| Company Overview, Basis of Presentation, and Summary of Significant Accounting Policies | Company Overview, Basis of Presentation, and Summary of Significant Accounting Policies Nature of Operations As used in this report, the terms “Rackspace,” “Rackspace Hosting,” “we,” “our company,” “the company,” “us,” or “our” refer to Rackspace Hosting, Inc. and its subsidiaries. Rackspace Hosting, Inc., through its operating subsidiaries, is a provider of managed cloud services in the business information technology ("IT") market. We serve our customers from our data centers on four continents. We help customers tap the power of cloud computing by delivering world-class service on the world's leading technology platforms. We are experts in IT, so our customers do not have to be. Our operations began in 1998 as a limited partnership, and Rackspace Hosting, Inc. was incorporated in Delaware in March 2000 . Basis of Consolidation The accompanying consolidated financial statements include the accounts of Rackspace Hosting and our wholly-owned subsidiaries, which include, among others, Rackspace US, Inc., our domestic operating entity, and Rackspace Limited, our United Kingdom operating entity. Intercompany transactions and balances have been eliminated in consolidation. Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States ("GAAP") requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenue and expenses, and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate our estimates, including those related to accounts receivable and customer credits, property and equipment, fair values of intangible assets and goodwill, useful lives of intangible assets, fair value of share-based compensation, contingencies, and income taxes, among others. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results could differ from our estimates. Cash and Cash Equivalents For the purposes of the consolidated financial statements, we consider all highly liquid investments with original maturities of three months or less when acquired to be cash equivalents. Our available cash and cash equivalents are held in bank deposits, overnight sweep accounts, and money market funds. Gains and losses are included in interest and other income in our accompanying consolidated statements of comprehensive income. We actively monitor the third-party depository institutions that hold our deposits. Our emphasis is primarily on safety of principal, secondly on the liquidity of our investments, and finally on maximizing yield on those funds. Our money market mutual funds invest exclusively in high-quality, short-term obligations that include securities issued or guaranteed by the U.S. government or by U.S. government agencies and floating rate and variable rate demand notes of U.S. and foreign corporations. Accounts Receivable, Net Trade accounts receivable are recorded at the invoiced amount and do not bear interest. We generally do not request collateral from our customers; however, some customers choose to prepay for their services. We record an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. When evaluating the adequacy of the allowance, we analyze the overall quality of our accounts receivable portfolio, current economic conditions and trends, historical bad debt write-offs, customer creditworthiness, and specifically identified customer risks. In addition, our hosting arrangements contain service level commitments with our customers. To the extent that such service levels are not achieved or are otherwise disputed due to third-party power or service issues, unfavorable weather, or other service interruptions or conditions, we are required to issue service credits for a portion of the hosting service fees paid by our customers. At each reporting period, we estimate the amount of service level credits to be issued and record a reduction to revenue. To estimate service credits, we utilize historical data and specific knowledge of factors impacting the delivery of services to our customers. Prepaid Expenses and Other Assets Prepaid expenses and other assets consist primarily of prepaid software and equipment maintenance contracts and prepaid operating expenses. Maintenance contracts are amortized over the agreement period, generally one to three years. Prepaid operating expenses are expensed in the period in which services are received. Property and Equipment, Net Property and equipment is stated at cost, net of accumulated depreciation and amortization. Included in property and equipment are capitalized costs related to computer software developed or acquired for internal use. Capitalized computer software costs consist of purchased software licenses, implementation costs, and salaries and related compensation costs of employees and consultants for certain projects that qualify for capitalization. Replacements and major improvements to property and equipment are capitalized, while maintenance and repairs are charged to expense as incurred. We also capitalize interest costs incurred during the acquisition, development and construction of certain assets until the asset is ready for its intended use. For the years ended December 31, 2014 and 2015 , we capitalized interest of $2.1 million and $7.1 million , respectively. There was no interest capitalized during the year ended December 31, 2013 . Property and equipment is depreciated on a straight-line basis over the estimated useful life of the asset. Leasehold improvements are depreciated over the shorter of their estimated useful lives or the remaining lease term. The following table shows estimated useful lives of property and equipment: Classification Estimated Useful Lives Computers and equipment 3 to 5 years Computer software 3 years Furniture and fixtures 7 years Buildings and leasehold improvements 2 to 39 years The cost of assets and related accumulated depreciation and amortization are written off upon retirement or sale, and any resulting gain or loss is credited or charged to income from operations. Goodwill and Intangible Assets Goodwill consists of the excess of the purchase price over the fair value of identifiable net assets of businesses acquired. Goodwill is evaluated for impairment at a reporting unit level using a fair value approach on an annual basis at the beginning of the fourth quarter or whenever events or circumstances indicate that impairment may have occurred. No goodwill impairment was recognized in any of the years presented, and there were no changes in the carrying amount of goodwill in 2014 or 2015 . Intangible assets, including purchased technology, customer contracts and relationships, certain tradenames, license agreements, and non-compete agreements arising principally from acquisitions, are recorded at cost less accumulated amortization, and the definite-lived intangibles are amortized using a method that reflects the pattern in which the economic benefits of the related intangible asset are consumed or utilized. Impairment of Long-Lived Assets Long-lived assets, including property and equipment and intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets is measured at the asset group level and if the carrying amount of the asset group exceeds its estimated undiscounted future cash flows, an impairment charge is recognized. Leases We lease most of our data center facilities and office space under non-cancelable operating lease agreements. Total rent payments, inclusive of rent increases, rent holidays, rent concessions, leasehold incentives or any other unusual provisions or conditions, are expensed on a straight-line basis over the lease period. The difference between the straight-line expense and the cash payment is recorded as deferred rent. We lease certain equipment under capital lease agreements with major vendors. The assets held under capital lease and related obligations are recorded at the lesser of the present value of aggregate future minimum lease payments, including estimated bargain purchase options, or the fair value of the assets held under capital lease. Such assets, included within "property and equipment, net" on our consolidated balance sheets, are depreciated on a straight-line basis over the shorter of the terms of the leases or the estimated useful lives of the assets. For assets for which the lease agreement includes a bargain purchase option or transfer of ownership at the completion of the lease and the lease term is shorter than the estimated useful life of the asset, the asset is depreciated over its estimated useful life. Interest expense is recorded on the outstanding capital lease obligation throughout the lease term. Additionally, we have entered into complex real estate development and build-to-suit lease arrangements with independent real estate developers to design, construct and lease certain real estate projects. While the independent developers legally own the real estate projects and must finance the overall construction, we agreed to fund certain structural improvements and/or retain obligations related to certain potential construction cost overruns. As a result of our involvement during the construction period, we are considered the owner of these construction projects for accounting purposes. During the construction period, we record construction costs for these projects as a work in process asset within "property and equipment, net" and a corresponding long-term liability within "finance lease obligations for build-to-suit leases" on our consolidated balance sheets. The cost of these real estate projects is not depreciated during the construction period. When construction of a project is complete, we evaluate whether the build-to-suit lease arrangement qualifies for sales recognition under sale-leaseback accounting guidance. If the lease meets the criteria to qualify as a sale-leaseback, the asset and liability can be derecognized and the lease is accounted for as an operating lease with rent expense recognized over the lease term. If the sale-leaseback criteria are not met, the asset and liability remain on our consolidated balance sheets. The asset is then depreciated over the term of the lease, and rental payments are recorded as a reduction of the corresponding liability and as interest expense. At the end of the lease term, the remaining lease obligation and residual asset balance are derecognized. The Company has asset retirement obligations associated with commitments to return properties subject to operating and build-to-suit leases to their original condition upon lease termination. The Company's asset retirement obligations were $3.6 million and $4.0 million as of December 31, 2014 and 2015 , respectively, and are recorded in "accounts payable and accrued expenses" and "other liabilities" on our consolidated balance sheets. Debt Issuance Costs Debt issuance costs, such as underwriting, financial advisory, professional fees and other similar fees are capitalized and recognized in interest expense over the estimated life of the related debt instrument using the effective interest method or straight-line method, as applicable. Refer to "Recent Accounting Pronouncements" below for information on our adoption of new accounting guidance on the presentation of debt issuance costs in the balance sheet. Revenue and Deferred Revenue We provide cloud computing to customers, which is broadly defined as the delivery of computing, storage and applications over the Internet. Cloud computing is a service transaction for which revenue is recognized when persuasive evidence of an arrangement exists, usually either a signed, written contract or customer acknowledgment of online terms of service; services have been delivered to the customer; the amounts to be received for the services delivered are fixed or determinable; and collection of such amounts is reasonably assured. Customers primarily consume our principal service offerings in one of two ways: (i) via dedicated computing resources or (ii) via multi-tenant pools of computing resources provided on demand. We also offer customers the flexibility to select the best combination of the two in order to meet the requirements of their unique applications and provide the technology to operate and manage multiple cloud computing environments seamlessly. Each service offering is priced according to the terms of our committed resources and services. Contracts for dedicated computing resources are generally fixed term agreements with a 12 - 36 month term with a monthly recurring fee based on the computing resources reserved and provided to the customer, the complexity of the underlying infrastructure and the level of support we provide. At the end of the initial term, contracts may be renewed or automatically extended on a month-to-month basis. Customers generally have the right to cancel their contracts by providing prior written notice to us of their intent to cancel the remainder of the contract term. In the event that a customer cancels their contract, they are not entitled to a refund for services already rendered. In certain instances we may charge a non-refundable installation fee. Beginning on the date the service is made available to customers, the monthly recurring fee is recognized monthly as services are provided and installation fees are recognized ratably over the estimated average life of a customer relationship. If a customer terminates its relationship with us before the expiration of the estimated average customer life, any unamortized installation fees are recognized as revenue at that time. Setup and other direct implementation activities performed at the inception of a customer contract are expensed as incurred. Contracts for services utilizing pooled resources on demand can be canceled at any time without penalty. Customers are billed according to usage for only the resources consumed, and revenue is recognized in the month in which the customer uses the services. Revenue recognition for multiple-element arrangements requires judgment to determine whether elements can be accounted for as separate units of accounting, and if so, the fair value for each of the elements using a hierarchy for allocating revenue to the elements: (i) vendor-specific objective evidence of fair value, (ii) third-party evidence, and (iii) best estimate of selling price. Revenue arrangements with multiple deliverables are divided into separate units of accounting when the delivered item(s) has value to the customer on a standalone basis, which is normally the situation for our services contracts. In this circumstance, revenue is recognized for each unit of accounting based on its relative estimated selling price. Estimated selling prices are management’s best estimates of the prices that we would charge our customers if we were to sell the standalone elements separately and include considerations of customer demand, prices charged by us and others for similar deliverables, and the cost of providing the service. Revenue is recognized as each element is delivered. Revenue is reported net of customer credits and sales and use tax. Invoiced amounts and accrued unbilled usage is recorded in accounts receivable and either deferred revenue or revenue, depending on whether the revenue recognition criteria have been met. Therefore, deferred revenue primarily consists of amounts that have been prepaid or deferred installation fees. As of December 31, 2015 , of the total $31.2 million in deferred revenue recorded on our balance sheet (the majority of which related to prepaid amounts), $29.6 million , $1.4 million and $0.2 million will be amortized to revenue in 2016 , 2017 and 2018 , respectively. Cost of Revenue Cost of revenue consists primarily of expenses related to personnel, licenses, and our data center facilities. Personnel expenses include the salaries, non-equity incentive compensation, share-based compensation and related expenses of our support teams and data center employees, and data center facility costs include rental fees, power costs, maintenance fees, and bandwidth. Advertising Costs We charge advertising costs to sales and marketing expense in the period incurred. Advertising expenses for the years ended December 31, 2013 , 2014 and 2015 were approximately $58.9 million , $59.2 million and $58.4 million , respectively. Share-Based Compensation We grant equity awards, including stock options and restricted stock, to eligible participants. The fair value of stock options is determined using the Black-Scholes valuation model, which requires us to make assumptions and judgments about variables related to our common stock and the related awards. We recognize share-based compensation expense on a straight-line basis over the vesting period. All restricted stock grants include a service requirement for vesting. We have also granted restricted stock that includes either a performance or market condition. The fair value of restricted stock with either solely a service requirement or with the combination of service and performance requirements is based on the closing fair market value of our common stock on the date of grant. The fair value of restricted stock with vesting conditions dependent market performance is determined using a Monte Carlo simulation. Share-based compensation expense is recognized on a straight-line basis over the service period or over our best estimate of the period over which the performance condition will be met, as applicable. Income Taxes Income taxes are accounted for using the asset and liability method. Deferred income taxes are provided for temporary differences in recognizing certain income, expense, and credit items for financial reporting purposes and tax reporting purposes. Such deferred income taxes primarily relate to the difference between the tax bases of assets and liabilities and their financial reporting amounts. Deferred tax assets and liabilities are measured by applying enacted statutory tax rates applicable to the future years in which deferred tax assets or liabilities are expected to be settled or realized. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversals of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based upon projections of future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that we will realize the benefits of these deductible differences. We are currently under income tax audits in the U.K., California, and Pennsylvania. Due to the complexity involved with certain tax matters, there is the possibility that the various taxing authorities may disagree with certain tax positions filed on our income tax returns. We have considered all relevant facts and circumstances and believe that we have made adequate provision for all income tax uncertainties. For a further discussion of the impact of uncertain tax positions, see Note 11 , " Taxes ." We do not provide for a U.S. income tax liability on undistributed earnings of our foreign subsidiaries. The earnings of non-U.S. subsidiaries, which reflect full provision for non-U.S. income taxes, are currently indefinitely reinvested in non-U.S. operations. Refer to "Recent Accounting Pronouncements" below for information on our adoption of new accounting guidance on the presentation of deferred taxes in the balance sheet. Fair Value of Financial Instruments Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There is a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: Level 1 – Observable inputs such as quoted prices in active markets for identical assets or liabilities; Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and Level 3 – Unobservable inputs that are supported by little or no market activity, which require management judgment or estimation. Money market funds, classified in cash and cash equivalents, were $11 million and $226 million as of December 31, 2014 and 2015 , respectively, and are Level 1 financial instruments. See Note 6 , " Debt " for discussion on the fair value of our debt instruments. Foreign Currency We have assessed the functional currency of each of our international subsidiaries and have generally designated the local currency to be their respective functional currencies. The consolidated financial statements of these foreign subsidiaries are translated into the U.S. dollar. All assets and liabilities are translated to the U.S. dollar at the end-of-period exchange rates. Capital accounts are determined to be of a permanent nature and are therefore translated using historical exchange rates. Revenue and expenses are translated using average exchange rates. Foreign currency translation adjustments arising from differences in exchange rates from period to period are included in the foreign currency translation adjustment account in accumulated comprehensive income (loss). The income tax expense allocated to foreign currency translation adjustments during the year ended December 31, 2015 was $0.2 million . There was no income taxes allocated in the years ended December 31, 2013 or 2014 . Transaction gains or losses in currencies other than the functional currency are included as a component of other income (expense) in the consolidated statements of comprehensive income. Recent Accounting Pronouncements Revenue Recognition In May 2014, the Financial Accounting Standards Board ("FASB") issued a new standard on revenue recognition. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the standard requires capitalization of incremental costs to obtain a contract and significantly expanded quantitative and qualitative disclosures. In August 2015, the FASB issued guidance which deferred the effective date by one year. The standard is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period, with early adoption permitted for annual periods beginning after December 15, 2016. We intend to adopt the standard on January 1, 2018. Upon adoption, the new guidance will be applied retrospectively using one of two methods. One method is to apply the guidance retrospectively to each prior period presented with practical expedients available. The second method is to apply the guidance retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application. We are continuing to evaluate our method of adoption and the impact this new accounting standard will have on our consolidated financial statements. Debt Issuance Costs In April 2015, the FASB issued guidance to simplify the presentation of debt issuance costs in the balance sheet. The guidance requires that debt issuance costs be presented as a direct deduction from the carrying value of the related debt liability. The recognition and measurement guidance for debt issuance costs are not affected by this new guidance. In August 2015, the FASB issued additional guidance to clarify the views of the SEC staff on the presentation of debt issuance costs related to line-of-credit arrangements. Under the additional guidance, an entity can defer and present debt issuance costs related to a line-of-credit arrangement as an asset and subsequently amortize the such costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings under the arrangement. We elected to early adopt this guidance in the fourth quarter of 2015. As a result, we have classified debt issuance costs related to the November 25, 2015 issuance of 6.5% Senior Notes due 2024 as a direct deduction from the carrying value of the debt liability on our consolidated balance sheet as of December 31, 2015. Debt issuance costs related to our new Revolving Credit Facility due 2020 entered into on November 25, 2015 are classified as an asset within "Other non-current assets" on our consolidated balance sheet as of December 31, 2015. We are required to apply this new guidance on a retrospective basis; however, there was no retrospective impact on our balance sheet as of December 31, 2014, as all capitalized debt issuance costs were related to our previous Revolving Credit Facility due 2016 and were classified as an asset within "Other non-current assets." Balance Sheet Classification of Deferred Taxes In November 2015, the FASB issued guidance to simplify the presentation of deferred taxes in the balance sheet. The new guidance eliminates the requirement that companies must present all deferred tax assets and liabilities as current and non-current in the balance sheet. Under the new guidance, companies are required to classify all deferred tax assets and liabilities as non-current. We elected to early adopt this new standard in the fourth quarter of 2015 on a retrospective basis. All prior period financial information has been adjusted to reflect the retrospective application of this new guidance. The reclassification of our consolidated balance sheet as of December 31, 2014 resulted in a net decrease of $8.2 million in total assets, including a $9.3 million reduction in current assets and a $1.1 million increase in non-current assets, with an offsetting decrease of $8.2 million in non-current liabilities. Revision to Prior Period Financial Statements During the first quarter of 2016, we discovered an error in the reporting of certain software licenses for the period from July 2013 through December 2015, resulting in an immaterial understatement of license expense and the related liability for these periods. The cumulative decrease to retained earnings as a result of this error, net of the related income tax impact, was $1.4 million , $4.6 million , and $8.4 million as of December 31, 2013, 2014, and 2015, respectively. We have evaluated the materiality of this error and determined that the impact is not material to our results of operations, financial position, or cash flows in previously issued financial statements. We have retrospectively revised our financial statements for all periods presented to reflect the correction of this error and the related income tax effect. The impact of this revision on the consolidated balance sheets as of December 31, 2014 and 2015 was as follows: As of December 31, 2014 (In millions) As Previously Reported Adjustments As Revised Consolidated Balance Sheet: Deferred income taxes $ 63.0 $ (2.9 ) $ 60.1 Other liabilities 32.3 7.5 39.8 Total liabilities 542.3 4.6 546.9 Retained earnings 398.4 (4.6 ) 393.8 Total stockholders' equity 1,073.8 (4.6 ) 1,069.2 As of December 31, 2015 (In millions) As Previously Reported Adjustments As Revised Consolidated Balance Sheet: Deferred income taxes $ 60.0 $ (5.2 ) $ 54.8 Other liabilities 32.8 13.6 46.4 Total liabilities 1,037.7 8.4 1,046.1 Retained earnings 178.1 (8.4 ) 169.7 Total stockholders' equity 976.5 (8.4 ) 968.1 The impact of this revision on the consolidated statements of comprehensive income for the years ended December 31, 2013, 2014, and 2015 was as follows: Year Ended December 31, 2013 (In millions, except per share data) As Previously Reported Adjustments As Revised Consolidated Statement of Comprehensive Income: Cost of revenue $ 492.5 $ 2.3 $ 494.8 Income from operations 133.1 (2.3 ) 130.8 Income before income taxes 130.7 (2.3 ) 128.4 Income taxes 44.0 (0.9 ) 43.1 Net income 86.7 (1.4 ) 85.3 Comprehensive income 90.3 (1.4 ) 88.9 Net income per share Basic $ 0.63 $ (0.01 ) $ 0.62 Diluted $ 0.61 $ (0.01 ) $ 0.60 Year Ended December 31, 2014 (In millions, except per share data) As Previously Reported Adjustments As Revised Consolidated Statement of Comprehensive Income: Cost of revenue $ 582.3 $ 5.2 $ 587.5 Income from operations 163.5 (5.2 ) 158.3 Income before income taxes 159.6 (5.2 ) 154.4 Income taxes 49.0 (2.0 ) 47.0 Net income 110.6 (3.2 ) 107.4 Comprehensive income 94.4 (3.2 ) 91.2 Net income per share Basic $ 0.78 $ (0.02 ) $ 0.76 Diluted $ 0.77 $ (0.03 ) $ 0.74 Year Ended December 31, 2015 (In millions, except per share data) As Previously Reported Adjustments As Revised Consolidated Statement of Comprehensive Income: Cost of revenue $ 675.5 $ 6.1 $ 681.6 Income from operations 206.1 (6.1 ) 200.0 Income before income taxes 193.6 (6.1 ) 187.5 Income taxes 67.4 (2.3 ) 65.1 Net income 126.2 (3.8 ) 122.4 Comprehensive income 110.7 (3.8 ) 106.9 Net income per share Basic $ 0.91 $ (0.03 ) $ 0.88 Diluted $ 0.90 $ (0.03 ) $ 0.87 The impact of this revision on the consolidated statements of cash flows for the years ended December 31, 2013, 2014, and 2015 was as follows: Year Ended December 31, 2013 (In millions) As Previously Reported Adjustments As Revised Consolidated Statement of Cash Flows: Net income $ 86.7 $ (1.4 ) $ 85.3 Deferred income taxes (2.1 ) (0.9 ) (3.0 ) Other non-current assets and liabilities 9.3 2.3 11.6 Year Ended December 31, 2014 (In millions) As Previously Reported Adjustments As Revised Consolidated Statement of Cash Flows: Net income $ 110.6 $ (3.2 ) $ 107.4 Deferred income taxes 0.4 (2.0 ) (1.6 ) Other non-current assets and liabilities (0.4 ) 5.2 4.8 Year Ended December 31, 2015 (In millions) As Previously Reported Adjustments As Revised Consolidated Statement of Cash Flows: Net income $ 126.2 $ (3.8 ) $ 122.4 Deferred income taxes (4.0 ) (2.3 ) (6.3 ) Other non-current assets and liabilities 9.3 6.1 15.4 There was no impact on the consolidated statements of stockholders’ equity for any of the respective periods other than the impact on net income as reflected in the above tables. |
