Rackspace Technology, Inc.

Good day and thank you for standing by. Welcome to the RACspace second quarter 2025 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star 1 1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1 1 again. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to Sagar Habar, Head of Investor Relations. Please go ahead.

Thank you, and welcome to Rackspace Technologies' second quarter 2025 earnings conference call. I'm Sagar Habar, Head of Investor Relations. Joining me on today's call are Amar Malatira, our Chief Executive Officer, and Mark Marino, our Chief Financial Officer. As a reminder, certain comments we make on this call will be forward-looking. These statements involve risks and uncertainties which could cause actual results to differ. A discussion of these risks and uncertainties is included in our SEC filings. 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 these measures, which we believe provide useful information to our investors. In accordance with SEC rules, we have provided a reconciliation of these measures to their most directly compatible GAAP measures in the earnings press release and presentation, both of which are available on our investor relations website. I will now turn the call over to Omar for an update on the business.

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

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

Thank you, Mark. Let us begin the question and answer session. We ask everyone to limit discussion to one question and one follow-up. Please go ahead.

As a reminder, if you'd like to ask a question at this time, please press star 1 1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1 1 again.

Please stand by while we compile the Q&A roster. Our first question will come from Kevin McVey with UBS.

Great. Thank you so much, and congratulations on the results. I don't know whether it's for Amor or Mark, but maybe both. Maybe talk about the guidance. It looks like a little bit of uptick sequentially, but definitely more outpaced success on the free cash flow. So maybe talk about, you know, is there any seasonality you think about in the guidance sequentially? just relative to kind of where you came in, and then ultimately, if you could spend a minute on the free cash flow conversion as well. Go ahead, Mark.

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

Terrific. Thank you. And so, Kevin, if I may just give some color on private cloud. So as Mark mentioned, we are forecasting a flat revenue in private cloud sequentially. Now this will be, Kevin, as you know, this is three quarters in a row. As we had mentioned before, we expect private cloud business to start stabilizing, and that's exactly what we are seeing. And we feel good about the bookings performance that we had. The mix of the bookings also came in quite favorable because of broad-based bookings performance in the private cloud business. And so pretty, pretty pleased with the performance there. In fact, just to give you some color here, you know, the mix of the bookings in private cloud is actually changed significantly from a deal size perspective. Now, if you go back to fiscal 22, roughly about 60% of the deals that we had were about small size deals, right? The lower ACV value. And now if you, and about 40% was mid size to large size deals. And that has now actually flipped in 2024 and 2025. First half of 25, 40% of the deals were small deals and 60% was large and mid-sized deals. So that's the very important dynamics that we are starting to see. And this is on top of us growing a double-digit CAGR in the last two and a half years. Similarly, the contract length has also gone up. In fact, the contract length, if I have to just go back to 22, You know, we had roughly 25% of our bookings in fiscal 22 were deals with longer than 24 months. Today, in first half of 25, as well as in fiscal 24, that number is now close to 50%. So the deal sizes have gone up, the contract length has gone up, which means we are really building a good book of business here across most of the verticals as well as from a geo perspective. And on public cloud, because since you asked about the guidance in public cloud, we feel good about the services performance. In this quarter, we saw services revenue in Q2 was flat sequentially. We expect that to, was actually up sequentially and flat year on year. We expect that to, services revenue to start growing in the second half. In fact, in Q4 of 2025, our fourth quarter, we expect a services business in public cloud to grow anywhere from 10% to 20% year on year. So which will be a real good turn in the business, in the public cloud business. So pretty pleased with the performance in the public cloud business too.

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

I know maybe just anybody. Yes, yes. Thank you very much. So let's start with the public cloud side, Kevin. You know, just as a recap, we have three types of services that we offer to our customers. On one end is professional services. And then you have managed services on the other end of the spectrum, which is long-term contracts and very sticky. And then right in the middle is elastic engineering. And then we offer this across applications, platform, as well as data. We are starting to see broad-based trends across all those three services, mainly professional services. As we go and drive more cloud migration work, we also drive work in AI as an example, which are mainly professional services kind of engagement. We are starting to see our data business, for example, I've mentioned that before, our data business this quarter in Q2, I mean, the second quarter grew sequentially, the bookings grew sequentially significantly. So we are starting to see strength in data, strength in applications, strength in platform support across professional services, elastic engineering and managed services in that quarter. And the attach of our services to infrastructure also went up. When we do an infrastructure sale today, we attach 70% of services to it. So for every dollar of infrastructure, we are attaching at least 70 cents of services to this infrastructure resale business. So the services attach motion is working well, good execution on the field. and also the offerings that we have is playing to where the market is heading. More and more work is on the transformational side, digital transformations led by cloud and AI, and that really plays to a strength in public cloud. So those are the factors, macro as well as our execution, that gives us confidence that we are now turning the corner on services. On the private cloud side, we offer managed private cloud for our customers. Clearly, healthcare, we really hit the sweet spot with healthcare. It was strong even in Q2. When I look at just the healthcare vertical, in the first half, it grew 60 plus percent year on year compared to first half of last year from a revenue perspective. So really, really good performance there. We have good deals in the funnel. And we also are starting to see traction. We have a good traction in the telco sector with some very good deals signed. And if I look at the services component, the main services component in private cloud, Kevin, is all managed services. Very, very sticky business. Once we get this business, it stays with us for the next three to close to seven years. And the average contract length has also gone up significantly in that business. Hopefully that's helpful.

Very helpful. Thank you so much, Amar. Thanks, Kevin.

Our next question comes from Frank Luther with Raymond James.

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

Yes, yes, absolutely. Thanks, Frank. So the focus has always been, Frank, in mid-market and enterprise, in both public cloud as well as private cloud business. And we have made those investments in the end of fiscal 23 and fiscal 24, and now you're starting to see benefit of this. For example, in a public cloud business, we have grown in public cloud for several quarters in a row from a bookings perspective. So not much of investments, incremental investments needed now from a go-to-market perspective, Frank. We will be making investments on the edge. For example, a healthcare protocol is really kicked off very well. You know, we went from being a small player in 2022 to being a really good, being a very viable, credible player in the healthcare provider space with our private card offerings in 24 and 25. So not much of investment. Most of the investments will be, even the CapEx investments will be success-based. So if you win a customer, then only we make an investment in CapEx. Now talking about AI, and we have started to see a lot of traction in AI in both the businesses. In fact, let me start with private cloud first. As you know, our offering in private cloud is we will, our goal is to become a private AI infrastructure provider for our customers. So we think about workloads, and we will be focusing mainly on inferencing workloads. That inferencing workload, Frank, will either be run on public environment, public cloud, private cloud, or at the edge. And we like our chances of winning in the private AI as well as at the edge, and we'll partner with hyperscalers on the public cloud side. As an example, for the first time, we won a private AI infrastructure deal with a healthcare organization in the U.S. that actually supports adults with development disabilities. Now, they were facing some major pain points there in terms of care delivery, manual and time-consuming review of services notes, lack of automation. And so we basically delivered an AI-powered solution which was a combination of a private AI anywhere managed infrastructure with NVIDIA GPUs, as well as elastic engineering services, and we wrapped that around with managed services. So, you know, this has resulted in 80%, you know, reduction in the manual review time. It has improved the care of delivery. So this is a good example of how we are now, you know, basically also catering to the customer's needs on having their private AI inferencing workload close to where the data is. Similar on the public cloud side, we implemented really a very good authentic AI platform with J.Crew, and we went public with that. J.Crew, as you know, is a leading fashion retailer. They were really struggling with the effectiveness and efficiency of their customer, vendor, and employee support organization. So we actually implemented three distinct AI agents, one for their IT department, one for their vendor management, and the third was for customer service. And this was architected, powered by Amazon's Bedrock, as well as Cloud Sonnet models. So great examples of how we are winning now in the AI space. We also announced, since you asked about agentic AI, I want to also highlight this. We announced a good partnership with a company called Semaphore.ai, which is a very innovative company backed by Mayfield Venture Capital firm. And our Rackspace and Semaphore.ai are highly complementary in what we bring to the table for our customers. For example, Semaphore.ai will provide the agentic AI platform, and Rackspace then brings in the delivery muscle, including the infrastructure. And so we are basically bringing a complete turnkey solution for, I would say, cutting-edge AI agent platform at the enterprise grade, both from implementation, operations, and governance, and bringing technology and service solutions together. So feel very good. And then lastly, we are also internally becoming an AI company, Frank. There's a lot to talk about AI. Our CTO, Srini Kaushik, and his organization, working with all the functional leaders, have done a fantastic job in implementing a genetic AI within the company to drive productivity of our, you know, functional personnel. Also, it's now we're bringing it to the CSM as well as the sales community.

Okay, great. That's a very great answer, thorough answer. Appreciate that. Thanks, Frank.

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

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

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