RACKSPACE TECHNOLOGY, INC.
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations ("MD&A") is intended to help readers understand our
results of operations, financial condition and cash flows and should be read in
conjunction with the audited consolidated financial statements and the related
notes included elsewhere in this Annual Report. References to "Rackspace
Technology ," "we," "our company," "the company," "us," or "our" refer to
Rackspace Technology, Inc. and its consolidated subsidiaries.
The following discussion contains forward-looking statements that that involve
risk, assumptions and uncertainties, such as statements of our plans,
objectives, expectations, intentions and forecasts. Our actual results and the
timing of selected events could differ materially from those discussed in these
forward-looking statements as a result of several factors, including those set
forth under the section of this Annual Report titled "Risk Factors" and
elsewhere in this Annual Report. You should carefully read the "Risk Factors" to
gain an understanding of the important factors that could cause actual results
to differ materially from our forward-looking statements. Please also see
"Special Note Regarding Forward-Looking Statements" contained elsewhere in this
Annual Report.
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Overview
We are a leading end-to-end multicloud technology services company. We design,
build and operate our customers' cloud environments across all major technology
platforms, irrespective of technology stack or deployment model. We partner with
our customers at every stage of their cloud journey, enabling them to modernize
applications, build new products and adopt innovative technologies. We serve our
customers with a unique combination of proprietary technology resulting from
over $1 billion of investment and services expertise from a team of highly
skilled consultants and engineers. And we provide our customers with unbiased
expertise and technology solutions, delivered over the world's leading cloud
services, all wrapped in a Fanatical Experience.
We aim to be our customers' most trusted advisor and services partner in their
path to cloud transformation and to accelerate the value of their cloud
investments. We give customers the ability to make fluid decisions when choosing
the right technologies, and we recommend solutions based on customers' unique
objectives and workloads, irrespective of the underlying technology stack or
deployment option. In this way, we empower our customers to harness the strength
of the cloud.
Our customers are served by a family of approximately 7,200 Rackers, including
some of the most qualified architects and engineers in the world. Our Rackers
are at the center of the customer experience - they maintain a hyper-focus on
customer experience and satisfaction and are available to our customers 24x7x365
by phone, chat, email or web portal.
We deliver our services to a global customer base through an integrated service
delivery model. We have a presence in more than 60 cities around the world. This
footprint allows us to better serve customers based in various countries,
especially multinational companies requiring cross-border solutions. We have a
strong presence with customers of all sizes, including large global enterprises,
mid-market businesses and SMBs, which we define to be made up of customers with
total revenue in excess of $1 billion , between $300 million and $1 billion and
less than $300 million , respectively. As of December 31, 2020 , our customer base
included over 1,000 enterprises, over 1,000 mid-market businesses and over
114,000 SMBs.
On November 3, 2016 , Rackspace Hosting, Inc. (now named Rackspace Technology
Global, Inc. , or "Rackspace Technology Global") was acquired by Inception
Parent, Inc. , an indirect wholly-owned subsidiary of the company ("Inception
Parent"). Pursuant to the Merger Agreement, dated as of August 26, 2016 ,
Rackspace Technology Global merged with a wholly-owned subsidiary of Inception
Parent, with Rackspace Technology Global surviving as a wholly-owned subsidiary
of Inception Parent (the "Rackspace Acquisition"). Since the Rackspace
Acquisition, we have made significant changes to our business model, including
through acquisitions, divestitures, corporate transformation initiatives and
significant investments to adapt to changing customer needs and competitive
market dynamics. See Item 1 of Part I, Business, - Overview - "Our
Transformation."
We operate our business and report our results through three reportable
segments: (1) Multicloud Services, (2) Apps & Cross Platform and (3) OpenStack
Public Cloud. Our Multicloud Services segment includes our multicloud services
offerings, as well as professional services related to designing and building
multicloud solutions and cloud-native applications. Our Apps & Cross Platform
segment includes managed applications, managed security and data services, as
well as professional services related to designing and implementing application,
security and data services. In early 2017, we determined that our OpenStack
Public Cloud offering was not core to our go-forward operations and we ceased to
incentivize our sales team to promote and sell the product by the end of that
year. We continue to serve our existing OpenStack Public Cloud customer base
while we focus our growth strategy and investments on our Multicloud Services
and Apps & Cross Platform offerings. See Item 8 of Part II, Financial Statements
and Supplementary Data - Note 19, "Segment Reporting" for additional information
about our segments. We refer to certain supplementary "Core" financial measures,
which reflect the results or otherwise pertain to the performance of our
Multicloud Services and Apps & Cross Platform segments, in the aggregate. Our
Core financial measures exclude the results and performance of our OpenStack
Public Cloud segment.
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We generate revenue primarily through the sale of consumption-based contracts
for our services offerings, which are recurring in nature. We also generate
revenue from the sale of professional services related to designing and building
customer solutions, which are non-recurring in nature. Arrangements within our
Multicloud Services offerings generally have a fixed term, typically from 12 to
36 months, with a monthly recurring fee based on the computing resources
provided to and utilized by the customer, the complexity of the underlying
infrastructure and the level of support we provide. Our other primary sources of
revenue are for public cloud services within our Multicloud Services, our Apps &
Cross Platform and our OpenStack Public Cloud offerings. Contracts for these
arrangements typically operate on a month-to-month basis and can be canceled at
any time without penalty.
We sell our services through direct sales teams, third-party channel partners
and via online orders. Our sales model is based on both distributed and
centralized sales teams with leads generated from technology partners, customer
referrals, channel partners and corporate marketing efforts. We offer customers
the flexibility to select the best combination of resources in order to meet the
requirements of their unique applications and provide the technology to
seamlessly operate and manage multiple cloud computing environments.
On May 14, 2018 , we acquired 100% of RelationEdge, LLC ("RelationEdge"), a
full-service Salesforce Platinum Consulting Partner and digital agency that
helps clients engage with their customers from lead to loyalty by improving
business processes, leveraging technology and integrating creative digital
marketing, for net cash consideration of $65 million , with a majority of the
purchase price allocated to goodwill. RelationEdge was integrated into our Apps
& Cross Platform segment and contributed $16 million in revenue to our results
in 2018 for the seven and a half months following its acquisition.
RelationEdge's results of operations subsequent to the May 14, 2018 acquisition
date are included in the accompanying consolidated financial statements.
On November 15, 2019 , we acquired 100% of Onica, an AWS managed service provider
of cloud-native consulting and managed services, including strategic advisory,
architecture and engineering and application development services, for net cash
consideration of $316 million , of which $62 million was allocated to amortizable
intangible assets. Onica was integrated into our Multicloud Services segment and
contributed $21 million in revenue to our results in 2019 for the month and a
half following its acquisition. Onica's results of operations subsequent to the
November 15, 2019 acquisition date are included in the accompanying consolidated
financial statements.
Refer to Item 8 of Part II, Financial Statements and Supplementary Data - Note 15, "Acquisitions" for more detail of these acquisitions.
OnAugust 7, 2020 , we completed the IPO, in which we issued and sold 33,500,000 shares of our common stock at a public offering price of$21.00 per share. We received proceeds of$666.6 million from sales of shares in the IPO, after deducting underwriters' discounts and commissions of$36.9 million , but before deducting offering expenses of$8.8 million .
Subsequent Events
For a description of subsequent events, see Item 8 of Part II, Financial Statements and Supplementary Data - Note 1, "Company Overview, Basis of Presentation, and Summary of Significant Accounting Policies."
Impact of COVID-19
The recent outbreak of a novel strain of coronavirus, now referred to as COVID-19, has spread globally, including withinthe United States and resulted in TheWorld Health Organization declaring the outbreak a "pandemic" inMarch 2020 . The effects of COVID-19 are rapidly evolving, and the full impact and duration of the virus are unknown. Managing COVID-19 has severely impacted healthcare systems and businesses worldwide. The effects of COVID-19 and the response to the virus have negatively impacted overall economic conditions. To date, COVID-19 has not adversely affected our results of operations or financial condition in any material respect; however, the ultimate extent of the impact of COVID-19 on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak and its impact on our customers, vendors and employees and its impact on our sales cycles as well as industry events, all of which are uncertain and cannot be predicted. If the pandemic or the resulting economic downturn continues to worsen, we could experience service disruption, loss of customers or higher levels of doubtful trade accounts receivable, which could have an adverse effect on our results of operations and cash flows. At this point, we are focused on the health and safety of our employees, customers and partners and, among other things, have implemented a work-from-home policy and are limiting contact between our employees and customers while continuing to deliver a Fanatical Experience. To date, the impact on our business has been limited as most of our services are already delivered remotely or capable of being delivered - 51 - -------------------------------------------------------------------------------- Table of Contents remotely and we have a diverse customer base. In addition, our mitigation efforts, including offering our customers contract extensions in exchange for better payment terms and obtaining improved payment terms from our vendors, have generally been successful since the start of the pandemic. The full extent to which COVID-19 may impact our financial condition or results of operations over the medium to long term, however, remains uncertain. Due to our recurring revenue business model, the effect of COVID-19 may not be fully reflected in our results of operations until future periods, if at all. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities, or that we determine are in the best interests of our employees, customers, partners, suppliers and stockholders.
Impact of Accounting Change on Results of Operations
We adopted Accounting Standard Codification ("ASC") No. 606 (Revenue from
Contracts with Customers) as of January 1, 2019 using the full retrospective
method, which required us to restate each prior period presented. As the
consolidated financial statements prior to the Rackspace Acquisition date were
presented on a different accounting basis than the consolidated financial
statements subsequent to the Rackspace Acquisition, ASC 606 was only applied to
the periods subsequent to the Rackspace Acquisition date. Our results reflect
the impact of the transition on our balance sheet as of January 1, 2018 , the
earliest period presented, and retrospective adjustments to our consolidated
statements of operations and cash flows for the year ended December 31, 2018 .
The most significant impact of the adoption of ASC 606 on our results of
operations is related to the capitalization of costs to obtain and fulfill a
contract with a customer, such as sales commissions and implementation and set
up related expenses, and their amortization over the period the related services
are delivered to customers, whereas under previous guidance we expensed such
costs as they were incurred. As a result, our loss before income taxes and
Adjusted EBITDA were both positively impacted by $32.8 million , $4.9 million and
$7.9 million in 2018, 2019 and 2020, respectively. We also adopted ASC No. 842
(Leases) as of January 1, 2019 using the modified retrospective method,
recording the impact of the transition on our balance sheet as of January 1,
2019 . The impact of our adoption of ASC 842 resulted in a positive $1.9 million
and $3.4 million impact on our loss before income taxes for the years ended 2019
and 2020, respectively, and a negative $8.9 million and $3.1 million impact on
our Adjusted EBITDA for the years ended 2019 and 2020, respectively. See
"Non-GAAP Financial Measures" below for our presentation and reconciliation of
Adjusted EBITDA.
Key Factors Affecting Our Performance
We believe our combination of proprietary technology, automation capabilities
and technical expertise creates a value proposition for our customers that is
hard to replicate for both competitors and in-house IT departments. Our
continued success depends to a significant extent on our ability to meet the
challenges presented by our highly competitive and dynamic market, including the
following key factors:
Differentiating Our Service Offerings in a Competitive Market Environment
Our success depends to a significant extent on our ability to differentiate,
expand and upgrade our service offerings in line with developing customer needs,
while deepening our relationships with leading public cloud service providers
and establishing new relationships, including with sales partners. We are a
certified premier consulting and managed services partner to some of the largest
cloud computing platforms, including AWS, Azure, Google Cloud, Oracle, SAP and
VMWare. We believe we are unique in our ability to serve customers across major
technology stacks and deployment options, all while delivering a Fanatical
Experience. Our existing and prospective customers are also under increasing
pressure to move from on-premise or self-managed IT to the cloud to compete
effectively in a digital economy and maximize the value of their cloud
investments, which we believe presents an opportunity for professional services
projects as well as new recurring business. See Item 1 of Part I, Business, -
Overview - "Our Transformation."
Annualized Recurring Revenue ("ARR"), which we believe is an important indicator
of our market differentiation and future revenue opportunity from recurring
customer contracts, was $2,374.3 million , $2,411.6 million and $2,711.1 million
for the years ended December 31, 2018 , 2019 and 2020, respectively. See "Key
Operating Metrics." We also believe that many of our prospective customers will
need external support for their cloud transformations, which are non-recurring
projects excluded from ARR provided through our professional services, and that
our hybrid, platform-neutral approach, and ability to deliver a Fanatical
Experience to customers, will continue to be key to our success in attracting
and retaining customers over time.
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Customer Relationships and Retention
Our success greatly depends on our ability to retain and develop opportunities
with our existing customers and to attract new customers. We operate in a
growing but competitive and evolving market environment, requiring innovation to
differentiate us from our competitors. We believe that our integrated cloud
service portfolio and our differentiated customer experience and technology are
keys to retaining and growing revenue from existing customers as well as
acquiring new customers. For example, we believe that the Rackspace Fabric
provides customers a unified experience across their entire cloud and security
footprint, and that our Rackspace Service Blocks model provides for customizable
services consumption, enabling us to deliver IT services in a recurring and
scalable way. These offerings differentiate us from legacy IT service providers
that operate under long-term fixed and project-based fee structures often
tethered to their existing technologies with less automation.
Shift in Capital Intensity
In recent years, the mix of our revenues has shifted from high capital intensity service offerings to low capital intensity service offerings and we expect this mix shift to continue. Historically, we primarily offered dedicated hosting and OpenStack Public Cloud services to our customers, which required us to deploy servers and equipment to ensure adequate capacity for new customers and, in certain cases, on behalf of customers at the start or during the performance of a contract, resulting in a high level of anticipatory and success-based capital expenditures. Today, the vast majority of our revenue is derived from service offerings, such as multicloud services, application services and professional services, which have significantly lower success-based capital requirements because they allow us to leverage our partners' infrastructure or technology because we are able to use technology to make our capital expenditures more efficient. As a result, we have recently experienced and expect to continue to experience changes in our capital expenditures requirements. Our capital expenditures equaled 14%, 9% and 8% of our revenue for the years endedDecember 31, 2018 2019 and 2020, respectively. While there is some variability in capital expenditures from quarter to quarter due to timing of purchases, we expect to maintain current capital intensity levels over the longer term.
Business Transformation
Since the Rackspace Acquisition, we have invested in multiple high growth service offerings, including multicloud services, professional services, managed security and data services. In this process, we established one of the broadest partner ecosystems across the technology industry. We have also invested heavily in proprietary technology and automation tools for both us and our customers. We invested in a professional services-driven go-to-market, providing holistic multicloud solutions to meet our customers' objectives which aim to evolve those solutions over the full lifecycle of their cloud journey. Several experienced professionals joined our management team in mid-2019, includingKevin Jones (CEO) andSubroto Mukerji (COO). InOctober 2020 , we announced the hiring of our new CFO,Amar Maletira . Our efforts have enabled us to improve our underlying operating cost efficiencies and expand our revenue opportunities. This transformation has benefited our financial model as well. Today, we benefit from a subscription-based model (including both long-term and month-to-month subscriptions) that accounted for 95% of our revenue in 2020. Over 90% of our revenue in 2020 came from our Core Segments, which we expect to continue to drive our growth. For example, on a constant currency basis, assuming the RelationEdge and Onica acquisitions were consummated onJanuary 1, 2018 , we estimate that our constant currency Core Revenue would have increased by 9% in 2020 compared to 2019, and by 5% in 2019 compared to 2018. Additionally, our capital intensity, which we define as total capital expenditures as a percentage of total revenue, has decreased from 16% for the twelve months endedSeptember 30, 2016 , to 8% for the year endedDecember 31, 2020 . - 53 - -------------------------------------------------------------------------------- Table of Contents Mergers and Acquisitions We have completed and substantially integrated four acquisitions since 2017, including Onica, an AWS cloud services company that we acquired in the fourth quarter of 2019. See Item 8 of Part II, Financial Statements and Supplementary Data - Note 15, "Acquisitions." We routinely evaluate potential acquisitions that align with our growth strategy. Our acquisitions in any period may impact the comparability of our results with prior and subsequent periods. The integration of acquisitions also requires dedication of substantial time and resources, and we may never fully realize synergies and other benefits that we expect. Acquisition purchase price accounting, which may require significant judgment, and amortization and depreciation of acquired assets, may result in our recording post-acquisition costs that are higher or lower than the underlying, steady state operating costs of the acquired business. Additionally, the terms of any such acquisition, particularly with respect to the treatment of deferred revenue, may adversely impact our post-acquisition recognition of revenue from the acquired business. Additionally, our acquired businesses or assets may not perform as we expect, which could adversely affect our results of operations. Key Operating Metrics
The following table and discussion present and summarize our key operating performance indicators, which management uses as measures of our current and future business and financial performance:
Year Ended December 31,
(In millions, except %) 2018 2019 2020
Bookings $ 597.5 $ 700.7 $ 1,126.1
Annualized Recurring Revenue (ARR) $ 2,374.3 $ 2,411.6 $ 2,711.1
2018 2019 2020
Core Quarterly Net Revenue Retention Rate
First Quarter 100 % 99 % 98 %
Second Quarter 99 % 98 % 99 %
Third Quarter 99 % 99 % 100 %
Fourth Quarter 99 % 98 % 101 %
Quarterly Net Revenue Retention Rate
First Quarter 98 % 98 % 98 %
Second Quarter 98 % 98 % 98 %
Third Quarter 98 % 99 % 100 %
Fourth Quarter 98 % 98 % 100 %
Bookings
We calculate Bookings for a given period as the annualized monthly value of our
recurring customer contracts entered into during the period from (i) new
customers and (ii) net upgrades by existing customers within the same workload,
plus the actual (not annualized) estimated value of professional services
consulting, advisory or project-based orders received during the period.
"Recurring customer contracts" are any contracts entered into on a multi-year or
month-to-month basis, but excluding any professional services contracts for
consulting, advisory or project-based work.
Bookings for any period may reflect orders that we perform in the same period,
orders that remain outstanding as of the end of the period and the annualized
value of recurring month-to-month contracts entered into during the period, even
if the terms of such contracts do not require the contract to be renewed.
Bookings include net upgrades by existing customers within the same workload,
but exclude net downgrades by such customers within that workload. Any customer
that contracts for a new workload is considered a new customer and the entire
value of the contract or upgrade is recorded in Bookings, irrespective of
whether the same customer canceled or downgraded other workloads. Bookings also
do not include the impact of any known contract non-renewals or service
cancellations by our customers, except for positive net upgrades by existing
customers. In cases where a new or upgrading customer enters into a multi-year
contract, Bookings include only the annualized contract value. Bookings do not
include usage-based fees in excess of contracted minimum commitments until
actually incurred.
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We use Bookings to measure the amount of new business generated in a period,
which we believe is an important indicator of new customer acquisition and our
ability to cross-sell new services to existing customers. Bookings are also used
by management as a factor in determining performance-based compensation for our
sales force. While we believe Bookings, in combination with other metrics, is an
indicator of our near-term future revenue opportunity, it is not intended to be
used as a projection of future revenue. Our calculation of Bookings may differ
from similarly titled metrics presented by other companies.
Our Bookings were $597.5 million , $700.7 million and $1,126.1 million for the
years ended December 31, 2018 , 2019 and 2020, respectively. The increase in
Bookings was attributable to the execution of several initiatives focused on
enhancing growth, including an investment in sales, an improvement in sales
productivity, an increase in the number of enterprise customers and an increase
in the number of new deals with large contract values.
Annualized Recurring Revenue
We calculate Annualized Recurring Revenue, or ARR, by annualizing our actual revenue from existing recurring customer contracts (as defined under "Bookings" above) for the most recently completed fiscal quarter. ARR is not adjusted for the impact of any known or projected future customer cancellations, service upgrades or downgrades or price increases or decreases. We use ARR as a measure of our revenue trend and an indicator of our future revenue opportunity from existing recurring customer contracts, assuming zero cancellations. The amount of actual revenue that we recognize over any 12-month period is likely to differ from ARR at the beginning of that period, sometimes significantly. This may occur due to new Bookings, higher or lower professional services revenue, subsequent changes in our pricing, service cancellations, upgrades or downgrades and acquisitions or divestitures. For the avoidance of doubt, ARR for any period endingDecember 31 is calculated by annualizing our actual revenue from existing recurring customer contracts for the fourth quarter in that year. Our calculation of ARR may differ from similarly titled metrics presented by other companies.
Our ARR was
Quarterly Net Revenue Retention Rate
Our Quarterly Net Revenue Retention Rate, which we use to measure our success in retaining and growing revenue from our existing customers, compares sequential quarterly revenue from the same cohort of customers. We calculate our Quarterly Net Revenue Retention Rate for a given quarterly period as the revenue from the cohort of customers for the latest reported fiscal quarter (the numerator), divided by revenue from such customers for the immediately preceding fiscal quarter (denominator). Existing customer revenue for the earlier of the two fiscal quarters is calculated on a constant currency basis, applying the average exchange rate for the latest reported fiscal quarter to the immediately preceding fiscal quarter, to eliminate the effects of foreign currency fluctuations. The numerator and denominator only include revenue from customers that we served and from which we recognized revenue in the first month of the earliest of the two quarters being compared. Our calculation of Quarterly Net Revenue Retention Rate for any fiscal quarter includes the positive revenue impacts of selling new services to existing customers and the negative revenue impacts of attrition among this cohort of customers. Our calculation of Quarterly Net Revenue Retention Rate may differ from similarly titled metrics presented by other companies.
Throughout the Annual Report, we present our Quarterly Net Revenue Retention Rate on a consolidated basis and also on a Core basis, referred to as "Core Quarterly Net Revenue Retention Rate."
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Key Components of Statement of Operations
Revenue
A substantial amount of our revenue, particularly within our Multicloud Services
segment, is generated pursuant to contracts that typically have a fixed term
(typically from 12 to 36 months). Our customers generally have the right to
cancel their contracts by providing us with written notice prior to the end of
the fixed term, though most of our contracts provide for termination fees in the
event of cancellation prior to the end of their term, typically amounting to the
outstanding value of the contract. These contracts include a monthly recurring
fee, which is determined based on the computing resources utilized and provided
to the customer, the complexity of the underlying infrastructure and the level
of support we provide. Our public cloud services within the Multicloud Services
segment and most of our Apps & Cross Platform and OpenStack Public Cloud
services generate usage-based revenue invoiced on a month-to-month basis and can
be canceled at any time without penalty. We also generate revenue from
usage-based fees and fees from professional services earned from customers using
our hosting and other services. We typically recognize revenue on a daily basis,
as services are provided, in an amount that reflects the consideration to which
we expect to be entitled in exchange for our services. Our usage-based
arrangements generally include a variable consideration component, consisting of
monthly utility fees, with a defined price and undefined quantity. Our customer
contracts also typically contain service level guarantees, including with
respect to network uptime requirements, that provide discounts when we fail to
meet specific obligations and, with respect to certain products, we may offer
volume discounts based on usage. As these variable consideration components
consist of a single distinct daily service provided on a single performance
obligation, we account for all of them as services are provided and earned.
Cost of revenue
Cost of revenue consists primarily of usage charges for third-party infrastructure, depreciation of servers, software and other systems infrastructure and personnel costs (including salaries, bonuses, benefits and share-based compensation) for engineers, developers and other employees involved in the delivery of services to our customers. Cost of revenue also includes data center rent and other infrastructure maintenance and support costs, including software license costs and utilities. Cost of revenue is driven mainly by demand for our services, our service mix and the cost of labor in a given geography.
Selling, general and administrative expenses (SG&A)
Selling, general and administrative expenses consist primarily of personnel costs (including salaries, bonuses, commissions, benefits and share-based compensation) for our sales force, executive team and corporate administrative and support employees, including our human resources, finance, accounting and legal functions. SG&A also includes research and development costs, repair and maintenance of corporate infrastructure, facilities rent, third-party advisory fees (including audit, legal and management consulting costs), marketing and advertising costs and insurance, as well as the amortization of related intangible assets and certain depreciation of fixed assets.
SG&A also includes transaction costs related to acquisitions and financings along with costs related to integration and business transformation initiatives which may impact the comparability of SG&A between periods.
Additionally, SG&A has historically included management fees. The management consulting agreements were terminated onAugust 4, 2020 , and therefore no management fees will accrue or be payable for periods subsequent to that date, thereby reducing our SG&A expenses; however, we also expect certain of our other our recurring SG&A costs to increase on account of the expansion of accounting, legal, investor relations and other functions, incremental insurance coverage and other services needed to operate as a public company.
Income taxes
Our income tax benefit (provision) and deferred tax assets and liabilities reflect management's best assessment of estimated current and future taxes to be paid. To date, we have recorded consolidated tax benefits, reflecting our net losses, though certain of our non-U.S. subsidiaries have incurred corporate tax expense according to the relevant taxing jurisdictions. We are under certain domestic and foreign tax audits. Due to the complexity involved with certain tax matters, there is the possibility that the various taxing authorities may disagree with certain tax positions filed on our income tax returns. We believe we have made adequate provision for all uncertain tax positions. See Item 8 of Part II, Financial Statements and Supplementary Data - Note 13, "Taxes." - 56 -
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Results of Operations
We discuss our historical results of operations, and the key components of those
results, below. Past financial results are not necessarily indicative of future
results.
Year Ended
The following table sets forth our results of operations for the specified periods, as well as changes between periods and as a percentage of revenue for those same periods (totals in table may not foot due to rounding):
Year Ended December 31,
2019 2020 Year-Over-Year Comparison
(In millions, except %) Amount % Revenue Amount % Revenue Amount % Change
Revenue $ 2,438.1 100.0 % $ 2,707.1 100.0 % $ 269.0 11.0 %
Cost of revenue (1,426.9) (58.5) % (1,722.7) (63.6) % (295.8) 20.7 %
Gross profit 1,011.2 41.5 % 984.4 36.4 % (26.8) (2.7) %
Selling, general and (911.7) (37.4) % (959.7) (35.4) % (48.0) 5.3 %
administrative expenses
Gain on sale 2.1 0.1 % - - % (2.1) (100.0) %
Income from operations 101.6 4.2 % 24.7 0.9 % (76.9) (75.7) %
Other income (expense):
Interest expense (329.9) (13.5) % (268.4) (9.9) % 61.5 (18.6) %
Gain on investments, net 99.5 4.1 % 0.7 0.0 % (98.8) (99.3) %
Gain (loss) on extinguishment of
debt 9.8 0.4 % (71.5) (2.6) % (81.3) NM
Other income (expense), net (3.3) (0.1) % 2.5 0.1 % 5.8
NM
Total other income (expense) (223.9) (9.2) % (336.7) (12.4) % (112.8) 50.4 % Loss before income taxes (122.3) (5.0) % (312.0) (11.5) % (189.7) 155.1 % Benefit for income taxes 20.0 0.8 % 66.2 2.4 % 46.2 NM Net loss$ (102.3) (4.2) %$ (245.8) (9.1) %$ (143.5) 140.3 % NM = not meaningful. Revenue Revenue increased$269 million , or 11.0%, to$2,707 million in 2020 from$2,438 million in 2019. Revenue was positively impacted by the acquisition of Onica inNovember 2019 as well as new customer acquisition and growing customer spend in our Multicloud Services and Apps & Cross Platform segments, as discussed below. After removing the impact from foreign currency fluctuations, on a constant currency basis, revenue increased 10.9% year-over-year. On a constant currency basis, assuming the Onica acquisition was consummated onJanuary 1, 2019 , we estimate that our constant currency revenue would have increased by 6.0% year-over-year. Although such estimate of constant currency revenue is based on assumptions that management believes are reasonable, it is not necessarily indicative of the constant currency revenue that would have been achieved had such acquisition occurred onJanuary 1, 2019 . The following table presents revenue growth by segment: Year Ended December 31, % Change (In millions, except %) 2019 2020 Actual Constant Currency (1) Multicloud Services$ 1,832.6 $ 2,141.5 16.9 % 16.7 % Apps & Cross Platform 319.2 336.6 5.4 % 5.4 % Core Revenue 2,151.8 2,478.1 15.2 % 15.1 % OpenStack Public Cloud 286.3 229.0 (20.0) % (20.1) % Total$ 2,438.1 $ 2,707.1 11.0 % 10.9 %
(1) Refer to "Non-GAAP Financial Measures" in this section for further explanation and reconciliation.
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Multicloud Services revenue in 2020 increased 17%, on an actual and constant
currency basis, from 2019, reflecting the positive impact of the November 2019
acquisition of Onica. Underlying growth was driven by both the acquisition of
new customers and increased spend by existing customers, partially offset by
cancellations by existing customers.
Apps & Cross Platform revenue in 2020 increased 5%, on an actual and constant
currency basis, from 2019, due to growth in our offerings for management of
productivity and collaboration applications, partially offset by a decrease in
professional services revenue.
OpenStack Public Cloud revenue in 2020 decreased 20%, on an actual and constant currency basis, from 2019 due to customer churn.
Cost of Revenue
Cost of revenue increased$296 million , or 21%, to$1,723 million in 2020 from$1,427 million in 2019, primarily due to an increase in usage charges for third-party infrastructure associated with growth in these offerings and the impact of an increased volume of larger, multi-year customer contracts which typically have a larger infrastructure component and lower margins. Personnel costs also increased, primarily due to the addition of former Onica employees and an increase in share-based compensation expense related to restricted stock granted to all eligible employees upon completion of the IPO, partially offset by a reduction in non-equity incentive bonus expense. The increase in third-party infrastructure and personnel costs was partially offset by a decrease in depreciation expense primarily related to certain property, equipment and software reaching the end of its useful life for depreciation purposes as we shift towards faster-growing, value-added service offerings which have significantly lower capital requirements than our legacy capital-intensive revenue streams. We also had year-over-year expense reductions in data center and license expenses as a result of initiatives to lower our cost structure, which included the consolidation of data center facilities and optimizing our vendor license spending. As a percentage of revenue, cost of revenue increased 510 basis points in 2020 to 63.6% from 58.5% in 2019, driven by a 1,030 basis point increase in usage charges for third-party infrastructure, partially offset by a 270 basis point decrease related to data center and license expenses and a 240 basis point reduction in depreciation expense.
Gross Profit and Non-GAAP Gross Profit
Our consolidated gross profit was$984 million in 2020, a decrease of$27 million from$1,011 million in 2019. Our Non-GAAP Gross Profit was$1,026 million in 2020, a decrease of$13 million from$1,039 million in 2019. Non-GAAP Gross Profit is a non-GAAP financial measure. See "Non-GAAP Financial Measures" below for more information. Our consolidated gross margin was 36.4% in 2020, a decrease of 510 basis points from 41.5% in 2019. - 58 -
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The table below presents our segment non-GAAP gross profit and gross margin for the periods indicated, and the change in gross profit between periods:
Year Ended December 31,
(In millions, except %) 2019 2020 Year-Over-Year Comparison
% of Segment % of Segment
Non-GAAP gross profit by segment: Amount Revenue Amount Revenue Amount % Change
Multicloud Services $ 774.7 42.3 % $ 810.2 37.8 % $ 35.5 4.6 %
Apps & Cross Platform 118.7 37.2 % 115.5 34.3 % (3.2) (2.7) %
OpenStack Public Cloud 146.0 51.0 % 100.3 43.8 % (45.7) (31.3) %
Non-GAAP Gross Profit 1,039.4 1,026.0 (13.4) (1.3) %
Less:
Share-based compensation expense (5.7) (14.5)
Other compensation expense (1) (2.8) (5.9)
Purchase accounting impact on
revenue (2) 0.2 -
Purchase accounting impact on
expense (2) (9.6) (5.9)
Restructuring and transformation
expenses (3) (10.3) (15.3)
Total consolidated gross profit $ 1,011.2 (1) Adjustments for retention bonuses, mainly in connection with restructuring and
transformation projects, and the related payroll tax. (2) Adjustment for the impact of purchase accounting from the Rackspace Acquisition on
revenue and expenses. (3) Adjustment for the impact of business transformation and optimization activities, as
well as associated severance, facility closure costs and lease termination expenses.
Multicloud Services non-GAAP gross profit increased by 5% in 2020 from 2019. Segment non-GAAP gross profit as a percentage of segment revenue decreased by 450 basis points, reflecting a 26% increase in segment cost of revenue and a 17% increase in segment revenue. The increase in costs was mainly driven by higher third-party infrastructure costs and the addition of former Onica employees' personnel costs. Partially offsetting the increase was lower depreciation and data center costs. Apps & Cross Platform non-GAAP gross profit decreased by 3% in 2020 from 2019. Segment non-GAAP gross profit as a percentage of segment revenue decreased by 290 basis points, reflecting a 10% increase in segment cost of revenue and a 5% increase in segment revenue. The increase in cost of revenue was driven by the segment's higher business volume as well as investments to support more service-oriented offerings and higher third-party infrastructure costs.
OpenStack Public Cloud non-GAAP gross profit decreased 31% in 2020 from 2019 due to customer churn. Segment non-GAAP gross profit as a percentage of segment revenue decreased by 720 basis points, reflecting a 20% decrease in segment revenue, partially offset by a 8% decrease in segment cost of revenue.
The aggregate amount of costs reflected in consolidated gross profit but excluded from segment non-GAAP gross profit was$41.6 million in 2020, an increase of$13.4 million from$28.2 million in 2019, reflecting higher restructuring and transformation expenses, share-based compensation and other compensation expense, partially offset by lower purchase accounting adjustments. For more information about our segment non-GAAP gross profit, see Item 8 of Part II, Financial Statements and Supplementary Data - Note 19, "Segment Reporting." - 59 - -------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Expenses Selling, general and administrative expenses increased$48 million , or 5%, to$960 million in 2020 from$912 million in 2019, due to costs related to business transformation initiatives, integrating Onica, and costs incurred related to the IPO, including incremental costs to operate as a public company, partially offset by a reduction in management consulting fees as the agreements were terminated in connection with the IPO. Personnel costs increased due to higher commissions expense, driven by bookings growth, and share-based compensation expense, partially offset by lower severance expense and non-equity incentive bonus expense in 2020. Additionally, travel costs declined as a result of COVID-19 travel restrictions. As a percentage of revenue, selling, general and administrative expenses decreased 200 basis points, to 35.4% in 2020 from 37.4% in 2019, for the reasons discussed above, including a 150 basis points reduction in personnel costs, and further impacted by our revenue growth while other SG&A expenses decreased.
Gain on Sale
InMarch 2019 , we recorded a$2 million gain related to the payment of a promissory note receivable that was issued in conjunction with the sale of ourMailgun business inFebruary 2017 . See Item 8 of Part II, Financial Statements and Supplementary Data - Note 14, "Divestitures," included elsewhere in this Annual Report for more information on this transaction.
Interest Expense
Interest expense decreased$62 million to$268 million in 2020 from$330 million in 2019 primarily due to theJanuary 2020 designation of certain of our interest rate swap agreements as cash flow hedges, as further discussed in Item 8 of Part II, Financial Statements and Supplementary Data - Note 16, "Derivatives." In 2019, we recorded$52 million of interest expense related to the change in the fair value of interest rate swaps compared to$14 million recorded to interest expense in 2020. Also contributing to the decrease in interest expense was the reduction in our total debt balance largely due to the repayment of$1,120 million aggregate principal amount of 8.625% Senior Notes during 2020.
Gain on Investments, Net
Gain on investments was
Gain (Loss) on Extinguishment of Debt
In 2020 we recorded a$72 million loss on debt extinguishment related to the repayment of$1,120 million aggregate principal amount of 8.625% Senior Notes. We recorded a$10 million gain on debt extinguishment in 2019 related to repurchases of$77 million principal amount of 8.625% Senior Notes. See Item 8 of Part II, Financial Statements and Supplementary Data - Note 7, "Debt" for further discussion. Other Income (Expense), Net
We had
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Benefit for Income Taxes
Our income tax benefit increased by $46 million to $66 million in 2020 from $20
million in 2019. Our effective tax rate increased from 16.4% in 2019 to 21.2% in
2020. The increase in the effective tax rate year-over-year and the difference
between the effective tax rate for 2020 and the statutory rate are primarily due
to the geographic distribution of profits and changes in income tax reserves, as
well as executive compensation that is nondeductible under Internal Revenue Code
("IRC") Section 162(m) as a result of the IPO.
For a full reconciliation of our effective tax rate to the
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Year Ended December 31, 2018 Compared to Year Ended December 31, 2019 The following table sets forth our results of operations for the specified periods, as well as changes between periods and as a percentage of revenue for those same periods (totals in table may not foot due to rounding):
Year Ended December 31,
2018 2019 Year-Over-Year Comparison
(In millions, except %) Amount % Revenue Amount % Revenue Amount % Change
Revenue $ 2,452.8 100.0 % $ 2,438.1 100.0 % $ (14.7) (0.6) %
Cost of revenue (1,445.7) (58.9) % (1,426.9) (58.5) % 18.8 (1.3) %
Gross profit 1,007.1 41.1 % 1,011.2 41.5 % 4.1 0.4 %
Selling, general and (949.3) (38.7) % (911.7) (37.4) % 37.6 (4.0) %
administrative expenses
Impairment of goodwill (295.0) (12.0) % - - % 295.0 (100.0) %
Gain on sale - - % 2.1 0.1 % 2.1 NM
Income (loss) from operations (237.2) (9.7) % 101.6 4.2 % 338.8 142.8 %
Other income (expense):
Interest expense (281.1) (11.5) % (329.9) (13.5) % (48.8) 17.4 %
Gain on investments, net 4.6 0.2 % 99.5 4.1 % 94.9 NM
Gain on extinguishment of debt 0.5 0.0 % 9.8 0.4 % 9.3 NM
Other income (expense), net 12.7 0.5 % (3.3) (0.1) % (16.0) NM
Total other income (expense) (263.3) (10.7) % (223.9) (9.2) % 39.4 (15.0) %
Loss before income taxes (500.5) (20.4) % (122.3) (5.0) % 378.2 (75.6) %
Benefit for income taxes 29.9 1.2 % 20.0 0.8 % (9.9) (33.1) %
Net loss $ (470.6) (19.2) % $ (102.3) (4.2) % $ 368.3 (78.3) %
NM = not meaningful.
Revenue
Revenue decreased $15 million , or 0.6%, to $2,438 million in 2019 from $2,453
million in 2018. Revenue was negatively impacted by $22 million from foreign
currency translation effects in 2019, due to a stronger U.S. dollar relative to
other foreign currencies, primarily the British pound sterling. Conversely,
revenue was positively impacted by the acquisitions of RelationEdge in May 2018
and Onica in November 2019 as well as new customer acquisition and growing
customer spend in our Multicloud Services and Apps & Cross Platform segments, as
discussed below.
After removing the impact of foreign currency fluctuations, on a constant
currency basis, revenue increased 0.3% year-over-year. On a constant currency
basis, assuming the RelationEdge and Onica acquisitions were consummated on
January 1, 2018 , we estimate that our constant currency revenue would have
increased by 1.6% year-over-year. Although such estimate of constant currency
revenue is based on assumptions that management believes are reasonable, it is
not necessarily indicative of the constant currency revenue that would have been
achieved had such acquisition occurred on January 1, 2018 . The following table
presents revenue growth by segment:
Year Ended December 31, % Change
(In millions, except %) 2018 2019 Actual Constant Currency (1)
Multicloud Services $ 1,803.4 $ 1,832.6 1.6 % 2.6 %
Apps & Cross Platform 290.0 319.2 10.1 % 10.4 %
Core Revenue 2,093.4 2,151.8 2.8 % 3.7 %
OpenStack Public Cloud 359.4 286.3 (20.3) % (19.6) %
Total $ 2,452.8 $ 2,438.1 (0.6) % 0.3 %
(1) Refer to "Non-GAAP Financial Measures" in this section for further explanation and reconciliation.
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Multicloud Services revenue in 2019 increased 2% on an actual basis, or 3% on a
constant currency basis, from 2018, reflecting the positive impact of the
November 2019 acquisition of Onica, which contributed $21 million to 2019
revenue. Underlying growth was driven by both the acquisition of new customers
and increased spend by existing customers, partially offset by cancellations by
existing customers.
Apps & Cross Platform revenue in 2019 increased 10%, on an actual and constant
currency basis, from 2018, due to the favorable full year impact of
RelationEdge, which we acquired in May 2018 , and growth in our offerings for
managed security, professional services and management of productivity and
collaboration applications.
OpenStack Public Cloud revenue in 2019 decreased 20%, on an actual and constant
currency basis, from 2018 due to customer churn. While we expect revenue from
this business to continue to decline, we also saw the quarterly year-over-year
rate of decline stabilize during 2019 as many large OpenStack Public Cloud
customers terminated their OpenStack Public Cloud contracts with us and our
remaining customer base for this offering was composed of smaller customers who
tend to churn at lower rates.
Cost of Revenue
Cost of revenue decreased$19 million , or 1%, to$1,427 million in 2019 from$1,446 million in 2018, primarily driven by a decrease in depreciation expense, partially offset by an increase in infrastructure expenses related to offerings on third-party clouds. The decrease in depreciation expense was primarily due to certain property, equipment and software reaching the end of its useful life for depreciation purposes and a decrease in our overall depreciable asset base as a result of the shift towards faster-growing, value-added service offerings which have significantly lower capital requirements than our legacy capital-intensive revenue streams. The increase in infrastructure expenses related to offerings on third-party clouds was due to growth in these offerings and the impact of an increased volume of larger, multi-year customer contracts which typically have a larger infrastructure component and lower margins. The remaining decrease in cost of revenue was driven by the execution of various initiatives in 2019 to lower our cost structure, such as consolidating data center facilities and optimizing our vendor license spending, which resulted in year-over-year decreases in these expenses. Personnel costs were largely flat as an increase in non-equity incentive compensation expense was offset by expense recorded in the prior year related to our obligations to settle share-based awards in connection with the Rackspace Acquisition. As a percentage of revenue, cost of revenue decreased 40 basis points in 2019 to 58.5% from 58.9% in 2018, driven by a 450 basis point decrease related to depreciation expense, partially offset by a 410 basis point increase largely related to infrastructure expense.
Gross Profit and Non-GAAP Gross Profit
Our consolidated gross profit was$1,011 million in 2019, an increase of$4 million from$1,007 million in 2018. Our Non-GAAP Gross Profit was$1,039 million in 2019, an increase of$10 million from$1,029 million in 2018. Non-GAAP Gross Profit is a non-GAAP financial measure. See "Non-GAAP Financial Measures" below for more information. Our consolidated gross margin was 41.5% in 2019, an increase of 40 basis points from 41.1% in 2018. - 63 - -------------------------------------------------------------------------------- Table of Contents The table below presents our segment non-GAAP gross profit and gross margin for the periods indicated, and the change in gross profit between periods: Year Ended December 31, (In millions, except %) 2018 2019 Year-Over-Year
Comparison
% of Segment % of Segment
Non-GAAP gross profit by segment: Amount Revenue Amount Revenue Amount % Change
Multicloud Services $ 736.6 40.8 % $ 774.7 42.3 % $ 38.1 5.2 %
Apps & Cross Platform 107.3 37.0 % 118.7 37.2 % 11.4 10.6 %
OpenStack Public Cloud 185.0 51.5 % 146.0 51.0 % (39.0) (21.1) %
Non-GAAP Gross Profit 1,028.9 1,039.4 10.5 1.0 %
Less:
Share-based compensation expense (4.1) (5.7)
Other compensation expense (1) (7.3)
(2.8)
Purchase accounting impact on revenue (2) (1.2)
0.2
Purchase accounting impact on expense (2) (6.9)
(9.6)
Restructuring and transformation expenses (3) (2.3)
(10.3)
Total consolidated gross profit$ 1,007.1
(1) Adjustments for expense related to the cash settlement of unvested equity awards that
were outstanding at the consummation of the Rackspace Acquisition, retention bonuses,
mainly in connection with restructuring and transformation projects, and the related
payroll tax. (2) Adjustment for the impact of purchase accounting from the Rackspace Acquisition on
revenue and expenses. (3) Adjustment for the impact of business transformation and optimization activities, as
well as associated severance, facility closure costs and lease termination expenses.
Multicloud Services non-GAAP gross profit increased by 5% in 2019 from 2018. Segment non-GAAP gross profit as a percentage of segment revenue increased by 150 basis points, reflecting a 2% increase in segment revenue and a 1% decrease in segment cost of revenue. The decrease in costs reflects savings obtained as a result of lower personnel costs, reflecting our prior period integration and transformation efforts. The shift in capital intensity described above resulted in lower depreciation and data center costs, offset by higher third-party infrastructure costs. Apps & Cross Platform non-GAAP gross profit increased 11% in 2019 from 2018. Segment non-GAAP gross profit as a percentage of segment revenue remained unchanged at 37%, reflecting proportional increases in segment revenue and cost of revenue. The increase in cost of revenue was driven by the segment's higher business volume, reflecting the favorable full year impact of the RelationEdge acquisition. OpenStack Public Cloud non-GAAP gross profit decreased 21% in 2019 from 2018 due to customer churn. Segment non-GAAP gross profit as a percentage of segment revenue remained unchanged at 51%, reflecting proportional decreases in revenue and costs. The aggregate amount of costs reflected in consolidated gross profit but excluded from segment non-GAAP gross profit was$28.2 million in 2019, an increase of$6.4 million from$21.8 million in 2018, reflecting higher restructuring and transformation costs that more than offset the decrease from cash-settled equity awards. For more information about our segment non-GAAP gross profit, see Item 8 of Part II, Financial Statements and Supplementary Data - Note 19, "Segment Reporting." - 64 - -------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Expenses Selling, general and administrative expenses decreased$38 million , or 4%, to$912 million in 2019 from$949 million in 2018. Contributing to this decrease was a decline in expenses for research and development activities as our business shifts towards providing cloud-centric, value-added services, such as our offerings on third-party clouds, application management and professional services that require fewer research and development activities to develop and support as compared to our historical, legacy offerings such as the OpenStack Public Cloud. Additionally, personnel costs declined in certain administrative functions due to a decrease in employee count driven, in part, by transformation and outsourcing initiatives. We also incurred lower expense related to our obligations to settle share-based awards in connection with the Rackspace Acquisition, a reduction in marketing activity spend and a decrease in expenses related to cost savings initiatives and closing and integrating our recent acquisitions. These decreases were partially offset by incremental amortization expense in 2019 related to sales commissions capitalized in accordance with ASC 606 and higher severance and share-based compensation expense.
As a percentage of revenue, selling, general and administrative expenses decreased 130 basis points, to 37.4% in 2019 from 38.7% in 2018, for the reasons discussed above.
Impairment ofGoodwill As a result of our 2018 annual goodwill impairment test performed during the fourth quarter of 2018, we determined that the carrying amount of our Multicloud Services reporting unit, exceeded its fair value and recorded a goodwill impairment charge of$295 million . The impairment was driven by a significant decrease in forecasted revenue and cash flows and a lower long-term growth rate, as current and forecasted industry trends reflect lower demand for traditional managed hosting services. There was no such impairment in 2019.
Gain on Sale
InMarch 2019 , we recorded a$2 million gain related to the payment of a promissory note receivable that was issued in conjunction with the divestiture of ourMailgun business in 2017. See Item 8 of Part II, Financial Statements and Supplementary Data - Note 14, "Divestitures," included elsewhere in this Annual Report for more information on this transaction.
Interest Expense
Interest expense increased$49 million to$330 million in 2019 from$281 million in 2018, primarily due to changes in the fair value of interest rate swaps, as further discussed in Item 8 of Part II, Financial Statements and Supplementary Data - Note 16, "Derivatives."
Gain on Investments, Net
Gain on investments was$5 million in 2018 compared to$100 million in 2019, driven by a$97 million realized gain related to the sale of our CrowdStrike investment in 2019, as further discussed in Item 8 of Part II, Financial Statements and Supplementary Data - Note 6, "Investments."
Gain on Extinguishment of Debt
We recorded a
Other Income (Expense), Net
We had
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Benefit for Income Taxes
Our income tax benefit decreased by $10 million to $20 million in 2019 from $30
million in 2018. Our effective tax rate increased from 6.0% in 2018 to 16.4% in
2019. The effective tax rate for 2019 was impacted by the current year global
intangible low-taxed income ("GILTI") inclusion, the impact of changes in income
tax rates, changes in valuation allowances, research and development credits,
changes to income tax reserves and other permanently nondeductible items.
For a full reconciliation of our effective tax rate to the
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Non-GAAP Financial Measures
We track several non-GAAP financial measures to monitor and manage our
underlying financial performance. The following discussion includes the
presentation of constant currency revenue, Non-GAAP Gross Profit, Non-GAAP Net
Income (Loss), Non-GAAP Operating Profit, Adjusted EBITDA and Non-GAAP Earnings
Per Share ("EPS"), which are non-GAAP financial measures that exclude the impact
of certain costs, losses and gains that are required to be included in our
profit and loss measures under GAAP. Although we believe these measures are
useful to investors and analysts for the same reasons they are useful to
management, as discussed below, these measures are not a substitute for, or
superior to, U.S. GAAP financial measures or disclosures. Other companies may
calculate similarly-titled non-GAAP measures differently, limiting their
usefulness as comparative measures. We have reconciled each of these non-GAAP
measures to the applicable most comparable GAAP measure throughout this MD&A.
Constant Currency Revenue
We use constant currency revenue as an additional metric for understanding and assessing our growth excluding the effect of foreign currency rate fluctuations on our international business operations. Constant currency information compares results between periods as if exchange rates had remained constant period over period and is calculated by translating the non-U.S. dollar income statement balances for the most current period toU.S. dollars using the average exchange rate from the comparative period rather than the actual exchange rates in effect during the respective period. We also believe this is an important metric to help investors evaluate our performance in comparison to prior periods. The following tables present, by segment, actual and constant currency revenue and constant currency revenue growth rates, for and between the periods indicated: Year Ended December 31, 2019 Year Ended December 31, 2020 % Change Revenue in Foreign Currency Constant (In millions, except %) Revenue Revenue Translation (a) Currency Actual Constant Currency Multicloud Services$ 1,832.6 $ 2,141.5 $ (1.8)$ 2,139.7 16.9 % 16.7 % Apps & Cross Platform 319.2 336.6 (0.1) 336.5 5.4 % 5.4 % OpenStack Public Cloud 286.3 229.0 (0.2) 228.8 (20.0) % (20.1) % Total$ 2,438.1 $ 2,707.1 $ (2.1)$ 2,705.0 11.0 % 10.9 % Year Ended December 31, 2018 Year Ended December 31, 2019 % Change Revenue in Foreign Currency Constant (In millions, except %) Revenue Revenue Translation (a) Currency Actual Constant Currency Multicloud Services$ 1,803.4 $ 1,832.6 $ 18.4$ 1,851.0 1.6 % 2.6 % Apps & Cross Platform 290.0 319.2 1.1 320.3 10.1 % 10.4 % OpenStack Public Cloud 359.4 286.3 2.7 289.0 (20.3) % (19.6) % Total$ 2,452.8 $ 2,438.1 $ 22.2$ 2,460.3 (0.6) % 0.3 %
(a) The effect of foreign currency is calculated by translating current period results using the
average exchange rate from the prior comparative period.
Non-GAAP Gross Profit
Our principal measure of segment profitability is segment non-GAAP gross profit.
We also present Non-GAAP Gross Profit in this MD&A, which is the aggregate of
segment non-GAAP gross profit, because we believe the measure is useful in
analyzing trends in our underlying, recurring gross margins. We define Non-GAAP
Gross Profit as our consolidated gross profit, adjusted to exclude the impact of
share-based compensation expense and other non-recurring or unusual compensation
items, purchase accounting-related effects, and certain business
transformation-related costs. For a reconciliation of our Non-GAAP Gross Profit
to our total consolidated gross profit, see "Gross Profit and Non-GAAP Gross
Profit" above.
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Non-GAAP Net Income (Loss), Non-GAAP Operating Profit and Adjusted EBITDA
We present Non-GAAP Net Income (Loss), Non-GAAP Operating Profit and Adjusted
EBITDA because they are a basis upon which management assesses our performance
and we believe they are useful to evaluating our financial performance. We
believe that excluding items from net income that may not be indicative of, or
are unrelated to, our core operating results, and that may vary in frequency or
magnitude, enhances the comparability of our results and provides a better
baseline for analyzing trends in our business.
The Rackspace Acquisition was structured as a leveraged buyout of Rackspace
Technology Global, our Predecessor, and resulted in several accounting and
capital structure impacts. For example, the revaluation of our assets and
liabilities resulted in a significant increase in our amortizable intangible
assets and goodwill, the incurrence of a significant amount of debt to partially
finance the Rackspace Acquisition resulted in interest payments that reflect our
high leverage and cost of debt capital, and the conversion of Rackspace
Technology Global's unvested equity compensation into a cash-settled bonus plan
and obligation to pay management fees to our equityholders resulted in new cash
commitments. In addition, the change in ownership and management resulting from
the Rackspace Acquisition led to a strategic realignment in our operations that
had a significant impact on our financial results. Following the Rackspace
Acquisition, we acquired several businesses, sold businesses and investments
that we deemed to be non-core and launched multiple integration and business
transformation initiatives intended to improve the efficiency of people and
operations and identify recurring cost savings and new revenue growth
opportunities. We believe that these transactions and activities resulted in
costs, which have historically been substantial, and that may not be indicative
of, or are not related to, our core operating results, including interest
related to the incurrence of additional debt to finance acquisitions and third
party legal, advisory and consulting fees and severance, retention bonus and
other internal costs that we believe would not have been incurred in the absence
of these transactions and activities and are also may not be indicative of, or
related to, our core operating results.
We define Non-GAAP Net Income (Loss) as net income (loss) adjusted to exclude
the impact of non-cash charges for share-based compensation and cash charges
related to the settlement of our Predecessor's equity plan, transaction-related
costs and adjustments, restructuring and transformation charges, management
fees, the amortization of acquired intangible assets and certain other
non-operating, non-recurring or non-core gains and losses, as well as the tax
effects of these non-GAAP adjustments.
We define Non-GAAP Operating Profit as net income (loss), plus interest expense
and income taxes, further adjusted to exclude the impact of non-cash charges for
share-based compensation and cash charges related to the settlement of our
Predecessor's equity plan, transaction-related costs and adjustments,
restructuring and transformation charges, management fees, the amortization of
acquired intangible assets and certain other non-operating, non-recurring or
non-core gains and losses.
We define Adjusted EBITDA as Non-GAAP Operating Profit plus depreciation and amortization.
Non-GAAP Operating Profit and Adjusted EBITDA are management's principal metrics
for measuring our underlying financial performance. Adjusted EBITDA, along with
other quantitative and qualitative information, is also the principal financial
measure used by management and our board of directors in determining
performance-based compensation for our management and key employees.
These non-GAAP measures are not intended to imply that we would have generated
higher income or avoided net losses if the Rackspace Acquisition and the
subsequent transactions and initiatives had not occurred. In the future we may
incur expenses or charges such as those added back to calculate Non-GAAP Net
Income (Loss), Non-GAAP Operating Profit or Adjusted EBITDA. Our presentation of
Non-GAAP Net Income (Loss), Non-GAAP Operating Profit and Adjusted EBITDA should
not be construed as an inference that our future results will be unaffected by
these items. Other companies, including our peer companies, may calculate
similarly-titled measures in a different manner from us, and therefore, our
non-GAAP measures may not be comparable to similarly-tiled measures of other
companies. Investors are cautioned against using these measures to the exclusion
of our results in accordance with GAAP.
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The following table presents a reconciliation of Non-GAAP Net Income (Loss),
Non-GAAP Operating Profit and Adjusted EBITDA to our net loss for the periods
indicated:
Year Ended December 31,
(In millions) 2018 2019 2020
Net loss $ (470.6) $ (102.3) $ (245.8)
Share-based compensation expense 20.0 30.2 74.5
Cash settled equity and special bonuses (a) 36.1 24.1
37.5
Transaction-related adjustments, net (b) 31.5 22.5
46.7
Restructuring and transformation expenses (c) 44.8 54.3
104.8 Management fees (d) 15.9 16.2 8.4 Impairment of goodwill 295.0 - -
Net gain on divestiture and investments (e) (4.6) (101.6)
(0.7)
Net (gain) loss on extinguishment of debt (f) (0.5) (9.8)
71.5
Other (income) expense, net (g) (12.7) 3.3
(2.5)
Amortization of intangible assets (h) 164.2 167.5
176.3
Tax effect of non-GAAP adjustments (i) (53.9) (42.0) (119.4) Non-GAAP Net Income 65.2 62.4 151.3 Interest expense 281.1 329.9 268.4 Benefit for income taxes (29.9) (20.0) (66.2) Tax effect of non-GAAP adjustments (i) 53.9 42.0 119.4 Non-GAAP Operating Profit 370.3 414.3 472.9 Depreciation and amortization 609.7 496.0 466.2 Amortization of intangible assets (h) (164.2) (167.5) (176.3) Adjusted EBITDA$ 815.8 $ 742.8 $ 762.8
(a) Includes expense related to the cash settlement of unvested equity awards that were
outstanding at the consummation of the Rackspace Acquisition (amounting to
and
retention bonuses, mainly relating to restructuring and integration projects, and,
beginning in 2019, senior executive signing bonuses and relocation costs. The year
ended
successful completion of the IPO.
(b) Includes legal, professional, accounting and other advisory fees related to the
acquisitions of RelationEdge in 2018 and Onica in the fourth quarter of 2019 and the
IPO in the third quarter of 2020, integration costs of acquired businesses, purchase
accounting adjustments (including deferred revenue fair value discount), payroll costs
for employees that dedicate significant time to supporting these projects and
exploratory acquisition and divestiture costs and expenses related to financing
activities.
(c) Includes consulting and advisory fees related to business transformation and
optimization activities, payroll costs for employees that dedicate significant time to
these projects, as well as associated severance, facility closure costs and lease
termination expenses. We assessed these activities and determined that they did not
qualify under the scope of ASC 420 (Exit or Disposal costs).
(d) Represents historical management fees pursuant to management consulting agreements.
The management consulting agreements were terminated effective
therefore no management fees have accrued or will be payable for periods after August
4, 2020.
(e) Includes gains and losses on investment and from dispositions, including our
investment in CrowdStrike realized in 2019.
(f) Includes gains and losses on our repurchases of 8.625% Senior Notes.
(g) Reflects mainly changes in the fair value of foreign currency derivatives.
(h) All of our intangible assets are attributable to acquisitions, including the Rackspace
Acquisition in 2016.
(i) We utilize an estimated structural long-term non-GAAP tax rate in order to provide
consistency across reporting periods, removing the effect of non-recurring tax
adjustments, which include but are not limited to tax rate changes,
share-based compensation, audit conclusions and changes to valuation allowances. For
2018, 2019 and 2020, we used a structural non-GAAP tax rate of 27%, 26% and 26%,
respectively, which reflects the removal of the tax effect of non-GAAP pre-tax
adjustments and non-recurring tax adjustments on a year-over-year basis. The non-GAAP
tax rate could be subject to change for a variety of reasons, including the rapidly
evolving global tax environment, significant changes in our geographic earnings mix
including due to acquisition activity, or other changes to our strategy or business
operations. We will re-evaluate our long-term non-GAAP tax rate as appropriate. We
believe that making these adjustments facilitates a better evaluation of our current
operating performance and comparisons to prior periods.
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Non-GAAP Earnings Per Share (EPS)
We define Non-GAAP EPS as Non-GAAP Net Income divided by our GAAP average number
of shares outstanding for the period on a diluted basis, after giving effect to
the twelve-for-one stock split that was approved and effected on July 20, 2020
(the "Stock Split"), and further adjusted for the average number of shares
associated with securities which are anti-dilutive to GAAP earnings per share
but dilutive to Non-GAAP EPS. Management uses Non-GAAP EPS to evaluate the
performance of our business on a comparable basis from period to period,
including by adjusting for the impact of the issuance of shares that would be
dilutive to Non-GAAP EPS. The following table reconciles Non-GAAP EPS to our
GAAP net loss per share on a diluted basis:
Year Ended December 31,
(In millions, except per share amounts) 2019 2020
Net loss attributable to common stockholders $ (102.3) $ (245.8)
Non-GAAP Net Income $
62.4
Weighted average number of shares - Diluted 165.3 179.6 Effect of dilutive securities (a) 0.6 3.7 Non-GAAP weighted average number of shares - Diluted 165.9 183.3 Net loss per share - Diluted$ (0.62) $ (1.37) Per share impacts of adjustments to net loss (b) 1.00 2.21 Per share impacts of shares dilutive after adjustments to net loss (a) (0.00) (0.01) Non-GAAP EPS$ 0.38 $ 0.83
(a) Reflects impact of awards that would have been anti-dilutive to Net loss per share,
and therefore not included in the calculation, but would be dilutive to Non-GAAP EPS
and are therefore included in the share count for purposes of this non-GAAP measure.
Potential common share equivalents consist of shares issuable upon the exercise of
stock options, vesting of restricted stock or purchase under the ESPP, as well as
contingent shares associated with our acquisition of
our potential common share equivalents are contingent on Apollo achieving
pre-established performance targets based on a multiple of their invested capital
("MOIC"), which are included in the denominator for the entire period if such shares
would be issuable as of the end of the reporting period assuming the end of the
reporting period was the end of the contingency period. (b) Reflects the aggregate adjustments made to reconcile Non-GAAP Net Income to our net
loss, as noted in the above table, divided by the GAAP diluted number of shares
outstanding for the relevant period.
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Liquidity and Capital Resources
Overview
We primarily finance our operations and capital expenditures with
internally-generated cash from operations and hardware leases, and if necessary,
borrowings under our Revolving Credit Facility or Receivables Financing
Facility. As of December 31, 2020 , the Revolving Credit Facility provided for up
to $375 million of borrowings, none of which was drawn as of December 31, 2020 .
As of December 31, 2020 , $65 million was borrowed and outstanding under the
Receivables Financing Facility. Of this balance, approximately $15 million was
classified as current debt due to a borrowing base deficit under the facility
subsequent to December 31, 2020 . The amount of incremental borrowing capacity
available under the Receivables Financing Facility fluctuates based on the
eligibility of receivables held at a given time. Our primary uses of cash are
working capital requirements, debt service requirements and capital
expenditures. Based on our current level of operations and available cash, we
believe our sources will provide sufficient liquidity over at least the next
twelve months. We cannot provide assurance, however, that our business will
generate sufficient cash flows from operations or that future borrowings will be
available to us under the Revolving Credit Facility, the Receivables Financing
Facility or from other sources in an amount sufficient to enable us to pay our
indebtedness or to fund our other liquidity needs. Our ability to do so depends
on prevailing economic conditions and other factors, many of which are beyond
our control. In addition, upon the occurrence of certain events, such as a
change of control, we could be required to repay or refinance our indebtedness.
We cannot assure that we will be able to refinance any of our indebtedness,
including the Senior Facilities, the 5.375% Senior Notes and the 3.50% Senior
Secured Notes, on commercially reasonable terms or at all. Any future
acquisitions, joint ventures or other similar transactions will likely require
additional capital, and there can be no assurance that any such capital will be
available to us on acceptable terms or at all.
From time to time, depending upon market and other conditions, as well as upon
our cash balances and liquidity, we, our subsidiaries or our affiliates may
acquire (and have acquired) our outstanding debt securities or our other
indebtedness through open market purchases, privately negotiated transactions,
tender offers, redemption or otherwise, upon such terms and at such prices as
we, our subsidiaries or our affiliates may determine (or as may be provided for
in the Indentures, if applicable), for cash or other consideration.
On August 7, 2020 , we completed the IPO, in which we issued and sold 33,500,000
shares of our common stock at a public offering price of $21.00 per share. We
received net proceeds of $667 million from sales of shares in the IPO, after
deducting underwriters' discounts and commissions of $37 million , but before
deducting offering expenses of $9 million . We used a portion of the net proceeds
from the IPO to repurchase $601 million aggregate principal amount of the 8.625%
Senior Notes for aggregate cash of $647 million , including related premiums,
fees and expenses. The remaining amount of net proceeds will be used for general
corporate purposes.
On December 1, 2020 we issued $550 million aggregate principal amount of the
5.375% Senior Notes and used a portion of the proceeds to repurchase $259
million aggregate principal amount of the 8.625% Senior Notes and pay related
premiums, fees and expenses. On December 16, 2020 , we used the remaining net
proceeds from the issuance of the 5.375% Senior Notes, together with cash on
hand, to redeem and cancel the remaining $260 million aggregate principal amount
of outstanding 8.625% Senior Notes and paid related premiums, fees and expenses.
See "8.625% Senior Notes" and "5.375% Senior Notes" below for more information
on repurchases and issuances of debt completed during the year ended
December 31, 2020 .
At December 31, 2020 , we held $105 million in cash and cash equivalents (not
including $3 million in restricted cash, which is included in "Other non-current
assets"), of which $69 million was held by foreign entities.
We have entered into installment payment arrangements with certain equipment and
software vendors, along with sale-leaseback arrangements for equipment and
certain property leases that are considered financing obligations. We had
$123 million outstanding with respect to these arrangements as of December 31,
2020 . We may choose to utilize these various sources of funding in future
periods. Refer to Item 8 of Part II, Financial Statements and Supplementary Data
- Note 9, "Financing Obligations" for more information regarding financing
obligations.
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We also lease certain equipment and real estate under operating and finance
lease agreements. In June 2020 , we entered into lease amendments for two of our
data centers to, among other items, extend the lease term. Both lease amendments
were deemed a lease modification, which resulted in a change of classification
from operating leases to finance leases of $220 million . We had $579 million
outstanding with respect to operating and finance lease agreements as of
December 31, 2020 . We may choose to utilize such leasing arrangements in future
periods. Refer to Item 8 of Part II, Financial Statements and Supplementary Data
- Note 8, "Leases" for more information regarding our operating and finance
leases.
As of December 31, 2020 , we had $3,346 million aggregate principal amount
outstanding under our Term Loan Facility and 5.375% Senior Notes, with $375
million of borrowing capacity available under the Revolving Credit Facility.
Additionally, at December 31, 2020 , we had $65 million principal outstanding
under the Receivables Financing Facility. Our liquidity requirements are
significant, primarily due to debt service requirements.
On February 9, 2021 , we issued $550.0 million of 3.50% Senior Secured Notes that
will mature on February 15, 2028 and bear interest at a fixed rate of 3.50% per
year, payable semi-annually on each February 15 and August 15 through maturity.
The 3.50% Senior Secured Notes are not subject to registration rights.
On February 9, 2021 , we amended and restated the First Lien Credit Agreement,
which included a new seven-year $2,300.0 million senior secured first lien term
loan facility (the "New Term Loan Facility") and the Revolving Credit Facility.
We borrowed the entire $2,300.0 million New Term Loan Facility and used the
borrowings under the New Term Loan Facility, together with the proceeds from the
issuance of the 3.50% Senior Secured Notes described above, to repay all
borrowings under our existing Term Loan Facility, to pay related fees and
expenses and for general corporate purposes. The New Term Loan Facility will
mature on February 15, 2028 . We may request one or more incremental term loan
facilities up to a specified dollar amount plus additional amounts, subject to
compliance with applicable leverage ratios and certain terms and conditions.
Borrowings under the New Term Loan Facility bear interest at an annual rate
equal to an applicable margin plus, at our option, either (a) a LIBOR rate
determined by reference to the costs of funds for Eurodollar deposits for the
interest period relevant to such borrowing, adjusted for certain additional
costs, subject to a 0.75% floor, or (b) a base rate determined by reference to
the highest of (i) the federal funds rate plus 0.50%, (ii) the prime rate of
Citibank, N.A . and (iii) the one-month adjusted LIBOR plus 1.00%. The applicable
margin for the New Term Loan Facility is 2.75% for LIBOR loans and 1.75% for
base rate loans. Interest is due at the end of each interest period elected, not
exceeding 90 days, for LIBOR loans and at the end of every calendar quarter for
base rate loans.
Beginning June 30, 2021 , we will also be required to make quarterly amortization
payments on the New Term Loan Facility in an annual amount equal to 1.0% of the
original principal amount of the New Term Loan Facility, with the balance due at
maturity on February 15, 2028 .
Debt
Senior Facilities
OnNovember 3, 2016 , in conjunction with the Rackspace Acquisition, we entered into the First Lien Credit Agreement withCitibank, N.A . ("Citi") as the administrative agent. The Senior Facilities originally included the Term Loan Facility in the amount of$2,000 million , which was fully drawn at closing of the Rackspace Acquisition, and an undrawn Revolving Credit Facility of$225 million (together, the "Senior Facilities"). We may request additional Revolving Credit Facility commitments, and had the right to request additional Term Loan Facility commitments, in each case, up to a specified dollar amount plus additional amounts, subject to compliance with applicable leverage ratios and certain terms and conditions. The proceeds of the Term Loan Facility were used to partially finance the Rackspace Acquisition. The Term Loan Facility was set to mature onNovember 3, 2023 and the Revolving Credit Facility was originally set to mature onNovember 3, 2021 . OnAugust 7, 2020 , we increased the size of the Revolving Credit Facility to$375 million from$225 million and extended the maturity date of the Revolving Credit Facility toAugust 7, 2025 . OnJune 21, 2017 , we amended the terms of the First Lien Credit Agreement to reprice the Term Loan Facility, decreasing the applicable margin to 3.00% for "LIBOR" loans and 2.00% for base rate loans. We also raised an additional$100 million of incremental borrowings under the Term Loan Facility on the same terms as the repriced Term Loan Facility. The proceeds of the$100 million incremental term loans were used for general corporate purposes, including permitted acquisitions, capital expenditures and transaction costs. - 72 -
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OnNovember 15, 2017 , in connection with the Datapipe Acquisition, we raised an additional$800 million of incremental borrowings under the Term Loan Facility. The proceeds of the$800 million incremental term loans were used to finance a portion of the Datapipe Acquisition, repay certain ofDatapipe's existing debt obligations and pay related fees and expenses. Borrowings under the Senior Facilities bear interest at an annual rate equal to an applicable margin plus, at our option, either (a) a LIBOR rate determined by reference to the costs of funds for Eurodollar deposits for the interest period relevant to such borrowing, adjusted for certain additional costs, subject to a 1.00% floor in the case of the Term Loan Facility (and, effective uponAugust 7, 2020 , also in the case of the Revolving Credit Facility), or (b) a base rate determined by reference to the highest of (i) the federal funds rate plus 0.50%, (ii) the prime rate of Citi and (iii) the one-month adjusted LIBOR plus 1.00%. Interest is due at the end of each interest period elected, not exceeding 90 days, for LIBOR loans and at the end of every calendar quarter for base rate loans. We were required to make quarterly amortization payments on the Term Loan Facility in an annual amount equal to 1.0% of the original principal amount, including incremental borrowings since the Rackspace Acquisition, or$7 million per quarter, with the balance due at maturity.
As of
The Revolving Credit Facility has historically had an applicable margin of 4.00% for LIBOR loans and 3.00% for base rate loans and is subject to step-downs based on the net first lien leverage ratio. In connection with the amendment to the First Lien Credit Agreement, onAugust 7, 2020 , we reduced the applicable margin for the Revolving Credit Facility to 3.00% for LIBOR loans and 2.00% for base rate loans, with a 1.00% LIBOR "floor" applicable to LIBOR loans. The Revolving Credit Facility also includes a commitment fee equal to 0.50% per annum in respect of the unused commitments that is due quarterly. This fee is subject to one step-down based on the net first lien leverage ratio. The amendment onAugust 7, 2020 also extended the maturity date with respect to the Revolving Credit Facility fromNovember 3, 2021 toAugust 7, 2025 . In addition to the quarterly amortization payments discussed above, our Senior Facilities require us to make certain mandatory prepayments, including using (i) a portion of annual excess cash flow, as defined in the FirstLien Credit Agreement, to prepay the New Term Loan Facility, (ii) net cash proceeds of certain non-ordinary assets sales or dispositions of property to prepay the New Term Loan Facility and (iii) net cash proceeds of any issuance or incurrence of debt not permitted under the Senior Facilities to prepay the New Term Loan Facility. We can make voluntary prepayments at any time without penalty, subject to customary breakage costs. Rackspace Technology Global, our wholly-owned subsidiary, is the borrower under the Senior Facilities, and all obligations under the Senior Facilities are (i) guaranteed by Inception Parent, Rackspace Technology Global's immediate parent company, on a limited recourse basis and secured by the equity interests of Rackspace Technology Global held by Inception Parent and (ii) guaranteed by Rackspace Technology Global's wholly-owned domestic restricted subsidiaries and secured by substantially all material owned assets ofRackspace Technology Global and the subsidiary guarantors, including the equity interests held by each, in each case subject to certain exceptions. We have entered into interest rate swap agreements to manage the interest rate risk associated with interest payments on the Term Loan Facility that result from fluctuations in the LIBOR rate. See Item 8 of Part II, Financial Statements and Supplementary Data - Note 16, "Derivatives" for more information on the interest rate swap agreements. Over the course of 2020, we borrowed and repaid an aggregate$245 million under the Revolving Credit Facility. As ofDecember 31, 2020 , we had no outstanding borrowings under the Revolving Credit Facility. - 73 - -------------------------------------------------------------------------------- Table of Contents 8.625% Senior Notes OnNovember 3, 2016 , in conjunction with the Rackspace Acquisition, we completed the issuance of$1,200 million aggregate principal amount of 8.625% Senior Notes to qualified institutional buyers pursuant to Rule 144A under the Securities Act and outsidethe United States to non-U.S. persons pursuant to Regulation S under the Securities Act. The 8.625% Senior Notes were set to mature onNovember 15, 2024 and bore interest at a fixed rate of 8.625% per year, payable semi-annually on eachMay 15 andNovember 15 through maturity. The proceeds of the 8.625% Senior Notes were used to partially finance the Rackspace Acquisition. The 8.625% Senior Notes were not subject to registration rights. InDecember 2018 , we repurchased and surrendered for cancellation$3 million aggregate principal amount of 8.625% Senior Notes for$2 million , including accrued interest and excluding related fees and expenses. During 2019, we repurchased and surrendered for cancellation$77 million aggregate principal amount of 8.625% Senior Notes for$67 million , including accrued interest of$1 million and excluding related fees and expenses. Between August andDecember 2020 , Rackspace Technology Global repurchased or redeemed and cancelled the remaining aggregate principal amount of the$1,120 million outstanding 8.625% Senior Notes and paid related premiums, fees and accrued and unpaid interest for aggregate cash of$1,192 million . We funded the repurchases and redemptions with proceeds from the IPO and the issuance of the 5.375% Senior Notes. As ofDecember 31, 2020 , no 8.625% Senior Notes remained outstanding.
5.375% Senior Notes
Rackspace Technology Global issued$550 million aggregate principal amount of the 5.375% Senior Notes onDecember 1, 2020 . The 5.375% Senior Notes will mature onDecember 1, 2028 and bear interest at a fixed rate of 5.375% per year, payable semi-annually on eachJune 1 andDecember 1 , commencing onJune 1, 2021 through maturity. The proceeds of the 5.375% Senior Notes were used to fund the repurchase or redemption of all of our outstanding 8.625% Senior Notes and to pay related fees and expenses. The 5.375% Senior Notes are not subject to registration rights. Rackspace Technology Global is the issuer of the 5.375% Senior Notes, and obligations under the 5.375% Senior Notes are guaranteed on a senior unsecured basis by all of Rackspace Technology Global's wholly-owned domestic restricted subsidiaries (as subsidiary guarantors) that guarantee the Senior Facilities. The 5.375% Senior Notes are effectively junior to the indebtedness under the Senior Facilities, to the extent of the collateral securing the Senior Facilities. The 5.375% Indenture describes certain terms and conditions under which other current and future domestic subsidiaries are required to become guarantors of the 5.375% Senior Notes. Rackspace Technology Global may redeem the 5.375% Senior Notes at its option, in whole at any time or in part from time to time, at the following redemption prices: prior toDecember 1, 2023 , at a redemption price equal to 100.000% of the principal amount, plus the applicable premium described in the 5.375% Indenture and accrued and unpaid interest, if any, to but excluding the redemption date; fromDecember 1, 2023 toDecember 1, 2024 , at a redemption price equal to 102.688% of the principal amount, plus accrued and unpaid interest, if any, to but excluding the redemption date; fromDecember 1, 2024 toDecember 1, 2025 , at a redemption price equal to 101.344% of the principal amount, plus accrued and unpaid interest, if any, to but excluding the redemption date; and fromDecember 1, 2025 and thereafter, at a redemption price equal to 100.000% of the principal amount, plus accrued and unpaid interest, if any, to but excluding the redemption date. Rackspace Technology Global may also redeem up to 40% of the aggregate principal amount of the 5.375% Senior Notes with funds in an aggregate amount not to exceed the net cash proceeds from certain equity offerings at a redemption price equal to 105.375% of the principal amount of the 5.375% Senior Notes to be redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date.
As of
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Debt covenants
Our New Term Loan Facility is not subject to a financial maintenance covenant.
As of December 31, 2020 , our Revolving Credit Facility included a financial
maintenance covenant that limits the borrower's net first lien leverage ratio to
a maximum of 5.00 to 1.00. This ratio was modified from the historical 3.50 to
1.00 ratio on August 7, 2020 in the amendment of the First Lien Credit
Agreement. The net first lien leverage ratio is calculated as the ratio of (x)
the total amount of the borrower's first lien debt for borrowed money (which is
currently identical to the total amount outstanding under the Senior
Facilities), less the borrower's unrestricted cash and cash equivalents, to (y)
consolidated EBITDA (as defined under the First Lien Credit Agreement governing
the Senior Facilities). However, this financial maintenance covenant will only
be applicable and tested if the aggregate amount of outstanding borrowings under
the Revolving Credit Facility and letters of credit issued thereunder (excluding
$25 million of undrawn letters of credit and cash collateralized letters of
credit) as of the last day of a fiscal quarter is equal to or greater than 35%
of the Revolving Credit Facility commitments as of the last day of such fiscal
quarter. Additional covenants in the Senior Facilities limit our subsidiaries'
ability to, among other things, incur certain additional debt and liens, pay
certain dividends or make other restricted payments, make certain investments,
make certain asset sales and enter into certain transactions with affiliates.
The Indentures contains covenants that, among other things, limit our subsidiaries' ability to incur certain additional debt, incur certain liens securing debt, pay certain dividends or make other restricted payments, make certain investments, make certain asset sales and enter into certain transactions with affiliates.
Our "consolidated EBITDA," as defined under our debt instruments, is calculated in the same manner as our Adjusted EBITDA, presented elsewhere in this report, except that our debt instruments allow us to adjust for additional items, including certain start-up costs, and to give pro forma effect to acquisitions, including resulting synergies, and internal cost savings initiatives. In addition, under the Indentures, the calculation of consolidated EBITDA does not take into account substantially any changes in GAAP subsequent to the date of issuance, whereas under the Senior Facilities, the calculation of consolidated EBITDA takes into account the impact of certain changes in GAAP subsequent to the original closing date other than with respect to capital leases.
As of
Receivables Financing Facility
OnMarch 19, 2020 ,Rackspace US, Inc. ("Rackspace US"), aDelaware corporation and our wholly-owned indirect subsidiary, entered into the Receivables Financing Facility. Under the Receivables Financing Facility, (i) certain of our subsidiaries sell or otherwise convey certain trade receivables and related rights (the "Conveyed Receivables") toRackspace US and (ii)Rackspace US then sells, contributes or otherwise conveys certain Conveyed Receivables to our wholly owned bankruptcy-remote subsidiary (the "SPV"). The SPV may thereafter make borrowings from the lenders under the Receivables Financing Facility, which borrowings will be secured by the Conveyed Receivables. An affiliate of the administrative agent under the Receivables Financing Facility, in its capacity as a lender, has committed an amount up to$100 million under the Receivables Financing Facility.Rackspace US services and administers the Conveyed Receivables on behalf of the SPV.Rackspace Technology Global provides a performance guaranty to the administrative agent on behalf of the secured parties in respect of the obligations of the subsidiaries originating the receivables andRackspace US , as servicer, including, without limitation, obligations to pay the purchase price and indemnity obligations. The scheduled termination date of the Receivables Financing Facility isMarch 21, 2022 , subject to earlier termination due to a termination event described in the agreement governing the Receivables Financing Facility. Advances bear interest based on an index rate plus a margin. As ofDecember 31, 2020 , the interest rate on borrowings under the Receivables Financing Facility was 2.37%. The SPV is also required to pay a monthly commitment fee to each lender based on the amount of such lender's outstanding commitment. The Receivables Financing Facility contains representations and warranties, affirmative and negative covenants and events of default that are customary for financings of this type. - 75 -
-------------------------------------------------------------------------------- Table of Contents As ofDecember 31, 2020 ,$65 million was borrowed and outstanding under the Receivables Financing Facility. Subsequent toDecember 31, 2020 , the SPV repaid a portion of the Receivables Financing Facility in the amount of$15 million to cover a borrowing base deficit of approximately$14 million . The Receivables Financing Facility requires us to comply with a leverage ratio and an interest coverage ratio. We were in compliance with all applicable covenants under the Receivables Financing Facility as ofDecember 31, 2020 .
Capital Expenditures
The following table sets forth a summary of our capital expenditures for the
periods indicated:
Year Ended December 31,
(In millions) 2018 2019 2020
Customer gear (1) $ 225.7 $ 138.1 $ 127.2
Data center build outs (2) 29.1 9.0 15.3
Office build outs (3) 2.1 4.6 2.7
Capitalized software and other projects (4) 91.2 58.0 79.4
Total capital expenditures $ 348.1 $ 209.7 $ 224.6
(1) Includes servers, firewalls, load balancers, cabinets, backup libraries,
storage arrays and drives and certain software that is essential to the
functionality of customer gear, which we provide.
(2) Includes generators, uninterruptible power supplies, power distribution
units, mechanical and electrical plants, chillers, raised floor, network
cabling, other infrastructure gear and other data center building improvements.
(3) Includes building improvements, raised floor, furniture and equipment.
(4) Includes salaries and payroll-related costs of employees and consultants
who devote time to the development of certain internal-use software projects,
purchased software licenses and other projects that meet the criteria for
capitalization.
Capital expenditures were $225 million in 2020, compared to $210 million in
2019, an increase of $15 million . The majority of the increase is due to the
refresh of certain data center equipment within our normal maintenance cycle and
multi-year agreements for software and customer licenses.
Capital expenditures were $210 million in 2019, compared to $348 million in
2018, a decrease of $138 million , primarily due to the non-recurrence in 2019 of
several other factors driving higher capital expenditures in 2018. In 2018,
there was incremental capital spend related to Datapipe customers, higher spend
to deploy customer environments, reflecting the changed mix of Bookings, higher
customer demand for new devices due to the launch of a new server line,
investments in customer experience and product capabilities and integration
efforts in certain data centers. Capital expenditures in 2018 also included $61
million in upfront purchases of certain software licenses and equipment under
installment payment arrangements.
Cash Flows
The following table sets forth a summary of certain cash flow information for
the periods indicated:
Year Ended December 31,
(In millions) 2018 2019 2020
Cash provided by operating activities $ 429.8 $ 292.9 $ 116.7
Cash used in investing activities $ (348.3) $ (386.5) $ (128.4)
Cash provided by (used in) financing activities $ (53.7) $ (79.2) Cash Provided by Operating Activities
Net cash provided by operating activities results primarily from cash received
from customers, offset by cash payments made for employee and consultant
compensation (less amounts capitalized related to internal-use software that are
reflected as cash used in investing activities), data center costs, license
costs, third-party infrastructure costs, marketing programs, interest, taxes,
and other general corporate expenditures.
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Net cash provided by operating activities for 2020 decreased $176 million , or
60%, from 2019. This decrease was due to a $400 million increase in operating
expense payments, largely for third-party infrastructure costs, and a $70
million increase in employee-related payments, both reflecting the impact of the
Onica acquisition. These variances were partially offset by a $261 million
increase in cash collections, primarily reflecting higher revenue levels
resulting from the acquisition of Onica, a $20 million decrease in debt interest
payments and a $19 million decrease in obligations to settle share-based awards
in connection with the Rackspace Acquisition, as the final payment was made
during the three months ended March 31, 2019 .
Net cash provided by operating activities for 2019 decreased $137 million , or
32%, from 2018. This decrease was driven by lower cash collections in 2019 due
to lower revenue, coupled with higher cash payments for operating expenses.
These higher cash payments were primarily due to increased infrastructure
expense for third-party clouds reflecting growth in offerings utilizing those
third-party clouds. Other significant changes between periods included a $43
million decrease in employee-related payments due to a decline in headcount and
a $27 million decrease in payments related to our obligations to settle
share-based awards in connection with the Rackspace Acquisition.
Cash Used in Investing Activities
Net cash used in investing activities primarily consists of capital expenditures to meet the demands of our customer base and our strategic initiatives. The largest outlays of cash are for purchases of customer gear, data center and office build-outs, and capitalized payroll costs related to internal-use software development.
Net cash used in investing activities for 2020 decreased$258 million , or 67%, from 2019, mainly due to lower cash payments for acquisitions. Cash paid for the acquisition of Onica in 2019 was$316 million compared to$10 million paid for the acquisition ofBright Skies GmbH ("Bright Skies") in 2020. In addition, there was an$82 million decrease in cash purchases of property, equipment and software, as we increased our usage of financing arrangements in place of upfront cash payments to procure capital assets. The impact of these decreases was partially offset by the receipt of$110 million in proceeds related to the sale of equity investments in 2019, including$107 million from the sale of our CrowdStrike investment, and the receipt of$17 million in proceeds in 2019 related to the repayment of a promissory note receivable issued in conjunction with the 2017 sale of ourMailgun business. Net cash used in investing activities for 2019 increased$38 million , or 11%, from 2018, mainly due to higher cash payments for acquisitions. Cash paid for the acquisition of RelationEdge in 2018 was$65 million compared to$316 million paid for the acquisition of Onica in 2019. This was partially offset by a$96 million decrease in cash purchases of property, equipment and software and the receipt of$110 million in proceeds related to the sale of equity investments in 2019, including$107 million from the sale of our CrowdStrike investment. In addition, we received$17 million in proceeds in 2019 related to the repayment of a promissory note receivable issued in conjunction with the 2017 sale of ourMailgun business.
Cash Provided by or Used in Financing Activities
Financing activities generally include cash activity related to debt and other long-term financing arrangements (for example, finance lease obligations and financing obligations), including proceeds from and repayments of borrowings, and cash activity related to the issuance and repurchase of equity. Net cash provided by financing activities was$30 million for 2020 compared to net cash used in financing activities of$79 million for 2019. The change was primarily driven by net proceeds of$658 million from the IPO, which was comprised of$667 million in proceeds from the issuance of common stock, net of$9 million in offering fees paid. In addition, we received proceeds of$31 million from employee stock plans and borrowed$65 million under our Receivables Financing Facility in 2020. These net cash inflows were offset by net repayments on senior notes of$627 million , reflecting the repurchase of our 8.625% Senior Notes and issuance of 5.375% Senior Notes, compared to$66 million in 8.625% Senior Notes repurchases in 2019. In addition, there was a$42 million decrease in proceeds from other financing obligations and a$32 million increase in payments for other financing obligations in 2020 from 2019. - 77 - -------------------------------------------------------------------------------- Table of Contents Net cash used in financing activities for 2019 increased$26 million , or 47%, from 2018. The change was primarily driven by$66 million in repurchases of our 8.625% Senior Notes in 2019, an increase of$20 million in principal payments for financing obligations, and equity-related cash activity, which included$3 million of proceeds in 2018 compared to$5 million of payments in 2019. This was partially offset by$63 million in proceeds received in 2019 in conjunction with financing obligations related to equipment sale-leaseback arrangements. Additionally, we borrowed a total gross amount of$225 million under the Revolving Credit Facility over the course of the fourth quarter of 2019, primarily in connection with the closing of the Onica Acquisition. As ofDecember 31, 2019 , we had fully repaid these borrowings with a combination of the proceeds received from financing obligations, proceeds received from the sale of our CrowdStrike investment and internally-generated cash. Off-Balance Sheet Arrangements
During the periods presented, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities. These entities are typically established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
We have entered into various indemnification arrangements with third parties,
including vendors, customers, landlords, our officers and directors,
stockholders of acquired companies and third parties to whom and from whom we
license technology. Generally, these indemnification agreements require us to
reimburse losses suffered by third parties due to various events, such as
lawsuits arising from patent or copyright infringement or our negligence.
Certain of these agreements require us to indemnify the other party against
certain claims relating to property damage, personal injury or the acts or
omissions by us, our employees, agents or representatives. These indemnification
obligations are considered off-balance sheet arrangements. To date, we have not
incurred material costs as a result of such obligations and have not accrued any
material liabilities related to such indemnification obligations in our
consolidated financial statements. See Item 8 of Part II, Financial Statements
and Supplementary Data - Note 10, "Commitments and Contingencies" for more
information related to these indemnification arrangements.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with GAAP,
which requires us to make judgments and estimates that affect the reported
amounts of assets, liabilities, revenue, costs and expenses and related
disclosures. We consider accounting policies that require significant management
judgment and estimates to be critical accounting policies. We review our
estimates and judgments on an ongoing basis, including those related to business
combinations, revenue recognition, allowance for doubtful accounts, property,
equipment and software and definite-lived intangible assets, goodwill and
indefinite-lived intangible assets, contingencies, share-based compensation and
income taxes. We base our estimates on historical experience and on various
other assumptions that we believe to be reasonable under the circumstances to
determine the carrying values of assets and liabilities. In many instances, we
could have reasonably used different accounting estimates, and in other
instances, changes in the accounting estimates are reasonably likely to occur
from period-to-period. Accordingly, actual results could differ significantly
from the estimates made by our management. To the extent that there are material
differences between these estimates and actual results, our future financial
statement presentation, financial condition, results of operations and cash
flows will be affected.
Business Combinations
Mergers and acquisitions are accounted for using the acquisition method, in
accordance with accounting guidance for business combinations. Under the
acquisition method, we allocate the fair value of purchase consideration to the
tangible and intangible assets acquired ("identifiable assets") and liabilities
assumed based on their estimated fair values. The excess of the fair value of
purchase consideration over the fair values of these identifiable assets and
liabilities is recorded as goodwill. When determining the fair values of
identifiable assets acquired and liabilities assumed, including contingent
consideration when applicable, management makes significant estimates and
assumptions.
Critical estimates in valuing certain intangible assets include but are not
limited to discount rates and future expected cash flows from customer
relationships and developed technology. The fair value of equity and contingent
consideration includes estimates and judgments related to the discount rates and
future discounted cash flows based on management's internal forecasts, timing of
achievement of milestones and probability-weighted scenarios. Management's
estimates of fair value are based upon assumptions believed to be reasonable,
but which are inherently uncertain and unpredictable and, as a result, may
differ from estimates.
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Other estimates associated with the accounting for acquisitions may change as
additional information becomes available regarding the identifiable assets
acquired and liabilities assumed.
Revenue Recognition
We provide cloud computing to customers, which is broadly defined as the
delivery of computing, storage and applications over the Internet. Cloud
computing is a service transaction under which the services we provide vary on a
daily basis. The totality of services provided represent a single integrated
solution tailored to the customer's specific needs. As such, our performance
obligations to our customers consist of a single integrated solution delivered
as a series of distinct daily services. We recognize revenue on a daily basis as
services are provided in an amount that reflects the consideration to which we
expect to be entitled in exchange for the services.
Our usage-based arrangements generally include variable consideration components
consisting of monthly utility fees with a defined price and undefined quantity.
Additionally, our contracts contain service level guarantees that provide
discounts when we fail to meet specific obligations and certain products may
include volume discounts based on usage. As these variable consideration
components consist of a single distinct daily service provided on a single
performance obligation, we account for this consideration as services are
provided and earned.
Our largest source of revenue relates to fees associated with certain
arrangements within our Multicloud Services offerings that generally have a
fixed term, typically from 12 to 36 months with a monthly recurring fee based on
the computing resources utilized and provided to the customer, the complexity of
the underlying infrastructure and the level of support we provide. Contracts for
our service offerings falling within our Apps & Cross Platform and OpenStack
Public Cloud segments and public cloud service offerings within our Multicloud
Services segment typically operate on a month-to-month basis and can be canceled
at any time without penalty.
We also provide customers with professional services for the design and
implementation of application, security and data services. Professional service
contracts are either fixed-fee or time-and-materials based. We typically
consider our professional services to be a separate performance obligation from
other integrated solutions being provided to the same customer. Our performance
obligations under these arrangements are typically to provide the services on a
daily basis over a period of time and we recognize revenue as the services are
performed.
We offer customers the flexibility to select the best combination of resources
in order to meet the requirements of their unique applications and provide the
technology to seamlessly operate and manage multiple cloud computing
environments. Judgment is required in assessing whether a service is distinct,
including determination of whether the customer could benefit from the service
on its own or in conjunction with other readily available resources and whether
certain services are highly integrated into a bundle of services that represent
the combined output specified by the customer. Arrangements can contain multiple
performance obligations that are distinct, which are accounted for separately.
Each performance obligation is recognized as services are provided based on
their standalone selling price ("SSP"). Judgment is required to determine the
SSP for each of our distinct performance obligations. We utilize a range of
prices when developing our estimates of SSP. We determine the range of prices
for estimating SSP for all our performance obligations using observable inputs,
such as standalone sales and historical contract pricing. Our estimates of SSP
are updated quarterly.
In addition, our customer agreements provide that we will achieve certain
service levels related primarily to network uptime, critical infrastructure
availability and hardware replacement. We may be obligated to provide service
credits for a portion of the service fees paid by our customers to the extent
that such service levels are not achieved or are otherwise disputed. Credit
memos are recognized in the period of service to which they relate.
Revenue recognition for revenue generated from arrangements in which we resell
third-party infrastructure bundled with our managed services, requires judgment
to determine whether revenue can be recorded at the gross sales price or net of
third-party fees. Typically, revenue is recognized on a gross basis when it is
determined that we are the principal in the relationship. We are considered the
principal in the relationship when we are primarily responsible for fulfilling
the contract and obtain control of the third-party infrastructure before
transferring it as an integral part of our performance obligation to provide
services to the customer. Revenue is recognized net of third-party fees when we
determine that our obligation is only to facilitate the customers' purchase of
third-party infrastructure.
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Valuation of Accounts Receivable and Allowance for Doubtful Accounts
We record an allowance for doubtful accounts on trade accounts receivable for
estimated losses resulting from uncollectible receivables. When evaluating the
adequacy of the allowance, we consider historical bad debt write-offs and all
known facts and circumstances such as current economic conditions and trends,
customer creditworthiness and specifically identified customer risks. If actual
collections of customer receivables differ from our estimates, additional
allowances may be required which could have an impact on our results of
operations.
Property, Equipment and Software and Definite-Lived Intangible Assets
In providing services to our customers, we utilize significant amounts of
property, equipment and software, which we depreciate on a straight-line basis
over their estimated useful lives. Definite-lived intangible assets are
primarily comprised of customer relationships and are stated at their
acquisition-date fair value less accumulated amortization. These intangible
assets are amortized on a straight-line basis over their estimated useful lives.
Property and equipment under operating and finance leases are included within
"Operating right-of-use assets" and "Property, equipment and software, net,"
respectively, in our Consolidated Balance Sheets. Operating right-of-use assets
are amortized on a straight-line basis over the lease term whereas finance lease
assets are amortized on a straight-line basis over the shorter of the estimated
useful lives of the assets or the lease term. We routinely review the estimated
useful lives of our property, equipment and software and definite-lived
intangible assets ("long-lived assets"). A change in the useful life of a
long-lived asset is treated as a change in accounting estimate in the period of
change and future periods.
Long-lived assets, including operating right-of-use assets and finance lease
assets, are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount may not be recoverable. Recoverability of
assets is measured at the asset group level and if the carrying amount of the
asset group exceeds its estimated undiscounted future cash flows, an impairment
charge is recognized in the amount by which the carrying amount of the asset
group exceeds its fair value.
We capitalize the salaries and related compensation costs of employees and
consultants who devote time to the development of certain internal-use software
projects. Judgment is required in determining whether an enhancement to
previously developed software is significant and creates additional
functionality to the software, thus resulting in capitalization. All other
software development costs are expensed as incurred. Capitalized software
development costs are amortized over the expected useful life of the software,
which is generally three years; however, we evaluate the nature and utility of
each project which can result in a useful life ranging between one and five
years on certain projects.
Goodwill represents the excess of the purchase price over the fair value of identifiable net assets of businesses acquired. Our indefinite-lived intangible assets consists of our Rackspace trade name, which was recorded at fair value on our balance sheet at the date of the Rackspace Acquisition. Application of the goodwill and other indefinite-lived intangible asset impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units and determination of the fair value of each reporting unit. We test goodwill and our indefinite-lived intangible asset, the Rackspace trade name, for impairment on an annual basis as ofOctober 1st or more frequently if events or circumstances indicate a potential impairment. These events or circumstances could include a significant change in the business climate, regulatory environment, established business plans, operating performance indicators or competition.Goodwill is tested for impairment at the reporting unit level. A reporting unit is an operating segment or one level below an operating segment (referred to as a component). We allocate goodwill to reporting units based on the reporting unit expected to benefit from the business combination. Assets and liabilities are assigned to each of our reporting units if they are employed by a reporting unit and are considered in the determination of the reporting unit fair value. Certain assets and liabilities are shared by multiple reporting units, and thus, are allocated to each reporting unit based on the relative size of a reporting unit, primarily based on revenue. We have three reporting units: Multicloud Services, Apps & Cross Platform and OpenStack Public Cloud. - 80 - -------------------------------------------------------------------------------- Table of Contents We estimate the fair values of our reporting units and the Rackspace trade name using the discounted cash flow method and relief-from-royalty method, respectively. These calculations require the use of significant estimates and assumptions, such as: (i) the forecasted royalty rate; (ii) the estimation of future revenue and projected margins, which are dependent on internal cash flow forecasts; (iii) estimation of the terminal growth rates and capital spending; and (iv) determination of discount rates. The discount rates used are based on our weighted average cost of capital and are adjusted for risks and uncertainties inherent in our business and in our estimation of future cash flows. The estimates and assumptions used to calculate the fair value of our reporting units and the Rackspace trade name from year to year are based on operating results, market conditions, and other factors. Changes in these estimates and assumptions could produce materially different results. As a result of our annual goodwill impairment test performed during the fourth quarter of 2018, we determined that the carrying amount of our Multicloud Services reporting unit exceeded its fair value and recorded a goodwill impairment charge of$295 million , resulting in a decrease of approximately 16% in the goodwill allocated to this reporting unit. The impairment was driven by a significant decrease in forecasted revenue and cash flows and a lower long-term growth rate, as current and forecasted industry trends reflected lower demand for traditional managed hosting services. The results of our goodwill impairment test for the years endedDecember 31, 2019 and 2020 did not indicate any impairments of goodwill.
Contingencies
We accrue for contingent obligations when the obligation is probable and the amount is reasonably estimable. As facts concerning contingencies become known, we reassess our position and make appropriate adjustments to the recorded accrual. Estimates that are particularly sensitive to future changes include those related to tax, legal and other regulatory matters, changes in the interpretation and enforcement of international laws, and the impact of local economic conditions and practices, which are all subject to change as events evolve and as additional information becomes available during the administrative and litigation process. Changes in our estimates and assumptions could have a material impact on our consolidated financial statements.
Share-Based Compensation
We account for share-based awards under the recognition and measurement provisions of ASC 718 (Compensation-Stock Compensation). Share-based compensation cost is measured at the grant date based on the fair value of the underlying common stock and is recognized as expense over the requisite service period. The fair value of stock options with vesting conditions dependent upon market performance is determined using a Monte Carlo simulation. Determining the grant date fair value of share-based awards with performance vesting conditions and the probability of such awards vesting requires judgment. Prior to the completion of our IPO onAugust 7, 2020 , there had been no public market for our common stock since the Rackspace Acquisition in 2016. The estimated fair value of our common stock was determined by our board of directors as of the grant date of each option grant, with input from management, including consideration of our most recent third-party valuations of our common stock, which were completed periodically throughout the fiscal year. The third-party valuation specialists used the Income Approach to estimate the value of our equity. Within the Income Approach, the valuation specialists relied upon the Discounted Cash Flow ("DCF") method, which focused on our estimated expected cash flow available for distribution to the equityholders. The DCF calculation was prepared based on detailed revenue and expense projections prepared by management as part of its annual budgeting process and reflected the financial and operational facts and circumstances specific to our company. Significant assumptions impacting the DCF calculation also included expected future capital expenditures, our long-term growth rate, and the applicable discount rate. For purposes of capturing the dilution from outstanding options, the valuation utilized the Option-Pricing Method ("OPM"). The OPM depended on key assumptions regarding the volatility and time to a liquidity event but did not require explicit estimates of the possible future outcomes. The input and assumptions used in this calculation were total equity value, time to liquidity, expected volatility and dividends, which were all determined by management. A discount for lack of marketability was not applied as its impact was already reflected in the equity value through the discount rate, given that there were no differential rights attributable to different shareholders (as we have only one class of shares). These estimates were complex, involved a number of variables, uncertainties and assumptions and the application of management's judgment, as they were inherently subjective. - 81 - -------------------------------------------------------------------------------- Table of Contents Income Taxes We are subject to income taxes in theU.S. and numerous foreign jurisdictions. Significant judgments and estimates are required in evaluating our tax positions and determining our provision for income taxes. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final tax outcome of these matters will not be different. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made. Our effective tax rates may differ from the statutory rate for various reasons, including differences due to the tax impact of foreign operations, research and development tax credits, state taxes, contingency reserves for uncertain tax positions, certain benefits realized related to share-based compensation, executive compensation that is nondeductible under IRC Section 162(m), changes in the valuation of our deferred tax assets or liabilities, or from changes in tax laws, regulations, accounting principles or interpretations thereof. In addition, we are subject to the continuous examination of our income tax returns by theU.S. Internal Revenue Service (the "IRS"), Her Majesty's Revenue and Customer and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements, which will result in taxable or deductible amounts in the future. In evaluating our ability to recover our deferred tax assets within the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies and results of recent operations. The assumptions about future taxable income require significant judgment and are consistent with the plans and estimates we are using to manage the underlying businesses. For a description of accounting pronouncements recently adopted and issued, see Item 8 of Part II, Financial Statements and Supplementary Data - Note 1, "Company Overview, Basis of Presentation, and Summary of Significant Accounting Policies." - 82 -
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