Q4 2023 Rackspace Technology Inc Earnings Call
Participants
Sagar Hebbar; Vice President, Corporate Finance and Investor Relation; Rackspace Technology Inc
Amar Maletira; Chief Executive Officer; Rackspace Technology Inc
Mark Marino; Chief Financial Officer; Rackspace Technology Inc
Ryan Campbell; Analyst; Barclays
Presentation
Operator
Good afternoon and thank you for standing by. (Operator Instructions) Please be advised that today's conference is being recorded. I would now like to hand the call over to the Sagar Hebbar, Head of Investor Relations, you may begin.
Sagar Hebbar
Welcome to Rackspace Technology's Fourth Quarter 2023 earnings conference call. I am Sagar Hebbar, Head of Investor Relations. Joining me on today's call are Amar Maletira, 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. Tax-based Technology assumes no obligation to update the information presented on the call. Except as required by law, our presentation includes certain non-GAAP financial measures and adjustments to these measures, which we believe provide useful information to our investors. In accordance with SEC rules, we have provided a reconciliation of these measures to their most directly comparable GAAP measures in the earnings press release and presentation, both of which are available on our Investor Relations website. Please note that unless stated otherwise, all results are presented as non-GAAP except revenue.
I will now turn the call over to Amar for an update on the business.
Amar Maletira
Thank you, Sagar. First of all, I'd like to introduce our new CFO, Mark Marino. Having worked with Mark. Since I joined Rackspace, I witness firsthand what a strong asset is to our company. Mark's comprehensive understanding of the business and extensive financial leadership experience will continue to be instrumental as we strengthen our position in an attractive and growing hybrid, multi-cloud and a market. I look forward to collaborating with mark as we continue to execute our strategy and deliver value to our customers and our shareholders.
I would also like to thank our former CFO, Bobby Malone, for his contributions this past year. I'm also pleased to welcome Mark Rose to our Board of Directors. Mark succeeds, Thomas Cole, who unexpectedly passed away with the holidays. We are grateful for Tom's significant contributions in his short time.
On the Board, Mark comes to Rackspace with extensive business and executive leadership experience and with deep insight in leading business transformations. I look forward to working with Mark before we get to our results, let me cover the three strategic priorities I present to the Board and the progress we have made against them first drive the operational turnaround. In 2023, we made major structural changes needed for a turnaround.
We set a clear vision, direction and strategy for the company, operationally, our two business unit structure and refreshed leadership and talent at various levels in the company. I'm happy with the progress and confident we have the right strategy team and operating model in place to ensure our turnaround succeeds second, reposition Rackspace as a forward-leaning, innovative hybrid multicloud and a solutions company that makes informed bets in new technology trends because the cloud wave, which is still in its infancy, we believe we are now well positioned to catch the next big wave of AI.
This is why we set aside resources to launch foundry for AI by Rackspace or fair in June 2023. And we are seeing early success and to right-size our capital structure and ensure ample liquidity to support our profitable growth strategy. As you may have seen, we announced a transaction that will significantly strengthen our balance sheet and position our business for continued growth, enhancing Rackspace's competitive position while we'll accelerate our operational and strategic plans and walk through some of the high-level outcomes of this transaction, and Mark will go into more detail later in the call.
The private debt exchange transaction and assuming the public debt exchange is fully subscribed, when combined with the company's open-market purchases over the past year will result in total debt reduction of over $800 million and net debt reduction of over $900 million from the start of 2023. Shortly after I took over as the CEO following the transaction, which included $275 million of new cash infusion.
We expect to have approximately $330 million of cash net of all transaction expenses on the books compared to $197 million as of year-end 2023, with access toward $375 million revolver extended to 2028. Current available liquidity is over $700 million this transaction demonstrates the strong confidence of our key financial partners in the future and the business for which I'm extremely appreciated.
Now let me get into our business performance. Starting with private cloud. Today, private cloud is tracking towards a turnaround in the second half of 2024. In the fourth quarter of 2023, private cloud bookings were up 86% sequentially and 96% year over year. Bookings for full year 2023 were up 20% year over year, but fourth quarter posting the strongest finishing eight quarters. In addition, our backlog at the start of the new year is up 188% compared to the start of last year.
Our private cloud strategy is to defend and expand our private cloud business. We're expanding our offerings and bringing compelling new solutions to the market. We're accelerating our go-to-market motion with both vertical and horizontal strategies, and we are creating high-potential opportunities in attractive markets such as health care banking, financial services and insurance, Sovereign and private DI.
The strategy is paying off. For example, in our healthcare vertical, we won approximately $225 million TCV business in 2023, including several new logos and over $100 million TCV long-term contract with a large hospital system. There's another nearly $700 million of potential TCV in our health care funnel to capitalize on the success we have brought in new talent with deep expertise in health care and a big costing. We'll continue to press on and broaden our vertical strategy in 2024.
In private cloud, we also launched over 30 new offerings in the past 12 months, including software defined data center across enterprise business and Flex. We also deployed AI anywhere this is an on-premise enterprise-grade, a optimized platform with flexible architecture. It allows deployment in private data centers or in third-party co-location facilities and sport, as its name implies a spot market for compute capacity based on the robust capabilities platform.
This caters to a growing market for quick reliable enterprise-grade container cloud infrastructure. It is a natural fit for enterprise developer environments and startups. And we see good early interest for Rackspace, but allows us to monetize reserve capacity and leverage our existing product offerings at attractive incremental margins. In addition to new offerings, we have solid program in place to help customers with their go-forward architectural decisions and renew the business in the near term.
However, private cloud continues to work through the consequences of customer decisions made 12 to 18 months ago when Rackspace was not focused on this business, and we expect to see some revenue runoff over the next two to three quarters, including the current quarter from customer decisions made more than 12 months ago. However, we expect our recent strong bookings and backlog entering 2024 to start converting to revenue in the second half of 2024, as we expect quarterly revenue for private cloud to stabilize in the second half of this year.
Now moving to public cloud. Our strategy here is to ride the secular growth built in the cloud market. We are focused on meeting customers wherever they are in their cloud journey offering of full stack multi-cloud solutions spanning platform applications, data and security. We walked through a tough transition last year as we made a deliberate strategic pivot to lead with services and sort of low margin infrastructure resale.
This meant refreshing nearly 40% of our overall go-to-market workforce, including over 70% of our sales team. We replaced them with sales professionals with services centric experience and added similarly qualified go-to-market resources, including client partners who have started seeing some early signs that the pivot is working with Q4 2023 services bookings growing 13% sequentially after a tough start to the year. Public cloud continues to also develop innovative new services and solutions.
For instance, managed to VMDR is an industry-leading vulnerability services offering a complete turnkey service to enable visibility and remediation of software vulnerabilities and misconfiguration of hybrid and cloud environments. We also develop cloud BB ops, the managed services part of Rackspace managed cloud that provides regular health checks along with many other advanced monitoring and analysis services.
And we updated modern operations with Version two that adds new enhancements such as an increased level of services per tier and improved SLAs in 2023. Both the disruptions arising from structural changes and cyclical headwinds of the macro environment slowed the pace of the turnaround and services it has taken longer than I originally expected.
However, as we enter 2024, I am confident we have the right foundation in place and are headed in the right direction. I expect to see services start to report sequential growth in the second half of 2024 as our go-to-market organization matures and overall market demand for cloud services improves. As I noted, Rackspace is catching the next wave of market growth. We did that with cloud and are doing it with AI over the course of the past year, we have transformed Rackspace into an AO ready organization since introducing fail in June of 2023.
We have several active projects in progress. We continue to see growth in AI with nearly 30 customers, including more than 10 new logos at varying stages of implementation across our ideate and incubate phases. We also have a robust and growing offerings in private cloud. We launched EI. anywhere as a landing zone for customers who want to move that application into production in public cloud. We are integrating with all three hyperscalers.
Recently we announced a partnership with Microsoft copilot to guide customers to the EA journey. We also achieved the Amazon Web Services generated a competency in the categories of consulting services. Generally, we application infrastructure and data. This specialization recognizes Rackspace Technology as an AWS partner that helps customers drive the advancement of services, tools and infrastructure Piltel for implementing generative AI technologies.
We are taking a realistic and measured approach to help our customers use AI to build useful, economically viable analytical services. There's a tremendous opportunity ahead. I'm happy with the plan we have developed and a first steps on this journey.
In summary, we made significant progress in 2023. Instead of opting for a quick fix. We made the difficult decision to focus on our turnaround, invest for the long term, restructure the organization and bring in new leadership. I expect 2024 to get off to a slow start. But given the strong backlog in private cloud and the typical six to nine months lag between bookings and revenue realization. We anticipate improving revenues and margins in the second half of 2024 with continued solid execution.
Our goal for 2024 is to lock in a sustainable business model that generates consistent revenue and profit growth over the long term. We want to build momentum throughout 2024 that will put us on a growth trajectory entering 2025 recent bookings trends and improved customer engagement. Tell me, we are on the right track and today's debt refinancing gives us the financial flexibility to stay the course.
Before we wrap up, I would like to thank our customers, partners and all our Rackers. I'm proud of all we have achieved together during this year of change.
I will now turn it over to Mark Marino for an overview of our financial results and guidance.
Mark Marino
Thanks, Amar. Having been with Rackspace over the past few years, I have seen and participated in many of the strategic changes Omar has initiated. The changes happening throughout the organization are transformational. So I'm excited to have stepped into this role at this important inflection point. And I look forward to continuing to support the vision and become an even more integral part of the future of Rackspace.
As Omar mentioned, we closed a very positive transaction with a group of our lenders and financial partners. Specifically, we actually closed a private debt exchange with an ad hoc group representing more than 72% of our first lien term loan holders and more than 64% of our first lien note holders, as well as 100% of our revolving credit facility lenders. In connection with this transaction, we plan to launch a public debt exchange offer to the rest of our outstanding lenders and first lien note holders in the coming days and close that in the next month.
Through the private exchange, we eliminated more than $375 million of net debt and received $275 million of new money that will come to the balance sheet as additional liquidity to advance our key strategic initiatives. And we are extremely encouraged by this injection of new money as it reinforces our financial partners, conviction in our turnaround strategy and continued momentum in our execution through full participation in the public debt exchange.
We have the opportunity to eliminate more than $600 million in total debt, reducing annual interest expense by more than $45 million since the end of fiscal year 2022. Assuming full participation in the public debt exchange and when combined with the company's open market purchases over the past year would result in a total debt reduction of over $800 million and net debt reduction of over $900 million and reduction in annual interest expense by more than $70 million.
Additionally, the maturities on the revolver and other participating senior debt facilities have been extended to May of 2028. The company has effectively no funded corporate maturities prior to 2028. Notably, none of the exchange transactions have any impact on the equity capitalization of the company. Overall, this transaction strengthens the company's financial flexibility, extends maturities and deleveraged our balance sheet while providing Rackspace with ample runway to accelerate our strategic growth initiatives.
Now onto the results. Fiscal Fourth Quarter 2023 results exceeded the midpoint of our revenue, operating profit and EPS guidance in the fourth quarter. Total company GAAP revenue of $720 million was at the high end of our guidance, driven by strength in public cloud.
Total net revenue was $413 million, down 4% sequentially, and down 14% year over year due to declines in both private cloud and public cloud. We are more focused on net revenue as it represents the true growth of our business gross profit margin was 22% of GAAP revenue and 38% of net revenue for the quarter.
Operating profit was $48 million at the high end of our guidance and up 6% sequentially. Operating margin was 7% of GAAP revenue and 12% of net revenue. Loss per share was $0.03, which was within our guided range of three to $0.05 loss per share. Cash flow from operations was $72 million and free cash flow was $38 million in the fourth quarter.
Turning to our segment results for private cloud. Gaap revenue for the fourth quarter was $285 million, which was at the low end of our guidance. This includes legacy OpenStack revenue of $29 million. Total private cloud revenue was down 5% sequentially due to customers rolling off older generation private cloud offerings. Private cloud gross margin was 37%, down one percentage point sequentially, primarily due to revenue declines.
Segment operating margin was 27%, down two percentage points quarter over quarter, and public cloud GAAP revenue of $435 million exceeded the high end of our guidance and was up 1% quarter over quarter, primarily due to consumption driven growth on infrastructure resale volumes offset by declines in services.
Public cloud services revenue was down 5% sequentially, given the continued cyclical headwinds in IT services and the structural changes we implemented in our go-to-market organization. Gross margin for public cloud segment was 40% of net revenue, up 3-percentage-points sequentially, driven by cost savings. Segment operating profit was 21% of net revenue, up five percentage points sequentially.
Now turning to full year 2023 results. Total company GAAP revenue was down 5% year over year, driven by declines in private cloud, while total net revenue was down 11% year over year due to declines in both private cloud and public cloud. Gross profit was 22% of GAAP revenue and 38% of net revenue, while operating margin was 6% of GAAP revenue and 11% of net revenue, demonstrating strong cash flow management.
Cash flow from operations was $375 million and free cash flow was $278 million for the year. Normalizing for the impact of our AR securitization, full year 2023 cash flow from operations would have been $159 million and free cash flow would have been $63 million. Total CapEx for 2023 was $181 million with a CapEx intensity of 6% within our full year guided range of 5% to 7%. For full year 2023 segment results Private cloud GAAP revenue was down 12% compared to 2022 due to customers rolling off the older generation private cloud offerings.
Private cloud gross margin was 38%, down seven percentage points year over year, driven by declines in revenue with a relatively fixed cost structure. Segment operating margin of 28% was down eight percentage points year over year in public cloud 2023 GAAP revenue was essentially flat year over year, while net revenue was down 8% year over year, given a tightening of discretionary spending, gross margin for our public cloud segment was 37% of net revenue, down seven percentage points, driven by declines in revenue. Operating profit was 17% of net revenue, down five percentage points year over year.
Now onto our guidance. As Omar mentioned, we are still managing through residual private cloud revenue runoff that will impact the first half of 2024 and do not expect a major financial contribution from our new bookings and backlog until later in the year due to the typical six to nine months lag between bookings and revenue realization.
Also the first quarter costs will reflect investments in areas that align to our strategy as well as the headwind from seasonal fringe benefits in the US. For these reasons, we expect first quarter GAAP revenue to be approximately $680 million to $690 million. Total operating profit is expected to be $12 million to $14 million and loss per share of $0.12 to $0.14.
From a segment perspective, we expect private cloud revenue of $268 million to $273 million and public cloud revenue of $412 million to $417 million. Our tax rate is expected to be 26% and other income and expense of approximately $50 million to $52 million in expenses. The share count is expected to be around $221 million to $223 million shares. We expect profits to trough in the first quarter and improve throughout the year. We anticipate second half 2020 for profits to be higher than the first half, led by private cloud revenue stabilization and growth in public cloud services setting us up for solid momentum exiting 2024.
I will now turn the call over to Sagar.
Question and Answer Session
Sagar Hebbar
Thank you, Mark. That has begin the question-and-answer session. We ask everyone to limit discussion to one question and one follow-up. Please go ahead.
Operator
Thank you. (Operator Instructions)
Frank Louthan, Raymond James.
Hey, guys, this is Rob on for Frank. So you know, beyond what you shared with us already as it pertains to the debt deal. Are there any other significant covenants we should know about such, as you know, say, restricted payments, baskets? And then my follow-up is the new debt callable and if so, when and at what rate? Thank you.
Amar Maletira
So I think we didn't follow the first one. It was not very clear. Can you repeat the question? I'm sorry, it not very clear that the room.
Yes. Yes. So So other than what you've shared with us so far about the debt deal, are there any other significant covenants we should know about such as you know, any restricted payments baskets? And then my follow-up was about the debt being callable or not, and if so, when and at what rate you hire.
Amar Maletira
So just relative to your first question there about the restricted basket, right? Obviously, in a transaction like this, some of our covenants and baskets did get tightened up throughout the transaction. But in no way, are there any restrictions that will impair our ability to operate the Company moving forward. So I think from that perspective, we've got latitude and flexibility with them with those baskets and covenants.
And then your second question is new debt callable. Now the answer is no the answer to your question.
Yeah, yeah. Thank you guys, very much.
Amar Maletira
Thanks.
Operator
Thank you.
Ramsey El-Assal, Barclays.
Ryan Campbell
Hi, this is [Ryan Campbell] on for Ramsey and thank you for taking my question today. In your prepared remarks, you mentioned the six to nine month lag between bookings and revenue realization. And I was curious to see how that compared to a more normalized event demand environment? And what are you seeing today that gives you confidence that this lag won't elongate any further?
Amar Maletira
Thank you. Yes. I think the so thank you very much for the question. Ron and Doug, are the six to nine months lag of that commentary was mainly on our bookings converting to revenue. So the bookings is what builds the backlog. Our private cloud business did very well from a bookings perspective in Q4 and up in fiscal Q4, where we grew sequentially 86%, grew 96% year on year.
It was the highest quarter in the last eight quarters, and we entered the year with a huge backlog and the backlog actually grew 88% year on year compared to what we saw when we entered fiscal '23. So and that backlog to convert to revenue typically takes six to nine months because we have to stand up the environment we have to migrate the application.
And once the application migrates to our data center, we manage and operated than those that application and workload stays with us for the next 5 to 10 years. So that six to nine month lag is mainly for backlog converting to revenue.
Now in terms of sales cycles, I think that's where your question is this is I think the demand environment continues to remain uncertain. Entering 2023, 2024. We see similar to what we saw in 2023 we believe customers will continue to spend on digital transformation, mainly enabled by cloud and AI.
However, we continue to see slower decision cycles and the sales cycles are getting extended in a public cloud services business. As you know that it's a very it's a cyclical business of many companies in the services ecosystem are reporting that they are facing some cyclical headwinds and so are we.
But when we talk about our private cloud business, the dynamics are really different in our customers are looking to move out of the data centers and reduce both the CapEx and OpEx investments. And so we relating we see relatively better demand in private cloud and the very fact that we grew our overall bookings in 2023 at 20% year on year is basically a proof point that the the private cloud demand, it's pretty strong.
Was it helpful, Ron?
Ryan Campbell
yes, thank you.
Operator
Thank you. I would now like to turn the call back over to Sagar for closing remarks.
Sagar Hebbar
Thank you, everyone, for joining us. If you did not get your question or if you have a follow-up, please e-mail us at ir.rackspace.com. Have a great evening, everyone.
Operator
Ladies and gentlemen, that concludes today's conference call. Thank you for your participation. You may now disconnect.
