Rackspace Technology, Inc. (NASDAQ:RXT) Q2 2023 Earnings Call Transcript

Rackspace Technology, Inc. (NASDAQ:RXT) Q2 2023 Earnings Call Transcript August 8, 2023

Rackspace Technology, Inc. misses on earnings expectations. Reported EPS is $-0.06 EPS, expectations were $0.08.

Operator: Good day and thank you for standing by. Welcome to Rackspace Second Fiscal Quarter 2023 Earnings Call. [Operator Instructions] My name is Robert Watson, vice president of corporate finance. As a reminder, today’s call is being recorded. I would now like to hand the conference over to your speaker today, Sagar Hebbar, Head of Investor Relations. Please go ahead.

Sagar Hebbar: Thank you. And welcome to Rackspace Technology’s second quarter 2023 earnings conference call. I am Sagar Hebbar, Head of Investor Relations. Joining me on today’s call are Amar Maletira, our Chief Executive Officer; and Bobby Molu our Chief Financial Officer. As a reminder, certain comments we make on this call will be forward-looking. These statements involve risks and uncertainties, which could cause actual results to differ. A discussion of these risks and uncertainties is included in our SEC filings. Rackspace Technology assumes no obligation to update the information presented on the call, except as required by law. Our presentation includes certain non-GAAP financial measures and certain further adjustments to these measures, which we believe provide useful information to our investors.

In accordance with SEC rules, we have provided a reconciliation of these measures to their most directly comparable GAAP measures in the earnings release and presentation, both of which are available on our website. After our prepared remarks, we will take your questions. Please note that unless stated otherwise, all results are presented as non-GAAP except revenues. I’ll now turn the call over to Amar for an update on the business.

Amar Maletira: Thank you, Sagar. And welcome to Rackspace. Fiscal second quarter 2023 exceeded our guidance for both revenue and EPS. This is the fourth consecutive quarter in which we exceeded our expectations. As we updated last quarter, we have reorganized the company and are focusing on our two business unit operating model and strategy shifting to a more profitable business mix, right sizing our cost structure and building our product offerings to position Rackspace for long-term success. We are already seeing the benefits of organizing into two separate business units. Our increased focus in the private cloud business has resulted in solid pipeline expansion and bookings growth. In public cloud we are starting to see some early positive signs in improved bookings mix, although it will take some time to work through this transition.

The reorganization has also helped drive productivity improvements and optimize our expenses. I’m confident we have the right operating structure, people, and capabilities to achieve this turnaround. The progress achieved to date has been meaningful as a focus is on long-term sustained profitable growth. While we are making progress internally, overall market conditions are consistent with the first half of the year with companies continuing to prioritize cost optimization. However, recently Generative AI has emerged as a top priority for companies as they’re looking to understand how to leverage and benefit from this technology. The AI marketplace has propelled into a new era fueled by an unparalleled convergence of trends. Abundant computing and storage made easily accessible through cloud computing has unleashed innovation.

At the same time, the volume and variety of data explosion have provided the foundation for cutting edge machine learning and deep learning techniques to thrive, driving unprecedented and exciting opportunities for businesses across all industries. As a pure play global multi-cloud solutions company, Rackspace’s unique proposition is our expertise and experience in building and operating an AI aware multi-cloud infrastructure and infrastructure aware AI solutions. Combined with our commitment to open source and the Racker DNA of open innovation, we are the right company at the right time to accelerate the adoption of AI to commercial mid-market and enterprise customers. In June, we launched foundry for AI by Rackspace called Fair, a global spin up dedicated to accelerating the adoption of responsible AI solutions across all industries.

With Fair, we have tapped into open innovation with our vast partner ecosystem. For instance, we are combining forces with Google’s AI Cloud Center of Excellence and expanding our partnership with AWS to help our customers realize AI’s full potential. We also recently announced a launch of our hosted AI reference architecture powered by Nvidia and Dell Technologies. This partnership gives Rackspace customers a simplified path to build, deploy, and operate enterprise AI solutions across public clouds and the Rackspace private cloud. In less than two months since the launch, we are already seeing significant early interest from existing customers and new prospects. We currently have nearly 250 leads or 50 opportunities in the pipeline and executing on three global generative AI projects.

We also are using Fair and its capabilities to transform Rackspace internal operations using AI. As an example, we launched Rackspace Intelligent Co-pilot for the enterprise and engine designed to streamline and enhance the workflow of our knowledge workers. As we move into this rapidly evolving world of AI, we want to ensure we have an AI-ready workforce at Rackspace. We launched FAIR Learn, an innovative AI literacy program that combines the power of massive open online courses or mocks and digital credentialing to ensure that Rackers across our entire company have the skills and knowledge to capitalize on AI. We launched FAIR Learn in late July to get our entire workforce AI ready in six months. In the first two weeks since the launch, we have 12% of our global workforce certified as AI ready.

This demonstrates a key element of the Racker culture, the relentless commitment to continuous learning and the desire to deliver the best outcomes for our customers. Now turning to second quarter updates on our business units. In Public Cloud, we continue to implement our strategy of transitioning from low value infrastructure resale towards higher value added services. In Q2, we launched several new capabilities. For example, we initiated a tri partner collaboration with AWS and Trend Micro to ensure a secure and streamlined AWS cloud migration delivered by Rackspace’s Elastic Engineering offering. We also expanded our advisory offerings to help customers jumpstart their zero trust strategy, streamlined migrations to Google Cloud, and expanded our investment in Azure landing zones.

In addition, we released several new features supporting our modern cloud offerings for multi-cloud that range from architectural reviews to customer self-service options. We continue to evolve our go-to-market strategy, particularly in Americas with a sharper focus on our market segmentation and product offerings. We also recently hired indiscernible] as a Public Cloud Chief Revenue Officer and experienced go-to market leader with a strong track record of driving growth in digital and cloud services. While the public cloud services market remains challenging, we are seeing early signs of stabilization. We recently won a cloud strategy and implementation program with a leading international insurance company as well as a cloud transformation project with the multinational Beverage and Retail Company.

We also extended our relationship for another five years with a large Canadian government financial services agency. Now turning to Private Cloud. Demand for Private Cloud solution remains robust, especially around workloads that may not operate efficiently in public cloud and applications requiring data sovereignty, especially in vertical such as: healthcare, driving strong growth in both pipeline and bookings. We significantly expanded our private cloud new product releases this quarter. We enriched our VMware based software defined data center platform with enhanced management, security, data protection and ransomware prevention. We scaled our private cloud storage and data freedom offerings to include block, file and most recently object storage, rolling it out to an additional six data centers in the U.S. and Europe.

We also published a reference architecture for AI Cloud as part of our partnership with NVIDIA and Dell Technologies. Demand in healthcare has been strong and we want businesses with two leading healthcare providers, one to host their core electronic medical record application and the other to build and operate their high performance compute environment for genomic research. We expect the healthcare vertical to show solid growth in the second half of the year and into 2024. I’m pleased with the renewed focus on both innovation and go-to-market execution in a private cloud business. As I mentioned last quarter, we also hired two seasoned technology leaders who have hit the ground running Lance Weaver as a Private Cloud Chief Product & Technology Officer; and Maureen Sweeny as the Private Cloud Chief Revenue Officer.

Now let me wrap up by reiterating our top four priorities, which we are focused on to turn around our company’s financial performance. First, grow our public cloud services business at or above market rate. Second, there was the decline in private cloud and position this business to capitalize on growth opportunities in an attractive market. Third, build a highly efficient cost structure and ultimately drive sustained growth in operating profit and free cash flow. With that, I’ll turn it over to Bobby.

Bobby Molu: Thank you, Amar. I’ll cover the total company results for the second quarter. Then share some details on our segment performance followed by our Q3 guidance. In addition to the benefits Amar described in our shift to the 2 BU model. As mentioned in the last earnings call we have uncovered opportunities for further efficiencies in both businesses. We’ve also been able to more tightly manage working capital, specifically driving a more granular focus on collections. We continue to pursue other cost reduction opportunities while balancing that with investment in the market opportunity ahead of us. Total company GAAP revenue of $746 million was above the high end of our guidance, down 3% year-over-year. Total net revenue was $447 million, down 10% year-over-year with declines in both public and private cloud.

Gross profit of $163 million was 22% of GAAP revenue and 37% of net revenue. On our last call, we indicated that operating profit this year will trough in the second quarter with sequential quarterly profit improvements anticipated for the remainder of 2023, driven primarily by cost reduction and some improvement in mix. We are on track. We reduced overhead with SG&A down 7% year-over-year and 3% sequentially. Given this operating profit was $39 million, also above the high end of our guidance. This was down 60% year-over-year primarily due to revenue declines in our private cloud business unit. Operating margin was 5% of GAAP revenue and 9% of net revenue. Loss per share was $0.06, which was better than our guided range of $0.07 to $0.09 loss per share.

Cash flow from operations was $38 million and free cash flow was $14 million in the second quarter. These results were in line with expectations due to our strong working capital management. In second quarter, we deployed $47 million of cash sourced from our revolving credit facility to opportunistically repurchase another $142 million of our senior unsecured notes in the marketplace. Through July year-to-date, we have repurchased a total of $222 million of senior unsecured notes using $77 million of cash. We continue to monitor and assess further opportunities to deploy capital in accretive downside protected ways for shareholders. Total CapEx for the second quarter was $45 million with a CapEx intensity of 6%. We continue to expect CapEx to be lower for the next couple quarters and end up in our typical 5% to 7% CapEx intensity range for the full-year.

Turning to our segment results. For Public Cloud GAAP revenue of $435 million was up 3% year-over-year driven by our infrastructure resale business, partially offset by declines in services. Public cloud net revenue, which includes our public cloud services revenue and infrastructure resale profit, was $135 million, down 7% year-over-year. Services revenue was down 5% year-over-year given the tightening of discretionary spending and customer optimizations. We expect our pivot to a stronger services led focus to pay dividends as the macro environment improves and we mature our go-to-market. Gross margin for our public cloud segment was 11% of GAAP revenue, down 5 percentage points year-over-year and 35% of net revenue. Margin compression was driven by lower volumes across both services and infrastructure resale.

Segment operating profit in public cloud was $17 million, which was 4% of total segment revenue and 13% of net revenue. In private cloud GAAP revenue for Q2 was $311 million, which includes legacy OpenStack revenue of $32 million. Year-over-year total private cloud revenue was down 11%. The private cloud segment revenue decrease resulted from customers rolling off old generation private cloud offerings, expected decline in legacy OpenStack offerings as well as the impact from the December hosted exchange ransomware incident. Private cloud gross margin was 37%, down 10 percentage points year-over-year and segment operating profit was $87 million at an operating margin of 28%, down 10 percentage points. The margin compression reflects the fixed costs associated with revenue runoff in this business, partially offset by cost efficiencies.

Overall, the quarter was in line with our expectations and consistent with our plan to improve our cost structure and transform our business mix to higher margin revenues over time. During this transformation, we will continue to invest in innovative technologies and key market verticals as well as focus on cash management and continue to drive efficiencies. Now onto our Q3 guidance. We expect the third quarter GAAP revenue to be approximately $722 million to $732 million. Total operating profit is expected to be $43 million to $47 million and loss per share of $0.04 to $0.06. From a segment perspective, we expect public cloud revenue of $428 million to $433 million and private cloud revenue of $294 million to $299 million. Our tax rate is expected to be 26% and other income and expense of approximately $58 million to $60 million in expenses.

The share count is expected to be around 215 million to 217 million shares. As we noted last quarter, we expect Q3 cash flow from operations and free cash flow to be positive. Sagar, over to you.

Sagar Hebbar: Thank you, Bobby. Let us begin the question-and-answer session. We ask everyone to limit discussion to one question and one follow up. Please go ahead.

Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Kevin McVey with Credit Suisse. Kevin, your line is now open.

Kevin McVey: Great. Thanks so much and really congratulations on the results given the transformation. Hey, I don’t know where best-to-start. Amar, you talked about the Generative AI and it seems like that’s a massive opportunity. Is there any way to frame what that could mean to the enterprise overall and did that contribute to the beat? I mean, I know there was a series of product introductions in quarter, but just a really, really strong beat and maybe help – help frame the puts and takes on the beat and if, again, if the Generative AI impacted that or if there’s a way to think about what that can mean to the enterprise longer term?

Amar Maletira: Okay, thanks Kevin and thanks for the question. And Bobby will cover the beat in the quarter. I’ll say Generative AI did not contribute to the beat and Bobby will go through the details there for you, Kevin. Generative AI can be a massive opportunity for us, Kevin. When you take a look at Generative AI and AI in general, it is all workload. We are a multi-cloud solutions company and we are very workload centric. So what Generative AI does is it gives us an opportunity to go after this massive workloads. Generative AI is going to be very pervasive. It’s going to impact all businesses, all functions and the amount of workloads that will get created will be absolutely massive. Now, think about Generative AI the way we think about it is in three layers, right?

One is the infrastructure layer, the second is data, and third is application. So when you think about the infrastructure layer, it has compute, it has storage, and it has networking. And when you look at compute, it has both the GPUs as well as CPUs, for example, we believe that all the training models will run on GPUs, but when it comes to inferences where most of the monetization will happen, it’ll be a combination of both CPUs as well as GPUs. Storage is also very important because data has to be stored, and then, and networking component also is critically important because there’ll be ultra low latency and you have to improve the performance of the network. And we, as – we have about two decades of experience in optimizing infrastructure for any workload.

So we are very well positioned to build an AI aware infrastructure both on the private cloud side and also partner with the public cloud hyper-scaler partners on the public cloud side. Data is another big opportunity for us as well as for the industry. Now, you can do all the plumbing you – with the infrastructure, but if you do not have water flowing through the plumbing, in this case data it’s useless. So we have a sizable data practice we can help customers to basically migrate data, create the right data architecture. We can also help them in data reclassification; so good opportunity there.

aware: When you look at our strengths, we have 20,000 customers in commercial mid-market and enterprise that we can tap into. We have our 6,500 employees, 6,000 of them are technologists with 10,000 plus certification. As I’ve mentioned in my prepared remark, I’ve launched AI learn, about 12% of our workforce is AI ready in the last two weeks or so. And we have an ambitious goal in getting everyone AI ready in the next six months. And more importantly, I think we also have the partner ecosystem and we continue to add to that partner ecosystem with announcements that we have made. So we feel very, very confident that if this takes off and which we believe will, it’ll definitely be a positive for Rackspace. Now, we are not counting on this to turn around the business.

I want to be very clear. Our turnaround plans are based on the market opportunity we have in public and private cloud, excluding AI. We have a very good plan that we are executing on, and I’m very pleased with where – where we landed in Q2. So talking about the beat let me turn it over to Bobby so he can go over, where we outperformed.

Bobby Molu: Yes. Thanks Amar. So Kevin that the beat was primarily in our private cloud business. We’re essentially – we were able to push out runoffs from customers on old generation private cloud offerings. And then we also had a bit of conservatism built into the model as well. The public cloud business came in line with our estimates, even though as the macro environment was pretty much constant from Q1. So overall, I’d say we were pleased with our execution in the quarter and the beat that we had.

Kevin McVey: That’s great. And then just one quick follow up because you’ve just done a really, really opportunistic job of retiring some of that debt. But if I look at the cadence, if my match’s right, it looks like you did – you committed about $10 million in the first quarter or retired $10 million – you committed $23 million of capital in the first quarter, $142 million in the second, and then $57 million after the second quarter. I guess Bobby, is there any way to think about what the potential capacity is to take down even more of those senior unsecured just again, to really, really nice use of capital, particularly given where and it looks like your average is somewhere around $0.35 to $0.30 to $0.43 is where you’ve been taking that debt down?

Bobby Molu: Correct. Correct. Look Kevin, we were opportunistic with that, right? So our priorities – our capital allocation remain unchanged. As Amar mentioned, right, our party is around investing the business organically, and that’s what we’re focused on. We were opportunistic in what we did this quarter. We saw the – the debt trading at very attractive rates, and so we executed on exactly what you just talked about. Could we be doing that again in the future? Possibly, but we’re more focused on the operations, if the debt continues to trade at those levels and it’s attractive we’ll look at it, but we also want to maintain our liquidity, right? It’s a tough macro. So we want to be conscious of that. Want to make sure we have dollars to invest back in the business and turn around the business. So that’s really our focus and that’s kind of what we’re looking – we’re out looking for the rest of the year.

Kevin McVey: Congrats again.

Amar Maletira: Thank you, Kevin.

Operator: Our next question comes from the line of Bradley Clark with BMO.

Bradley Clark: Hi. Yes, thanks for taking my question. I know you discussed that Generative AI didn’t contribute to the revenue beat in the quarter. But is there – is there anything you can talk about related to bookings or customer conversations related to Generative AI? And specifically what are you thinking in terms of timing or obstacles that organizations have to go through, particularly on the data side before they can really start implementing large scale GenAI projects? Thank you.

Amar Maletira: Sure. Thank you very much, Bradley. I think listen, as I said, I mentioned to Kevin we are very optimistic about the opportunity ahead of – for us with Generative AI. Now the deals that we have been closing are modest in size from both revenue and bookings perspective, but that’s what we expect, right? Generative AI is that its infancy, it’s evolving very rapidly. We are at a very early phase, which we call it the discovery and the incubation phase probably, discovery is – is ideation phase where we basically have consulting services and workshop with our customers, identifying the use cases. We are about – we have identified in all about 512, 513 used cases in the last two months across multiple functions and across multiple industries.

Roughly around 12 domains, so that’s the early phase. Once we identify the use cases for the customers the second phase we call as the incubation phase where we help the customers look at different foundational models look at whether they have the right data architecture and help them also work out the integration with their, with their current processes. So that’s the incubation phase. So most of the projects that we are seeing are in those early phases of discovery, or ideation and incubation. I think when this moves into what we call as industrialization, which is moving into the production phase, that’s where we will start see seeing the scaling in terms of the deal sizes, et cetera. And that’s the area where there is a lot of monetization.

That’s why we are so excited about it because ultimately these workloads it’s all – it’s workloads and workloads have to run on infrastructure, and there will be a massive requirement of infrastructure across compute, storage and networking. And that’s what we are very good at doing. So, listen, I think, we have in less than two months, just to give you a little bit of more color here, as I mentioned my prepared remarks, we have roughly about 250 leads in the pipeline, we have qualified opportunities that are over 50, and we have closed three deals across multiple industries, and in fact, we are closing two more deals by the end of this week. So very good traction. I think the key hurdle for any customer is identifying those use cases Generative AI has foundation as it is, it is going to impact every single function.

So there will be massive number of use cases. So identifying those use cases, then the biggest challenge is do they have the data ready. And the third challenge is where are they going to run both their and the training models as well as inferences? And that’s where we believe it’s going to be on multi-cloud infrastructure, both public cloud as well as private cloud.

Bradley Clark: Appreciate all the insight. Thank you.

Operator: [Operator Instructions] Our next question comes from the line of Frank Louthan with Raymond James.

Frank Louthan: Great, thank you very much. I just wanted to check, was there anything sort of one time in the quarter that helped the revenue? Just curious about that relative to the sequential guide? And then separately, can you give us an idea of what sort of – number of bookings or the percentage of bookings from new logos? And where are you as far as bookings coming in that are more AI-centric these days? Is that a material part of your bookings these days? Thank you,

Bobby Molu: Frank. Let me take the one-time question. No, there were no material one-timers. This was really around what I just said around private cloud business where we were essentially be able to push out the runoff from customers that are on some of our old generation private cloud offerings. And then we did have a little bit of conservatism built in that I mentioned. So that’s essentially what drove that beat. There is nothing material in terms of a, a one-timer.

Amar Maletira: Yes. So in terms of bookings, Frank, I am quite pleased with how the quarter panned out. We had a good quarter given the macro backdrop as well as with all the changes we are making internally from a re-org perspective. If you look at our second quarter bookings, we were up sequentially in both the businesses, private cloud as well as public cloud. In private cloud our increased focus [indiscernible] structure has also resulted in a strong, sequential growth in bookings, and it’s mainly coming in from international, but we do expect that trend to continue even in Q3. We also saw a strong growth in private cloud pipeline. In fact, it was significant growth. In particular, we are experiencing solid interest in a, in one of our key verticals such as healthcare.

Now in public cloud we did improve bookings sequentially. So we did see a double digit growth also in bookings in the second quarter with an uptick in services bookings. As you know, we are moving towards the higher margin services business and shifting away from infrastructure. Now this all takes time, but we remain focused on making that shift. And our customers are – many of our customers on the public cloud side are also focused on cost optimization. So as you think about Q3, we expect another quarter next quarter to be a sequentially growth quarter for us in bookings across the company. Does that help Frank?

Frank Louthan: Yes. And what’s that on the cost optimization, are you seeing – are you seeing anything going the other direction where are any – any segments of your business looking to cost optimize to pull back on some services, or are they – or is it more coming to you to try and save money that way?

Amar Maletira: Yes, I think cost optimization also placed to a strength. We have cost optimization offerings that are helping public cloud customers in their cost optimization. We have 2000 plus public cloud customers. We have good view of their usage. We can’t predict the usage, but we know where they are using their infrastructure. So we do help in cost optimization, and so that is also helping. But let me give you an overall color on the demand environment. I think when we look at the demand environment across, you know, it’s not gotten worse, it’s consistent with the first half of the year different dynamics in public versus private cloud. Frank, in public cloud as we talked about, customers continue to optimize the cloud infrastructure, spend, cloud services spend typically lag infrastructure.

So we continue to see softness in services demand, and we are not the only company seeing that every company in the services ecosystem is seeing the same challenge. However, we have started seeing better engagement from our customers. We believe that demand will recover in the next two to three quarters, and when it does, we will be there to capture it as we are continuing to see an increase in engagement, we also fine tuned our go-to-market specifically in Americas. Now in private cloud, the dynamics a little bit different Frank. Customers are looking to move out of the data centers, reduce their CapEx and OpEx investments, and also looking at moving workloads that are not operating efficiently in public cloud. And this has created a little bit of sort of a momentum for us, and it’s a tailwind.

And given our focus, we are showing up in many opportunities that we never had before. So, this is overall good for a private cloud business. So two different dynamics. I can also give you some color on verticals because we are focused on three verticals as we reorganize the business and we’ll expand it in the future. Those three verticals, healthcare specifically, as I mentioned, solid momentum in healthcare as customers are grappling with reduction in the revenue per patient and the cost per patient going up. So, they are trying to do more with less. And these are mainly regulated workloads, which are moving out of the data centers, and we are capturing it in a private cloud hosted environment. We also have a vertical in private equity. We basically serve about 18 funds, about 150 portco companies, and we are seeing good traction and momentum in the private equity vertical tool, where most of the private equity firms are driving value acceleration.

And the third which has been a positive surprise for us is a public sector vertical in the U.S. That’s a vertical that beat their bookings target for first half, they grew their bookings year-on-year and we expect that bookings to actually sequentially grow from Q2 to Q3.

Frank Louthan: Great. That’s good color. I really appreciate it. Thank you.

Operator: Our next question comes from the line of [indiscernible] with Bank of Hope.

Unidentified Analyst : Hi. Yes, good afternoon. Congratulations on a good quarter. I have two questions. One relates to the overall amount of debt. Just wanted to get some color on your finance leases and on your operating leases. And if that exposure is still about the same as of Q1, it was about $534 million for both of those tranches.

Amar Maletira: That’s right.

Unidentified Analyst : And if that was reduced at all?

Bobby Molu: That is about the same, those are the right estimates not materially reduced from Q1 with respect to that.

Unidentified Analyst : Thank you. My other question is a little hypothetic though, but I was wondering if you ever expect like further equity support from some of the lead owners say Apollo? Do you ever factor that in as far as your ongoing planning?

Bobby Molu: So, listen, I think, I cannot disclose that, but listen, at the end of the day, we are a publicly traded company. So your question is whether we will get any further equity support from our sponsors. Is that the question? Can you hear us?

Bobby Molu: I think we lost in there.

Amar Maletira: Yes.

Bobby Molu : Let’s go to the next question,

Amar Maletira: Liz, we can take the next question if there are any other questions,

Operator: We have no further questions in queue at this time.

Amar Maletira: Thank you, Liz. If we did not get to your question or if you have a follow-up, please email us ir@rackspace.com. Thank you everyone for joining us and have a great evening.

Operator: This concludes today’s conference call. Thank you for participating. You may now disconnect.