Earnings Call Transcript - RXT Q1 2025

Operator, Operator

Good day, and thank you for being here. Welcome to the Rackspace First Quarter 2025 Earnings Webcast. At this moment, all participants are in a listen-only mode. Following the speaker's presentation, there will be a question-and-answer session. I would now like to hand the call over to Sagar Hebbar, Head of Investor Relations. Please continue.

Sagar Hebbar, Head of IR

Thank you, and welcome to Rackspace Technologies first quarter 2025 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.

Amar Maletira, CEO

Thank you, Sagar, and welcome everyone to our first quarter 2025 earnings conference call. Results in the first quarter of 2025 exceeded our expectations across all key metrics. Revenue was at the high end of our guidance, while profit and EPS exceeded our guidance range. This marks the 11th consecutive quarter in which we have either met or exceeded our guidance. Our operational turnaround is gaining steady momentum with growth in pipeline across both business units, increased bookings and improved efficiency. Bookings measured by annual contract value grew 9% year-over-year in the first quarter, driven primarily by strong performance in The Americas, where we saw a 13% increase. Our non-GAAP operating profit grew 83% year-over-year and we also saw significant growth year-over-year in both cash flow from operations and free cash flow. As we drive our digital transformation agenda for our customers enabled by cloud and AI, we are also helping them with cyber resiliency. Last week, we announced a strategic partnership with Rubrik. Together, we launched the world's first fully-managed end-to-end isolated recovery environment called Cyber Recovery Cloud, powered by Rubrik's leading technology and Rackspace's Managed Private Cloud Platform. This solution allows customers to recover clean data and restore critical business systems within hours, not weeks or months, following a cybersecurity breach, significantly improving their cyber resiliency. Both Rubrik and Rackspace anticipate solid demand for this offering, and we expect it to drive revenue for Rackspace starting in 2025. Although government cost-cutting measures have impacted federal agencies, I would like to highlight that Rackspace's exposure is minimal, with federal contracts comprising only 1% of 2024 revenue. That said, we remain cautious of the broader macroeconomic environment, which may impact onboarding timelines for recently closed deals and customer decision cycles in the short-term. However, we remain well-positioned to capitalize on long-term secular trends in Private Cloud, Public Cloud, and AI. Now let me get into our business performance, starting with Private Cloud. On the heels of a record-setting fourth quarter of 2024, sales bookings in Private Cloud, we delivered good results in the first quarter of 2025 with bookings remaining flat year-over-year despite slippage of a couple of large deals into the second quarter, which we closed in the first two weeks in April. Factoring in these deals that subsequently closed, our Private Cloud bookings for the first quarter would have grown 20% year-over-year. Private Cloud revenue for the first quarter came in at $250 million right in line with guidance and down single digits year-over-year. After many periods of double-digit decline in Private Cloud, we saw moderation in revenue decline for two consecutive quarters. We have made meaningful progress stabilizing Private Cloud and believe it's on a path back to growth as this trend continues. This progress is a result of consistent bookings performance and steady improvement in revenue retention. We are winning higher value long-term business underscoring the strength of our platform and our strategic expansion into the mid and large enterprise customer segments. In the first quarter, we continue to expand in the healthcare market by securing a new win with a healthcare provider in the Northwest that shows Rackspace Healthcare Cloud for their Epic and other clinical and non-clinical workloads. This move is designed to lower their IT cost while modernizing their IT infrastructure and improving service levels for their end users. We are also expanding across other regulated industries. Rackspace was selected to design, build, and operate a customized Private Cloud solution for a leading European energy company. This is a long-term agreement to migrate two of their six data centers onto a Private Cloud platform. By partnering with Rackspace, the company is moving away from managing complex infrastructure internally and embracing a flexible platform-driven operating model. This win not only reflects the growing demand for Private Cloud solutions, but also marks a significant entry into the energy vertical. Private Cloud is also pushing forward with new products and solutions. I shared details about our strategic partnership with Rubrik, which was largely driven by our ability to deliver the broad range of assets and operational expertise required to support cyber recovery and maintain critical business continuity in the event of a cyberattack. We also launched OpenStack Flex, an enterprise-grade on-demand infrastructure-as-a-service offering that provides secure, fully supported and monitored infrastructure. It simplifies hybrid cloud management by bridging the gap between dedicated and multi-tenant environments. Additionally, we introduced UK Sovereign Secure, a next-generation platform built to address the stringent compliance and security requirements of the UK's Healthcare, government, and public sector. This solution offers secure, reliable hosting tiers and advanced security operations and monitoring, purpose-built to meet UK public sector standards. We are encouraged by the success of the Private Cloud strategy in both defending and expanding our cloud business. As we focus on execution, we are seeing strong momentum across our pipeline, bookings, and new product offerings, reflecting growing customer demand for hybrid cloud environments. Now turning to Public Cloud. In the first quarter, Public Cloud bookings grew 16% year-over-year, driven by strong execution in The Americas, which delivered 26% year-over-year growth. This performance reflects continued progress on our land-and-expand strategy, enabling deeper customer relationships and higher value engagements. Public Cloud revenue for the first quarter reached $416 million, exceeding our guidance range and was down low single digits year-over-year due to declines in lower margin infra resale and services. Public Cloud delivered several notable wins this quarter. As a key highlight, we secured a significant follow-on engagement with a top-tier aircraft leasing company. We are designing and implementing a modern flexible data infrastructure to support their business growth that is projected to save them multimillion dollars over five years. Additionally, we expanded our work with one of the largest U.S. airlines, securing new data, DevOps, and security services. On the product side, we launched an enhanced version of Rackspace Managed Cloud, a full-stack hybrid cloud managed service built to meet the complex needs of mid-market and enterprise customers. The platform now supports two flexible delivery models, a shared services option powered by a Rackspace cloud management platform and a dedicated delivery team model that integrates with customers' existing tool sets. We also expanded our modern operations portfolio with the launch of modern operations for databases, a managed service that complements in-house teams by managing and optimizing cloud database environments. In summary, in Public Cloud, we remain focused on disciplined infrastructure resale, a pivot to services, and a lean operating model. While macroeconomic uncertainty adds complexity to forecasting, we anticipate services revenue to perform well in 2025, assuming no significant external disruptions. Turning to AI, we continue to make strong progress with FAIR, with approximately 60 wins and over 200 opportunities in our pipeline, nearly 20% of which are already in advanced stages along with several active leads we are pursuing. This quarter, the Private Cloud business unit launched Rackspace AI business, a comprehensive AI-ready platform designed to optimize enterprise AI workloads. Built on a Private Cloud infrastructure, the solution is engineered to support a wide range of AI use cases. Additionally, in Public Cloud, we introduced modern operations for data and AI, a managed service that streamlines organization-wide data pipeline management. This offering automates data preparation, analysis, and integration tasks. Before I wrap up, I want to sincerely thank our customers, partners, and all our Rackers. I'm proud of what we have achieved this quarter and encouraged to see continued momentum with new customers and expansion with existing customers. As we look ahead, our goal for 2025 is clear: stay focused on our key strategic priorities and build 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.

Mark Marino, CFO

Thanks, Amar. In the first quarter, total company GAAP revenue of $665 million was down 4% year-over-year, but met the high end of our guidance, driven by solid performance across both business units. Non-GAAP gross profit margin was approximately 20% of GAAP revenue, down 0.5 percentage points year-over-year, due to declines in Private Cloud, partially offset by margin improvements in Public Cloud. For the quarter, non-GAAP operating profit was $26 million, exceeding the high end of our guidance and up 83% year-over-year, largely due to OpEx efficiencies. Non-GAAP loss per share was $0.06, compared to our guided range of $0.07 to $0.09 loss per share, an improvement of $0.05 year-over-year. First-quarter cash flow from operations was $13 million and free cash flow was $4 million, which was a significant improvement from last year. We ended the quarter with $128 million in cash on hand and $473 million of total liquidity. Turning to our segment results. For Private Cloud, GAAP revenue for the first quarter was $250 million, which was in line with our guidance. Total revenue decreased 7% year-over-year due to customers rolling off older generation offerings, partially offset by revenue from new bookings. Private Cloud non-GAAP gross margin was 37.1%, down 1.8 points year-over-year, primarily due to lower revenue, resulting in lower fixed cost absorption. Non-GAAP segment operating margin was 24.4%, a year-over-year decline of 2.1 points, driven by lower gross margins, partially offset by OpEx efficiencies. In our Public Cloud segment, GAAP revenue was $416 million, surpassing the high end of our guidance. Total revenue was down 2% year-over-year as a result of a decline in infrastructure volumes and services. Non-GAAP gross margin was 9.5%, up one point year-over-year, driven by improved revenue mix. Non-GAAP segment operating margin was 4.2%, up 2.3 points year-over-year due to improved gross margins and OpEx efficiency. Now on to guidance. We expect second-quarter GAAP revenue of $653 million to $665 million, down 4% year-over-year at the midpoint, driven by our reduced forecast for low margin infrastructure resale volume. In Private Cloud, we expect revenue of $247 million to $253 million, flat sequentially and down 4% year-over-year at the midpoint. We expect Public Cloud revenue of $406 million to $412 million, down 2% sequentially and down 4% year-over-year at the midpoint. Total non-GAAP operating profit is expected to be $25 million to $27 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%, while non-GAAP other expenses will be in the $42 million to $46 million range. Non-GAAP share count is expected to be $244 million to $248 million shares.

Sagar Hebbar, Head of IR

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.

Irwin Liu, Analyst

Hi, thank you. This is Irwin Liu actually on for Amit. I had a question on basically what you're seeing from a macro perspective. Amar, I think you mentioned the potential for delayed customer decision cycles and onboarding timelines related to just broader macro uncertainty. And now that we're kind of one month into the current quarter, have there been any noticeable changes in customer behavior, or have things been more business as usual?

Amar Maletira, CEO

Yes. So, thank you very much for your question. So from a macro standpoint, let me just give you what we are seeing, right? That will give you some color on the markets that we address. So starting with Q1, which is our March quarter, our bookings came in line with our expectations. In fact, our Public Cloud business hit their targets and also posted double-digit growth. Our Private Cloud business had a couple of deals that actually slipped from Q1 into Q2, and we were able to close those deals in the first 10 days of April. There were some services deals that also slipped in Public Cloud that we were able to close in the first 10 days of April, which gives us some confidence that the decisions that the customers are making, they're not delaying the decisions in terms of business and from a bookings perspective for us. When I look at our funnel, the funnel looks good, both the top of the funnel as well as the bottom of the funnel. In fact, the funnel remains very strong. And so, when I combine those two facts, it seems that the customers are not delaying their decisions in terms of their transformational projects. We are seeing bookings coming in as expected just for Q1 and how we started the month of April. Now where we are a bit cautious is from bookings to billing, means bookings conversion to revenue. We are a bit cautious that customers could make some delayed decisions on onboarding some of these contracts that we signed, and that's the place that we are particularly cautious on. We have not seen that immediately right now. I feel good about Q2. I'm just being cautious because the macro environment continues to remain quite uncertain. So our caution is on booking to billing that cycle.

Irwin Liu, Analyst

Got it. Thank you. And then for my follow-up, I think you highlighted sales execution as a driver behind recent booking strength. Can you just talk about how your pipeline has evolved over the past several quarters? And then, within this, how have your win rates trended?

Amar Maletira, CEO

Yes. So the pipelines have continued to remain strong. The last three or four quarters, both the businesses have performed quite well. If you go back to the September quarter of 2024, Public Cloud had a record sales bookings quarter. They performed very well even in the December quarter. In December, Private Cloud had a record bookings quarter. And following on the heels of two strong quarters, we delivered Q1 also remained strong. So the sales execution is working very well. I think we have been laying the foundation for this for the last two years. We spent 2023, the first half of 2023 refreshing our sales organization, particularly in Public Cloud. Seventy percent of our go-to-market organization was refreshed. We improved sales enablement. We also changed the compensation. And it takes time from the time you refresh salespeople for them to get productive. So we started seeing a strong second half from a bookings perspective in both the business units. And Q1 is also off to a good start this year. Therefore, I feel very good that the strategy we have in place and the execution against it, at least from a market perspective, is playing out quite well. Additionally, I think if you also see, we have launched several new offerings in the last two years, more offerings than we probably would have launched in the last five or six years in this company. And that's also resonating very well with our customers. We are now doing value-based selling, which is mainly focused on business outcomes. And so, the mix of the pipeline is changing to higher-value, long-term contracts. We are moving more into the enterprise segments, both mid- and high-end enterprise, and we are winning large deals. And so, that's the change that has happened in the last two years, and we are starting to see the benefit of that now.

Irwin Liu, Analyst

Got it. Thank you.

Unidentified Analyst, Analyst

Hi. This is Ryan on for Ramsey. Thanks for taking our questions today. I wanted to ask a bit about Public Cloud. It was nice to see infrastructure resale come down a bit. I was curious to know where you're really seeing win rates for the services side and how we should think about that for the remainder of the year. Should infrastructure stay at these levels or could we see a tick up as we enter the back half of the year? Thanks.

Amar Maletira, CEO

Thank you very much, Ryan. Thanks for the question. So two questions there. Where are we seeing the wins in the services business? And the second is, how should the infrastructure resale trend from here on? So, a couple of things. On the services side, we have pivoted to a services-led motion, and that's playing out very well. As I also mentioned earlier, we are pivoting to the enterprise and mid-market, and that's playing out well too. As an example, if you recall, we have been giving this data to you guys for the last 12 months or so on the number of MSAs we have signed. This quarter, we have signed overall about 19 to 20 MSAs, which is twice what we had signed by the end of Q1 last year. We have 14 more in the funnel in progression right now, which means that we are landing and expanding into these larger enterprises. In terms of services, our platform services did well this quarter. Data services also did well on the backs of AI. So we are starting to see good wins in the services business on the Public Cloud side. So win rates have gone up. The funnel is going up. Therefore, we feel very good about how services are spanning out. What we will be focused on going forward and we have already started laying the foundation for it is focusing more on managed services and doubling down on data services and security services when it comes to Public Cloud. Regarding infrastructure resale, listen, we have a stated objective; we want to do business where we can drive profitable growth. We were very mindful of the kind of business we win on infrastructure resale as well as what kind of business we renew when it comes up for renewal. We are walking away from deals that do not make sense. If it doesn't meet a certain profit threshold, we are just walking away from those deals regarding infrastructure resale. In some cases, we are going back to the customers and asking for more services attached, and we have started seeing those panel too. Customers are providing us with more services business, and in those cases, we actually go and renew the infrastructure resale business. So you should expect the infrastructure resale business to continue to decline by about low to mid-single digits for the year, and that's very purposeful. It should not impact our profits. In fact, operating profit for the Public Cloud business is going to grow double-digits year-on-year. So this purposeful shift from low-margin infrastructure resale to high-margin services while being very focused on winning the right type of infrastructure resale is panning out.

Unidentified Analyst, Analyst

Very helpful. Thank you. Congrats on a great quarter. Hi, guys. This is Rob on for Frank. Congrats on the quarter. Thanks for taking my question. So one of the things that you talked about last quarter that we discussed was these larger customers who are sort of more focused on a holistic cost and are willing to pay for some of that CapEx upfront in exchange for lower OpEx over the life of the deal. Are you continuing to see that? Is that still a trend that you're seeing with those larger customers and with those larger deal sizes? And then, as a follow-up, as it pertains to the more regulated industries and if you addressed this in your prepared remarks and I missed it, I apologize. With respect to those more regulated industries, are you still seeing those uplift your Private Cloud business the way you were last quarter? Thank you.

Amar Maletira, CEO

Yes. Thank you very much. Thanks for the question, Rob. So with regards to upfront CapEx payments from our large customers, yes, we continue to see interest. We have a couple of large deals that we are continuing to talk to customers, where customers are interested in paying upfront CapEx to get a lower OpEx towards the life of the deal. That's the trend, and it's good for us because we get CapEx upfront to invest in the infrastructure that we stand up for the customer. So it's a win-win for both the customer as well as for Rackspace. With that said, we have a lot of focus on CapEx. We have initiatives in place to drive CapEx efficiency, making sure that we reutilize our inventory. So we have a new leader for global operations and delivery in a Private Cloud business, and he is very focused on that aspect. Our products and solution team and offerings team are also focused on creating solutions and technology where the CapEx intensity goes down. Internally, we are launching a platform called UnderCloud, which will help us to reutilize inventory and deploy it to new engagements. Additionally, we also launched a Flex environment, which is a multi-tenant environment for our customers. So we have Flex for OpenStack environment as well as Flex for SDDC, which is Software Defined Data Center on the VMware platform. This flex environment, a multi-tenant environment will also help us to reduce our CapEx intensity. So one of my stated objectives for the company was to optimize our capital structure and also drive CapEx efficiency, and we are working on all those fronts. So yes, we are seeing the trend from large customers where they want to pay upfront CapEx, and internally we are also very focused through technology as well as operational discipline to reduce our CapEx intensity. Now talking about regulated industries, absolutely this is the bet that we made, and it's panning out. We said we will operate in regulated industries, which have more propensity to buy Private Cloud, whether it's healthcare, BFSI, Sovereign, and energy. And we are seeing very good traction in all those four verticals. In Energy, as I mentioned in my prepared remarks, we closed a large deal with a European energy company, one of our first deals in the energy sector, where we are trying to help them create a custom Private Cloud and modernize their infrastructure. That environment is very data-intensive. Data sovereignty is a big challenge for them, and our offering on Flex as well as our enterprise offering is very suitable for their needs. Now we will go rinse and repeat that with other energy companies. We are starting to see some of that pipeline also start developing. Healthcare continues to remain strong. We are working on the BFSI, especially with core banking applications, and Sovereign, both UK Sovereign as well as our business with The Kingdom of Saudi Arabia, continues to remain strong.

Operator, Operator

Thank you. There are no further questions. I'd like to turn the call back over to Sagar for any closing remarks.

Sagar Hebbar, Head of IR

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

Operator, Operator

Thank you for your participation. This does conclude the program. You may now disconnect.