Rackspace Technology, Inc. (RXT) Earnings Call Transcript & Summary

I'm Kevin McVeigh, part of the UBS research effort here. I think, Amar, this is the second year we've had you here. So we're thrilled to have Amar Maletira and the broader Rackspace team. For anybody on the audience, if you have any questions, there's going to be a mic in the room, but anybody on the audience, if you want to e-mail me, keevin.mcveigh [email protected], I'll definitely have the questions answered. I'm here to introduce Amar. I think he's going to read the safe harbor real quick, and then we're going to get right into the Q&A.

Thank you. Thank you very much, Kevin. So let me do the most interesting part of this presentation here. So I should have got my glasses. Rackspace may make certain comments today that may 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 Rackspace's SEC filings. Rackspace assumes no obligations to update the information discussed today, except as required by law.

That was fantastic. Great. Okay. So Amar, and I've done this with a handful of the companies today. I want to go back and help just frame the Rackspace story a little bit, but I even want to go back a little bit further from the time you were public, the first time went private and then came back out because I think the evolution of the company, you've gone through kind of a couple of strategic reviews. And I think since you and Mark have really come over, you've seen an incredible amount of stabilization and execution that's been culminated by the debt restructuring, which has really helped stabilize the go-to-market motion. But I think it's important for the market and anyone online or in the audience to kind of help understand where the initial initiatives were, why the resets occurred and why we think, for sure, you're on a path to success going forward. But I think it will help frame just a little bit how we got to kind of where we are and some of the decisions you made before we kind of talk about kind of the private versus the public cloud, the more current business mix. So let's spend a couple of minutes there. I think it's important because it just -- I think it really helps crystallize why you made what are clearly the right decisions for the business longer term? What drove that decision?

Yes. Thank you very much for having us here, Kevin. So I took over as the CEO, as you know, in late 2022, been with the company for -- I was a CFO prior to that. I was not there as a CFO when the company was taken public in June of 2020, roughly. And the company has been in business for 25 years, right? 25 years, whenever I go to customers, I don't have to explain who Rackspace is. They know who Rackspace is, right? But they don't know how we have evolved. If you just think about the company, 25 years, a very rich history of innovation, one of the first companies to put customers who didn't have a data center and data center in 1998, okay? One of the first companies to coin the term fanatical customer experience and which is very important that stays with us as a DNA today, and that's one of our key differentiators. One of the first companies to host VMware on private cloud VMware, right? And today, we are one of the largest hosted VCF providers in the world, and we are the largest CSP for VMware. One of the first companies to launch OpenStack right? Today, OpenStack is in demand again. But OpenStack working with NASA, and we were actually growing even faster than hyperscalers between 2012 to 2014. And then today, we have evolved into what I call as a hybrid multi-cloud and AI solutions company. So we have been -- we do only two things very well. We do cloud which is public and private and we do AI. So we are in very good markets. I couldn't have asked for a company in a better market, right? And so -- and the market is growing because workloads are moving from customer data centers, they have to land either in public cloud. And now many customers have realized that not all workloads are suited for public cloud and those workloads in regulated industries, and we'll talk about some of the vertical bets we have made like in health care, in BFSI, et cetera, and workloads that cannot be refactored, needs to find a home, and that's hosted private cloud. And so we catch the workloads on both public side as well as private side as well as at the Edge. And AI is a net new workload that didn't exist before. And so that is a massive TAM expansion for us, right? So that is what Rackspace is all about. So let me tell you how we have transformed the company and in the process of transforming. So two years ago, when I joined as the CEO, I had three priorities. And I talk about it in every earnings call. Number one, priority number one is turning around -- doing an operational turnaround of the company. Priority number two is being a technology company, catching the next big wave in technology, which is AI. And number three is rightsizing our capital structure. So on the first one, on the turnaround, we laid the foundation in 2023. We set a clear vision, clear strategy, clear direction for the company. We restructured the company, created two business units and operationalized the two business units across public and private, refreshed the talent, both at the leadership level as well as various levels in the organization, including sales talent. About 50% of the sales organization is new, and it was a very deliberate process in late 2023. We invested in new offerings, so to speak. And we said, in public cloud, we want to ride the secular growth wave with these hyperscalers, and we want to lead with services. That was a hard pivot we made, leading with services and attaching infrastructure to it as opposed to in prior years, it was infrastructure-led motion, assuming that once you land with infrastructure, you can expand into services. We pivoted that completely, right? So that is number one. And number two, in private cloud, we said listen, we don't want to go after all the workloads, right? Because workloads will go to public cloud. We want to go after workloads that are suited for custom cloud, which I call as a private cloud. And those workloads are in regulated industries like health care, BFSI, workloads that cannot be refactors, workloads that needs security and compliance. And so we made some bets on verticals. We made bet on health care vertical. We made a bet on BFSI, banking, financial services and insurance, and we've made a bet on Sovereign. And that bet has worked out because we've been executing against that strategy for the last 18 to 24 months. So for example, in public cloud, as we refresh the sales organization and a services-led motion, the last three quarters, which is bookings is a leading indicator. Bookings have been growing sequentially as well as year-on-year the last three quarters. Because remember, we were making all the changes in 2023. And now the sales force is now hitting the productivity curve, right? So we saw a good jump in bookings. We signed a major agreement -- a strategic agreement with AWS for the next three years that gives us a lot of funding for MAP, which is Migration Assistant Programs and so on and so forth, including AI. We also, for the first time in many quarters, we saw our services revenue flatten from Q3 -- from Q2 to Q3, first time in many quarters. So these are some leading indicators, so to speak. Our services attach has gone up significantly, right? Roughly 65% to 70% of our bookings are now services. Out of the 28 large deals that we signed in last quarter, 23 had services attached, right? We believe that we can attach $0.20 to $0.30 of services for every dollar of infrastructure at the point of sale, and that should grow to $5 or $6 for the dollar of infrastructure over the life of that infrastructure. And this is validated even by AWS. So the opportunity to lead with services and drive value even on the infrastructure side is humongous. And all hyperscalers love it because now you're driving more volumes to the infrastructure, okay? So public cloud is on track, and we are very pleased. And we have people with digital services transformation in the organization. On the private cloud side, we made some really good bets. We invested in new products. We launched our SDDC product line, complete product line, refreshed it. And we also made bets in health care. Health care, we made bets in provider. And within provider, we said we want to go host and manage Epic workloads on health care cloud. And that is -- I'm very happy to report that we have made tremendous progress, right? That business now, which is roughly 10% to 11% of our private cloud revenue today, which is less than 5%, is now 10% to 11% in the last 12 months, is growing 30% year-on-year, right? It's a substantial base. And I expect it to continue growing double digit in fiscal '25 because we have won some large deals. The deal that we talked about, Kevin, if you recall, during the earnings call that slipped into Q4, we closed it last quarter. We are making immense progress in Sovereign. We won the opportunity, the contract to design and build a Sovereign Cloud for the Kingdom of Saudi Arabia, right? We are doing that with UK Sovereign. And that business, Sovereign Cloud is also growing 50% year-on-year, right? So AI is another thing that we can talk about. So long story short, great, we are starting to see early signs of turnaround, okay? When it comes to the second priority on AI, we launched FAIR, Foundry for AI by Rackspace in June of 2023. We have won 60-plus new engagements, 250 new opportunities, tip of the spear services offerings. Now we want to monetize it either on public cloud as they want to run the workloads or on private, especially on inferencing, and we can talk about that later. So good traction there. And on the debt side, which you brought up, we were able to restructure the debt in the last 12 months. And we reduced the debt by net $900 million. That gives us more liquidity. There's more cash infusion by the debt holders. So I would like to thank the debt holders who trusted the company story. And that gives us liquidity to go win more business and make sure that the return on capital for the debt holders is and all the capital holders is very high. So pretty pleased with the progress. And what you're seeing right now is Rackspace 2.0.

Sure. Listen, I think one thing that's important too, and it was super helpful was they contribute an incremental $250 million of capital to kind of bridge the cash flow, which we thought was super important, too, because not only the willingness to recapitalize you folks, but also contribute an incremental $250 million. And just the CPA and may won't allow me to kind of talk to that without saying there was no going concern opinion. It was very efficient done in the public markets without any concern. And I think one thing as we think about the value proposition, Amar, and maybe we talked to this a little bit is there's been some shifts in the revenue. But as you were going through that -- I mean, the core of what you do in a lot of different ways is an outsourced function, a pretty important function. And to me, I think you overperformed on that as you're going through that restructuring because anyone that would have been concerned about how that process could have potentially turned out as opposed to how it did, it didn't feel like there was a pause in the business at all. And I think that's a function of the product you bring to bear as well as the senior management shift. So maybe talk to that a little bit to the extent you can. And we see it as a potential tailwind to the business now that there's not that concern about liquidity. And I think that probably affords you the opportunity to maybe even be more effective on the go-to-market.

Oh, absolutely. I think the liquidity -- there's no concern about liquidity. We have enough of liquidity. My CFO is here. He keeps a track on cash every single day, and that's not an issue. We have enough of liquidity on the books as well as we have not even tapped into the revolver, right? And even on cash CapEx side, we are making very informed decisions on whether we want to do a financing lease because the return -- the cost of capital might be high or using our cash CapEx, cash to go invest or even talking to the customers of investing upfront on some of their build-outs, right? So very efficiently using it. It has helped our go-to-market, to your point, the refinancing and the restructuring of the debt and the liquidity. So that's not a going concern at all. Otherwise, why would large health care providers actually sign a multiyear deal with us. We are bringing the EMR, EHR application into our data center. It's massive. They are running the whole hospital on the workloads that we are managing and operating. We just migrated for AdventHealth, and it's a public information because we put a press release out there. One of the largest health care provider system in the U.S., 56 hospitals, 38,000 concurrent users. And we manage them record time, and they couldn't feel -- they didn't miss a beat, and they were -- that helped them to even plan for the hurricane that was approaching at the same time when we were doing this migration. So long story short, performance has improved. We offer five-nines high availability for these customers, and we've been managing mission-critical workloads for 25 years. So we know what we're doing here.

And Amar, maybe shifting gears a little bit. Talk about the revenue mix today, private versus public cloud. And on the private side, I think one of the opportunities we see too is you've got a fair amount of data center capacity. So as some of that revenue starts to scale, maybe talk about the margin nuances of the business as it relates to private versus public cloud. And there's a lot here, but I think it's important. And you alluded to this earlier, but if I heard you right, I think it was about $0.25, $0.30 of professional services signed at point of contract and that scales to $5 or $6. Is that ratable? Is that kind of $5 to $6 over the life of the contract or -- because, again, it seems like you're seeing some outsized success on the professional services side, and that's something that historically was a little bit of a struggle.

Yes. Yes. So let me start with the last one, and then I'll give you the mix of public, private as well as what we think of from a gross margin perspective. I think this is a very pertinent question. So on the services side, I think what we have seen is we are starting to expand into mid-market and enterprise, okay? Mid-market customers are customers that don't get the love from the large service providers because they don't have the coverage model, okay? They don't have the coverage model. The large SIs go for larger deals and larger enterprise customers. Mid-market customers have the wallet and the competition is less. But coverage becomes a challenge, and that's why we basically go with the hyperscalers and then lead with services, bring in infrastructure and help them, okay? So we are seeing expansion in mid-market. And I'll give you a little color on the services side, too. On the enterprise, we said we pick top 25 enterprise. We signed MSAs, Master Service Agreements with those enterprise. We have signed about now 12 or 13 MSAs out of the 25 that we have picked. And that gives us a license to hunt for services on those large enterprises. These are massive enterprises, right? Now how do we go differentiate? Why would they buy from Rackspace cloud services? Why not go to some large service providers? Three reasons. Number one, they know Rackspace DNA is all about customer service. Our fanatical experience is -- gives us very high NPS scores. Number two, we always innovate. It's an open innovation is what we believe in. We bring the right solution for the customers working with different providers, okay, partners. And that's very -- it gives the flexibility. And number three, which is very important is most of these systems -- service providers, it's a labor plus model, okay? More the labor, more the revenue. That's why they announced their attrition rates, the hiring rates because that's a leading indicator. We are a labor minus model. By that, I mean, when we go to the customer and have a discussion, your data migration project, I'm not going to put 100 resources. I'm going to bring my IP and tool and automation to move that from whatever sourced on to Azure or AWS and do it very effectively. That labor minus model is absolutely -- that's where we get entry into customers, right, large customers. Number two is Elastic Engineering, right? You have managed services on one side, which is outsourcing services is very sticky then you have professional services very transactional. We created Elastic Engineer right in the middle. So customers don't have to sign 3-year contract, but they take a part of resources that we have, that's Uber kind of stuff, and then they use it for a number of years, right? So that innovative way is how we are winning business, okay? Now let me talk about public and private. See, I think we are still in the transformation story, and I think we have made a lot of progress. Ultimately, we want to grow both public and private cloud, okay? Public cloud, if you look at the hyperscale market, it's a 15%, 17%, 20% growth, pick a number, right? And we believe the infra side, we might grow mid-single digit. That is purposeful because we want to win the right type of business so that we can generate the right kind of margins and EBITDA dollars. On the services side, we'll grow double digits, okay? So we'll perform at or above market on services. And given all the MSAs we are winning, I think I feel that that's doable. On the private cloud side, the private cloud market is a mid-single-digit grower, okay? And I believe that we will stabilize in 2025. Maybe a flattish to slight decline in private cloud, and then we start growing in 2026. And I think early signs of year-on-year growth we might see in the second half of 2025 on private cloud. And that is a big deal because now we are weaning off and running off the old generation products and customers, and now we are bringing a new backlog of customers that might be very sticky for the next 5 to 10 years. So we are really building a backlog of recurring revenue for this business. And so it takes time for a recurring business to fall off the cliff, and it takes time to basically bring it on. So I think we have actually made good progress with making bets in health care, Sovereign, BFSI and other areas.

Importantly, at a much different margin profile.

And different margin profile. So the good point that you make. So I think private cloud, mid- to high-30% right? That's where we've been operating. Now can we go drive 45%, 50%? Yes, because you mentioned something very important. We have fixed cost in the model. We have data center capacity. As you pour revenue, that might come in at 45%, 50% drop rate. But we are going to use some of it to actually win more business, okay? So I want to maintain the margins between mid-30s to high 30s. Can we do better? Potentially. But I want to have that capacity to go win more business. In case of public cloud, public cloud gross margins because of the infra mix of 70% is roughly about 11%. I believe that 11% is going to expand, too, because our services mix will go up, and we will also start winning good business on infra side and walk away from business which doesn't make sense from an ROIC perspective. So margin expansion overall in EBITDA and EBIT driven by OpEx efficiency and slight gross margin expansion, mainly driven by the public cloud side of the house.

And on the public side of Amar, as you think about what's the optimal mix here in terms of professional services versus infrastructure over time? Maybe if there's a way to think about that.

So I think we have a lot of infra in the business, right, because -- and it is sticky and it's like long term. So you can't change the mix overnight, Kevin, right? So right now, it's 70%, 30%. As we continue to grow double digit as services, I think you should expect that to be sort of services going to 40%, 45% and infra going down a little bit, right? So I think we'll change the mix over a period of time, but we'll also make sure that infra revenue mix is a good quality revenue.

And I think it's -- I think one of the things you've had some success even on the margin on the infrastructure side because you come to realize their clients couldn't deliver the value, which is why maybe talk to that because I think you've taken -- you've been a little bit more rigid in terms of renewal and saying, "Hey, there's just a certain rate of return we're going to absorb. And if not, we move on." So maybe talk to that.

And so we walked away from a few deals because when -- there are two ways of approaching this, right? That's why services-led motion is very important, right? So I'll give you an example of a deal where we were able to win the renewals with higher margins. So there were deals in where we went in. I told the customer, called the CIO and said, "I don't want this deal. You can take it back." Then we went and had a discussion. I said, if you attach services to it, and give me a better margins on infra, I can sign another 5-year deal. We won that deal, okay? We won one more deal in Europe, similar one. So a good case in point that you can go and talk to the customer and customer knows you're driving value. Now the question is you'll have to pay up for the value, right? But there are customers who won't agree for that, right? They have other plans. They want to go directly to the hyperscalers. That's okay. If I don't make money, I'm okay with you going to the hyperscaler as long as my hyperscaler partner can retain that business because my relationship with the hyperscaler is very strong. So those deals we walk away, and you have started seeing infrastructure business and revenue going down is because we are walking away from those deals. And we are very selective on the type of deals we win also in the market.

There's still a lot to talk about, but I think one of the things that is important is the Gen AI opportunity, right, particularly as your clients shift their workload. So maybe -- and you've been front-footed on that in terms of introducing new initiatives. Maybe talk to that a little bit? And is there a way to think about how that would sit across the organization just directionally because the good thing is in your very healthy end markets as you're kind of transitioning the business. So that gives you an opportunity. And then maybe weaving into the Gen AI, I think one of the debates that people have gotten comfortable with over time is why the hyperscalers wouldn't come in to kind of do what you do. And I think there's a lot of reasons for that, but maybe just for the broader audience to talk to...

So I think we will play across the entire AI life cycle, okay? Starting with helping customers identify use cases, and we have a lot of customers. We have 60-plus engagements that we have won, where we help customers identify the use cases, help them pick the large language models and help them train those large language models, right? And then finally, once it's trained, the models are trained. Now you have to go run the inferencing on it. And then you land it either on public cloud or on private cloud. And so you can monetize across the entire AI journey. And that's what we are doing. With FAIR, we said, listen, currently, enterprises are just dabbling still, okay? Most of the money is spent by the hyperscalers, by OpenAI, by Metas of the world in training large language models. That's why you see CoreWeave, Lambda, the system providers, the chip providers like NVIDIA, Broadcom, et cetera, all making money, right? Enterprise wave has not started yet, right? The training wave is just getting started. Where we want to focus is training for sure, a little bit, but mainly on inferencing. Inferencing is the day two plus workload. That is the longest workload. And you want to manage the inferencing workload, manage and operate it like any other workload. Now why will private AI be suitable? Two reasons. Number one is there are a lot of customers who do want to move their data, right, move their data to public cloud. They want to have AI come to where the data is as opposed to data to going where AI is run. So in those cases, that's where Rackspace comes in, right, with a private AI offering. We have a private AI anywhere offering. So we expanded our offering. That offering may not sit in my data center. I can have that offering sit -- the stack sit in customers' data center. I can connect it back to a data that might sit in my storage in my data center and manage and operate it for them. That's why it's called AI anywhere. It can be anywhere, but it can be in customer prem or it can be in a hosted private environment like ours. So in the entire life cycle, we are going to monetize it. We are early cycle. So the reason FAIR has given us thought leadership that will lead to mind share and ultimately lead to wallet share. And we will go after this wallet share. But I think the real monetization is going to be in inferencing and fine-tuning, and that's what we are going to focus on. For example, we also launched Spot -- GPU-as-a-Service, by the way, on a Spot platform. You should go look it up. Very innovative. We have used Kubernetes platform and containers to launch GPU-as-a-Service for developer community because now we are learning what do they need, right? And we are going to use that learning as we move into enterprise with large enterprise customers. So we have a large Japanese conglomerate who is actually running a POC with us on private AI and running the inferencing workload with us.

Intriguing. I think the other thing too, Amar, you talked about this a little bit, but maybe the amount of workloads that are still on-prem that can shift over. I mean there's just -- there's a lot of runway in the broader model.

Oh, absolutely. I think if you tell the hyperscalers, they'll say 80% of the workloads is still in on-prem, right? So pick a number, 60%, 70%, 80% is a large number of workloads, right? Customers in mid-market and even in enterprise, enterprise customers want to consolidate their data center. Nobody wants to be in the data center business. We have 34 data centers. We know how challenging it is to manage data centers, right? And that's become our key strength here, too. So that workload will have to move. 60%, 70% of the workload will have to move either to public cloud, to private, which I call as a custom cloud or to Edge. And we want to catch the workloads everywhere. On the public cloud side, we'll catch it on a services offering, working with our hyperscalers. Private cloud, we will be the Infrastructure-as-a-Service provider. And in the Edge, we'll have our own Edge offering.

Maybe we're close to time, Amar, but I don't think we could end without talking about kind of your consultants, right, and kind of the maniacal client service focus and the IP you've created over time, which I think is one of the subtle points of the model. So maybe talk to that because I think there's been some stabilization on the consultant front, too. Maybe talk to that because there's been multiple decades of just IP and investment that help create just the culture and go-to-market motion of Rackspace.

So I think when you think about Rackspace, it's a very heavy engineering culture, right? Everything is about solving customers' problem, ultimately driving business outcome through a solution driven by engineering, right? And that culture, no one will take it away because it's been there for 25 years. It's embedded in the company, right? And that culture we have continued to nurture. I'll give you an example. See, OpenStack is coming back, okay? We have some boomerang Rackers who have come back to the company on OpenStack because we invented OpenStack. And OpenStack -- by the way, because we had the talent in OpenStack and VMware, et cetera, we were able to win the Kingdom of Saudi Arabia deal, knocking out almost half a dozen large providers, okay? So the talent has stabilized. I think people are looking forward. We have now become more of a technology company. If you go back into 2021, '22 -- '21, '22 -- late '22s, we were mainly an infrastructure resale provider for hyperscalers. That's where all the growth was coming. So when you have infrastructure resale motion and become just a reseller, you lose engineering talent. So in the last 18, 20 months, we have made investments in not just products and services, but nurturing the engineering culture within the company. So it's existed for the next last 25 years, and we wanted to grow and thrive for the next 25 years.

And can you just remind us, I guess it keeps close it out, but I forget my train of thought, but anything we didn't ask? I mean it's always -- it's terrific to have you, but just anything in the close of moments here you wanted to highlight?

No, I think we covered everything. I will just say, listen, I think this is -- thank you very much for having me here. We are a very unique company. We are a category of one. You can -- whenever I go to customers, as I say, I don't have to convince customers who Rackspace is but customers are looking for help. Customers are looking for help from partners like us who will go with an unbiased but an opinionated view. Why do I say unbiased? Because we have talent across all three cloud providers as well as private as well as on-prem. So customers are looking for that kind of help. And customers also realize that not all workloads are suitable for public cloud because of cost, complexity reasons and lack of talent, right? And so I think they are looking for alternative. And I think we -- you will see us continue to thrive in that space. I'm happy with the progress, more to do because there's a huge market out there but we have put all the right foundations in place to go drive it from here on. So the focus is all about execution and plan conservatively, execute aggressively.

Without a doubt. Anything -- I keep saying last question, but as you shifted the go-to-market motion a little bit from a competitive perspective, anyone to call out in terms of where you're seeing folks more or less in terms of...

No, I think so. Listen, I think we picked Epic as an example here, right? I think we were very focused on what we should not do. That is one thing that we did early on last two years. Pick stuff where we can actually win and there's enough of market. We are not a $20 billion, $30 billion, $40 billion company. We're a $3 billion company. I need a market that is $5 billion or $10 billion, good enough. If I get 20%, 30%, 40% market share, I'm growing. So we picked Epic. And the reason I'm bringing up Epic is when you think about Epic, 40-plus percent market share in EMR/EHR, Cerner and MediTech are other competitors there. Epic is growing here in the U.S. as well as internationally. Epic, there are only three ways people can do it, either Epic host Epic applications themselves or third-party providers like us or how they do in their on-prem. As I said, no customers want to do on-prem because it's becoming tough to manage data centers. So the third part -- so for us, we have picked spots where we can differentiate and become sole source, okay? And that is the one point I want. Other than that, in services business, there's a lot of competition. There's a lot of competition. But we pick markets like mid-market where you don't see the big providers. So when you are an international company going into mid-market and customers have a global presence, you start differentiating there itself, right? So we have a good key differentiators, but competition is the same. I think the thing is how do we go outflank the competition, and that's what we are doing by picking -- that's the strategy becomes very important and execute against it.

Terrific. I think we'll end it there.

All right. Thank you very much.

Really, really helpful.