Rackspace Technology, Inc. Q3 FY2024 Earnings Call

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. I would now like to hand the conference over to your first speaker today, Sagar Hebbar, Investor Relations. Please go ahead.

Thank you, and welcome to Rackspace Technology's third quarter 2024 earnings conference call. I'm Sagar Hebbar, Head of Investor Relations. Joining me on today's call are Amar Maletira, our Chief Executive Officer; and Mark Marino, our Chief Financial Officer. As a reminder, certain comments we make on this call will be forward-looking. These statements involve risks and uncertainties, which could cause actual results to differ. A discussion of these risks and uncertainties is included in our SEC filings. Rackspace Technology assumes no obligation to update the information presented on the call, except as required by law. Our presentation includes certain non-GAAP financial measures and adjustments to these measures, which we believe provide useful information to our investors. In accordance with SEC rules, we have provided a reconciliation of these measures to their most directly comparable GAAP measures in the earnings press release and presentation, both of which are available on our Investor Relations website. 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. Results in the third quarter exceeded the midpoint of our guidance for revenue, profit, and EPS. This marks the ninth consecutive quarter in which we have either met or exceeded our guidance. 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. In the third quarter, we grew bookings and pipeline while improving efficiency. Second, we continue to position Rackspace as a forward-leaning innovative hybrid cloud and AI solutions company. We are launching new products, solutions, and offerings that target the next big secular waves of growth in both hybrid cloud and AI. And third, we remain focused on improving our capital structure to support and sustain profitable growth over the long term. We have ample liquidity and flexibility to focus on our operational priorities. 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. I'm pleased to see the new capabilities we developed through those decisions and investments are now meeting emerging demand in our target markets. 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. 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. The event team 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. These sessions were exceptionally well received! We were thrilled by the analysts' positive feedback and enthusiastic social media posts and commentary that captured the achievements and vision we shared. Now let me get into our business performance, starting with Private Cloud. Private Cloud GAAP revenue of $258 million was within our guided range this quarter, though slightly down sequentially. I'm particularly pleased with the steady progress we are making towards our strategic priorities in Private Cloud. The delivery team has done an excellent job onboarding major customers from deals closed in the fiscal fourth quarter of 2023 and first quarter of 2024. As we have discussed, it often takes six to nine months for signed bookings to translate into revenue. It is rewarding to see last year's efforts in winning, and then onboarding these deals now reflected in our current revenue numbers. Bookings in Q3 saw a slight sequential decline, mainly due to deal timing delays. However, some of these deals have since closed this quarter. Furthermore, we expect one of the largest healthcare deals in Rackspace's history to close by the end of this month. This will set us up for an expected strong sequential bookings growth in Q4. Most of these new agreements are long-term, ensuring a steady recurring revenue base. Looking ahead, our pipeline is promising with a 41% increase year-over-year. Private Cloud is making significant strides in the Healthcare Sector, with revenue for fiscal 2024 in our healthcare Private Cloud business projected to increase by nearly 30% year-over-year. Our differentiated Healthcare Cloud Offerings, including Epic Hosting and growing industry reputation, are powering the pipeline growth in our healthcare vertical. I'm excited to share a significant milestone that we achieved recently on October 6th. We successfully migrated one of the nation's largest healthcare providers to our healthcare cloud, representing one of the most significant single deployments of an Epic system to date. These accomplishments 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. 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. We are told by the customer that the transition could not have gone more smoothly, enabling this provider to focus on other operational initiatives. This project highlights our commitment to delivering excellence in Healthcare Technology Solutions, further solidifying our position as a trusted partner in this industry. We are also seeing momentum in our Sovereign vertical, where we project the Private Cloud revenue for this vertical to grow over 50% in 2024, compared to 2023. The strategic MOUs signed 18 months ago with the Kingdom of Saudi Arabia to design, build, and operate a sovereign cloud resulted in a successful launch of the first version of ExaCloud earlier this year. We continue to build on that success in the Kingdom. Additionally, we also expanded our offerings for the U.K. sovereign market with the introduction of our branded data centers and solutions. We're also gaining traction in other regulated industries. For example, we were down selected to build and operate a custom Private Cloud for a large European energy company. The proof of capability is currently underway and slated to complete this quarter. We expect to launch in 2025. In the third quarter, we continued rolling out innovative solutions, launching 15 new products and enhancing 19 others. Our market-leading VMware and OpenStack private cloud solutions give customers a wide range of virtualization choices. Rackspace is one of the largest VMware CSPs in the world, managing approximately 300,000 Bcf cores. We are also seeing renewed customer interest in our OpenStack offerings. As the pioneers in OpenStack, along with NASA, we have taken a significant step forward in our commitment to open-source innovation. We officially joined the Board of the OpenInfra Foundation. We will work with fellow Board members to influence the strategic direction of the Foundation and drive industry standards. In conclusion, I'm confident that private cloud will become a thriving market not only for traditional workloads but also for AI workloads. I will cover our private AI solutions in the AI section later in my prepared remarks. 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. However, with pipeline steadily growing, we believe that private cloud will stabilize and eventually drive significant growth. Now let's move on to Public Cloud. Public cloud GAAP revenue of $418 million was down 2% sequentially and came in above our guidance midpoint, driven by services. Public Cloud had a record bookings quarter, achieving the highest level of bookings since the beginning of 2023 and the formation of the two business units. Bookings were up high double digits sequentially and year-over-year with strong performance across the board. Public Cloud has now delivered three consecutive quarters of sequential and year-over-year bookings growth. From a regional perspective, our largest region, Americas, continued to show robust sales performance in Q3, marking the third consecutive quarter where it exceeded internal bookings targets and outperformed our expectations. Platform and data services bookings grew double digits sequentially and year-over-year. 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. In late October, we announced a multiyear strategic collaboration agreement with AWS to accelerate digital transformation for our customers. 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. Public Cloud had several notable wins this quarter. We are helping a growing U.K. parcel services delivery firm transition their data stores to cloud and modernize applications for cost savings and market expansions. We also signed a professional services agreement with a renewable energy company for data transformation, cloud engineering, and migration. Our new Public Cloud offerings support our services-led strategy by continuing to advance capabilities and applications, data, security, and platform. In Q3, we launched four new solutions and enhanced four others. For example, in data, we announced Amazon Q Incubate, an AI-powered assistant built using Amazon Q to leverage internal company data. Use cases include empowering IT help desks, support teams, and call centers by providing easy access to organizational data. In conclusion, Public Cloud had another quarter of strong performance across its key performance indicators driven by: first, 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. 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 our land-and-expand strategy. 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 attach rates. For example, in Q3, we attached services to 22 of the top 28 deals. Our services-led strategy has also helped us to drive immense value for our cloud infrastructure resale customers, thereby driving higher consumption of cloud infrastructure and improving customer profitability. Now moving to AI. As I mentioned, Rackspace is riding the next secular wave of market growth with AI. 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. We are seeing good progress in AI with our FAIR initiatives with nearly 50 customers and over 250 opportunities at various stages of implementation. We also expanded our AI-related product offerings across both business units. In public cloud, we joined AWS' new Generative AI Partner Innovation Alliance, a program that will help AWS customers successfully build and deploy generative AI solutions. In private cloud, we have a proof of concept underway with a large international company to run their inferencing workload on our private AI infrastructure. We also launched on-demand GPU as a Service on our spot platform powered by NVIDIA's H100 Tensor Core GPUs. Customers can harness high-performance GPUs without an upfront investment to achieve both cost efficiency and scalability. 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. Before I wrap up, I'd like to thank our customers, partners, and all our team members. I'm pleased with our performance this quarter and proud of all we have achieved together during this year of change. I will now turn it over to Mark for an overview of our financial results and guidance.

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. 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 4 in our earnings presentation. 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. This was primarily driven by better-than-expected performance in both public cloud and private cloud. Non-GAAP operating margin was 5.1% of GAAP revenue, up 180 basis points sequentially. Non-GAAP loss per share was $0.04, better than our guided range of a $0.06 to $0.08 loss per share, driven by better-than-expected operating profit. Cash flow from operations was $52 million, and free cash flow was $27 million in the third quarter. We closed the quarter with $157 million in cash and $532 million of total liquidity, including $375 million of undrawn commitments. 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. Total private cloud revenue was down 1% sequentially, due to customers rolling off older generation private cloud offerings. Private cloud non-GAAP gross margin was 38.6%, up 120 basis points sequentially, due to cost efficiencies, partially offset by lower revenue. Non-GAAP segment operating margin at 28.9% was up 210 basis points sequentially, driven by gross margin expansion and better cost management. 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. I'm pleased to see services revenue coming in flat sequentially after several quarters of decline, forming a promising foundation for future growth. Non-GAAP gross margin for our public cloud segment was 10.4%, up 50 basis points sequentially, driven by an improvement in resale margins. 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. We expect fourth quarter GAAP revenue to be $668 million to $680 million, slightly down sequentially at the midpoint. Total non-GAAP operating profit is expected to be $34 million to $36 million, and non-GAAP loss is expected to be from $0.03 to $0.05 per share. From a segment perspective, we expect private cloud revenue of $258 million to $264 million, up 1% sequentially at the midpoint, and public cloud revenue of $410 million to $416 million, down 1% sequentially at the midpoint, due to reduced consumption and lower margin infrastructure resale. Our non-GAAP tax rate is expected to be 26% and non-GAAP other expenses are expected to be $47 million 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. Let us begin the question-and-answer session. We ask everyone to limit discussion to one question and one follow-up. Please go ahead.

Great. Thanks so much, and congratulations. And just another quarter, really, really good execution. Amar and Mark, can you help us dimensionalize the size of that healthcare win? If I heard you right more, it sounds like it's the largest one you've ever signed. Is there any way to dimensionalize that as to what just I guess maybe we could start there?

Yeah. So thanks, Kevin. Thanks for your question. So the healthcare win that we talked about was a healthcare win in Q4 of last year; it was in the hundreds of millions of dollars in TCV. So it was a sizable win. And what we did in the last nine months is basically onboard that customer and transition the customer over to our Rackspace Healthcare Cloud. So that was very significant, Kevin. Think about the magnitude here: 38,000 concurrent users; one of the largest Epic system installations in the world. And I'm very proud of the private cloud delivery team for pulling it off and doing a very smooth and seamless transition. And so that's the real achievement. It's also given us a lot of our reputation in the industry has gone up tenfold based on that transition.

And, Amar, have you seen kind of the network effect? Because it sounds like the other thing was open can you dimensionalize kind of on the private cloud, like how much today's government versus healthcare versus other? Is there any way just to think about kind of the vertical in that particular business?

Yes. I think that's a great question, Kevin. So if you recall, let me just put some context here. If you recall, we were very focused on going by vertical. And we picked specifically three or four verticals: healthcare, BFSI, which is banking, financial services and insurance, our sovereign and public sector. Now jointly, these verticals make up, it was roughly about 25% of our total revenue in fiscal 2023. And by the time we end fiscal 2024, it will be about one-third of our total revenue base. When it comes to healthcare and sovereign, they were roughly between 5% to 10% of our overall revenue because remember, we just got started about 18 months ago. And we will be nearly at 15% by the time we exit fiscal 2024, and that will continue growing in fiscal 2025. For example, with healthcare, we believe that given the deals that we have in the funnel and the confidence of us closing these deals, this 30% growth early 30% growth in fiscal 2024 might translate to another high double-digit growth in fiscal 2025.

That makes sense. Congrats again, and thank you for the time.

Thank you, Kevin. Please stand by for the next question.

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

Hi. This is Ryan on for Ramsey. Thanks for taking the question today. Last quarter, you mentioned an 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 6 to 12 months? Thank you.

Thank you for the question. As you may remember, we made a significant shift in our go-to-market strategy from an infrastructure-focused approach to one centered on services about 18 to 19 months ago. This involved restructuring our entire go-to-market organization and empowering our sales team. Currently, we have a robust services-led strategy that is gaining traction in enterprise markets while also selectively expanding into the mid-market. Our approach for the SOHO market is also performing well. To address your question directly, our services-led strategy has unlocked opportunities for us to engage with C-level executives within organizations. This marks a significant change in our customer interactions. Unlike the previous infrastructure-led method, which started with procurement discussions, we are now entering conversations at the C-level and moving down to procurement. This shift is highly beneficial, allowing us to maintain high margins on our services while also positively impacting our infrastructure resale margins. Engaging at the C-level enriches our discussions by focusing on delivering holistic value to our customers, fundamentally transforming how we view our public cloud portfolio.

Great. Thanks.

Thank you. At this time, I'm 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. If we did not get to your question or if you have a follow-up, please e-mail us. Have a great evening, everyone.

Thank you for your participation in today's conference. This does conclude the program, and you may now disconnect.