Rackspace Technology, Inc. Q2 FY2025 Earnings Call

Good day, and thank you for standing by. Welcome to the Rackspace Second Quarter 2025 Earnings Conference Call. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to Sagar Hebbar, Head of Investor Relations. Please go ahead.

Thank you, and welcome to Rackspace Technology's Second Quarter 2025 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 second quarter 2025 earnings conference call. Results for the second quarter met our expectations across all key metrics. Revenue and operating profit exceeded the midpoint of our guided range, while EPS was within our guided range, marking our 12th consecutive quarter of meeting or exceeding guidance. Sales pipeline generation remains strong across both the business units with bookings, as measured by annual contract value, growing 2% sequentially and 16% year-over-year. The outperformance was primarily driven by Private Cloud, which secured several key wins. Non-GAAP operating profit grew 34% year-over-year, and we delivered positive cash from operations of $8 million for the quarter, reflecting our operational and financial discipline. Now let me get into our segment performance, starting with Private Cloud. Private Cloud bookings in the second quarter of 2025 grew 24% sequentially and 42% year-over-year, driven by several large, long-term deals across key industries, including healthcare, BFSI and telecom. We also saw double-digit year-over-year bookings growth across both the Americas and EMEA, underscoring the broad-based strength of our go-to-market efforts. This solid bookings performance was despite a large healthcare deal that got pushed, and we expect this opportunity to close within the third quarter. Revenue for the Private Cloud segment came in at $250 million, in line with guidance and down 4% year-over-year. We are seeing continued revenue stabilization as prior year bookings convert into revenue, reflecting the strength of our underlying business. Our disciplined focus on revenue retention and growing bookings momentum continues to lay a solid foundation for our long-term, sustainable growth. We are also making strong progress in our strategic expansion into the mid-market and enterprise segments, positioning us to capture new opportunities and drive future scale. In April, we signed a long-term agreement with a leading healthcare provider in the U.S. to host their virtual desktop infrastructure supporting clinical kiosks. This was previously hosted on a hyperscale public cloud. The customer is getting enhanced control, consistent performance, predictable and highly competitive costs by transitioning the environment to Rackspace's secure Private Cloud. This win underscores Rackspace's expertise in delivering compliant, high-performance infrastructure for critical healthcare and other enterprise workloads. We also expanded our relationship with a large U.K. bank through a strategic engagement to modernize its entire edge infrastructure. We have been engaged to deploy a secure network solution across approximately 80 branch locations. Our engagement is a comprehensive end-to-end managed service over 5 years. Our Private Cloud team continues to deliver innovative solutions. In the second quarter, we had 13 product releases and 28 enhancements. More notably, we announced Rackspace OpenStack Business, a new open-source dedicated solution for organizations running mission-critical or regulated workloads. This fully managed offering delivers enhanced performance, improved security and comprehensive operational support, all without the overhead and complexity of managing your own infrastructure. Overall go-to-market and solutions momentum in the Private Cloud segment remains strong, reflected in both our results and customer wins. We remain focused on expanding our footprint while continuing to defend and grow our Private Cloud business. Now turning to Public Cloud. In the second quarter, bookings for Public Cloud grew 1% year-over-year, primarily driven by strong performance in EMEA. Services bookings increased 6% sequentially, reflecting our disciplined focus on higher-value engagements. Revenue for the segment totaled $417 million, exceeding our guided range. Revenue declined 2% year-over-year due to expected declines in lower-margin infrastructure resale. We continue to focus on services revenue, which grew 3% sequentially and remained flat year-over-year. We are also seeing success in increasing our footprint with existing relationships. In the second quarter, we expanded our engagement with a top-tier aircraft leasing company. They are leveraging Rackspace's data modernization and engineering services to accelerate their data transformation strategy and platform implementation. Additionally, we expanded our offering with a midsized cybersecurity company through a long-term deal that bundles infrastructure and services, demonstrating our continued ability to deliver integrated solutions that align with client needs. On the product side, we introduced Rackspace CloudOps, a managed service that offers 24/7 operational support in the cloud. CloudOps is purpose-built for mid-market organizations at any stage of their cloud journey, helping them drive operational excellence, optimize performance and maximize cloud efficiency. This expands the service offerings that can be attached to infrastructure resale. In summary, our focus on higher-value services, strategic bundling and expanding existing customer relationships is yielding positive results. Our services revenue continued to grow sequentially, underscoring continued progress in our Public Cloud business. Turning to AI. We continue to make good progress with FAIR, which is Foundry for AI by Rackspace with over 80 wins and over 235 opportunities in our pipeline, of which over 20% are already in advanced stages, along with several active leads we are pursuing. Last month, we announced a strategic alliance with enterprise AI agent innovator, Sema4.ai, bringing together Rackspace's application and infrastructure management expertise with Sema4.ai's advanced 'SAFE' AI Agent Platform. Through this partnership, organizations will be able to rapidly deploy scalable, production-grade AI agents across key business functions built on a foundation of strong governance, transparency and security. Additionally, we launched the Fair Model Context Protocol Enterprise Accelerator on the AWS Marketplace, empowering organizations to deploy AI agents at scale with robust security and seamless integration. This solution delivers over a 70% reduction in legacy application integration time, accelerating value realization and enabling real-world impact across healthcare, finance and manufacturing sectors. We are also driving AI innovation across our service offerings in Public Cloud. AI integration within our services spans three areas: accelerating cloud migration timelines by 20% to 30%, reducing operational overhead for our managed services teams by 10% to 20% and automating security operations at scale. For example, we recently reduced migration time by 40% using SnowConvert AI for a leading healthcare services company. These AI at scale initiatives are accelerating time to value for customers and strengthening our position in enterprise transformation through intelligent automation. Before I wrap up, I want to sincerely thank our customers, partners and all our team members. I'm pleased with what we have achieved this quarter and encouraged to see momentum in acquiring new customers and expanding with existing customers. We remain laser-focused on our key strategic priorities for 2025, building a sustainable business model that consistently delivers revenue, profit and cash flow growth. With that, I will turn it over to Mark to walk us through the financial results and guidance.

Thanks, Amar. In the second quarter, total company GAAP revenue of $666 million was down 3% year-over-year and slightly up sequentially, beating our guidance, driven by solid performance across both business units. Non-GAAP gross profit margin was 19.8% of GAAP revenue, slightly down year-over-year, driven by lower cost absorption in Private Cloud, while it remained flat sequentially. For the quarter, non-GAAP operating profit was $27 million, exceeding the high end of our guidance and up 34% year-over-year. The improvement was largely due to OpEx efficiencies in Public Cloud and in corporate overhead, partially offset by lower cost absorption in Private Cloud. Non-GAAP loss per share was $0.06 at the lower end of our guided range of $0.04 to $0.06 loss per share. This was primarily due to higher expenses within the other income and expense line, driven by accruals related to data center leases as well as lower-than-expected diluted share count. Second quarter cash flow from operations was $8 million and free cash flow was negative $12 million. We ended the quarter with $104 million in cash on hand and $414 million of total liquidity. Turning to our segment results. For Private Cloud, GAAP revenue for the second quarter was $250 million, which was in line with our guidance. Private Cloud revenue decreased 4% year-over-year due to customers rolling off older-generation offerings, partially offset by revenue from new bookings. Sequentially, Private Cloud revenue was relatively flat. Private Cloud non-GAAP gross margin was 36.8%, down 50 basis points year-over-year and 30 basis points sequentially, primarily due to lower fixed cost absorption on lower revenue. Non-GAAP segment operating margin was 24.6%, a year-over-year decline of 190 basis points, driven by lower gross margins and higher OpEx. Sequentially, non-GAAP segment operating margin was up 20 basis points, driven by lower OpEx, partially offset by lower non-GAAP gross margin. In our Public Cloud segment, GAAP revenue was $417 million, surpassing the high end of our guidance. Public Cloud revenue was down 2% year-over-year as a result of a decline in infrastructure volumes and flat sequentially, driven by growth in high-margin services business, offset by declines in low-margin infrastructure resale. Non-GAAP gross margin was 9.6%, down 20 basis points year-over-year, reflecting one-time benefits realized last year. Sequentially, non-GAAP gross margin was up 10 basis points, driven by favorable rate and mix. Non-GAAP segment operating margin was 3.9%, up 140 basis points year-over-year due to improved OpEx efficiency and slightly down sequentially as a result of higher OpEx. Now on to guidance. We expect third quarter GAAP revenue of $660 million to $674 million, flat sequentially and down 1% year-over-year at the midpoint. In Private Cloud, we expect revenue of $246 million to $254 million, flat sequentially and down 3% year-over-year at the midpoint. We expect Public Cloud revenue of $414 million to $420 million, flat sequentially at the midpoint. Total non-GAAP operating profit is expected to be $30 million to $32 million and non-GAAP loss per share is expected to be $0.04 to $0.06. Our non-GAAP tax rate is expected to be 26% and non-GAAP share count is expected to be 239 million to 241 million shares. In the second half of 2025, we expect strong free cash flow generation, positioning us to exit the year with $70 million to $80 million in positive free cash flow. This trajectory reflects the strength of our business model and financial discipline. I will now turn the call back over to Sagar.

Thank you, Mark. Let us begin the question-and-answer session. Please go ahead.

Our first question will come from Kevin McVeigh with UBS.

Congratulations on the results. I'm not sure if this is for Amar or both of you, but could you discuss the guidance? It seems like there's a slight sequential uptick, but the success with free cash flow is definitely more pronounced. Could you address any seasonality in the guidance in relation to your previous performance? Also, if you could spend a moment discussing the free cash flow conversion, that would be great.

Go ahead, Mark.

Yes, sure. So yes, thanks, Kevin, for the question. Yes, in terms of our Q3 guidance, you're right, overall $660 million to $674 million with the midpoint around $667 million, right? We're seeing things ultimately kind of flat sequentially from a Private Cloud perspective. We are forecasting some uptick on the Public Cloud side, especially on the services, while infra continues to stay sort of flattish to slightly down. And in terms of free cash flow for the year, you saw we called out positive for the second half, positive for the full year. We did have some seasonality in the first half of the year related to some kind of one-time vendor prepayments, and those will not cycle in the second half. So that's driving a lot of our improvement as well as higher adjusted EBITDA and overall working capital performance. So I feel pretty confident about that free cash flow range.

Kevin, I’d like to provide some insights on Private Cloud. As Mark mentioned, we are expecting flat revenue sequentially in this segment for three consecutive quarters. We had previously indicated that the Private Cloud business would begin to stabilize, and that is indeed what we are observing. We are pleased with our bookings performance, which showed a favorable mix. The bookings were broad-based in the Private Cloud sector, and we are satisfied with that outcome. Notably, the size of the deals has shifted significantly. In fiscal '22, around 60% of our deals were small-sized with lower annual contract values, while 40% were midsized to large-sized. This has flipped in 2024 and the first half of 2025, where 40% of the deals are now small and 60% are large and midsized. This change reflects an important trend, especially considering our double-digit CAGR growth over the past 2.5 years. Additionally, the average contract length has increased. In fiscal '22, about 25% of our bookings involved contracts longer than 24 months, while now, in the first half of '25 and fiscal '24, that figure has risen to nearly 50%. We are successfully building a strong portfolio across various verticals and geographic areas. Regarding Public Cloud, we feel optimistic about our services performance. In Q2, services revenue was flat sequentially, but we anticipate growth in the second half. Specifically, in Q4 of 2025, we expect our services business in Public Cloud to grow between 10% and 20% year-on-year, which will represent a significant turnaround. Overall, we are quite satisfied with our performance in both the Private and Public Cloud sectors.

And Amar, just remind me, and I know we talked about this a couple of times, but the services on the private side and I guess, what's driving the strength on the public side? And then just any thoughts on the services, I guess, more on the implementation work on the private? Just anything just around services on the private side as well? I know maybe if you have just any thoughts.

Thank you very much. Let's begin with the Public Cloud segment. We provide three types of services to our customers: first, Professional Services; second, managed services, which consist of long-term contracts that are very secure; and third, Elastic Engineering, positioned between the two. We offer these services across applications, platform, and data. We are witnessing solid performance across all three services, particularly in Professional Services. As we pursue more cloud migration projects, we are also engaging in work related to AI, which primarily falls under Professional Services. Our data business has shown promising growth this quarter compared to the previous quarter, reflecting significant increases in bookings. Therefore, we are seeing robust performance in data, applications, and platform support across Professional Services, Elastic Engineering, and managed services during this quarter. The integration of our services with infrastructure sales has also improved; we attach approximately 70% of services to each infrastructure sale. For every dollar of infrastructure sold, we are attaching at least $0.70 worth of services. This strategy is proving effective with strong execution in the field. Additionally, our offerings align well with market trends, as more projects focus on digital transformation driven by cloud and AI, which enhances our position in the Public Cloud space. These macro factors and our operational execution reinforce our belief that we are making progress with our services. On the Private Cloud front, we provide managed Private Cloud solutions for our clients where we have found success, particularly in healthcare, which performed strongly even in Q2. In the healthcare sector during the first half of the year, revenue grew by over 60% year-on-year, reflecting excellent performance. We have promising deals in the pipeline and are also gaining traction in the telecommunications sector with several significant contracts signed. In terms of services within Private Cloud, the primary focus is on managed services, which is a very stable business. Once we secure these contracts, they tend to last between three to seven years, and the average contract duration has also increased considerably. I hope that clarifies things.

Our next question comes from Frank Louthan with Raymond James.

Great. You mentioned getting some more traction in mid-market. Kind of what investments do you think you'll need to make there, either on the sales or the support side? And then with regard to the partnership with some of the AI agents, how did that come about? And when can we begin to see some of the benefits of that more broadly across the business?

Thank you, Frank. Our focus has consistently been on the mid-market and enterprise sectors, particularly within both Public Cloud and Private Cloud businesses. We made strategic investments toward the end of fiscal '23 and into fiscal '24, and we are beginning to see the advantages of these efforts. For instance, our Public Cloud business has registered growth in bookings for several consecutive quarters. Currently, we don’t anticipate needing additional investments in go-to-market strategies. We will, however, invest in edge computing, particularly in the healthcare sector, where we have significantly improved our standing from being a minor player in 2022 to becoming a strong contender in the healthcare provider market with our Private Cloud solutions for 2024 and 2025. Most of our future investments, including capital expenditures, will be made based on success. That means we will invest in CapEx only when we secure a new customer. Regarding AI, we are witnessing significant momentum in both business areas. In the Private Cloud sector, our goal is to establish ourselves as a private AI infrastructure provider for our clients, concentrating on inferencing workloads that can operate in public environments, Private Cloud, or at the edge. We are optimistic about our prospects in private AI and edge applications and will collaborate with hyperscalers on the Public Cloud side. For example, we recently secured a private AI infrastructure deal with a U.S. healthcare organization that supports adults with developmental disabilities. They faced several challenges, including manual care delivery processes and a lack of automation. Our AI-powered solution combined private AI-managed infrastructure using NVIDIA GPUs with our Elastic Engineering services and managed services, which led to an 80% reduction in manual review times and enhanced care delivery. This example illustrates how we are addressing customer needs related to having their private AI inferencing workloads close to where data is generated. On the Public Cloud front, we successfully implemented an agentic AI platform with J.Crew, which we have publicly announced. J.Crew, a leading fashion retailer, was struggling with the effectiveness of their customer, vendor, and employee support systems. We introduced three distinct AI agents for their IT, vendor management, and customer service departments, powered by Amazon's Bedrock and cloud sonic models. These instances show how we are advancing in the AI sector. Additionally, we have initiated a partnership with Sema4.ai, an innovative company that has the backing of Mayfield Venture Capital. Rackspace and Sema4.ai complement each other well for our clients. Sema4.ai provides the agentic AI platform, while Rackspace offers the delivery capabilities, including infrastructure. Together, we are creating a comprehensive turnkey solution for a state-of-the-art AI-based agentic platform at the enterprise level, including implementation, operations, governance, technology, and service solutions. Finally, we are also evolving into an AI company ourselves. Our CTO, Srini Koushik, along with his team, has done an excellent job of integrating agentic AI within our organization to enhance the productivity of our personnel. This development is also extending to our customer success management and sales teams.

That concludes today's question-and-answer session. I'd like to turn the call back to Sagar Hebbar for closing remarks.

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

This concludes today's conference call. Thank you for participating. You may now disconnect.