C3.ai, Inc. (NYSE:AI) Q3 2023 Earnings Call Transcript

C3.ai, Inc. (NYSE:AI) Q3 2023 Earnings Call Transcript March 2, 2023

Operator: Good day and thank you for standing by. Welcome to the C3 AI Third Quarter Fiscal Year 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Reuben Gallegos. Please go ahead.

Reuben Gallegos: Thank you, and good afternoon, and welcome to C3AI’s Earnings Call for the third quarter of fiscal year 2023, which ended January 31, 2023. My name is Reuben Gallegos, and I am the Vice President of Investor Relations. With me on the call today is Tom Siebel, Chairman and Chief Executive Officer; Ed Abbo, our Chief Technology Officer; Juho Parkkinen, our Chief Financial Officer. After the market closed today, we issued a press release with details regarding our third quarter results as well as the supplemental to our results, both of which can be accessed through our 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 this 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. Before 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. Today, all figures will be discussed on a non-GAAP basis unless otherwise noted. And also after the course of today’s call, we will refer to certain non-GAAP financial measures and the reconciliation of GAAP to non-GAAP is included in our press release.

Finally, at times in our prepared remarks in response to your questions, we may discuss the metrics that are incremental to our usual presentation to get 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. And with that, let me turn the call over to Tom.

Tom Siebel: Okay. Good afternoon, everyone, and thank you for joining our call today. You might recall that two quarters ago, I spoke of economic headwinds, lengthening sales cycles, as our customers and prospects anticipated recession. In July and August of 2022, we saw a significant negative change in the business environment with the lengthening of decision cycles, and I caution that the market downturn could be significant. Now as we enter into our fourth quarter, we are seeing tailwinds on from improved business optimism and increased interest in applying C3 AI solutions to address an increasing range of applications across a broadening set of industries. This is a dramatic change from what we experienced in mid-2022. There is a genuine optimism in the marketplace for our solutions.

And the overall business sentiment appears to be substantially improving. In the course of the quarter, we validated our transition to a consumption-based pricing model. We expanded our partner ecosystem. We expanded our business pipeline. We delivered industry-leading product innovation in enterprise AI. And importantly, we remain on track to become cash positive and non-GAAP profitable by the end of fiscal year ’24. Looking at third quarter results, we delivered a strong quarter. Our total revenue was $66.7 million, which exceeded our guidance. Current RPO increased to $176.3 million, and we have 236 customers. We ended the quarter with almost $790 million in cash. And as we enter Q4, we believe C3 AI is well positioned to continue to invest in growth through enterprise AI innovation and sales expansion while sustaining our path to profitability.

Importantly, we have validated the consumption-based pricing model. The response to our consumption-based pricing model from partners and prospects has been uniformly enthusiastic Believe it or not, we currently have more than 290 qualified pilot opportunities in our pipeline, exceeding our expectations. Our pilot to production conversion rate is on track. The consumption pricing revenue conversion model that we provided last quarter, and Juho will review that with you in a few minutes, appears to be realistic, suggesting substantially increasing revenue growth rates in fiscal year ’24 and beyond. We made significant progress with our partner ecosystem in the third quarter. We established, reestablished and substantially expanded our go-to-market partnerships.

With Google Cloud, we closed eight new customer deals and expanded our joint pipeline. Our combined teams are currently pursuing 291 enterprise opportunities for our joint solutions, over 100 of which we are currently engaged in licensing discussions. Thomas Kurian, the CEO of Google Cloud and I held a joint meeting with a number of clients, prospects and partners in the U.S. federal region. We’ve made substantial progress to ensure that all C3 products perform optimally in the Google cloud environment. Finally, we expanded our partnership agreement with Google, so that our customers can purchase any C3 AI software solution on the Google cloud marketplace. We also renewed and expanded our go-to-market partnership with AWS in the quarter. AWS funded C3 AI to enhance its C3 AI law enforcement application to ensure that it’s optimized for AWS, integrating Amazon Open Search and AWS machine learning services to enhance the speed and quality of analysis for state and local agencies using the application on AWS.

C3 and AWS are currently pursuing 75 new opportunities, of which 41 appear highly qualified, and we closed six agreements in the quarter. With Azure, we collaborated to close the deal with a super major U.S. energy company and a European technology company serving the mining and construction sectors. We’ve cooperated to deliver a highly successful pilot engagement to a large U.S. defense agency that shows potential for very large expansion. In the quarter, we established a highly strategic relationship with Booz Allen focused on providing solutions to the government defense intelligent sectors. When we are jointly going to market with Booz Allen to bring the C3 AI platform and our suite of prebuilt C3 AI solutions to solve their requirements, together, the companies have cross-trained our employees on our respective services, and we already closed our first engagement with the Chief Digital Artificial Intelligence Office CDAO.

With Accenture, we renewed our partnership to help customers drive product innovation, design and development and provide strategic support and systems integration at scale. Together, the companies have trained Accenture employees on the C3 AI platform and have already collaborated to close two pilot deals in the consumer packaged goods and oil and gas sectors. We are actively engaged with a large oil and gas services company and have generated several new opportunities with target accounts. With EY, we are teaming to address the needs of the health care industry in the U.K. With Peraton, a Washington, D.C. Beltway systems integrator, we entered into a partnering agreement to address the modernization of the Veterans Administration. With Baker Hughes, we substantially expanded our strategic partnership in the third quarter.

The terms of this expansion resulted in an incremental C3 booking of $32.5 million and the frequency of payments from Baker Hughes was accelerated over the term of the agreement. C3 AI agreed to provide additional products and services to Baker Hughes and provided Baker Hughes additional flexibility in the manner in which they sell AI products and services. The expanded agreement also enables Baker Hughes to extend the term of the agreement at its option beyond its current six-year term. We believe the partnership with Baker Hughes has substantially enhanced our credibility in oil and gas and chemicals markets. As a result of our partnership with Baker Hughes, combining both joint selling through the partnership and the sales that we have closed independently of Baker Hughes, C3 AI has closed to date, 87 contracts in the oil and gas and chemical sector, including LyondellBasell, Shell, ExxonMobil, Petronas, ENI, Aramco, Qatar Gas, ADNOC, Yokagawa, Baker Hughes, Braskem, Frontier Resources and others.

All of these in aggregate have resulted in our closing over $650 million in bookings, and we have recognized in excess of $350 million in revenue through the third quarter of fiscal year ’23. Let me talk for a minute about our ESG solutions. We’ve made significant progress with our ESG application, which is part of our sustainability suite, which includes C3 AI energy management, our most mature application that was first introduced to market in the first quarter of 2010. This product used to measure, manage and mitigate the energy and greenhouse gas footprint at over 6 million residences and businesses today. In September of 2022, we announced the availability of C3 AI ESG developed as a significant enhancement to the C3 AI energy management suite.

C3 AI ESG provides a single source of truth for all matters of materiality related to ESG, aggregated and synthesis size the many ERP, supply chain, procurement, Cadence, CRM, HR and other enterprise systems installed in an enterprise, all track longitudinally at the asset division and corporate levels. This enables organizations to publish their ESG compliance reports consistent with a multiplicity of conflicting ESG reporting standards, including SASB, GRI, TCFD and CDP. Most importantly, C3 AI ESG provides rich predictive analytics using AI to allow managers to track their gaps to plan for ESG materiality in out years, be it CO2, H2O, methane, workplace injuries, whatever. And it recommends mitigation measures to close the gaps so the Company can be assured of meeting its ESG objectives in 2030, 2040, 2050, et cetera.

According to Verdantix, ESG represents a $16 billion addressable market in 2027, and our product is being enthusiastically received. Our initial ESG customers are EY, Shell and Baker Hughes. Now I’d like to talk a little bit about our intellectual property portfolio. C3 AI continues to make significant investments in technology innovation. We have been awarded 26 patents to date and have an additional 90 patents pending. One of our most important inventions is the model-driven architecture for enterprise AI applications, the core architecture of the platform. We have issued several patents for this architecture, including systems, methods and devices for an enterprise AI application development platform. This platform provides all the software service is necessary and sufficient for the rapid development, deployment and operation of enterprise AI applications.

Importantly, it also serves as an orchestration system, allowing us to immediately embed and exploit the utility of ongoing innovations in the open source and proprietary world. Examples include new techniques in machine learning, virtualization, encryption, commercial products like Databricks, Snowflake, Vertex AI, Amazon SageMaker; Azure ML, TensorFlow, Jupyter, Python, et cetera, all of which are immediately compatible and interoperable with the C3 AI platform and all of which are commonly used by many of our customers. The recent explosion of innovation and availability of large language models and generative free trading transformers are also immediately compatible with the C3 AI platform, enabling us to increase the utility of our platform and our applications.

We believe the importance of the ongoing developments in generative AI is difficult to overestimate. Now, there’s been a lot of recent news about C3 generative AI. Let me address that for a moment. By combining the utility of the C3 AI platform, predictive analysis enterprise search, natural language processing, generative pre-trained transformers and reinforcement learning, we have developed a new and novel technique to fundamentally improve the human computer interface for enterprise applications. This is kind of a non-obvious use of generative AI. This is not about chat, okay? This is about enterprise search. And we believe that this invention represents a breakthrough development that will dramatically facilitate the ease of use and explainability of enterprise AI applications.

In addition to providing users immediate, highly controlled access to potentially the entire body of data and information systems within an enterprise, be it Dow Chemical, the United States Air Force, Shell, whatever it may be. In the news release that we put out, we have a link to that application. So you can actually see what it is, how it works and how it put it together. And if you’re interested, I encourage you to take a look at it. It is really neat. Okay. We expect the C3 AI generative search capability to be incorporated into the C3 platform and applications and generally available to our customer base this spring. It is currently being deployed as a core capability in the C3 AI platform, and we are doing early deployments at Koch Industries and Baker Hughes.

To protect this intellectual property, we have several patents pending in multiple jurisdictions around the world. And I encourage you to go find the link on our website and take a look at it because it is really something. Okay. Let’s talk about guidance. Turning to guidance for the fourth quarter and fiscal year 2021, I will remind everybody on the call that this is the eighth consecutive quarter as a public company, in which the third quarter is the eighth consecutive quarter in which we have exceeded our revenue guidance, okay? We expect revenue for Q4 to be between — Q4 2023 between $70 million and $72 million. And for the full year fiscal year ’23, we expect revenue to range between $264 million and $266 million. Bottom line, Q3 was solid.

We have validated the consumption-based pricing model, okay? The addressable market is huge. Business is strong. Customers are happy. Our workforce is highly productive and the future is bright. And now, I will turn this over to my colleague, Juho Parkkinen, for additional details regarding our financial results. Juho?

Juho Parkkinen: Thank you, Tom. I will now provide a recap of our financial results, add some color to the drivers of our financials discuss our expected path to non-GAAP operating profitability by the end of fiscal ’24, and I will conclude with some additional color related to the consumption-based revenue model we introduced two quarters ago. All figures will be discussed on a non-GAAP basis, unless otherwise noted. As Tom mentioned, we ended the quarter with revenue of $66.7 million, of which subscription revenue was 85.6%. Gross profit was $51 million and gross margin was 76%. As I mentioned during the last quarter’s update, we have a short-term pressure on our gross margins due to a higher mix of climate which carry a higher cost of revenue during the pilot phase of our customer life cycle.

Operating loss of a negative $15 million improved year-over-year and was significantly above our guidance due to improved vendor expense management and timing of payment. Operating loss margin was flat at negative 23% as compared to the same period in the prior year. However, on a sequential basis, our operating loss margin improved. Our customer count increased 8% to 236, and we closed 27 deals during the quarter, 17 of which were pilot deals under the consumption model. Now turning to RPO and bookings. We reported GAAP RPO of $403 million, which is down 14% from last year. This was expected as we transition to consumption-based deals. Trade GAAP RPO of $176.3 million is up 3% from last year and 7% on a sequential basis. We continue to see positive trends in pilot bookings diversity as we have increased to nine industry segments in Q3 compared to six in Q2.

Regarding our cash flow, free cash flow improved to an outflow of $71.7 million compared to $77 million in the prior quarter. Breaking this down, $19.4 million was related to the build-out of our new headquarters, which we moved into in February. Normalizing for this payment, our adjusted free cash flow improved to an outflow of $52.3 million compared to $54.3 million last quarter. We continue to expand our headquarters and we’ll have additional cash outflow in the following quarters as we take over additional spend. During the quarter, we expanded the Baker Hughes partnership. As Tom mentioned, the changes are designed to provide increased flexibility to Baker Hughes to provide the BH C3 AI solutions to the market. This resulted in the elimination of the variable consideration, which increased the transaction price by $32.5 million.

Regarding outlook. As Tom highlighted, we are able to narrow our range as we have more visibility as we enter Q4. As such, we’re guiding Q4 to $70 million to $72 million. And for the year, we’re tightening the guide from $264 million to $266 million. For Q4 ’23, we expect our non-GAAP loss from operations in the range of $24 million to $28 million, that is negative. And for the full year, we expect the non-GAAP loss from operations of negative $69 million to negative $73 million. In accordance with our plan, we do expect gross margin percentage to be negatively impacted by the number of pilots active in the fourth quarter. Please recall that during the two quarter pilot period, customer will have unlimited run time and premium support resources sufficient to be successful with their target engagement and gain value from the C3 AI software.

During this pilot period, our subscription cost of revenue will be elevated until the conversion to consumption-based pricing occurs. Over time, we expect gross margin percentage to revert to historical ranges as higher percentage of customers on a pilot move to consumption revenue. Our operating margin guidance reflects the fact that we have C3 transform the world’s premier enterprise AR conference and our major customer events happening next week, and we will have related marketing expenses for this quarter’s costs. In addition, as we have discussed previously, we’re increasing our sales head count to meet the demand we are seeing for our consumption-based pricing sales and expect to see increased expense in the fourth quarter as a result.

It is important to note that we expect that our cash balance will continue to decline into next fiscal year as we complete the build-out of our headquarters. We expect our cash and investments to be at its lowest at around $700 million during fiscal ’24. Broadly speaking, as a result of the introduction to consumption-based pricing, we expect RPO to trend down over the coming quarters with some exceptions relating to renewals and existing customer expansions. Also, before I end, I’d like to take the opportunity to shed some light into the details in our financial plan and the progress we’re making with our consumption-based pricing. As Tom mentioned in his comments, we are on track with our plan to achieve non-GAAP profitability by the end of fiscal year ’24.

On a quarterly basis, we assess the business landscape and adjust our operating plan based on what we’re experiencing in the market. During Q1, as Tom mentioned in his remarks, back then, we experienced headwinds and to caution that the market downturn could be significant. We and the management team adjusted our operating plan and build out a careful trap to become operating profitable by the end of FY ’24. We are on that plan. In order to make sure that we monitor that plan, we have prepared detailed department of budgets. We track variances, we hold managers responsible. And if there are variances, we correct them immediately. In our investor supplement, we have shared our current projected path to operating profit on a relative expense basis.

Obviously, as I mentioned, we review our plan each quarter, but I wanted to share the detailed path with you guys at this time. As it relates to the model assumptions that we provided two quarters ago for our consumption-based pricing business, our preliminary analysis of the actual results suggest that we are at or better than that model. Therefore, to summarize, quarter results were above expectations and guidance clear and well-understood plan for our path to profitability is in action and our consumption-based model assumptions are on track. With these remarks, I would like to open this call up for questions. Operator?

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Q&A Session

Operator: And our first question comes from the line of Mike Cikos with Needham & Company. Your line is open. Please go ahead.

Mike Cikos: I wanted to start off with some of the comments that you guys had around the customer dynamics because I just want to make sure I’m clear on how we’re looking at things. If I’m counting, I think the customer count was actually flat quarter-to-quarter as far as total customer count. But I know — I think Juho in your prepared remarks have discussed C3 had closed 27 deals 17 of those were pilots under the consumption model. Can you just help us think through like how are you guys prioritizing? Who goes into that category, when do they become would you term a customer?

Juho Parkkinen: Of course, yes. Thanks, Mike, for the question. So if you take a look at our quarterly filings, we’ve provided kind of a detailed definition of what our customer is, but I’ll provide it here as well. So within a customer entity, which you can think about the ultimate parent of, let’s say, coke industries there could be several subsidiaries, groups, departments, various budget owners or various groups that use either incrementally or tool or use it in different use cases. That — all of those individual groups we would characterize as a customer.

Mike Cikos: I guess what I’m getting at is if you closed 27 deals and 17 were pilots, right? If I think about the 27 deals that you guys closed, the assumption is then that they were all with existing customers. Is that fair? Or I guess there’s movement under the hood in that customer cap that you’re providing Again, I’m just looking at the customer count being flat quarter-to-quarter.

Juho Parkkinen: Yes, totally understand. So let me clarify. So, we are still broadly speaking, in our transition phase to the pure pilot model. And if you recall in some of our prior conversations, some of the old trial arrangements, which are a customer in the period when their trials upon the ending of the trial period. We engaged in negotiations to turn them into production customers. During that phase, that customer is not considered a customer. It effectively falls off the calculation. And then when they would enter into a production deal, they come back into the calculation. So those dynamics are still at play because obviously, we still have a tail of the former trial model at the — during the quarter. Now the 17 new pilot arrangements, those also are a mixture of new customers and then we could have an existing customer who wants to do a trial project with us. So that would be — that could be part of the bridge as well.

Mike Cikos: Got it. Got it. And one other thing, if I could, but I know you guys obviously cited the better profitability here versus expectations. And one of the — I guess there were two primary big drivers. The first is we had a large sequential uptick in the pro services revenue and that pro services gross margin. Can you help us think about what drove that strong return in pro services as well as the gross margin there coming in, it was in the 90% plus range, which I think was much higher than what you guys have typically done. Was there any onetime item that benefited that gross margin?