Q3 2022 Rackspace Technology Inc Earnings Call

November 9, 2022

Okay.

Good afternoon, and thank you for standing by welcome to Rackspace Technologies' third quarter 2022 earnings Conference call. At this time all participants are in a listen only mode. After the presentation. There will be a question and answer session.

To ask a question during the session you will need to press star one on your telephone.

Please be advised that today's call is being recorded I would now like to hand, the call over to Robert Watson Vice President of corporate Finance. Please go ahead.

Thank you and good afternoon, I'm joined today by Tomorrow military our Chief Executive Officer. Please note that we have made some changes to the supplemental earnings materials, we provide including a revised presentation and an excel factsheet. These materials as well as a replay of today's call can be found on <unk>.

Our Investor Relations website.

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 branch based 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.

I will now share our third quarter financial results and then turn the call over to Omar for an update on the business.

And the third quarter, both revenue and core revenue exceeded the high end of the guidance. We provided on our Q2 call in August and reiterated on September 26th with the CEO announcement.

Total revenue was $788 million, which represents 3% year over year growth on a reported basis and 5% growth in constant currency, we continue to experience material currency headwinds from our Europe business.

Core revenue was $751 million, which grew 5% year over year on a reported basis and 7% in constant currency.

Revenues in EMEA grew 8% in constant currency driven in part by the continued ramp of the BT contract, but declined 1% on an as reported basis.

Americas grew 3% in APG grew 24% on an as reported basis and experienced minimal FX impacts.

non-GAAP operating profit of $80 million also exceeded the high end of our third quarter guidance.

Was down 36% year over year, primarily due to reduced gross profit from the ongoing revenue decline in our legacy open stack and managed hosting private cloud businesses non.

non-GAAP operating margin was 10% and non-GAAP earnings per share was <unk> 10.

Operating cash flow of $71 million and free cash flow of $52 million were positive for the seventh consecutive quarter driven in part by our continued focus on managing working capital as a reminder, Q4 is a seasonally low cash flow quarter for the company.

Capex in the third quarter was inline with expectations with total capex of $31 million in cash capex of $19 million Capex.

Capex intensity was 4% and 2% respectively.

For the full year, we expect to be within our targeted capex intensity range of 5% to 7%.

We ended the third quarter with $249 million of cash and our $375 million revolver remained undrawn, resulting in total available liquidity of $624 million at quarter end.

Also note that the company recorded $464 million of noncash impairment charges in the third quarter.

The primary driver of these charges was a goodwill impairment in our multi cloud segment.

Additional details of these noncash expenses can be found in our press release and SEC filings.

And lastly, I will provide our guidance for the fourth quarter. This guidance reflects some caution related to an uncertain macroeconomic environment and continued foreign currency exchange headwinds.

We expect total revenues in the range of $772 million to $782 million core revenue in the range of 738% to $746 million non-GAAP operating profit of 65 to 69 million and non-GAAP earnings per share of 4% to six.

I will now turn the call over to Omar Thank.

Thank you Robert I'm excited to lead Rackspace technology into its next chapter as a customer first cloud first company.

Since being appointed CEO I have been focused on having an honest dialogue with our customers partners and employees.

It is clear that our customers need our help and they want us to win.

And we have a world class partner ecosystem and talented employee base with ready to serve them.

I remain confident in our strategy and firmly believe we are implementing the right operating model to execute on the market opportunity in front of us.

As I shared during my September 26th Investor update it is critical that we quickly improve our execution focus and accountability across the organization. So let me share some early actions and progress.

First.

I know, we need to rebuild our credibility as a team.

Im pleased that in the third quarter, we delivered revenue and profitability above our guidance.

Looking ahead, we followed our normal guidance process, but we are adding some caution to reflect the uncertain macro outlook.

We intend to build a track record of meeting and beating expectations.

Second.

I've made a few changes to my executive leadership team and we will continue to evaluate additional adjustments to position our organization for success and ensure alignment with our go forward operating model and priorities.

Third I am pleased that Shang salmon will be stepping up as the lead director for our board.

Shashank is a dynamic seasoned executive with specializes in that digital technology services business and the cloud market.

<unk>. Most recently served as President and Chief Executive Officer of Global logic.

Taxi group company.

Under his leadership global logic scaled to one 5 billion in sales as the leading brand in the digital transformation space.

In early 2021 global logic was acquired by Hitachi at an enterprise value of $9 6 billion.

Prior to global logic.

Our leadership positions at NES IBM and HP.

The entire company will benefit from his increased engagement and broad experience in cloud and digital businesses.

And lastly, we continue to make good progress on our realignment into two business unit structure and are on track to begin operating in this new structure on January 1st 2023.

Looking ahead, we know that 2023 will be a transition year with a lot of heavy lifting.

Already realized significant cost efficiencies over the last two years.

We will continue to streamline expenses, where we can but we are now repositioning rack space for profitable growth.

This is my mandate from the board.

Two rack spaces advantage, we addressed two distinct markets with strong unmet demand for the innovative solutions and services we provide.

As we have stated many times before we expect the demand across our multi cloud offerings to remain strong, but we have to step up our execution and focus so we can see that.

Public cloud operates in a hyper growth market with significant white space.

For Rackspace to achieve our goals in this market, we must sharpen our solutions development focused by launching value added and operationally scalable services.

We are making progress we will continue to make organic investments. So we can move even faster.

Going forward, we will not lead with infrastructure resale, we lead with higher value solutions and services in public cloud and with a deeper customer engagement.

Our new operating model will ensure that we emerge from 2023 with a public cloud organization focused on the high value opportunities and there's a wide open market space.

And hosted private cloud, including bare metal managed hosting the market opportunity is more significant than many may appreciate today.

We estimate that over 60% of workloads as til in customer data centers, and many will move to either public cloud or hosted private cloud over the next few years due to cost advantages.

<unk> operational complexity and fewer resource constraints among many other factors.

We find that many of these workloads are better suited for hosted private cloud. Examples include workloads in regulated industries, such as government and healthcare legacy applications that are too expensive to be re factored for public cloud and data and performance intensive workloads.

And Rackspace is uniquely positioned to win in the private cloud market.

We are a well known brand with deep experience in private cloud a global data center footprint cutting edge technology, and IP and strong partnerships with key ecosystem players such as Dell and Vmware.

And while we are still in the early innings of a push to revitalize and arrest the declines and our managed hosting and private cloud business. We are seeing early signs of progress.

For instance, we recently signed one of the largest hosted private cloud deals in the history of the company.

This is a multiyear commitment that provides a glimpse into the promising market opportunity in private cloud.

We're also launching industry specific private cloud offerings for example in health care, which are already driving good pipeline generation.

And finally in September we launched direct space accelerated migration program.

This industry, leading program is designed to help customers move their workloads from on Prem or Colo facilities into Rackspace private cloud.

It has been several years since we've seen this much activity and traction in private cloud.

An encouraging trend, which we are working hard to capitalize on with new and innovative solutions.

Before I conclude I just want to remind everyone on what gives me the confidence that we will turn this company around.

First we operate in two multibillion dollar markets.

Private cloud and public cloud and both are growing.

As I often see we're in a great neighborhood.

Second our core revenue basis over 90% recurring it includes a large diverse customer base with more than half of the fortune 100 companies.

We truly have a phenomenal base of customers, who need our help and want us to succeed.

Third we have roughly 7000 dedicated reckless with more than 11000 technical certifications will collectively make up our unique rekha culture.

Rackspace is truly a great place to work and we will continue to invest in our people.

Fourth we have strong deep relationships with World class partners in both public and private cloud we continue to strengthen our long standing relationships, while also developing partnerships in new cutting edge cloud technologies.

And finally, we have a well respected brand in the tech market based on our long history of innovation.

In closing there is a lot of work ahead of us and the path will certainly not be easy.

But I truly believe the actions we are taking will position our business for sustained growth.

Stability and success in the years to follow.

I look forward to sharing more on our strategies and financial aspirations in the future.

And with that we'll take your questions.

Thank you at this time, we will conduct a question and answer session. As a reminder to ask a question you will need to press star one on your telephone and wait for your name to be announced please standby, while we compile the Q&A roster.

Our first question comes from Kevin Mcveigh with Credit Suisse. Please go ahead.

Great. Thanks, so much and congratulations on the results tomorrow.

Obviously, there is a lot going on in terms of the transition.

I Wonder can you give us a sense as you think about 2023.

And you've repositioned the business across the two new segments.

Are you starting at the same base of revenue.

Or should there be some shrinkage and if.

Maybe some sequencing on margins just so we can get a couple of goalposts and I know, it's still a little bit early but just try to frame that a little bit.

Yeah, Hey, Kevin.

To hear your voice and thank you for the question you're absolutely right Kevin.

Difficult as you can imagine right to provide guidance for the full year.

Given the number of macro and micro changes that we're experiencing but let me give some color.

First there is as I mentioned in my prepared remarks, there is a macro uncertainty, which may lead to sort of longer sales cycles as well as a slowdown in decision making in 2023.

Second to improve our execution, we are making some tough choices here.

And also implementing operational changes over the next couple of quarters that will position the company for sustained profitable growth. While this will be reflected in our numbers. So these choices Kevin.

Deemphasizing infrastructure resale and shifting the mix of our pipeline and bookings to higher value services and solutions. So this takes time, but as you can imagine this is the right thing to do for the business.

It will enroll refocusing our go to market organization and in some cases also rebuilding certain areas.

And more importantly will also have been very targeted investments and solutions development such as industry verticals.

As we get to the end of 2023, Kevin we'll start to see the benefits of our reorganization and also our execution focus and we are seeing some really encouraging pipeline development and bookings, but it is still early and the business that we can close.

You know can take about six or nine months to materialize into revenue.

So with that said.

Although the outlook for next four quarters is really tough.

Given the near term is tough, but based on what we have seen for example, macro uncertainty as I mentioned earlier.

Result in potentially longer sales cycle operating model changes that may lead to some disruption the de emphasis on infrastructure retail that I mentioned earlier as well as some continued FX headwinds, we expect Q1, which is seasonally down quarter, because youll have some usage based volumes in our managed public cloud seasonally goes.

We expect revenue to be sequentially down between one 5% to 2% as a result of all those factors that I mentioned.

Does that help Kevin.

It helps a lot and then just.

Maybe just this is a two part but I'll ask it.

Really nice to see Shashank, it sounds like not only <unk>.

Elevated to the board, but by $2 $5 million of stock, which is really nice signal.

Is there any way to think about the bookings.

Margins.

For Q4, just within the context and again very helpful. On the sequencing of the revenue for Q1.

Sure so.

On bookings for Q3, let me give some color here, Kevin I'm actually very pleased to see a favorable mix shift in the bookings to.

So more of a higher value and higher margin business away from infrastructure resale.

So as you know infrastructure retail bookings come at low margins. So this shift in focus to higher margin services and solution bookings was by design and so I'm pleased that we're making that shift.

Fact of public cloud services bookings were up year on year and included about 17, new public cloud services customers and also a large expansion deal with a major media and communications company in Europe . So we're pleased with that of course, the base of the public cloud services business is smaller compared to our infrastructure retail Saar.

Our focus is on growing the services bookings space more quickly.

And on the private cloud side as I mentioned in my prepared remarks, and I'll give some color. There we had a strong very strong bookings quarter, and which was largely driven by this large private cloud deal and I will talk a little bit more about it but we continue to gain traction in both pipeline and private cloud as we grew our focus there.

Now on the since you asked about the bookings question that I referenced.

I referenced the large private Colby, let me give some color there. So if you understand the dynamics here.

This private cloud deal is one of the largest deal in the history of the company.

And these are a couple of hundreds of millions of dollars of GCB or five years in fact with the customer in the technology sector.

We offer a very compelling value proposition to the customer.

These were stable.

<unk> intends to analytics heavy workloads, which are better suited to operate in a private cloud environment. In fact, rackspace was able to offer a solution that significantly lower the cost while delivering improved performance in both storage and compute.

So this is particularly a large opportunity Kevin but it is a representative of the types of deals will begin to see in our managed hosting and private cloud business. As a result of multiple things we have a very strong brand in this market great market presence, we have the scale and we will also see an increased focus.

Two business unit structure.

Very helpful. Thank you Omar.

Thank you one moment for our next question.

Our next question comes from Amit <unk> from Evercore. Please go ahead.

Thanks for taking my question up too as well.

Thank you.

I was hoping if you could just talk about when you look at the desktop your debt structure right now.

Just talk about how much of this floating versus fixed and then more importantly, given the compression in margins that we've been seeing.

Could you just talk about what are some of the covenants and the leverage metric that we should be aware about lifestyles.

Okay, Amit good to hear your voice by the way Youre not coming across very clear, but I caught it just took a question you wanted to basically is our debt structure looks fixed versus variable and the covenant on it right. So let me start with the covenant first.

We have minimal debt covenants after the debt refinancing that debt in early 2021. So when I arrived we have number 2020, we took advantage of the of the very favorable debt market and refinanced our debt in 2021.

All of this debt not view further six or seven years.

We have to see.

<unk> secured note, which is at 335%.

We have a term loan b, which has.

Available component to it and that we have are not.

Startups for non secured note, which is at five 375% so.

A very variety of the debt structure.

I think I'm, not sleeping and not losing any sleep. So to speak are servicing this from an interest expense perspective, and as you know based on the.

The rates right now, it's a very attractive.

Pricing right now on the debt side, so minimal debt covenants.

A wide variety of.

Interest expenses on this but overall I think it is very manageable interest expense given that.

Most of this debt.

Two of those notes are actually fixed interest rates.

Hello.

Yes, no that is very helpful. Thank you for that.

Let me just follow up.

Simba quarter guide right, maybe just something on the more near term site you started talking about flattish revenues on a year over year basis, I think right on total number maybe just talk about how much of the FX headwind that you're seeing in the December quarter numbers on a year over year basis, and then how is the macro impacting you'd think of in the December quarter I am wondering.

Deal push out deals getting delayed just any clarity on that.

The macro and FX and how that's impacting your December quarter, yes, it would be helpful.

I think I think you have covered.

The key points there.

Amit So let me start with the macro right. So we.

We took our revenue headset.

Primarily in services and also a bit in the usage based volumes that come through our managed public cloud business, mainly due to macro outlook. Okay.

And the macro outlook.

As you know we.

But when you take a look at what's going on from a demand environment et cetera, and all companies in the cloud ecosystem are being cautious about the demand environment and rightfully. So given the tough macro outlook in fact, a hyperscale as a caution at the growth rates are slowing although they are still growing double digits and we do believe that come.

<unk> will maintain their current spend on mission critical projects, but slow down spending on lower priority less typical projects and this of course varies by customer and verticals, but broadly speaking Amit customers will be focused on.

On cost optimization as well as on projects that have a faster payback period.

And.

I've done this a long time and I've gone through these cycles multiple times and it's not unusual expects of the changes in the size and scope of the deals longer sales cycles and also a slowdown in decision making.

So we have factored those in when we guided so typically you would see us revenue either be flattish or up sequentially.

Direct to a sequential decline in revenue because of that FX continues to remain a headwind. It was I think two percentage points of headwind in Q3. We are also taking a look at our October numbers that are coming in now.

Have any color right now, but we have factored in the FX equity, it's very difficult to predict but we did factor some of the FX headwinds and we did that in Q3, two so we're not changing the way we guide when it comes to FX.

Perfect. Thank you.

Thank you one moment for our next question.

Our next question comes from tension Huang with Jpmorgan. Please go ahead.

Hey, Thanks, so much and it's good to have a track record here from the with these results I wanted to ask if you don't mind on also on bookings and because we've been hearing me through this results season.

Our clients as well as vendors are being more careful around the gross profit.

Our margins around new contracts.

Award activity.

Are you seeing that manifest itself in some way in your business are you may be seeing a shift in need to spend a little bit more in terms of capital intensity to win.

I'm just curious if youre already seeing that and that that's a factor with your selectivity on winning business on the bookings side.

So it'll I think.

Thanks for the question. So there are two parts of our business like we are a multi cloud provider tension we have public cloud and then also we have private clouds.

And I can tell you let me just public cloud demand continues to remain strong.

To believe that.

As we go through this process.

<unk>.

The tech demand in multi cloud will remain but it may start moving to the right and we have seen that happen.

And down cycles.

<unk> multi cloud business, but in other businesses.

To be honest of extended market is taking a pause it comes at a good time for us to go complete the reorganization exercise exercise et cetera.

Get ready when the customers are critical normal spending levels and we'll be prepared to capture the demand with newer offerings and operationally realigned organization. So for us on the on the public cloud side customers are looking for.

Cost optimization.

Note that multiple.

Most of the Hyperscale is talking about it we're also seeing that and so we do have cost optimization services that we deliver today, we are going to expand those offerings. They want to lead with those offerings. So that we start building relationship with our public cloud customers would need help on optimizing the spend on public cloud, but the service.

This business the demand still remains but the sales cycles will be longer as you know to go and as you are making the pivot from say infrastructure resale two services.

Takes time for us to build the services pipeline and but it's all doable and the focus will help us to start building those pipeline fast so on the public cloud side I feel I think we have a.

Good opportunity to pursue on the private cloud side. Many many have thought that the private cloud.

I'll just give you. An example, I've been in this job for 45 days and I've been on the road for 40 out of the Spotify base and are talking to customers partners and employees.

And the biggest surprise for me attention is there is an ample demand signals out there.

The issue is we have not been listening carefully we need to better listen to those demand signals and you'd be surprised how much of opportunity. There is in the private cloud space, which has been underestimated by the company as well as the market.

So I feel that if we are focused on a couple of industry verticals. For example, regulated industries like healthcare on the commercial side industries like technology I think we are going to do quite well in private cloud. So stay tuned we haven't or we are going to launch a lot of offerings in this area in the next six to 12.

Months or even before that but we are definitely seeing traction in private cloud and public cloud remained strong despite the slowdown in growth from the Hyperscale us.

Yes.

Got you thanks for that I appreciate the hard work as well thanks.

Thank you as a reminder to ask a question. Please press star one on your telephone one moment for our next question.

Our next question comes from Nate <unk> with Deutsche Bank. Please go ahead.

Hi, guys. This is Nate on for Brian I, just wanted to ask about sort of gross margin expectations in the fourth quarter and sort of the right way to think about modeling margins into next year. So I think at the end of our last earnings call. You had snuck in some comments that you expected gross margins around 26% in the fourth quarter in mid twenties for fiscal 'twenty three.

The check in to see if there's any update to that thinking or if those numbers still hold.

Yeah. So thanks for asking the question now given the mix of the business needs to be projecting in Q4 after taking the effort etcetera, we still expect the gross margins to be between 25, 5% and 36% for fiscal Q4. Okay. So that is that is actually not changing.

Now when it comes to gross margins.

For our fiscal 2023, you've seen at my mandate from the board is to turn this business around and alignment to the strong growth markets that we address today, so I'm not going to manage to and other create near term targets since I'm driving a transformation. So in 2023, we're going to make some tough decisions and set us up well for <unk>.

<unk> 2004, and as I mentioned to tension with demand signals remain strong and with extended market is taking a pause. It comes at a good time for us to complete this reorganization that we are undertaking today.

And so just as a reminder, right our gross margin pressures are almost entirely a function of the mix of the business and so as we turn the business around.

As we stabilize the private cloud business start growing the services component of our public cloud, we will see improvement in our mix that will drive gross margin accretion, but similar to revenue. It is difficult to know exactly how the mix will play out in the next few quarters.

Now I can also tell you from an Opex standpoint, we plan to keep it roughly flat year on year and we'll continue to monitor monitor it. So we have a very very tight control on our expenses. We have cost efficiency programs that we are running that will continue to run and we will keep a tight lid on expenses as we close with this.

Macro environment and also the macro changes that we're making the company.

Got it that's very helpful. And then just my follow up was on <unk>. So is there any updates or color you can give beyond sort of the high level comments that were given in the prepared remarks. So I think last quarter. You had mentioned it was sort of ramping slower than you.

You had hoped for but it seems like maybe thats turnarounds or any way to any way to quantify that impact or any sort of broader qualitative color you could give on beauty would be great.

So let me give some qualitative color here.

On BT. So when you look at the BT deal.

And probably we will explain this in the past two distinct phases in the BT deal.

First is the customer Onboarding phase we are currently operating in the first phase Onboarding over 200 marketing customers. We have made some good progress on transitioning customers since our last update last quarter.

The second phase is I call that as a transformation phase, where we can transform a customer's environment by moving them to the rack as private cloud solutions and this will create significant value for them.

As well as for Us and when I talk about our partnership with BT will great partnership with BT border companies PT and rack space are working well together, we are aligning our product and solution Roadmaps, we will collaborate on bringing the best value to the market through this newly developed joint solutions.

That we are launching.

I appreciate the color. Thank you.

Okay.

Thanks.

Thank you I'm showing no further questions at this time I would now like to turn it back to Robert Watson for closing remarks.

Thanks, Andrea and thank you everyone for joining us if we didn't get to your question or you have a follow up E mail at IR at rack space Dot Com have a great evening everyone. Thank you.

Thank you for your participation in today's conference. This concludes the program you may now disconnect.

The conference will begin shortly.

To raise your hand during Q&A you can dial star one one.

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I'll ask a question during the session you will need to press star one on your telephone. Please be advised that today's call is being recorded I would now like to hand, the call over to Robert Watson Vice President of corporate Finance. Please go ahead.

Thank you and good afternoon, I'm joined today by EMR voluntary our Chief Executive Officer. Please note that we have made some changes to the supplemental earnings materials, we provide including a revised presentation and an excel factsheet. These materials as well as a replay of today's call can be found.

On our Investor Relations website.

I will now share our third quarter financial results and then turn the call over to Omar for an update on the business.

In the third quarter, both revenue and core revenue exceeded the high end of the guidance. We provided on our Q2 call in August and reiterated on September 26th with the CEO announcement.

Revenue was $788 million, which represents 3% year over year growth on a reported basis and 5% growth in constant currency, we continue to experience material currency headwinds from our Europe business.

Core revenue was $751 million, which grew 5% year over year on a reported basis and 7% in constant currency.

Revenues in EMEA grew 8% in constant currency driven in part by the continued ramp of the BT contract, but declined 1% on an as reported basis.

Americas grew 3% and APG grew 24% on an as reported basis and experienced minimal FX impacts.

non-GAAP operating profit of $80 million also exceeded the high end of our third quarter guidance.

Was down 36% year over year, primarily due to reduced gross profit from the ongoing revenue decline in our legacy open stack and managed hosting private cloud businesses non.

non-GAAP operating margin was 10% and non-GAAP earnings per share was <unk> 10.

Capex in the third quarter was in line with expectations with total capex of $31 million in cash capex of $19 million Capex.

Capex intensity was 4% and 2% respectively for the full year, we expect to be within our targeted capex intensity range of 5% to 7%.

We ended the third quarter with $249 million of cash and our $375 million revolver remained undrawn, resulting in total available liquidity of $624 million at quarter end.

Also note that the company recorded $464 million of noncash impairment charges in the third quarter.

The primary driver of these charges was a goodwill impairment in our multi cloud segment additional details of these noncash expenses can be found in our press release and SEC filings.

We expect total revenues in the range of 772% to $782 million core revenue in the range of 738% to $746 million non-GAAP operating profit of 65 to 69 million and non-GAAP earnings per share of 4% to six.

I will now turn the call over to Omar Thank.

Thank you Robert I am excited to lead Rackspace technology into its next chapter as a customer first cloud first company.

Since being appointed CEO I have been focused on having an honest dialogue with our customers partners and employees.

It is clear that our customers need our help and they want us to win.

And we have a world class partner ecosystem and talented employee base with ready to serve them.

I remain confident in our strategy and firmly believe we are implementing the right operating model to execute on the market opportunity in front of us.

First.

I know, we need to rebuild our credibility as a team.

Im pleased that in the third quarter, we delivered revenue and profitability above our guidance.

Looking ahead, we followed our normal guidance process, but we are adding some caution to reflect the uncertain macro outlook.

We intend to build a track record of meeting and beating expectations.

Second.

We've made a few changes to my executive leadership team and will continue to evaluate additional adjustments to position our organization for success and ensure alignment with our go forward operating model and priorities.

Third I am pleased that Shang salmon will be stepping up as the lead director for our board.

<unk> is a dynamic seasoned executive who specializes in the digital technology services business and the cloud market.

<unk>. Most recently served as President and Chief Executive Officer of Global logic.

Taxi group company.

Under his leadership global logic scaled to one 5 billion in sales as the leading brand in the digital transformation space.

In early 2021 global logic was acquired by Hitachi at an enterprise value of $9 6 billion.

Prior to global logic.

Our leadership positions at NES IBM and HP.

The entire company will benefit from this increased engagement and broad experience in cloud and digital businesses.

And lastly, we continue to make good progress on our realignment into two business unit structure and are on track to begin operating in this new structure on January 1st 2023.

Looking ahead, we know that 2023 will be a transition year with a lot of heavy lifting.

Already realized significant cost efficiencies over the last two years.

We will continue to streamline expenses, where we can but we are now repositioning rackspace for profitable growth.

This is my mandate from the board.

Two rack spaces advantage, we had two distinct markets with strong unmet demand for the innovative solutions and services we provide.

As we have stated many times before we expect the demand across our multi cloud offerings to remain strong, but we have to step up our execution and focus so we can see that.

Public cloud operates in a hyper growth market with significant white space.

For Rackspace to achieve our goals in this market, we must sharpen our solutions development focused by launching value added and operationally scalable services.

We are making progress we'll continue to make organic investments. So we can move even faster.

Going forward, we will not lead with infrastructure retail, we lead with higher value solutions and services in public cloud and with a deeper customer engagement.

Our new operating model will ensure that we emerge from 2023 with a public cloud organization focused on the high value opportunities and there's a wide open market space.

And hosted private cloud, including bare metal managed hosting the market opportunity is more significant than many may appreciate today.

We estimate that over 60% of workloads are still in customer data centers and many will move to either public cloud or hosted private cloud over the next few years due to cost advantages.

<unk> operational complexity and fewer resource constraints among many other factors.

And Rackspace is uniquely positioned to win in the private cloud market we.

We have a well known brand with deep experience in private cloud a global data center footprint cutting edge technology, and IP and strong partnerships with key ecosystem players such as Dell and Vmware.

And while we are still in the early innings of a push to revitalize and arrest the declines in our managed hosting and private cloud business. We are seeing early signs of progress.

For instance, we recently signed one of the largest hosted private cloud deals in the history of the company.

This is a multiyear commitment that provides a glimpse into the promising market opportunity in private cloud.

We're also launching industry specific private cloud offerings for example in health care, which are already driving good pipeline generation.

And finally in September we launched direct space accelerated migration program.

This industry, leading program is designed to help customers move their workloads from on Prem or Colo facilities into Rackspace private cloud.

It has been several years since we've seen this much activity and traction in private cloud.

An encouraging trend, which we are working hard to capitalize on with new and innovative solutions.

Before I conclude I just want to remind everyone on what gives me the confidence that we'll turn this company around.

First we operate in two multibillion dollar markets.

Private cloud and public cloud and both are growing.

As I often see we're in a great neighborhood.

Second our core revenue basis over 90% recurring it includes a large diverse customer base with more than half of the fortune 100 companies.

We truly have a phenomenal base of customers, who need our help and want us to succeed.

Third we have roughly 7000 dedicated records with more than 11000 technical certifications, who collectively make up our unique rekha culture.

Rackspace is truly a great place to work and we will continue to invest in our people.

And finally, we have a well respected brand in the tech market based on our long history of innovation.

In closing there is a lot of work ahead of us and the path will certainly not be easy.

But I truly believe the actions we are taking will position our business for sustained growth profitability and success in the years to follow.

I look forward to sharing more on our strategies and financial aspirations in the future.

And with that we'll take your questions.

Our first question comes from Kevin Mcveigh with Credit Suisse. Please go ahead.

Great. Thanks, so much and congratulations on the results tomorrow.

Obviously, there is a lot going on in terms of the transition.

Can you give us a sense as you think about 2023.

And you repositioned the business across the two new segments.

Are you starting at the same base of revenue.

Or should there be some shrinkage and if.

If you look at the goodwill impairment it looks like it's about 15% of the goodwill on your balance sheet is that a proxy for the adjustment on the revenue or is there any way to think about just the base of revenue and then maybe some sequencing on margins. Just so we can get a couple of goalposts and I know, it's still a little bit early but just try to frame that a little bit.

Yes, Hey, Kevin good to hear your voice. Thank you for the question you're absolutely right Kevin.

Difficult as you can imagine right to provide guidance for the full year.

Given the number of macro and micro changes that we're experiencing later, but let me give you some color.

First there is as I mentioned in my prepared remarks, there is a macro uncertainty, which may lead to sort of longer sales cycles as well as a slowdown in decision making in 2023.

Second to improve our execution, we are making some tough choices here.

And and also implementing operational changes over the next couple of quarters that will position the company for sustained profitable growth. While this will be reflected in our numbers. So these choices Kevin.

It will enroll refocusing our go to market organization and in some cases also rebuilding certain areas.

And more importantly, we also have very very targeted investments and solutions development such as industry verticals.

As you know can take about six or nine months to materialize into revenue.

So with that said.

Although the outlook for next four quarters is really tough.

Given the near term is tough, but based on what we have seen for example, macro uncertainty as I mentioned earlier.

Result in potentially longer sales cycle operating model changes that may lead to some disruption the de emphasis on infrastructure ratio that I mentioned earlier as well as some continued FX headwinds, we expect Q1, which is seasonally down quarter. Because you have some usage based volumes in our managed public cloud seasonally.

We expect revenue to be sequentially down one 5%, 2% as a result of all those factors that I mentioned.

Does that help Kevin.

It helps a lot and then just.

Maybe just this is a two part but I'll ask it.

Really nice to see Shashank, it sounds like not only.

Elevated to the board by $2 $5 million of stock, which is really nice signal.

Is there any way to think about the bookings.

Our margins.

For Q4, just within the context and again very helpful. On the sequencing of the revenue for Q1.

Sure so.

On bookings for Q3, let me give some color here, Kevin I'm actually very pleased to see a favorable mix shift in the bookings to.

Two more of our higher value and higher margin business away from infrastructure resale.

So as you know infrastructure resale bookings come at low margins. So this shift in focus to higher margin services and solutions bookings was by design and so I'm pleased that we are making that shift in.

In fact, the public cloud services bookings were up year on year and included about 17, new public cloud services customers and also a large expansion deal with a major media and communications company in Europe . So we're pleased with that of course, the base of the public cloud services business is smaller compared to our infrastructure retail.

So our focus is on growing the services bookings space more quickly and.

And I will talk a little bit more about it but we continue to gain traction in both pipeline and private cloud as we grew our focus there.

Now on the since you asked about the bookings question.

I referenced the large private Claudia let me give some color there. So if you understand the dynamics here.

This private cloud deal is one of the largest deal in the history of the company.

And as or a couple of hundreds of millions of dollars of GCB or five years in fact with the customer in the technology sector.

<unk>, a very compelling value proposition to the customer.

These were stable storage intensive analytics heavy work groups, which are better suited to operate in a private cloud environment. In fact, rackspace was able to offer a solution that significantly lower the cost while delivering improved performance in both storage and compute.

So this is particularly a large opportunity Kevin packages are representative of the types of deals will begin to see in our managed hosting and private cloud business. As a result of multiple things we have a very strong brand in this market great market presence, we have the scale and we will also see an increased focus with us.

Two business unit structure.

Very helpful. Thank you Omar.

Thank you one moment for our next question.

Our next question comes from Amit <unk> from Evercore. Please go ahead.

Thanks for taking my questions I have two as well.

First one I was hoping if you.

Could you just talk about when you look at the debt stock your debt structure right now maybe just talk about how much of this floating versus fixed and then more importantly, given the compression in modulating thing.

Can you just talk about what are some of the covenants and the leverage metrics that we should be aware about we'll go after those.

Okay, Amit good to hear your voice by the way Youre not coming across very clear, but I got the gist of your question you wanted to basically is our debt structure looks fixed versus variable and the covenant on it right. So let me start with the covenant first.

We have minimal debt covenants after the debt refinancing the debt in early 2021. So when I arrived we have number 2020 with took advantage of the of the very favorable debt market and refinanced our debt in 2021.

All of this debt not view further six or seven years.

We have to us.

Senior secured note, which is at 335%.

Next we have a term loan b, which has.

Available component to it and that we have are not.

Startup certain non secured note, which is at five 375% so.

A variety of the debt structure.

I think I'm, not sleeping and not losing any sleep so to speak or servicing this from an interest expense perspective, and as you know based on the <unk>.

Rates right now, it's still very attractive.

Pricing right now on the debt side, so minimal debt covenants or.

A wide variety of.

Our interest expenses on this but overall I think it is very manageable interest expense given that.

Most of this debt.

Two of those notes are actually fixed interest rates.

Hello.

Yes, no that is really helpful. Thank you for that.

Let me just follow up.

At the December quarter Guide, maybe just something on the more near term site you started talking about flattish revenues on a year over year basis, I think right on total numbers.

Maybe just talk about how much of the FX headwind AUC in the December quarter number on a year over year basis, and then how macro impacting you eating in the December quarter.

<unk> deal push out deals getting delayed just any clarity on that.

Macro and FX and how that's impacting your December quarter, yes, it'd be helpful.

I think I think you have covered the key points there.

Amit So let me start with the macro right. So we.

We took our revenue headset.

Primarily in services and also a bit in the usage based volumes that come through our managed public cloud business, mainly due to macro outlook. Okay.

And the macro outlook.

As you know we.

But when you take a look at what's going on from a demand environment et cetera, and all companies in the cloud ecosystem are being cautious about the demand environment and rightfully. So given the tough macro outlook. In fact, a hyperscale is have caution at the growth rates are slowing although they are still growing double digits and we do believe that cash.

Tumors will maintain their current spend on mission critical projects, but slow down spending on lower priority less critical projects and this of course varies by customer and verticals, but broadly speaking Amit customers will be focused on.

On cost optimization as well as on projects that have a faster payback periods.

And.

I've done this a long time and I've gone through these cycles multiple times and it's not unusual to expect further changes in the size and scope of the deals longer sales cycles and also a slowdown in decision, making so we have factored those in when we guided so typically you would see as the revenue either be flattish or go up sequentially.

Actually we have.

To a sequential decline in revenue because of that FX continues to remain a headwind. It was I think two percentage points of headwind in Q3. We are also taking a look at our October numbers that are coming in now.

You have any color right now.

We have factored in that FX headwind, it's very difficult to predict but we did factor some of the FX headwinds and we did that in Q3, two so we're not changing the way we guide when it comes to FX.

Perfect. Thank you.

Thank you one moment for our next question.

Our next.

<unk> comes from Tien Tsin Huang with Jpmorgan. Please go ahead.

Hey, Thanks, so much and it's good to have a track record here from the with these results I wanted to ask if you don't mind on also on bookings because we've been hearing about through this results season.

Our clients as well as vendors are being more careful around the gross profit.

Our margins around new contracts.

New award activity.

Are you seeing that manifest itself in some way in your business are you may be seeing a shift in need to spend a little bit more in terms of capital intensity to win work I'm just curious if youre already seeing that and that's a factor with your selectivity on winning business on the booking side.

So I think.

Thanks <unk> for the question. So there are two parts of our business like we are a multi cloud provider condition. We have public cloud and then also we have private clouds.

And I can tell you let me to public cloud demand continues to remain strong.

To believe that.

As we go through this process.

<unk>.

The tech demand in multi cloud will remain but it may start moving to the right and we are seeing that happen.

And down cycles.

<unk> multi client business, but in other businesses.

To be honest with extended market is taking a pause it comes at a good time for us to go complete the reorganization exercise exercise et cetera.

Get ready when the.

Customers return to normal spending levels, and we'll be prepared to capture the demand with newer offerings and operationally realigned organization.

So for us on the on the public cloud side customers are looking for.

Cost optimization.

Note that multiple.

Most of the Hyperscale is talking about it we are also seeing that and so we do have cost optimization services that we deliver today, we are going to expand those offerings, we want to lead with those offerings. So that we start building relationships with our public cloud customers will need help on optimizing the spend on public cloud, but the server.

As this business the demand still remains but the sales cycles will be longer as you know.

As we're making the pivot from state infrastructure resale two services.

It takes time for us to build the services pipeline and but it's all solid doable and the focus will help us to start building those pipeline fast so on the public cloud side I feel I think.

Have a good opportunity to pursue on the private cloud side. Many many had thought that the private cloud.

I'll just give you an example.

<unk>.

And the job for 45 days and I've been on the road.

Of those 45 days and are talking to customers partners and employees.

And the biggest surprise for me attention is there.

Ample demand signals out there.

We are going to launch a lot of offerings in this area in the next six to 12 months or even before that but we are definitely.

Separately seeing traction in private cloud and public cloud remained strong despite the slowdown in growth from the Hyperscale us yes.

Yes.

Got you. Thanks for that appreciate the hard work as well.

Thank you as a reminder to ask a question. Please press star one on your telephone one moment for our next question.

Our next question comes from Nate <unk> with Deutsche Bank. Please go ahead.

Hi, guys. This is Nate on for Brian I, just wanted to ask about sort of gross margin expectations in the fourth quarter and sort of the right way to think about modeling margins into next year. So I think at the end of the last earnings call you had snuck in some comments, saying you expected gross margins around 26% in the fourth quarter in mid twenties for fiscal 'twenty three you just wanted to.

Check in to see if there's any update to that thinking or if those numbers still hold.

Yes. So thanks for asking the question now given the mix of the business needs to be projecting in Q4 after taking the effort etcetera, we still expect the gross margins to be between 25, 5% and 36% for fiscal Q4. Okay. So that is that is actually not changing.

Now when it comes to gross margins.

For our fiscal 2023, you see my mandate from the board is to turn this business around and alignment to the strong growth markets that we had yesterday, so I'm not going to manage to an arbitrary near term targets since I'm driving a transformation. So in 2023, we're going to make some tough decisions and set us up.

Well for 2024, and as I mentioned to ensure that the demand signals remain strong and we've extended the market is taking a pause. It comes at a good time for us to complete this reorganization that we are undertaking today.

And so just as a reminder, right our gross margin pressures are almost entirely a function of the mix of the business and so as we turn the business around.

As we stabilize the private cloud businesses start growing the services component of our public cloud, we will see improvements in our mix that will drive gross margin accretion, but similar to revenue. It is difficult to know exactly how the mix will play out in the next few quarters.

Now I can also tell you from an Opex standpoint, we plan to keep it roughly flat year on year, and we will continue to monitor monitor it. So we have a good very very tight control on our expenses, we have cost efficiency programs that we're running that will continue to run and we'll keep a tight lid on expenses as we close with this.

Macro environment and also the macro changes that we're making the company.

You had hoped for but it seems like maybe thats turnarounds or any way to any way to quantify that impact or any sort of broader qualitative color you could give on beauty would be great.

So let me give some qualitative color here.

On BT. So when you look at the BT deal.

And probably we will explain this in the past with two distinct phases in the BT deal.

First is the customer on boarding fees. We are currently operating in the first phase Onboarding over 200 market customers. We have made some good progress on transitioning customers since our last update last quarter the.

The second phase is I call that as a transformation phase, where we can transform a customer's environment by moving them to the rack is private cloud solutions and this will create significant value for them.

As well as for US and we talk about our partnership with BT will great partnership with BT border companies PT and rack space are working well together, we are aligning our product and solution Roadmaps, we will collaborate on bringing the best value to the market through this newly developed joint solutions set that.

That we are launching.

I appreciate the color. Thank you.

Okay.

Thanks.

Thank you I'm showing no further questions at this time I would now like to turn it back to Robert Watson for closing remarks.

Thanks, Andrea and thank you everyone for joining us if we didn't get to your question or you have a follow up please vanessa.

Vanessa E mail at IR at rack space Dot Com have a great evening, everyone. Thank you.

Thank you for your participation in today's conference. This concludes the program you may now disconnect.

Q3 2022 Rackspace Technology Inc Earnings Call

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