Rackspace Technology, Inc. (RXT) Q1 2022 Earnings Report, Transcript and Summary

Good afternoon, and welcome to Rackspace Technology's First Quarter 2022 Earnings Conference Call. As a reminder, today's call is being recorded. Kevin Jones, our CEO; and Amar Maletira, our President and CFO, join us today. The slide deck we will reference during the call can be found on our IR website. On Slide 2, certain comments we make on this call will be forward-looking. These statements are subject to 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 certain further 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 release and presentation, both of which are available on our website. After our prepared remarks, we'll take your questions. [Operator Instructions]. And I'll now turn the call over to Kevin.

Good afternoon, and thanks for joining us. I'll discuss quarterly highlights and the strategic direction of our business. Then Amar will go into detail on the financial results. Turning to Slide five. Rackspace Technology benefits from secular tailwinds and a cloud market that continues to grow with no signs of slowing. In the first quarter. Our cloud hyperscaler partners all grew year-over-year revenue by 35% to 50% that represents $10 billion of new cloud revenue in the first quarter alone. So cloud revenue continues to accelerate. And the cloud revolution is in the very early stages, with winners still to be determined and plenty of whitespace to attack. And Rackspace Technology remains well positioned as the leading pure play multi-cloud services company. In the first quarter, our financial results were in line with our guidance and expectations and we once again delivered solid growth, profitability and cash flow. On the new business front, it was a very productive quarter. We renewed and strengthened our relationship with AWS and closed a major new deal with VMware to support their Global Edge offerings. We also just launched a new partnership with Nvidia, which I'll touch on in a moment. We closed the acquisition of Just Analytics and began introducing their products and services to our customers globally. And Rackspace technology was recognized as an industry leader in two major analysts reports that were published in the first quarter, including the ISD provider lens AWS ecosystem partners report, where we were named a leader in three quadrants, and the ISD index, where we were named a top 15 sourcing standout in the breakthrough 15 category for the Global, Americas and EMEA regions. Turning to Slide six, revenue growth was solid, with total revenue up 7% and core revenue up 9% compared to last year's first quarter. Non-GAAP operating profit was $112 million and non-GAAP EPS was $0.22 both at the high-end of our guidance range for the first quarter. As noted on the slide, our first quarter bookings put us on track to achieve our targeted $1 billion of new sales bookings in 2022. As we discussed with investors last quarter, Rackspace Technology and our Board of Directors have been carefully examining every area of our business, weighing the company's strategic options to increase shareholder value. I'd like to share with you how we're thinking about this. As Slide seven notes, we operate in two very different multi-cloud markets with different operating models, growth trajectories and investment prospects. On one hand, public cloud is right in a long-term secular growth wave and is a services centric capital light product line where we can make smart investments to capture additional whitespace and growth opportunities. And on the other hand, private cloud and managed hosting is in a low growth market where we're focused on optimizing profit and free cash flow. Our strategy to maximize shareholder value is now coming into focus and we are therefore considering reorganizing Rackspace Technology across these two markets. We are also exploring other strategic alternatives as noted in our press release, Amar will discuss this more in a moment. We will provide shareholders with details as well as the growth drivers, profit dynamics and long-term financial model at an Analyst Day in September. On Slide eight, you can see how the development of our partner network is essential and different in each of these two markets. We have painstakingly built our partner network to add value across the two operations and we work to strengthen these partnerships every quarter. On the left side of the slide in public cloud long-term success starts with a strong relationship with the hyperscalers. We must act as a bridge between the needs of our customers and the hyperscalers as we onboard an ever-growing volume of new clients to the public cloud. In this vein, in the first quarter, we extended our strategic collaboration agreement with market leader AWS, for an additional multi-year period, which serves as a strong validation of the value we deliver to AWS as ecosystem to-date. It is also essential in public cloud to provide customers with up the stack functionality once they've migrated to the cloud. Again, as an example, on the first quarter, we achieved premier partnership level with Snowflake, making us one of their top 30 partners in the U.S. On the right side of the chart, you see our key partners for private cloud and managed hosting. Here strategic partnerships have served to provide upside through access to exciting strategic service adjacencies. As an example of the former, in the first quarter, we launched our new private cloud relationship with BT and started onboarding their customers to Rackspace technology. As a reminder, the BT deal was the largest in Rackspace Technology’s history with the potential for hundreds of millions of dollars of revenue. We are encouraged that even in the early going, we're seeing plenty of opportunity for further expansion of our relationship with BT. Earlier this week, we announced that we are now certified to deploy NVIDIA’s AI computing platform, and we've been named an advanced technology partner in the NVIDIA partner network. We are excited about this new partnership with a leading technology company, which we believe will help us grow private cloud and facilitate development of highly compelling services for our customers. Now let's talk about the different ways we support our customers. On Slide nine, Carrier Global is a world-leader in heating, air conditioning and refrigeration solutions. After spinning off from its parent company, Carrier was looking to modernize their infrastructure and existing applications. We worked with Carrier to transform the IoT technology that powers all their connected thermostats, and build a scalable, robust cloud native platform that they can use as the basis for their entire connected device portfolio. After this modernization effort, Carrier reduced technical debt, increased security, sped up infrastructure provisioning time from 35 days to 30 minutes, and reduced infrastructure costs by 45%. On Slide 10, Provenir provides artificial intelligence powered software to help the FinTech industry manage risk across identity, credit and fraud. Provenir had multiple microservices deployed in Kubernetes clusters running in AWS but didn't have the capacity to quickly create monitors and dashboards. Rackspace professional services helped Provenir integrate their software with Datadog, resulting in enhanced visibility into their micro services and infrastructure, along with increased accuracy and consistency across multiple environments. More importantly, we built automation into the process, enabling Provenir to launch additional monitoring and alerts for its applications and infrastructure without having to write a single line of code. Now, Amar will take you through the financials. Amar.

Thank you, Kevin. And thank you everyone for joining our call today. Slide 12 recaps our financial results for the first quarter. Revenue was 776 million a 7% year-over-year increase. Core revenue was 735 million up 9% compared to the first quarter of 2021. Non-GAAP operating profit was 112 million, which was at the high-end of our guidance for the first quarter and was down 6% year-over-year, primarily due to the impact to gross profit from revenue decline in a legacy OpenStack and mature manage hosting. Non-GAAP operating margin was 14% and non-GAAP earnings per share was $0.22, both at the high-end of our guidance for the first quarter. Slide 12 shows the company's revenue mix in the first quarter by segment and by geography. Multi-cloud continues to represent the vast majority of our revenue at 83% of the mix, and it grew 10% year-over-year. Apps and cross platform at 12% of total revenue was down 3% year-over-year. As we have discussed previously, year-over-year compares in this segment were impacted by the discontinuance of a non-core product line in 2021. We lapped that strategic change in the second quarter. OpenStack declined 17% in line with our expectations. This segment now represents only 5% of total revenue. From a regional perspective, Americas continues to represent 75% of our revenue and had 7% year-over-year growth. APJ grew at 32%, while EMEA grew 2% year-over-year. Excluding currency impact, EMEA growth would have been in the mid-single digits. On Slide 14 in the first quarter, operating cash flow was 65 million and free cash flow was 45 million an increase from 38 million in the fourth quarter. First quarter 2022 operating cash flow included the 2021 annual company bonus payout. Total CapEx was 31 million and cash CapEx was 19 million with CapEx intensity of 4% and 2% respectively. We expect total CapEx intensity of 5% to 7% and cash CapEx intensity of 3% to 5% for the full year in line with our previous guidance. Cash at quarter end was 269 million up 71 million year-over-year. On Slide 15, I want to remind the investors that we have a strong balance sheet with no material debt maturities until 2028. In addition, all of our debt was refinanced in late 2020 and early 2021 at historically low rates with minimal financial covenants. At quarter end, total debt was 3.4 billion and net debt was 3.1 billion. Our net leverage ratio of 4.3x the adjusted trailing 12-month EBITDA is very manageable for a company with our growth profile. On Slide 16, we have a guidance for the second quarter. We expect total revenue in the range of 780 million to 790 million. Core revenue in the range of 744 million to 752 million, non-GAAP operating profit of 93 million to 97 million and non-GAAP EPS of $0.15 to $0.17. Now, let me provide you some additional color on our outlook. As I mentioned last quarter, we expect revenue growth to accelerate through the year. This is due to three main reasons. First, the ramping of BT-related revenue in the third and fourth quarter, which will bolster private cloud and managed hosting within the multi-cloud segment. Second, continued growth in managed public cloud as we have a growing pipeline of large opportunities in the multimillion dollar range that we expect to close in the second half of the year. And third, because of the investments we made in go-to-market, we have many new sales professionals that are ramping the first half and who will become more productive in the second half of the year. Now with regard to the operating profit and non-GAAP EPS. The second quarter will be impacted by 15 million to 20 million of investments that we're making to support growth, acceleration in cloud services and the startup of a BT partnership. These investments are primarily in cost of revenue and some inoperating expenses. They represent most of the divergence between our guidance and the constraint estimates. Given the secular growth opportunity in the cloud market, we will prudently invest in long-term profitable growth. On Slide 17, in closing, I would like to recap and summarize what Kevin said earlier. We offered across both public and private cloud. We are the only pure play multi-cloud services company that is addressing both of these markets at scale. That said the market has evolved rapidly in the last 18 to 24 months. We have been proactively evaluating all of our strategic options to take advantage of this opportunity. To that end, we have taken a number of actions. First, we completed an in depth strategic review of the company. Second, we have a clearly defined strategy for the company across public cloud and private cloud managed hosting. Third, we are working on aligning our operating model and reorganizing the company to sharpen our focus in these two markets. And fourth, we are also working to align our financial models and plan accordingly. As we completed this strategic review, and also based on inbound interest for one of our businesses, we concluded that some of the parts valuation of Rackspace Technology could be greater than our current enterprise value. This is in part driven by the attractive growth profile of our public cloud offerings. Accordingly, we are evaluating strategic alternatives and options. We plan to share details on our strategy, operating organization, and long-term financial model at an Analyst Day to be held in September. With that, we'll take your questions. Joe, please go ahead and queue up the audience for Q&A.

Thanks, Amar. [Operator Instructions] Our first question comes from Bryan Keane at Deutsche Bank. And Ramsey El-Assal, you're up next.

Hi, guys, I just want to ask about the margin profile. I know we talked about 14% to 15% EBIT margins for the year. Just any update on that Amar and then on gross margins as well. What's the outlook there?

Thanks, Brian. So Brian, as noted in last quarter's call, we're going to continue to guide the street one quarter at a time. Now, if you look at our Q2 guidance, the midpoint of our guidance implies that the operating margins in Q2 of about 12%. But also keep in mind, as I mentioned in my prepared remarks, within our second quarter, we do have growth investments of about 15 million to 20 million that impacts operating margins by about 200 basis points, which implies that our operating margin excluding these investments will be approximately about 14%. So Brian long-term, I do see operating models in the low to mid teens. And so that's what a long-term outlook is. Let me just give you some color on the gross margin since you asked that question. Now when you look at our Q2 investments of 15 million to 20 million Bryan. Most of this investments are primarily in cost of revenue, to deliver incremental services growth in the second half. And these investments are primarily in building out our delivery capability in both professional services, and elastic engineering. And so including this investments in our Q2, gross margins will be in the 28% to 29% range. But if I again, exclude this investments we will still be in the 30% range for Q2.

Got it. And just to follow-up on the strategic review, it sounded like there was an inbound inquiry that came in which business was that that got that inquiry, is that a smaller piece of the business, a larger piece, just trying to get a sense of what that business unit was? Thanks so much.

Hey, Bryan, it's Kevin, I'll take the strategic question. So right now, we can't provide specifics, due to the ongoing nature of our conversations, both internally and externally. As I mentioned, in my prepared remarks, we're addressing two markets that are very edge practice, and we're going -- or really organizing around those two markets. But, I can assure you in terms of strategic alternatives, everything is on the table. And we're evaluating all options, including this current inbound interest for one of our businesses and we'll provide further information as appropriate in light of developments.

Ramsay El-Assal from Barclays you are up and Frank Louthan, you're on deck.

I was wondering if you could give us some color on the demand environment, just given the more kind of challenging macro backdrop. Are you seeing any impacts out there on client decisioning? Any color here will be helpful?

Yes, sure thing. So let me take that one, Amar. I'll talk a little bit about, the economic environment in general, and then I'll sort of transition into the demand environment that we're seeing. I would say just kind of up front, while there are near-term headwinds in the economy, such as supply chain disruption, you have the war in Ukraine, we do not see any recessionary pressure in this business. If you just think about it, our hyperscaler partners grew cloud revenue by a record amount over $10 billion in the first quarter. So Cloud is really only accelerating, even in the challenging economic environment we've seen so far this year. Now, if the economy does, slip into recession, we think that multi-cloud becomes even more of a must have for customers, because it helps customers save money, quickly scale up, or scale down and change their business model. And we saw this in early 2020, when the economic slowdown caused by COVID and resulted in acceleration of demand for digital services and multi-cloud. So, that's the broader macroeconomic picture and how it relates to our business. Now, if I just look at the demand environment, let me give you a little bit of color on how I see the demand environment. Now we'll start out with the market. And then I'll go through, what we're hearing from customers and partners. Now, the market Ramsey really is very strong. We believe that, at this point only 10% to 15% of workloads have been moved to the cloud. So there's many years of growth runway ahead. And our view is that will result in lots of opportunity for migrations and integrations and managed services. First, that's one piece, multi-cloud continues to be really the overwhelming choice for customers that are moving to the cloud. And as you know, as the hyperscalers continue to innovate, they're innovating at such a pace, that choice is now really abundant in the market for customers. And customers need firms like Rackspace Technology to help them make the right decisions for their cloud environment. So that's another piece. And then, we see lots of desire for innovation beyond infrastructure into the apps and data layers of the IT stack in particular. The other thing we're seeing is industry. Industry specialization is becoming a trend in a lot of areas. And from a geographic perspective, demand for multi-cloud services continues to pick up pace all over the world, particularly in Europe, in the U.K., and Asia and South Pacific, Latin America, and of course, United States. So that's the market. Now, from a customer perspective. It's quite interesting. I was just with a large healthcare CEO last week, and they're a big customer for Rackspace Technology and a multi-cloud customer. And the CEO told me, thank goodness Rackspace handles cloud for us, the complexity of multi-cloud really is mind boggling. And Rackspace takes all that off his plate. And the other thing he said and I keep hearing this, over-and-over from other customers is data. Data is becoming a huge differentiator in healthcare and customers are saying we want to increase the pace of innovation, both in cloud native data, and cloud native apps. And we hear this from customers' and a lot of industries now that data and apps innovation is important to them, and a focus of, how they're becoming more competitive. And then finally, just to wrap up from a partnership perspective, right, now, the demand for the hyperscalers products continues. And what I would say is a breathtaking pace. Now with all three hyperscalers, last week, and the demand for cloud continues to be amazing, AWS, Google, Microsoft are adding giant amounts of sales and revenue every quarter. It's unlike anything I've ever seen in my career. And when I talk to my friends at Dell and VMware, there's big demand from customers for private cloud and multi-cloud as well. So our partners all tell me, we need Rackspace Technology, we need Rackspace to help make sure these customers have the very best services partner and help them on their cloud journey. So overall, Ramsey, it's a very strong demand environment, extremely encouraged by the opportunity.

Our next question comes from Frank Louthan with Raymond James. And Bradley Clark, you're on deck.

So maybe going a little more detail on the dip that you're forecasting here for the operating income in Q2, what's kind of causing that sequential decline? And then, if you don't end up selling the whole company, give us a little bit color of what is the reorg look like? What sort of things will you be adjusting going forward in areas you think need some more help? Thanks.

I'll take the first question. And Kevin could you take the next one. So Ramsey [sic] [Frank] in terms of the dip, sequential dip in our operating profit, we did about $112 million in Q1, it's going down to about $95 million in Q2, that's the midpoint of our guidance. And that's mainly the investments that we're making Frank in our business. And if you take a look at the investments in, I'll give you some additional color on where we're making those investments. Investments are in three areas, right? First is, we're making investments, as I mentioned earlier, to expand delivery capacity for professional services, and elastic engineering across all three cloud platform. So that includes AWS, GCP, which is Google, as well as the Microsoft Azure. Second, we're also making some investments, Frank in our go-to-market organization. And third, we are making some investments, which are mainly startup investments as we ramp, our BT accounts. And BT is expected to reach full run rate revenue by the end of second half. And so, as I mentioned earlier, most of these investments are in cost of revenue in Q2. And so this is what's basically creating the decline in operating profit going from Q1 to Q2. That's mainly the reason.

Very good. And the second question that you had Frank around, how are we going to kind of reorganize and manage the business and the company. Just a little bit of backdrop, we operate, I would say, a very attractive multi-cloud market, right? And it spans across both public and private clouds. And, as we talked about, we're the only pure play multi-cloud services company that's addressing both of these markets at scale. Having said that, when you look at the market and the markets evolved, and it's evolved pretty rapidly in the last 18 to 24 months and we have a public cloud business that is significantly scaled from 18 months ago. And we've been proactively evaluating all of our strategic options to take advantage of this public cloud, market opportunity and sharpen our focus. So public cloud and private cloud, they've got very different business dynamics as we talked about on the call. They also require very different skill sets and levels of investment demand. And so for basically developing a plan to best align our resources with these findings and what we're going to do, Frank, at this analyst and Investor Day in September, we'll provide additional details on what this looks like, both from an operational standpoint and the financial standpoint on a go forward basis. But hopefully, that gives you some color.

Bradley Clark from BMO Capital, you're up next. And Matt Roswell after that.

I have two parts here. But I want to ask the incremental investment in the June quarter, focused around expanding delivery capability and the BT account, more broadly, as you know, you potentially win other large deals mention to multi-million dollar opportunities in the pipeline in the second half? How do you think about the incremental investment that these large deals are going to take? And the idea that with every one of these deals, more incremental investments that are already in the model? Are you investing, more so ahead of time, so that this 10 million to 15 million becomes less and less over time? And then, part two of the question, I wanted to ask about pricing and in an inflationary environment, with higher wage inflation, the operating environment may be different than some other services company, but are you having placing complications with your customers to potentially offset some higher wages and expenses, and if so, any comments you can make, sort of on the strategy there? Thank you.

Yes. So let me let me take the first one. Bradley, thank you very much for asking the question. To give you a little bit of more specifics on investments. So you're absolutely right, we are making investments ahead of the demand that we are seeing mainly in cloud services. As you know, there's a lot of demand in cloud services. So this $15 million to $20 million of investments we're making in Q2 will also carry forward into Q3 and Q4 but it will be run rate costs, but it will be supported by incremental revenue, right? So you got to build ahead of the demand. That's what we are doing. Now, as we see more growth opportunities, we may prudently make additional investments to capture further growth. And these investments will be primarily in cost of revenue, to build capability in advance of the services demand that we are seeing in cloud. And we will continue to update the street, if there is any change to our investment outlook per se, right? So it's a very dynamic market. We see a lot of demand as Kevin talked about, and it is very prudent for us to continue investing and capturing those demand because as you know, services is a very sticky business. And we have a very high recurring revenue base, too. So these are kinds of investments we'll make to continue driving profitable growth in the business. So regarding your second question around pricing, that's a very interesting question. If you look at and I will have Kevin jump in here too. We are not having kind of a pricing pressure, so to speak from a customer's the markets that we play in, in cloud services, whether it is application migration, or modernizing of those applications, or even data migration and data ops, these are very hot areas of the market today. And it is sometimes very difficult to find skills in those markets. So we do not see a lot of pricing pressure. We do not have a very labor-intensive model, so to speak. We have and our key differentiator is, combining labor with automation, and we have talked about it at length in the past, that we have driven about 75% of automation on our workflows. And so that's the reason why we do not see a lot of pressure need on the pricing side and on the labor cost side, because we are not a very labor-intensive model. Kevin, you want to add anything here?

I think you said it. I think you said it really well. Yes, so Bradley, we don't have nearly as many employees, there's a lot of firms out there in the market. So we don't have that same exposure to the labor inflation that's happening in the broader economy. And we definitely don't see any pricing pressure, per se, and where it makes sense for delivering more value and it makes sense. For us to reflect that additional value and in our pricing, then we certainly were having those conversations. But in general, it's not as much of a factor in our business, particularly because we're very automated, we got 75% of our multi-cloud transactions automated. Highest automation in the industry, really a technology on automation driven business, if that makes sense.

Our next question comes from Matt Roswell at RBC Capital Markets. Go ahead, Matt.

I was wondering follow-up on the investments and apologize for this, just wondering if you would be willing to kind of bucket how much of them are going into the three areas. I use a cloud investment to go-to-market? And for BT, and I think you just said we should kind of expect the same level into the third and fourth quarter, when would you expect to see kind of revenue return on the investment?

Yes. So let me start with the last question, first. The revenue return on the investments are typically fast, it's within three to 12 months -- three to six months. So very fast return on the investments, because we need to build a delivery capability ahead of the services that we can deliver the services to our customers. Now, in terms of giving you a little bit additional color on the investments. As I mentioned, most of the investments are in cost of revenue. So when you take a look at our investments, I would say 75% to 80% of those investments are roughly in cost of revenue. And the balance is in OpEx and 75% to 80% of the investments are into hiring professional services, resources -- sources for elastic engineering, et cetera. So that's where our investments are going. So OpEx investments are mainly in go-to-market as we continue to expand our go-to-market and some in starting up our BT environment.

Thank you. If I could sneak in a quick one. How should we think about cash conversion in the second quarter?

So, I will just talk about cash conversion in general. As you know, we had a very strong cash flow year in 2021, with all the improvements we drove and those improvements are very sustainable. And long-term, we expect cash flow from operations to track to anywhere between 60% to 70% of our operating profit. For example, in Q1, our operating cash flow was quite solid at 65 million, which was at about 58% of our operating profit. But also keep in mind, the first quarter is typically the seasonal low for cash flow, as it is a quarter in which we pay employee bonus. So there was a big cash payout from an employee bonus perspective. So I would say, if you're tracking to 60% to 70% of our operating profit, conversion to cash flow from operations, I would say the quality of earnings is -- I consider a very high-quality earnings. Now, our cash CapEx is also going down. And Matt, and Cash App cash CapEx should be anywhere between, say, 3% to 5% of our revenue, and that CapEx intensity continues to go down. So which means our free cash flow margin should be really good. This is a comment overall for fiscal '22.

Thanks, Matt. We haven't had anyone else queue up. So we'll shut it down there. I want to thank everyone for joining us. If you have a follow up, please give me a shout at ir@rackspace.com and we'll talk to you soon.