Earnings Call Transcript - AI Q3 2021

Operator, Operator

Thank you for joining us for the C3.ai Third Quarter Fiscal Year 2021 earnings call. All participants are currently in listen-only mode. Following the presentation, there will be a question-and-answer session. I would now like to turn the call over to our speakers, Paul Phillips, Vice President of Investor Relations at C3.ai. Please proceed.

Paul Phillips, Vice President of Investor Relations

Good afternoon, everybody. And welcome to C3.ai's earnings call for the third quarter of fiscal year 2021, which ended January 31, 2021. This is Paul Phillips, Vice President of Investor Relations for C3.ai. With me on the call today are Tom Siebel, Chairman and Chief Executive Officer; and David Barter, Chief Financial Officer. After the markets 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 related 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. These risks are summarized in the press release that we issued today. For a further discussion of the material risks and other important factors that could affect our financial results, please refer to our filings with the SEC, including our prospectus. 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 or responses to your questions, we may discuss metrics that are incremental to our usual presentation to provide 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 Siebel, Chairman and Chief Executive Officer

Thank you, Paul, and good afternoon, everyone. It's my great pleasure to have the opportunity to spend some time with you this afternoon. So let's talk about the company and talk about the market. Overall, we're really quite pleased with the progress that we continue to make in the market globally. We continue to break ground as the only enterprise AI software pure play. This is a large and rapidly growing market. We continue to innovate and expand our market partner ecosystem along with the associated increased distribution capacity. We continue to demonstrate technology leadership. I believe we are increasingly well positioned to establish a global market leadership position in enterprise AI software. So let's talk about the financial highlights. All in all, it was a strong third quarter. Revenue in the third quarter was $49.1 million. $42.7 million of that was subscription revenue, an increase of 23% from a year earlier. Subscriptions have increased to 87% of our revenue mix. Services revenue for the quarter was $6.4 million or 13% of total revenue, representing a decrease of 4% from a year ago. Non-GAAP operating expenses for the quarter increased to $49.2 million, up 27% from a year ago, and a non-GAAP operating loss for the quarter was $11.9 million compared to $8.4 million a year ago. Let's talk about the overall state of the market. When we think about enterprise AI and digital transformation, we are focused on an extraordinarily large addressable market that analysts estimated was $174 billion in 2020, increasing to $271 billion by 2024. This is a significant opportunity by any standard and the largest software market opportunity that I have seen in my professional career. Digital transformation enabled by enterprise AI remains at the top of the agenda of virtually every CEO and board globally. We see increasingly robust interest and demand for enterprise AI solutions, and our pipeline continues to grow substantially across all industries in all regions. Let me address some significant customer wins in the third quarter. Firstly, Infor. We have formed a strategic wide-ranging relationship with Infor, a multi-billion dollar ERP software provider. Under the terms of the agreement, Infor will be integrating many existing Infor applications with the C3.ai suite and the C3.ai applications to market, sell, and deploy AI-based solutions to their customers under the Infor brand. This will evolve into a broader partnership with Infor to market C3.ai solutions to Infor customers, including C3.ai reliability, C3.ai CRM, and C3.ai Ex Machina, a next-generation predictive analytics application that empowers anyone to develop, scale, and produce AI-based insights without writing code. Secondly, I want to talk about Johnson Controls in Milwaukee. Johnson Controls recently selected C3.ai for their inventory and supply chain optimization. Johnson Controls is a $23.5 billion company and a leading manufacturer of fire, HVAC security equipment for building and energy services. Finally, I want to talk about an opportunity at the United States Army, where we expanded our work with US Army Aviation to improve aircraft readiness. In addition, with our partner Raytheon, we recently began work on the US Army's next-generation tactical ground station that will enable automated processing and analytics of massive amounts of incoming sensor data for improved situational battlefield awareness. This is very advanced technology, think Star Wars-level technology. This AI-based system will provide decision support to commanders based on information coming from a multitude of sensors and sources within the C3.ai suite, synthesizing risk into a single unified data image. I want to talk about industry diversification. We continue to diversify across industries. We're seeing increasing contributions from the life sciences, financial services, and high-tech sectors, as well as increasingly healthy growth in international sales. High tech accounted for 8% of our business in fiscal year '21 year-to-date compared to less than 1% for the same period a year ago. Life sciences accounted for 7% of our business in fiscal year '21 year-to-date, compared to less than 1% for the same period a year ago. The manufacturing sector accounted for 11% of our business in fiscal year '21 year-to-date compared to approximately 1% over the same period a year ago. At the same time, oil and gas accounted for 38% of our business in fiscal year 2021 year-to-date compared to approximately 59% a year ago. Addressing strategic partnerships is core to our market growth strategy. We are evolving our global direct geographic and vertical market sales organizations to include major accounts, enterprise sales, mid-market sales, and mass market sales channels. We realized significant benefits from these efforts in the third quarter with increased geographical expansion, increased vertical diversification, significant growth in software subscriptions, and importantly, increased volume and diversity in the average contract in our sales pipeline. Our average total subscription contract value decreased from $12.1 million in fiscal year '20 to $5.2 million in Q3 fiscal '21, which is substantial progress. We're continuing to build and increase our engagement with our partner ecosystem as a key growth strategy, enabling us to significantly expand our market reach and serve customers across industries globally. In the third quarter, we established expanded partnerships with Microsoft, Baker Hughes, ENGIE, Shell, Infor, FIS, and Raytheon, and you can expect to see continued activity, accelerated activity in this area going forward. In the financial services sector, our industry partner, FIS AML compliance hub powered by C3.ai, represents the first joint product release under a broad alliance between FIS and C3.ai. This solution leverages C3.ai’s advanced machine learning technology, combined with the deep financial industry domain expertise of FIS, to significantly improve the effectiveness of financial crime detection. We also closed our first AI CRM deal with a Fortune 500 customer through our partnership with Microsoft. We believe AI will represent a significant and growing part of the $60 billion-plus CRM market globally. In the defense sector, we engaged with our defense industry partner Raytheon to provide technology for the US Army’s intelligent ground station initiative. As I referenced earlier, we formed a comprehensive alliance with Infor to integrate many existing Infor applications using the C3.ai suite and C3.ai applications, enabling Infor to market these applications to its customers through all its channels. You can expect that in the coming quarters, we will make increased efforts to expand our market partner ecosystem across both horizontal and vertical markets as we see this as a key leverage point for market growth. We focused extensively on strengthening company leadership and expanded the company's leadership with the addition of Jim Snabe, formerly co-CEO of SAP and Chairman of Zeeman's, also Chairman of Mayers, to the C3.ai Board of Directors. I've come to rely on Jim as a trusted advisor as he has been an advisor to the company for some time. As we work to establish C3.ai as a leading global enterprise software company, he brings a unique set of leadership skills and expertise to the company and is a great addition to our world-class Board. In addition, we continue to expand our global advisory board. This has been critically important in establishing customer relationships and building our presence in various countries and industries. The advisory board now includes Jacques Attali, who is founder and first President of the European Bank for Reconstruction and Development and former special advisor to the President of France; Sajid Javid, who is a Member of Parliament and former Home Secretary and former Chancellor of Exchequer in the UK; Admiral Danny McGinn, former US Assistant Secretary of the Navy in the Obama Administration; Rick Ledgett, former deputy director of the NSA in the Obama Administration; Franck Cohen, former President of SAP in Europe; and George Matthew, former President and COO of Alteryx. Many of you who have been tuned into financial channels or reading the Wall Street Journal or Financial Times have noticed that we have been investing in branding globally. We expanded our enterprise AI branding campaign to include significant cable TV and radio presence with spots running on virtually all the major business and financial networks in the United States and Europe. We also expanded our advertising to include the UK, EMEA, APAC, as well as the United States. We are becoming increasingly known as the enterprise AI market leader. Leading indicators of brand equity and brand recognition have been substantially increasing, including public relations volume, news sentiment, social media sentiment, and internet search frequency. Let’s talk about energy sustainability. The energy and sustainability market is back and it is on fire, so we are seeing increased interest for AI-enabled solutions in this market. This market is rapidly growing. Over the last year alone, the number of companies and governments that have committed to reaching net zero emissions has doubled. You have likely seen the flood of announcements from companies such as ENGIE, Shell, Baker Hughes, Microsoft, Amazon, Ford, BP, JetBlue, American Airlines, and others announcing their zero carbon commitments. Sustainability is also clearly a top priority for the new US administration, targeting a $2 trillion investment in climate security. C3.ai is a leader in this space. Energy and climate sustainability is the core market where we started with our first product offering in 2010, C3 Energy Management, which we have deployed in production use with many large organizations globally, including ENGIE and the New York Power Authority. One iconic Fortune 100 company has been a customer since 2012. They have set ambitious sustainability goals and use our energy management application to identify and prioritize their energy efficiency and carbon reduction investments globally to meet their climate goals. Many utilities use C3.ai technology and C3 Energy Management not only to optimize their energy usage and improve grid infrastructure but also to help their customers meet their energy efficiency and greenhouse gas reduction goals. A great example is New York Power Authority, which deployed C3.ai Energy Management as a service, enabling its large commercial and industrial customers to achieve their energy efficiency and greenhouse gas goals. With our energy partner ENGIE, we're delivering innovative solutions built with C3 Energy Management. Ohio State University, for example, has deployed ENGIE Smart Institutions built on C3.ai technology to reduce and manage energy use and carbon footprint across its entire 485 building campus in Columbus. We're also working with ENGIE on a novel, cutting-edge solution addressing the very difficult challenges of managing Scope 3 emissions, a problem that requires an entirely new technological approach. In the third quarter, we significantly expanded our efforts and investment in the C3.ai Digital Transformation Institute, issuing a new call for papers to find innovative research and apply AI and digital transformation to energy and climate security. We're very excited to support this next wave of research by providing cleaner, safer, lower-cost, and more reliable energy and assisting in leading the way to a lower carbon future. We are exceptionally well positioned for this new opportunity. Many of you will know that C3.ai was recognized by Glassdoor as the best place to work during the pandemic. We were ranked among the top 25 cloud computing companies with stellar employee satisfaction throughout the COVID crisis. This ranking is based on employee feedback provided through Glassdoor during the first six months of the pandemic. I encourage those of you who are interested to take a look at Glassdoor to gauge the high levels of employee engagement and enthusiasm in C3.ai. As you know, we place an exceptionally strong focus on human capital at C3.ai, and we are aggressively expanding the company. In a few short months since the company went public in December, we've increased our headcount by approximately 10% to roughly 560 today. We continue to attract massive interest from the global data science and data engineering software pools. In the third quarter, we received over 17,000 job applicants, we conducted 30,966 interviews with over 1,700 candidates, and administered almost 700 assessments. Of that, we hired 60 full-time employees and we've processed an additional 57 job offers that have been accepted. One of the unique aspects of C3.ai is our clear technology and product differentiation. We continue to protect the company's intellectual property with a combination of trade secrets, copyrights, trademarks, and a growing family of US and foreign patents, with 13 US and foreign patents awarded and 40 US and foreign patent applications pending. The US Patent Office recently awarded us a broad and important patent entitled systems, methods, and devices for an enterprise AI development platform. This is the most significant and substantial patent awarded to date. This patent essentially secures the fundamental concepts of applying a model-driven architecture for enterprise AI applications and protects C3.ai’s intellectual property while we work to establish a technology licensing office at C3 to license some of this IP to companies that choose to internally develop their enterprise AI applications. Big picture, we see robust and growing interest in the enterprise AI software solutions that we offer. We continue to make significant progress on all fronts and our objective to establish and maintain a global leadership position in enterprise AI. We continue to aggressively grow the company, diversify our business across industries and geographies, and expand our partner ecosystem. We believe we are very well positioned to address the $200 billion plus addressable market opportunity, and we are just getting started. With that, I will turn it over to our CFO, David Barter, for further details on our financial results in the third quarter.

David Barter, Chief Financial Officer

Thank you, Tom. We delivered a strong performance in the third quarter and we are optimistic about the growing demand we’re seeing for our software. Revenue in the third quarter was $49.1 million, up 19% from a year ago, reflecting continued business momentum and increased adoption of enterprise AI. During the third quarter, subscription revenue was $42.7 million, an increase of 23% from a year ago. Professional services revenue was $6.4 million, a decrease of 4% from a year ago. We also saw an increasing diversification of our revenue mix. Our revenue growth in the quarter was highlighted by contributions from over six different industry verticals, including some of our newer verticals, such as life sciences and financial services, that delivered approximately 24% of our third-quarter revenue. Geographically, EMEA and APAC drove over 30% of our revenue. Finally, it's important to note the improving operating efficiency. This quarter, subscription revenue increased 23% year-over-year while non-GAAP sales and marketing expense increased 14% year-over-year. An important aspect of our model is the usage of market partners. It is a leveraged selling model that significantly extends our sales reach into each industry vertical. Our partners possess deep domain expertise in their respective vertical markets, a commitment to enterprise AI, and a significant customer base that will benefit from our enterprise AI applications. This will provide us with sales leverage over time. It is worth noting that our contract with Baker Hughes, our market partner for oil and gas, includes a very specific contractual commitment. It is a five-year agreement and the total contract value is $450 million. Their commitment to C3.ai increases over the five-year term of the agreement, which offers predictable growth in the years ahead. For example, the Baker Hughes commitment is $75 million in fiscal year '22, compared to $53 million in fiscal year '21. Our contractual backlog continues to provide us with healthy revenue visibility. It is important to note that we use adjusted RPO to measure our backlog. This metric includes our GAAP remaining performance obligations, our contracts with a cancellation clause, and the Baker Hughes commitment. At the end of Q3, adjusted RPO was $538 million, up 16% from the prior year. Within adjusted RPO, the GAAP RPO was $247.5 million, our contracts with a cancellation clause were $48.4 million, and the Baker Hughes commitment was $241.8 million. With this healthy revenue visibility and coverage from an unusually large contractual backlog, we continue to focus on expanding our footprint within existing customers, adding new market partners, and adding new customers in existing and new industry verticals. In discussing our expenses and profitability, I will be referring to non-GAAP measures unless otherwise indicated. A GAAP to non-GAAP reconciliation is provided with our earnings press release, which can be found in the IR section of our website and is on file with the SEC. The difference between our GAAP and non-GAAP financial measures in the quarter was stock-based compensation expense. Gross margin in the third quarter was 75.9% compared to 73.8% a year ago. This expansion was driven by subscription gross margin, which increased to 84% compared to 74.7% in the prior year period. Operating expenses increased to $49.2 million, up 27% from a year ago. As Tom described, we are making significant investments in R&D to bring new products to market that can enhance our growth. C3.ai CRM and C3.ai Ex Machina are two such initiatives. We are also investing in our go-to-market efforts, including the expansion of our direct sales force, as well as investments in brand awareness, market education, and enterprise AI thought leadership. The operating loss for Q3 was $11.9 million or a margin of 24.3% compared to $8.4 million or a margin of 20.3% a year ago. Turning to our balance sheet and cash flows, we ended the third quarter with $1.12 billion in cash and cash equivalents. This includes net proceeds of $844.6 million from our Initial Public Offering in December. Our operating cash outflow for the period was $24.7 million due primarily to increased investments in sales, marketing, and headcount. CapEx in Q3 was $0.2 million, leading to a free cash outflow of $24.9 million. The timing of our billings and collections can vary. To capture a complete picture of our cash flow margin, it is recommended and calculated on a rolling four-quarter basis. For the last four quarters, our free cash flow margin was a negative 24%. Deferred revenue was $63.3 million at the end of the quarter. It's important to note that deferred revenue is not a perfect measure for our business due to the quarter-to-quarter variability and the timing of invoices to our customers and our historical large transaction sizes. In addition, our billing terms vary. For some contractual arrangements, we are not billing at inception but instead we will bill a customer periodically over the duration of the agreement. These customers’ revenue commitments do not appear in deferred revenue. At the end of the third quarter, we booked several deals that will generate $4.1 million of revenue, but this amount is not in our deferred revenue. Looking to the fourth quarter, we expect total revenue to be in a range of $50 million to $51 million, representing approximately 21% year-over-year growth at the midpoint of the range. Non-GAAP loss from operations is expected to be in the range of $28 million to $27 million. For full fiscal year 2021, we expect total revenue to be in the range of $180.9 million to $181.9 million, representing approximately 16% year-over-year growth at the midpoint of the range. Historically, the difference between our GAAP and our non-GAAP financial measures has been limited to stock-based compensation expense. Beginning with this guidance for the fourth quarter and full year fiscal 2021 and in future reporting periods, the difference between GAAP and non-GAAP measures will include stock compensation expense and the employer portion of payroll tax expense related to stock transactions. In summary, we are pleased with our strong performance in our first quarter as a public company. Our results and outlook reflect growing market demand from enterprises across an increasing range. With continued investments in multiple growth drivers, we're increasingly well positioned to capitalize on a large multibillion-dollar market opportunity, generating value for all of our stakeholders. Thank you for joining today's call. Now I'll turn the call over to the operator for questions.

Operator, Operator

Your first question comes from the line of Brad Sills with BofA Securities.

Brad Sills, Analyst

I wanted to ask about the vertical partner focus here. Obviously, you talked about some leverage that you'll see from some of these partnerships. Could you help us understand, perhaps some of the newer ones like Raytheon and FIS? These are relatively new verticals for the company. What kind of resources are committed from these partners? How are you going to market together? How are you expected to get that leverage through these partnerships? Thank you so much.

Tom Siebel, Chairman and Chief Executive Officer

I'll address this one as it pertains to sales and marketing. As you know, we're targeting three main areas. Our horizontal market partners include major players like Microsoft, alongside IBM and NVIDIA. We're establishing a geographic marketing division in North America, Asia Pacific, and Europe. Additionally, we have specialized sales teams in various sectors such as oil and gas, utilities, financial services, and precision health. The objective for each of these sectors is to collaborate closely with strategic market partners. A prime example is Baker Hughes. In oil and gas, we have partnered with Baker Hughes, which is approximately a $24 billion oil services firm, providing us access to 12,000 sales personnel working with us globally. We are actively engaging with nearly all of the largest oil companies, including Aramco, ADNOC, Rosneft, Gazprom, and Shell, giving us substantial sales capacity. In financial services, we maintain a strong and fruitful relationship with Bank of America and several applications, as well as with Standard Chartered Bank. We have developed a comprehensive product line that meets the demands of financial institutions, covering areas like anti-money laundering, cash management, securities lending, Volcker Rule compliance, and inter-day liquidity. Through our partnership with FIS, which generates around $12 to $13 billion in banking revenue, we now have access to their 20,000 banking clients worldwide. Regarding Infor, although I’m uncertain about the exact number of salespeople they have, it’s significant. They generate billions in software sales and are now incorporating our software solutions as integral to their offerings. With contributions from companies like Microsoft and Adobe in customer relationship management, alongside our efforts in oil and gas with Baker Hughes, banking with FIS, and manufacturing with Infor, we are coordinating with tens of thousands of salespeople who are promoting our offerings globally. If we successfully implement this strategy over the next two to three years, I believe we can achieve market dominance before our competitors arrive. This strategy is crucial for us, and we consider it one of our core strengths. You can expect dedicated individuals, including myself, to invest substantial time in this area. We recently appointed Gene Reznik, formerly the Chief Strategy Officer at Accenture, to lead this initiative focused on our vertical market partners. We anticipate significant investments moving forward and further announcements regarding these partnerships that will strengthen our competitive position.

Brad Sills, Analyst

And then one more, if I may please. The concept of embedding C3’s platform into some of these horizontal categories. You mentioned an early win with the Microsoft partnership here for C3.ai-enabled CRM. Infor is a new partner for ERP. Can you remind us a bit on where you are with those partnerships? I know they're early. How quickly does it take one of these partners to ramp up from an integration standpoint and then go to market? When do you think you'll see the leverage out of those two partnerships in particular? Thanks.

Tom Siebel, Chairman and Chief Executive Officer

I think with Baker Hughes, we’ve been engaged for around five quarters now. If I'm not mistaken, guys?

David Barter, Chief Financial Officer

Seven quarters.

Tom Siebel, Chairman and Chief Executive Officer

Seven quarters. Thank you, guys. Baker Hughes is a large global company, and they're fully engaged. We're building probably four products together to bring to market, and we already have two products in the marketplace. We're fully engaged. Granted, Infor is brand new, and FIS is relatively new. You can expect it will take one, two, three, or four quarters to get these going and generate the momentum. It's not going to happen overnight, but we're building a revenue capacity flywheel, and once you start looking at calendar year '22 and '23, this will be a significant force.

Operator, Operator

Your next question comes from the line of Jack Andrews with Needham.

Jack Andrews, Analyst

I want to see if you could expand a little bit on your go-to-market strategy around the Ex Machina product. I believe this is somewhat of a different offering from the solutions that you've historically sold. So how should we be thinking about your strategy? Is this something that you expect the uptake to be mainly from your existing base of customers, or do you expect Ex Machina to effectively draw in some brand new customers to the C3.ai family?

Tom Siebel, Chairman and Chief Executive Officer

Ex Machina is a product that we've had in the market for some time. We are releasing this now, and we've done all the necessary work with documentation, stack overflow, online training, and community support to offer this as a mass market product. You can think of this as serving the same market needs currently met by Alteryx, which is associated with the democratization of data science. This allows people who would typically be doing analytics with pivot tables on Excel to conduct no-code, low-code, WYSIWYG (what you see is what you get) data science. What we've released is a 21st-century version of that solution. The democratization of data science is critical. This isn't going to happen solely through hiring 50 PhD-level data scientists from MIT at $250,000 each. We need to provide the tools that allow anyone to apply data science to their business to achieve the benefits, and that's what Ex Machina is all about. While Alteryx is a fine company, it has some constraints. It runs on any computer you want as long as it's on-premise with Windows. Ex Machina, on the other hand, runs on any computer that supports a browser; it's entirely cloud-native. Whereas Alteryx can handle data up to two gigabytes, we manage data for organizations like Aneel, Shell, and UnitedHealthcare, dealing with hundreds of petabytes, not just a couple of gigabytes. Ex Machina is a mass-market product, available for a free trial today, and I encourage you to check it out. After your 30-day free trial, it costs around $300 per month. Our goal is to build a significant customer base.

Operator, Operator

Your next question comes from the line of Michael Turits with Keybanc.

Michael Turits, Analyst

I was really pleased to see the Fortune 500 deal in the Microsoft partnership. I was wondering if you can elaborate on that and tell us what the value creation was there and why that seems promising going forward.

Tom Siebel, Chairman and Chief Executive Officer

We have a number of significant partners and we go to market with AWS, Google, and many others. However, I would say the organization that aligns most closely with our DNA is Microsoft. They are strong in enterprise selling, and we've managed to align with them. We're collaborating with some of the largest organizations in the world, including the United States government and Shell. Our partnership is productive and they understand the enterprise landscape. They believe we understand that process too, and we're selling with them across oil and gas, utilities, and banking. We have a significant pipeline of transactions with Microsoft, and they are willing to bring out high-level executives such as Satya or Judson if they need to close a deal. They're a fantastic partner.

Michael Turits, Analyst

And Tom, if I could just get you to provide a macro forecast for a moment. You did 20% sequential growth and almost 9% sequential growth in the quarter, but that's the most you've seen in seven quarters. Is this an indication that demand or macro factors are leading to larger projects?

Tom Siebel, Chairman and Chief Executive Officer

I think our subscription revenue growth was about 24%, which is pretty healthy. This is what we're focused on, not the services line. We want to keep our services line under control, which we have made clear by disaggregating those figures. In January 2020, we were growing rapidly, with last fiscal year's growth rate at 71% top line. However, when COVID impacted us, especially in February and March, everything came to a halt. Businesses shut down across major cities, which was a significant speed bump for us. However, as stimulus measures took effect, we found a dramatic uptick in business starting around June, which encouraged us to pursue going public. We're seeing a significant acceleration in our business and believe that as we move into fiscal year '22 and '23, we will see increased growth rates. The market is healthy, and we know how to grow a business rapidly.

Operator, Operator

Your next question comes from the line of Dan Ives with Wedbush. Your line is open.

Dan Ives, Analyst

Tom, could you talk about how your customer conversations have changed over the past six to nine months compared to a year ago? It feels like there has been a shift from push to pull. What are some of the drivers and some anecdotal conversations you've had with CEOs and CIOs?

Tom Siebel, Chairman and Chief Executive Officer

I did not anticipate the effects of the IPO on our brand, but the impact has been significant. The IPO and associated PR have substantially enhanced our perceived credibility in the business. We're seeing a notable increase in pipeline growth, and conversations are happening faster. Companies are coming in with the default assumption that it works and asking how it can work for them. In terms of executive hiring, nearly everyone will return calls at this point. The IPO, the global economy, and a focus on digital transformation and AI have positioned us well.

Operator, Operator

Your next question comes from the line of Mark Murphy with JP Morgan.

Mark Murphy, Analyst

We've seen excitement around a commodity super cycle, especially in oil due to pandemic recovery. How does your energy deal pipeline today compare to a year ago? I don't believe you've commented on PETRONAS; could you provide insights on that as well? How different is that pipeline, and do oil and gas companies feel more pressure to modernize during tough times, or more inclination to spend during a super cycle?

Tom Siebel, Chairman and Chief Executive Officer

I don’t pretend to be an expert in the energy market, but it's been fascinating to observe. Our relationship with Baker Hughes is extraordinarily positive. We have frequent discussions and collaboration at an unprecedented level. When oil prices plummeted to negative $37 a barrel during the early COVID period, energy companies faced significant challenges. Yet, after re-evaluating, companies like Shell, which is roughly a EUR300 billion business, recognized the need to reinvent themselves. They're transitioning towards renewable energy, and the fluctuations in oil prices are prompting energy companies to adopt AI technologies to evolve and remain competitive.

Mark Murphy, Analyst

David, could you clarify how the GAAP RPO or backlog behaved sequentially in the January quarter? I'm not sure I caught that number correctly.

David Barter, Chief Financial Officer

Our GAAP RPO is down sequentially, from 267.4 million last quarter to 247.5 million.

Tom Siebel, Chairman and Chief Executive Officer

One change we've made is to engage more flexibly with customers. Before the IPO, we were strict about only committing to irrevocable, nonrefundable contracts. Now, we're focusing on expanding market share, engaging in multi-year transactions, some of which may include cancelable clauses. This has slightly impacted our RPO, but it makes us easier to work with and supports revenue growth.

David Barter, Chief Financial Officer

The cancelable component of RPO has increased from 37.1 million to 48.4 million, a sequential rise of 30%.

Operator, Operator

Your next question comes from the line of Patrick Colville with Deutsche Bank.

Patrick Colville, Analyst

I have a two-part question. I want to just clarify the delta between RPO and billings. Looking at the quarter, billings appeared to be off about 5%, while adjusted RPO is up 16%. Can you help me understand why that might be?

David Barter, Chief Financial Officer

In previous quarters, our billing may have intersected with deferred revenue issues. However, with the flexibility we’ve developed, certain parts of our deals are not flowing through deferred revenue that are strengthening our overall metrics.

Operator, Operator

Your next question comes from the line of DJ Hynes with Canaccord.

DJ Hynes, Analyst

Tom, considering your need to build domain expertise while entering new verticals, how much of that success stems from your internal development versus the Lighthouse accounts with which you're partnering? How are you replicating your model as you grow in new markets?

Tom Siebel, Chairman and Chief Executive Officer

One of the significant aspects of our strategy is that across all markets, whether it's predictive maintenance for F-35 jets or churn analysis at Bank of America, 99% of the code we install is the same across our entire installed base because of our architecture. We don’t need to understand how a turbine works to build effective digital twins for those units. We leverage partnerships to access subject matter experts, but 99% of our code remains consistent across various applications, which gives us the flexibility to operate in diverse industry verticals without needing extensive domain expertise.

Operator, Operator

Your next question comes from the line of Peggy Yu with Morgan Stanley.

Peggy Yu, Analyst

First, regarding the pipeline, you've mentioned seeing greater customer interest and substantial growth in your pipeline. I wanted to see if you could give us some insight on pipeline conversion trends as the year progresses?

Tom Siebel, Chairman and Chief Executive Officer

I apologize, but I don’t have those specific pipeline conversion trends with me right now. It's a legitimate question, and I’ll ensure we gather this information for our next conversation.

Peggy Yu, Analyst

My apologies for that. Could you discuss trends around margins as we head into Q4? It appears the margins improved in Q3, yet Q4 seems to be slightly down. What are some of the factors influencing this?

Tom Siebel, Chairman and Chief Executive Officer

If margins are projected down for Q4, that relates to our focus on being a software company rather than a software services company. Although professional services could be lucrative, we will supplement to facilitate our customers by outsourcing those services to third-party providers, which could apply downward pressure on margins while maintaining our software focus.

Operator, Operator

Your next question comes from the line of Arvind Ramnani with Piper Sandler.

Arvind Ramnani, Analyst

Regarding your vertical partnerships, which are crucial to your strategy, how are you tracking progress with these partnerships, especially the new ones compared to the more established ones? Are you monitoring deals or pipeline?

Tom Siebel, Chairman and Chief Executive Officer

We employ very impressive instrumentation to monitor our business activities, tracking pipeline growth, deal activity, revenue goals, and performance metrics with each partner. Thankfully, we haven’t faced any unsuccessful partnerships yet; our current focus is on ensuring success with all partners. However, I believe we have a detailed and sophisticated method for evaluating our partnership effectiveness.

Operator, Operator

Your next question comes from the line of Pat Walravens with JMP.

Pat Walravens, Analyst

If I can, I have two questions. First, for investors looking at this, C3 grew 71% in fiscal '20, then COVID hit, and fiscal '21 revenue midpoint is going to grow 16%. What should we think about the long-term durable growth rate for this business?

Tom Siebel, Chairman and Chief Executive Officer

We believe the growth rate will expand over time.

Pat Walravens, Analyst

Can you elaborate on the deal with the US Army you won with Raytheon? These contracts are typically very competitive; I’m curious about the competition. Also, how large is the market opportunity C3 has with the defense industry?

Tom Siebel, Chairman and Chief Executive Officer

I can't speak in detail about the specific Raytheon deal, as I haven't been directly engaged with that recently. However, the opportunities in defense and intelligence are enormous. The US government is ramping up its focus on AI, matching the investments of countries like China, and we're looking to capitalize significantly on that shift. While we won't transform into a federal contractor, we do anticipate considerable growth in that segment of our business.

Operator, Operator

There are no further questions at this time…

Tom Siebel, Chairman and Chief Executive Officer

Let me provide a couple of closing comments, and then we'll wrap things up. First of all, thank you for your attention and your thoughtful questions. To the extent that I think there were two questions I didn't have answers to, I apologize. We believe our third-quarter results illustrate the power and potential of our highly differentiated model-driven architecture, which enables enterprises across various industries to develop and operate complex predictive AI applications. We're well positioned to tap into a rapidly growing $200 billion addressable market opportunity. As we enter our fourth fiscal quarter of 2021, I believe C3.ai has never been more strongly positioned. We're demonstrating clear technology leadership, building a powerful brand, and our human capital resources are exceptional. Thank you all for your time. We look forward to sharing our progress with you in the months and years ahead. Have a great day.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.