Rackspace Technology, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. Rackspace provides multicloud, application, security, data, and cloud services through Multicloud Services, Apps & Cross Platform, and OpenStack Public Cloud. The company completed its IPO after quarter-end, on August 7, 2020.
Key financial results
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Revenue | $656.5 million | $602.4 million | $1,309.2 million | $1,209.3 million |
| Gross profit / margin | $241.9 million / 36.8% | $252.1 million / 41.8% | $491.2 million / 37.5% | $503.0 million / 41.6% |
| Operating income / margin | $22.7 million / 3.5% | $25.6 million / 4.3% | $44.2 million / 3.4% | $46.9 million / 3.9% |
| Net income (loss) | $(32.6) million | $62.5 million | $(80.8) million | $5.0 million |
| Operating cash flow | Not reported quarterly | Not reported quarterly | $98.8 million | $112.4 million |
Q2 revenue grew 9.0% year over year (9.7% in constant currency); management estimated constant-currency growth of 3.8% excluding the Onica acquisition. First-half revenue increased 8.3% (8.7% constant currency), with estimated acquisition-adjusted constant-currency growth of 3.4%. Adjusted EBITDA, a non-GAAP measure, was $187.6 million for Q2 and $373.2 million for the first half, versus $182.7 million and $368.3 million, respectively, in 2019.
Q2 net loss compares with 2019 net income that included a $143.3 million investment gain, primarily from CrowdStrike. First-half 2019 also included a $9.5 million debt extinguishment gain. Lower interest expense in 2020 partly reflected the accounting designation of certain interest-rate swaps as cash flow hedges; it should not be viewed solely as a reduction in underlying borrowing costs.
Business trends and material changes
- Multicloud Services: Q2 revenue rose 15.4% to $519.0 million, including Onica; segment adjusted gross profit rose 5.9%, while adjusted gross margin fell to 38.7% from 42.1%.
- Apps & Cross Platform: Q2 revenue increased 1.1% to $79.9 million; segment adjusted gross profit declined 4.3%.
- OpenStack Public Cloud: Q2 revenue fell 22.0% to $57.6 million, and segment adjusted gross profit fell 38.4%, primarily due to customer churn. Rackspace said it had stopped prioritizing this offering and is focusing growth and investment on its other segments.
- Bookings increased to $288.5 million from $138.8 million, while ARR rose to $2,492.9 million from $2,355.8 million. Q2 consolidated net revenue retention was 98%; Core retention was 99%.
- Cost of revenue grew faster than revenue, driven mainly by third-party infrastructure charges, larger customer contracts, and Onica personnel costs. Management cited cost reductions from data-center consolidation and vendor-license optimization. First-half capital expenditures were $126.2 million, up from $96.7 million.
Financial position, liquidity, and debt
- At June 30, cash and cash equivalents were $161.4 million; current assets were $651.1 million and current liabilities $674.0 million. First-half operating cash flow was $98.8 million; investing cash outflow was $62.8 million and financing cash inflow was $43.3 million.
- Debt carrying value was $3,932.2 million, including $2,763.1 million for the term loan, $1,104.1 million for the 8.625% senior notes, and $65.0 million under the receivables financing facility. Total principal outstanding was approximately $3,995 million. The term loan rate was 4.00%; the notes mature in 2024 and bear 8.625% interest.
- The company had no revolver borrowings at quarter-end and reported $225 million of revolver commitments; the receivables facility had $92.7 million of borrowing capacity, of which $65 million was drawn. Management said available sources were expected to provide sufficient liquidity for at least 12 months, while cautioning that future cash generation and access to financing were not assured.
- After quarter-end, the IPO generated approximately $658 million in net proceeds after estimated offering costs. On August 27, the company used approximately $549 million, plus accrued interest, to purchase and cancel $507.6 million principal amount of senior notes. The tender offer could cover up to a further $92.4 million.
Outlook, risks, and unusual items
- The filing gives no specific revenue or earnings guidance. Management described improving bookings and continuing growth in its core segments, but the acquisition-adjusted growth estimates were materially lower than reported growth.
- Management said COVID-19 had not materially affected results or financial condition through the filing date, but warned that a prolonged pandemic or downturn could disrupt services, weaken customer demand, increase receivable losses, and affect sales cycles. The full medium- and long-term impact remained uncertain.
- The June 2020 modification of two data-center leases reclassified $220.3 million from operating leases to finance leases. The filing also reported $42.5 million of equipment and software acquired through finance leases during the first half.
- After quarter-end, the revolving facility was increased to $375 million, its maturity extended to August 2025, and its leverage covenant threshold raised from 3.50:1 to 5.00:1, subject to the facility’s testing conditions. The company reported covenant compliance at June 30.
- Management said litigation and other contingencies were not material, but could not estimate a possible loss range for the matters described. Other risks include high indebtedness, refinancing needs, competition, customer retention, infrastructure costs, interest-rate and foreign-exchange exposure, and power costs.
Investor verification priorities
- Determine how much reported growth reflects Onica versus underlying organic growth, and whether bookings convert into recurring revenue.
- Track gross-margin pressure, particularly third-party infrastructure costs and margins on larger multiyear contracts.
- Reconcile operating cash flow with capital spending and monitor total debt, lease and financing obligations, interest costs, and post-IPO note repayments.
- Review the effect of OpenStack customer churn and whether retention and growth trends in Multicloud Services and Apps & Cross Platform persist.
- Assess COVID-19 impacts on customers, collections, sales cycles, and future results; management noted that recurring revenue may delay visible effects.