C3.ai, Inc. (NYSE:AI) Q2 2023 Earnings Call Transcript December 7, 2022
C3.ai, Inc. beats earnings expectations. Reported EPS is $-0.11, expectations were $-0.16.
Operator: Hello, and thank you for standing by. Welcome to the C3 AI Second Quarter Fiscal Year Earnings Conference Call. It is now my pleasure to introduce from Investor Relations, Mr. Reuben Gallegos.
Reuben Gallegos : Thank you, Andrew, and good afternoon, and welcome to C3 AI’s earnings call for the second quarter of fiscal year 2023, which ended on October 31, 2022. My name is Reuben Gallegos, and I’m the Vice President of Investor Relations. With me on the call today is Tom Siebel, Chairman and Chief Executive Officer; and Juho Parkkinen, Chief Financial Officer. After the market closed today, we issued a press release with details regarding our second quarter results as well as a supplemental to our results, both of which can be accessed through 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 that 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 our 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. All figures will be discussed on a non-GAAP basis unless otherwise noted. 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 remarks, in 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 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.
Photo by Austin Distel on Unsplash
Tom Siebel : Thank you, Reuben, and hello, everyone. Thank you for joining us. I’m here with Juho Parkkinen, our Chief Financial Officer, and we are most pleased to share our results for the second quarter for fiscal year ’23. Bottom line, it was a solid quarter in which we delivered our stated objectives and met expectations despite the rocky economic situation and the generally morose condition of the markets. In the last earnings call, we described two strategic initiatives to spur faster growth. One was to recompose our sales team with an emphasis on technical and domain expertise. The second was to shift our pricing model from a subscription-based pricing model to a consumption-based pricing model. I’m happy to report these initiatives have been successfully completed in the second quarter.
I will explain these actions in some detail, but first, I’ll comment on the financial results and some of the successes that we achieved during the quarter. With large, the quarter was quite solid. Subscription revenue for the quarter was $59.5 million, an increase of 26% year-over-year. Operating loss improved 15 points year-over-year to 24%. We continue to maintain a healthy gross margin of 77%. Customer comp grew 16% year-over-year to 236. Current RPO of $164.5 million was down slightly and consistent with our expectations as we transition to a consumption-based pricing model. We ended the quarter with cash reserves of approximately $860 million. The number of completed contracts in the quarter increased to 25, approximately a 100% increase year-over-year.
Our average contract value in the second quarter was just over $800,000, down from $19 million a year earlier. This reduction in contract value was a direct result of our new pricing model. We believe the new pricing model will result in a substantially increased number of smaller transactions, providing greater forward visibility in both revenue and bookings. Our new consumption-based pricing model was well-received by our customers, our prospects, our partners and by our sales organization. We expect this new model to increase the number of customers with which we engage in any given quarter by an order of magnitude. As these customers continually increase their usage over time, we expect the compound effect on revenue growth to be quite significant.
Our customers and prospects find a new consumption-based pricing easier to understand and easier to contract. Our market partners find this new pricing model well-aligned with how they price their own services and one that facilitates their successfully selling C3 AI products. I’m happy to report that our transition to this new consumption-based fishing model is now complete. Simultaneously, last quarter, we completed a transition of similar magnitude with the rig composition of our global sales team. We are now growing a team of highly qualified, well-trained technologically expert sales professionals, who are engaging with prospective customers in selling pilots and expanding production usage with existing customers. There is no question that there is pervasive economic uncertainty in the global business community that continues to provide bookings headwinds.
This has been especially significant in the tech markets that are experiencing a blood bath in equity prices, with significant layoffs at companies, including Amazon, Meta, Salesforce, Google, Snap and many others. I believe this is just the start of what will be a significant tech market correction. Layoffs of established companies will accelerate. The many Series A, B, C and D companies that are hemorrhaging cash will simply not survive. Just like every other tech recession that we’re seeing, the human capital at the piece parts companies will be redistributed to those companies that survive. We are confident in our business outlook, especially with the nearly $600 billion addressable market opportunity that we have before us. We continue to invest in our products and in the talent required to meet our goal of building a cash positive profitable business that will return to a growth rate of greater than 30% year-over-year within the next 18 months.
Our employee base grew last quarter to over 850, a sequential increase of 83, and we continue to hire key engineers, data scientists, sales professionals and other key roles across the organization. Turning to some of our customer successes in the quarter. Shell has continued to expand their use of our solutions in new areas, and have successfully implemented C3 AI sustainability for manufacturing at two of their key offshore platforms in the Gulf of Mexico. We also have successfully concluded an ESG trial with Shell, this focus on leveraging NLP to generate targeted insights on the rapidly evolving ESG priorities of Shell’s key stakeholders. Shell has already addressed and communicated that they are realizing massive economic value annually by deploying our C3 AI applications across the enterprise, upstream, downstream, midstream renewables.
See also 10 Best Medical Stocks Under $20 and 15 Countries That Produce the Most Solar Energy.
We’re just getting started. There’s a large and growing pipeline of enterprise applications that Shell is building, testing and deploying using the C3 AI platform, realizing the strategic value of our partnership and the fulfillment of the digital transformation of one of the largest and most iconic companies in the world. Cargill has continued to expand their use of our solutions and optimizing food production and distribution to meet the dynamic needs of the market and ensuring sustained food value chains in North America, Latin America, Europe, Africa and Asia. This is a critical mission that has enormous humanitarian ramifications, and we are proud to participate with Cargill in this important mission. Lastly, we are proud to say that we’ve continued to expand our relationship with the United States Air Force, working closely with them to improve aircraft availability and efficiency of readiness programs of the entire fleet of over 3,700 aircraft.
The AI capabilities that we are putting into operation today offers the potential to improve readiness rates by up to 20% and reduce the cost of maintenance for up to $4 billion per year. Let me address our partner ecosystem. In recent weeks, there’s been something of a seismic shift in the enterprise AI software space. Traditionally, the primary competition to purchasing C3 AI enterprise applications was the license — was for a company to — the alternative of C3 AI was for a company to license a large number of tools from the hyperscalers, piece parts some providers like Cloudera, Pivotal, DataBridge, DataRobot and the many of the scores of other point solution providers, and then engage in a long and expensive science experiment in an attempt to build a custom enterprise AI platform.
No one to our knowledge ever succeeded with that. Now the market is truly changing due to — changing and demonstrating an increased desire for production, tried, tested, proven enterprise AI solutions. All of the hyperscalers have acknowledged this within the last few months. Thomas Kurian at Google Cloud was the leader, announcing the GCP would lead in the market, okay, not with piece parts, but with turnkey production enterprise applications from C3 AI. Then last week, Adam Selipsky, CEO of AWS, announced that their customers were now demanding turnkey applications, not toolkits. This was followed the next day by Scott Guthrie, EVP of Microsoft Azure. All announced that the customers were telling them they no longer wanted toolkits to build applications, they now want functional turnkey AI applications that accrue immediate value.
With a growing family of 42 production enterprise C3 AI applications in the market that serve the needs of financial services, utilities, health, manufacturing, defense, intelligence and other industries, C3 AI is well positioned to capitalize on this now clearly recognized market requirement. We sell it with GCP. We sell with Azure. We sell with AWS. We sell with Baker Hughes. We sell with Booz Allen Hamilton. And we are well positioned to help our partners to deliver to their customers the solutions they are demanding. C3 AI and Google Cloud are continuing to jointly invest in industry applications with the launch of two new enterprise AI applications last quarter optimized on GCP. Our sales teams are actively co-selling today to over 300 accounts around the world.
Last quarter, we closed an expansion with a large transportation company, currently signed one of the top 50 retailers in the world to license our supply chain applications and signed several new deals in the financial services and oil and gas industries. Our GCP joint selling activity is quite brisk, and as a result, GCP is our fastest growing install base. That being said, AWS remains C3 AI’s largest installed base, constituting about 56% of our customer base. C3 AI and Microsoft continue to close deals, particularly in the energy and manufacturing sectors. Azure remains our second largest installed base, constituting approximately 27% of our customer base. We announced a number of new product enhancements here in the course of the quarter that I’m not going to review in this call, but we continue to invest in technology leadership.
We continue to invest in R&D and we’ll continue to add to our industry-leading portfolio of enterprise AI applications and add fair debt and increase performance to these existing applications. Let me talk for a minute about human capital. C3 AI continues to be recognized as a Great Place to Work. In the second quarter, we received over 23,000 job applications. We interviewed over 2,200 of these applicants, and we hired 90. One of the secular changes of this tech downturn is the increased availability of highly trained professionals who are willing to come into the office, roll up their sleeves and get to work. We have never been more confident with the team that we have and with their ability to execute our strategy. Turning to guidance. Our Q3 revenue is expected to be between $63 million and $65 million, and we are reaffirming our full year fiscal year ’23 revenue guidance of $255 million to $270 million.
For non-GAAP operating loss, we expect in Q3 between $25 million and $29 million. And for the full year, we expect an operating loss between $85 million and $98 million. We continue to operate at roughly an 80% non-GAAP gross profit margin. We have a clear path to top line growth, non-GAAP profitability and a cash positive operations by the end of fiscal year ’24. At this time, we did not see our cash balances below — we did not see our cash balances falling below $700 million before that inflection. Final comment on the big picture. C3 AI is addressing a $600 billion addressable AI software market. If not the largest, we are one of the largest providers of these applications globally. Our business is exactly on track with what we have communicated to you.
Our goal remains to establish and maintain a global leadership position in enterprise AI software. In the short run, we believe tech companies and tech equities will continue to face headwinds, as long as the Fed keeps its foot on the brake. The collateral damage, I think, is going to be more significant than people think. That being said, when the Fed takes its foot off the brake, be that in 2023 or 2024, C3 AI will be bigger, stronger, cash positive, profitable, a clear market leader and well positioned to benefit from the inevitable equity market surge that will ensue. Now let me turn the call over to our CFO, Juho Parkkinen, for a summary of our financials and additional commentary. Juho?
Juho Parkkinen : Thank you, Tom. Now I will provide a recap of our financial results, add some color to the drivers of our financials for the back half of the year and conclude with some additional color related to the consumption-based revenue model we introduced on our last call. As Tom mentioned, we ended the quarter with revenue of $62.4 million, which represents 7% year-over-year growth. Subscription revenue increased by a solid 26% and was 95% of total revenues. Gross profit increased 5% to $47.8 million, and gross margin decreased 122 basis points to 76.6%. The decline is primarily due to a higher mix of trials and pilots, which carry a higher cost required to ensure customer success during this early phase of engagement.
Operating loss of $15 million improved $7.6 million year-over-year, and operating loss margin also improved from 39% in the prior year to 24% in Q2. Our customer count increased by 16% year-over-year to 236, and we closed 25 deals during the quarter. It’s noteworthy that deals under $1 million grew 167 year-over-year in Q2. Now turning to RPO and bookings. We reported RPO of $417.3 million, which met our expectations as we continue to convert to consumption-based deals. Current RPO was $164.5 million, down 8% from last year. We continue to see positive trends in bookings diversity outside of oil and gas, particularly in the Federal, aero and defense sectors, which grew sequentially and year-over-year. Turning to cash flow. Free cash flow for the quarter was an outflow of $77 million.
Breaking this down, $23.7 million was for the build-out of our new headquarters. As I have mentioned previously, this will be amortized over the term of the lease and will not have a meaningful impact on our path to profitability. Normalizing for this payment, our adjusted free cash flow was an outflow of $54.3 million. Turning to guidance-related assumptions. As Tom mentioned, we have completed our transition from a subscription-based pricing model to a consumption-based pricing model and are now focused on ramping revenue from consumption-based deals. With respect to gross margin as the number of pilots ramp in the coming quarters and as the proportion of period revenue is more weighted towards pilots, we expect gross margin percentage to decline.
However, consistent with the financial model we shared with you as part of the prior quarter earnings call, we expect the gross margin to increase to historical levels by the same time we expect to reach our initial non-GAAP profitability. Operating margin model and guidance includes our expectations for revenue growth and gross margin impact. Looking at our cash reserves, we have sufficient capacity to execute our plan to invest for growth in the coming quarters. We are well capitalized, having approximately $860 million available. With the planned expenditures related to the build-out of our new headquarters and investments in our business, we expect our cash investment balance to bottom out in fiscal ’24 before we see improving free cash flow and improving cash balances thereafter.
As a reminder, one of our most significant cash usages has been for the build-out of our new headquarters, which unlike many high-tech companies, we actually occupy. We are on track to achieve positive non-GAAP operating margin in the fourth quarter of the next fiscal year, driven by accelerating revenue growth and improving gross margin. Regarding the transition to consumption-based pricing, as a reminder, we do not require existing customers to move to a consumption-based arrangement. Our customers have been satisfied and are expected to remain in their current contract terms. As such, we expect the RPO to decline as our new deals will not require a significant upfront non-cancelable arrangement, but rather a consumption-based usage arrangement.
The assumptions we provided last quarter for modeling the consumption-based business remain unchanged. In summary, we are focused on delivering profitable growth to our shareholders, and we continue to expect achieving non-GAAP profitability in the fourth quarter of fiscal ’24, while growing the top line in excess of 30%. With these remarks, I would like to open the call up for questions. Operator?
To continue reading the Q&A session, please click here.