Q1 2022 Rackspace Technology Inc Earnings Call
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Good afternoon, and welcome to rack space Technologies first quarter 2022 earnings Conference call. As a reminder, today's call is being recorded Kevin Jones, our CEO and <unk> <unk>, our president and CFO join US today, the slide deck, we will reference during the call can be found on our IR web.
On slide two certain comments, we make on this call will be forward. Looking these statements are subject to 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 web.
Site.
After our prepared remarks, we will take your questions to queue up for a question. Please use the Q&A function in zoom.
I'll now turn the call over to Kevin.
Good afternoon, and thanks for joining us I'll discuss quarterly highlights and the strategic direction of our business then o'meara will go into detail on the financial results.
Turning to slide five.
Rackspace technology benefits from secular tailwind and a cloud market that continues to grow with no signs of slowing in.
In the first quarter, our cloud Hyperscale or partners all grew year over year revenue by 35% to 50% that represents $10 billion of new cloud revenue in the first quarter alone.
So cloud revenue continues to accelerate and the cloud Revolution is in the very early stages with winter still to be determined and plenty of white space to attack and.
And Rackspace technology remains well positioned as the leading pure play multi cloud services company.
In the first quarter, our financial results were in line with our guidance and expectations and we once again delivered solid growth profitability and cash flow.
On the new business front, it was a very productive quarter.
We renewed and strengthened our relationship with AWS and closed a major new deal with Vmware to support their global edge offerings.
We also just launched a new partnership with Nvidia, which I'll touch on in a moment.
We closed the acquisition of just analytics and began introducing their products and services to our customers globally.
And Rackspace technology was recognized as an industry leader in two major analysts reports that were published in the first quarter, including.
The ISG provider lens AWS ecosystem partners report, where we were named a leader in three quadrants.
And the ISG index, where we were named a top 15 sourcing standout in the breakthrough 15 category to the global Americas and EMEA regions.
Turning to slide six revenue growth was solid with total revenue up 7% and core revenue up 9% compared to last year's first quarter.
non-GAAP operating profit was $112 million and non-GAAP EPS was <unk> 22, <unk> both at the high end of our guidance range for the first quarter.
As noted on slide our first quarter bookings put us on track to achieve our targeted $1 billion of new sales bookings in 2022.
As we discussed with investors last quarter, Rackspace technology, and our board of directors, having carefully examining every area of our business Wayne the company's strategic options to increase shareholder value I'd like to share with you how we're thinking about this.
As slide seven notes, we operate in two very different multi cloud markets with different operating models growth trajectories and investment prospects.
On one hand.
Public cloud is riding a long term secular growth wave and as a services centric capital light product line, where we can make smart investments to capture additional white space and growth opportunities.
And on the other hand.
Private cloud and managed hosting is in a low growth market, where we're focused on optimizing profit and free cash flow.
Our strategy to maximize shareholder value is now coming into focus and we are therefore, considering reorganizing rackspace technology across these two markets.
We're also exploring other strategic alternatives as noted in our press release Omar will discuss this more in a moment.
We will provide shareholders with details as well as the growth drivers profit dynamics and long term financial model at an analyst day in September .
On slide eight you can see how the development of our partner network is essential and different and each of these two markets we.
We have painstakingly build our partner network to add value across the two operations and we worked to strengthen these partnerships every quarter.
On the west side of the slide in public cloud long term success starts with a strong relationship with the Hyperscale.
We must act as a bridge between the needs of our customers and the hyper scaler as we onboard an ever growing volume of new clients to the public cloud.
In this vein in the first quarter, we extended our strategic collaboration agreement with market leader AWS.
Additional multiyear period, which serves as a strong validation of the value we deliver to aws's ecosystem today.
It is also essential in public cloud to provide customers with up the stack functionality once they've migrated to the cloud.
Again as an example in the first quarter, we achieved premier partnership level with Snowflake.
In us one of their top 30 partners in the U S.
On the right side of the chart.
You see our key partners for private cloud and managed hosting.
Here strategic partnerships have served to provide upside through access to exciting strategic service Adjacencies.
As an example of the former in the first quarter, we launched our new private cloud relationship with BT and started onboarding their customers to Rackspace technology.
As a reminder, the BG deal was the largest and Rackspace technology's history with the potential for hundreds of millions of dollars of revenue.
We are encouraged that even in the early going we are seeing plenty of opportunity for further expansion of our relationship with BT.
Earlier this week, we announced that we are now certified to deploy in videos AI computing platform and we've been named an advanced technology partner and the Nvidia partner network.
We are excited about this new partnership with a leading technology company, which we believe will help us grow private cloud and facilitate development of highly compelling services for our customers.
Now, let's talk about the different ways, we support our customers.
On slide nine carrier global as a world leader in heating air conditioning and refrigeration solutions.
After spinning off from its parent company carrier was looking to modernize their infrastructure and existing applications.
We worked with carrier to transform the Iot technology that powers all of their connected thermostats and build a scalable robust cloud native platform that they could use as the basis for their entire connected device portfolio.
After this modernization effort.
Carrier reduce technical debt.
Increased security.
<unk> infrastructure provisioning time from 35 days to 30 minutes and reduced infrastructure cost by 45%.
On slide 10 profit near provides artificial intelligence powered software to help the fintech industry manage risk across identity credit and fraud.
Profit near had multiple micro services deployed in kubernetes clusters running in AWS.
But didn't have the capacity to quickly create monitors and dashboards.
Rackspace professional services helped proppant near integrate their software with data dog, resulting in enhanced visibility into their micro services and infrastructure, along with increased accuracy and consistency across multiple environments.
More importantly, we built automation into the process, enabling private near to launch additional monitoring and alerts for its applications and infrastructure.
Now having to write a single line of code.
Now Mark will take you through the financials Omar.
Thank you Kevin and thank you everyone for joining our call today.
<unk> 12, recaps, our financial results for the first quarter.
Revenue was 776 million, a 7% year over year increase.
Core revenue was $735 million up 9% compared to the first quarter of 2021.
non-GAAP operating profit was $112 million, which was at the high end of our guidance for the first quarter.
<unk>, 6% year over year.
Primarily due to the impact to gross profit from revenue decline in our legacy open stack and mature managed hosting.
non-GAAP operating margin was 14% and non-GAAP earnings per share was 22.
Both at the high end of our guidance for the first quarter.
Slide 13 shows the company's revenue mix in the first quarter by segment and by geography.
Multi cloud continues to represent the vast majority of our revenue at 83% of the mix and it grew 10% year over year.
Absent cross platform at 12% of total revenue was down 3% year over year.
As we have discussed previously year over year compares in this segment were impacted but the discontinuance of our noncore product line in 2021.
We lapped that strategic change in the second quarter.
Open stack declined 17% in line with our expectations.
This segment now represents only 5% of total revenue.
From a regional perspective Americas continues to represent 75% of our revenue and had 7% year over year growth.
APG grew at 32%, while EMEA grew 2% year over year.
Excluding currency impact EMEA growth would have been in the mid single digits.
On slide 14 in the first quarter operating cash flow was $65 million and free cash flow was $45 million, an increase from $38 million in the fourth quarter.
First quarter 2022 operating cash flow included the 2021 annual company bonus payout.
Total Capex was 31 million and cash Capex was $19 million with capex intensity of 4% and 2% respectively.
We expect total capex intensity of 5% to 7% and cash capex intensity of 3% to 5% for the full year in line with our previous guidance.
Cash at quarter end was $269 million up $71 million year over year.
On slide 15, I want to remind investors.
That we have a strong balance sheet with no material debt maturities until 2028.
In addition, all of our debt was refinanced in late 2020, and early 2021 at historically low rates with minimal financial covenants.
At quarter end total debt was $3 4 billion and net debt was $3 1 billion.
Our net leverage ratio of four three times. The adjusted trailing 12 month EBITDA is very manageable for a company with our growth profile.
On slide 16, we have our guidance for the second quarter. We expect total revenue in the range of 70 to 70 90 million core revenue in the range of 744% to $752 million non-GAAP operating profit of 93 to 97 million and non-GAAP EPS of <unk> 15 to 17.
Now let me provide you some additional color on our outlook.
As I mentioned last quarter, we expect revenue growth to accelerate through the year.
This is due to three main reasons first the ramping of BP related revenue in the third and fourth quarter.
Which will bolster private cloud and managed hosting within the multi club segment.
Second continued growth in managed public cloud as we have a growing pipeline of large opportunities in the multimillion dollars range that we expect to close in the second half of the year.
And third because of the investments we made in go to market. We have many new sales professionals that are ramping in the first half and who will become more productive in the second half of the year.
Now with regard to the operating profit and non-GAAP EPS.
The second quarter will be impacted by 15 to 20 million of investments that we're making to support growth acceleration and cloud services and the startup of our BT partnership.
These investments are primarily in cost of revenue and some in operating expenses.
They represent most of the divergence between our guidance and the current Street estimates.
Given the secular growth opportunity in the cloud market, we will prudently invest in long term profitable growth.
On slide 17 in closing I would like to recap and summarize what Kevin said earlier.
We operate across both public and private cloud we are the only pure play multi cloud services company that is addressing both of these markets at scale.
That said the market has evolved rapidly in the last 18 to 24 months.
We have been proactively evaluating all of our strategic options to take advantage of this opportunity.
To that end, we have taken a number of actions first we completed an in depth strategic review of the company.
Second we have a clearly defined strategy for the company across public cloud and private cloud managed hosting.
Could we are working on aligning our operating model and reorganizing the company to sharpen our focus in these two markets.
And food.
We're working to align our financial models and plans accordingly.
As we completed the strategic review and also based on inbound interest for one of our businesses.
We concluded that a sum of the parts valuation of Rackspace technology could be greater than our current enterprise value.
This is in part driven by the attractive growth profile of our public cloud offerings.
Accordingly, we are evaluating strategic alternatives and options.
We plan to share details on our strategy operating organization and long term financial model at an analyst day to be held in September .
With that we'll take your questions.
Joe. Please go ahead and queue up the audience for Q&A.
Thanks, Omar as a reminder to ask a question. Please use the Q&A function in zoom portal. Our tech team will promote you to a speaker on the webcast when youre up in the queue. Our first question comes from Bryan Keane of Deutsche Bank, and Ramzi <unk> Europe next.
Hi, guys.
Just wanted to ask about the margin profile I know, we talked about 14% to 15% EBIT margins for the year.
Just any update on that Omar and then and then on gross margins as well what's the outlook there.
Thanks, Brian .
You hear me.
Yes, I got you so yes, so Bryan as noted in last quarter's call.
They're willing to continue to guide the street one quarter at a time.
If you look at the Q2 guidance the midpoint of our guidance implies that the operating margins in Q2 up 12%.
But also keep in mind as I mentioned in my prepared remarks.
Within the second quarter, we do have growth investments of about $15 million to $20 million that impact operating margins by about 200 basis points.
You can place that our operating margin excluding these investments will be approximately about 14%.
Brian long term, we do see operating margins in the low to mid teens.
So thats and Thats, what our long term outlook is.
Got it out with regard to.
Go ahead, yes, let me just also let me also give you some color on the.
On the gross margins since you asked that question now when you look at our.
Q2 investments of $15 million to $20 million, Brian Maass.
Most of this investments primarily in cost of revenue.
To deliver incremental services growth in the second half.
And these investments are primarily in building out our delivery capability.
In both professional services and elastic and Juliet.
And so including this investments.
Gross margins within the continue to come to 9% range, but if I again exclude this investments we would still be in the 30% range for Q2.
Got it and just a follow up on the strategic review it sounded like there was an inbound inquiry that came in which business was that that got that inquiry is that a smaller piece of the business. A larger piece is trying to get a sense of what that business unit was thanks. So much.
Hey, Brian It's Kevin I'll I'll take the strategic question so.
So right now we can't provide specifics.
Due to the ongoing nature of our conversations both internally and externally.
And as I mentioned in my my.
My prepared remarks, we're we're addressing two markets that are very attractive and we're going to write or really organizing around those two markets but.
I can assure you in terms of strategic alternatives everything is on the table and we are evaluating all options, including this.
And down interest for one.
All of our businesses and we'll provide further information as.
And as appropriate in light of developments.
Great. Thanks for taking the questions. Thanks, Brian Ramsey El <unk> from Barclays Capital, Your App and Frank Louthan Youre on deck.
Okay can you guys hear me okay.
Hey, Ryan, Yes, Hi, Hi.
Hi, Thanks for taking my question.
I was wondering if you could give us some color on the demand environment I guess, just given the more kind of challenging macro backdrop are you seeing any impacts out there on client decisioning.
Any color there would be helpful.
Yes sure thing so let me take that one I'll talk a little bit about.
The.
The economic environment in General and then I'll.
Transitioning to the demand environment that we're seeing I would say.
Say just kind of upfront.
While there are near term headwinds in the economy.
Such as.
Supply chain disruption the worn Ukraine, we do not see any recessionary pressure in this business.
If you just think about it our Hyperscale partners grew cloud revenue by a record amount over $10 billion in the first quarter. So.
Cloud is really only accelerating even in the challenging economic environment. We've seen so far this year now if the economy does.
But in a recession, we think that multi cloud becomes even more of a must have for customers because it helps customers save money quickly scale up or scale down and changed our business model and we saw this in early 2020, when the economic slowdown caused by Covid and resulted in acceleration of demand for.
Digital services and multi cloud, so and thats the economic.
The broader macroeconomic picture and how it relates to our business now.
Just look at the demand environment, Let me give you a little bit of color on how I see the demand environment and I'll start out with the market.
And then I will go through.
What we're hearing from customers and partners.
Now the market.
<unk> really is very strong we believe that at this point only 10% to 15% of workloads have been moved to the cloud.
So there is many years of growth runway ahead.
And <unk>.
Our view is that will result in lots of opportunity for migrations and integrations and managed services.
So that's one piece multi cloud continues to be really the overwhelming choice.
For customers that are moving to the cloud.
And as the hyper scaler continue to innovate there innovating at such a pace.
The choices now really abundant in the market for customers and customers need firms like Rackspace technology to help them make the right decisions for their cloud environment. So.
So thats another piece and then we see lots of desire.
For innovation beyond infrastructure and to the apps and data layers of the stack in particular, yes.
And we are seeing is industry industry specialization is becoming a trend and a lot of areas and from a geographic perspective.
Demand for multi cloud services continues to pick up pace all over the world, particularly in Europe .
In the UK and Asia, and the South Pacific.
Latin America and of course, the United States. So that's the market now from a customer perspective.
It's quite interesting.
Just with the.
A large health care CEO last week, and they're a big customer for <unk> technology in a multi cloud customer and.
And the CEO told me.
Thank goodness Frac states handles cloud for us the complexity of multi cloud really is mind boggling.
And Rackspace takes all that office play and the other thing you said and I keep hearing this over and over from other customers as data.
Data is becoming a huge differentiator and healthcare and customers are saying.
We want to increase the pace of innovation, both in cloud native data and cloud native apps and we hear this from customers and a lot of industries now the data and apps innovation is important to them and a focus of.
They are becoming more competitive.
And then finally just to wrap up from a partnership perspective right the demand for the Hyperscale there's products continues.
What I would say, it's a breathtaking pace now as with all three hyper scaler last week and the demand for cloud continues to be amazing and AWS, Google, Microsoft Theyre, adding giant giant amounts of sales and revenue every quarter. It's unlike anything I've ever seen in my career and when I talk to my <unk>.
<unk>, Dell and Vmware and big demand from customers for private cloud and multi cloud as well. So our partners. All tell me, we need Rackspace technology, we need racks that helped make sure. These customers have the very best services partner to help them on their cloud journey. So overall Ramsey I'd say.
Very strong demand environment.
Extremely encouraged by the opportunity.
Great. Thanks for the detailed answer ill back in the queue. After that one thanks for taking my question Sidney.
Thanks Ramsey.
Our next question comes from Frank Louthan, with Raymond James and Bradley Clark you are on deck.
Great. Thank you so maybe got a little more detail on the dip that you're forecasting here for the operating income in Q2, what's kind of causing that sequential decline and then if you don't end up selling the whole the whole company give us a little more color on what does it look like what sort of things will you be adjusting.
Going forward in areas, you think needs some more help thanks.
So I'll take the first question and then Kevin just the next one.
So ramsey in terms of the debt.
Sequential dip in our operating profit and all that did about $112 million in Q1.
It's gone down to about $95 million.
In Q2, that's the midpoint of our guidance and Thats, mainly the investments that we're making Frank.
In the in our business and it could take a look at the investments and I'll give you some additional color on where we.
We're making those investments.
Investments in three areas they posters.
We are making investments as I mentioned earlier to expand delivery capacity for professional services and elastic in engineering across all three cloud platform. So that includes AWS.
<unk>, which is Google as well as to Microsoft Azure.
We are also making some investments plank in our go to market organization.
Third we are making some investments which are mainly startup investments as we ramp our BT accounts and BT is expected to reach full run rate revenue by the end of second half.
And so.
As I mentioned earlier most of these investments are in cost of revenue in Q2.
And so this is basically creating.
The decline in operating profit going from Q1 to Q2.
Mainly the reason.
Okay. Good.
Yeah.
The second question that you had Frank around how are we going to kind of reorganized and manage the business in the company.
Yes, just a little bit of backdrop, we operate.
I would say a very attractive multi client market Ryan it spans across both public and private clouds and as we talked about we're the only pure play multi cloud services company. That's addressing both of these markets at scale.
Having said that when you look at the market.
And the markets evolve and its all pretty rapidly in the last 18 to 24 months.
And we have a public cloud business that is.
Significantly scaled from 18 months ago.
And we've been proactively evaluating all of our strategic options to take advantage of this public cloud.
Market opportunity and sharpen our focus so public cloud and private cloud that got very different business dynamics, we talked about on the call. You also require a very different skill sets and levels of investment demand and so and we are basically developing a plan to best align our resources with these findings.
And what we're gonna do Frank.
Analyst and Investor Day in September we'll provide additional details on what this looks like both from an operational standpoint, and a financial standpoint on a go forward basis, but hopefully that gives you some color.
Okay, great. Thank you.
Thanks, Frank Bradley Clark from BMO capital you're up next.
At Roswell after that.
Yes.
Hi, Thank you for taking my question Jeremy.
Two parts here first I wanted to ask the incremental investments in the June quarter.
Focused around expanding delivery capability and debris Tia couch more broadly.
Potentially when other large deal dramatically multimillion.
Dollar opportunities in our pipeline in the second half how do you think about.
The incremental investments that Keith wanted to deal with I'm going to take and the idea of that.
With every.
One of these large deals.
More incremental investment that's not already in the model or are you investing more show ahead of time, so that 10.
10 to 15 million, but come into Washington Wash over time, and then part two of the question I wanted to ask about pricing.
In an inflationary environment with higher wage inflation.
The operating environment may be different than some other companies, but are you having pricing conversations with your customers.
Potentially offset from higher wages and expenses.
Any comments you can make it up on the strategy there. Thank you.
Yes, So let me let me take the first one alright. Thank you very much for asking the question.
So give you a little bit of more specifics on investments so you're absolutely right, we are making investments.
Ahead of the demand that we are seeing mainly in folks services as you know there's a lot of demand in cloud services. So this $15 million to $20 million of investments, we're making in Q2 will also carry forward into Q10-Q, four but it will be a run rate costs, but it will be supported by incremental revenue right. So you've got to build ahead of the demand that's what we have.
Doing well.
As we see more growth opportunities, we may prudently and make additional investments to capture further growth and these investments will be primarily in cost of revenue to build capability in advance of the services demand that we're seeing in cloud and we will continue to update the street. If there is any change to our investment outlook per se.
So it's a very dynamic market, we see a lot of demand as Kevin talked about and it is very prudent for us to continue investing in capturing those demand because as you know services is a very sticky business and it has.
Very high recurring revenue base too. So these are these are the types of investments we make to continue driving profitable growth in the business.
Now regarding your second question on pricing.
Interesting question.
If you look at and I will have Kevin jump in here too.
We are not having kind of a pricing pressure so to speak from our customers.
The markets that we play in and cloud services.
It is application migration.
Or modernizing of those applications are you when data migration and data ops. These are very hot areas of the market today.
<unk>.
It is sometimes difficult to find skills in those markets. So we do not see a lot of pricing pressure. We are also not a very labor will not have a very labor intensive model so to speak.
We have in our.
Our key differentiator.
Is combining labor with automation and we have talked about it at length in the past that we have driven about 75% of automation on the on our on our workflows and so that's the reason why we did not see a lot of pressure on the pricing side.
And on the on the labor cost side, because we're not a very labor intensive market.
So when you want to add anything here.
You said I think you said it really well, yes, we are.
Bradley we don't have.
Nearly as many employees there is a lot of <unk>.
Arms out there in the market. So we don't have that same exposure.
Two to the labor inflation that's happening.
And the broader economy.
And yes, we definitely don't see any pricing pressure per stay and where it makes sense, if we're delivering more value.
Makes sense.
For us to reflect that additional value in and our pricing then we certainly are happening those conversations.
<unk>.
But in general it's not as much of a factor in our business, particularly because were.
Sure.
Automated we've got 75% of our multi cloud transactions automated highest automation in the industry and really are technology and automation driven business if that makes sense.
Thank you very much.
Thanks, Brad.
Our next question comes from Matt Roswell at RBC Capital markets go ahead, Matt.
Okay.
Matt Roswell are you there.
Yes, Hello can you hear me, yes, we can hear you now sorry about that.
I was wondering to follow up on the investments and I apologize for this I was wondering if you would be willing to kind of bucket how much of them are going into the three areas I E. The cloud investments to go to market and for <unk> and I think you just said, what we should kind of expect the same level into the third and fourth quarter.
When would you expect to see kind of the revenue return on the investment.
Yes, So let me start with the last question first the revenue return on the investments that typically fast.
And those.
Three to 12 months three to six months, so very fast return on the investments because we need to build.
Delivery capability ahead of the services that we can deliver the services for our customers now in terms of giving you a little bit additional color on the investments.
And then mentioned most of the investments are in cost of revenue. Okay. So when you take a look at our investments.
I would say.
75% to 80% of those investments are roughly in cost of revenue and the balance is in opex and the 75% to 80% of that.
Investments are.
Into hiring professional services resources.
Social for elastic engineering et cetera, So that's where our investments are going so opex investments are mainly in go to market as we continue to expand our go to market and some in starting up <unk>.
Environment.
Thank you and if I could sneak in a quick one how should we think about cash.
Cash conversion in the second quarter.
So I was just talking about cash conversion in general.
No.
As you know we had a very strong cash flow year in 2021 with all the improvements we drove.
And those improvements are very sustainable and long term we expect.
Cash flow from operations to track to anywhere between 60% to 70% of our operating profit for example in Q1, our operating cash flow was quite solid at $65 million, which was at about 58% of our operating profit, but also keep in mind.
First quarter is typically.
The seasonal low for cash flow as it is a quarter in which we pay employee bonus. So there was a big cash payout from an employee bonus perspective, So I would say if you if.
If you're tracking to 60% to 70% of our operating profit.
Conversion to cash flow from operations I would say the quality of earnings.
I consider a very high quality earnings now our cash Capex is also going down.
And Matt.
Cash app cash capex should be anywhere between 3% to 5% of our revenue and that.
The Capex intensity continues to go down so which means our free cash flow margins should be really good.
Okay. Thank you very much as a comment overall overall for fiscal 'twenty two.
Okay. Thank you.
Thanks, Matt.
We haven't had anyone else queue up so we'll shut it down there I want to thank everyone for joining us.
If you have a follow up please give me a shout at IR at Rackspace Dot Com and we will talk to you soon.