Rackspace Technology, Inc.

Good afternoon and thank you for standing by. Welcome to Rackspace Technologies' fourth quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. After the presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 1 on your telephone. Please be advised that today's call is being recorded. I would now like to hand the call over to Robert Watson, Vice President of Corporate Finance. Please go ahead.

Thank you, and good afternoon. I am joined today by Amar Malatera, our Chief Executive Officer, and Bobby Maloo, our Chief Financial Officer, who recently joined in January. Supplemental materials to today's earnings announcement, as well as a replay of today's call, can be found on our investor relations website. 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. RAC space 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 those 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 IRA website. I will now turn the call over to Amar for an update on the business.

Thank you, Robert. First, I would like to quickly update you on the ransomware incident we experienced late in Q4. On December 2nd, Rackspace detected suspicious activity in our hosted exchange email environment, which triggered our incident response team to act immediately to contain the threat. We quickly engaged industry-leading cybersecurity firm CrowdStrike and other experts to assist us with the forensic investigation, which was completed in roughly 30 days. The investigation determined this was the result of a zero-day exploit, which means the attack vector was not previously known and it was a sophisticated attack. Due to our team's swift action to contain the threat, the impact was limited solely to the hosted exchange email environment, which makes up less than 1% of our total revenue. No enterprise customers were impacted and no other Rackspace products, platforms, solutions, or businesses were affected as a result of this incident. We provided our hosted exchange customers with a path to migrate their email services to Microsoft 365 and assisted many customers with both the email and data transition. Security is extremely critical for our business. and we have the right focus and investments to continue to provide our customers with a secure environment. With that, let me share what else I've been doing since taking the helm in September. I've been laser focused on transforming Rackspace technology into a customer-first, cloud-first company and changing the trajectory of our performance. In just the last few months, we have achieved many significant milestones, which include implementing a two-business unit operating model, adding new leadership, strengthening our board, and introducing new products and services. We are now poised to drive these changes throughout the company and bring our strategy to life. We are very focused on fixing this business for the long term, even if it requires near-term disruption. While the next few quarters may be choppy, our focus is on positioning the company for sustainable growth heading into 2024. I'm pleased to share some of the progress since our last earnings call. First, we delivered fourth quarter revenue and profitability above the high end of our guidance. This is a positive step as we continue to build a track record of meeting or exceeding our commitments. Second, I'm excited to welcome Bobby Maloo, our new CFO who joined in January and has hit the ground running given his services background and broad operational finance experience. Third, we have hired Brian Lilly as the president of a private cloud business and have previously announced DK Sinha as the president of the public cloud business unit. Given this, we now have strong leadership for each of these two core segments. Brian's deep technology experience and focus on strategy and execution will be instrumental in transforming our private cloud business. And finally, Anthony Roberts has joined our board of directors. Anthony's extensive experience as a senior technology executive will be a tremendous asset that together with the recent elevation of Shashank Samant to lead director will help define and fortify our position as the industry's leading provider of multi-cloud solutions. While we are only a couple of months into our new operating model, I am encouraged by the early signs of progress. Although it will take time to fully reflect this progress in our financial results, I strongly believe we are headed in the right direction. As we navigate the challenging macro environment, we are experiencing some of the same trends highlighted by others in our industry. Growth of the broader cloud market has slowed as customers are showing a heightened focus on efficiency. We are also experiencing longer sales cycles, The recent economic slowdown has also led many companies to take a more deliberate approach to evaluating whether workloads should operate in public or private cloud to optimize for performance and cost. With demand shifting to the right, we are taking advantage of current macro conditions to complete our transformation, improve execution, and launch new offerings. In public cloud, we continue our accelerated pivot from an infrastructure resale-led motion to a services-led motion with deeper customer engagement. As we change the mix of the business, we are experiencing some near-term disruptions. We are committed to building a services backlog that will yield sustained long-term growth and improved margins. We have already taken several steps to accelerate our shift to a higher margin suite of services and expand our existing offerings. Let me highlight a few examples. We recently announced an expanded long-term strategic partnership with Google Cloud. As part of this partnership, Rackspace will build out a Google Cloud Center of Excellence with 250 certified GCP resources. Together with GCP, we'll drive joint business development around Rackspace's Google Cloud services focused on areas such as application migration, modernization, data, and AI. We also recently launched Modern Operations, which is a new managed service offerings for public cloud that will provide customers across AWS, Azure, and GCP a 24 by 7 unified support model for a broad range of services. Modern Operations is a good example of the sticky annuity services we are focused on expanding. Our new operating model will ensure that we emerge from 2023 with a public cloud organization focused on the high value opportunities in this wide open market space. The growth of public cloud has also spurred new demand for private cloud solutions. Public Cloud is a great place for many new and emerging workloads. Companies are now realizing, however, that many workloads are most efficiently operated in their existing native environment. Many companies also no longer want to build or operate in-house data centers and need a safe, reliable partner to run mission-critical workloads. All that sums up to a significant opportunity for Rackspace as one of the largest scaled players in private cloud. To address demand across a broad range of private cloud customers, we recently launched software-defined data center offerings including enterprise, business, and flex options. These enhanced higher value offerings position us well to meet unmet demand in private cloud. As Rackspace moves forward, you should expect a continued focus on higher-value innovations in public and private cloud, which underpin our strategy and new operating model. In parallel, we are progressing on industry-specific offerings in both public and private cloud. We are building focused teams and solutions in verticals such as healthcare, telecom, tech and gaming, and public sector to better leverage our core multi-cloud strengths and address the complex challenges facing our customers. As an example, we recently signed an important memorandum of understanding with Sadiya, the Saudi Data and AI Authority, a government agency with a mission to unlock the value of data as a national asset. This MOU will enable Rackspace and Sadiya to collaborate on strategic technology initiatives in support of Saudi Arabia's Vision 2030, an ambitious blueprint for the kingdom's digital future. This partnership is an example of Rackspace's relevance in an exciting multi-cloud market. Before I conclude, I'd like to extend my heartfelt gratitude to each and every one of our talented Rackers, customers and partners around the world. Over the past five months, we have accomplished a great deal and initiated critical changes within the company. Our two-business unit structure is now fully operational, and we have assembled a strong leadership team to execute our strategy and plan. 2023 will be a transformational year for us as we continue to lay the foundation for long-term sustained performance in the future. I will now turn the call over to Bobby for an overview of our Q4 financials.

Thank you, Ammar. Before I begin, I would like to say that I am extremely excited to join the Rackspace team. I strongly believe in the turnaround and look forward to being a part of the next chapter of the Rackspace story. I'm also looking forward to meeting and talking with our investors in the coming days and weeks. Now, on to the results. In the fourth quarter, both revenue and core revenue exceeded the high end of the guidance that was provided on the Q3 call in November. Total revenue was $787 million, which represents 3% year-over-year growth in constant currency and 1% growth on a reported basis. We continue to experience material year-over-year currency headwinds from our Europe business. Core revenue was $752 million, which grew 4% year-over-year in constant currency and 2% on a reported basis. Revenue in EMEA grew 7% in constant currency, driven in part by the continued ramp of the BT contract, but declined 1% on a reported basis. Americas grew 1% and APJ grew 19% on an as reported basis with minimal FX impact. Non-GAAP operating profit of $74 million also exceeded the high end of our fourth quarter guidance. This was down 40% year over year, primarily due to reduced gross profit from the ongoing revenue decline in our legacy OpenStack and private cloud businesses. Non-GAAP operating margin was 9% and non-GAAP earnings per share was $0.06. In the fourth quarter, we generated cash flow from operations of $40 million and free cash flow of $25 million. On a full year basis, we generated $259 million of cash flow from operations and $179 million of free cash flow. We ended the year with $241 million of cash and our $375 million revolver remained undrawn, resulting in over $600 million of total available liquidity. We anticipate cash flow from operations to be negative in Q1, driven by seasonal cash outflows, but expect positive cash flow from operations in the remaining quarters. CapEx in the fourth quarter was in line with expectations with total CapEx of $43 million and cash CapEx of $15 million. CapEx intensity was 5% and 2% respectively. For the full year, we ended at 5% total CapEx intensity, which was at the low end of our 5% to 7% guided range. In the fourth quarter, we recorded $217 million of non-cash impairment charges, driven primarily by $129 million of goodwill and a $75 million asset impairment. The goodwill impairment was in our apps and cross-platform segment and was driven primarily by the decline in market capitalization following the ransomware attack on our hosted exchange email business. The asset impairment was for our San Antonio headquarters office as we prepare for our relocation to a smaller footprint in North San Antonio later in 2023. Additional details of these non-cash expenses can be found in our press release and SEC filings. Now moving on to the Q1 guidance. Our guidance for the first quarter of 2023 reflects continued caution related to an uncertain macroeconomic environment and includes impacts from the December ransomware attack. For the first quarter, we expect total revenue in the range of $752 to $762 million. Core revenue in the range of $719 to $729 million. Non-GAAP operating profit of $47 to $53 million. other income and expense of $55 to $57 million, and non-GAAP loss per share of 1 to 5 cents. Before I conclude, I would like to remind everyone that beginning in Q1, we will start reporting revenue and profitability for our new operating segments, public cloud and private cloud. We will also continue to separately report our legacy OpenStack business as we have been doing. We anticipate providing historical financials in the new segmentation prior to our Q1 earnings release in May.

And with that, we will take your questions.

Thank you. At this time, we'll conduct the question and answer session. As a reminder, to ask a question, you'll need to press star 11 on your telephone and wait for your name to be announced. To withdraw your question, press star 11 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Kevin McVey of Credit Suisse. Your line is open. Go ahead.

Great. Thanks so much, and congratulations on the Q4 results. Hey, I don't know if this would be for Maura or who, but can you give us a sense as we're going through the restructuring just how we're thinking about free cash flow? It sounds like a use of cash in Q1, but any sense of how we should think about that holistically for all of 2023? Because it seems like you've got the capital to kind of shepherd through this. restructuring, but just any thoughts on how free cash flow overall should shape up over 2023? Yeah, thanks, Kevin.

Thanks for the question. So as Bobby mentioned in his prepared remarks, cash flow from operations in Q1 will be negative because of a seasonal impact that we have for two reasons. One is there's a bonus payment company bonus payment, as well as we have a payment to one of the vendors. So this is typically a low cash flow quarter for us in Q1. For the full year, we do expect free cash flow, as well as cash flow from operations for the full year to be positive. And as we roll through the year, you should expect our cash flow from operations to be positive.

I would just add, look, cash flow generation is going to be a major focus for us, major focus for me. We are working on a number of initiatives to drive these improvements. So let me give you a little bit of color on this, Kevin. Just in terms of our cash conversion cycle, we're very focused on that, on receivables and payables. We're focused on our CapEx efficiency and improving that. We continue to look for cost optimization opportunities. And look, as the CFO of this company, my sole focus is going to be around managing cash and expenses and making sure that we're making the investments to drive a long-term growth.

Great. Thanks so much.

One moment for our next question, which comes from the line of Ashwin Chewbacca of Barclays. Your line is now open. Ashwin?

Yeah. Hi, Ashwin from Citi. You guys, good to speak with you.

Bobby, good to meet you. Yes, my first question is, if you can provide maybe more granularity with regards to, you know, how the demand environment is evolving, what we've heard from other companies is that, you know, obviously a pretty strong slowdown in December, but by February things have started picking up just a bit. Is that similar to or different than what you're seeing? Any color you can provide with regards to visibility that you have in the forward look would be great.

Thank you for the question, Ashwin. Good to hear your voice. So, as you rightly said, you know, all companies in the cloud ecosystem, as you know, Ashwin, are being cautious about the demand environment. And rightfully so, even the tough macro outlook, right? You know, we work very closely with the hyperscalers too. And as you know, hyperscalers have also cautioned that the growth rates are slowing. But still, it's a double-digit growth. You know, they are still reporting double-digit growth. We believe that the customers will maintain the IT spend, Ashwin, on mission-critical projects, but slow spending on lower-priority, less-critical projects. And this, of course, varies by customer as well as vertical. But broadly, customers will be more focused on cost optimization of existing high-usage workloads on projects that have a faster payback. We're also seeing customers, Ashwin, as we work with them on transformation projects, that they want to accelerate their transformation projects so they can they can really realize the returns of those projects within the year. So in this kind of environment, we also see it's not very unusual to expect some changes in the size and scope of the deals that we pursue. We're also seeing longer sales cycle and also a slowdown in decision making. So this is, I'm sure you've heard this across the ecosystem, And, you know, looking forward, you know, I think the demand will definitely be there. Ashwin, what I'm seeing is I've been talking to a lot of customers. I've been going around, you know, I've been spending a lot of time on the road talking to our customers, to our partners. The demand is still there. I think the demand is just shifting to the right because of the slowdown in decision-making. We are also seeing that as budgets are getting released, you know, this is the first quarter, so it takes time for the budgets to actually show up. So people are a bit cautious. Now, given this backdrop, Rackspace is prepared. We will control what we can and manage what we cannot. We will have a very tight control on our expenses, as Bobby mentioned. We'll continue to execute on our ongoing cost efficiency programs. We have lined up those programs. We'll also make targeted investments to expand our services and solutions offerings. to help customers optimize their costs and also deliver projects with faster payback. As I mentioned, these projects are shifting to the right, and we want to go capture those with the right offerings that we can provide to the customers. So we believe that the demand for multi-cloud will remain as I look into the future. And to be honest, Ashwin, as we go through our transformation here in the company, we are taking advantage of this current macro conditions to complete our transformation, improve our execution, and also launch new offerings so that we can continue to meet the customer demand. So that's what I'm seeing from a demand perspective, what I've seen in the last few months and what I expect in going forward.

Thank you.

That's a lot of good detail, Amar. If I can follow up on that last part of what you said, obviously, from a personnel standpoint, the organization seems complete now. But from, you know, from the perspective of investors looking to figure out what the key initiatives or deliverables are that we should, you know, hold management accountable for over the course of the year. If you could kind of comment a bit more on on those, what goals have you set for your management team and for yourself?

Yeah. So let me, I think that's a great question, Ashwin. You know, I've been on the job for the last four and a half, five months. As I mentioned in my prepared remark, the first three, four months was making sure that we have the, you know, we formalize the strategy. We create the operating model. We did a lot of heavy lifting, Ashwin. in our December quarter to reorganize across the two business units. We have started operating as the two business units starting Jan 1st. As you have seen, we have made the right leadership changes. I'm very pleased with the leaders that have joined Rackspace. And so our execution going forward, our focus going forward will be all about execution. Now, you can imagine as we do this kind of heavy lifting, this is, we are, positioning the company for long-term growth. And it's 2024 and beyond. And as we do that, and we are expecting some disruption. It happens when we go or reorganize the company in a way where we take almost 6,000 people and reorganize across the two business units. So what we expect is the productivity will continue to improve. DK, Sina, Brian, Lily, and myself We are very much engaged with our go-to-market organization to make sure we drive clarity on the field on how we will go execute as a multi-cloud company, although we'll carry private cloud and public cloud solutions to our customers. So a lot of things going on. I think the key indicator, Ashwin, is we will provide you more granularity and also visibility into the financials of the two business units. So as Bobby mentioned in his prepared remark, we will be reporting by essentially three segments. We'll report by public cloud, private cloud, and OpenStack. And how we report externally is how we will continue to manage internally, right? So stay tuned, and you will see, you know, we will also be looking at how we come and give you more color on what is net revenue versus gross revenue. Because as you can see, we are making a real hard pivot from infrastructure resale motion to a services-led motion. And in doing so, I think we are making some really tough, thoughtful decisions. Because we believe for every dollar of infrastructure that on the hyperscale side, we have an opportunity to go and sell anywhere between 3% to 7%. or $8 of services on top of their infrastructure or the life of the infrastructure. That's the kind of opportunity we are looking at. So there will be a lot of indicators that we will be providing. I think the first one, Ashwin, will be giving you a visibility on the segments, both public cloud and private cloud. And that is, I think, stay tuned for that, and you will see us come and talk about it. Now, in terms of indicators inside the company, We have set up a financial plan. We have an investment thesis that we are working on for the next three years. We are lining up our operating plan so that we can go execute against those operating plans. Every single business unit has their KPIs and OKRs that are getting defined and will manage very, very tightly. So we are getting into an operating rhythm so that we can go execute on a strategy.

All right. And, Ashwin, I would just add that, look, this is a major pivot, right, and we're trying to focus more on services. And as you know, services is a longer sales cycle. So it's going to take a little bit longer for that sales engine to get going. And as Amar mentioned in his prepared remarks, it's going to be choppy for the next few quarters. So, you know, we've got to understand that as we make this pivot.

Yeah. And if I can just add that, it's a great point, Bobby, that you bring up, right? So we have two businesses, right? Let's think about private cloud. It's an infrastructure as a service business. That business has been largely sort of I would say not ignored, but it was not sort of de-emphasized, although we are seeing a lot of demand in that business coming up, right? So that's the reason we brought Brian Lillian, who has a great experience in the private cloud space, because that's the business that we are going to transform and make sure that the business stops declining, stabilize that business. On the public cloud side, Ashwin, we are going to sell cloud services on top of the infrastructure. And that's the reason we have DK Senal who has a lot of experience in scaling cloud, a lot of experience in scaling digital services business. So stay tuned. We will, you know, this pivot takes time, but we are starting to see some initial, you know, we have, you know, for example, last quarter we sold one of the largest private cloud deal in the history of the company. So we're starting to see some traction there this quarter. We signed a very strategic deal, an expanded deal with Google on GCP that impacts the public cloud business. And we also signed a MOU with Sadiya.

Thank you for all the details.

Thank you. One moment, please. Our next question comes from the line of Ramzi Alassai of Barclays, your line is open.

Hi, this is Ryan on for Ramzi. Thank you for taking my question today. I was hoping for some additional color on the order book in the quarter and the backlog. As you make the shift to higher value services and solutions, are you being more selective with the workloads you take on? And what strategy do you have to accelerate the percentage of the order book coming from these higher value services?

Yes. So let me first give you some color on the bookings itself for Q4, and I'll give you additional color on what we are doing so that we make this pivot. So that's a great question. Now, you know, in Q4, as we expected, we were seeing a bit of a slowdown in bookings volume, and this was driven by the impact of a reorganization and also the macro trend that we're seeing in the market. As I mentioned earlier, Ryan, we are seeing sales cycles are getting extended. Companies are reevaluating the IT spend, and there's a shift of focus to more of a cost optimization, and more critical projects are getting done. So in terms of a performance specific to fourth quarter, we saw good traction in the tip of the sphere professional services for critical cloud projects as it relates to cost optimization. We continue to drive the makeshift to services in a public cloud business. From a regional perspective, Asia Pacific and Japan, I was very pleased with the performance, although it's small base for us, but it did exceptionally well with very high double-digit growth driven by our data business on cloud. And we also had a couple of large deals across both public and private cloud. For example, in public cloud, we signed a fairly good-sized professional services deal for application modernization with a major airline, as an example. In private cloud, we renewed and expanded the contract with a mobile SaaS company to support their data platform in a private cloud environment. So we are starting to see that pivot, Ryan. It does take time when you make that pivot. And for us, the most important thing, as Bobby mentioned, is to build that services backlog. And so in some cases, we will walk away from some of the infrastructure resale deals. specifically if it is in the commercial side, which is in the small, in the S of the SMV, so to speak, where there's no opportunity to land and expand. So we'll walk away from those low-margin deals where we cannot expand with services. So that might impact our bookings, and it might also impact our overall revenue in the short term. But those are the decisions we want to make so that we can shift the DNA of the company to more of a high-margin, services-led and high-value

Thank you. Our next question.

The next question comes through the line of Frank Luthan of Renan Homes. Your line is open.

Great. Thank you. Two quick questions. Where can we expect as far as EBITDA margins sort of in Q1 and then kind of going forward and also on the level of capital intensity? And then secondly, you made a lot of changes to the management team. Is that largely behind you or are there more hires that you think you need to make to get the team where it needs to be? Thanks.

Yeah. So I will start with the guidance question and then Bobby will definitely jump in here. So Let me start with the revenue first. And I will not give you the EBIT margins, but I'll give you enough of color so that you can model it. Because Q1, we already provided you the guidance on that. We continue to be a bit cautious, Frank, with our guidance. We took a conservative approach here to our revenue, given the uncertain macroenvironment. We also expected lower usage in public cloud as companies focus on optimizing the workloads in effort to reduce their overall operational costs. We also had some revenue impact due to post-exchange ransomware attack. And as we mentioned in my prepared remark, we also believe that there's a potential disruption from our operating model realignment that we are undertaking right now. So these impacts also flow through to our profit. So essentially, you know, we expect, you know, based on the guidance that we provided, we expect the EBIT margin to be in the 6.6, 6.6 to 7% range, so to speak. And our CAPEX would be roughly, you know, where we landed in Q4 of 2022. So you can calculate what the EBITDA margin is going to be based on that.

Yeah, the only thing I'd add there is on CAPEX, Look, as we're focusing on the private cloud business, we will see CapEx increase, particularly if we're very successful. So that would be a good problem to have. And Amar mentioned the large deal that we had signed in our history of the company. There is a large CapEx associated with that, so you will see a spike in our CapEx in Q1.

And on the – yeah, I think you had the second question. Frank, any follow-up on that, or should I go to the – Yeah, so on the CapEx,

With that deal, are they paying for any of that up front? How should we think about that? And how will that get booked? And then what's sort of a long-term run rate for capital intensity of the business?

So I think, well, the contract is a long-term contract, Frank. And so we make the initial CapEx investment is no different than what we do in any of our private cloud deals. And we call this as a success-based CapEx, right? Success-based CapEx means CapEx where we only put the CapEx in if we have a firm order and a contract from a customer. So it's a good CapEx, so to speak. Then we have maintenance CapEx. So we are going to make sure we tightly manage the maintenance CapEx and Bobby's all over it. Even on the success-based CapEx, as we continue to drive innovation, We should see CapEx efficiency in the success-based CapEx 2 case.

Okay, great.

And then on any – yeah, no, that's great. Any future changes, any more changes to the management team, or do you think you have things where you need to be for now?

Yeah, listen, I think that's a good point. As noted in my prepared remarks, you know, I feel strongly that we now have the right leadership team in place, Frank, to drive us forward in our transformation. We had, you know, we hired DK a few months ago. We have Brian Willey managing a private cloud. We have Bobby Malou who joined us as a CFO. So we now have seasoned leaders across all the functions. So, you know, we also made some other leadership changes when necessary. And so I feel confident that a lot of the heavy lifting is behind us.

Okay, great. Thank you very much. Thank you.

Our next question comes from the line of Tin-Cheng Wang of JP Morgan. Your line is open.

Hey, guys. This is Brendan Biles on for Tin-Cheng. Thanks so much for the time and welcome, Bobby.

So first off, congratulations.

Nicely done. um uh thanks for all the details on the changes just from like sort of a personnel and cultural perspective could you guys um opine on like the competitive environments in these new areas these new incremental areas for the business um and services both from you know competing for talent any incremental ads like in subject matter experts in private cloud and then also uh incremental competitive operator incremental competitive dynamics uh from winning your business, especially in the challenging macro.

Thanks so much.

Yeah, sure. So if I got it, but thank you very much for your question. If I got a question right, it's, you know, the competitive environment in a new service offering and also competition for talent, if I got that right. Exactly. Yeah, thank you very much. I think the market, and we see this all the time, there's definitely a lot of demand in the market of this. We have to go capture the demand and then we have to execute against that demand. So when you talk about the market opportunity, there's definitely competition there, but there's enough of market for everyone to play. And we are very uniquely positioned, so to speak. We are a pure play multi-cloud company. That means we do both public as well as private cloud. And that's a very unique position for us. So as we go and talk to our customers, we are... you know, we are very, very neutral on where the workload needs to reside. So it's all about workloads and where the workloads can be hosted. So in terms of competition, you know, we address all three segments of the market. We address commercial segment of the market, mid-market, as well as the enterprise segment. And we face off against different types of competitors in each of these segments. In private cloud, that was on the public cloud side. In the private cloud side, It's a very fragmented market, and we are one of the largest scaled player in private cloud, which means that there is a huge opportunity for us to go redefine the private cloud market itself, given the surge in demand that we're seeing on the private cloud side. A lot of workloads in the regulated industries, as an example, we believe will stay in a hosted private cloud environment, will move out of the data centers. Customers don't want to go be in the business of running a data center. We're also seeing workloads that cannot be refactored but needs a sort of an on-ramp to public cloud. Private cloud becomes a very good, you know, solution for those kind of workloads. So as you can see here, I think, you know, we believe that we are very, very well placed from a competitive perspective. Now, we need to get the right offerings in. There's a lot of work to be done, so don't get me wrong. You know, we have a lot of work to do on the offering side, on the solution side. as well as on the operations side. In terms of talent, we are a technology and an automation driven company. So unlike large system integrators, we do not have a large staff augmentation business. So you don't see us reporting attrition numbers or hiring numbers because we think instead of just having a labor plus model, we want to go with an automation and IP-led offering, which we believe is a labor minus model, which is very compelling for our customers. So we will have to go compete for the talent. Don't get me wrong. We are attracting talent because of our brand, as well as a strong customer base that we have and the solutions that we offer. And that's not an area that we are really concerned about.

Thank you very much.

Thank you. Our next question comes from the line of, one moment please, comes from the line of James Breen of William and Mary.

Thank you. Thanks. Thanks for taking the question. Can you talk a little bit about, you touched on the margins a little bit, I think it was Frank's question. Obviously, the operating margin coming down sequentially in the first quarter. Is there seasonality to that, and how do you feel about that as sort of a bottom for the year? And then just looking at your gross margins across the three businesses as you report them now, and I understand this is going to change, but you had a pretty good step down, obviously, in the third quarter. And then in the open SAC segment, again, this quarter, are there any thoughts around just basically trying to have that attrition be quicker

um and and you know giving up that revenue but given also giving up also the losses that are happening or given how the gross margin continues to decline thanks let me let me start and let me talk to the sequential decline that you see there so uh there's several factors uh causing that sequential decline in q1 so from a revenue standpoint there is a seasonality impact like you mentioned right q4 to q1 we normally do see that There's also the impact of the December ransomware attack that's now fully baked into the forecast for Q1. And then, as you've seen, there's, you know, continues to be decline in private cloud, as well as our legacy OpenStack business, as you mentioned. And look, the reality of that is the fact, like Amar mentioned early on, there's, you know, de-emphasis on private clouds. There's no surprise that that's been declining, and that's something that we're trying to arrest the decline on with the new focus and the new BU structure. So a lot of these revenue impacts also flow down to profit. And then in addition, on the profit side, there's also a seasonality impact from Q4 to Q1 for seasonal payroll taxes and benefits. But look, we're looking for opportunities to reduce costs and offset some of these revenue impacts and profit impacts. But we've got to still remain focused on growth. Mario, you want to add anything?

No, I think you quoted well. On the OpenStack piece, I think that's another question you had, James. Let me just jump. Well, that business is declining. I think the rate of decline has actually lowered in that OpenStack business, which is an OpenStack public cloud business. So I think we had already factored that in our financial plan and financial model that continues to happen. And I think the rate of decline used to be 20% plus. Now it's in the 15%, 16% range.

And do you continue to expect as that?

Yeah, I think we continue to expect that decline to continue as customers move away from that platform. And that's why we call it as a legacy because that's a natural kind of trajectory that we are seeing for the last few years, in fact. And what we do is, as this happens, we continue to take cost out and basically optimize our costs so that we minimize the impact on the profit. So that's all a part of the plan.

Thank you. Our next question comes from the line of Bradley Clark of BMO. Your line is open.

Hi, Bradley.

All right, thanks for taking my question. I just wanted to touch on the demand environment a little bit more. And more specifically, are you seeing any difference in behaviors across geographies in terms of, you know, demand or focus on certain types of deals? Any more granularity you could provide on geographical demand trends? Thank you.

Yeah, I think, so listen, I think I did mention on my earlier response, Our demand environment across all the regions, especially in public cloud on the infrastructure side, has slowed down. But again, as I said, most of the hyperscalers are reporting it, but they are still printing double-digit growth. So there still remains a lot of demand there. You know, by verticals, I can use a little bit of more color on verticals, especially, you know, retail and technology verticals. as well as, you know, in financial services, et cetera, we have, again, we don't go by vertical in financial services, but we have started seeing some demand slow down. But there's other verticals, like, for example, healthcare. You know, we are seeing demand slow down, but there's a huge opportunity to help transform, especially on the provider side, and help healthcare providers to accelerate that digital transformation. And so we are seeing a little bit of, we are seeing some demand on that side. We are also, in telco also, we are seeing good demand. So it's a mixed bag. But generally, the demand has slowed down across the board and across all geographies. In APJ, we did very well, as I mentioned earlier. We posted double-digit growth, but APJ is a small base for us. It is mainly driven by data services, which is also a focus area. Migration, modernization, and AI continues to remain a focus area across the board.

Kathy, any other questions?

That's all our questions. So I would now like to turn it back to Robert Watson for closing remarks.

I just want to say thank you, everyone, for joining us. And I think we got to all the questions. But if we didn't get to your question or you have any follow-ups, please reach out. You can email us at ir at Rackspace.com or contact me directly. So thanks, everyone, and have a great evening.

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

I think we're still, we're back. Oh, hi.

I didn't realize I was still on. I think we're good to go. you Thank you. Thank you. Thank you.

Thank you. Bye. you

Good afternoon, and thank you for standing by. Welcome to Rackspace Technologies' fourth quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. After the presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 1 on your telephone. Please be advised that today's call is being recorded. I would now like to hand the call over to Robert Watson, Vice President of Corporate Finance. Please go ahead.

Thank you, and good afternoon. I am joined today by Amar Malatira, our Chief Executive Officer, and Bobby Maloo, our Chief Financial Officer, who recently joined in January. Supplemental materials to today's earnings announcement, as well as a replay of today's call, can be found on our investor relations website. 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. RAC space 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 those 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 IRA website. I will now turn the call over to Amar for an update on the business.

Thank you, Robert. First, I would like to quickly update you on the ransomware incident we experienced late in Q4. On December 2nd, Rackspace detected suspicious activity in our hosted exchange email environment, which triggered our incident response team to act immediately to contain the threat. We quickly engaged industry-leading cybersecurity firm CrowdStrike and other experts to assist us with the forensic investigation, which was completed in roughly 30 days. The investigation determined this was the result of a zero-day exploit, which means the attack vector was not previously known and it was a sophisticated attack. Due to our team's swift action to contain the threat, the impact was limited solely to the hosted exchange email environment, which makes up less than 1% of our total revenue. No enterprise customers were impacted and no other Rackspace products, platforms, solutions, or businesses were affected as a result of this incident. We provided our hosted exchange customers with a path to migrate their email services to Microsoft 365 and assisted many customers with both the email and data transition. Security is extremely critical for our business. and we have the right focus and investments to continue to provide our customers with a secure environment. With that, let me share what else I have been doing since taking the helm in September. I will laser focus on transforming Rackspace technology into a customer-first, cloud-first company and changing the trajectory of our performance. In just the last few months, we have achieved many significant milestones, which include implementing a two-business unit operating model, adding new leadership, strengthening our board, and introducing new products and services. We are now poised to drive these changes throughout the company and bring our strategy to life. We are very focused on fixing this business for the long term, even if it requires near-term disruption. While the next few quarters may be choppy, our focus is on positioning the company for sustainable growth heading into 2024. I'm pleased to share some of the progress since our last earnings call. First, we delivered fourth quarter revenue and profitability above the high end of our guidance. This is a positive step as we continue to build a track record of meeting or exceeding our commitments. Second, I'm excited to welcome Bobby Maloo, our new CFO who joined in January and has hit the ground running given his services background and broad operational finance experience. Third, we have hired Brian Lilly as the president of a private cloud business and have previously announced DK Sinha as the president of the public cloud business unit. Given this, we now have strong leadership for each of these two core segments. Brian's deep technology experience and focus on strategy and execution will be instrumental in transforming our private cloud business. And finally, Anthony Roberts has joined our board of directors. Anthony's extensive experience as a senior technology executive will be a tremendous asset that together with the recent elevation of Shashank Saman to lead director will help define and fortify our position as the industry's leading provider of multi-cloud solutions. While we are only a couple of months into our new operating model, I am encouraged by the early signs of progress. Although it will take time to fully reflect this progress in our financial results, I strongly believe we are headed in the right direction. As we navigate the challenging macro environment, we are experiencing some of the same trends highlighted by others in our industry. Growth of the broader cloud market has slowed as customers are showing a heightened focus on efficiency. We are also experiencing longer sales cycles, The recent economic slowdown has also led many companies to take a more deliberate approach to evaluating whether workloads should operate in public or private cloud to optimize for performance and cost. With demand shifting to the right, we are taking advantage of current macro conditions to complete our transformation, improve execution, and launch new offerings. In public cloud, we continue our accelerated pivot from an infrastructure resale-led motion to a services-led motion with deeper customer engagement. As we change the mix of the business, we are experiencing some near-term disruptions. We are committed to building a services backlog that will yield sustained long-term growth and improved margins. We have already taken several steps to accelerate our shift to a higher margin suite of services and expand our existing offerings. Let me highlight a few examples. We recently announced an expanded long-term strategic partnership with Google Cloud. As part of this partnership, Rackspace will build out a Google Cloud Center of Excellence with 250 certified GCP resources. Together with GCP, we'll drive joint business development around Rackspace's Google Cloud services focused on areas such as application migration, modernization, data, and AI. We also recently launched Modern Operations, which is a new managed service offerings for public cloud that will provide customers across AWS, Azure, and GCP a 24 by 7 unified support model for a broad range of services. Modern Operations is a good example of the sticky annuity services we are focused on expanding. Our new operating model will ensure that we emerge from 2023 with a public cloud organization focused on the high value opportunities in this wide open market space. The growth of public cloud has also spurred new demand for private cloud solutions. Public Cloud is a great place for many new and emerging workloads. Companies are now realizing, however, that many workloads are most efficiently operated in their existing native environment. Many companies also no longer want to build or operate in-house data centers and need a safe, reliable partner to run mission-critical workloads. All that sums up to a significant opportunity for Rackspace as one of the largest scaled players in private cloud. To address demand across a broad range of private cloud customers, we recently launched software-defined data center offerings including enterprise, business, and flex options. These enhanced higher value offerings position us well to meet unmet demand in private cloud. As Rackspace moves forward, you should expect a continued focus on higher-value innovations in public and private cloud, which underpin our strategy and new operating model. In parallel, we are progressing on industry-specific offerings in both public and private cloud. We are building focused teams and solutions in verticals such as healthcare, telecom, tech and gaming, and public sector to better leverage our core multi-cloud strengths and address the complex challenges facing our customers. As an example, we recently signed an important memorandum of understanding with Sadiya, the Saudi Data and AI Authority, a government agency with a mission to unlock the value of data as a national asset. This MOU will enable Rackspace and Sadiya to collaborate on strategic technology initiatives in support of Saudi Arabia's Vision 2030, an ambitious blueprint for the kingdom's digital future. This partnership is an example of Rackspace's relevance in an exciting multi-cloud market. Before I conclude, I'd like to extend my heartfelt gratitude to each and every one of our talented Rackers, customers and partners around the world. Over the past five months, we have accomplished a great deal and initiated critical changes within the company. Our two-business unit structure is now fully operational, and we have assembled a strong leadership team to execute our strategy and plan. 2023 will be a transformational year for us as we continue to lay the foundation for long-term sustained performance in the future. I will now turn the call over to Bobby for an overview of our Q4 financials.

Thank you, Ammar. Before I begin, I would like to say that I am extremely excited to join the Rackspace team. I strongly believe in the turnaround and look forward to being a part of the next chapter of the Rackspace story. I'm also looking forward to meeting and talking with our investors in the coming days and weeks. Now, on to the results. In the fourth quarter, both revenue and core revenue exceeded the high end of the guidance that was provided on the Q3 call in November. Total revenue was $787 million, which represents 3% year-over-year growth in constant currency and 1% growth on a reported basis. We continue to experience material year-over-year currency headwinds from our Europe business. Core revenue was $752 million, which grew 4% year-over-year in constant currency and 2% on a reported basis. Revenue in EMEA grew 7% in constant currency, driven in part by the continued ramp of the BT contract, but declined 1% on a reported basis. Americas grew 1% and APJ grew 19% on an as reported basis with minimal FX impact. Non-GAAP operating profit of $74 million also exceeded the high end of our fourth quarter guidance. This was down 40% year over year, primarily due to reduced gross profit from the ongoing revenue decline in our legacy OpenStack and private cloud businesses. Non-GAAP operating margin was 9% and non-GAAP earnings per share was $0.06. In the fourth quarter, we generated cash flow from operations of $40 million and free cash flow of $25 million. On a full year basis, we generated $259 million of cash flow from operations and $179 million of free cash flow. We ended the year with $241 million of cash and our $375 million revolver remained undrawn, resulting in over $600 million of total available liquidity. We anticipate cash flow from operations to be negative in Q1, driven by seasonal cash outflows, but expect positive cash flow from operations in the remaining quarters. CapEx in the fourth quarter was in line with expectations with total CapEx of $43 million and cash CapEx of $15 million. CapEx intensity was 5% and 2% respectively. For the full year, we ended at 5% total CapEx intensity, which was at the low end of our 5% to 7% guided range. In the fourth quarter, we recorded $217 million of non-cash impairment charges, driven primarily by $129 million of goodwill and a $75 million asset impairment. The goodwill impairment was in our apps and cross-platform segment and was driven primarily by the decline in market capitalization following the ransomware attack on our hosted exchange email business. The asset impairment was for our San Antonio headquarters office as we prepare for our relocation to a smaller footprint in North San Antonio later in 2023. Additional details of these non-cash expenses can be found in our press release and SEC filings. Now moving on to the Q1 guidance. Our guidance for the first quarter of 2023 reflects continued caution related to an uncertain macroeconomic environment and includes impacts from the December ransomware attack. For the first quarter, we expect total revenue in the range of $752 to $762 million. Core revenue in the range of $719 to $729 million. Non-GAAP operating profit of $47 to $53 million. other income and expense of $55 to $57 million, and non-GAAP loss per share of 1 to 5 cents. Before I conclude, I would like to remind everyone that beginning in Q1, we will start reporting revenue and profitability for our new operating segments, public cloud and private cloud. We will also continue to separately report our legacy OpenStack business as we have been doing. We anticipate providing historical financials in the new segmentation prior to our Q1 earnings release in May.

And with that, we will take your questions.

Thank you. At this time, we'll conduct the question and answer session. As a reminder, to ask a question, you'll need to press star 1 1 on your telephone and wait for your name to be announced. To withdraw your question, press star 1 1 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Kevin McVey of Credit Suisse. Your line is open. Go ahead.

Great. Thanks so much. And congratulations on the Q4 results. Hey, I don't know if this would be for Maura or who, but can you give us a sense as we're going through the restructuring, just how we're thinking about free cash flow? It sounds like a use of cash in Q1, but any sense of how we should think about that holistically for all of 2023? Because it seems like you've got the capital to kind of shepherd through this restructuring, but just any thoughts on how free cash flow overall should shape up over 2023?

Yeah, thanks, Kevin. Thanks for the question. So as Bobby mentioned in his prepared remarks, cash flow from operations in Q1 will be negative because of a seasonal impact that we have for two reasons. One is there's a bonus payment, a company bonus payment, as well as we have a payment to one of the vendors. So this is This is typically a low cash flow quarter for us in Q1. For the full year, we do expect free cash flow as well as cash flow from operations for the full year to be positive. And as we roll through the year, you should expect our cash flow from operations to be positive.

I would just add, look, cash flow generation is going to be a major focus for us, major focus for me. We are working on a number of initiatives to drive these improvements. So let me give you a little bit of color on this, Kevin. Just in terms of our cash conversion cycle, we're very focused on that, on receivables and payables. We're focused on our CapEx efficiency and improving that. We continue to look for cost optimization opportunities. And look, as the CFO of this company, my sole focus is going to be around managing cash and expenses and making sure that we're making the investments to drive our long-term growth.

Great. Thanks so much.

One moment for our next question, which comes from the line of Ashwin Chewbacca of Barclays. Your line is now open.

Ashwin? Yeah. Hi. Ashwin Chewbacca from Citi. Amar, good to speak with you. Bobby, good to meet.

Yes, my first question is if you can provide maybe more granularity with regards to, you know, how the demand environment is evolving. What we've heard from other companies is that, you know, obviously a pretty strong slowdown in December. But by February, things have started picking up just a bit. Is that similar to or different than what you're seeing? Any color you can provide with regards to visibility that you have in the forward look would be great.

Thank you for the question, Ashwin. Good to hear your voice. So as you rightly said, you know, all companies in the cloud ecosystem, as you know, Ashwin, are being cautious about the demand environment. And rightfully so, even the tough macro outlook, right? You know, we work very closely with the hyperscalers too. And as you know, hyperscalers have also cautioned that the growth rates are slowing, but still it's a double-digit growth. You know, they are still reporting double-digit growth. We believe that the customers will maintain the IT spendishment on mission-critical projects, but slow spending on lower-priority, less-critical projects. And this, of course, varies by, you know, customer as well as vertical. But broadly, customers will be more focused on cost optimization of existing high usage workloads on projects that have a faster payback. We're also seeing customers, Ashwin, as we work with them on transformation projects, that they want to accelerate their transformation projects so they can really realize the returns of those projects within the year. So in this kind of environment, Ashwin, we are also seeing it's not very unusual to expect some changes in the size and scope of the deals that we pursue, we're also seeing longer sales cycle and also a slowdown in decision making. So this is, you know, I'm sure you've heard this across the ecosystem. And, you know, looking forward, you know, I think the demand will definitely be there. Ashwin, what I'm seeing is I've been talking to a lot of customers. I've been going around, you know, I've been spending a lot of time on the road talking to our customers, to our partners. The demand is still there. I think the demand is just shifting to the right. because of the slowdown in decision-making. We are also seeing that as budgets are getting released, this is the first quarter, so it takes time for the budgets to actually show up. So people are a bit cautious. Now, given this backdrop, Rackspace is prepared. We will control what we can and manage what we cannot. We will have a very tight control on our expenses, as Bobby mentioned. We'll continue to execute on our ongoing cost efficiency programs. We have lined up those programs. We'll also make targeted investments to expand our services and solutions offerings to help customers optimize their costs and also deliver projects with faster payback. As I mentioned, these projects are shifting to the right, and we want to go capture those with the right offerings that we can provide to the customers. So we believe that the demand for multi-cloud will remain as I look into the future. And to be honest, Ashwin, as we go through a transformation here in the company, we are taking advantage of this current macro conditions to complete our transformation, improve our execution, and also launch new offerings so that we can continue to meet the customer demand. So that's what I'm seeing from a demand perspective, what I've seen in the last few months and what I expect in going forward.

Thank you.

That's a lot of good detail, Amartya. If I can follow up on that last part of what you said, obviously, from a personnel standpoint, the organization seems complete now. But from, you know, from the perspective of investors looking to figure out what the key initiatives or deliverables are that we should, you know, hold management accountable for over the course of the year. If you could kind of comment a bit more on those, what goals have you set for your management team and for yourself?

Yeah. So let me, I think that's a great question, Ashwin. You know, I've been on the job for the last four and a half, five months. As I mentioned in my prepared remark, the first three, four months was making sure that we have the, you know, we formalized the strategy. We created the operating model. We did a lot of heavy lifting, Ashwin, in our December quarter to reorganize across the two business units. We have started operating as the two business units starting Jan 1st. As you have seen, we have made the right leadership changes. I'm very pleased with the leaders that have joined Rackspace. And so our execution going forward, our focus going forward will be all about execution. Now, you can imagine that as we do this kind of heavy lifting, we are positioning the company for long-term growth, and it's 2024 and beyond. And as we do that, and we are expecting some disruption. It happens when we go or reorganize the company in a way where we take almost 6,000 people and reorganize across the two business units. So what we expect is the productivity will continue to improve. DK, Sina, Brian, Lily, and myself, We are very much engaged with our go-to-market organization to make sure we drive clarity on the field on how we will go execute as a multi-cloud company, although we'll carry private cloud and public cloud solutions to our customers. So a lot of things going on. I think the key indicator, Ashwin, is we will provide you more granularity and also visibility into the financials of the two business units. So as Bobby mentioned in his prepared remark, we will be reporting by essentially three segments. We'll report by public cloud, private cloud, and OpenStack. And how we report externally is how we will continue to manage internally, right? So stay tuned, and you will see, you know, we will also be looking at how we come and give you more color on what is net revenue versus gross revenue. Because as you can see, we are making a real hard pivot from infrastructure resale motion to a services-led motion. And in doing so, I think we are making some really tough, thoughtful decisions. Because we believe for every dollar of infrastructure on the hyperscale side, we have an opportunity to go and sell anywhere between $3 to $7. or $8 of services on top of their infrastructure or the life of the infrastructure. That's the kind of opportunity we are looking at. So there will be a lot of indicators that we will be providing. I think the first one, Ashwin, will be giving you a visibility on the segments, both public cloud and private cloud. And that is, I think, stay tuned for that. And you will see us come and talk about it. Now, in terms of indicators inside the company, We have set up a financial plan. We have an investment thesis that we are working on for the next three years. We are lining up our operating plan so that we can go execute against those operating plans. Every single business unit has their KPIs and OKRs that are getting defined and will manage very, very tightly. So we are getting into an operating rhythm so that we can go execute on a strategy.

All right. And, Ashwin, I would just add that, look, this is a major pivot, right, and we're trying to focus more on services. And as you know, services is a longer sales cycle. So it's going to take a little bit longer for that sales engine to get going. And as Amar mentioned in his prepared remarks, it's going to be choppy for the next few quarters. So, you know, we've got to understand that as we make this pivot.

Yeah. And if I can just add that, it's a great point, Bobby, that you bring up, right? So we have two businesses, right? Let's think about private cloud. It's an infrastructure as a service business. That business has been largely sort of I would say not ignored, but it was not sort of de-emphasized, although we are seeing a lot of demand in that business coming up, right? So that's the reason we brought Brian Lillian, who has a great experience in the private cloud space, because that's the business that we are going to transform and make sure that the business stops declining, stabilize that business. On the public cloud side, Ashwin, we are going to sell cloud services on top of the infrastructure. And that's the reason we have DK Senal who has a lot of experience in scaling cloud, a lot of experience in scaling digital services business. So stay tuned. We will, you know, this pivot takes time, but we are starting to see some initial, you know, we have, you know, for example, last quarter we sold one of the largest private cloud deal in the history of the company. So we're starting to see some traction there this quarter. We signed a very strategic deal, an expanded deal with Google on GCP that impacts the public cloud business. And we also signed a MOU with Sadiya.

Thank you for all the details.

Thank you. One moment, please. Our next question comes from the line of Ramzi Alassai of Barclays, your line is open.

Hi, this is Ryan on for Ramzi. Thank you for taking my question today. I was hoping for some additional color on the order book in the quarter and the backlog. As you make the shift to higher value services and solutions, are you being more selective with the workloads you take on? And what strategy do you have to accelerate the percentage of the order book coming from these higher value services?

Yes. So let me first give you some color on the bookings itself for Q4, and I will give you additional color on what we are doing so that we make this pivot. So that's a great question. Now, you know, in Q4, as we expected, we were seeing a bit of a slowdown in bookings volume, and this was driven by the impact of a reorganization and also the macro trend that we're seeing in the market. As I mentioned earlier, Ryan, we are seeing sales cycles are getting extended. Companies are reevaluating the IT spend, and there's a shift of focus to more of a cost optimization, and more critical projects are getting done. So in terms of a performance specific to fourth quarter, we saw good traction in the tip of the sphere professional services for critical cloud projects as it relates to cost optimization. We continue to drive the makeshift to services in a public cloud business. From a regional perspective, Asia Pacific and Japan, I was very pleased with the performance, although it's small base for us, but it did exceptionally well with very high double-digit growth driven by our data business on cloud. And we also had a couple of large deals across both public and private cloud. For example, in public cloud, we signed a fairly good-sized professional services deal for application modernization with a major airline, as an example. In private cloud, we renewed and expanded the contract with a mobile SaaS company to support their data platform in a private cloud environment. So we are starting to see that pivot, Ryan. It does take time when you make that pivot. And for us, the most important thing, as Bobby mentioned, is to build that services backlog. And so in some cases, we will walk away from some of the infrastructure resale deals. specifically if it is in the commercial side, which is in the small, in the S of the SMV, so to speak, where there's no opportunity to land and expand. So we'll walk away from those low margin deals where we cannot expand with services. So that might impact our bookings, and it might also impact our overall revenue in the short term. But those are the decisions we want to make so that we can shift the DNA of the company to more of a high margin, services-led and high value I see this motion.

Thank you. Our next question.

The next question comes through the line of Frank Luthan of Rain and Homes. Your line is open.

Great. Thank you. Two quick questions. Where can we expect as far as EBITDA margins sort of in Q1 and then kind of going forward and also on the level of capital intensity? And then secondly, you made a lot of changes to the management team. Is that largely behind you or are there more hires that you think you need to make to get the team where it needs to be? Thanks.

Yeah. So I will start with the guidance question and then Bobby will definitely jump in here. So Let me start with the revenue first. And I will not give you the EBIT margins, but I'll give you enough of color so that you can model it. Because Q1, we already provided you the guidance on that. We continue to be a bit cautious, Frank, with our guidance. We took a conservative approach here to our revenue, given the uncertain macroenvironment. We also expected lower usage in public cloud as companies focus on optimizing the workloads in effort to reduce the overall operational cost. We also had some revenue impact due to post-exchange ransomware attack. And, you know, as we mentioned in my prepared remark, we also believe that there's a potential disruption from our operating model realignment that we are undertaking right now. So these impacts also flow through to our profit. So essentially, you know, we expect, you know, based on the guidance that we provided, we expect the EBIT margin to be in the 6.6, 6.6 to 7% range, so to speak. And our CAPEX would be roughly, you know, where we landed in Q4 of 2022. So you can calculate what the EBITDA margin is going to be based on that.

Yeah, the only thing I'd add there is on CAPEX, Look, as we're focusing on the private cloud business, we will see CapEx increase, particularly if we're very successful. So that would be a good problem to have. And Amar mentioned the large deal that we had signed in our history of the company. There is a large CapEx associated with that, so you will see a spike in our CapEx in Q1.

And on the – yeah, I think you had the second question. Frank, any follow-up on that, or should I go to the – Yeah, so on the CapEx,

With that deal, are they paying for any of that up front? How should we think about that? And how will that get booked? And then, you know, what's sort of a long-term, you know, run rate for capital intensity of the business?

So I think, well, the contract is a long-term contract, Frank. And so we make the initial CapEx investment is no different than what we do in any of our private cloud deals. And we call this as a success-based CapEx, right? Success-based CapEx means CapEx where we only put the CapEx in if we have a firm order and a contract from a customer. So it's a good CapEx, so to speak. Then we have maintenance CapEx. So we are going to make sure we tightly manage the maintenance CapEx and Bobby's all over it. Even on the success-based CapEx, as we continue to drive innovation, we should see CapEx efficiency in the success-based CapEx 2 case.

Okay, great.

And then on any, yeah, no, that's great. Any future changes, any more changes to the management team, or do you think you have things where you need to be for now?

Yeah, listen, I think that's a good point. As noted in my prepared remarks, you know, I feel strongly that we now have the right leadership team in place, Frank, to drive us forward in our transformation. We had, you know, we hired DK a few months ago. We have Brian Lilly managing a private cloud. We have Bobby Malou who joined us as a CFO. So we now have seasoned leaders across all the functions. So, you know, we also made some other leadership changes when necessary. And so I feel confident that a lot of the heavy lifting is behind us.

Okay, great. Thank you very much. Thank you.

Our next question comes from the line of Tin Cheng Wong of JP Morgan. Your line is open.

Hey, guys. This is Brendan Biles on for Tin Cheng. Thanks so much for the time, and welcome, Bobby. So first off, congratulations. Nicely done. um uh thanks for all the details on the changes just from like sort of a personnel and cultural perspective could you guys um opine on like the competitive environments in these new areas these new incremental areas for the business um and services both from you know competing for talent any incremental ads like in subject matter experts in private cloud and then also uh incremental competitive operator incremental competitive dynamics uh from winning your business, especially in the challenge of macro.

Thanks so much.

Yeah, sure. So if I got it, but thank you very much for your question. If I got a question right, it's, you know, the competitive environment in a new service offering and also competition for talent, if I got that right. Exactly. Yeah, thank you very much. I think the market, and we see this all the time, there's definitely a lot of demand in the market of this. We have to go capture the demand and then we have to execute against that demand. So when you talk about the market opportunity, there's definitely competition there, but there's enough of market for everyone to play. And we are very uniquely positioned, so to speak. We are a pure play multi-cloud company. That means we do both public as well as private cloud. And that's a very unique position for us. So as we go and talk to our customers, we are... we are very, very neutral on where the workloads needs to reside. So it's all about workloads and where the workloads can be hosted. So in terms of competition, we address all three segments of the market. We address commercial segment of the market, mid-market, as well as the enterprise segments. And we face off against different types of competitors in each of these segments. In private cloud, that was on the public cloud side. In the private cloud side, It's a very fragmented market, and we are one of the largest scaled player in private cloud, which means that there is a huge opportunity for us to go redefine the private cloud market itself, given the surge in demand that we're seeing on the private cloud side. A lot of workloads in the regulated industries, as an example, we believe will stay in a hosted private cloud environment, will move out of the data centers. Customers don't want to go be in the business of running a data center. We're also seeing workloads that cannot be refactored but needs a sort of an on-ramp to public cloud. Private cloud becomes a very good solution for those kind of workloads. So as you can see here, I think we believe that we are very, very well-placed from a competitive perspective. Now, we need to get the right offerings in. There's a lot of work to be done, so don't get me wrong. We have a lot of work to do on the offering side, on the solution side. as well as on the operations side. In terms of talent, we are a technology and an automation-driven company. So unlike large system integrators, we do not have a large staff augmentation business. So you don't see us reporting attrition numbers or hiring numbers because we think instead of just having a labor-plus model, we want to go with an automation-driven an IP-led offering, which we believe is a labor minus model, which is very compelling for our customers. So we will have to go compete for the talent. Don't get me wrong. We are attracting talent because of our brand, as well as a strong customer base that we have and the solutions that we offer. And that's not an area that we are really concerned about.

Thank you very much.

Thank you. Our next question comes from the line of, one moment please, comes from the line of James Breen of William and Mary.

Thank you. Thanks. Thanks for taking the question. Can you talk a little bit about, you touched on the margins a little bit, I think it was Frank's question. Obviously, the operating market coming down sequentially in the first quarter. Is there seasonality to that, and how do you feel about that as sort of a bottom for the year? And then just looking at your gross margins across the three businesses as you report them now, and I understand this is going to change, but you had a pretty good step down, obviously, in third quarter. And then in the open SAC segment, again, this quarter, are there any thoughts around just basically trying to have that attrition be quicker?

um and and you know giving up that revenue but given also giving up also the losses that are happening or given how the gross margin continues to decline thanks let me let me start and let me talk to the sequential decline that you see there so look uh there's several factors uh causing that sequential decline in q1 so from a revenue standpoint there is a seasonality impact like you mentioned right q4 to q1 we normally do see that There's also the impact of the December ransomware attack that's now fully baked into the forecast for Q1. And then, as you've seen, there's, you know, continues to be decline in private cloud, as well as our legacy OpenStack business, as you mentioned. And look, the reality of that is the fact, like Amar mentioned early on, there's, you know, de-emphasis on private clouds. There's no surprise that that's been declining, and that's something that we're trying to arrest the decline on with the new focus and the new BU structure. So a lot of these revenue impacts also flow down to profit. And then in addition, on the profit side, there's also a seasonality impact from Q4 to Q1 for seasonal payroll taxes and benefits. But look, we're looking for opportunities to reduce costs and offset some of these revenue impacts and profit impacts. But we've got to still remain focused on growth. Mario, you want to add anything? No, I think you quoted well.

On the OpenStack piece, I think that's another question you had, James. Let me just check. Well, that business is declining. I think the rate of decline has actually lowered in that OpenStack business, which is an OpenStack public cloud business. So I think we had already factored that in our financial plan and financial model that continues to happen. And I think the rate of decline used to be 20% plus. Now it's in the 15%, 16% range.

And do you continue to expect as that?

Yeah, I think we continue to expect that decline to continue as customers move away from that platform. And that's why we call it as a legacy because that's a natural kind of trajectory that we are seeing for the last few years, in fact. And what we do is, as this happens, we continue to take cost out and basically optimize our costs so that we minimize the impact on the profit. So that's all a part of the plan.

Thank you. Our next question comes from the line of Bradley Clark of BMO. Your line is open.

Hi, Bradley. All right, thanks for taking my question.

I just wanted to touch on the demand environment a little bit more, and more specifically, are you seeing any difference in behaviors across geographies in terms of, you know, demand or focus on certain types of deals? Any more granularity you could provide on geographical demand trends? Thank you.

Yeah, I think, so listen, I think I did mention on my earlier response Our demand environment across all the regions, especially in public cloud, on the infrastructure side has slowed down. But again, as I said, most of the hyperscalers are reporting it, but they are still printing double-digit growth. So there still remains a lot of demand there. You know, by verticals, I can use a little bit of more color on verticals, especially, you know, retail and technology verticals. as well as, you know, in financial services, et cetera. We have, again, we don't go by vertical in financial services, but we have started seeing some demand slowdown. But there's other verticals, like, for example, healthcare. You know, we are seeing demand slowdown, but there's a huge opportunity to help transform, especially on the provider side, and help healthcare providers to accelerate that digital transformation. And so we are seeing a little bit of, we are seeing some demand on that side. We are also, in telco also, we are seeing good demand. So it's a mixed bag. But generally, the demand has slowed down across the board and across all geographies. In APJ, we did very well, as I mentioned earlier. We posted double-digit growth, but APJ is a small base for us. It is mainly driven by data services, which is also a focus area. Migration, modernization, and AI continues to remain a focus area across the board.

Kathy, any other questions?

That's all our questions. So I would now like to turn it back to Robert Watson for closing remarks.

I just want to say thank you, everyone, for joining us. And I think we got to all the questions. But if we didn't get to your question or you have any follow-ups, please reach out. You can email us at ir at Rackspace.com or contact me directly. So thanks, everyone, and have a great evening.

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