Rackspace Technology, Inc. Q4 FY2024 Earnings Call

Good day, and thank you for standing by. Welcome to the Rackspace Fourth Quarter 2024 Earnings Webcast. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. Please be advised that today's conference is being recorded. I would now like to turn the conference over to your first speaker today, Sagar Hebbar, Head of Investor Relations. Please go ahead.

Thank you, and welcome to Rackspace Technologies fourth quarter 2024 earnings conference call. I am 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. Our fourth quarter results exceeded guidance for revenue, profit, and EPS, marking the tenth consecutive quarter of meeting or beating expectations. We also achieved a record-breaking quarterly sales booking, reaching the highest level since early 2023 and the formation of our two business units. Bookings, as measured by annual contract value for the fourth quarter, grew high double digits both sequentially as well as year-over-year, reflecting excellent go-to-market execution in a strengthening demand environment. I'm also pleased with our sales execution in fiscal 2024. Full-year sales bookings grew by 14% fueled by strong performance in the Americas and the increasing adoption of hybrid cloud solutions across multiple industries. Notably, second-half bookings grew 32% over the first half, underscoring the accelerating momentum across both business units. This reaffirms that our strategy and go-to-market execution are driving tangible results. We initiated this approach two years ago, and with significant market uncertainty, today both market conditions and customer demand validate our direction. As we move into 2025, we are leveraging this momentum and, with a strategic focus, optimized operating model, and a strong team, I'm confident we will accelerate our progress. With that, let's dive into the performance of our business units starting with private cloud. Fourth quarter of 2024 was a record sales bookings quarter for private cloud. Private cloud bookings in the fourth quarter more than doubled sequentially and grew high double digits year-over-year, driven by the strong performance across most of our go-to-market segments. For the full year of 2024, private cloud sales bookings were up 4% year-over-year. Bookings in the second half of 2024 grew 42% compared to the first half, highlighting significant acceleration towards the end of the year. In the fourth quarter, we also signed a transformative multi-year managed cloud agreement with Seattle Children's Hospital. Under this 10-year multimillion-dollar deal, Rackspace will deliver an end-to-end managed cloud solution designed to revitalize the hospital's data center operations and modernize its infrastructure for both clinical and non-clinical workloads. This strategic partnership will enable Seattle Children's to seamlessly transition to Rackspace's state-of-the-art healthcare cloud, ensuring enhanced performance, efficiency, and security. Overall, on the sales front, we are consistently gaining market traction by leveraging our strong installed base and attracting new customers. Private cloud GAAP revenue was $269 million for the quarter, exceeding our guided range and rising 4% sequentially. This growth was driven by the successful onboarding of a major healthcare customer secured in 2023. Our Private Cloud segment is making significant progress, particularly in the healthcare and sovereign markets. In fiscal 2024, healthcare revenue grew 34% year-over-year, while sovereign revenue surged by 59%. Within the Sovereign segment, we are expanding our footprint in the UK and the Kingdom of Saudi Arabia and we are seeing interest from other nation-states driven by rising data sovereignty, security, and compliance requirements. For the past two years, our value proposition in private cloud has evolved from an infrastructure as a service provider into a specialized high-value solutions partner. In 2024, we launched several innovative solutions and platforms. Notably, we expanded our Rackspace Anywhere offerings to capture new and incremental workloads in customers' data centers, delivering unparalleled flexibility and enabling true hybrid cloud environments. We're also excited to announce the upcoming release of Open Cloud, our next-generation cloud platform targeting customers across large enterprises, sovereign organizations, and other cloud service providers. Leveraging our deep open-source expertise, Open Cloud unifies its existing silos into a single operational platform, simplifying internal cloud operations while delivering hyperscale capabilities to end users. In fiscal 2025, we expect a modest year-over-year decline in private cloud revenues with a leveling effect by year-end as we onboard a large deal signed in 2024. We are seeing strong momentum in our bookings driven by an increasing mix of large deals that will underpin a sustainable recurring revenue base. Moreover, in fiscal 2025, our annualized sales bookings for new offerings are expected to be in line with or outpace the runoff from legacy private cloud products, highlighting a shift from a turnaround to a more resilient growth-focused business model beyond 2025. Given the rapid expansion of the private cloud market, we are exceptionally well-positioned to emerge as one of the world's largest private cloud providers. Now, turning to public cloud. In the fourth quarter of 2024, our public cloud GAAP revenue was $417 million, surpassing our guided range due to an uptick in higher cloud consumption. Building on record third-quarter bookings, we sustained strong sales momentum into the fourth quarter with the fourth-quarter bookings growing in the high double digits year-over-year, driven by robust performance in both our services and infrastructure resale. For the full fiscal year, public cloud bookings grew 22% year-over-year with both services and infrastructure resale posting double-digit growth. Notably, data services bookings more than doubled, driven in part by AI-related projects. So other factors also contributed to this growth. These results underscore significant progress in 2024 as we strategically shifted our focus to a services-led sales motion rather than low-margin infrastructure resale. This transformation has been propelled by refreshing over 70% of our sales team, revamping our go-to-market strategy, and building a strong services value proposition. In the fourth quarter, Rackspace was recognized by ISG as a leader in the AWS Ecosystem Partners category in the U.S. We also earned the AWS small and medium business competency, differentiating us as a partner with expertise and commitment to enable small and medium businesses to leverage AWS Cloud. Throughout 2024, we strengthened our partnership with key hyperscalers by focusing on high-demand areas with significant revenue potential. We signed 16 new master service agreements, creating fresh growth opportunities for our land and expand strategy. These initiatives have fostered deeper collaboration, bolstered partner support, and increased sales leads, demonstrating our ability to deliver tailored solutions that meet customer needs. Our public cloud segment continued to innovate with the introduction of new services. This quarter, we launched Edge Security, a cloud-native managed security service designed to protect online applications, remote workers, and networks from cyber threats. We also unveiled our AWS accelerated migration analysis offerings, which help organizations build data-driven business cases for cloud migration by emphasizing cost optimization, licensing flexibility, and enhanced performance. In summary, 2024 marked a significant inflection point for our public cloud business, driven by improving IT budgets, growing interest in our solutions, and outstanding sales execution in the latter half of the year. As we look to 2025, our focus is on solidifying a sustainable business model centered on managed cloud services, migration, modernization, and data services, setting the stage for consistent revenue and profit growth. Recent booking trends and stronger customer engagements position us well to accelerate that momentum in 2025. Turning to AI. We continue to be optimistic about the progress made with more than 50 customers and close to 200 opportunities in the pipeline at various stages. In the fourth quarter, we successfully deployed multiple customer solutions leveraging multimodal GenAI and Agentic AI, enabling them to process and analyze text, images, videos, and structured data simultaneously. This delivered richer, more contextual insight that enhanced operational efficiency, decision-making, compliance, and automation. In private cloud, we launched a solution that accelerates the deployment and management of AI tools, frameworks, and applications, as well as a high-performance platform optimized for AI workloads, enabling organizations to leverage hybrid AI capabilities. Before wrapping up, I want to highlight consistent execution and a focus on three key strategic priorities. First, we're making steady progress on our operational turnaround. This is reflected in our bookings growth and efficiency improvements in 2024. Second, we continue to position Rackspace as a forward-leaning innovative hybrid cloud and AI Solutions Company. We're launching new products, solutions, and offerings that target the next particular 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. Finally, I would like to thank our customers, Rackers, partners, and suppliers. I'm proud of all we have achieved together during this year of change. I will now turn the call over to Mark Marino for an overview of our financial results and guidance.

Thank you, Amar. In the fourth quarter, total company GAAP revenue was $686 million, above our guided range, driven by solid performance across the board. For the quarter, non-GAAP gross profit margin was 20.6% of GAAP revenue, down 50 basis points sequentially. For the full year 2024, non-GAAP gross profit margin was 20.6%, down 172 basis points year-over-year. Non-GAAP operating profit was $39 million in the fourth quarter, exceeding the high end of our guidance range. Non-GAAP operating margin for the quarter was 5.7% of GAAP revenue, an increase of 94 basis points sequentially. For the full year of 2024, non-GAAP operating margin was 3.9%, down 146 basis points versus the prior year. Non-GAAP loss per share was $0.02 higher than our guided range, driven by better-than-expected operating profit. Cash flow from operations was $54 million and free cash flow was $34 million in the fourth quarter. For the full year, cash flow from operations was $40 million and free cash flow usage was $71 million. We ended the year with $144 million in cash on hand and $519 million of total liquidity, including $375 million of undrawn commitments. Turning to our segment results. For Private Cloud, GAAP revenue for the fourth quarter was $269 million, above our guided range. This includes legacy OpenStack revenue of $27 million. Total Private Cloud revenue was up 4% sequentially due to strength in our Healthcare segment. Private Cloud non-GAAP gross margin was 39.8%, up 120 basis points sequentially due to higher revenue and cost efficiencies. Non-GAAP segment operating margin at 30% was up 130 basis points sequentially driven by gross margin expansion and improved cost management. In our Public Cloud segment, GAAP revenue was $417 million, above our guided range, driven by higher cloud infrastructure volumes, partially offset by a slight decline in services. Non-GAAP gross margin was 8.2%, down 10 basis points sequentially driven by an increase in infrastructure revenue mix. Non-GAAP segment operating margin was 2.4%, down 130 basis points sequentially due to lower gross margins, partially offset by operational efficiencies. Now on to guidance. We expect first-quarter GAAP revenue to be $653 million to $665 million consistent with normal seasonality. From a segment perspective, we expect private cloud revenue of $247 million to $253 million and public cloud revenue of $406 million to $412 million. Total non-GAAP operating profit is expected to be $19 million to $21 million, and non-GAAP loss is expected to be from $0.07 to $0.09 per share. Our non-GAAP tax rate is expected to be 26%, while non-GAAP other expense will be in the $46 million to $50 million range. Non-GAAP share count is expected to be approximately 245 million shares. I'll 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.

At this time, we'll conduct a question-and-answer session. Please be advised that the first question comes from the line of Kevin McVeigh of UBS. Your line is now open.

Great. Thank you so much. And team, congratulations on the strong results. You continue to really execute well. So, we appreciate that. Maybe Amar, can you maybe talk to, I think you talked about some of the trends within the private business. And did you say you expected that to be down for the year in '25? And if that is the case, it sounds like there was a lot of momentum in the second half of ’24 as opposed to the first half of ‘24. So maybe help us understand that a lot because it seems like that business is really starting to flex.

Hey, Kevin, thank you very much. I really appreciate your question here. Hope you're doing well. So, yes, Kevin, you heard it right. I think we saw some and I will give you some color on the outlook for 2025 for private cloud the way we look at it right now. But I'm really pleased with the overall sales bookings performance, Kevin, and it was a combination of both improving demand environment as well as very good sales execution. And you're spot on; in the second half of ‘24, we did see not only an improving demand environment for our hybrid cloud solutions, but we also started seeing some faster decision cycles coupled with great execution from our go-to-market teams. So in private cloud, we are seeing increased interest for our custom cloud solutions, specifically around data center transformation, resulting in a higher mix of larger deals. So private cloud bookings did grow 4%, the Americas sales bookings within private cloud grew more than 20%, Healthcare grew more than 60%, and the Commercial segment, which is of the SMB, also grew probably 8%. So overall, I think it was a very good bookings quarter. So you heard it right. We expect private cloud revenues after a couple of years of double-digit declines to show modest declines in fiscal 2025, which is definitely a good indicator of a turnaround in this business. Now it's still early to say, but in the second half of 2025, I expect revenues in private cloud to be flattish year-over-year given the deals that we signed in 2024. So I think you're spot on with that question. There's a lot of static noise on the line, operator.

Got it. And then, Amar, any thoughts to free cash flow in 2025? Do you think we'll be able to hold that breakeven in ‘25?

Yes. So I'll let Mark talk about it.

Hey, Kevin. Yeah, look, I anticipate both positive operating cash flow and free cash flow in 2025. Hope that's helpful.

Kevin, did you hear that? So positive operating cash flow and free cash flow in 2025 on the backs of operating profit growth of low double digits mainly driven by margin improvements because of the changing business mix and ongoing efficiency improvements.

Thank you. One moment for our next question. Our next question comes from the line of Ramsey El Assal of Barclays. Your line is now open.

Hi. This is Ryan on for Ramsey. Thanks for taking my questions and congrats on a strong quarter. I wanted to ask on visibility a bit more. Have you seen any changes in the demand environment over the last 30 days? It seems like bookings are coming in well, but are deals actually converting on time? And are you seeing any additional green shoots as 2025 budgets are being finalized? Thank you.

Yes, I think visibility has definitely improved a bit. We closed the year on a very high note in both Q3 and Q4. Let me start with the public cloud business. Q3 was a record quarter for public cloud, and we maintained this momentum into Q4, our December quarter. We hope to continue this trend into fiscal 2025. This success is due to several factors. Firstly, we are outperforming the market in sales bookings compared to our competitors. One key reason for this is effective execution. We have also established a strong foundation in our public cloud business over the last year and a half by refreshing 70% of our sales force, enabling the sales organization, and introducing new offerings. Our relationships with hyperscalers have strengthened, and leading with services is starting to pay off. This approach is more focused on value rather than just reselling infrastructure, although we're still selling a lot of infrastructure. However, our services attach rate on infrastructure has significantly increased. Regarding visibility, I believe it has improved. In fiscal 2025, we expect customers to pursue transformational projects they've postponed over the past couple of years, which should benefit us, along with better execution in the public cloud business, reflected in the growth numbers for hyperscalers. In our private cloud business, we're starting to see encouraging signs. A few years ago, it was thought that all workloads would shift to public cloud, but that's not the case. Hybrid is becoming the preferred solution, and many workloads are now landing in private cloud. We are engaged in numerous data center transformation projects in this area, with deal sizes significantly increasing and leading to more large, multi-year agreements. This helps create a solid annuity base for the business. Overall, I am pleased with our strategies and execution, and if the market improves, we should see even better results.

Great. Thanks. And just a quick follow-up for me. The infrastructure resale picked up just a bit in the quarter. Is there anything specific that drove that or any seasonality, and how should we think about it into 2025?

Yeah. So let me just give some color, and Mark, please jump in here with additional color. So the infrastructure volumes, we have limited visibility, to be honest with you. So we always plan a bit conservatively because of that. The infrastructure volumes, because of seasonality, Q4 is typically pretty strong going into the month of December, and so we saw an uptick in infrastructure volumes. So that was good, good guy. Of course, it comes in at lower margins. So, we'll take it any day as long as the margins are okay. Now, going into fiscal 2025, first of all, Q1 is a seasonally low quarter. So you typically see in public cloud business as well as in a private cloud business, the revenues and the volumes decline going from the December quarter to the March quarter. So that’s going to happen. Now, when it comes to infrastructure resale for Rackspace, I think the market will continue to grow. So for Rackspace, it's a little hard for us to predict because we are going to make some very informed decisions when it comes to some of these deals that come up for renewal, whether we want to renew these contracts or walk away if it doesn't hit certain profitability thresholds, and that's something that we've been doing all along even in fiscal '24 as well as in '25. So, we'll continue that in '25. So, it's a little hard for me to predict whether the infrastructure business is going to grow. I expect it to be flattish to slight decline depending on what we do when these big contracts come up for renewal. But overall, the market I think will continue to grow.

Great. Thank you and congrats again.

Thank you very much, Ryan.

Thank you. One moment for our next question. Our next question comes from the line of Frank Louthan of Raymond James and Associates. Your line is now open.

Great. Thank you. Can you walk us through the new logo growth in Q4? Where have you seen that? Any particular segments that were better or worse there? And then with the booking success, how should we think about the time for book-to-bill? Is that elongated at all? How should we think about that?

Thank you for your question, Frank. We are continuing to acquire new clients across various sectors in both public and private cloud. In private cloud, our focus is on key verticals such as healthcare, BFSI, sovereign, public sector, and energy, while also pursuing broader opportunities. We have brought in over 250 new clients in our private cloud segment. While some of these clients are smaller and others larger, our priority is to grow within these accounts. For instance, we recently announced a multi-year, multi-million dollar agreement with Seattle Children's Hospital, which we secured in late 2023 or early 2024. Initially, this deal involved an epic workload, and about eight or nine months later, we expanded to undertake a complete data center transformation for them. We are committed to seeking new clients and have plans in place to grow within these new accounts going forward. Regarding your second question on deal cycles, they have remained consistent in private cloud as we are now finalizing larger deals. The type of business we are winning is significantly larger than what we've historically achieved, leading to longer deal cycles. In contrast, deal cycles in the public cloud are relatively shorter as we focus on high-value services such as migration and advisory services. These cycles remain short compared to private cloud, and there hasn't been any change compared to the second half of 2024.

Thank you. One moment for our next question. Our next question comes from the line of Irwin Liu of Evercore ISI. Your line is now open.

Hi. Thank you for letting me on. I also have two related to your strong bookings performance. I think it's good to see broader booking strength. But can you just talk about your overall headcount utilization and whether there's a need to increase headcount to deliver on some of your recent bookings?

Thank you for your question. I appreciate you joining the call. To elaborate on our bookings, let me first address the public cloud since your inquiry about headcount is more relevant to that area. In the private cloud sector, we have managed services and serve as an infrastructure-as-a-service provider, which tends to be less labor-intensive compared to traditional service systems integrators. The public cloud does involve more labor; however, we distinguish ourselves by employing a labor-minus model that incorporates greater automation in our service delivery. This approach contrasts with some Indian service integrators that focus on headcount and attrition numbers. Regarding bookings in the public cloud, we experienced a 22% growth overall, and when broken down by geography, the Americas saw over 30% growth while EMEA grew in the mid-single digits, despite a challenging macroeconomic environment. We target three market segments: enterprise, mid-market, and commercial, and all have experienced high double-digit growth in sales bookings. Our Professional Services and Data offerings are particularly noteworthy, with the Data sector seeing high triple-digit growth. As for headcount, any increase will be concentrated in professional services and data, as we aim to enhance the current utilization of our resources strategically.

Got it. Thank you for that. I wanted to ask about public cloud, but specifically the topic of AI. Can you just help us or talk about whether this was a meaningful contributor or driver of your booking strength? And if so, can you help us quantify the overall AI contribution?

Yeah. So, it did contribute to some of the bookings in data. As I said, data, it was primarily driven by AI, although there are other factors that contributed to the data services bookings. But let me give you how we look at the AI world and how we play in that AI lifecycle. So there are three phases in any AI lifecycle; that’s the way we look at it. One is the design-build and the re-architect phase, which is mainly services-related where you do POCs and pilots. That's where most of our 50-plus engagements are in the POC and pilot phase. The second phase is mainly around creating landing zones on a hybrid AI environment, whether it's public cloud or private cloud. That's we call it an implementation or a production phase. And the third phase is manage and operate, which is the managed services phase, which is the long tail. Now, where we play right now is in phase one and a little bit in phase two. That's where the reason why we are here today is because we are very early days from an enterprise adoption perspective in AI. So, I'm not surprised that we are in those two phases. But given the strength we have with a hybrid AI approach, both on public and private, I feel that we are very well-positioned when customers start moving from a training phase to inferencing and fine-tuning because that's where we believe 90% of the workloads will be in inferencing as well as fine-tuning. And that's where our hybrid AI solutions will play very strongly. So today, just to size it, probably it's less than 2% of our revenue today in AI. It was almost zero a year ago; it's less than 2%, and I expect in the next couple of years to be probably 5% plus, conservative estimate, so to speak. So, there are still early cycles, there's a long way to go, especially in enterprise, and that's where we play, and I think I feel very strongly in our offerings as well as our approach to actually capture this AI market when it starts taking off in enterprise. Does it help, Irwin? Hello?

Thank you. This concludes the question and answer session. I would now like to turn it back to Sagar Hebbar for closing remarks.

Thank you, everyone, for joining us. If we did not get your question or if you have a follow-up, please email us at ir@rackspace.com. Have a great evening, everyone. Thank you, Marvin.

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