C3.ai, Inc. Q3 FY2022 Earnings Call

Good afternoon, and thank you for joining today's C3 AI Third Quarter Fiscal Earnings Call. My name is Amber, and I will be your moderator for this call. It's now my pleasure to turn the conference over to our host, Paul Phillips with C3 AI. Paul, please proceed.

Good afternoon, and welcome to C3 AI's earnings call for the third quarter of fiscal year 2022, which ended January 31, '22. My name is Paul Phillips, and I'm the Vice President of Investor Relations. With me on the call today is Tom Siebel, Chairman and Chief Executive Officer. After the market closed today, we issued a press release with details regarding our third quarter results as well as a supplement to our results both of which can be accessed on the Investor Relations section of our website at ir.c3.ai. This call is being webcast, and a replay will be available on our IR website following the conclusion of the call. During today's call, we will make statements relating to our business that may be considered forward-looking under federal securities laws. These statements reflect our views only as of today and should not be considered representative of our views as of any subsequent date. We disclaim any obligation to update any forward-looking statements or outlook. These statements are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations. For a further discussion of the material risks and other important factors that could affect our actual results, please refer to our filings with the SEC. Also, during the course of today's call, we will refer to certain non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in our press release. Finally, at times in our prepared comments and response to your questions, we may discuss metrics that are incremental to our usual presentation to give greater insight into the dynamics of our business or our quarterly results. Please be advised that we may or may not continue to provide this additional detail in the future. With that, let me turn the call over to Tom for his prepared remarks. Tom?

Thank you, Paul. Hello, everyone. I'm glad to have you with us today for a briefing on our recently concluded quarter. It was a strong quarter for us. Our third quarter results showed robust performance across all aspects of our business, with a year-over-year revenue growth of 42%. We saw exceptionally strong activity in new business. Our results were driven by increased sales momentum, attributed to the successful realignment of our sales organization, growth in customer numbers, expansions of the C3 application footprint with existing customers, and greater industry diversification for our AI products and sales. Key highlights from the third quarter include total revenue of $69.8 million, which is a 42% year-over-year increase. Subscription revenue was $57.1 million, up 34%. Our customer count increased by 82% year-over-year, reaching 218. Non-GAAP gross profit for the quarter stood at $55.8 million, marking an 80% gross margin. Notably, our GAAP remaining performance obligations now represent 168% of annualized Q3 sales. Regarding customer successes and expansions, contracts signed this quarter showed significant industry diversification. Our revenue breakdown reveals that 32% came from utilities, 30% from chemicals, 20% from agribusiness, and 12% from financial services. I previously mentioned our commitment to growing business with small and medium customers, and I’m proud to say we made significant advances here. During the quarter, we signed 12 agreements under $1 million; 3 contracts between $1 million and $5 million; 2 transactions between $5 million and $10 million; and 3 agreements in the $10 million to $50 million range. Shell, one of our largest clients, continues to extend its use of the C3 application, currently monitoring over 10,000 devices with C3 AI's machine learning models across 23 large-scale production assets, including the Pernis refinery in Europe—one of the largest. Shell processes 1.3 trillion predictions each month with our suite and has expanded both the duration and scale of its contract with us during this quarter. The Department of Defense awarded us a 5-year, $500 million agreement, allowing any DoD agency to acquire our suite of enterprise AI applications without going through a competitive bidding process. We also established a production deployment with the Defense Counterintelligence and Security Agency and gained additional business from the U.S. Space Force. LyondellBasell, a major player in the plastics and chemicals sector, signed a 5-year contract to enhance its application of enterprise AI and machine learning. Royal Philips expanded its partnership with us to improve resilience and visibility for its North American supply chains. Cargill extended its AI contract to broaden its deployment of the C3 AI Supply Chain Suite. ENGIE expanded its C3 AI contract to deliver a wider range of AI-driven energy and sustainability solutions. Swift also stepped up its partnership with us, utilizing our Financial Services Suite. Our collaboration with Baker Hughes C3.ai continues to grow rapidly, and I will provide more updates on that later. Turning to corporate highlights, we successfully realigned our sales organization in the third fiscal quarter, leading to immediate and positive results. We have appointed Lisa Davis to our Board of Directors, a seasoned leader from the industrial and energy sector with over 30 years of experience. We received a notable boost in the federal sector with the passing of the fiscal year 2022 National Defense Authorization Act, which calls for increased access for commercial AI solutions for the DoD. This change indicates a pivotal shift in procurement practices, favoring commercial software like ours over custom solutions. C3 AI has opened a new software development and professional services center in Guadalajara, Mexico, planning to hire up to 1,000 senior engineers to meet increasing global demand. We have a solid cash position with $1.02 billion in cash and investments, enabling us to continue investing in our market leadership. Regarding go-to-market partnerships, we are collaborating closely with major players like Microsoft, AWS, Google Cloud, and Baker Hughes. We have achieved significant business with Microsoft, currently engaged in over 50 active joint discussions. Our partnership with AWS has also flourished, with over $70 million closed in business this year. Our relatively new partnership with Google Cloud has led to active engagement in 42 joint prospects, with a dedicated team collaborating closely on sales initiatives. Google is a platinum sponsor of our upcoming C3 Transform conference in Miami, where their CEO will deliver a keynote address. Baker Hughes remains a crucial partner, having expanded our agreement significantly, and we saw 32% of our revenue come from this partnership in Q3, a significant rise from the previous year. We are looking at a vast addressable market; recent IDC data indicates the total market for enterprise AI software is projected to grow from $365 billion this year to over $590 billion by 2025. C3 AI is one of the leading players in this rapidly expanding market. In summary, it has been a strong quarter for us, marked by sales growth, strategic partnerships, and technology leadership. Additionally, I want to inform you that last Friday, Adeel Manzoor, our CFO for the past 12 weeks, resigned for personal reasons. We will not comment further on this. Juho Parkkinen, our experienced Controller and Chief Accounting Officer, has been promoted to acting CFO effective immediately. With that, I’ll hand it over to Juho for more details about the quarter.

Thanks, Tom. I'll start with a review of our third quarter results. And following that, I'll provide our outlook for the fourth quarter and full fiscal year '22, then we'll be happy to take your questions. First, let's start with the third quarter results. Total revenue for the quarter was $69.8 million, up 42% year-over-year and above our guidance range of $66 million to $68 million. Subscription revenue was $57.1 million, up 34% year-over-year. Subscription revenue was approximately 82% of total revenue in the third quarter compared to 87% a year ago. Professional services revenue was $12.7 million. As Tom mentioned earlier, for the third quarter, remaining performance obligations or GAAP RPO, increased by 90% on a year-over-year basis to $469.3 million, up from $247.5 million last year, of which $171.6 million is expected to be recognized over the next 12 months and the remainder thereafter. Non-GAAP RPO increased by 81% to $536.7 million, up from $295.9 million last year. The RPO growth reflects a healthy industry mix as Tom mentioned in his earlier remarks. Baker Hughes-related RPO growth to third-party companies contributed 32% of total growth in RPO compared to 18% in the year-ago period. As of Q3 FY '22, customer count increased to 218, up 82% year-over-year. We believe this reflects the success of our go-to-market strategy of entering into large enterprise agreements with our customer entities and expanding within those customer entities. During the quarter, we performed an analysis of our customer entity usage and found that our previous customer count did not capture all the distinct divisions, departments, business units or groups within customer entities that are using our software or services. As part of the earnings release under section Other Metrics, we have provided the apples-to-apples comparison of customer count using the appropriate calculation. You will see that we have previously undercounted our customers. We will present the revised calculation of customers on a go-forward basis as we believe this provides more clarity and accuracy. Moving down the income statement. I will be discussing all metrics on a non-GAAP basis unless otherwise noted. As a reminder, our non-GAAP amounts exclude stock-based compensation expense and the employer portion of payroll tax expense related to stock transactions. A GAAP to non-GAAP reconciliation is provided with our earnings press release. Gross profit was $55.8 million in the third quarter, an increase of 50% from a year ago, primarily driven by revenue growth from new and existing contracts. Gross margin was 80% compared to 76% a year ago. This improvement reflects the inherent leverage in our operating model as our business continues to scale. Subscription gross margin in the quarter was 83%, in line with 84% one year ago, and professional services gross margin was 66% compared to 21% a year ago. Operating expenses were $71.5 million, up 45% from a year ago, reflecting our continuous and planned investments in research and development, brand awareness, and sales and marketing. We expect to continue to invest aggressively in sales and marketing and R&D to expand our market share and increase our presence in target industry verticals and geographic markets while continuing to extend our technology leadership position as the enterprise AI software company. All of these initiatives will drive growth in our business. Total operating loss was $15.7 million in the third quarter. Turning to our balance sheet and cash flows. We ended the quarter with $1.02 billion in cash, cash equivalents, and investments with no debt. Operating cash flow for the quarter was an outflow of $55.4 million, and after capital expenditures of $0.8 million, free cash outflow was $56.2 million. At quarter-end, deferred revenue was $59.4 million compared to $62.3 million in the prior year. We are well-positioned to continue to invest in our growth and execute on our growth strategy. Turning to our guidance for the fourth quarter and full year of fiscal '22. Our growing diversified customer base and increased sales momentum reinforce our confidence as we look forward. For the fourth quarter, we expect total revenue in the range of $71 million to $72 million, representing a growth of 36% to 38% from a year ago. We expect to continue to invest in R&D and sales and marketing that will drive the future growth of our business and anticipate a non-GAAP operating loss between $34 million and $30 million. For the full year of fiscal '22, we are increasing our revenue guidance to the range of $251 million to $252 million, representing a growth of 37% to 38%. We anticipate a non-GAAP operating loss in the range of $94 million to $90 million, an improvement from our prior guidance. In addition, the early indicators for Q1 fiscal '23 have us expecting a similar total revenue as for Q4 fiscal '22 and for the full year fiscal '23, the analyst consensus is in line with our growth expectations. In summary, we're pleased to report third-quarter results that were ahead of our guidance ranges. We are excited about our current sales momentum and customer growth as well as diversification, all of which supports our outlook for the remainder of fiscal '22 and beyond. With that, I'll turn the call over to the operator for questions.

Our first question comes from Pat Walravens with JMP.

It's JMP, not JPMorgan. Mr. Parkkinen, congratulations on your promotion. If you don't mind, I'd like to start with a question for you, then I'll ask one for Tom. Also, thank you for providing an overview of what next year might look like; that's very helpful. However, with the rapid changes in CFO leadership, my question is whether you are assured that there are no issues with accounting or financial reporting at C3.

Yes, thank you for that question. Yes, I've been here for a little over a year. I joined as the Vice President of Accounting, very quickly assumed the role of a Controller. In December, I was promoted to be Chief Accounting Officer. And I've been intimately involved with all the financial statements ever since I joined. I have no concerns whatsoever that all of our financials are top-notch and in line with generally accepted accounting principles. I'd like to also add that we have a very, very qualified accounting team. Just in the past year, we've enhanced the capabilities internally significantly, including multiple CPAs, lots of big four background, lots of master's degrees as well as we use external providers to help us in various technical accounting topics. So overall, I think our accounting is in top shape, and the financial statements are in top shape.

Okay, great. That's very helpful. Tom, considering the tragic situation in Ukraine, it appears that the greatest opportunity for C3 to make a significant impact is by assisting our Department of Defense and possibly those of our allies. If you could discuss the potential there, I think that would be interesting.

Great question, Pat. I think that business activity that we're seeing in the U.S. federal area in the defense intelligence community is very significant. This change in federal procurement policy is very significant, basically mandating the Secretary of Defense put in procedures in place to ensure that commercial software is considered first. And right now, the DoD has 600 build-it-yourself projects. So this affects all 600 of those projects. We are very actively engaged with the Department of the Army, the Department of the Air Force and with some of the intelligence agencies in some very large projects. We just received, as you know, $0.5 billion transaction authorization, making it very easy for these departments to opt to procure with us. So we are expanding that business in a very substantial way. General Ed. Cardon joining us, the Head of Federal Systems, H.R. McMaster recently joining our Advisory Board, Condi Rice on the Board. I think you'll see some additional significant additions to the Federal Advisory team. And I think we're going to be very, very well positioned to help serve the United States federal government and the Department of Defense. And to the extent that we have the opportunity to do so, we consider it a privilege. So I think that looks like a big opportunity, and we are very focused on it.

Our next question comes from Jamie Shelton with Deutsche Bank.

Can you hear me okay?

You're loud and clear, Jamie.

Brilliant. I'm on for Patrick Colville. Just a quick one for me. I noticed customer entities ticked down by 3 sequentially. If possible could you provide any additional color there, if there is any.

Juho here. We define a customer entity as one that generates revenue during the period. In the lifecycle of a customer, there may be trials in a quarter that will count towards the customer total for that period. However, in the following quarter, the customer might not be ready to make a purchase, which can lead to fluctuations in the customer count. Therefore, it's normal to see ups and downs in individual quarters, but we expect the overall trend of customer entities to continue increasing.

Brilliant. Very clear. And sorry, just one more, if I may. Could you quickly unpack your expectations for subscription versus services growth? Because one is clearly outperforming the other? I mean, how do you kind of look at that going forward?

I think Jamie, you can expect, and we've been pretty consistent in that. I mean, you're going to expect to see that services are going to be in the 15% to 20% range from quarter-to-quarter. And we clearly are a computer software company. We are not a services company. We are focused on staying a computer software company. And we continue to outsource a lot of the services business we do rather than take that revenue ourselves. So that will be the strategy. But you can expect it's going to kind of bounce around the 15% to 20% range from quarter-to-quarter as it has.

There are no further questions in the queue. Our next question comes from Sanjit Singh with Morgan Stanley.

Tom, I have a question. I appreciate the details on some of the deal sizes. You mentioned a dozen or so deals under $1 million, which is quite unusual for C3, but it seems you are moving in that direction. For those deals, what are the customers purchasing? Is Ex Machina driving those deals? Are they starting off with a single app? Any context on what those sub $1 million deals consist of?

I think there are three categories. The largest is trials, which we typically conduct as paid trials. These usually fall in the $400,000 to $600,000 range for a paid trial. Occasionally, for a straightforward proof-of-concept trial, the payment may be $250,000, which is included in that category. The expectation is that a successful trial will lead to a larger enterprise license agreement one, two, or three quarters after the trial ends. The second category consists of Ex Machina transactions, which are generally under $1 million and represent the bulk of our activity. Sometimes, there may be requests for minor professional services or similar offerings, but the first two categories cover most of it. We anticipate that this segment's mix will increase going forward.

Right. My follow-up question, Tom, concerns the return to the traditional strategic account model and the resurgence of new business. If I simplify things by comparing the federal business, like DoD and federal government opportunities, to the enterprise opportunity, it appears that the enterprise space is fragmented with many players involved. Additionally, the evolving preferences of buyers regarding AI adoption are still being clarified. So, considering the near-term growth potential over the next 12 to 24 months, should we anticipate that C3 will focus primarily on federal as the main growth driver? Or will there continue to be a balance between government and nongovernment business?

Thank you for your question. The answer is no, we do not see ourselves becoming a federal contractor. While we are engaged in discussions with the federal government and welcome those opportunities, we anticipate that federal business will represent about 15% of our operations in the long term. The majority of our business will come from other regions: approximately 40% from North America, 40% from EMEA, and 20% from APAC, excluding China, where we do not operate. Therefore, we are not shifting towards being a federal contractor.

Our next question comes from Mark Murphy with JPMorgan.

Tom, we've just heard from Snowflake and several other data, analytics, and infrastructure companies about a slowdown in consumption trends over the holidays and into January. There has also been some impact from lower CPU pricing from Amazon and other cloud platforms affecting these companies. Given the strength of your guidance, should we conclude that you have not experienced any slowdown in consumption, even though it may not directly affect you, or that more users are taking longer vacations or anything similar?

Well, with 42% growth, you can assume that we exceeded our guidance and surpassed any consensus expectations. We are quite pleased with this level of growth, which places us among the fastest-growing software companies. Looking ahead to next year, we are comfortable with the consensus guidance of around 33%. We are not detecting any noticeable slowdown at this time.

Yes. And just to clarify, yes, it's all above my numbers, which were probably pretty in line.

Even your numbers, I didn't know that was possible, okay.

Yes, that happened. But yes, I just wanted to try to clarify or to kind of draw that contrast, but it didn't seem like you saw that this probably running around.

I think our growth rate, we should be in the upper decile next year of rapidly growing software companies.

Yes, yes. Okay. My other question is...

By the way as it will be this year.

My other question is regarding the commodity price for oil and gas, which has sharply increased in a way we haven't seen in a long time. Given your exposure in this area, is there anything notable regarding the pipeline? Does this increase seem to translate into greater spending capacity for those oil and gas customers?

I absolutely agree, with the exception of oil and gas companies in Russia. Looking at Q4 and Q1, we have been working on some business that we expected to close in Russia, but the chances of that happening are pretty low. I would say the probability is close to none. This situation moderates our outlook for Q4 and Q1 somewhat. There are three deals in Russia that will not materialize anytime soon, but for the rest of the oil and gas sector, I believe we can expect these companies to increase their investments.

Okay. Is it safe to assume that, that nets out positively, if it's 3 deals that won't happen and the rest is in good shape?

Yes.

Our next question comes from Jamie Shelton with Deutsche Bank.

Apologies, guys. I had no question. All good here.

Our next question comes from Mike Cikos of Needham & Company.

Thank you for including me in the Q&A. I apologize if this has already been addressed, but I've been listening to several earnings calls this evening. I wanted to inquire about the sales reorganization and the refocusing. I know you have mentioned the realignment. Can you share any insights or data points that could help us understand potential improvements in sales activity or productivity resulting from the sales reorganization discussed in the previous quarter?

Yes. First, thank you for the question, Mike. To clarify, there was no sales reorganization. We still have the same organization in place, but we did change the sales methodology to our traditional strategic selling approach. So it's the same sales team, just a different traditional way of selling. I think the biggest indication of our success is the change in RPO. Help me out, Juho, what was the change in RPO?

So I think, Mike, the best way to think about this is to aid the diversity in RPO. If we go sequentially, I know Tom mentioned in the last earnings call.

Let's discuss diversity. The increase in RPO was driven by 32% from utilities, 30% from chemicals, 20% from agribusiness, 11% from financial services, 2.6% from oil and gas, with the remainder coming from life sciences, manufacturing, and others. It was quite diverse, involving a significant number of agreements. Juho, what else would you like to add to respond to Mike's question?

I think in general, Mike, that the overall activity was just significantly improved in Q3 versus Q2.

Thank you for the clarification. I apologize for coming in late, but I would like to ask if you can provide any insights on the adoption or pipeline development for CRM. Additionally, how has the reception been for Data Vision? Any information on either of these would be appreciated.

We are preparing for a major release called C3 AI Version 8, scheduled for March. This will involve a substantial rewrite of nearly our entire technology stack. We will launch this at C3 Transform, our International Users Group event in Miami during March. Additionally, Data Vision will be deeply integrated into almost all of our products. Our CRM solution is just being introduced to the market, and there is significant interest, indicating strong potential. The CRM market is valued at $120 billion this year, encompassing software and services. There is considerable enthusiasm for making CRM implementations predictive. Importantly, our approach is not about replacing existing systems like Salesforce or Dynamics; instead, we enhance them by adding predictive capabilities, such as AI-driven revenue forecasting and relationship modeling. I believe that interest in this area will grow and, in a year, it could become a substantial business, although it will take time to develop fully.

Just building on that, I think on the previous earnings call as well, as it relates to CRM, you had spoken to substantial interest coming from the global SIs for that product and exactly what you said, not the rip and replace so much is the standing up C3 on top of that to drive at that AI that you guys are delivering. So thank you very much. I appreciate you taking the time for the questions.

Thank you. To reiterate, that is ongoing. I believe that at our users conference, there will be participation from Accenture, PwC, and others. This presents a significant opportunity with the strategic integrators.

There are no additional questions waiting at this time, so I will pass the conference back over to the management team for closing remarks.

Thank you all very much for your time. We're very pleased to announce that it was an exceptional quarter. We exceeded our expectations and the market's expectations. I believe we have our sales organization back on track. Our customers continue to accelerate their implementations at a significant rate. As we enter the fourth quarter of this fiscal year, the company is on track, doing exactly what we committed to when we went public. We feel quite optimistic. Thank you for your time, and we look forward to continuing this discussion with you. Have a great day, everybody.

That concludes the C3 AI Third Quarter 2022 Fiscal Year Earnings Call. Thank you for your participation. You may now disconnect your lines.