Rackspace Technology Q4 2023 Earnings Call Transcript

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March 12, 2024

There are 5 speakers on the call.

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. Please be advised that today's conference is being recorded. I would now like to hand the call over to Sagar Habar, Head of Investor Relations.

Operator

You may begin.

Speaker 1

Thank you, and welcome to Rackspace Technologies' 4th quarter 2023 earnings conference call. I am Sagar Hebar, Head of Investor Relations. Joining me on today's call are Amar Malatera, 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.

Speaker 1

A discussion of these risks and uncertainties is included in our SEC filings. Zackspace 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.

Speaker 1

I will now turn the call over to Omar for an update on the business.

Speaker 2

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've 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.

Speaker 2

I would also like to thank our former CFO, Bobby Maloo 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.

Speaker 2

I look forward to working with Mark. Before we get to our results, let me cover the 3 strategic priorities I present to the Board and the progress we have made against them. 1st, 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 2 business unit structure and refresh leadership and talent at various levels in the company.

Speaker 2

I'm happy with the progress and confident we have the right strategy, team and operating model in place to ensure our turnaround succeeds. 2nd, 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.

Speaker 2

And 3rd, 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 $800,000,000 and net debt reduction of over $900,000,000 from the start of 2023 shortly after I took over as the CEO. Following the transaction, which included $275,000,000 of new cash infusion, we expect to have approximately $330,000,000 of cash, net of all transaction expenses on the books compared to $197,000,000 as of year end 2023.

Speaker 2

With access to our $375,000,000 revolver extended to 2028, current available liquidity is over $700,000,000 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 twenty twenty four. In the Q4 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 Q4 posting the strongest finish in 8 quarters.

Speaker 2

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.

Speaker 2

For example, in our healthcare vertical, we won approximately $225,000,000 TCV business in 2023, including several new logos and over $100,000,000 TCV long term contract with a large hospital system. There's another nearly $700,000,000 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.

Speaker 2

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 3rd party colocation 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.

Speaker 2

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 run off over the next 2 to 3 quarters including the current quarter from customer decisions made more than 12 months ago.

Speaker 2

However, we expect our recent strong bookings and backlog entering 2024 to start converting to revenue in the second half of twenty twenty four. 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 where we are in their cloud journey, offering a full stack multi cloud solution spanning platform, applications, data and security.

Speaker 2

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've started seeing some early signs that the pivot is working with Q4 2023 services bookings growing 13% sequentially after a tough start to the year. Public cloud continues to also develop innovative new services and solutions.

Speaker 2

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 DBOps, 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 2 that adds new enhancements such as an increased level of services per tier and improved SLAs. In 2023, both the disruptions arising from a 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.

Speaker 2

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 twenty twenty four 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. For the course of the past year, we have transformed Rackspace into an AI ready organization.

Speaker 2

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 3 hyperscalers.

Speaker 2

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.

Speaker 2

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 our 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 6 to 9 months lag between bookings and revenue realization, we anticipate improving revenues and margins in the second half of twenty twenty four 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.

Speaker 2

We want to build momentum throughout 2024 that will put us on a growth trajectory entering 2025. Recent bookings trends 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 we wrap up, I would like to thank our customers, partners and all our Rackers. I am proud of all we have achieved together during this year of change.

Speaker 2

I will now turn it over to Mark Marino for an overview of our financial results and guidance.

Speaker 3

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.

Speaker 3

Specifically Rackspace closed a private debt exchange with an ad hoc group representing more than 72% of our 1st lien term loan holders and more than 64% of our 1st lien note holders, 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 1st lien noteholders in the coming days and close that in the next month. Through the private exchange, we eliminated more than $375,000,000 of net debt and received $275,000,000 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 $600,000,000 in total debt, reducing annual interest expense by more than $45,000,000 dollars 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 $800,000,000 and net debt reduction of over $900,000,000 dollars and reduction in annual interest expense by more than $70,000,000 Additionally, the maturities on the revolver and other participating senior debt facilities have been extended to May of 2028.

Speaker 3

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 delevers our balance sheet, while providing Rackspace with ample runway to accelerate our strategic growth initiatives. Now onto the results. Fiscal Q4 2023 results exceeded the midpoint of our revenue, operating profit and EPS guidance.

Speaker 3

In the Q4, total company GAAP revenue of $720,000,000 was at the high end of our guidance driven by strength in public cloud. Total net revenue was $413,000,000 down 4% sequentially and down 14% year over year due to declines in both private cloud and 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 $48,000,000 at the high end of our guidance and up 6% sequentially.

Speaker 3

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 $72,000,000 and free cash flow was $38,000,000 in the 4th quarter. Turning to our segment results. For private cloud, GAAP revenue for the Q4 was $285,000,000 which was at the low end of our guidance.

Speaker 3

This includes legacy OpenStack revenue of $29,000,000 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 1 percentage point sequentially, primarily due to revenue declines. Segment operating margin was 27%, down 2 percentage points quarter over quarter. In public cloud, GAAP revenue of $435,000,000 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.

Speaker 3

Gross margin for public cloud segment was 40% of net revenue, up 3 percentage points sequentially driven by cost savings. Segment operating profit was 21% of net revenue, up 5 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.

Speaker 3

Demonstrating strong cash flow management, cash flow from operations was $375,000,000 and free cash flow was $278,000,000 for the year. Normalizing for the impact of our AR securitization, full year 2023 cash flow from operations would have been $159,000,000 and free cash flow would have been $63,000,000 Total CapEx for 2023 was $181,000,000 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 7 percentage points year over year, driven by declines in revenue with a relatively fixed cost structure. Segment operating margin of 28% was down 8 percentage points year over year.

Speaker 3

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 7 percentage points driven by declines in revenue. Operating profit was 17% of net revenue, down 5 percentage points year over year. Now on to our guidance. As Amar mentioned, we are still managing through residual private cloud revenue runoff that will impact the first half of twenty twenty four and do not expect a major financial contribution from our new bookings and backlog until later in the year due to the typical 6 to 9 months lag between bookings and revenue realization.

Speaker 3

Also the 1st 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 Q1 GAAP revenue to be approximately $680,000,000 to $690,000,000 Total operating profit is expected to be $12,000,000 to $14,000,000 and loss per share of $0.12 to $0.14 From a segment perspective, we expect private cloud revenue of $268,000,000 to $273,000,000 and public cloud revenue of $412,000,000 to $417,000,000 Our tax rate is expected to be 26% and other income and expense of approximately $50,000,000 to $52,000,000 in expenses. The share count is expected to be around 221,000,000 to 223,000,000 shares. We expect profits to trough in the Q1 and improve throughout the year.

Speaker 3

We anticipate second half twenty twenty four 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.

Speaker 1

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. Our first question comes from the line of Frank Louthan with Raymond James. Your line is open.

Speaker 3

Hey, guys. This is Rob on for Frank. So beyond what you shared with us already as it pertains to the debt deal, are there any other significant covenants we should know about such as say restricted payments baskets? And then my follow-up is, is the new debt callable? And if so, when and at what rate?

Speaker 3

Thank you.

Speaker 2

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.

Speaker 3

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 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? Yes.

Speaker 3

Hi. So just relative to your first question there about the restricted baskets, 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 latitude and flexibility with those baskets and covenants.

Speaker 3

And then your second question?

Speaker 2

Is new debt callable? No. The answer is no. Did I answer your question?

Speaker 3

Yes. Yes. Thank you guys very much. 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.

Speaker 4

Hi, this is Ryan Campbell on for Ramsey. Thank you for taking my question today. In your prepared remarks, you mentioned the 6 to 9 month lag between bookings realization. And I was curious to see how that compared to a more normalized demand environment. And what are you seeing today that you confidence that this lag won't elongate any further?

Speaker 4

Thank you.

Speaker 2

Yes. I think the so thank you very much for the question, Ron. And the 6 to 9 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 fiscal Q4, where we grew sequentially 86%, grew 96% year on year.

Speaker 2

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 2023. So that backlog to convert to revenue typically takes 6 to 9 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 it, then that application and workload stays with us for the next 5 to 10 years. So that 6 to 9 month lag is mainly for backlog converting to revenue. Now in terms of sales cycles, I think that's where your question is.

Speaker 2

Listen, I think the demand environment continues to remain uncertain. Entering 2023 2024, we see 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.

Speaker 2

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.

Speaker 2

Was that helpful, Ron?

Speaker 1

Yes. Thank you.

Operator

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

Speaker 1

Thank you, everyone, for joining us. If we did not get your question or if you have a follow-up, please email us at irrackspace.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.

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Rackspace Technology Q4 2023
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