Q3 2024 Rackspace Technology Inc Earnings Call

Speaker Change: Good day and thank you for standing by. Welcome to the Rackspace Third Quarter 2024 Earnings Webcast. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised.

Speaker Change: Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today. Sagar Hebbar, Investor Relations. Please go ahead.

Sagar Hebbar: Thank you, and welcome to Rackspace Technology's 3rd Quarter 2024 Earnings Conference Call.

I am Sagar Hebbar, Head of Investor Relations.

Sagar Hebbar: Joining me on today's call are Amar Maletira, our Chief Executive Officer, and Mark Marino, our Chief Financial Officer.

Sagar Hebbar: As a reminder, certain comments we make on this call will be forward-looking.

Sagar Hebbar: These statements involve risks and uncertainties which could cause actual results to differ. A discussion of these risks and uncertainties is included in our SEC filings.

Sagar Hebbar: Backspace technology assumes no obligation to update the information presented on the call except as required by law.

Sagar Hebbar: Our presentation includes certain non-GAAP financial measures and adjustments to these measures which we believe provide useful information to our investors.

Sagar Hebbar: In accordance with SEC rules, we have provided a reconciliation of these measures to their most directly compatible GAAP measures in the earnings press release and presentation, both of which are available on our Investor Relations website.

Sagar Hebbar: I will now turn the call over to Amar for an update on the business.

Thank you, Sagar, and welcome everyone to our earnings call.

Amar Maletira: Results in the third quarter exceeded the midpoint of our guidance for Revenue, Profit and EPS.

Amar Maletira: This marks the ninth consecutive quarter in which we have either met or exceeded our guidance.

Amar Maletira: This achievement is attributed to our consistent execution and a strong focus on advancing our three strategic priorities.

First, we are making steady progress on our operational turnaround.

Amar Maletira: In the third quarter, we group bookings and pipeline while improving efficiency.

Amar Maletira: Second, we continue to position Rackspace as a forward-leaning, innovative hybrid cloud and AI solutions company.

Amar Maletira: We're launching new products, solutions, and offerings that target the next big secular waves of growth in both hybrid cloud and AI.

Amar Maletira: And third, we remain focused on improving our capital structure to support and sustain profitable growth over the long term.

Amar Maletira: We have ample liquidity and flexibility to focus on our operational priorities.

Speaker Change: As you may recall, when I took on the CEO role, we made several key strategic decisions to pivot the company in response to changing market dynamics.

Speaker Change: I'm pleased to see the new capabilities we developed through those decisions and investments are now meeting emerging demand in our target markets.

Speaker Change: As we had anticipated at the outset, the private and public Cloud markets are maturing, with customers increasingly embracing a hybrid Cloud model that leverages both private and public Cloud environments.

Speaker Change: We recently highlighted the progress we are making on our strategy and unique capabilities at our annual Industry Analyst Day event in Boston, which drew nearly twice as many industry analysts as last year.

Speaker Change: The event theme, Delivering Hybrid Cloud for an Innovation-Driven, AI-Powered Future, set the stage for panel discussions with CIOs and senior IT leaders from five of our major public and private cloud customers.

Speaker Change: These sessions were exceptionally well-received, and we were thrilled by the analysts' positive feedback and enthusiastic social media posts and commentary that captured the achievements and vision we shared.

Speaker Change: Now let me get into our business performance starting with private cloud.

Speaker Change: Private cloud gap revenue of $258 million was within our guided range this quarter, though slightly down sequentially.

Speaker Change: I'm particularly pleased with the steady progress we are making towards our strategic priorities in private Cloud.

Speaker Change: The delivery team has done an excellent job onboarding major customers from deals closed in fiscal fourth quarter of 2023 and first quarter of 2024.

Speaker Change: As we have discussed, it often takes 6-9 months for signed bookings to translate into revenue.

Speaker Change: It is rewarding to see last year's efforts in winning and then onboarding these deals now reflected in our current revenue numbers.

Speaker Change: Bookings in Q3 saw a slight sequential decline mainly due to timing delays.

However, some of these deals have since closed this quarter.

Speaker Change: Furthermore, we expect one of the largest healthcare deals in Rackspace's history to close by the end of this month.

Speaker Change: This will set us up for an expected strong sequential bookings growth in Q4.

Speaker Change: Most of these new agreements are long-term, ensuring steady recurring revenue base.

Speaker Change: Looking ahead, our pipeline is promising with a 41% increase year-over-year.

[inaudible]

Speaker Change: Private cloud is making significant strikes in the health care sector with revenue for fiscal 2024 in our health care private cloud business projected to increase by nearly 30% year-over-year.

Speaker Change: Our differentiated healthcare cloud offerings, including Epic Hosting, and growing industry reputation is powering the pipeline growth in our healthcare vertical.

Speaker Change: I'm excited to share a significant milestone that we achieved recently on October 6th.

Speaker Change: We successfully migrated one of the nation's largest health care providers to a health care cloud, representing one of the most significant single deployments of an EPIC system to date.

Speaker Change: This accomplishment involved a seamless transition of over 38,000 concurrent users across 54 hospitals in nine states, resulting in continued performance improvements ranging from 15% to 45% since go live.

Speaker Change: These enhancements enable healthcare providers, patients, and families to access essential medical records more quickly and efficiently.

The feedback we received post-migration has been outstanding.

Speaker Change: We are told by the customer that the transition could not have gone more smoothly, enabling this provider to focus on other operational initiatives.

Speaker Change: This project highlights our commitment to delivering excellence in healthcare technology solutions, further solidifying our position as a trusted partner in this industry.

Speaker Change: We are also seeing momentum in a sovereign vertical where we project the private cloud revenue for this vertical to grow over 50% in 2024 compared to 2023.

Speaker Change: The strategic MOU signed 18 months ago with the Kingdom of Saudi Arabia to design, build and operate a sovereign cloud resulted in successful launch of the first version of HexaCloud earlier this year.

We continue to build on that success in the kingdom.

Speaker Change: Additionally, we also expanded our offerings for the UK sovereign market with the introduction of ARC-branded data centers and solutions.

Speaker Change: We are also gaining traction in other regulated industries. For example, Rackspace was down-selected to build and operate a custom private cloud for a large European energy company.

Speaker Change: The proof of capability is currently underway and slated to complete this quarter.

We expect to launch in 2025.

Speaker Change: In the third quarter, we continued rolling out innovative solutions, launching 15 new products and enhancing 19 others.

Speaker Change: Our market-leading VMware and OpenStack private cloud solutions give customers a wide range of virtualization choices.

Speaker Change: We are also seeing renewed customer interest in our OpenStack offerings.

Speaker Change: As the pioneers in OpenStack along with NASA, we have taken a significant step forward in our commitment to open source innovation.

Speaker Change: We officially joined the board of the OpenInfra Foundation, where we will work with fellow board members to influence the strategic direction of the foundation and drive industry standards.

Speaker Change: In conclusion, I'm confident that private cloud will become a thriving market, not only for traditional workloads, but also for AI workloads.

Speaker Change: I will cover a private AI solutions in the AI section later in my prepared remarks.

Speaker Change: While we have done well with these large new deals, the results also highlight both the variability of big contracts and the lag between bookings and revenue.

Speaker Change: However, with pipelines steadily growing, we believe that private cloud will stabilize and will eventually drive significant growth.

Now let's move on to public cloud.

Speaker Change: Public cloud gap revenue of 418 million was down 2% sequentially and came in above a guidance midpoint driven by services.

Speaker Change: Public Cloud had a record booking quarter, achieving the highest level of booking since the beginning of 2023 and the formation of the two business units.

Speaker Change: Bookings were up high double-digit sequentially and year-over-year with strong performance across the board.

Speaker Change: Public Cloud has now delivered three consecutive quarters of sequential and year-over-year bookings growth.

Speaker Change: From a regional perspective, our largest region, Americas, continues to show robust sales performance in Q3.

Speaker Change: marking the third consecutive quarter where it exceeded internal bookings target and outperformed our expectations.

Platform and data services bookings grew double-digit sequentially and year-over-year.

Speaker Change: Data services continue to remain a bright spot with strong bookings performance driven in part by solid demand in AI related data modernization.

We have significantly strengthened our partnership with hyperscalers.

Speaker Change: In late October, we announced a multi-year strategic collaboration agreement with AWS to accelerate digital transformation for our customers.

Speaker Change: This agreement enhances our existing partnership, allowing us to deliver comprehensive cloud and AI solutions, tailored to driving innovation and achieving business outcomes for customers globally.

Speaker Change: Public cloud had several notable wins this quarter. We are helping a growing UK parcel services delivery firm transition their data stores to cloud and modernize applications for cost savings and market expansions.

Speaker Change: We also signed a professional services agreement with a renewable energy company for data transformation, cloud engineering, and migration.

Speaker Change: Our new public cloud offerings support our services-led strategy by continuing to advance capabilities in applications, data, security, and platform.

Speaker Change: In Q3, we launched four new solutions and announced four others. For example, in data, we announced Amazon Q Incubate.

Speaker Change: An AI-powered assistant built using Amazon Q to leverage internal company data.

Speaker Change: Use cases include empowering IT helpdesks, support teams, and call centers by providing easy access to organizational data.

Speaker Change: In conclusion, public cloud had another quarter of strong performance across its key performance indicators driven by FIRST.

Speaker Change: Structural changes made to our go-to-market in late 2023, including pivoting to services-led motion, refreshing our sales force, building a client-partner model, changing the incentive structure, and reorganizing the market segments.

Speaker Change: Second, expanding in mid-market while selectively penetrating the enterprise segment, which resulted in signing over 10 master service agreements and continuing to focus on additional ones that will generate new opportunities for growth with a land and expand strategy.

Speaker Change: And third, a disciplined approach to infrastructure resale, where we continue to focus on deals that meet our return hurdles and improve our overall margins with a focus on higher services attached rates.

Speaker Change: For example, in Q3, we attached services to 22 of the top 28 deals.

Speaker Change: Our services led strategy has also helped us to drive immense value for cloud infrastructure resale customers, thereby driving higher consumption of cloud infrastructure and improving customer profitability.

Speaker Change: Now moving to AI. As I mentioned Rackspace is riding the next secular wave of market growth with AI.

Speaker Change: At our recent Industry Analyst Day, I shared our three-point AI strategy that includes, first, enabling customers in their AI journey with services and solutions. Second, designing, building, and operating hybrid AI infrastructure for inferencing and fine-tuning workloads.

And third, transforming Rackspace into an AI-driven company.

Speaker Change: We are seeing good progress in AI with our FAIR initiatives, with nearly 50 customers and over 250 opportunities at various stages of implementation.

Speaker Change: We also expanded our AI-related product offerings across both business units.

Speaker Change: In public cloud, we joined AWS's new Generative AI Partner Innovation Alliance, a program that will help AWS customers successfully build and deploy generative AI solutions.

Speaker Change: In private cloud, we have a proof-of-concept underway with a large international company to run the inferencing workload on a private AI infrastructure.

Speaker Change: We also launched on-demand GPU as a service on a SPOT platform powered by NVIDIA's H100 Tensor Core GPUs.

Speaker Change: Customers can harness high-performance GPUs without an upfront investment to achieve both cost efficiency and scalability.

Speaker Change: The opportunities in AI are promising, but we are taking a practical, balanced approach to helping our customers leverage AI for building impactful, economically sustainable, and ethical solutions.

Speaker Change: Before I wrap up, I'd like to thank our customers, partners, and all our actors.

Speaker Change: I am pleased with our performance this quarter and proud of all we have achieved together during this year of change.

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

Mark Marino: Thank you, Amar. In the third quarter, total company GAAP revenue of $676 million was within our guided range, driven by strength in public cloud.

Mark Marino: Note, we are no longer presenting non-GAAP net revenue as a stand-alone line item. To ensure transparency and full disclosure, the impact of the lower-margin infrastructure resale contracts and those pass-through costs for the quarter are found on slide number four in our earnings presentation.

Mark Marino: For the quarter, non-GAAP gross profit margin was 21.2% of GAAP revenue, up 90 basis points sequentially. Non-GAAP operating profit was $34 million, exceeding the high end of our guidance.

Mark Marino: This was primarily driven by better than expected performance in both public cloud and private cloud.

Mark Marino: Non-GAAP operating margin was 5.1% of GAAP revenue, up 180 basis points sequentially.

Mark Marino: Non-GAAP loss per share was 4 cents, better than our guided range of a 6 to 8 cent loss per share driven by better than expected operating profit.

Mark Marino: Cash flow from operations was $52 million, and free cash flow was $27 million in the third quarter.

Mark Marino: We close the quarter with $157 million in cash and $532 million of total liquidity, including $375 million of undrawn commitments.

Mark Marino: Turning to our segment results. For Private Cloud, GAAP revenue for the third quarter was $258 million within our guided range. This includes legacy OpenStack revenue of $25 million.

Mark Marino: Total private cloud revenue was down 1% sequentially due to customers rolling off older generation private cloud offerings.

Mark Marino: Private cloud non-gap gross margin was 38.6% up 120 basis points sequentially due to cost deficiencies partially offset by lower revenue.

Mark Marino: Non-GAAP segment operating margin at 28.9% was up 210 basis points sequentially driven by gross margin expansion and better cost management.

Mark Marino: In public cloud, GAAP revenue was $418 million at the high end of our guided range, and down 2% sequentially, primarily due to lower cloud infrastructure volumes.

Mark Marino: I am pleased to see services revenue coming in flat sequentially after several quarters of decline, laying a promising foundation for future growth.

Mark Marino: Non-GAAP gross margin for our public cloud segment was 10.4 percent, up 50 basis points sequentially, driven by an improvement in resale margins.

Mark Marino: Non-GAAP segment operating margin was 3.9%, up 110 basis points sequentially due to improved gross margins and operational efficiency.

Now on to guidance.

Mark Marino: Total non-GAAP operating profit is expected to be $34 to $36 million and non-GAAP loss is expected to be from $0.03 to $0.05 per share.

Mark Marino: From a segment perspective, we expect private cloud revenue of $258 to $264 million, up 1% sequentially at the midpoint.

Mark Marino: and public cloud revenue of $410 to $416 million down 1% sequentially at the midpoint due to reduced consumption and lower margin infrastructure resale.

Mark Marino: Our non-GAAP tax rate is expected to be 26%, and non-GAAP other expense is expected to be $47 to $51 million. The non-GAAP share count is expected to be approximately 240 million shares.

I will now turn the call back over to Sagar.

Thank you, Mark.

Sagar Hebbar: Let us begin the question and answer session. We ask everyone to limit discussion to one question and one follow-up.

Please go ahead.

Speaker Change: The first question comes from the line of Kevin with UBS. Kevin, your line is open.

Kevin: Great, thanks so much and congratulations on just another quarter really really good execution.

Speaker Change: Hey, Amar, Mark, can you help us dimensionalize the size of that health care win? If I heard you right, Amar, it sounds like it's the largest one you've ever signed. Is there any way to dimensionalize that as to...

what what just I guess maybe we could start there.

Speaker Change: Yeah, so thanks Kevin, thanks for your question. So the health care, so the health care win that we talked about was health care

Speaker Change: when in Q4 of last year, it was in hundreds of millions of dollars in TCB. So it was a sizable win and what we did in the last...

Speaker Change: nine months is basically on board that customer and and you know transition the customer over to our Rackspace healthcare cloud

Speaker Change: So that was very significant, Kevin. You know, think about the magnitude here. 38,000 concurrent users, one of the largest EPIC system installations in the world.

Speaker Change: and I'm very proud of the private cloud delivery team for pulling it off and doing a very smooth and seamless transition.

Speaker Change: And so that's a real achievement. It's also given us a lot of, you know, our reputation in the industry has gone up ten-folds based on that transition.

Speaker Change: Have you seen kind of the network effect because it sounds like the other thing was open. You know, can you dimensionalize kind of on the private cloud, like how much today's government versus healthcare versus other, you know, or is there any way just to think about kind of the vertical in that particular business?

Speaker Change: Yes, I think that's a great question, Kevin. So, if you recall, let me just put a context here. If you recall, we were very focused on going by vertical.

Speaker Change: and we picked, you know, specifically three or four verticals, healthcare, BFSI, which is banking, financial services, and insurance, our sovereign and public sector.

Speaker Change: Now, jointly, these verticals make up, you know, it was roughly about 25% of our total revenue in fiscal 23, and by the time we end fiscal 24, it'll be about

one-third of our total revenue base.

Speaker Change: When it comes to health care and sovereign You know, they were roughly between 5 to 10 percent of our overall revenue because remember we just got started about 18 months ago

Speaker Change: and we will be nearly at 15% by the time we exit Fiscal 24 and that will continue growing in Fiscal 25.

For example, health care.

Speaker Change: We believe that given the deals that we have in the funnel and the confidence of us closing these deals, you know, this 30% growth, nearly 30% growth in fiscal 24 might translate to another high double-digit growth in fiscal 25.

Speaker Change: That makes sense. Congrats again and thank you for the time.

Thank you.

Please stand by for the next question.

Speaker Change: The next question comes from Ramsey at Barclays. Ramsey, the line is open.

Speaker Change: Hi, this is Ryan on for Ramsey. Thanks for taking my question today.

Speaker Change: Last quarter you mentioned 85% attach rate of services on large infrastructure deals. In this quarter 22 of 28 deals. I just wanted to see what specific solutions are driving that attach rate and maybe how should we think about it progressing over the next six to 12 months. Thank you.

Speaker Change: Yeah, so I think, thank you very much. That's a great question. You know, if you recall

Speaker Change: We pivoted the whole go-to-market motion from infrastructure-led to services-led. That was a bold decision we as a company made 18-19 months ago.

Speaker Change: We re-did the whole go-to-market organization. We enabled the sales organization. And today, we have a very good services-led version, where we are penetrating the enterprises selectively, expanding into the mid-market, and our commercial motion for the S of the SMB, working with the hyperscaler, is also hitting in all cylinders.

Speaker Change: So, to answer your question specifically, I think you will see as the services-led motion has resulted in us talking now to the C-level of the organization.

Speaker Change: So, this is a completely different discussion we are having with our customers today.

Speaker Change: Unlike in an infrastructure-led, where we go from a procurement-run motion to the C-level, here we are coming from C-level to the procurement team.

Speaker Change: So it's adding a lot of value, and it is resulting in two things. Number one,

Speaker Change: We are going to continue to drive our high margin services into those accounts.

Speaker Change: And number two, we are also seeing benefits to our infrastructure resale too, where we are able to protect margins on this infrastructure resale.

Speaker Change: Because instead of having a discussion with procurement organization where it's only pricing and discount related, now we are having a discussion at the sea level and we are bringing a holistic value to our customers. So this has completely transformed the way we look at a public cloud business.

The End

Great, thanks.

Speaker Change: At this time, I am showing no further questions. I would now like to turn it back to Sagar Hebbar of Investor Relations for closing remarks.

Thank you everyone for joining us.

Sagar Hebbar: If we did not get to your question or if you have a follow-up, please email us at ir at Rackspace.com

Have a great evening, everyone.