandum of understanding with Red
Hat for a proposed joint marketing arrangement. The joint marketing
proposal contemplates that we will jointly promote our respective products
and services by entering into a "Premier Partner" relationship, which will
allow each party to place its marks and information about its products and
services on the other party's Web site. As a Premier Partner of Red Hat,
we will have prominent placement as a managed hosting vendor within Red
Hat's recently launched Open Source Marketplace. In addition, the proposal
contemplates that Red Hat will distribute Rackspace.com information with
its version 7.0 software, which is scheduled for release later this year.
We also propose to enter into a strategic alliance agreement with Red Hat
under which we will agree with Red Hat to jointly promote each other's
products and services through non-Internet marketing initiatives. The
proposed arrangement contemplates our payment of an upfront fee and
customer referral fees to Red Hat. In addition, Red Hat invested
$2.0 million in our March 2000 private placement. There are no future
performance obligations or stated or unstated rights or privileges
associated with this investment by Red Hat.
- PEROT SYSTEMS. In March 2000, we entered into a distribution agreement
with Perot Systems. This agreement provides for (1) customer referrals for
our services by Perot Systems, (2) the establishment of a hot-link between
the parties' Web sites, (3) the placement of the Rackspace.com
Configurator on Perot Systems' primary Web site and (4) the creation of a
joint marketing program. We have agreed to pay Perot Systems a fee based
upon revenues derived by us under this agreement.
- SUN MICROSYSTEMS. We serve as an Embedded Solutions Provider of the
Microelectronics Division of Sun Microsystems. Under this arrangement, we
custom build servers and provide managed hosting solutions based on Sun's
Solaris platform. As Solaris is an established operating system for many
enterprise applications, we believe that this relationship will complement
our ability to support our customers' needs as they expand their
implementation of enterprise applications in Internet-based internal
networks, or intranets.
- OTHER STRATEGIC RELATIONSHIPS. We have developed strategic relationships
with Trident Data Systems, Mercantec, SiteLite and Akopia to provide
enhanced products and services to our customers. For further information,
see the section above captioned "--Services--Enhanced Services."
MARKETING AND SALES
Our marketing efforts are intended to build awareness of our services,
create channel partner interest and generate end-user demand. Our marketing
activities include participation in technology trade shows and conferences,
outbound telemarketing, direct mail advertisements, targeted advertisements on
Web sites and searches that are directed at hosting services, advertisements in
business and technology publications and regional public relations activities.
Additionally, we intend to leverage our current and future strategic
relationships through co-marketing and cross-selling campaigns. Our current
arrangements with Red Hat, Perot Systems and Sun Microsystems contemplate
co-marketing activities that we anticipate will be rolled-out over the next
12 months.
As part of our marketing and sales efforts, our Rackspace.com Configurator
enables our prospective customers to configure, price and order our services
online. The Rackspace.com Configurator complements our marketing efforts by
supporting our channel partners as well as our end
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users when they have questions concerning our services or want to begin service.
We believe that the Rackspace.com Configurator enables our channel partners and
customers to investigate and choose various configuration options and prices in
real time.
We employ both a direct and indirect sales model to generate sales of our
managed hosting services. Direct sales are conducted by sales representatives in
our San Antonio, Austin, Silicon Valley and London sales offices who field calls
generated from referrals and our marketing activities. As of March 31, 2000, our
direct sales force consisted of 12 sales representatives. We intend to expand
both our outside and inside sales forces as well as our telemarketing activities
over the next six months. We also receive direct sales through our Web site via
the Rackspace.com Configurator.
Our indirect sales efforts focus on the establishment of relationships with
channel partners, including:
- independent software vendors, such as Red Hat;
- information technology service providers, including Perot Systems and
other international and regional system integrators and e-business
consultants;
- hardware manufacturers, such as Sun Microsystems;
- application service providers; and
- Web site designers and developers.
Because we focus on offering managed hosting services and, therefore, do not
provide application development or system integration services, we believe we
are not perceived by our channel partners as competitive to them. Typically,
these relationships are collaborative, with our channel partners focusing on
hardware design and manufacturing, software development, Web site design and
development, and system integration, while we address the hardware deployment
and hosting of the end user's Internet operations. As of March 31, 2000, we have
established relationships with 18 channel partners.
To further address sales opportunities, we maintain an "affiliates" program
to generate indirect sales. Affiliates are compensated for referring new
customers to our service plans. As of March 31, 2000, we had over 200 registered
affiliates participating in this program.
We believe that a significant percentage of our customers will select our
services due to a referral from an existing customer or channel partner.
Accordingly, we intend to continue to focus significant resources to offer
superior customer service and technical support to attain high levels of
customer satisfaction which we believe will lead to future referrals. We believe
that referrals, combined with our marketing efforts to establish the
Rackspace.com brand, will enable us to attract a significant number of new
customers for our hosting services.
CUSTOMER SERVICE AND TECHNICAL SUPPORT
We believe a critical element of our customer service is providing a high
level of responsiveness and technical expertise within our customer service and
technical support organizations. To this end, each customer is assigned a
customer support team that consists of a support specialist and several systems
specialists. The support specialist generally addresses routine inquiries
concerning billing, network performance, server upgrade status and similar
items. Inquiries that are more technically oriented are referred to a systems
specialist. In addition, we recently introduced the Rackspace.com Wizard at our
Web site. Through use of the Wizard, a channel partner or customer can analyze
the configuration of the server system used by the customer to assist the
customer in setting up user accounts, adding new Web sites and expanding domain
name server entries.
All systems are monitored and maintained on a 24X7 basis. Monitoring
includes the transmission of test signals to each server in five-minute
intervals to assure that the server is responding to incoming data requests. In
many instances we proactively remedy performance issues before they develop into
problems for our customers. Furthermore, we provide customer service and
technical assistance on a
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24X7 basis via telephone and e-mail. Due to the broad scope of our international
operations, we maintain a customer service and technical support staff that is
proficient in several languages, including Dutch, French, German and Spanish. We
strive to respond within 15 minutes or less to reports of business-critical
incidents and to less critical incidents within a two-hour period on an
internally-prioritized basis.
Our customer care system provides support personnel with timely online
information regarding the status of all set-up and support activities.
Additionally, support personnel have access to information regarding the sales
history and current sales activities for each customer account. This integration
of support and sales systems enables us to allocate resources with a full
knowledge of both new business opportunities and any customer support issues. We
believe that this system will support substantially greater economies of scale
and quality of service across our customer service and technical support
department.
DATA CENTERS AND NETWORK INFRASTRUCTURE
We currently operate a highly secure, fault-tolerant data center in San
Antonio, Texas consisting of up to approximately 12,000 dedicated square feet
ready for expansion. This data center can support up to 10,000 servers in a 24X7
hosted environment. Our network is certified as a Cisco-powered network and,
accordingly, most of our networking equipment is supplied by Cisco Systems. We
believe that our location is an advantageous site for our data center due to the
general lack of earthquake activity and other natural calamities affecting the
local region. We recently established a data center presence in London to
further support our customers in Europe. Our data center in London is housed in
a data center facility operated by AboveNet Communications. Our leased space in
AboveNet's facility can accommodate up to 1,000 dedicated servers and is fully
equipped with multiple levels of physical security, redundant power,
environmental controls and high performance Internet connectivity.
The security controls, physical infrastructure and network of our data
centers have been designed to support the rigorous requirements of a robust and
reliable Internet hosting service, including:
- high levels of physical security measures to prevent unauthorized access
to the data center;
- redundant and diverse systems to maintain electrical power, air
conditioning and network operation; and
- high performance Internet connectivity.
DATA CENTER SECURITY
We maintain three levels of physical security to restrict unauthorized
access to the data center. First, the perimeter of our building is secured with
a passkey protection system. Security guards are stationed on a 24X7 basis on
the ground floor of our building to control use of the elevators and to
investigate suspicious activities. Surveillance cameras are also positioned to
enable security guards to monitor data center visits. Second, the elevator to
the data center floor, along with the doors at the elevator landing, are
controlled by additional passkey systems. Finally, the data center uses a
biometric hand scanner identification system to limit entrants to people who
have received pre-authorization to access the data center.
REDUNDANT SYSTEMS
Operation of servers in our data center is supported by multiple and diverse
redundant systems. The primary utility power is supported by an on-site diesel
generator which can generate sufficient power to maintain uninterrupted
operation of the data center until primary power is restored. Our air
conditioning system also has redundant back-up units. Cabling is run diversely
within the data center to overcome problems that may occur due to mechanical
failure and electrical interference. Multiple fiber transport connections enter
our facility at different building penetration points to prevent network outages
caused by construction or other events that are outside of our control.
Additionally, we use five
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Internet backbone providers to help ensure that servers housed within our data
center will remain connected to the Internet should any one primary supplier
fail to maintain connectivity. We also intend to establish an additional data
center in the U.S. to expand our available capacity and maintain a redundant
data site that is geographically distant from our primary data center in San
Antonio.
HIGH PERFORMANCE INTERNET CONNECTIVITY
We designed our network to provide high throughput and low latency by
deploying high performance routing and switching equipment from Cisco Systems.
With one OC-3 and two OC-12 fiber connections, our U.S. data center provides
approximately 1.5 gigabits per second of available transport connectivity. We
currently have network agreements with Intermedia, Qwest, SBC Communications,
Time Warner Telecom and UUNET. These network agreements generally are long-term
contracts over two to five years with monthly pricing based on the amount of
network traffic experienced by the respective provider. We currently have
network capacity for 2,000 servers at our U.S. data center and can upgrade our
capacity through our current network providers to handle up to 5,000 servers. We
attempt to maintain low utilization rates to reduce congestion and to absorb
bursts of traffic that our customers' applications may produce. As our San
Antonio data center is located near the half-way mark between the major U.S.
public peering points on the West Coast and East Coast, we have access to both
peering points without being dependent on either of them to route our traffic.
Additionally, since we have five Internet backbone providers, we often are able
to route traffic to the closest backbone termination point that is available to
us without traversing congested public exchange points.
COMPETITION
The markets in which we operate are highly competitive, and competition is
increasing because few apparent substantial barriers to entry exist in the
managed hosting and colocation markets. Although it is impossible to quantify
our relative competitive position in our market, many of our competitors have
substantially greater financial, technical and marketing resources, larger
customer bases, longer operating histories, greater name recognition and more
established relationships in the industry than we have. We expect that we will
face competition from existing competitors as well as new market entrants in the
future. The primary competitive factors in our market are:
- quality of service, including network capability, reliability and
functionality;
- customer service and technical support;
- variety of services and products offered;
- technical expertise in developing managed hosting solutions;
- price;
- brand name recognition;
- Internet system engineering and technical expertise;
- timing of introductions of value-added services and products;
- network security;
- financial resources; and
- conformity with industry standards.
Our current and potential competitors vary by size and service offerings and
by geographic region. These competitors may elect to partner with each other or
with focused companies like us to deliver service on Linux or other popular
operating systems. They include:
- other providers of managed hosting services, including Data Return, Digex,
Genuity (formerly GTE Internetworking), MCI WorldCom (including UUNET) and
USWeb/CKS Group;
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- Internet and application hosting service providers, such as Critical Path,
Interliant, Navisite, USINTERNETWORKING and Verio;
- colocation providers, including AboveNet, Digital Island, Exodus,
GlobalCenter and Globix;
- local, regional and international Internet service providers, such as
AppliedTheory, Concentric, EarthLink and PSINet;
- original equipment manufacturers of servers that have recently introduced
hosting services for purchasers of their server products, including Dell
and Intel;
- local, regional and international telecommunications companies, such as
AT&T, British Telecommunications, Cable & Wireless, Qwest, Nippon
Telegraph and Telephone and Telecom Italia, and the regional Bell
operating companies, including Bell Atlantic and U S WEST; and
- system integrators and large information technology outsourcing companies,
such as Andersen Consulting, EDS, IBM, Oracle and PricewaterhouseCoopers.
We believe that our expertise and primary focus on providing managed hosting
services based on the Linux platform enable us to differentiate ourselves from
our competitors. We also believe that our emphasis on customer service, rapid
deployment, technical support, and our ability to maintain a service delivery
infrastructure that is designed to parallel or surpass the performance provided
by Internet backbone providers and other telecommunications carriers will
further differentiate us from our competitors. Additionally, we focus our
marketing and sales methodologies on enabling customers to custom-configure a
server that best addresses their short-term needs and to deploy that server
within our U.S. data center within 24 hours, which ultimately enhances overall
customer satisfaction with our services.
INTELLECTUAL PROPERTY RIGHTS
We rely on a combination of copyright, trademark, service mark and trade
secret laws and contractual restrictions to establish and protect certain
proprietary rights in our data, applications and services. We have no patented
technology that would bar competitors from our market. We are in the process of
filing federal and international registrations for the trademark
"Rackspace.com." In addition, "PrivateNet," "Leader in Linux," "Rackspace.com
Configurator" and "Rackspace.com Wizard" are unregistered trademarks of our
company.
GOVERNMENT REGULATION
As a provider of managed hosting services, we are not currently subject to
direct federal, state or local government regulation, other than regulations
applicable to businesses generally. We could also, under some circumstances,
become subject to foreign laws and regulations.
To date, the number of laws and regulations with direct applicability to
Internet-related products and services has been relatively limited. Congress
enacted the "Digital Millennium Copyright Act," which became effective in
October 1998. The Digital Millennium Copyright Act provides a limitation on
liability of online service providers for copyright infringement for
transmitting, routing or providing connections, transient storage, caching or
storage at the direction of a user, if the service provider had no knowledge or
awareness that the transmitted or stored material was infringing and meets other
specified conditions. Since this law has not been extensively interpreted by
U.S. courts and does not apply outside of the U.S., we are unsure of how it will
be applied to limit any liability we may face in the future for any possible
copyright infringement or copyright-related issues. This law also requires
service providers to follow "notice and take-down" procedures and to meet other
conditions in order to be able to take advantage of the limitation on liability.
We have not yet implemented these procedures, met these conditions or evaluated
the cost of complying with them. However, our customers are subject to an
acceptable use policy which prohibits them from transmitting, storing or
distributing material on or through any of our services which, in our sole
judgment is (1) in violation of any U.S. federal, state
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or local law or regulation, (2) fraudulent online marketing or sales practices
or (3) fraudulent customer information, including identification and payment
information. Although this policy is designed to promote the security,
reliability and privacy of our systems and network, we cannot be certain that
our policy will accomplish this goal or effectively limit our liability.
Despite enactment of the Digital Millennium Copyright Act, the law relating
to the liability of online services companies and Internet access providers for
information carried on or disseminated through their networks remains largely
unsettled. It is possible claims could be made against online services companies
and Internet access providers under both U.S. and foreign law for defamation,
obscenity, negligence, copyright or trademark infringement, or other theories
based on the nature and content of the materials disseminated through their
networks. Several private lawsuits seeking to impose liability upon online
services companies and Internet access providers are currently pending.
Application of existing, modified or new legislation or regulations to our
services and products could materially and adversely affect our business.
Although sections of the Communications Decency Act of 1996 that proposed to
impose criminal penalties on anyone distributing indecent material to minors
over the Internet were held to be unconstitutional by the U.S. Supreme Court,
similar laws may be proposed, adopted and upheld. The nature of future
legislation and the manner in which it may be interpreted and enforced cannot be
fully determined and, therefore, legislation similar to the Communications
Decency Act could subject us and/or our customers to potential liability, which
in turn could harm our business. The adoption of any of these types of laws or
regulations might decrease the growth of the Internet, which, in turn, could
decrease the demand for our services or increase our cost of doing business or
in some other manner harm our business.
Due to the increasing popularity and use of the Internet, it is likely that
a number of additional laws and regulations with respect to the Internet may be
adopted in foreign jurisdictions, or at the federal, state and local levels,
covering issues such as user privacy, freedom of expression, pricing,
characteristics and quality of products and services, taxation, advertising,
intellectual property rights, information security, access fees and the
convergence of traditional telecommunications services with Internet
communications. In addition, applicability to the Internet of existing laws
governing issues such as property ownership, copyrights and other intellectual
property issues, taxation, libel, obscenity and personal privacy is uncertain.
The vast majority of these laws were adopted prior to the advent of the Internet
and related technologies and, as a result, do not contemplate or address the
unique issues of the Internet and related technologies. The adoption or
application of any laws or regulations of this type might decrease the growth of
the Internet, which in turn, could decrease the demand for our services,
increase the cost of doing business or in some other manner harm our business.
EMPLOYEES
As of April 30, 2000, we had 107 employees. None of our employees is covered
by collective bargaining agreements. We believe that our relations with our
employees are good.
FACILITIES
Our corporate headquarters are located in San Antonio, Texas and consist of
approximately 16,600 square feet of office space that is leased until
February 2003. We also maintain sales offices in Austin, Texas, Santa Clara,
California and London. Our London data center, which began operations in June
2000, is located within a state-of-the-art data center operated by AboveNet
Communications. Our current arrangements with AboveNet provide us with 300
square feet of leased space, with options to double the available space, under a
long-term lease.
LEGAL PROCEEDINGS
We are not a party to any material legal proceedings.
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MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
The following table sets forth information concerning our executive
officers, directors and key employees as of April 30, 2000:
<TABLE>
<CAPTION>
NAME AGE POSITION(S)
---- -------------------- -----------
<S> <C> <C>
Graham M. Weston....................... 36 Chief Executive Officer and Director
Morris A. Miller....................... 33 President, Chief Operating Officer and Director
Lanham Napier.......................... 29 Chief Financial Officer
Richard K. Yoo......................... 25 Chief Technology Officer
David E. Bryce......................... 28 Vice President, Operations
Patrick R. Condon...................... 24 Vice President, Business Development
Dirk J. Elmendorf...................... 24 Vice President, Product Development
Quincy J. Lee.......................... 28 Vice President, Finance
John J. Miksa.......................... 45 Vice President, Channel Sales
Lew Moorman............................ 29 Vice President, Marketing and Strategic Planning
</TABLE>
------------------------
GRAHAM M. WESTON has served as our Chief Executive Officer since July 1999
and as a director since March 2000. Prior to joining us, Mr. Weston was a
founder and principal at Assessment Technologies, Inc., an ad valorem tax
consulting firm. Mr. Weston is also Chief Executive Officer of Weston
Properties, LLC, a real estate company owning industrial and office properties
in Texas. Mr. Weston received a B.S. from Texas A&M University.
MORRIS A. MILLER has served as our Chief Operating Officer since July 1999
and as our President and a director since March 2000. From March 1997 to
June 1999, Mr. Miller was a managing director for Knightsbridge, LC, an
investment management firm. From July 1995 to March 1997, Mr. Miller was a
principal in Curtis Hill Publishing Company, a legal software publishing
company, which was subsequently acquired. Mr. Miller received a B.A. in
psychology from The University of Texas at Austin and a J.D. from Southern
Methodist University.
LANHAM NAPIER has served as our Chief Financial Officer since April 2000.
From June 1997 to April 2000, Mr. Napier served as a director for Silver Brands
Partners, an investment company. From May 1993 to June 1995, Mr. Napier worked
as an analyst for Merrill Lynch & Co., an investment banking firm. Mr. Napier
received a B.A. in economics from Rice University and an M.B.A. from Harvard
University.
RICHARD K. YOO is one of our co-founders and has served as our Chief
Technology Officer since December 1998. From January 1998 to December 1998,
Mr. Yoo was a co-founder and principal of Cymitar Technology Group, Inc., an
information technology consulting company. From January 1996 to December 1997,
Mr. Yoo was a principal of Cymitar Network Systems, a partnership. Mr. Yoo
attended Trinity University from September 1993 to February 1996.
DAVID E. BRYCE has served as our Vice President, Operations since
November 1999. From January 1995 to November 1999, Mr. Bryce founded and served
as a principal for USA EnviroClean, Inc, a commercial services company. While at
USA EnviroClean, Mr. Bryce also co-founded and consulted with the Pearl Group, a
consulting firm. Mr. Bryce received a B.A. in business administration from
Ambassador University.
PATRICK R. CONDON is one of our co-founders and has served as Vice
President, Business Development since December 1998. Mr. Condon was a co-founder
and principal in Cymitar Technology Group, Inc. from June 1998 to
December 1998. From May 1997 to June 1998, Mr. Condon was involved in strategic
consulting for high technology clients for Focus, Inc., a management consulting
company. From February 1996 to January 1997, Mr. Condon worked for Global
Village
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Communication, Inc., a communications hardware company. Mr. Condon received a
B.A. in finance from Santa Clara University.
DIRK J. ELMENDORF is one of our co-founders and has served as Vice
President, Product Development since December 1998. From December 1997 to
December 1998, Mr. Elmendorf was a principal in Cymitar Technology Group, Inc.
From August 1996 to December 1997, Mr. Elmendorf worked for Cymitar Network
Systems. Mr. Elmendorf received a B.A. in international economics from Trinity
University.
QUINCY J. LEE has served as our Vice President, Finance since
September 1999. From September 1999 to April 2000, Mr. Lee served as our Chief
Financial Officer. From August 1998 to March 1999, Mr. Lee served as a Vice
President of Finance of FlashNet Communications, Inc., an Internet service
provider. From September 1997 to August 1998, Mr. Lee worked as an assistant
portfolio manager for Kleinheinz Capital, Inc., an investment management firm.
Prior to this time, Mr. Lee worked with the corporate finance group of
Deloitte & Touche, LLP. Mr. Lee received a B.B.A. in accounting and a B.A. in
economics from The University of Texas at Austin and an M.B.A. from Rice
University.
JOHN J. MIKSA has served as our Vice President, Channel Sales and Strategic
Alliances since December 1999. From June 1997 to November 1999, Mr. Miksa was
responsible for business development for application outsourcing at Computer
Sciences Corporation, a consulting firm. From July 1990 to February 1997,
Mr. Miksa held various management positions with General Electric Information
Services and AMR Corporation, including professional services, marketing, sales
and global channel development. Mr. Miksa received a B.S. in computer sciences
from the University of West Florida.
LEW MOORMAN has served as our Vice President, Marketing and Strategic
Planning since April 2000. From September 1997 through March 2000, Mr. Moorman
served in several positions at McKinsey & Company, a consulting company, and
most recently as Engagement Manager for the E-commerce Practice Group. From May
1996 to August 1996, Mr. Moorman worked as an investment analyst for Silver
Brands. Mr. Moorman received a B.A. in political science from Duke University
and a J.D. from Stanford Law School.
BOARD COMPOSITION
Our authorized board of directors is fixed at five members, with three
vacancies existing. We intend to fill these vacancies prior to the consummation
of this offering. Our certificate of incorporation provides that at the first
annual meeting of stockholders following this offering, our board of directors
will be divided into three classes, Class I, Class II and Class III, each of
whose members will serve for a staggered three-year term.
Any additional directorships resulting from an increase in the authorized
number of directors will be distributed among the three classes so that, as
nearly as possible, each class will consist of one-third of the directors. Upon
expiration of the term of a class of directors, the directors in that class will
be elected for three-year terms at the annual meeting of stockholders in the
year in which their term expires. With respect to each class, directors' terms
are subject to the election and qualification of their successors, or their
death, resignation or removal. This staggered classification of the board of
directors may have the effect of delaying or preventing changes in control of
our company or our management.
BOARD COMMITTEES
We will establish an audit committee of the board prior to the effective
date of the registration statement for this offering. This committee will review
and monitor our internal accounting procedures and the results and scope of the
annual audit and other services provided by our independent accountants. The
audit committee also will consult with our management and our independent
auditors prior to the presentation of financial statements to stockholders and,
as appropriate, will initiate inquiries into aspects of our financial affairs.
In addition, the audit committee will be responsible for
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considering and recommending the appointment of, and reviewing fee arrangements
with, our independent auditors.
We also will establish a compensation committee concurrently with the
formation of the audit committee. The compensation committee will recommend,
review and oversee the salaries, benefits and stock plans for our directors,
executive officers and other employees. The compensation committee also will
administer our stock plans.
DIRECTOR COMPENSATION
Other than reimbursing directors for customary and reasonable expenses of
attending board of director or committee meetings, we do not intend to pay cash
compensation to our directors. Under our 2000 Stock Incentive Plan, each
non-employee board member who first joins our board after , 2000 will
automatically receive a grant of an option to purchase shares of common
stock at the time of his or her commencement of board service. In addition, on
the date of each annual stockholders meeting beginning in 2001, each
non-employee member of the board of directors who is to continue to serve as a
non-employee board member will be automatically granted an option to purchase
shares of common stock. See "--2000 Stock Incentive Plan."
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
We did not have a compensation committee during 1999. During that period,
the general partner of Rackspace, Ltd. made decisions regarding compensation to
our executive officers. None of our executive officers serves on the board of
directors or compensation committee of any entity which has one or more
executive officers serving as a member of our board of directors or our
compensation committee.
LIMITATION OF LIABILITY AND INDEMNIFICATION
Our certificate of incorporation limits the liability of our directors to us
or our stockholders for breaches of the directors' fiduciary duties to the
fullest extent permitted by Delaware law. In addition, our certificate of
incorporation and bylaws authorize indemnification of directors and officers to
the fullest extent permitted by Delaware law. We plan to maintain directors' and
officers' liability insurance and will enter into indemnification agreements
with all of our directors and executive officers.
EXECUTIVE COMPENSATION
Our chief executive officer received no compensation during the year ended
December 31, 1999. No executive officer had annual compensation in excess of
$100,000 during the year ended December 31, 1999. No stock options were granted
to any of our executive officers during the year ended December 31, 1999.
EMPLOYMENT AGREEMENTS
We require each of our employees to enter into confidentiality agreements
prohibiting the employee from disclosing any of our confidential or proprietary
information. Rackspace is currently in negotiations with Mr. Weston concerning
the terms of his employment agreement.
1999 UNIT OPTION PLAN
As of March 31, 2000, options to purchase 432,897 limited partner interests
were outstanding under our 1999 Unit Option Plan. Upon the completion of this
offering, no additional options will be granted under the plan and all
outstanding options will be converted, on a 1-for-1 basis, into the right to
purchase shares of our common stock. Currently outstanding options under this
plan will remain outstanding until exercised or until the options terminate or
expire in accordance with their terms.
The administrator of the 1999 Unit Option Plan is the general partner of
Rackspace, Ltd. The administrator of the plan may modify the plan, make
interpretations and adopt rules and regulations for carrying out the plan. The
plan may be terminated or amended at any time. However, termination
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or amendment will not adversely affect rights granted under the plan prior to
the amendment or termination.
Options generally vest one-third on each of the anniversary dates following
the grant date. The optionees forfeit their options if they compete with us at
any time while the option remains outstanding. Any options granted under this
plan will expire on or before seven years from the date of the grant.
The options are granted at fair market value which, unless otherwise
determined in good faith by the administrator pursuant to its powers set forth
in the plan, is deemed to equal the greater of (1) $50,000,000 divided by the
number of limited partner interests outstanding, (2) the last purchase price in
an arms' length transaction closed within 120 days prior to the date the option
is granted, or (3) our annualized revenue based on our revenues for the previous
month as the basis for the determination times 10, and then divided by the
limited partner interests then outstanding.
The options terminate to the extent not vested at the time the optionee is
no longer a full-time employee. If the option is vested and exercisable, it must
be exercised within 60 days of termination of the optionee's employment. If
vested and not exercisable, the option terminates on the 120th day following the
last day of the optionee's employment. Options are not transferable, other than
upon the death or under the will of the holder or by intestate succession.
2000 STOCK INCENTIVE PLAN
The 2000 Stock Incentive Plan is intended to serve as the successor equity
incentive program to our 1999 Unit Option Plan. The 2000 Stock Incentive Plan
became effective on , 2000.
We have authorized shares of common stock for issuance under the 2000
Stock Incentive Plan. The share reserve will automatically be increased on the
first trading day of January each calendar year, beginning in January 2001, by a
number of shares equal to 1% of the total number of shares of common stock
outstanding on the last trading day of the immediately preceding calendar year,
but no such annual increase will exceed shares. However, in no event may
any one participant in the 2000 Stock Incentive Plan receive option grants or
direct stock issuances for more than shares in the aggregate per calendar
year.
The 2000 Stock Incentive Plan has four separate programs. The first program
is the discretionary option grant program under which eligible individuals in
our employ or service, including officers, non-employee board members and
consultants, may be granted options to purchase shares of our common stock. The
second program is the stock issuance program under which eligible individuals
may be issued shares of common stock directly, through the purchase of such
shares or as a bonus tied to the performance of services. The third program is
the salary investment option grant program under which executive officers and
other highly compensated employees may elect to apply a portion of their base
salary to the acquisition of special below-market stock option grants. The
fourth program is the automatic option grant program under which option grants
will automatically be made at periodic intervals to eligible non-employee board
members.
The discretionary option grant and stock issuance programs will be
administered by our compensation committee. This committee will determine:
- which eligible individuals are to receive option grants or stock
issuances;
- the time or times when option grants or stock issuances are to be made;
- the number of shares subject to each grant or issuance;
- the exercise or purchase price for each grant or issuance;
- the status of any granted option as either an incentive stock option or a
non-statutory stock option under the federal tax laws;
- the vesting schedule to be in effect for the option grant or stock
issuance; and
- the maximum term for which any granted option is to remain outstanding.
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<PAGE>
The committee will also select the executive officers and other highly
compensated employees who may participate in the salary investment option grant
program in the event that program is activated for one or more calendar years.
Neither the compensation committee nor the board will exercise any
administrative discretion with respect to option grants made under the salary
investment option grant program or under the automatic option grant program for
the non-employee board members.
The exercise price for options may be paid in cash or in shares of our
common stock valued at fair market value on the exercise date. Options may also
be exercised through a same-day sale program without any cash outlay by the
optionee. In addition, the compensation committee may allow a participant to pay
the option exercise price or direct issue price, and any associated withholding
taxes incurred in connection with the acquisition of shares, with a
full-recourse, interest-bearing promissory note.
In the event that we are acquired, whether by merger or asset sale or sale
by our stockholders of more than 50% of our voting stock in a transaction
recommended by the board of directors, each outstanding option under the
discretionary option grant program which is not to be assumed by the successor
corporation or otherwise continued will automatically accelerate in full, and
all unvested shares under the discretionary option grant and stock issuance
programs will immediately vest, except to the extent our repurchase rights with
respect to those shares are to be assigned to the successor corporation or
otherwise continued in effect. The compensation committee may grant options
under the discretionary option grant program which will accelerate in the event
of an acquisition even if the options are assumed, or which will accelerate if
the optionee's service is subsequently terminated.
The compensation committee may grant options and issue shares which
accelerate in connection with a hostile change in control effected through a
successful tender offer for more than 50% of our outstanding voting stock or by
proxy contest for the election of board members, or which accelerate upon a
subsequent termination of an individual's service. Stock appreciation rights may
be issued under the discretionary option grant program which will provide the
holders with the option to surrender their outstanding options for an
appreciation distribution from us equal to the fair market value of the vested
shares subject to the surrendered option less the aggregate exercise price
payable for the shares. Such appreciation distribution may be made in cash or in
shares of our common stock. There are currently no outstanding stock
appreciation rights.
The compensation committee will have the authority to cancel outstanding
options under the discretionary option grant program in return for the grant of
new options for the same or a different number of option shares with an exercise
price per share based upon the fair market value of the common stock on the new
grant date.
In the event the compensation committee elects to activate the salary
investment option grant program for one or more calendar years, each of our
executive officers and other highly compensated employees selected for
participation may elect to reduce his or her base salary for that calendar year
by a specified dollar amount not less than $ nor more than $ . In
return, the individual will be automatically granted, on the first trading day
in the calendar year for which the salary reduction is to be in effect, a
non-statutory option to purchase that number of shares of common stock
determined by dividing the salary reduction amount by two-thirds of the fair
market value per share of our common stock on the grant date. The option
exercise price will be equal to one-third of the fair market value of the option
shares on the grant date. As a result, the fair market value of the option
shares on the grant date less the exercise price payable for those shares will
be equal to the salary reduction amount. The option will become exercisable in a
series of 12 equal monthly installments over the calendar year for which the
salary reduction is to be in effect and will be subject to full and immediate
vesting in the event of an acquisition or change in control of our company.
Under the automatic option grant program, each individual who first joins
our board after , 2000 as a non-employee board member will be
automatically granted an option for shares of our common stock at the time
of his or her commencement of board service. In addition, on the date of each
annual stockholders meeting, beginning with the meeting in the year 2001, each
individual who
48
<PAGE>
is to continue to serve as a non-employee board member will receive an option
grant to purchase shares of our common stock. Each automatic grant will
have an exercise price equal to the fair market value per share of our common
stock on the grant date and will have a maximum term of 10 years, subject to
earlier termination following the optionee's cessation of board service. Each
share option will become exercisable upon the optionee's completion of
months of board service measured from the option grant date and each
share option grant will become exercisable upon the optionee's completion
of six months of service measured from the grant date. However, each outstanding
option will immediately vest upon an acquisition or change in control or the
death or disability of the optionee while serving as a board member.
Limited stock appreciation rights will automatically be included as part of
each grant made under the automatic option grant and salary investment option
grant programs and may be granted to one or more officers as part of their
option grants under the discretionary option grant program. Options with this
limited stock appreciation right may be surrendered to us upon the successful
completion of a hostile tender offer for more than 50% of our outstanding voting
stock. In return for the surrendered option, the optionee will be entitled to a
cash distribution from us in an amount per surrendered option share equal to the
highest price per share of common stock paid in connection with the tender offer
less the exercise price payable for the share.
The board may amend or modify the 2000 Stock Incentive Plan at any time,
subject to any required stockholder approval. The 2000 Stock Incentive Plan will
terminate no later than , 2010.
2000 EMPLOYEE STOCK PURCHASE PLAN
The 2000 Employee Stock Purchase Plan is designed to allow our eligible
employees and any participating subsidiaries to purchase shares of common stock,
at semi-annual intervals, through periodic payroll deductions. A total of
shares of our common stock are reserved for issuance under the plan.
The plan has a series of successive offering periods, each with a maximum
duration of 24 months. The initial offering period began in , 2000 and
will end on the last business day in . The next offering period will begin
on the first business day in , and subsequent offering periods will be set
by our compensation committee.
Individuals who are eligible employees on the start date of any offering
period may enter the plan on that start date or on any subsequent semi-annual
entry date, generally February 1 or August 1 each year. Individuals who become
eligible employees after the start date of the offering period may join the plan
on any subsequent semi-annual entry date within that period.
A participant may contribute up to % of his or her cash earnings through
payroll deductions and the accumulated payroll deductions will be applied to the
purchase of shares on the participant's behalf on each semi-annual purchase
date, the last business day in January and July each year. The purchase price
per share will be % of the lower of the fair market value of our common stock
on the participant's entry date into the offering period or the fair market
value on the semi-annual purchase date. In no event, however, may any
participant purchase more than shares, nor may all participants in the
aggregate purchase more than shares on any one semi-annual purchase date.
Should the fair market value of our common stock on any semi-annual purchase
date be less than the fair market value on the first day of the offering period,
then the current offering period will automatically end and a new offering
period will begin, based on the lower fair market value.
The board may at any time amend or modify the plan. The plan will terminate
no later than the last business day in 2010.
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<PAGE>
CERTAIN TRANSACTIONS
OUR FORMATION
In connection with the formation of Rackspace, Ltd. in December 1998,
Messrs. Condon, Elmendorf and Yoo each received limited partner interests.
Trout, Ltd. also received limited partner interests at that time. As part of our
holding company restructuring, these limited partner interests will be exchanged
for shares of our common stock, which will result in Messrs. Condon, Elmendorf
and Yoo and Trout, Ltd. receiving 792,380 shares, 396,190 shares, 3,565,714
shares and 7,279,619 shares of our common stock, respectively. These numbers
reflect a 10-for-1 limited partner interest split effected on November 30, 1999.
Messrs. Weston and Miller, our directors and executive officers, are the
managing members of the general partner of Trout, Ltd and the sole beneficial
owners of Trout, Ltd.
Macroweb, LC is the general partner of Rackspace, Ltd., and holds the
general partner interest in Rackspace, Ltd. which will be converted into 9,904
shares of our common stock in connection with our holding company restructuring.
Messrs. Weston and Miller are the managing members of Macroweb, LC. Following
the restructuring, Macroweb, LC will no longer serve as the general partner of
Rackspace, Ltd.
FINANCING PROVIDED BY EXETER FINANCIAL, LC
Since our formation in December 1998, we have been financed, in part, by
loans made by Exeter Financial, LC an entity affiliated with Messrs. Weston and
Miller. Exeter Financial, LC provided us with cash advances in the principal
amount of approximately $1.6 million. These cash advances accrued interest at a
fixed rate of 8% per year with repayments of the principal and interest due over
a five-year period beginning on January 2002. During 1999, Exeter Financial, LC
assigned its right to repayment of this indebtedness to Trout, Ltd. On
September 29, 1999, Trout, Ltd. converted $1.1 million of indebtedness,
representing the amount of principal and interest then outstanding under the
credit agreement, into 1,904,762 limited partner interests. This number reflects
a 10-for-1 limited partner interest split effected on November 30, 1999. On
November 30, 1999, Trout, Ltd. also converted $500,000 of the principal
outstanding under the second financial commitment into 238,095 limited partner
interests.
2000 PRIVATE PLACEMENT
In March 2000, we raised gross proceeds of $11.1 million through a private
placement of limited partner interests in Rackspace, Ltd. to a group of
investors. The investors in this financing were Norwest Venture Partners VII,
L.P., entities affiliated with Sequoia Capital, Red Hat, Inc. and Tailwind
Capital Partners 2000, L.P., for 1,015,901, 530,035, 353,357 and 53,004 limited
partner interests, respectively. We also have issued Norwest Venture
Partners VII, L.P., and entities affiliated with Sequoia Capital warrants to
purchase and of our limited partner interests, respectively. In
connection with our holding company restructuring, these limited partner
interests will be converted into an aggregate of 1,952,297 shares of our common
stock. The warrants convert into rights to purchase shares of our common
stock upon the completion of our holding company restructuring. Tailwind Capital
Partners 2000, L.P. is an affiliate of Thomas Weisel Partners LLC, an
underwriter in this offering.
1999 PRIVATE EQUITY FINANCING
In connection with our November 30, 1999 financing, we sold an aggregate of
2,766,667 limited partner interests at $2.10 per interest, for a total purchase
price of $5.8 million, which includes the conversion into limited partner
interests of the principal amount of $500,000 described above. In connection
with our holding company restructuring, these limited partner interests will be
exchanged for 2,766,667 shares of our common stock. On November 30, 1999, we
also granted warrants to Trango
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<PAGE>
Capital, LLC and The Hamilton Companies LLC giving them the right to purchase
380,952 and 238,095 limited partner interests, respectively, at an aggregate
exercise price of $800,000 and $500,000, respectively. This warrant will convert
into a right to purchase our common stock upon the completion of our holding
company restructuring. On January 17, 2000, The Hamilton Companies LLC exercised
its right to purchase 238,095 limited partner interests at an aggregate exercise
price of $500,000. Quincy Lee, our executive officer, is the managing member of
Trango Capital, LLC. Trango Capital, LLC is the general partner of First Inning
Investors, L.P., an entity affiliated with Quincy Lee. In connection with the
holding company restructuring, these limited partner interests and warrants to
acquire limited partner interests will be exchanged on a 1-for-1 basis for
shares of our common stock, with fractional interests rounded to the nearest
whole share.
The following table shows affiliates of our executive officers, directors
and our 5% stockholders who participated in this private equity investment.
<TABLE>
<CAPTION>
PERCENT OWNED
OFFICERS, DIRECTORS AND NUMBER OF SHARES FOLLOWING
5% STOCKHOLDERS RELATIONSHIP TO US BENEFICIALLY OWNED THE OFFERING
------------------------------ ------------------------------------- ------------------- -------------
<S> <C> <C> <C>
Trout, Ltd. Entity affiliated with Graham Weston 7,279,619 36.1%
and Morris Miller
Isom Capital Partners I, L.P. Principal stockholder 1,219,048 6.1
First Inning Investors, L.P. Entity affiliated with Quincy Lee 619,048 3.1
Beaulieu River Capital LC Entity affiliated with Graham Weston 357,143 1.8
(formerly, Weston Investment
Interests, LC)
MiniPat & Company, Ltd. Entity affiliated with Patrick Condon 95,238 *
</TABLE>
------------------------
* less than 1%
Beaulieu River Capital LC, formerly Weston Investment Interests, LC,
incident to purchasing 357,143 limited partner interests in connection with our
November 30, 1999 financing, delivered to us a promissory note with an interest
rate of 8% per year which was paid in full on February 18, 2000. Mr. Weston is
the managing member of Beaulieu River Capital LC.
Patrick Condon, an executive officer, serves as the general partner of
MiniPat & Company, Ltd.
See "Principal Stockholders" for a discussion of the beneficial ownership of
our directors, executive officers and 5% stockholders.
LEASES
During 1999, we leased our corporate offices in San Antonio, Texas from the
Santa Clara Land Company, an entity affiliated with Graham Weston, for
approximately $3,000 per month. On February 22, 2000, we entered into a
three-year lease agreement with Santa Clara Land Company. This agreement
provides for monthly rent of approximately $12,000, $16,000 and $31,000 in 2000,
2001 and 2002, respectively.
REGISTRATION RIGHTS
After 180 days from the date of this prospectus, each of Isom Capital
Partners I, L.P., First Inning Investors, L.P., MiniPat & Company, Ltd., The
Hamilton Companies LLC, Beaulieu River Capital LC, 2M Technology Ventures, L.P.,
Red Hat, Inc., Norwest Venture Partners VIII, L.P., entities affiliated with
Sequoia Capital and Tailwind Capital Partners 2000, L.P. will have the right to
demand that we register the 4,838,012 shares of our common stock held by them
prior to this offering. Trout, Ltd. will also have the right to participate in
this demand with respect to the 238,095 shares of common stock
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<PAGE>
held by it. Trango Capital, LLC, Norwest Venture Partners VIII, L.P. and
entities affiliated with Sequoia Capital also have the right to include the
shares that are subject to their respective warrants in any demand registration.
See "Description of Capital Stock--Registration Rights" for a description of
these registration rights.
PURCHASE AGREEMENT
In December 1998, Rackspace, Ltd. acquired substantially all of the assets
of Cymitar Technology Group, Inc. for approximately $192,000. This purchase
price represented the aggregate amount of liabilities assumed by it under the
terms of the asset purchase and sale agreement. At that time, Messrs. Condon,
Elmendorf and Yoo, who are executive officers, were officers and significant
stockholders of Cymitar Technology Group, Inc.
DIRECTED SHARE PROGRAM
The underwriters have reserved for sale, at the initial offering price, up
to 240,000 shares of our common stock for directors, employees and other persons
associated with us who have expressed an interest in purchasing common shares in
this offering.
OPTION GRANTS TO DIRECTORS AND EXECUTIVE OFFICERS
In the first quarter of 2000, we issued options to several of our directors
and executive officers. Our non-employee directors also will receive grants
under our 2000 Stock Incentive Plan. See "Management--Director Compensation,"
"--2000 Stock Incentive Plan" and "Principal Stockholders."
INDEMNIFICATION AGREEMENTS
We will enter into indemnification agreements with each of our executive
officers and directors prior to the effective date of the registration statement
for this offering.
FUTURE TRANSACTIONS
All future transactions between us and our executive officers, directors and
affiliates will be approved by a majority of the independent members or
disinterested members of our board of directors and will be on terms no less
favorable than that which could be obtained from unrelated third parties.
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<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information regarding the beneficial
ownership of our common stock as of April 30, 2000, on a pro forma basis to
reflect the completion of the holding company restructuring and on a pro forma
as adjusted basis to reflect the sale of common stock offered by us in this
offering for:
- each person known by us to beneficially own more than 5% of our common
stock;
- our chief executive officer;
- each of our directors; and
- all of our executive officers and directors as a group.
Except as otherwise indicated, and subject to applicable community property
laws, the persons named in the table have sole voting and investment power with
respect to all shares of common stock held by them. Beneficial ownership is
determined in accordance with the rules of the Securities and Exchange
Commission. In general, a person who has voting power or investment power with
respect to securities is treated as a beneficial owner of those securities.
Shares subject to options or rights currently exercisable or exercisable within
60 days of April 30, 2000 are considered beneficially owned by the person
holding these options or rights. Unless otherwise indicated, the address for
each 5% stockholder listed in the table is c/o Rackspace.com, Inc., 425 Soledad,
Suite 500, San Antonio, Texas 78205.
The post-offering ownership percentages in the table below assume that the
underwriters will not exercise their over-allotment option to purchase 480,000
additional shares from us.
<TABLE>
<CAPTION>
PERCENTAGE OF BENEFICIAL
NUMBER OF OWNERSHIP
SHARES -------------------------
BENEFICIALLY BEFORE AFTER
NAME OF BENEFICIAL OWNER OWNED OFFERING OFFERING
------------------------ ------------ ---------- ------------
<S> <C> <C> <C>
Graham M. Weston (1)........................................ 7,662,539 45.1% 38.0%
Morris A. Miller (2)........................................ 7,305,396 43.0 36.2
Richard K. Yoo.............................................. 3,565,714 21.0 17.7
Quincy J. Lee (3)........................................... 1,000,000 5.8 4.9
Patrick R. Condon (4)....................................... 895,713 5.3 4.4
Trout, Ltd. ................................................ 7,279,619 42.9 36.1
Isom Capital Partners I, L.P. (5)........................... 1,219,048 7.2 6.1
Norwest Venture Partners VIII, L.P. (6)..................... 1,015,901 6.0 5.0
All executive officers and directors as a group (eleven
persons) (7).............................................. 13,604,947 77.9% 65.9%
</TABLE>
------------------------
(1) Includes 15,873 shares issuable upon the exercise of stock options. Also
includes 7,279,619 shares held of record by Trout, Ltd. Mr. Weston serves as
a managing member of the general partner of Trout, Ltd. Also includes
357,143 and 9,904 shares held of record by Beaulieu River Capital LC and
Macroweb, LC, respectively, for which Mr. Weston is a managing member.
Mr. Weston disclaims beneficial ownership of the shares held by Trout, Ltd.,
Macroweb, LC and Beaulieu River Capital LC, except to the extent of his
pecuniary interest in these shares.
(2) Includes 15,873 shares issuable upon the exercise of stock options. Also
includes 7,279,619 shares held of record by Trout, Ltd. Mr. Miller serves as
a managing member of the general partner of Trout, Ltd. Also includes 9,904
shares held of record by Macroweb, LC for which Mr. Miller is a managing
member. Mr. Miller disclaims beneficial ownership of the shares held by
Trout, Ltd. and Macroweb, LC, except to the extent of his pecuniary interest
in these shares.
(3) Includes 619,048 shares held of record by First Inning Investors, L.P. Also
includes 380,952 shares issuable upon the exercise of an outstanding warrant
held by Trango Capital, LLC. Mr. Lee is the managing member of Trango
Capital, LLC, the general partner of First Inning Investors, L.P.
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<PAGE>
Mr. Lee disclaims beneficial ownership of the shares held by First Inning
Investors, L.P. and Trango Capital, LLC, except to the extent of his
pecuniary interest in these shares.
(4) Includes 8,095 shares issuable upon the exercise of stock options. Includes
95,238 shares held of record by MiniPat & Company, Ltd. for which
Mr. Condon serves as the general partner. Mr. Condon disclaims beneficial
ownership of these shares, except to the extent of his pecuniary interest in
these shares.
(5) The address for this stockholder is 970 Isom Road, San Antonio, Texas 78216.
S. James Bishkin is the beneficial owner and has sole voting power of these
shares.
(6) Includes shares issuable upon the exercise of an outstanding
warrant. The address for this stockholder is 245 Lyton Street, Palo Alto,
California 94301-1426.
(7) Includes 489,710 shares issuable upon the exercise of stock options and
warrants.
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<PAGE>
DESCRIPTION OF CAPITAL STOCK
GENERAL
Upon completion of this offering, our authorized capital stock will consist
of 170,000,000 shares of common stock, par value $0.001 per share, and
30,000,000 shares of preferred stock, par value $0.001 per share. The following
is a summary of material terms of the common stock and preferred stock. The
following summary is qualified by reference to our certificate of incorporation
and our bylaws, copies of which have been filed as exhibits to the registration
statement of which this prospectus is a part.
COMMON STOCK
As of March 31, 2000, assuming the completion of our holding company
restructuring, there were 16,980,868 shares of common stock outstanding that
were held of record by 18 stockholders. Based upon the number of shares
outstanding as of that date and after giving effect to the sale of shares of
common stock to the public under this prospectus, there will be
20,180,868 shares of common stock outstanding, assuming no exercise of the
underwriters' over-allotment option, upon the closing of this offering.
The holders of common stock are entitled to one vote per share on all
matters to be voted upon by the stockholders. Subject to limitations under
Delaware law and preferences that may apply to any outstanding shares of
preferred stock, holders of common stock are entitled to receive ratably such
dividends or other distributions, if any, as may be declared by our board of
directors out of funds legally available. In the event of our liquidation,
dissolution or winding up, holders of common stock are entitled to share ratably
in all assets remaining after payment of liabilities, subject to the liquidation
preference of any outstanding preferred stock. The common stock has no
cumulative, preemptive, conversion or other subscription rights. There are no
redemption or sinking fund provisions applicable to the common stock. All
outstanding shares of common stock are, and all shares of common stock to be
issued upon completion of the offering will be, validly issued, fully paid and
nonassessable. The rights, preferences and privileges of holders of common stock
are subject to, and may be adversely affected by, the rights of the holders of
shares of any series of preferred stock that we may designate and issue in the
future.
PREFERRED STOCK
Our certificate of incorporation provides that our board of directors may
establish one or more classes or series of preferred stock having the number of
shares and relative voting rights, dividend rates, liquidation preferences, and
other rights, preferences, and limitations as may be fixed by the board without
further stockholder approval. The holders of our preferred stock may be entitled
to preferences over common stockholders with respect to dividends, liquidation,
dissolution or our winding up in such amounts as are established by our board of
directors when issuing such shares.
The issuance of our preferred stock may have the effect of delaying,
deferring or preventing a change in control of our company without further
action by the stockholders and may adversely affect voting and other rights of
holders of our common stock. In addition, issuance of preferred stock, while
providing desirable flexibility in connection with possible acquisitions and
other corporate purposes, could make it more difficult for a third party to
acquire a majority of the outstanding shares of our voting stock. At present, we
have no plans to issue any shares of preferred stock.
REGISTRATION RIGHTS
According to the terms of a registration rights agreement, beginning
180 days after the closing of this offering, some of our stockholders who will
hold, in the aggregate, 17,472,543 shares of common stock, which amount includes
380,952 shares, shares and shares that may be purchased by
Trango Capital, LLC, Norwest Venture Partners VIII, L.P. and entities affiliated
with Sequoia Capital, respectively, under outstanding warrants, may require us
to file a registration statement under the Securities Act of 1933 with respect
to the resale of their shares. To demand this
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<PAGE>
registration, investors holding an aggregate of at least 8,736,272 shares must
request that the registration statement register the resale of all or part of
their shares.
Additionally, some of our stockholders who will hold, in the aggregate,
17,472,543 shares of common stock will have "piggyback" registration rights with
respect to the future registration of our shares of common stock under the
Securities Act. If we propose to register any shares of common stock under the
Securities Act, the holders of shares having piggyback registration rights are
entitled to receive notice of that registration and are entitled to include
their shares in the registration.
These registration rights are subject to conditions and limitations,
including the right of the underwriters of an offering to limit the number of
shares of common stock to be included in the registration. We generally are
required to bear all of the expenses of registrations under the registration
rights agreement, except underwriting discounts and commissions. The
registration rights agreement also contains our commitment to indemnify the
holders of registration rights for losses they may incur in connection with
registrations under the agreement. Registration of any of the shares of common
stock held by security holders with registration rights would result in those
shares becoming freely tradeable without restriction under the Securities Act.
ANTI-TAKEOVER EFFECTS OF THE CERTIFICATE OF INCORPORATION, BYLAWS AND DELAWARE
LAW
Various provisions of our certificate of incorporation and our bylaws could
have the effect of delaying or preventing a third party from acquiring our
company, even if the acquisition would benefit our stockholders. These
provisions are intended to ensure that our board of directors will have
sufficient time to act in what the board of directors believes to be in the best
interests of our company and stockholders. These provisions could delay or
frustrate the assumption of control of our company by the holder or holders of a
large block of common stock, and could also discourage or make more difficult a
merger, tender offer, or proxy contest that a stockholder may consider in its
best interest, including acquisition offers that might result in a premium over
the market price for the shares held by stockholders. These provisions of our
certificate of incorporation and bylaws are summarized in the following
paragraphs.
CLASSIFIED BOARD OF DIRECTORS. Our certificate of incorporation provides
that at the first annual meeting following our initial public offering, our
board of directors will be divided into three classes of directors, as nearly
equal in size as is practicable, serving staggered three-year terms. As a
result, approximately one-third of the board of directors will be elected each
year. These provisions, when coupled with the provisions of our certificate of
incorporation and bylaws authorizing our board of directors to fill vacant
directorships or increase the size of our board, may deter a stockholder from
removing incumbent directors and simultaneously gaining control of the board of
directors.
STOCKHOLDER ACTION; SPECIAL MEETING OF STOCKHOLDERS. Our certificate of
incorporation provides that stockholders may not take action by written consent,
but only at a duly called annual or special meeting of stockholders. Our
certificate of incorporation further provides that special meetings of
stockholders may be called only by the chairman of the board, the chief
executive officer or a majority of our board of directors.
ADVANCE NOTICE REQUIREMENTS FOR STOCKHOLDER PROPOSALS AND DIRECTOR
NOMINATIONS. Our bylaws provide that stockholders seeking to bring business
before an annual meeting of stockholders, or to nominate candidates for election
as directors at an annual meeting of stockholders, must provide us with timely
written notice of their proposals. To be timely, a stockholder's notice must be
delivered to or mailed and received at our principal executive offices not less
than 120 days before the date we released the notice of annual meeting to
stockholders in connection with the previous year's annual meeting. If, however,
no meeting was held in the prior year or the date of the annual meeting has been
changed by more than 30 days from the date contemplated in the notice of annual
meeting, then notice by the stockholder, in order to be timely, must be received
a reasonable time before we release the notice of annual meeting to
stockholders. Our bylaws will also specify certain requirements as to the form
and
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<PAGE>
content of a stockholder's notice. These provisions may preclude stockholders
from bringing matters before an annual meeting of stockholders or from making
nominations for directors at an annual meeting of stockholders.
AUTHORIZED BUT UNISSUED SHARES. Following this offering, we will have a
significant number of authorized but unissued shares of common stock and
preferred stock. These shares will be available for future issuance without
stockholder approval, subject to various limitations imposed by the Nasdaq
National Market. These additional shares may be used for a variety of corporate
purposes, including future public offerings to raise additional capital,
corporate acquisitions and employee benefit plans. The existence of authorized
but unissued shares of common stock and preferred stock could render it more
difficult, or discourage an attempt, to obtain control of our company by means
of a proxy contest, tender offer, merger or other transaction.
SUPERMAJORITY VOTE PROVISIONS. The Delaware General Corporation Law
provides generally that the affirmative vote of a majority of the shares
entitled to vote on any matter is required to amend a corporation's certificate
of incorporation or bylaws, unless a corporation's certificate of incorporation
or bylaws, as the case may be, requires a greater percentage. Our certificate of
incorporation will impose supermajority vote requirements in connection with the
amendment of certain provisions of our certificate of incorporation, including
the provisions relating to the classified board of directors and the elimination
of action by written consent of stockholders.
INDEMNIFICATION. Our certificate of incorporation and bylaws permit us to
indemnify our directors and officers to the fullest extent permitted by Delaware
law. In addition, our certificate of incorporation limits the personal liability
of our board members for breaches by the directors of their fiduciary duties to
the fullest extent permitted under Delaware law.
DELAWARE LAW. We are subject to the provisions of Section 203 of the
Delaware General Corporation Law, which generally prohibit a Delaware
corporation from engaging in a "business combination" with an "interested
stockholder" for a period of three years following the date that the stockholder
became an interested stockholder, unless:
- prior to that time, the board of directors of the corporation approved
either the business combination or the transaction which resulted in the
stockholder becoming an interested stockholder;
- upon consummation of the transaction which resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction commenced, excluding shares owned by directors and
executive officers; or
- on or after that date, the business combination is approved by the board
of directors and authorized at an annual or special meeting of
stockholders by the affirmative vote of at least two-thirds of our
outstanding voting stock which is not owned by the interested stockholder.
For purposes of Section 203, a "business combination" includes a merger,
asset sale or other transaction resulting in a financial benefit to the
interested stockholder, and an "interested stockholder" is a person who,
together with affiliates and associates, owns, or within three years prior to
the date of determination whether the person is an "interested stockholder," did
own, 15% or more of the corporation's voting stock.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is ChaseMellon
Shareholder Services, LLC.
NASDAQ NATIONAL MARKET LISTING
Our common stock has been approved for quotation on the Nasdaq National
Market under the trading symbol "RACK."
57
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of our common stock in the public market could
adversely affect the prevailing market prices of our common stock. Upon the
consummation of this offering, we will have outstanding an aggregate of
20,180,868 shares of common stock, based on the number of shares outstanding at
March 31, 2000 and assuming no exercise of the underwriters' over-allotment
option and no exercise of outstanding warrants and stock options. Of these
shares, all shares being sold in this offering will be freely tradeable without
restriction or further registration under the Securities Act unless these shares
are purchased by our "affiliates" as the term is defined in Rule 144 under the
Securities Act. The following table summarizes the time frames in which issued
and outstanding common stock will be eligible for sale in the public market
after this offering:
<TABLE>
<CAPTION>
NUMBER OF SHARES DATE
---------------- -------------------------------------------------
<S> <C>
3,200,000 After the date of this prospectus, freely
tradeable shares sold in this offering.
After 180 days from the date of this prospectus,
shares are eligible for sale in the public market
under Rule 144 (subject, in some cases, to volume
limitations), Rule 144(k) or Rule 701.
At various times more than 180 days from the date
of this prospectus, when these shares have been
held for more than one year and may be sold in
accordance with Rule 144.
</TABLE>
Shares of common stock held by our existing stockholders are "restricted
securities" as defined in Rule 144. Restricted securities may be sold in the
public market only if registered or if they qualify for an exemption from
registration under Rules 144 or 701 under the Securities Act, which rules are
summarized below.
RULE 144
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this prospectus, a person who has beneficially owned shares of our
common stock for at least one year will be entitled to sell within any
three-month period a number of shares that does not exceed the greater of:
- 1% of the number of shares of our common stock then outstanding, which
will equal approximately 201,475 shares outstanding immediately after the
offering, or
- the average weekly trading volume of our common stock on the Nasdaq
National Market during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to that sale.
Sales under Rule 144 are also subject to certain manner-of-sale provisions,
notice requirements and the availability of current public information about us.
RULE 144(K)
Under Rule 144(k), a person who is not an affiliate of our company at any
time during the three months preceding a sale and who has beneficially owned the
shares proposed to be sold for at least two years, including the holding period
of certain prior owners other than an affiliate, is entitled to sell these
shares without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144. Therefore, unless otherwise
restricted, Rule 144(k) shares may be sold immediately upon the closing of this
offering.
58
<PAGE>
RULE 701
In general, under Rule 701 as currently in effect, each of our employees,
consultants or advisors who purchases shares from us in connection with a
compensatory stock plan or other written agreement is eligible to resell these
shares 90 days after the effective date of this offering in reliance on
Rule 144, but without compliance with certain restrictions, including the
holding period, contained in Rule 144.
LOCK-UP AGREEMENTS
All of our directors, executive officers and stockholders of our common
stock prior to the offering have signed lock-up agreements with the
underwriters, which generally require them not to transfer or otherwise dispose
of, directly or indirectly, any shares of our common stock or any securities
convertible into or exercisable or exchangeable for shares of our common stock
for 180 days after the date of this prospectus, except under limited
circumstances. See "Underwriting--Lock-up."
REGISTRATION RIGHTS
After this offering, the holders of 17,472,543 shares of our common stock
and shares issuable upon the exercise of outstanding options will be entitled to
certain rights with respect to the registration of those shares under the
Securities Act. See "Description of Capital Stock--Registration Rights." After
any registration and resale under a registration statement, these shares will be
freely tradeable without restriction under the Securities Act. These sales could
have a material adverse effect on the trading price of our common stock.
FORM S-8
We intend to file a registration statement on Form S-8 under the Securities
Act covering shares of common stock reserved for issuance under our stock
option plans and employee stock purchase plan and the shares reserved for
issuance upon exercise of outstanding non-plan options. We expect this
registration statement to be filed and to become effective as soon as
practicable after the effective date of this offering.
59
<PAGE>
UNDERWRITING
We intend to offer our common stock through a number of underwriters.
Deutsche Bank Securities Inc., Bear, Stearns & Co. Inc. and Thomas Weisel
Partners LLC are acting as representatives of each of the underwriters named
below. Subject to the terms and conditions set forth in an underwriting
agreement among us and the representatives on behalf of the underwriters, we
have agreed to sell to the underwriters, and each of the underwriters severally
and not jointly has agreed to purchase from us, the number of shares of common
stock set forth opposite its name below.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ----------
<S> <C>
Deutsche Bank Securities Inc................................
Bear, Stearns & Co. Inc.....................................
Thomas Weisel Partners LLC..................................
----------
Total................................................. 3,200,000
==========
</TABLE>
The several underwriters have agreed, subject to the terms and conditions
set forth in the underwriting agreement, to purchase all of the shares of common
stock being sold pursuant to the underwriting agreement if any of the shares of
common stock being sold under the terms of the agreement are purchased. In the
event of a default by an underwriter, the underwriting agreement provides that,
in certain circumstances, the purchase commitments of the nondefaulting
underwriters may be increased or the underwriting agreement may be terminated.
We have agreed to indemnify the underwriters against liabilities, including
liabilities under the Securities Act, or to contribute to payments the
underwriters may be required to make in respect of those liabilities.
The shares of common stock are being offered by the underwriters, subject to
prior sale, when, as and if issued to and accepted by them, subject to approval
of legal matters by counsel for the underwriters and other conditions. The
underwriters reserve the right to withdraw, cancel or modify the offer and to
reject orders in whole or in part.
Thomas Weisel Partners LLC, one of the representatives of the underwriters,
was organized and registered as a broker-dealer in December 1998. Since
December 1998, Thomas Weisel Partners has been named as a lead or co-manager on
165 filed public offerings of equity securities, of which 122 have been
completed, and has acted as a syndicate member in an additional 95 public
offerings of equity securities. The limited partners of Tailwind Capital
Partners 2000, L.P. are employees of Thomas Weisel Partners LLC. Tailwind
Capital Partners purchased 53,004 limited partner interests representing limited
partner interests in Rackspace, Ltd. in March 2000 for an aggregate purchase
price of $300,000, which units will be converted into 53,004 shares of our
common stock prior to this offering. The securities acquired by Tailwind Capital
Partners are restricted from sale, transfer, assignment or hypothecation for a
period of one year from the date of acquisition. In addition, the registration
rights on the securities are limited to no more than one demand right.
COMMISSIONS AND DISCOUNTS
The representatives have advised us that the underwriters propose initially
to offer the shares of common stock to the public at the initial public offering
price set forth on the cover page of this prospectus and to dealers at that
price less a concession not in excess of $ per share of common stock. The
underwriters may allow, and the dealers may reallow, a discount not in excess of
$ per share of common stock on sales to other dealers. After the initial
public offering, the public offering price, concession and discount may change.
60
<PAGE>
The following table shows the per share and total public offering price,
underwriting discount to be paid by us to the underwriters and the proceeds
before expenses to us. This information is presented assuming either no exercise
or full exercise by the underwriters of the over-allotment option.
<TABLE>
<CAPTION>
PER SHARE WITHOUT OPTION WITH OPTION
--------- -------------- -----------
<S> <C> <C> <C>
Public offering price..................................... $ $ $
Underwriting discount..................................... $ $ $
Proceeds, before expenses, to us.......................... $ $ $
</TABLE>
The expenses of the offering, exclusive of the underwriting discount, are
estimated at $ and are payable by us.
OVER-ALLOTMENT OPTION
We have granted an option to the underwriters, exercisable for 30 days after
the date of this prospectus, to purchase up to an aggregate of 480,000
additional shares of our common stock at the public offering price set forth on
the cover page of this prospectus, less the underwriting discount. The
underwriters may exercise this option solely to cover over-allotments, if any,
made on the sale of our common stock offered in this offering. To the extent
that the underwriters exercise this option, each underwriter will be obligated,
subject to certain conditions, to purchase a number of additional shares of our
common stock proportionate to the underwriters' initial amount reflected in the
foregoing table.
RESERVED SHARES
At our request, the underwriters have reserved for sale, at the initial
public offering price, up to 240,000 of the shares offered in this offering to
be sold to some of our directors, officers, employees, distributors, dealers,
business associates and related persons. The number of shares of our common
stock available for sale to the general public will be reduced to the extent
that those persons purchase the reserved shares. Any reserved shares that are
not orally confirmed for purchase within one day of the pricing of the offering
will be offered by the underwriters to the general public on the same terms as
the other shares offered by this prospectus.
LOCK-UP
We and our executive officers and directors and all existing stockholders
have agreed, subject to certain exceptions, without the prior written consent of
Deutsche Bank Securities Inc. on behalf of the underwriters for a period of
180 days after the date of this prospectus, not to directly or indirectly:
- offer, pledge, sell, contract to sell, sell any option or contract to
purchase, purchase any option or contract to sell, grant any option, right
or warrant for the sale of or otherwise dispose of or transfer any shares
of our common stock or securities convertible into or exchangeable or
exercisable for or repayable with our common stock, whether now owned or
later acquired by the person executing the agreement or with respect to
which the person executing the agreement later acquires the power of
disposition, or file a registration statement under the Securities Act
with respect to any shares of our common stock; or
- enter into any swap or other agreement that transfers, in whole or in
part, the economic consequence of ownership of our common stock whether
any swap or transaction is to be settled by delivery of our common stock
or other securities, in cash or otherwise.
61
<PAGE>
NASDAQ NATIONAL MARKET QUOTATION
Our common stock has been approved for quotation on the Nasdaq National
Market under the symbol "RACK."
Before this offering, there has been no public market for our common stock.
The initial public offering price will be determined through negotiations
between us and the representatives. The factors to be considered in determining
the initial public offering price, in addition to prevailing market conditions,
will be the valuation multiples of publicly traded companies that the
representatives believe to be comparable to us, our financial information, our
history, our prospects, the industry in which we compete, and an assessment of
our management, its past and present operations, the prospects for, and timing
of, our future revenue, the present state of our development, and the above
factors in relation to market values and various valuation measures of other
companies engaged in activities similar to ours. There can be no assurance that
an active trading market will develop for our common stock or that our common
stock will trade in the public market subsequent to the offering at or above the
initial public offering price.
PRICE STABILIZATION, SHORT POSITIONS AND PENALTY BIDS
Until the distribution of our common stock is completed, rules of the
Securities and Exchange Commission may limit the ability of the underwriters to
bid for and purchase our common stock. As an exception to these rules, the
representatives are permitted to engage in transactions that stabilize the price
of our common stock. These transactions consist of bids or purchases for the
purpose of pegging, fixing or maintaining the price of our common stock.
If the underwriters create a short position in our common stock in
connection with the offering, that is, if they sell more shares of our common
stock than are set forth on the cover page of this prospectus, the
representatives may reduce that short position by purchasing our common stock in
the open market. The representatives may also elect to reduce any short position
by exercising all or part of the over-allotment option described above.
The representatives may also impose a penalty bid on underwriters. This
means that if the representatives purchase shares of our common stock in the
open market to reduce the underwriters' short position or to stabilize the price
of our common stock, they may reclaim the amount of the selling concession from
the underwriters and selling group members who sold those shares.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of these purchases. The imposition of a penalty bid
might also have an effect on the price of our common stock to the extent that it
discourages resales of our common stock.
Neither we nor any of the underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of our common stock. In addition, neither
we nor any of the underwriters makes any representation that the representatives
will engage in these transactions or that these transactions, once commenced,
will not be discontinued without notice.
The underwriters and their respective affiliates may be lenders to, engage
in transactions with, and perform services for us in the ordinary course of
business.
62
<PAGE>
LEGAL MATTERS
The validity of the common stock in this offering will be passed upon for us
by Brobeck, Phleger & Harrison LLP, Austin, Texas. We have agreed to issue a
warrant to Brobeck, Phleger & Harrison LLP to purchase 17,667 shares of common
stock with an exercise price of $5.66 per share. Certain legal matters in
connection with this offering will be passed upon for the underwriters by
Vinson & Elkins L.L.P., Dallas, Texas.
EXPERTS
The financial statements of Rackspace, Ltd. as of December 31, 1998 and 1999
and for the period from December 29, 1998 (inception) to December 31, 1998 and
the year ended December 31, 1999, and the financial statements of Cymitar
Technology Group, Inc. for the year ended December 31, 1997 and the period from
January 1, 1998 to December 28, 1998 have been included in this prospectus and
the registration statement of which this prospectus is a part in reliance upon
the report of KPMG LLP, independent certified public accountants, appearing
elsewhere in this prospectus, and upon the authority of said firm as experts in
accounting and auditing.
WHERE YOU CAN FIND ADDITIONAL INFORMATION ABOUT RACKSPACE.COM
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1, including exhibits and schedules, under the Securities
Act of 1933 with respect to the shares of common stock to be sold in this
offering. This prospectus does not contain all the information included in the
registration statement and the exhibits thereto. For further information about
us and the shares of our common stock to be sold in this offering, please refer
to this registration statement. Complete exhibits have been or will be filed
with our registration statement on Form S-1.
As a result of this offering, we will be subject to the information and
reporting requirements of the Securities Exchange Act of 1934, and will file and
furnish to our stockholders annual reports containing financial statements
audited by our independent auditors, make available to our stockholders
quarterly reports containing unaudited financial data for the first three
quarters of each fiscal year, proxy statements and other information with the
Securities and Exchange Commission.
You may read and copy any contract, agreement or other document referred to
in this prospectus and any portion of our registration statement or any other
information from our filings at the Securities and Exchange Commission's public
reference room at 450 Fifth Street, N.W., Washington, D.C. 20549, and at certain
regional offices. You can request copies of these documents, upon payment of a
duplicating fee, by writing to the Securities and Exchange Commission. Please
call the Securities and Exchange Commission at 1-800-SEC-0330 for further
information about the public reference rooms. Our filings with the Securities
and Exchange Commission, including our registration statement, are also
available to you without charge at the Securities and Exchange Commission's Web
site, http://www.sec.gov.
63
<PAGE>
INDEX TO RACKSPACE.COM, INC.
FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report................................ F-2
Balance Sheets at December 31, 1998 and 1999 and March 31,
2000 (unaudited).......................................... F-3
Statements of Operations.................................... F-4
The Company -- For the period from December 29, 1998
(inception) to December 31, 1998 and for the year ended
December 31, 1999 and the three months ended March 31,
1999 and March 31, 2000 (unaudited)
The Predecessor -- For the year ended December 31, 1997
and for the period from January 1, 1998 to
December 28, 1998
Statements of Partners' Capital/Stockholders' Equity........ F-5
The Company -- For the period from December 29, 1998
(inception) to December 31, 1998 and for the year ended
December 31, 1999 and the three months ended March 31,
2000 (unaudited)
The Predecessor -- For the year ended December 31, 1997
and for the period from January 1, 1998 to
December 28, 1998
Statements of Cash Flows.................................... F-6
The Company -- For the period from December 29, 1998
(inception) to December 31, 1998 and for the year ended
December 31, 1999 and the three months ended March 31,
1999 and March 31, 2000 (unaudited)
The Predecessor -- For the year ended December 31, 1997
and for the period from January 1, 1998 to
December 28, 1998
Notes to Financial Statements............................... F-7
</TABLE>
F-1
<PAGE>
The Board of Directors
Rackspace, Ltd.
When certain of the transactions referred to in note 7 of the Notes to
Financial Statements have been consummated, we will be in a position to render
the following report.
KPMG LLP
San Antonio, Texas
June 22, 2000
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Rackspace, Ltd.
We have audited the accompanying balance sheets of Rackspace, Ltd. (dba
Rackspace.com) (the "Company") as of December 31, 1998 and 1999 and the related
statements of operations, partners' capital, and cash flows for the period from
December 29, 1998 (inception) to December 31, 1998 and the year ended
December 31, 1999 and the statements of operations, stockholders' equity and
cash flows of Cymitar Technology Group, Inc. (the Company's Predecessor) for the
year ended December 31, 1997 and the period from January 1, 1998 to
December 28, 1998. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Rackspace, Ltd. as of
December 31, 1998 and 1999, and the results of its operations and its cash flows
for the period from December 29, 1998 (inception) to December 31, 1998 and the
year ended December 31, 1999 and the results of operations and cash flows of
Cymitar Technology Group, Inc. for the year ended December 31, 1997 and the
period from January 1, 1998 to December 28, 1998, in conformity with generally
accepted accounting principles.
San Antonio, Texas
February 29, 2000, except
as to Note 7 which
is as of .
F-2
<PAGE>
RACKSPACE, LTD.
BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31,
2000
PRO FORMA
DECEMBER 31, STOCKHOLDERS'
--------------------- MARCH 31, EQUITY
1998 1999 2000 (NOTE 7)
-------- ---------- ----------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents....................... $150,000 $3,794,784 $12,535,029
Accounts receivable, net of allowance for
doubtful accounts of $108,691 in 2000, $51,016
in 1999 and none in 1998...................... 5,233 136,260 254,325
Interest receivable--related party.............. -- 4,932 --
Note receivable................................. -- -- 250,000
Prepaid expenses and deposits................... -- 19,622 125,128
-------- ---------- -----------
Total current assets........................ 155,233 3,955,598 13,164,482
Property and equipment, net....................... 70,623 1,666,139 3,965,866
Goodwill, at cost, less accumulated
amortization.................................... 117,305 99,805 95,430
Other assets...................................... -- 142,244 514,812
-------- ---------- -----------
Total assets................................ $343,161 $5,863,786 $17,740,590
======== ========== ===========
LIABILITIES AND PARTNERS' CAPITAL/STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................ $ 896 $ 974,961 $ 1,436,129
Deferred revenue................................ -- 150,083 288,141
Accrued expenses................................ 105 95,217 587,116
-------- ---------- -----------
Total current liabilities................... 1,001 1,220,261 2,311,386
Note payable and accrued interest--related
party........................................... 150,066 -- --
-------- ---------- -----------
Total liabilities........................... 151,067 1,220,261 2,311,386
Partners' capital/stockholders' equity:
Partners' capital............................... 192,094 5,393,525 15,429,204
Note receivable for issuance of partnership
interest...................................... -- (750,000) -- --
Stockholders' equity--pro forma:
Preferred stock, $0.001 par value, 30,000,000
shares authorized; no shares issued and
outstanding................................. --
Common stock, $0.001 par value, 170,000,000
shares authorized; 16,980,868 shares issued
and outstanding............................. 16,981
Additional paid-in capital.................... 16,648,286
Deferred stock compensation..................... -- -- (1,236,063)
-------- ---------- ----------- -----------
Total partners' capital/stockholders'
equity.................................... 192,094 4,643,525 15,429,204 $15,429,204
-------- ---------- ----------- ===========
Total liabilities and partners'
capital/stockholders' equity.............. $343,161 $5,863,786 $17,740,590
======== ========== ===========
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE>
RACKSPACE, LTD.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THE PREDECESSOR THE COMPANY
--------------------------- ------------------------------------------------------
PERIOD FROM
DECEMBER 29,
PERIOD FROM 1998
JANUARY 1, (INCEPTION) THREE MONTHS ENDED
YEAR ENDED 1998 TO TO YEAR ENDED ------------------------
DECEMBER 31, DECEMBER 28, DECEMBER 31, DECEMBER 31, MARCH 31, MARCH 31,
1997 1998 1998 1999 1999 2000
------------ ------------ ------------ ------------ ---------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Total revenues........... $ 72,535 $ 166,632 $ 76 $ 1,700,537 $ 125,507 $ 1,434,967
-------- --------- ---------- ----------- ---------- -----------
Operating expenses:
Cost of revenues....... 38,895 73,767 -- 513,424 31,232 645,163
Sales and marketing.... 648 3,615 -- 1,612,071 78,414 1,639,054
General and
administrative....... 47,705 181,260 23 970,155 80,774 994,063
Product development.... -- -- -- 52,712 7,724 99,818
Depreciation and
amortization......... 6,912 12,363 262 261,730 20,513 304,442
-------- --------- ---------- ----------- ---------- -----------
Total operating
expenses......... 94,160 271,005 285 3,410,092 218,657 3,682,540
-------- --------- ---------- ----------- ---------- -----------
Loss from
operations....... (21,625) (104,373) (209) (1,709,555) (93,150) (2,247,573)
-------- --------- ---------- ----------- ---------- -----------
Other income (expense):
Interest expense....... (3,247) (7,767) (66) (53,112) (3,682) --
Other income, net...... -- -- -- 9,869 -- 102,874
-------- --------- ---------- ----------- ---------- -----------
(3,247) (7,767) (66) (43,243) (3,682) 102,874
-------- --------- ---------- ----------- ---------- -----------
Net loss........... $(24,872) $(112,140) $ (275) $(1,752,798) $ (96,832) $(2,144,699)
======== ========= ========== =========== ========== ===========
Pro forma basic and
diluted net loss per
common share
(unaudited).......... $ (0.00) $ (0.16) $ (0.01) $ (0.14)
========== =========== ========== ===========
Shares used in
computing pro forma
basic and diluted net
loss per common share
(unaudited).......... 10,000,000 10,733,098 10,000,000 15,035,893
========== =========== ========== ===========
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE>
RACKSPACE, LTD.
STATEMENTS OF PARTNERS' CAPITAL/STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
NOTE
PARTNERS' RECEIVABLE FOR
CONTRIBUTIONS ISSUANCE OF DEFERRED COMMON STOCK ADDITIONAL
------------------------ PARTNERSHIP STOCK ------------------- PAID IN
UNITS AMOUNT INTEREST COMPENSATION SHARES AMOUNT CAPITAL
---------- ----------- -------------- ------------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996....... -- $ -- -- -- 1,000 $5,552 --
Net loss........................... -- -- -- -- -- -- --
---------- ----------- --------- ----------- ----- ------ ---
Balance at December 31, 1997....... -- -- -- -- 1,000 5,552 --
Net loss........................... -- -- -- -- -- -- --
---------- ----------- --------- ----------- ----- ------ ---
Balance of Predecessor at
December 28, 1998................ -- -- -- -- 1,000 $5,552 $--
========== =========== ========= =========== ===== ====== ===
Formation of the Company and
initial contribution--at
inception (December 29, 1998).... 10,000,000 $ 192,369 $ -- $ -- -- $ -- $--
Net loss for the period from
December 29, 1998 to
December 31, 1998................ -- (275) -- -- -- -- --
---------- ----------- --------- ----------- ----- ------ ---
Balance at December 31, 1998....... 10,000,000 192,094 -- -- -- -- --
Cash contribution.................. -- 7,631 -- -- -- -- --
Conversion of advances on credit
agreement and accrued interest to
partnership interest............. 1,904,762 1,082,532 -- -- -- -- --
Conversion of advances on credit
agreement to partnership
interest......................... 238,095 500,000 -- -- -- -- --
Sale of partnership interest for
cash and note receivable, net of
related costs.................... 2,528,571 5,264,066 (750,000) -- -- -- --
Fair value of services contributed
by partners...................... -- 100,000 -- -- -- -- --
Net loss........................... -- (1,752,798) -- --
---------- ----------- --------- ----------- ----- ------ ---
Balance at December 31, 1999....... 14,671,428 5,393,525 (750,000) -- -- -- --
Sale of partnership interest for
cash............................. 357,143 750,000 -- -- -- -- --
Repayment of note receivable....... -- -- 750,000 -- -- -- --
Sale of partnership interest for
cash............................. 1,952,297 11,050,000 -- -- -- -- --
Compensatory element of stock
options granted.................. -- 1,616,441 -- (1,616,441) -- -- --
Amortization of deferred stock
compensation..................... -- -- -- 380,378 -- -- --
Net loss........................... -- (2,144,699) -- -- -- -- --
--------------------------------------------------------------------------------------------
Balance at March 31, 2000.......... 16,980,868 $16,665,267 $ -- $(1,236,063) $ -- $--
========== =========== ========= =========== ===== ====== ===
<CAPTION>
TOTAL
PARTNERS'
CAPITAL/
ACCUMULATED STOCKHOLDERS'
DEFICIT EQUITY
------------ -------------
<S> <C> <C>
Balance at December 31, 1996....... $ (8,582) $ (3,030)
Net loss........................... (24,872) (24,872)
------------ -----------
Balance at December 31, 1997....... (33,454) (27,902)
Net loss........................... (112,140) (112,140)
------------ -----------
Balance of Predecessor at
December 28, 1998................ $ (145,594) $ (140,042)
============ ===========
Formation of the Company and
initial contribution--at
inception (December 29, 1998).... $ -- $ 192,369
Net loss for the period from
December 29, 1998 to
December 31, 1998................ -- (275)
------------ -----------
Balance at December 31, 1998....... -- 192,094
Cash contribution.................. -- 7,631
Conversion of advances on credit
agreement and accrued interest to
partnership interest............. -- 1,082,532
Conversion of advances on credit
agreement to partnership
interest......................... -- 500,000
Sale of partnership interest for
cash and note receivable, net of
related costs.................... -- 4,514,066
Fair value of services contributed
by partners...................... -- 100,000
Net loss........................... -- (1,752,798)
------------ -----------
Balance at December 31, 1999....... -- 4,643,525
Sale of partnership interest for
cash............................. -- 750,000
Repayment of note receivable....... -- 750,000
Sale of partnership interest for
cash............................. -- 11,050,000
Compensatory element of stock
options granted.................. -- --
Amortization of deferred stock
compensation..................... -- 380,378
Net loss........................... -- (2,144,699)
----------------------------
Balance at March 31, 2000.......... $ $15,429,204
============ ===========
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE>
RACKSPACE, LTD.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THE PREDECESSOR THE COMPANY
--------------------------- -------------------------------------------------------------
PERIOD FROM
PERIOD FROM DECEMBER 29,
JANUARY 1, 1998 THREE MONTHS ENDED
YEAR ENDED 1998 TO (INCEPTION) TO YEAR ENDED -----------------------------
DECEMBER 31, DECEMBER 28, DECEMBER 31, DECEMBER 31, MARCH 31, MARCH 31,
1997 1998 1998 1999 1999 2000
------------ ------------ -------------- ------------ ------------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
Cash flows from operating
activities:
Net loss.......................... $(24,872) $(112,140) $ (275) $(1,752,798) $ (96,832) $(2,144,699)
Adjustments to reconcile net loss
to net cash provided by (used
in) operating activities:
Depreciation and
amortization................ 6,912 12,363 262 261,730 20,513 304,442
Amortization of deferred stock
compensation................ -- -- -- -- -- 380,378
Compensation expense for
services contributed by
partners.................... -- -- -- 100,000 -- --
Interest accrued on credit
agreement................... 886 7,642 66 53,112 3,682 4,932
Changes in operating assets
and liabilities:
Receivables................. (2,146) 1,875 (76) (135,959) (19,798) (118,031)
Prepaid expenses and other
assets.................... -- -- -- (163,661) (2,603) (485,456)
Accounts payable and accrued
expenses.................. (5,956) 51,145 1,001 1,048,530 66,037 953,031
Deferred revenues........... 1,543 10,052 -- 150,083 20,469 138,059
-------- --------- -------- ----------- --------- -----------
Net cash provided by (used
in) operating
activities.............. (23,633) (29,063) 978 (438,963) (8,532) (967,344)
Cash flows from investing
activities:
Acquisition of property and
equipment....................... (5,531) (47,359) (978) (1,837,950) (228,956) (2,592,411)
Issuance of note
receivable................ -- -- -- -- -- (250,000)
-------- --------- -------- ----------- --------- -----------
Net cash used in investing
activities.............. (5,531) (47,359) (978) (1,837,950) (228,956) (2,842,411)
-------- --------- -------- ----------- --------- -----------
Cash flows from financing
activities:
Sale of partnership interests,
net............................. -- -- -- 4,514,066 -- 11,800,000
Repayment of note receivable...... -- -- -- -- 750,000
Advances on credit agreement...... 47,460 70,000 150,000 1,400,000 200,000 --
Partner contribution.............. -- -- -- 7,631 -- --
-------- --------- -------- ----------- --------- -----------
Net cash provided by
financing activities.... 47,460 70,000 150,000 5,921,697 200,000 12,550,000
-------- --------- -------- ----------- --------- -----------
Increase (decrease) in
cash and cash
equivalents............. 18,296 (6,422) 150,000 3,644,784 (37,488) 8,740,245
Cash and equivalents, beginning of
period............................ 887 19,183 -- 150,000 150,000 3,794,784
-------- --------- -------- ----------- --------- -----------
Cash and cash equivalents, end of
period............................ $ 19,183 $ 12,761 $150,000 $ 3,794,784 $ 112,512 $12,535,029
======== ========= ======== =========== ========= ===========
Supplemental disclosures of non-cash
transactions:
Purchase of certain assets of
Predecessor for assumption of
liabilities..................... $ -- $ -- $192,369 $ -- $ -- $ --
======== ========= ======== =========== ========= ===========
Conversion of advances on credit
agreement and accrued interest
to partnership interest......... $ -- $ -- $ -- $ 1,582,532 $ -- $ --
======== ========= ======== =========== ========= ===========
Sale of partnership interest for
note receivable................. $ -- $ -- $ -- $ 750,000 $ -- $ --
======== ========= ======== =========== ========= ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
RACKSPACE, LTD.
NOTES TO FINANCIAL STATEMENTS
(INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE-MONTH PERIODS
ENDED MARCH 31, 2000 AND MARCH 31, 1999 IS UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES
(A) ORGANIZATION AND DESCRIPTION OF BUSINESS
Rackspace, Ltd. (the "Company"), a Texas limited partnership, was formed on
December 29, 1998 to provide Internet hosting services. The Company, at its
formation, was owned by Macroweb, LC, a Texas limited liability company (the
"General Partner"), Trout, Ltd., a Texas limited partnership, Richard Yoo,
Patrick Condon, and Dirk Elmendorf (collectively, the "Limited Partners"). The
Company provides Linux-based Internet hosting services primarily targeted to
small- to medium-sized enterprises worldwide. Through the Company's hosting
services, customers are offered a means to outsource their Internet operations
while enabling them to rapidly add bandwidth and upgrade their dedicated server
hardware to support their needs as they expand.
Upon formation, 10,000,000 partner interests were issued. Concurrent with
the formation, the Company entered into an asset purchase and sale agreement
with Cymitar Technology Group, Inc. ("Cymitar" or "the Predecessor"), a Texas
corporation, whereby the Company purchased substantially all of the assets of
Cymitar by assuming substantially all of its outstanding liabilities which
aggregated $192,369 on the date of the agreement (December 29, 1998). The
transaction was accounted for under the purchase method. The purchase price was
allocated principally to computer equipment, software and other equipment at
their estimated fair values, and the excess of cost over the fair value of net
assets acquired of $117,451 was recognized as goodwill which is being amortized
over seven years.
The significant accounting policies and practices utilized by the
Predecessor were consistent with those utilized by the Company.
(B) LIQUIDITY
The Company has incurred net operating losses and negative cash flows from
operations since its inception. Such losses are due primarily to the Company's
efforts to aggressively expand its customer base through targeted marketing and
advertising initiatives. The Company expects that it will continue to incur net
losses as it expends substantial additional resources in an attempt to rapidly
increase its market share. There can be no assurance that the Company will
achieve or sustain profitability or positive cash flow from its operations. The
Company may need to obtain additional debt or equity financing to fund its
operations.
(C) CASH EQUIVALENTS
For purposes of the statements of cash flows, the Company considers all
highly liquid interest-bearing instruments with original maturities of three
months or less to be cash equivalents. Cash balances at December 31, 1999
consisted of bank deposits and overnight money market accounts. Cash balances at
December 31, 1998 consisted of bank deposits.
(D) PROPERTY AND EQUIPMENT
Equipment and leasehold improvements are recorded at cost. Depreciation is
provided using the straight line method over the estimated useful lives of the
assets (three to five years for Internet access and computer equipment and seven
years for office equipment). Leasehold improvements are amortized over the
shorter of the lease term or the estimated useful life of the asset.
F-7
<PAGE>
RACKSPACE, LTD.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE-MONTH PERIODS
ENDED MARCH 31, 2000 AND MARCH 31, 1999 IS UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (CONTINUED)
(E) OTHER ASSETS
Other assets are comprised primarily of deposits and software licenses which
are amortized over the license term.
(F) INCOME TAXES
As a partnership, the Company is not directly liable for federal income
taxes. For federal income tax purposes, the partnership's tax attributes are
passed through to the partners and included on their individual returns.
Subsequent to the reorganization discussed in note 7, the Company will
account for income taxes in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 109, "ACCOUNTING FOR INCOME TAXES." Had the Company
applied the provisions of SFAS No. 109 for the period from inception through
December 31, 1999, the Company would have recorded a deferred tax asset, subject
to a 100% valuation allowance. This pro forma net deferred tax asset (pro forma
to exclude the effect of tax losses which passed through to the former partners)
is principally comprised of deferred revenue.
(G) REVENUE RECOGNITION
Revenues consist primarily of recurring monthly fees from customer use of
Internet servers and related services and from set-up fees. Contracts are
generally month-to-month; however, customers have the option of entering into
contracts for longer periods. Revenues from these contracts are recognized as
services are provided. Payments received and billings in advance of providing
services are deferred until the services are provided. Set-up fees are
nonrefundable and are separately priced from the use of Internet servers and
related services and are recognized at the time a new customer account is
created and the set-up process is completed. Set-up costs consist primarily of
labor by technical support personnel to configure the customer's Internet server
and to activate the new service. The Company has no obligation to perform any
future set-up services and no additional set-up services are necessary following
expiration of the initial contract period and upon renewal of the contract by
the customer.
(H) USE OF ESTIMATES
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities and the disclosure of
contingent assets and liabilities to prepare financial statements in conformity
with generally accepted accounting principles. Actual results could differ from
those estimates.
(I) IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company accounts for long-lived assets, including goodwill, in
accordance with the provisions of SFAS No. 121, "ACCOUNTING FOR THE IMPAIRMENT
OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF." This
Statement requires that long-lived assets and certain identifiable intangibles
be reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured
F-8
<PAGE>
RACKSPACE, LTD.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE-MONTH PERIODS
ENDED MARCH 31, 2000 AND MARCH 31, 1999 IS UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (CONTINUED)
by a comparison of the carrying amount of an asset to future undiscounted net
cash flows expected to be generated by the asset. If such assets are considered
to be impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of the assets exceeds the fair value of the assets.
Assets to be disposed of are reported at the lower of the carrying amount or
fair value less cost to sell.
(J) ADVERTISING AND MARKETING COSTS
The Company charges advertising and marketing costs to expense in the period
incurred. Advertising expenses for the year ended December 31, 1997, the period
from January 1, 1998 to December 28, 1998, the period from inception to
December 31, 1998 and the year ended December 31, 1999 were approximately
$1,000, $4,000, $-0- and $1,497,000, respectively.
(K) STOCK-BASED COMPENSATION
The Company applies the intrinsic value-based method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25, "ACCOUNTING
FOR STOCK ISSUED TO EMPLOYEES," and related interpretations, in accounting for
its stock options. As such, compensation expense would be recorded on the date
of grant only if the current market price of the underlying stock exceeded the
exercise price. The Company adopted the disclosure provisions of SFAS No. 123,
"ACCOUNTING FOR STOCK-BASED COMPENSATION." There were no options issued or
outstanding at December 31, 1999.
(L) PRO FORMA BASIC AND DILUTED NET LOSS PER SHARE
Following the reorganization discussed in note 7, the Company will compute
net loss per share in accordance with the provisions of SFAS No. 128, "EARNINGS
PER SHARE." Under the provisions of SFAS No. 128, basic and diluted net loss per
share is computed by dividing the net loss available to common stockholders for
the period by the weighted average number of common shares outstanding during
the period. The calculation of diluted net loss per share excludes all shares of
common stock issuable upon exercise of employee stock options as the effect of
the exercise would be antidilutive.
(M) COMPREHENSIVE INCOME (LOSS)
The Company reports comprehensive income (loss) in accordance with SFAS
No. 130, "REPORTING COMPREHENSIVE INCOME." In each period presented,
comprehensive net loss does not differ from the reported net loss.
(N) SEGMENT REPORTING
The Company has adopted SFAS No. 131, "DISCLOSURE ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION." SFAS No. 131 establishes standards for the
way that public business enterprises report selected information about operating
segments in annual and interim financial statements. It also establishes
standards for related disclosures about products and services, geographical
areas and major customers. SFAS No. 131 requires the use of the "management
approach" in disclosing segment information; based largely on how senior
management generally analyzes the business operations. The
F-9
<PAGE>
RACKSPACE, LTD.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE-MONTH PERIODS
ENDED MARCH 31, 2000 AND MARCH 31, 1999 IS UNAUDITED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND PRACTICES (CONTINUED)
Company did not have any operations or net assets or liabilities in foreign
locations for the period from inception to December 31, 1999 and currently
operates in only one segment. All sales were denominated in U.S. dollars. See
note 6.
(O) UNAUDITED INTERIM FINANCIAL STATEMENTS
The unaudited interim financial statements as of March 31, 2000, and for the
three-month periods ended March 31, 1999 and 2000, have been prepared in
accordance with generally accepted accounting principles for interim financial
information. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. They do reflect all adjustments (consisting only of normal
recurring accruals) which, in the opinion of the Company's management, are
necessary for a fair presentation of the results for the interim periods
presented.
The results of operations for the three month period ended March 31, 2000,
are not necessarily indicative of the results that may be expected for any other
interim period or for the full year.
(P) RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES," which
will be effective for the Company's fiscal year ending December 31, 2001. This
statement establishes accounting and reporting standards requiring that each
derivative instrument, including certain derivative instruments embedded in
other contracts, be recorded in the balance sheet as either an asset or
liability measured at its fair value. The statement also requires that changes
in the derivative's fair value be recognized in earnings unless specific hedge
accounting criteria are met. The Company has not evaluated the impact of SFAS
No. 133; however, it believes the adoption of SFAS No. 133 will not have a
material effect on its financial position, results of operations, or cash flows
as it has not entered into any derivative contracts.
(2) PROPERTY AND EQUIPMENT
A summary of property and equipment at December 31, 1998 and December 31,
1999 is as follows:
<TABLE>
<CAPTION>
1998 1999
-------- ---------
<S> <C> <C>
Internet access and computer equipment.................. $65,516 1,662,333
Office equipment........................................ 5,223 102,316
Leasehold improvements.................................. -- 144,040
------- ---------
70,739 1,908,689
Less accumulated depreciation and amortization.......... 116 242,550
------- ---------
$70,623 1,666,139
======= =========
</TABLE>
F-10
<PAGE>
RACKSPACE, LTD.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE-MONTH PERIODS
ENDED MARCH 31, 2000 AND MARCH 31, 1999 IS UNAUDITED)
(3) PARTNERS' CAPITAL
Pursuant to the second amendment to the partnership agreement dated
November 30, 1999, the Company declared a ten-for-one split of all limited
partner interests outstanding prior to November 30, 1999. Limited partner
interests for all periods presented have been adjusted to reflect this split.
Under this amendment, certain key personnel were given the option of receiving,
in lieu of their salary, options to acquire limited partner interests commencing
at the beginning of each calendar quarter of 2000. No options were granted as of
December 31, 1999.
Pursuant to a Subscription Agreement (the "Agreement") dated November 30,
1999, between the Company and private investors, some of whom were officers and
equity holders of the Company, the Company sold 2,766,667 limited partner
interests for $2.10 per limited partner interest. The Agreement provided for the
issuance of the limited partner interests for $4,560,000 in cash, conversion of
$500,000 of advances due under the Company's credit agreement and receipt of a
$750,000 short-term promissory note from an entity principally owned by one of
the investors who is also an officer. Subsequent to December 31, 1999, the note
was paid in full. The Agreement also provided certain of the investors warrants
to invest an additional $1,300,000 at the same price per limited partner
interest for a period beginning November 30, 1999 through December 31, 2001.
The Agreement provides the investors anti-dilution rights whereby if the
Company issues any additional limited partner interests, other than to employees
pursuant to an option agreement or as compensation for services rendered, or
incident to an acquisition of assets in which more than 700,000 limited partner
interests are issued to the seller, and the purchase price per limited partner
interest is less than $2.10, the Company will issue the investors additional
limited partner interests in an amount which provides them with the same
ownership percentage as was held by them on November 30, 1999.
(4) DEBT
The Company entered into credit agreements with Exeter Financial, L.C.
("Exeter"), a financial institution owned by the principal owners of
Trout, Ltd., to provide for cash advances in the form of term notes of not more
than $1,550,000 bearing interest at a fixed rate of 8% per annum. Total cash
advances under the credit agreements amounted to $1,550,000. Trout, Ltd.
subsequently acquired the rights to the debt from Exeter. Pursuant to amendments
to the partnership agreement, the partners agreed to convert the $1,550,000 in
outstanding principal and $32,532 of accrued but unpaid interest in exchange for
2,142,857 limited partner interests. Interest expense of $66 and $53,112 for the
period ended December 31, 1998 and for the year ended December 31, 1999,
respectively, was incurred under these related party advances.
(5) COMMITMENTS
The Company leased its office space on a month-to-month basis through
December 31, 1999 from an entity controlled by a principal owner of Trout, Ltd.
The Company and this entity entered into a lease agreement in February 2000
which expires in February 2003 and requires the Company to pay all maintenance
and insurance. The Company recognized approximately $38,000 in rental expense
for the year ended December 31, 1999 under this lease arrangement. The Company
has also entered into agreements for dedicated Internet access service with
multiple network vendors. The agreements vary from one to five years and provide
for penalties for early termination. The agreements are generally
F-11
<PAGE>
RACKSPACE, LTD.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE-MONTH PERIODS
ENDED MARCH 31, 2000 AND MARCH 31, 1999 IS UNAUDITED)
(5) COMMITMENTS (CONTINUED)
subject to a master contract which allows for service order upgrades at the
Company's request. Monthly billings are increased based on usage levels. The
Company's minimum commitments are accounted for ratably over the term of these
agreements.
Future minimum payments under these commitments are:
<TABLE>
<CAPTION>
YEAR ENDING RELATED
DECEMBER 31, TOTAL PARTY
------------ ---------- --------
<S> <C> <C>
2000................................................ $ 904,432 $120,000
2001................................................ 672,076 184,000
2002................................................ 518,967 333,510
2003................................................ 219,902 60,302
2004................................................ 146,300 --
---------- --------
Total................................................. $2,461,677 $697,812
========== ========
</TABLE>
Additionally, the Company entered into an agreement to purchase equipment in
December 1999 and paid approximately $106,000 (included in other assets at
December 31, 1999) as a down payment. The agreement is non-cancelable and the
Company is obligated for the remaining balance of $320,000 at December 31, 1999.
This amount, including $117,000 for a related service agreement, became due when
the equipment was delivered in February 2000. The service agreement will be
amortized over its term.
(6) GEOGRAPHIC AND OTHER FINANCIAL INFORMATION
The Company operates in one segment to provide dedicated servers and related
services to its customers. Total export revenues consisted of sales from the
Company's U.S. operation to customers in other geographic regions. No
geographical information is provided for 1997 and 1998 as the Company's
operations were limited to North America.
The following is a summary of revenues by geographic area for the year ended
December 31, 1999:
<TABLE>
<CAPTION>
NORTH AMERICA EUROPE ASIA OTHER TOTAL
------------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C>
Revenues.............................. $1,132,954 325,695 180,741 61,147 1,700,537
========== ======== ======== ======== ==========
</TABLE>
During the year ended December 31, 1999, the Company charged $91,883 to its
allowance for doubtful accounts and wrote off $40,867 of accounts receivable.
(7) SUBSEQUENT EVENTS
(A) CORPORATE REORGANIZATION
In 2000, the Company's partners authorized the reorganization of the
Partnership into a corporation prior to and in anticipation of the Company's
initial public offering. Upon the consummation of the reorganization, the
corporation will be authorized to issue 170,000,000 shares of $0.001 par value
common stock of which 16,980,868 shares will be issued to the existing partners
on a
F-12
<PAGE>
RACKSPACE, LTD.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE-MONTH PERIODS
ENDED MARCH 31, 2000 AND MARCH 31, 1999 IS UNAUDITED)
(7) SUBSEQUENT EVENTS (CONTINUED)
1-for-1 unit basis. The Company also authorized 30,000,000 shares of preferred
stock, par value $0.001. The reorganization will be accounted for at historical
cost.
(B) STOCK-BASED COMPENSATION ARRANGEMENTS
The Company has adopted the 1999 Unit Option Plan. The plan authorizes
grants of options to purchase limited partner interests at fair market value as
determined by the general partner of Rackspace, Ltd. Options have seven year
terms and vest over three years. During the three months ended March 31, 2000,
options to purchase 432,897 limited partner interests of the Company under this
plan were issued to employees at a weighted exercise price of $2.56. In April
2000, options to purchase 348,358 limited partner interests of the Company were
issued to employees at an exercise price of $5.66.
Commencing on January 1, 2000, certain key personnel exercised their right
to forgo salary in exchange for 47,936 options to acquire limited partner
interests at an exercise price of $0.01 per partner interest. Options vest
immediately.
The Company recorded deferred stock compensation of $1,616,441 upon the
issuance of these options during the three months ended March 31, 2000 as the
exercise price was below the fair market value of the partnership interest on
the date of the grant pursuant to APB Opinion No. 25. The deferred compensation
will be amortized over the vesting period. Amortization of deferred stock
compensation was $380,378 for the three months ended March 31, 2000. The Company
expects to recognize additional deferred stock compensation in the second
quarter of fiscal 2000 to account for the options granted in April 2000.
The 2000 Stock Incentive Plan was adopted in 2000, as the
successor to the 1999 Unit Option Plan. The 2000 Stock Incentive Plan will
provide for four separate programs. The first program is the discretionary
option grant program under which eligible individuals as defined and including
officers, non-employee board members and consultants, may be granted options to
purchase shares of common stock. The second program is the stock issuance
program under which eligible individuals may be issued shares of common stock
directly, through the purchase of such shares or as a bonus tied to the
performance of services. The third program is the salary investment option grant
program under which executive officers and other highly compensated employees
may elect to apply a portion of their base salary to the acquisition of special
below-market stock option grants. The fourth program is the automatic option
grant program under which option grants will automatically be made at periodic
intervals to eligible non-employee board members.
The Company adopted an Employee Stock Purchase Plan in 2000.
Under the plan, shares of the Company's common stock may be purchased at
six-month intervals at % of the lower of the fair market value on the first or
the last day of each six-month period.
(C) CAPITAL AND OTHER TRANSACTIONS
In January 2000, the Company sold for cash 238,095 limited partner interests
at $2.10 per partner interest pursuant to the Subscription Agreement dated
November 30, 1999 (note 3).
F-13
<PAGE>
RACKSPACE, LTD.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION AS OF MARCH 31, 2000 AND FOR THE THREE-MONTH PERIODS
ENDED MARCH 31, 2000 AND MARCH 31, 1999 IS UNAUDITED)
(7) SUBSEQUENT EVENTS (CONTINUED)
The Company also sold 119,048 limited partner interests at $2.10 per partner
interest to another investor for cash effective January 17, 2000.
In March 2000, the Company sold 1,952,297 limited partner interests at $5.66
per partner interest to certain investors for cash. In addition, two of the
investors were granted warrants to purchase $6 million in additional partner
interests at a price equal to the greater of $18.24 or the price which is at the
mid-point of the filing range of the Company's anticipated initial public
offering.
In March 2000, the Company executed a memorandum of understanding with Red
Hat for a proposed joint marketing arrangement. The proposed arrangement
contemplates the payment of a set up fee, quarterly contract fees and customer
referral fees to Red Hat to be accounted for ratably over a 12 month period.
In March 2000, the Company issued a short-term note receivable to a software
company bearing interest at a fixed rate of 7.5% per annum. The note receivable
and interest is due in June 2000.
(D) PRO FORMA EARNINGS PER SHARE
The pro forma information regarding net loss per share and weighted average
shares outstanding set forth below gives effect to the treatment of partner
interests as shares of common stock based on a 1.2-for-1 unit basis.
<TABLE>
<CAPTION>
PERIOD FROM
DECEMBER 29, 1998
(INCEPTION) YEAR ENDED
TO DECEMBER 31,
DECEMBER 31, 1998 1999
------------------ ------------
<S> <C> <C>
Numerator:
Net loss...................................... $ (275) $(1,752,798)
=========== ===========
Denominator:
Weighted average number of shares of common
stock outstanding........................... 10,000,000 10,733,098
=========== ===========
Pro forma basic and diluted net loss per
share......................................... $ (0.00) $ (0.16)
=========== ===========
</TABLE>
F-14
<PAGE>
Back Cover
[Description of Graphics]
<PAGE>
You may rely only on the information contained in this prospectus. We have
not authorized anyone to provide information different from that contained in
this prospectus. Neither the delivery of this prospectus nor the sale of common
stock means that information contained in this prospectus is correct after the
date of this prospectus. This prospectus is not an offer to sell or solicitation
of an offer to buy these shares in any circumstances under which the offer or
solicitation is unlawful.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
--------
<S> <C>
Prospectus Summary................ 3
Risk Factors...................... 7
Forward-Looking Statements and
Associated Risks................ 16
Use Of Proceeds................... 17
Dividend Policy................... 17
Holding Company................... 17
Capitalization.................... 18
Dilution.......................... 19
Selected Financial Data........... 20
Management's Discussion and
Analysis of Financial Condition
and Results of Operations....... 21
Business.......................... 30
Management........................ 44
Certain Transactions.............. 50
Principal Stockholders............ 53
Description of Capital Stock...... 55
Shares Eligible for Future Sale... 58
Underwriting...................... 60
Legal Matters..................... 63
Experts........................... 63
Where You Can Find
Additional Information About
Rackspace.com................... 63
Index to Rackspace.com, Inc.
Financial Statements............ F-1
</TABLE>
Dealer Prospectus Delivery Obligation:
Until , 2000 (25 days after the date of this prospectus), all
dealers that buy, sell or trade in these shares of common stock, whether or not
participating in this offering, may be required to deliver a prospectus. Dealers
are also obligated to deliver a prospectus when acting as underwriters and with
respect to their unsold allotments or subscriptions.
[LOGO]
3,200,000 Shares
Common Stock
Deutsche Banc Alex. Brown
Bear, Stearns & Co. Inc.
Thomas Weisel Partners LLC
Prospectus
, 2000
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the costs and expenses, other than the
underwriting discount, payable by us in connection with the sale of common stock
being registered under this registration statement. All amounts are estimates
except the SEC registration fee and the NASD filing fee.
<TABLE>
<S> <C>
SEC registration fee........................................ $16,152
NASD fee.................................................... 7,000
Nasdaq National Market listing fee.......................... 95,000
Printing and engraving expenses............................. *
Legal fees and expenses..................................... *
Accounting fees and expenses................................ *
Blue sky fees and expenses.................................. *
Transfer agent fees......................................... *
Miscellaneous............................................... *
-------
Total................................................. $ *
=======
</TABLE>
------------------------
* To be filed by amendment.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The following discussion assumes that our reorganization has occurred.
Section 145 of the Delaware General Corporation Law (the "DGCL") provides,
in effect, that any person made a party to any action by reason of the fact that
he is or was our director, officer, employee or agent may, and in certain cases
must, be indemnified by us against, in the case of a non-derivative action,
judgments, fines, amounts paid in settlement and reasonable expenses (including
attorneys' fees) incurred by him as a result of such action, and in the case of
a derivative action, against expenses (including attorneys' fees), if in either
type of action he acted in good faith and in a manner he reasonably believed to
be in or not opposed to our best interests. This indemnification does not apply,
in a derivative action, to matters as to which it is adjudged that the director,
officer, employee or agent is liable to us, unless upon court order it is
determined that, despite such adjudication of liability, but in view of all the
circumstances of the case, he is fairly and reasonably entitled to indemnity for
expenses, and, in a non-derivative action, to any criminal proceeding in which
such person had reasonable cause to believe his conduct was unlawful.
Article VI of our Certificate of Incorporation provides that no director
shall be liable to us or our stockholders for monetary damages for breaches of
the director's fiduciary duties to the fullest extent permitted by the DGCL.
Reference is made to Section 8 of the underwriting agreement to be filed as
Exhibit 1.1 hereto, pursuant to which the underwriters have agreed to indemnify
our officers and directors against certain liabilities under the Securities Act
of 1933.
We intend to enter into Indemnity Agreements with each director and certain
of our officers, a form of which is filed as Exhibit 10.1 to this registration
statement. Pursuant to these agreements, we will be obligated, to the extent
permitted by applicable law, to indemnify these persons against all expenses,
judgments, fines and penalties incurred in connection with the defense or
settlement of any actions brought against them by reason of the fact that they
were our directors or officers or assumed
II-1
<PAGE>
certain responsibilities at our direction. We also intend to purchase directors'
and officers' liability insurance in order to limit our exposure to liability
for indemnification of directors and officers.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
Since our inception in December 1998, we have issued and sold unregistered
securities in the following transactions:
(1) On December 29, 1998, we issued 999,000 limited partner interests to our
founders and an entity affiliated with our executive officers. We also
issued 1,000 general partner interests to our general partner.
(2) On September 29, 1999 we issued 1,904,760 limited partner interests to an
entity affiliated with our executive officers upon the conversion of
outstanding indebtedness under a promissory note in the approximate amount
of $1.1 million.
(3) On November 30, 1999 we issued an aggregate of 2,766,667 limited partner
interests to entities affiliated with our executive officers and other
purchasers in a private placement for an aggregate purchase price of
$5.8 million. The purchase price for the limited partner interests consisted
of cash in the approximate amount of $4.6 million, a promissory note for
$750,000 and the conversion of principal outstanding under a promissory note
in the amount of $500,000. On November 30, 1999, we issued warrants to
Trango Capital, LLC and The Hamilton Companies LLC for 380,952 and 238,095
limited partner interests, respectively, for an aggregate exercise price of
$800,000 and $500,000, respectively. We also effected a 10-for-1 limited
partner interest split incident to this private placement.
(4) Commencing on January 1, 2000 through April 30, 2000, Graham Weston, Morris
Miller, Pat Condon and Dirk Elmendorf exercised their right to forgo salary
in exchange for options to acquire additional limited partner interests.
Pursuant to an agreement, these individuals have elected to forgo salary
during this four-month period, and receive options to acquire 47,936 limited
partner interests at $.01 per limited partner interest.
(5) On January 17, 2000 we issued 238,095 limited partner interests to an
investor pursuant to the exercise of a warrant for an aggregate purchase
price of $500,000. Effective the same date, we also issued 119,047 limited
partner interests to an investor for $250,000.
(6) On January 1, 2000 we issued options to two of our executive officers for an
aggregate of 271,672 limited partner interests at $2.10 per limited partner
interest.
(7) On February 15, 2000 we issued to our employees options to acquire an
aggregate of 107,171 limited partner interests at $3.33 per limited partner
interest. In addition we issued options to one of our executive officers for
an aggregate of 54,054 limited partner interests at $3.33 per limited
partner interest.
(8) On March 27, 2000, we issued an aggregate of 1,952,297 limited partner
interests to investors in a private placement for an aggregate purchase
price of $11.1 million. We also issued warrants for limited partner
interests. The limited partners of Tailwind Capital Partners 2000, L.P., an
investor in this private placement, are employees of Thomas Weisel Partners
LLC, an underwriter in this offering.
The above securities were offered and sold by the registrant in reliance
upon exemptions from registration pursuant to either (1) Section 4(2) of the
Securities Act of 1933, as amended, as transactions not involving any public
offering or (2) Rule 701 promulgated under the Securities Act of 1933, as
amended. No underwriters were involved in connection with the sales of
securities referred to in this Item 15, except as described in (8) above.
II-2
<PAGE>
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
<C> <S> <C>
1.1* -- Form of Underwriting Agreement.
3.1^ -- Certificate of Incorporation of Rackspace.com, Inc.
3.2^ -- Bylaws of Rackspace.com, Inc.
4.1^ -- Specimen Stock Certificate.
5.1+ -- Opinion of Brobeck, Phleger & Harrison LLP.
10.1^ -- Form of Indemnity Agreement by and between Rackspace.com,
Inc. and each of its directors and executive officers.
10.2^ -- Lease Agreement between Rackspace, Ltd. and Santa Clara Land
Company dated February 22, 2000 for the premises located in
San Antonio, Texas.
10.3^ -- Confidential Anti-Dilution Agreement by and among Rackspace,
Ltd. and the investors named therein dated November 30, 1999
and Amendment thereto dated February 22, 2000.
10.4^ -- Credit Agreement between Rackspace, Ltd and Exeter
Financial, LC dated December 29, 1998.
10.5^ -- Support Agreement dated December 29, 1998 between Rackspace,
Ltd., Morris A. Miller, Graham M. Weston, Richard Yoo, Dirk
Elmendorf and Patrick Condon and First Amendment thereto
dated November 30, 1999 and Second Amendment thereto dated
February 22, 2000 and as amended by Exhibit 10.21.
10.6^ -- Employment Agreement between Rackspace, Ltd. and Richard Yoo
dated December 29, 1998.
10.7^ -- Employment Agreement between Rackspace, Ltd. and Dirk
Elmendorf dated December 29, 1998.
10.8^ -- Employment Agreement between Rackspace, Ltd. and Patrick
Condon dated December 29, 1998.
10.9^ -- Asset Purchase and Sale Agreement dated December 29, 1998
between Cymitar Technology Group, Inc., Richard Yoo, Dirk
Elmendorf and Patrick Condon.
10.10^ -- Transfer Agreement between Rackspace, Ltd., Richard Yoo,
Dirk Elmendorf and Patrick Condon dated December 29, 1998.
10.11^ -- Agreement of Limited Partnership of Rackspace, Ltd. dated
December 29, 1998, First Amendment dated September 29, 1999,
Second Amendment dated November 30, 1999, Third Amendment
dated February 22, 2000 and Fourth Amendment dated
March 27, 2000.
10.12^ -- Warrant between Rackspace, Ltd. and Trango Capital, LLC,
dated November 30, 1999.
10.13^ -- Registration Rights Agreement dated November 30, 1999
between Rackspace, Ltd. and the securityholders named
therein and Amendment thereto dated February 22, 2000 and
as amended by Exhibit 10.21.
10.14^ -- Promissory Note dated November 30, 1999 between Beaulieu
River Capital LC and Rackspace, Ltd. for $750,000.
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
<C> <S> <C>
10.15^ -- Second Financial Commitment between Rackspace, Ltd. and
Exeter Financial, LC dated September 29, 1999.
10.16^ -- 1999 Unit Option Plan.
10.17^ -- Form of Unit Option Agreement for Stock Unit Plan.
10.18* -- 2000 Stock Incentive Plan.
10.19* -- 2000 Employee Stock Purchase Plan.
10.20^ -- Promissory Note dated December 29, 1998 between Exeter
Financial, LC and Rackspace, Ltd. for $150,000.
10.21^ -- Agreement of Existing Partners of Rackspace Ltd. to
Facilitate Public Offering dated March 27, 2000 and form of
First Amendment thereto dated as May 10, 2000.
10.22^ -- Warrant between Rackspace, Ltd. and Norwest Venture
Partners, dated March 27, 2000.
10.23^ -- Warrant between Rackspace, Ltd. and Sequoia Capital
Franchise Fund dated March 27, 2000.
10.24^ -- Warrant between Rackspace, Ltd. and Sequoia Capital
Franchise Partners dated March 27, 2000.
10.25* -- Employment Agreement between Rackspace, Ltd. and Graham M.
Weston, dated May 1, 2000.
10.26* -- Employment Agreement between Rackspace, Ltd. and Morris A.
Miller, dated May 1, 2000.
10.27^ -- Employment Agreement between Rackspace, Ltd. and Lew
Moorman, dated April 26, 2000.
10.28^ -- Form of Registration Rights Agreement between Rackspace,
Ltd. and the security holders named therein, dated
November 30, 1999.
10.29^** -- Marketplace Agreement between Rackspace, Ltd. and Red Hat,
Inc., dated May 12, 2000.
10.30* -- Employment Agreement between Rackspace, Ltd. and Lanham
Napier
10.31* -- Employment Agreement between Rackspace, Ltd. and Andrew May
10.32* -- Employment Agreement between Rackspace, Ltd. and John J.
Miksa
21.1^ -- List of Subsidiaries.
23.1+ -- Consent of KPMG LLP.
23.2+ -- Consent of Brobeck, Phleger & Harrison LLP (Included in
Exhibit 5.1).
24.1^ -- Powers of Attorney.
27.1^ -- Financial Data Schedule.
</TABLE>
------------------------
+ Filed herewith.
* To be filed by amendment.
^ Previously filed.
** Confidential treatment has been requested on portions of this document.
(b) Financial Statement Schedules
II-4
<PAGE>
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the financial
statements or the related notes.
ITEM 17. UNDERTAKINGS
The undersigned hereby undertakes to provide to the underwriters at the
closing specified in the underwriting agreement certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to our directors, officers and controlling persons pursuant to
the DGCL, our Certificate of Incorporation, our Bylaws, the underwriting
agreement or otherwise, we have been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Securities Act, and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than the
payment by us of expenses incurred or paid by one of our directors, officers, or
controlling persons in the successful defense of any action, suit or proceeding)
is asserted by such director, officer or controlling person in connection with
the securities being registered hereunder, we will, unless in the opinion of our
counsel the matter has been settled by controlling precedent, submit to a court
of appropriate jurisdiction the question of whether such indemnification by it
is against public policy as expressed in the Securities Act and will be governed
by the final adjudication of such issue.
II-5
<PAGE>
We hereby undertake that:
1. For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by us pursuant to Rule 424(b)(1) or (4) or 497(h) under the
Securities Act shall be deemed to be part of this Registration Statement as
of the time it was declared effective.
2. For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and this offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-6
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, we
have duly caused Amendment No. 3 to this registration statement to be signed on
our behalf by the undersigned, thereunto duly authorized, in San Antonio, Texas,
on June 22, 2000.
<TABLE>
<S> <C> <C>
RACKSPACE.COM, INC.
By: /s/ GRAHAM M. WESTON*
-----------------------------------------
Graham M. Weston
Chief Executive Officer and Director
</TABLE>
POWER OF ATTORNEY
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Amendment No. 3 to this Registration Statement has been signed by the following
persons in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<C> <S> <C>
/s/ GRAHAM M. WESTON* Chief Executive Officer and
------------------------------------------- Director (principal executive June 22, 2000
Graham M. Weston officer)
/s/ MORRIS A. MILLER*
------------------------------------------- President, Chief Operating June 22, 2000
Morris A. Miller Officer and Director
/s/ LANHAM NAPIER Chief Financial Officer
------------------------------------------- (principal accounting and June 22, 2000
Lanham Napier financial officer)
</TABLE>
<TABLE>
<S> <C> <C> <C>
*By: /s/ LANHAM NAPIER
--------------------------------------
Lanham Napier
ATTORNEY-IN-FACT
</TABLE>
II-7
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
<C> <S> <C>
1.1* -- Form of Underwriting Agreement.
3.1^ -- Certificate of Incorporation of Rackspace.com, Inc.
3.2^ -- Bylaws of Rackspace.com, Inc.
4.1^ -- Specimen Stock Certificate.
5.1+ -- Opinion of Brobeck, Phleger & Harrison LLP.
10.1^ -- Form of Indemnity Agreement by and between Rackspace.com,
Inc. and each of its directors and executive officers.
10.2^ -- Lease Agreement between Rackspace, Ltd. and Santa Clara Land
Company dated February 22, 2000 for the premises located in
San Antonio, Texas.
10.3^ -- Confidential Anti-Dilution Agreement by and among Rackspace,
Ltd. and the investors named therein dated November 30, 1999
and Amendment thereto dated February 22, 2000.
10.4^ -- Credit Agreement between Rackspace, Ltd and Exeter
Financial, LC dated December 29, 1998.
10.5^ -- Support Agreement dated December 29, 1998 between Rackspace,
Ltd., Morris A. Miller, Graham M. Weston, Richard Yoo, Dirk
Elmendorf and Patrick Condon and First Amendment thereto
dated November 30, 1999 and Second Amendment thereto dated
February 22, 2000 and as amended by Exhibit 10.21.
10.6^ -- Employment Agreement between Rackspace, Ltd. and Richard Yoo
dated December 29, 1998.
10.7^ -- Employment Agreement between Rackspace, Ltd. and Dirk
Elmendorf dated December 29, 1998.
10.8^ -- Employment Agreement between Rackspace, Ltd. and Patrick
Condon dated December 29, 1998.
10.9^ -- Asset Purchase and Sale Agreement dated December 29, 1998
between Cymitar Technology Group, Inc., Richard Yoo, Dirk
Elmendorf and Patrick Condon.
10.10^ -- Transfer Agreement between Rackspace, Ltd., Richard Yoo,
Dirk Elmendorf and Patrick Condon dated December 29, 1998.
10.11^ -- Agreement of Limited Partnership of Rackspace, Ltd. dated
December 29, 1998, First Amendment dated September 29, 1999,
Second Amendment dated November 30, 1999, Third Amendment
dated February 22, 2000 and Fourth Amendment dated
March 27, 2000.
10.12^ -- Warrant between Rackspace, Ltd. and Trango Capital, LLC,
dated November 30, 1999.
10.13^ -- Registration Rights Agreement dated November 30, 1999
between Rackspace, Ltd. and the securityholders named
therein and Amendment thereto dated February 22, 2000 and
as amended by Exhibit 10.21.
10.14^ -- Promissory Note dated November 30, 1999 between Beaulieu
River Capital LC and Rackspace, Ltd. for $750,000.
10.15^ -- Second Financial Commitment between Rackspace, Ltd. and
Exeter Financial, LC dated September 29, 1999.
10.16^ -- 1999 Unit Option Plan.
10.17^ -- Form of Unit Option Agreement for Stock Unit Plan.
10.18* -- 2000 Stock Incentive Plan.
10.19* -- 2000 Employee Stock Purchase Plan.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
<C> <S> <C>
10.20^ -- Promissory Note dated December 29, 1998 between Exeter
Financial, LC and Rackspace, Ltd. for $150,000.
10.21^ -- Agreement of Existing Partners of Rackspace Ltd. to
Facilitate Public Offering dated March 27, 2000 and form of
First Amendment thereto dated as May 10, 2000.
10.22^ -- Warrant between Rackspace, Ltd. and Norwest Venture
Partners, dated March 27, 2000.
10.23^ -- Warrant between Rackspace, Ltd. and Sequoia Capital
Franchise Fund dated March 27, 2000.
10.24^ -- Warrant between Rackspace, Ltd. and Sequoia Capital
Franchise Partners dated March 27, 2000.
10.25* -- Employment Agreement between Rackspace, Ltd. and Graham M.
Weston, dated May 1, 2000.
10.26* -- Employment Agreement between Rackspace, Ltd. and Morris A.
Miller, dated May 1, 2000.
10.27^ -- Employment Agreement between Rackspace, Ltd. and Lew
Moorman, dated April 26, 2000.
10.28^ -- Form of Registration Rights Agreement between Rackspace,
Ltd. and the security holders named therein, dated
November 30, 1999.
10.29^** -- Marketplace Agreement between Rackspace, Ltd. and Red Hat,
Inc., dated May 12, 2000.
10.30* -- Employment Agreement between Rackspace, Ltd. and Lanham
Napier
10.31* -- Employment Agreement between Rackspace, Ltd. and Andrew May
10.32* -- Employment Agreement between Rackspace, Ltd. and John J.
Miksa
21.1^ -- List of Subsidiaries.
23.1+ -- Consent of KPMG LLP.
23.2+ -- Consent of Brobeck, Phleger & Harrison LLP (Included in
Exhibit 5.1).
24.1^ -- Powers of Attorney.
27.1^ -- Financial Data Schedule.
</TABLE>
------------------------
+ Filed herewith.
* To be filed by amendment.
^ Previously filed.
** Confidential treatment has been requested on portions of this document.
