Rackspace Technology, Inc. (NASDAQ:RXT) Q4 2023 Earnings Call Transcript

Rackspace Technology, Inc. (NASDAQ:RXT) Q4 2023 Earnings Call Transcript March 12, 2024

Rackspace Technology, Inc. beats earnings expectations. Reported EPS is $-0.03, expectations were $-0.04. Rackspace Technology, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, and thank you for standing by. At this time, all participants are in a listen-only mode. After the presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the call over to Sagar Hebbar, Head of Investor Relations. You may begin.

Sagar Hebbar: Thank you. And welcome to Rackspace Technology’s Fourth 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 Mark Marino, 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 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 press release and presentation, both of which are available on our Investor Relations website. 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. First of all, I’d like to introduce our new CFO, Mark Marino. Having worked with Mark since I joined Rackspace, I have witnessed firsthand, what a strong asset he is to our company. Mark’s comprehensive understanding of the business, and extensive financial leadership experience, will continue to be instrumental, as we strengthen our position in an attractive, and growing hybrid multi-cloud and AI market. I look forward to collaborating with Mark, as we continue to execute our strategy, and deliver value to our customers, and our shareholders. I would also like to thank our former CFO, Bobby Molu, for his contributions this past year. I’m also pleased to welcome Mark Gross to our Board of Directors.

Mark succeeds Thomas Cole, who unexpectedly passed away over the holidays. We are grateful for Tom’s significant contributions in his short time on the Board. Mark comes to Rackspace with extensive business, and executive leadership experience, and with deep insight in leading business transformations. I look forward to working, with Mark. Before we get to our results, let me cover the three strategic priorities, I present to the Board, and the progress we have made against them. First, drive the operational turnaround. In 2023, we made major structural changes, needed for a turnaround. We set a clear vision, direction, and strategy for the company, operationalize our two business unit structure, and refresh leadership, and talent at various levels in the company.

I’m happy with the progress and confident, we have the right strategy, team, and operating model in place, to ensure our turnaround succeeds. Second, reposition Rackspace as a forward-leaning, innovative, hybrid multi-cloud and AI solutions company that, makes informed bets in new technology trends. We caught the cloud wave, which is still in its infancy. We believe we are now well positioned, to catch the next big wave of AI. This is why, we set aside resources to launch foundry for AI by Rackspace or FAIR in June 2023, and we are seeing early success. And third, right-size our capital structure, and ensure ample liquidity, to support our profitable growth strategy. As you may have seen, we announced a transaction that, will significantly strengthen our balance sheet, and position our business for continued growth, enhancing Rackspace’s competitive position, while we’ll accelerate our operational and strategic plan.

I’ll walk through some of the high-level outcomes of this transaction, and Mark will go into more detail later in the call. The private debt exchange transaction, and assuming the public debt exchange, is fully subscribed, when combined with the company’s open market purchases over the past year, will result in total debt reduction, of over $800 million, and net debt reduction, of over $900 million from the start of 2023, shortly after I took over as the CEO. Following the transaction, which included $275 million of new cash infusion, we expect to have approximately $330 million of cash, net of all transaction expenses, on the books, compared to $197 million as of year-end 2023. With access to over $375 million revolver extended to 2028, current available liquidity is over $700 million.

This transaction demonstrates, the strong confidence, of our key financial partners in the future of the business, for which I’m extremely appreciative. Now let me get into our business performance, starting with Private Cloud. Today, Private Cloud is tracking towards a turnaround in the second half of 2024. In the fourth quarter of 2023, Private Cloud bookings were up 86% sequentially, and 96% year-over-year. Bookings for full year 2023, were up 20% year-over-year, with fourth quarter posting the strongest finish, in eight quarters. In addition, our backlog at the start of the New Year is up 188%, compared to the start of last year. Our Private Cloud strategy, is to defend and expand our Private Cloud business. We’re expanding our offerings, and bringing compelling new solutions, to the market.

We’re accelerating our go-to-market motion, with both vertical and horizontal strategies, and we are creating high potential opportunities in attractive markets, such as healthcare, banking financial services and insurance, sovereign, and private AI. The strategy is paying off. For example, in our healthcare vertical, we won approximately $225 million TCV business in 2023, including several new logos and over $100 million TCV long-term contract, with a large hospital system. There’s another nearly $700 million of potential TCV in our healthcare funnel. To capitalize on this success, we have brought in new talent, with deep expertise in healthcare and epic hosting. We’ll continue, to press on and broaden our vertical strategy in 2024. In Private Cloud, we also launched over 30 new offerings in the past 12 months, including software-defined data center across enterprise, business, and flex.

We also deployed AI Anywhere. This is an on-premise, enterprise-grade, AI-optimized platform with flexible architecture. It allows deployment in private data centers, or in third-party co-location facilities. And Spot, as its name implies, a Spot market for compute capacity. Based on the robust Kubernetes platform, this caters to a growing market for quick, reliable, enterprise-grade container cloud infrastructure. It is a natural fit, for enterprise developer environments and startups, and we see good early interest. For Rackspace, Spot allows us to monetize reserve capacity, and leverage our existing product offerings, at attractive incremental margins. In addition to new offerings, we have solid program in place to help customers, with their go-forward architectural decisions, and renew the business.

In the near term, however, Private Cloud continues to work, through the consequences of customer decisions, made 12 to 18 months ago, when Rackspace was not focused on this business. Hence, we expect to see some revenue runoff, over the next two to three quarters, including the current quarter, from customer decisions, made more than 12 months ago. However, we expect our recent strong bookings and backlog entering 2024, to start converting to revenue, in the second half of 2024. Thus, we expect quarterly revenue for Private Cloud, to stabilize in the second half of this year. Now, moving to Public Cloud, our strategy here is to ride the secular growth wave, in the cloud market. We are focused on meeting customers, wherever they are in their cloud journey, offering a full-stack multi-cloud solution spanning platform, applications, data, and security.

We worked through a tough transition last year, as we made a deliberate strategic pivot, to lead with services instead, of low margin infrastructure resale. This meant refreshing, nearly 40% of our overall go-to-market workforce, including over 70% of our sales team. We replaced them, with sales professionals with services-centric experience, and added similarly qualified go-to-market resources, including client partners. We have started seeing some early signs that, the pivot is working, with fourth quarter 2023 services bookings growing 13% sequentially, after a tough start to the year. Public Cloud continues to also develop, innovative new services and solutions. For instance, Managed VMDR, is an industry-leading vulnerability services offering, a complete turnkey service, to enable visibility and remediation of software vulnerabilities, and misconfigurations of hybrid and cloud environments.

We also developed Cloud DevOps, the managed services part of Rackspace Managed Cloud that, provides regular health checks, along with many other advanced monitoring and analysis services. And we updated modern operations with version two that adds new enhancements, such as an increased level of services per tier and improved SLAs. In 2023, both the disruptions arising from our structural changes, and cyclical headwinds of the macro environment slowed the pace of the turnaround in services. It has taken longer, than I originally expected. However, as we enter 2024, I am confident we have the right foundation in place, and are headed in the right direction. I expect to see services start, to report sequential growth in the second half of 2024, as our go-to-market organization matures and overall market demand for cloud services improves.

As I noted, Rackspace is catching the next wave, of market growth. We did that, with cloud and are doing it with AI. Over the course of the past year, we have transformed Rackspace into an AI-ready organization. Since introducing FAIR in June of 2023, we have several active AI projects in progress. We continue, to see growth in AI, with nearly 30 customers, including more than 10 new logos, at varying stages of implementation, across our IDH and incubate phases. We also have a robust and growing offerings. In Private Cloud, we launched AI Anywhere, as a landing zone for customers, who want to move their AI application into production. In Public Cloud, we are integrating with all three hyperscalers. Recently, we announced a partnership with Microsoft Copilot to guide customers, through their AI journey.

We also achieved the Amazon Web Services Generative AI Competency, in the categories of consulting services, generative AI application, infrastructure, and data. This specialization, recognizes Rackspace technology, as an AWS partner that, helps customers drive the advancement of services, tools, and infrastructure, pivotal for implementing generative AI technologies. We are taking a realistic, and measured approach, to help our customers use AI to build useful, economically viable, and ethical services. There’s a tremendous opportunity ahead. I’m happy with the plan we have developed, and our first steps on this journey. In summary, we made significant progress in 2023. Instead of opting for a quick fix, we made the difficult decision, to focus on a turnaround, invest for the long-term, restructure the organization, and bring in new leadership.

I expect 2024 to get off to a slow start, but given the strong backlog in Private Cloud and the typical six to nine months lag, between bookings and revenue realization, we anticipate improving revenues, and margins in the second half of 2024, with continued solid execution. Our goal for 2024, is to lock in a sustainable business model that generates consistent revenue and profit growth, over the long-term. We want to build momentum, throughout 2024. That will put us on a growth trajectory entering 2025. Recent booking strengths and improved customer engagement, tell me we are on the right track. And today’s debt refinancing, gives us the financial flexibility, to stay the course. Before I wrap up, I would like to thank our customers, partners, and all our Rackers.

I’m proud of all we have achieved together, during this year of change. I will now turn it over to Mark Marino, for an overview of our financial results and guidance.

Mark Marino: Thanks, Amar. Having been with Rackspace over the past few years, I have seen and participated in many of the strategic changes, Amar has initiated. The changes happening throughout the organization, are transformational. So I’m excited, to have stepped into this role, at this important inflection point, and I look forward to continuing, to support the vision, and become an even more integral part, of the future of Rackspace. As Amar mentioned, we closed a very positive transaction with a group of our lenders and financial partners. Specifically, Rackspace closed a private debt exchange, with an ad hoc group representing more than 72%, of our first lien termed loan holders and more than 64% of our first lien noteholders, as well as 100% of our revolving credit facility lenders.

In connection with this transaction, we plan to launch, a public debt exchange offer, to the rest of our outstanding lenders, and first lien noteholders in the coming days, and close that in the next month. Through the private exchange, we eliminated more than $375 million of net debt, and received $275 million of new money that, will come to the balance sheet, as additional liquidity, to advance our key strategic initiatives. We are extremely encouraged, by this injection of new money, as it reinforces our financial partners’ conviction, in our turnaround strategy, and continued momentum in our execution. Through full participation in the public debt exchange, we have the opportunity, to eliminate more than $600 million in total debt, reducing annual interest expense, by more than $45 million.

Since the end of fiscal year 2022, assuming full participation in the public debt exchange, and when combined with the company’s open market purchases, over the past year, would result in a total debt reduction, of over $800 million and net debt reduction, of over $900 million, and reduction in annual interest expense, by more than $70 million. Additionally, the maturities on the revolver, and other participating senior debt facilities have been extended, to May of 2028. The company has effectively, no funded corporate maturities, prior to 2028. Notably, none of the exchange transactions, have any impact on the equity capitalization, of the company. Overall, this transaction strengthens the company’s financial flexibility, extends maturities, and de-levers our balance sheet, while providing Rackspace, with ample runway to accelerate our strategic growth initiatives.

Now onto the results. Fiscal fourth quarter 2023 results, exceeded the midpoint of our revenue, operating profit, and EPS guidance. In the fourth quarter, total company GAAP revenue of $720 million, was at the high end of our guidance, driven by strength in Public Cloud. Total net revenue was $413 million, down 4% sequentially, and down 14% year-over-year, due to declines in both Private Cloud and the Public Cloud. We are more focused on net revenue, as it represents the true growth of our business. Gross profit margin was 22% of GAAP revenue and 38% of net revenue. For the quarter, operating profit was $48 million at the high end of our guidance and up 6% sequentially. Operating margin was 7% of GAAP revenue, and 12% of net revenue. Loss per share was $0.03, which was within our guided range of $0.03 to $0.05 loss per share.

Cash flow from operations, was $72 million and free cash flow, was $38 million in the fourth quarter. Turning to our segment results. For Private Cloud, GAAP revenue for the fourth quarter was $285 million, which was at the low end of our guidance. This includes legacy open stack revenue, of $29 million. Total Private Cloud revenue, was down 5% sequentially, due to customers rolling off, older generation Private Cloud offerings. Private Cloud gross margin was 37% down one percentage point sequentially, primarily due to revenue declines. Segment operating margin was 27%, down two percentage points, quarter-over-quarter. In Public Cloud, GAAP revenue of $435 million, exceeded the high end of our guidance, and was up 1% quarter-over-quarter primarily, due to consumption driven growth on infrastructure resale volumes, offset by declines in services.

Public Cloud services revenue, was down 5% sequentially, given the continued cyclical headwinds in IT services, and the structural changes we implemented, in our go-to-market organization. Gross margin for Public Cloud segment was 40% of net revenue up three percentage points sequentially driven by cost savings. Segment operating profit was 21% of net revenue up five percentage points sequentially. Now turning to the full year 2023 results. Total company GAAP revenue, was down 5% year-over-year, driven by declines in Private Cloud, while total net revenue was down 11% year-over-year, due to declines in both Private Cloud and Public Cloud. Gross profit was 22% of GAAP revenue and 38% of net revenue, while operating margin was 6% of GAAP revenue, and 11% of net revenue.

Demonstrating strong cash flow management, cash flow from operations was $375 million and free cash flow, was $278 million for the year. Normalizing for the impact of our AR securitization, full year 2023 cash flow from operations, would have been $159 million and free cash flow would have been $63 million. Total CapEx for 2023, was $181 million, with the CapEx intensity, of 6% within our full year guided range, of 5% to 7%. For full year 2023 segment results, Private Cloud GAAP revenue, was down 12%, compared to 2022, due to customers rolling off, older generation Private Cloud offerings. Private Cloud gross margin was 38%, down seven percentage points, year-over-year driven, by declines in revenue, with a relatively fixed cost structure. Segment operating margin of 28% was down eight percentage points, year-over-year.

In Public Cloud, 2023 GAAP revenue was essentially flat year-over-year while net revenue was down 8% year-over-year given a tightening of discretionary spending. Gross margin for our Public Cloud segment, was 37% of net revenue down seven percentage points driven, by declines in revenue. Operating profit was 17%, of net revenue down five percentage points, year-over-year. Now onto our guidance. As Amar mentioned, we are still managing through residual Private Cloud revenue runoff that, will impact the first half of 2024, and do not expect a major financial contribution, from our new bookings and backlog, until later in the year, due to the typical six to nine months lag between bookings, and revenue realization. Also, the first quarter costs, will reflect investments in areas that align, to our strategy as well, as the headwind from seasonal fringe benefits in the U.S. For these reasons, we expect first quarter GAAP revenue, to be approximately $680 million to $690 million.

Total operating profit is expected to be $12 million to $14 million and loss per share of $0.12 to $0.14. From a segment perspective, we expect Private Cloud revenue of $268 million to $273 million, and Public Cloud revenue of $412 million to $417 million. Our tax rate is expected to be 26%, and other income and expense, of approximately $50 million to $52 million in expenses. The share count is expected to be around 221 million to 223 million shares. We expect profits to drop in the first quarter and improve throughout the year. We anticipate second half 2024 profits, to be higher than the first half, led by private cloud revenue stabilization and growth in Public Cloud services, setting us up for solid momentum exiting 2024. I will now turn the call over to Sagar.

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

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Frank Louthan with Raymond James. Your line is open.

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Q&A Session

Unidentified Analyst: Hi guys, this is [Rob Warren] for Frank. So, you know, beyond what you’ve shared with us already as it pertains to the debt deal, are there any other significant covenants we should know about such as, you know, say restricted payments baskets? And then my follow-up is, is the new debt callable? And if so, when and at what rate? Thank you.

Amar Maletira: So, I think we didn’t follow the first one. It was not very clear. Can you repeat the question? I’m sorry. It was not very clear in the room.

Unidentified Analyst: Yes, yes. So other than what you’ve shared with us so far, about the debt deal, are there any other significant covenants we should know about such as, you know, any restricted payments baskets? And then my follow-up was about the debt being callable or not. And if so, when and at what rate?

Mark Marino: Yes, so just relative to your first question there, about the restricted basket, right? Obviously, in a transaction like this, some of our covenants and baskets, did get tightened up throughout the transaction. But in no way, is there any restrictions that will impair our ability, to operate the company moving forward. So, I think from that perspective, we’ve got a latitude and flexibility, with those baskets and covenants. And then your second question?

Unidentified Analyst: It’s new debt callable?

Mark Marino: No.

Amar Maletira: The answer is no. Did that answer your question?

Unidentified Analyst: Yes. Yes. Thank you guys very much.

Amar Maletira: Thanks.

Operator: Thank you. Please stand by for our next question. Our next question comes from the line of Ramsey El-Assal with Barclays. Your line is open.

Ryan Campbell: Hi. This is Ryan Campbell for Ramsey. Thank you for taking my question today. In your prepared remarks, you mentioned the six to nine-month lag, between bookings and revenue realization. And I was curious, to see how that compared to a more normalized demand environment? And what are you seeing today that gives you confidence that this lag won’t elongate any further? Thank you.

Amar Maletira: Yes. I think the – so thank you very much for the question, Ron [ph]. And the six to nine months lag of – that commentary was mainly on our bookings converting to revenue. So the bookings, is what builds the backlog. Our Private Cloud business did very well, from a bookings perspective in Q4 in the fiscal Q4, where we grew sequentially 86%, grew 96% year-on-year. It was the highest quarter in the last eight quarters, and we entered the year, with a huge backlog. And the backlog actually grew 188%, year-on-year, compared to what we saw, when we entered fiscal ’23. So that backlog to convert to revenue typically takes six to nine months, because we have to stand up the environment, we have to migrate the application, and once the application migrates to our data center.

And we manage and operate, then that application and workload stays with us for the next five to 10 years. So that six to nine-month lag, is mainly for backlog converting to revenue. Now in terms of sales cycles, I think that’s where your question is. Listen, I think the demand environment continues to remain uncertain. Entering 2023 – 2024, we see a similar – what we saw in 2023. We believe customers, will continue to spend on digital transformation, mainly enabled, by cloud and AI. However, we continue to see slower decision cycles, and the sales cycles are getting extended. In our Public Cloud services business, as you know, that it’s a very – it’s a cyclical business. Many companies in the services ecosystem, are reporting that they are facing, some cyclical headwinds, and so are we.

But when you talk about our Private Cloud business, the dynamics are really different. Customers are looking, to move out of their data centers, and reduce both their CapEx and OpEx investments. And so – we see relatively better demand in Private Cloud. And the very fact that, we grew our overall bookings in 2023 at 20% year-on-year, is basically a proof point that, the Private Cloud demand, is pretty strong. Was that helpful, Ron?

Ryan Campbell: Yes. Thank you.

Operator: Thank you. I would now like to turn the call back over to Sagar for closing remarks.

Sagar Hebbar: Thank you, everyone, for joining us. If we did not get to your question, or if you have a follow-up, please e-mail ir@rackspace.com. Have a great evening, everyone.

Operator: Ladies and gentlemen, that concludes today’s conference call. Thank you for your participation. You may now disconnect.