Rackspace Technology, Inc.

Good afternoon and welcome to Rackspace Technologies' second quarter 2021 earnings conference call. As a reminder, today's call is being recorded. Kevin Jones, our chief executive officer, and Amara Malatira, our president and chief financial officer, join us today. The slide deck we will refer to today can be found on our investor relations website. On slide two, 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 RSEC filings. RACS-based 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 respective and most directly comparable GAAP measures. These reconciliations are in the tables included in our earnings release and slide presentation, both of which are available on our website. After our prepared remarks, we will take your questions. To queue up for questions, please use the ask a question function in the Zoom portal. I'll now turn the call over to Kevin.

Good afternoon and thanks for joining us. I'll discuss quarterly highlights and touch on some customer case studies. Then Amar will go into detail on the financial results. As shown on slide five, we delivered a solid second quarter. Revenue and non-GAAP earnings per share were at the high end of our prior guidance. and non-GAAP operating profit exceeded the top end of our guidance. Our new product launches from earlier this year, Rackspace Elastic Engineering and Rackspace Services for VMware Cloud, were off to a good start with some early wins already on the board. The turnaround in cash flow resulting from our working capital and cash management transformation programs has been remarkable. And this quarter, we began paying down debt with the repayment and retirement of our accounts receivable financing facility. The strong cash flow we are now generating will enable us to continue to make progress on reducing our leverage ratio toward our stated targets. Turning to slide six, total revenue was up 13% and core revenue was up 17% compared to last year's second quarter. Non-GAAP operating profit was up 4% and non-GAAP EPS was up mid-teens at 14% in line with revenue growth. New sales bookings in the second quarter were $258 million, up 6% compared to the first quarter. This year, we are calibrating new sales bookings to drive both revenue growth and initial sold margin. We believe approximately $1 billion of new sales bookings in 2021 will enable us to drive double-digit revenue growth while optimizing profitability, and we are on track to meet that goal with just over $500 million of bookings in the first half of the year. On slide seven, I want to touch on the transformation initiatives that we announced in late July. Over the past six months, we've taken a hard look at every aspect of our business in light of the acceleration of digital transformations and continued migration of our business from mature products to growth products. Through this process, a few things became very clear. We had to free up resources and continue to invest in new solutions, We had to expand our delivery capabilities to meet demand for those new solutions. And we had an opportunity to help employees in our mature businesses develop high demand skills to meet needs in growing areas. The actions we announced in July accomplished all of these goals. As part of this initiative, we are providing our rackers, including those impacted by the restructuring, with the ability to reskill and retrain for hot new areas in cloud, including elastic engineering and cloud professional services. NetNet, we believe the transformation and restructuring initiatives announced in July position Rackspace technology extremely well to compete and win in the growing cloud technology solutions industry. As I've done in past quarters, let me share some case studies of how Rackspace technology is helping customers do innovative things in the cloud. On slide eight, let's talk about Pure Storage, a $6 billion market cap tech company. Pure Storage serves over 8,000 customers with its storage as a service offering, helping them run their operations seamlessly across multiple clouds. As containers became more practical and a proven technology, Pure took notice and looked for a world-class partner who could move fast to build reference architectures on Google Anthos and Kubernetes. A partnership with Rackspace Technology enabled Pure to hit an aggressive 90-day timeframe for initial product launch. Pure Storage now has reference architectures that can confidently take prospective customers that deliver the benefits of leveraging Pure Storage on Google Anthos. Slide nine is a case study from Bright Skies, the company we acquired in Germany in the fourth quarter of 2020. Bright Skies recently helped Dole, the international produce company, transition its European operations from company-owned data centers to the cloud. Our solution included an entire service package, starting with the cloud readiness assessment, a feasibility study and budget plan, and technical workshops to define the target architecture. On an accelerated three-month timeline, 100% of Dole's virtual machines moved to Microsoft Azure. Today, Dole benefits from having its data in the cloud with less complexity, increased productivity, and most importantly, reduced costs. Now, Amar will take you through the financials. Amar?

Thank you, Kevin, and thank you, everyone, for joining our call today. Slide 11 recaps our financial results for the quarter. Revenue was $744 million, an increase of 13% year-over-year. Our core business grew 17% year-over-year to 698 million. Non-GAAP operating profit was 119 million, up 4% year-over-year. Non-GAAP operating margin was 16.1%, down 1.5 percentage points year-over-year, but within our mid- to high-teens expected range. And non-GAAP earnings per share was 24 cents, up 4% from last year. Slide 12 shows the company's revenue mix in the first quarter by segment and by geography. Multicloud continues to represent the vast majority of our revenue at 82% of the mix, and it grew 17% year-over-year. Apps and cross-platform at 12% of total revenue grew 16% year-over-year, driven by growth in application services coupled with strength in our data and security services businesses. OpenStack, which is a legacy business, declined 20% in line with our expectations. This segment now represents only 6% of total revenue. From a regional perspective, Americas continues to represent 75% of our revenue and grew 12% year-over-year. APJ grew at 39%, while EMEA grew 13% year-over-year. As shown on slide 13, Q2 was another good quarter of cash flow. Gap cash from operations was $106 million, bringing first half cash from operations to $209 million. Free cash flow, defined as gap cash from operations minus cash capex, was $77 million, up from $66 million in Q1. This brings the total free cash flow for the first half to $143 million. As expected, total capex in Q2 was $82 million, and total capex intensity was 11%. This was due to the renewal of large enterprise license agreements. As a reminder, the accounting treatment for these renewals requires us to recognize ELAs as capex in the period the deal is signed. Cash capex was 29 million, and cash capex intensity was 4% in the first quarter. For fiscal year 2021, we expect cash capex intensity in the 4% to 6% range. Total cash at the quarter end was $215 million, and we had $375 million of unused revolving credit facility. We paid down $56 million of debt, including $50 million repayment and termination of the accounts receivable financing facility. On slide 14, we have a guidance for the third quarter. For the third quarter, we expect revenue in the range of $750 to $760 million, core revenue of $705 to $715 million, Non-GAAP operating profit of 118 to 122 million. Non-GAAP earnings per share in the range of 23 to 25 cents. Non-GAAP other expenses of 50 to 52 million. Non-GAAP tax expense rate of 26%. And we expect non-GAAP weighted average shares of 213 to 215 million. For the fourth quarter, we expect revenue to grow approximately 2% sequentially. and operating profit and EPS to be flat sequentially. With that, we'll take your questions. Joe, please go ahead and queue up the audience for Q&A.

Thanks, Ammar. As a reminder, to ask a question, please use the Q&A function in the Zoom portal.

Our tech team will promote you to a speaker on the webcast when you're up in the queue. Our first question comes from Dan Perlin at RBC.

Hey guys, can you hear me? Sorry, I just want to make sure I was unmuted. We can hear you, Dan. Great. Thanks. So I had a question, you know, you're targeting a billion dollars of bookings for the, for the full year that kind of suggests kind of absolute dollar flattish, you know, for the, for the second half of the next two quarters. So two questions, I think one, can you just, you know, remind us how that's going to translate into double digit revenue growth for the second half of the year? because it looks like the midpoint guidance looks like it decelerates a little bit, third quarter, fourth quarter. And then secondly, you know, you clearly have refined the strategy of what you're letting into that funnel, so maybe you can remind us of some of those changes and why that's beneficial to you guys longer term. Thank you.

Sure. Let me get started here, and Kevin can add additional color here. So then when you take a look at revenue growth, revenue growth is driven by multiple factors. First, we have a high base of recurring type revenue, which drives good visibility into the future, and that's what we have factored into our guidance. Second, we are also executing revenue-related initiatives that are less visible to the street, which are mainly focused on things like acceleration of revenue realization, churn reduction, and contract renewals. And third, of course, is the bookings that you alluded to. So, you know, we need to roughly deliver a billion dollar bookings to continue driving double-digit revenue growth in 21 and 22. And if you look at a fiscal 21 guidance, we call for a double-digit growth in revenue. Now, in Q3, based on our guidance, our core revenue will grow roughly about 13%. And in Q4, it'll grow about 10 plus percent, depending on what you model for your OpenStack business. So I think when you take a look at a billion dollars, you will see that the revenue growth continues. I think we are looking at the... all revenue growth for the full year. And for the full year, you will expect, you should expect us to continue delivering about 30, 14% growth, which is much higher than what we delivered last year.

Yeah, and I would just add to that, Dan, you know, when you kind of look at the second half for bookings, you know, I would expect, you know, third quarter bookings to be lighter than the $250 million run rate, you know, to get to that billion dollar total number. That's because of seasonality and, you know, summer holidays in certain parts of the world. But then go up again in Q4 to kind of balance out at that, you know, sort of billion-dollar number that, as Amar mentioned, we need to sustain, you know, double-digit revenue growth. And that's what's built into our guidance as well. And in terms of, you know, the second part of the question, about, okay, what kind of business we're calibrating. We've basically been calibrating new business bookings along with initial sold margin. And it's been a really, I think, a positive development in the company. And what that really is doing is it's allowing us to be more selective. There's a big market out there and we can be more selective in the actual deals that we take. And, you know, as we continue to grow our professional services business, our cloud-native application development business, multi-cloud managed services, such as the Elastic Engineering that we recently released, and those types of offerings. So that's kind of where the focus is. Amar, anything else to add on that?

Well, I think you said it well. Dan, the focus is there's a lot of demand out there, as we have said previously, want to focus on good quality bookings, bookings that will continue driving not just double digit revenue growth, but also more importantly, driving right margin profile for the business and expansion opportunities within those accounts.

Yep. Excellent.

Thank you, guys. Thanks, Dan.

Thanks, Dan.

Xinjun Huang, you're up next. And then Jim Breen, you are on deck. Matt Ramey, hopefully i'm muted now can you guys hear me.

Matt Ramey, We have this terrific appreciate the question here, I like the format just on the on the margin side I figured out as you know we've been focusing on the supply side of the equation. Matt Ramey, I think a lot of the industry is talking about you know war for talent and wage inflation i'm curious if you're seeing that and how much of that is a factor in some of your. your margin outlook. I know you're in some hot areas around cloud and whatnot. So I just want to check if that is a, uh, a focus area or that's it's influencing some of your thinking on the margin versus some of the other things we've talked about in the past.

You want to start with that one more on the margin and I'll pick up a little bit about the, um, the comment on the, uh, the war on talent. Yeah, absolutely.

So, um, Tingen, I think what we are seeing is when you look at our margin, and our gross margins have been declining and continues to do so purely because of the result of makeshift in our business. And it has two components we talked about. One is the ongoing decline in our legacy OpenStack business, which we are no longer actively marketing. And second is a makeshift within our multi-cloud segment where you're seeing from mature to growth products. So growth products have a lower initial gross margins, but also have, as you know, lower capex and opex intensity. Now, I know your question was about how are the gross margins getting impacted because of the war on talent. I think for us, that is already baked into our guidance. We have made room in a model to continue to make investment in the business. But what you're seeing right now from a gross margin perspective, and I want to give you guys more color and broader color on gross margins, We are in a transient phase right now, and we believe it will continue for another four to five quarters. And during that time, we do expect our gross margins will bottom out in the low 30% range. And once the gross margins bottom out at the end of this transient phase, we expect to inflect with a favorable mix shift to a higher value cloud services. And we are already seeing some very good traction in our land and expand motion. And that gives us a lot of confidence that the margins can start expanding with high margin products. In fact, if you look at our second half, first half 2021 port of customers where we sold managed public cloud engagements, we are seeing our cumulative bookings are growing double digits. The sold gross margins have been expanding significantly. And that gives us the confidence that this higher value expansion with higher value services will play out in the next four to five quarters. Now, just to give you more color, because this also leads into my guidance question. I'll give you more color on guidance later. But in Q3, we do expect gross margins in the 32.5% to 33% range. And we basically modeled it prudently for the reasons that I just mentioned. We are looking at the mix shift that is going on in the business. We are onboarding more managed public cloud customers. In fact, our new logos continue to grow. We actually grew 31% in the first half of 2021 compared to first half of 2020, which sees that there's a massive acceleration in the public cloud onboarding of customers. And that's also resulting in some gross margin decline. So we have factored that all into our model as we provided the guidance for the second half. Specifically with regard to the gross margins because of talent, I think that is already factored into our guidance. And we plan to continue investing in the business into the high growth areas of the market. One more thing I'll add, and I'll then cede the floor to Kevin, You know, we are managing this mid-shift and expect to deliver operating margins in the mid-teens during this transition phase because, as you can see, you know, we announced the restructuring on July 21st. We have made sure that the OPEC structure now aligns to the new gross margin profile of the business, and that should continue to help us deliver these mid-teens operating margins in the next, you know, four to five quarters.

Yes. In terms of the war for talent, yeah, we're definitely seeing an increase in activity across our industry and across our customers mentioned the same thing that they're seeing lots of activity from their competitors in terms of the war for talent. I think we continue to be really well positioned to Um, you know, to be able to, uh, to manage through that, you know, we, we still, um, you have to kind of look at our business. It's really a technology and automation driven business with fewer employees than the big systems integration companies and global managed services providers. Um, you know, we still accept, you know, uh, less than 2% of the applicants to the company. Having said all that, like Amar said, we, we've baked in investments here. Um, and we were monitoring this, you know, kind of industry wide. trend closely and being very proactive here.

No, thanks for that. And Amar, you answered my operating margin and gross margin question as well. So I'll cede the floor. Thank you. Thanks, Tinjan.

Thanks, Tinjan. Jim Breen from Liam Blair, you're up next.

And then Ramsey Ellisall from Barclays is on deck. Great. Can you hear me?

Yeah, we can hear you, Jim. Thanks. So can you just give us a little bit more color in the guidance for profitability? If you look at the full year guidance you gave last quarter, it was over $500 million in the non-GAAP operating profit. It seems like we're going to be a little bit below that. So just wondering sort of what's changed over the course of the last quarter or so. And then just any thoughts on the app cross-platform revenue. It was down sequentially this quarter. Can you just talk about the lumpiness there? Thanks.

Yeah, sure, Jim. So let me start with the guidance question first, and I did answer some of it in my previous response. But let me start with the revenue guidance first. What you see in the revenue guidance is we expect continued sequential growth in our revenue in both Q3 as well as Q4. And a double-digit core and overall revenue growth for fiscal 2021, that's what we have basically baked into our revenue guidance. for the full year is roughly in the midpoint of the overall guidance for fiscal 2021. Now, what do you see in our profit guidance? Is the profit guidance reflects low gross margins in the second half of 2021? And I may be repeating this, but I want to make sure that, you know, we give you more transparency into this, is we are seeing a makeshift happening in the business that's impacting our gross margins. I talked about the ongoing decline in the legacy OpenStack business. which we are no longer actively marketing. The second is the mixture within our multi-cloud segment from mature business to high growth business that we talked about and mainly manage public cloud. As I mentioned, we are onboarding a large number of public cloud customers. And this transition is happening very rapidly with accelerated growth in public cloud. And you could see that from the announcements, the growth announcement by hyper cloud providers. So what we have done is we have prudently modeled gross margins in the second half in the 32 to 33% range. Also with the restructuring that we announced on July 21st, we have aligned our optics to this new gross margin profile to continue delivering operating margins in the mid teens in the second half of 21, while we continue to make investments in growth offerings and go to market that we mentioned earlier. So all this is baked into our guidance. Now, if I just have to extend it a little bit and go forward and give you more color for the next four to five quarters, we believe that we are in this transient phase with this mixture that is happening in the business. And our projections indicate that this will continue for the next four to five quarters. And during this transient phase, we do expect our gross margins to bottom out in the low 30%. And by the end of fiscal 22, we do expect it to start inflecting with a favorable mix shift to higher value cloud services for three reasons. One, a legacy OpenStack product is becoming a smaller and smaller part of our revenue mix. It's already down to 6% of our revenue. Second is we expect the mix shift in multi-cloud to be largely complete. And it's expected to be more than 80% of the mix. And third is more meaningful expansion in the newer accounts with higher margin services. And these expansions typically take some time. But, you know, this is a long-term play for us. So those are a few reasons why we believe that it will stabilize. And then we have an inflection point starting the end of fiscal 2022. Did that help, Dan?

Yeah, that's great. And then just on the apps and cross-platform side, you know, you saw the revenue down a little bit this quarter. Sure. Yeah, just what your thoughts are there.

Right. So in Q2, when you look at our apps and cross-platform, it did grow about 16% year-on-year. So it was a healthy growth, but it was down about 5% sequentially. And also as a part of our restructuring, we did exit a small line of business in application services that we figured that it's non-strategic for us. So we continuously evaluate a portfolio and there was a non-strategic part of the business that we exited. And this explains most of the sequential decrease in apps and cross-platform going from say Q1 to Q2. Now we think that this segment will continue to deliver revenue in the 90 to $93 million range in Q3 and Q4 and continue to grow at a healthy clip.

Thanks, Jim. Our next question comes from Ramsey Ellisall with Barclays. Ramsey, are you there? I think we've lost Ramsey.

There are no further questions in the queue, so with that, we'll call it a wrap. Again, if you have follow-up questions, you can reach out to me after the fact at ir.rackspace.com, and have a good evening.