Rackspace Technology, Inc. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023; filed November 9, 2023. Rackspace provides hybrid multicloud technology services through Public Cloud and Private Cloud segments. The company reorganized into these two segments effective January 1, 2023.
Financial performance
Amounts below are in millions, except per-share data and percentages.
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Revenue | $732.4 | $787.6 | $2,237.4 | $2,335.3 |
| Gross profit / margin | $152.0 / 20.8% | $207.1 / 26.3% | $474.7 / 21.2% | $657.1 / 28.1% |
| Operating loss | $(239.4) | $(476.7) | $(884.2) | $(451.8) |
| Net loss | $(226.6) | $(511.7) | $(865.8) | $(590.8) |
| Adjusted EBITDA (non-GAAP) | $95.9 | $134.1 | $292.6 | $459.8 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $302.7 | $219.2 |
| Capital expenditures (MD&A measure) | Not provided for the quarter | Not provided for the quarter | $143.8 | $99.0 |
- Revenue and segments: Q3 revenue fell 7.0% year over year (7.7% constant currency). Public Cloud revenue declined 2.7% to $432.8 million; Private Cloud fell 12.5% to $299.6 million. For the first nine months, Public Cloud grew 2.2% to $1,312.3 million, while Private Cloud declined 12.0% to $925.1 million.
- Margins: Q3 gross margin contracted 550 basis points; nine-month gross margin contracted 690 basis points. Management attributed pressure mainly to higher third-party infrastructure usage charges, alongside data-center, license, and professional-services costs.
- Segment operating profit: Q3 Public Cloud profit was $21.6 million (5.0% margin) and Private Cloud was $84.9 million (28.3% margin). Nine-month segment profit was $63.1 million and $264.6 million, respectively; both segments’ margins declined year over year.
- Cash and liquidity: Cash and cash equivalents were $277.8 million at September 30, 2023; restricted cash was an additional $2.9 million. The company reported $845.1 million of current assets and $824.8 million of current liabilities. It had $375 million available under its revolving credit facility, with no borrowings outstanding at quarter-end.
- Debt: Aggregate principal debt was approximately $3.093 billion, including $2.243 billion of term loans, $550 million of 3.50% secured notes, and $300 million of 5.375% senior notes. The term loan rate was 8.19%. GAAP debt carrying value was $3.059 billion. Interest expense was $56.5 million in Q3 and $170.7 million for nine months.
- Other balance-sheet items: Total assets were $4.280 billion and stockholders’ deficit was $182.8 million. Goodwill declined to $1.448 billion after impairment charges.
Material changes and unusual items
- Q3 net loss narrowed versus 2022, primarily reflecting lower goodwill impairment and a $55.4 million gain on debt extinguishment. For nine months, net loss increased to $865.8 million, including $708.8 million of goodwill impairment; the prior-year period included $405.2 million of goodwill impairment.
- Q3 goodwill impairment was $165.7 million, all associated with Private Cloud. The company also recorded a $57.0 million non-cash impairment of its Rackspace trade name. Management cited sustained share-price weakness, revised cash-flow projections, market conditions, and business mix shifts. Further impairment could result if assumptions worsen.
- During the first nine months, the company repurchased and cancelled $250 million principal of 5.375% notes for approximately $86.6 million, recording a $163.1 million gain. It repurchased another $24.4 million principal after quarter-end through November 9, 2023.
- A new receivables facility, with a maximum limit of $300 million, began September 29. The company sold receivables with $209 million face value for $209 million cash by quarter-end and used $50 million to repay revolving-credit borrowings. Related expense was $4.9 million. The filing says the transfers are accounted for as sales.
- Nine-month operating cash flow included the $209 million receivables-sale proceeds. Management also cited higher operating expense and interest payments as offsets. Do not treat the cash-flow increase as solely reflecting improved underlying operations.
- Capital expenditures were $143.8 million for nine months, versus $99.0 million a year earlier. The increase included customer equipment initially intended for a new customer that did not materialize as expected; management said the equipment could be redeployed.
- The company recorded an $8.6 million gain in Q3 from remeasuring its headquarters property held for sale. It had a sale agreement for $21.5 million and was negotiating potential termination fees under an economic incentives agreement.
Outlook, risks, and contingencies
- No numerical earnings or revenue guidance is provided in the filing. Management expects liquidity sources to be sufficient for at least the next 12 months, but cautions that future operating cash flows or access to borrowing may not be sufficient under adverse conditions.
- Management describes the company as highly leveraged. Floating-rate debt, rising interest rates, debt-service needs, refinancing availability, and restrictive debt covenants remain important risks. The company reported covenant compliance at September 30, 2023.
- Management cited customer discretionary-spending pressure and optimization in Public Cloud, and legacy offering run-off, OpenStack declines, and the Hosted Exchange incident in Private Cloud. It aims to improve Public Cloud margins through cost efficiencies and growth in higher-margin services.
- Several lawsuits relate to the December 2022 Hosted Exchange ransomware incident. The company is defending the claims and cannot determine the probability or range of losses at this early stage. It recorded $5.0 million of incident expenses and $5.4 million of insurance recoveries received or expected during the first nine months of 2023.
- The company’s goodwill and trade-name valuations depend on significant, sensitive forecasts and discount-rate assumptions; management warned additional material impairment is possible. It also faces exposure to interest rates, foreign exchange, and data-center power costs.
- Management concluded disclosure controls and procedures were effective at quarter-end and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether revenue declines and margin compression stabilize, especially in Private Cloud, and whether Public Cloud growth translates into improved segment profitability.
- How much operating cash flow is sustainable after excluding receivables-sale proceeds, and the ongoing cost and availability of the receivables facility.
- Debt-service capacity under the 8.19% term-loan rate, refinancing options, and remaining liquidity after working capital and capital spending.
- Whether revised cash-flow forecasts, market capitalization, or discount rates lead to further goodwill or trade-name impairment.
- The outcome and potential financial exposure of Hosted Exchange litigation, insurance recoveries, and the headquarters sale and associated termination-fee negotiations.
Non-GAAP measures, including Adjusted EBITDA, are management-defined and should be considered alongside—not instead of—GAAP results.