C3.AI (NYSE: AI) CEO Tom Siebel: “Confident in Our Business Outlook, With Nearly $600 Billion Market Addressable Market Opportunity Before Us.”

C3.AI (NYSE: AI) AI Q2 2023 Earnings Call Discussion

CEO Tom Siebel

Hello everyone. Thank you for joining us. I’m here with you, ho Parken, our Chief financial Officer, and we are most pleased to share results with subject for or fiscal year 23.

Bottom line. It was a solid. In which we delivered our stated objectives and met expectations despite Rocky, despite the Rocky economic situation and the generally marose 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 E.

The second was to shift a 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, 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.

At 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 growth margin of 77%. Customer count grew 16% year over year to 236. Current RPO of 164 and a half million was down slightly and consistent with our expectations.

As we transitioned 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 hundred percent increase year per 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. 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 organiz.

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 upon revenue growth to be quite significant. Our customers and prospects find the 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 C T A R products. I’m happy to report that our transition to this new consumption based pricing model is now complete s. Last quarter, we completed a transition of similar magnitude with the recomposition 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 experience experiencing our bloodbath and equity prices with significant layoffs at companies including Amazon Meta, Salesforce, Google Snap, and many. I believe this is just the start of what will be a significant tech market correction, layoffs and 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’ve be seen, the human capital at the peace parts companies will re be redistributed to those companies that.

We’re confident in our business outlook, especially with the nearly 600 billion market 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 gross 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 into some of our customer successes in the quarter, shell has continued to expand their use of our solutions in new area.

And has 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 will shell the toss on leveraging NLP to generate targeted insights on the rapidly evolving es t priorities of Shell’s key stakeholders.

Shell has already addressed and communicated. They’re realize that they’re realizing massive economic value annually by deploying our C three A applications across the enterprise, upstream, downstream, midstream renewables, we’re just getting started. There’s a large and growing pipeline of enterprise AI applications.

That cell is building, testing and deploying using the C3 AI platform. Realizing this, 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 in 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 huma humanitarian ramifications, and we’re proud to participate with Cargill in this important. Lastly, we’re 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, have the entire fleet of over 3,700 aircraft. The AD capabilities that we are putting into operation today offer the potential to improve readiness rates right after 20% and reduce the cost of mainten. 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 C three A enterprise applications was to license was for a company to, so the alternative of purchasing C3 was for a company to license a large number of tools from the hyperscalers piece, parts from providers. Cardera Pivotal Databricks data, robots, 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 succeeds at that. Now the market is truly changing, uh, due to it. Change hand demonstrating an increased desire for production. Tri tested, proven enterprise AI solutions. All of the hyperscalers have acknowledged this within the last few months. Thomas Curran at Google Cloud was the leader announcing the GCP would, would, would lead in the market.

Okay. Not with peace parts, but with turnkey production. Enterprise applications from c3, ai. Then last week, Adam Solinsky, CEO of AWS, announced that their customers were now demanding turnkey applications, not toolkits. This was followed the next day by Scott Cut cut three, and Microsoft Azure all announced that the customers were telling them million.

They no longer wanted toolkits to build applications. They now want functional turnkey AI applic. Did 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 and is now clearly recognized market. We sell with gcp, we sell with a Zero. We sell with AWS s. We sell with Baker Hughes. We sell with Bruce Callen Hamilton, and we are well positioned to help our partners to deliver to their customers the solutions they’re demanding.

C J I and Google Cloud are continuing to jointly invest in C 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 sign several new deals in the financial services. In oil and gas industries, our GCP joint selling activity is quite brisk, and as a result, GCP is our fastest growing in salt base. That being said, AWS remains c3, AI’s large and install base constituting about, uh, 56% of our customer.

Set. C3 and ai C G I, Microsoft continue to close deals, particularly in the energy and manufacturing sectors. Azure remains our second largest installed base, uh, 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 gonna review in this call, but we continue to invest in technology leadership. We continue to invest in r and d, and we continue to add to our industry leading portfolio of enterprise AI applications and add our, add greater depth and and increased performance to these existing applic.

May 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 2200 of these applicants and we hired 90. . One of the secular changes of this tech down turn 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 the guidance. A Q3 revenue expert is expected to be between 63 and 65 million, and we are reaffirming our full year, fiscal year 23 revenue guidance of 255 million to 270 million for non GAT operating loss.

We expecting Q3 between 25,000,020 9 million, and for the full year we expected operating loss between 85,000,090 8 million. We continue to operate at roughly an 80% non gap gross profit margin. We have a clear path to top line. Non GA profitability added cash positive operations by the end of fiscal year 24.

At this time, we did not see our cash balances below fall. We did not see our cash balances falling below 700 million before that inflection. Final comments on the big picture? C3 three AI is addressing a 600 billion addressable AI software. 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 the global leadership position in enterprise AI software. In this short one, we believe tech companies and tech equities will continue to face headwind. As long as the Fed keeps its foot on the brake, the collateral damage I think is gonna be more significant than people think.

That being said, when the Fed takes its foot off the brake, be that in 2023 or 2024, AI will be c3, AI will be bigger, stronger. Cash positive, profitable. I’m 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, Yuha Parkinson, for a summary of our financials and additional commentary. You hope. 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 vast 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 157 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, uh, as we continue convert to consumption based deals. Current RPO was hundred 64.5 million, down 8% from last year. We continue to see positive trends in bookings, diversity outside of oil and gas, particularly in the federal arrow and defense sectors, which grew sequentially and year over year turn into cash.

Free cash flow for the quarter was an outflow of 77 million. Breaking this down, 23.7 million was for the buildout 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 cashflow 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 pockets, we expect gross margin percentage to decline.

However, consistent with the financial model we shared with you as part of the prior port earnings call, we expect the gross margin to increase to historical levels. By the same time we expect to reach our initial non-gap 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 our related to the buildout 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 cast usages has been for the buildout of our new headquarters, which unlike many high tech companies we actually occupy, we are on track to achieve positive non-AP operating margin in the fourth quarter of the next fiscal year, driven by accelerating revenue growth.

An improving gross margin regarding the trans 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 RPO to decline as our new deals will not require a significant upfront non-con.

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-gap 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. Thank you. As a reminder, ladies and gentlemen, to ask a question, you’ll need to press star 11 on your telephone. Please stand by while we compile the q and a roster.

Our first question comes from the line of Brad Zelnik with Deutsche Bank. Well, thanks so much guys. I really appreciate you taking my questions. Um, I, I, I guess my first one is either for you, Tom, or, or for you, ho just, you know, as we think about the plan that you’ve laid out, and it’s nice to see the, the progress relative to what you told us last quarter, but traditional metrics obviously don’t tell the full.

So, so what’s the right metric for us to track the progress quarter to quarter that you’re making? What are the miles, stones that we should be looking for? And maybe can you tell us what metrics do you, do you measure yourselves against internally and hold the Salesforce accountable to and incentivize them on?

So we can just get a sense quarter to quarter, uh, in addition to customers. Obviously they eventually translate the dollars, but, uh, any insight there is helpful. And then I’ve got a follow up.

Brad. Hi Brad. It’s Tom. I mean, I think the bottom line is when we go to this model, um, we’re looking at number of customers. Okay? So how many new pilots are, are, are, are closing every. Quarter we’d expect in the outer quarters. I mean, this should be an order of magnitude larger than we’re doing now. Yep. I think we did what, 13 or 15 last quarter in roughly half a quarter.

Cuz I mean, we announced the, the transition to this model about halfway through the quarter and we did, we did 15, about a half a quarter. So it’s basically. , uh, it, it’s really number we’re really looking at number of customers, Brad, and then, and then we’re looking at how far we, you know, how rapidly their growth grow, the use of their products.

If we’re, if in fact we get an order of magnitude more customers and they continue to grow their use as our customers have in the past, and, you know, we’ve modeled this very carefully. I mean, we get out there in 3, 4, 5 quarters, this revenue line. Accelerate pretty dramatically. Right. Brad? Just one thing to add to that.

Uh, uh, so, so we guided in our original model to, for the, an analyst community to expect five, uh, pilots for the quarter. We actually closed 13, uh, which, which was a combination of trials and pilots. So we, we were quite excited about how, how this started, this kicked. . Thank you for that. You ho, that’s helpful.

And, and maybe just one follow up, a appreciating the accelerated path to profitability and, and, and naturally just given what’s going on in the world, you guys, you know, are, are, are, are in a, in a pretty interesting position for sure. But, but what would need to happen to get you to positive free cash flow ahead of the fiscal 20.

Expectation. And, and, and maybe can you just clarify for us, is that an exit rate, uh, is, is that for the full year? H how do we h how do we measure that? And, and, and what circumstances would, would maybe cause you to accelerate that? Not that you need to, you’ve got plenty of cash. But I mean, this is, this is clearly the discipline that the world wants to see.

Brad, this, it’s simple. We, we could throw this to be cash positive and profitable. You know, honestly, within 90 days, all I gotta do is lay off about 40% of the workforce. Okay? Now that I don’t think, I mean, that might make some analysts happy and it might make some shareholder happy, but. , it’s absolutely not in the best interest of the shareholders, employees, or the customers.

And, but I mean, it’s all we have to do is basically stop on marketing expenses and last 40% of the people and it’s, you know, I don’t know whether it’s 40% or 50% or 35, but, you know, it’s, I mean, hard stop. It’s cash pods and, and profitable like next quarter, but, You know, I don’t think that would be responsible, and I don’t think it’s anybody’s interest, but you asked the question, we gave you the answer, you all, you have any further light on that o only thing, Brad, that, uh, we, the way that we’ve modeled our past profitability, we feel confident on that.

And, and, and we stick to that. Yeah. So just to clarify, the, the, the expectation though, it’s for the full year, is it an exit rate when, when you say fiscal 24? Oh, it’s an exit rate at two point f1. Awesome gentlemen, thank you so much. Truly appreciate you taking the questions. Thank you, sir. Thank you. And our next question comes from the line of Mike Psychos with Needham and Company.

Hey guys. Thanks. Thanks for getting me on here. Uh, I did wanna circle up on some of the, the customer count dynamics, just because I know that is gonna be one of the metrics we’re looking at while you guys are going through this transition. Um, uh, I think you guys incited two 30. , uh, up from 2 28 last quarter.

Right. And I just wanted to see what has the customer behavior been like since you guys announced this transition? And, and what I really would be interested in hearing, um, I know you guys are not forcing your customers to migrate down to the consumption model, but curious to hear, have you seen customers, uh, trade down to the consumption model since you announced this transition?

And then the, the second question there is, uh, have you seen any changes in, in customer behavior from a churn perspective?

Um, I’m Mike. It’s Tom. Uh, the no customer, existing customer has requested to convert to the conversion based pricing, uh, of the consumption based pricing model. I understand that these customers are huge. I mean, you get into Shell and you get into, uh, uh, um, uh, a Coke Baker Hughes. I mean, these are. Very, very large relationships now.

And you can imagine their licensing in terms are pretty favorable and unique to them. Uh, have we seen a, any significant change in customer maturity? No. Appreciate, appreciate the color there. And, and then, um, for the follow up, uh, I did want to, I, I guess look back at what we had spoken about last quarter with feels getting pushed out just given the current environment.

So specif. You guys had called out 66 deals last quarter, getting pushed. Have you closed any of those deals in the interim? Um, and, and do we still see a similar order of magnitude for deals getting pushed? Sure. Um, given that you guys have made this transition, are you, are you helping streamline the adoption process for those customers at accelerating those, those sales?

Yeah, so, so we did close, uh, uh, uh, some of those deals that were pushed out of last quarter and like we expected from our revenue guidance, uh, the macroeconomic climate was, was, was tougher for, for, for the second after q1. But it has sta stabilized and in particular with our new consumption based pricing, I think, uh, our customers and, uh, potential new customers are reacting well to that.

Got it. It makes a ton of sense, especially when I think about that average contract value declining from, from, call it 19 million to less than a million this quarter. So thanks a lot guys. I’ll, I’ll step back into the queue. Thank you. Thank you. And our next question comes from the line of pendulum Bora with JP Morgan.

Pardon me. Pendulum. Your line is now open. Please check your mute button. Oh, I was talking to myself. Um, hey guys. Thank you for the taking the question. Um, I wanted to ask about the subscription revenue. Outperformance seems like a big outperformance, uh, in the quarter. Was that largely because of the outperformance and the number of pilots that you’re doing?

Uh, because I, if even if you had closed some of the deals that got pushed, um, I wouldn’t have thought that you would recognize a ton of revenue from those. So help me underst.

Well, I think you kind of got it. There were, there were some previous transactions that, that were not based on consumption based pricing that did close in the quarter that did contribute to that. So I, I, I think, I think you called it accurately pendulum. Correct. Okay. So it was because of the, the deals that, uh, closed.

Okay. Tom, um, on a, on a high, high level, maybe, maybe I wasn’t understand what you’re hearing from CIOs, um, in terms of it budgets for next year. Um, are people, you kind have called out, uh, obviously the, the headwinds on macro, but are you hearing people kind of resetting their budgets for next year, next calendar year?

What are you. I think it, you know, it’s a really good question and it varies from company to company. I mean, there, there are a lot of companies that see this as a, and, and organizations in the federal government, and by the way, I didn’t comment on a federal business, but a federal business is really strong.

Okay. You know, particularly in the defense sector. And you know, if you saw the defense budget specific least flying through today, it increased. almost, you know, 200 million, uh, over, I’m sorry, $200 billion over last year, uh, if I’m not mistaken. So, you know, that’s a big business. Um, you know, I think there’s kind of two categories there, there, there, there’s companies that are like bearing down and using these technologies to figure out how to save money.

That would include Shell, that would include the Air Force. Okay. And then there’s companies that whose name I will not mention that are just absolutely going to the mat and slashing expenses and everything. They’re going into the bunkers and they’re going into recession mode and we will see some customer return from that.

Okay. Hard stop. Okay. They’re just cutting to the bone. and, uh, so there’s kinda two classes of companies out there. Um, those who are investing in savings and those who are just kind of going into a knee jerk, perfectly rational response to a, to a, you know, impending significant recession. And it’s a slashing all costs.

And so we see. , and I don’t know how long this lasts. You know, you, you guys are the pros at this, whether it’s 12 or 24 months, but you know, when it’s over, we’re gonna still be here, you know, plug it away at it. And, uh, but it’s, you know, it’s, um, you know, you, you cannot deny that it’s, you know, I mean, it is rocky out there.

Yep. Understood. Thank you, uh, so much for the insights.

Thank you. And our next question comes from the line of Patrick Wall Ravens with JMP Securities. Oh great, thank you. Um, I wanna do a couple sort of financial ones to start with, if that’s okay. So, gross margin, if I’m looking at it right, non-AP was 77 down from 81 last quarter. Is there anything, um, worth noting there?

Hi, pat. The only thing to call out there is when trials and, and pilots, as Tom mentioned on the opening remarks, there is more, uh, higher cost than those, than the ongoing subscription. So as, as we see increase of pilots and trials even in the coming quarters, uh, we are expecting some pressure on gross margins before it, uh, climbs back off to historical doubles.

Okay, so as I look forward, should I be around this, um, 70. Level I, I think you should, you should expect a little bit more of a pressure as we increase the pilot as proportion of total, total deals, and by the time we are back at Q4 FY 24, we should be back at these rates at higher. Okay. And then the subscription beat.

But services missed at least my number by a lot and went down sequentially by a lot. What, what’s to note there? Only thing is that it’s the, the services is a direct result of our transition to these pilots. In our new consumption based pricing model. There are minimal mm-hmm. upfront, big professional services deals associated with these.

Um, so as we, as the pilots convert to ongoing license arrangements, we do expect the services component to increase as well. And in the second half of this fiscal year, we actually are expecting services to return back to the 10 to 20% of our total revenue. Oh, for Q3 it would be 10 to 20% of total revenue.

I’m, I’m saying to default back half of the year. So it could be somewhere at the range for Q3 and higher lowering q4. Okay. And then, um, the, if you look at a subscription revenue of 59 million and, and change, the footnote says 32% of that is from related parties. Do you mind just explaining that for people?

Cause I do get that question quite a. Just the related party is relating to Baker Hughes. So Baker Hughes is our, uh, of course give a significant shareholder of C three ai and any revenues that we interact with Baker Hughes’s direct purchases, we, we call ’em out into financials. Yeah. And so Tom, the Bear case would be that in some way as a lower quality revenue.

What, what, what would your response be to that? Oh boy. It sure luck. Yeah, I’m sure. I’m sure you have one, but . Uh, I, I don’t, I don’t, I don’t, I don’t know what to, I don’t know how to respond, pat. The, we’re gonna be doing a lot more deals with a lot more customers. We’re gonna convert a lot more of ’em into production, and they’re gonna grow just like Shell Baker, Hughes, uh, Coke and everybody else has grown and, you know, There’s, um, you know, so right now things are looking pretty promising.

I think we’re right on track. Okay, great. Uh, last one, and this one is, is probably for you Tom. So you signed, it’s been a year since you signed that 500 million production, other transaction agreement with the, um, department of Defense. How, how, how would you say it’s going so far versus your original expectations?

Um, d o D is really big, so I, I think that year, year over year. Do od grew by what percent? Uh, a hundred percent. Roughly. A hundred percent Terms. Hundred percent In terms of bookings. Do od is, is a, is a real bright point. Pat, in, in m you’re, you’re talking specifically on mda. The MDA agreement applies to all of DO OD by the way.

Okay. Mm-hmm. , and then we have hundred million dollar agreement with rso and, uh, you, you will. In this release, but tomorrow morning is, should be announcement about a big partnership that we, that we’re doing with, with Booz Allen Hamilton. Okay. In, in, in, in all of the federal government, particularly d od, but that business isn’t looking strong.

Okay. All right. Great. Thank you very much. Thank you. Thank you. And our next, next question, Pete Singh with Morgan Stanley. Excellent, thank you. This is tier two for Sanje. Um, I, I really just want to, um, touch on sort of the consumption growth that you’re seeing, especially with the Ex Machina product. Um, just so you can sort of.

provide any color on, um, one, how you see consumption trending with those customers, and then how you expect that going forward and maybe sort of related to this environment. How are customers using it maybe differently than they have before? Okay. Okay. This is Tom and I would say of the various products that we have in the marketplace.

Okay. Of which we have, I think, 42 production products of X mock and being one of them. Okay. We are underperforming on the execution of X mock and a sales. It is a dramatically superior product to um, to, um, Other products that are out there in the marketplace. That being said, it’s kind of order of a thousand dollars thing.

Okay. And we, in terms of a unit, okay. And we really haven’t put the sales motion together to do that at scale. Now we’ve taken the objectives to get after it, but I cannot look you in the eye and. That we’re, we’re hitting that ball over the left field fast cause we’re not okay. And, and it, it, it’s a great product.

Our customers love it. We have somebody who, we have three customers that have much greater conceptual, call it Baker Hughes than Con Baker Hughes. Hundred percent increase. Hundred percent increase there. But can I look you in the eye and tell you that we’re killing, that we’re realizing the potential that product, that product could be an entire separate company.

Okay. Our, our, our CRM product could be an entire separate company. Our ESG product could be an entire separate company, standalone company. And in all three of those, I think we really need to get focused and get going. And we haven’t done that yet. So. Okay. That’s helpful. That’s helpful. I mean, your commentary sounds worse than the 270%, um, consumption increase that you’re seeing there, there any, any colors sort of on what’s enabling that increase in consumption and then to, how are you in your other products trying, like trying to enable similar consumption rates?

Is there anything sort of to highlight that you’re doing differently there to get. Those kind of trends that you’re seeing in this product, although you’re not highlighting it specifically, do you wanna focus on ex marketer or you want, is this about ex marketer or is this about overall products? Uh, this is more broadly.

Broadly, go ahead. Y no, I think just lemme just kind of add on to that. So, so for X marking out just what Tom said, like he was, we’re still very early stages on that. So yes, we see those, those those key customers that started earlier with us, massive increase in consumption. Yes, we’re excited about that.

But the entire, that, that entire product is completely, uh, uh, uh, in its infancy and we have high expectations on it with. The other point on other consumption. So remember again, we start these packets. The, the, the consumption deals start with a six month pilot and then it moves into consumption. We started this quarter, so we’re not really seeing any consumption until the initial six month phase.

It’s our complete. So that question, and as we start talking about consumption under the, uh, all the other deals that we do, uh, we’ll start reporting and discussing that more detailed, uh, probably in q1 next. Okay. Got it. Thank you. Thank you, thank you. And our next question comes from the line of Kingsley Crane with Canor Genuity.

Hi. Thanks for fitting me in. So for Tom, looks like there’s strong traction in Department of Defense, noon expanded deals with numerous agencies. Imagine the AI Defense Forum, uh, with a helpful touchpoint to close these. So how would you Charact. Momentum in this sector. And then are these companies embracing the new consumption model or are they preferring to commit more upfront in the legacy?

I’m showing our next question comes from the line of Kingsley Crane. Please go ahead. Yeah, this is Kingsley. That’s what, yeah. Kingsley. Hi. Yeah, could you hear me? No, please. One more time, please. Oh, okay. Right, so. For Tom. Looks like there was really strong traction in Department of Defense, uh, expanded deals with numerous agencies.

Uh, how would you characterize momentum in this sector compared to a few years ago? And then, are these companies looking at the consumption model? Are they, uh, primarily sticking to the the current model?

Great question. Um, you know, it takes some time to really get traction in p o d. Okay. And we’ve been working on that since, you know, 2014. Okay. You know, at, you know, at the level of the Secretary of the Army and the Secretary of the Air Force and the Joint Chiefs and, you know, the, and I mean, we’ve really been working it.

I think we have 12 projects, uh, all delivered on time, on budget to spec. And really what we’re, what we’re finding is the consumption model there is really, really well received. They like it. Okay. And you know, they’re kind of used to seeing these. You know, multi-billion dollar juggernaut projects from the Lockheed Martins of the world, or these, uh, um, or, you know, other providers.

And we’re coming in where, hey, we bring the project live for half a million bucks and after that 55 cents per CPU hour. So it’s like, where do I sign? So they’re, it, you know, it’s, it’s, it’s been very well received in that.

Okay. Thank you. That’s really great to hear. And then for you ho, just want to touch again on the services revenue. Um, you know, understandable that it would be lower given some of the trial activities. So, um, since we expect trials to continue in the new consumption model, uh, just trying to get a better handle on how quickly services should ramp back up to that 10, uh, to 20%.

Well, again, there’s a component of the ongoing regulations with our existing customers and, and, and, and potential services engagements with them. And then our expectation of services engagements as these p pilot deals convert to consumption deals. So, uh, what I was alluded to earlier to, uh, Pat’s question, we are expecting services activity.

in the second half of this year, and then separately in the long term models, you should expect that as the pilots convert to consumption, there are services deals associated with those as well. Okay, thanks. Very helpful.

Thank you. And our next question comes from the line of arson Matovich with Wolf research. Hi, this is our son, FRA Gal. And um, I think on the call you said there were 13 consumption pilot winds in the quarter, and maybe that was maybe better than you initially expected. Is that a run rate you’re comfortable with going into the end of the fiscal year, the back half, and, um, any particular callouts for sectors where the consumption model is maybe getting better traction than you initially expected?

Thank you. So, so, sorry, the, the second half of your question. Uh, it was a good one. Clear. We’re gonna, we address the first one? Yes. While we’re excited on the beginning of this, so we, we did 13 pilots and trials, so there’s still a combination of, of some of the trials in there, but we do expect them to, uh, convert to a consumption based arrangement at the end of the trial period.

Uh, I do not, uh, I, we would not want to increase any of our assumptions in the, in the, uh, model we shared with you. Quarter. So even though we said five this quarter and we came in at 13, um, I would, I want to keep the model as it was, uh, that we provided for last quarter. . Great. And then just a brief follow up, in terms of stock based compensation, I think it’s the second consecutive quarter where stock based compensation as a percentage just fails is above 85%.

I think you want, we talked about maybe that was a lot to do with share refreshers, and I wanted to see what dynamic was that happened in q2 and what level of stock based compensation should investors be com comfortable with moving forward? Yeah. Yeah, I think, I think broadly speaking, you see this across the industry, but stock based compensation under gap is stuck with the grant daycare value of the underlying equity instrument.

And as, as you obviously know, The history of the entire tech sector and C3 ai in the last year and a half, we are carrying significant stock-based compensation costs for awards that were granted when the share price was much higher than today. So unfortunately, there’s nothing we could do about that unless, you know, the underlying employee decides to seek for other opportunities.

So for now, um, un un, until the end of these testing terms for these awards, we are gonna be carrying these pretty, pretty high stock based compensation. For, thank you for, I’ll never realized by the person who was granted the stock option. Yeah. Especially or not, not never, but yeah. Yeah. No time soon. Yeah.

Thank you. Thank you. Thank you. One moment please for our next question.

Our next question comes from the line of Adam of America. Hey, great. This is Adam Va. Thanks for taking our question. Um, you free. Can you talk a bit about the shape of the revenue curve for next year? I guess naturally we expect it to kind of increase sequentially every quarter given the new sequential or given the new consumption model.

Um, is there a chance there’s still some lumpiness in that as, you know, certain, you know, larger customers may renew on kind of like the non-consumption, uh, license? Yeah. Yes. I think the short answer to that is yes and, uh, um, uh, what we got at that quarter. We beat it for this quarter, our guidance for next quarter, you see sequentially increase and it does have the q4 as, as, as an increase to data.

With respect to the implied guidance, um, the revenue curve is flattening as a result of the. Consumption based pricing, um, uh, business model. But as we enter into, in the short, in the short term, and as we enter into FY 24, and especially the second half of FY 24, you should start seeing the, the graph to get deeper and deeper.

Uh, in line with the presentation we share graph quarter. Okay, that’s helpful. And then again, just like the gross margin, um, did you kind of call out when that might chop out and. Kind of like the level of that might be, I think it was at like 77% for this quarter. So is it fair to assume that that’s kind of like the trough level for that?

Thanks. Well, thank you for the question. I think the more important thing is that we, we assume there would be a pressure in the gross margin when we provided the operating. Margin and operating profit guide and our path of profitability. So we are expecting pressure on it, but it doesn’t change our path of profitability in one bit.

So, uh, I, I, I cannot tell you exactly where I think it will dip down to, but I think in, in your models, as you prepare the business, uh, back in FY 20, sorry. When we hit FY 24 q4, we should be back at 77 plus, uh, gross margin. So it may go down in, in, in the interim and then it climbs back up as we enter profitability.

Okay. That’s super helpful. Thank you. Thank you. Thank you. And our next question comes from the line of Arvin Ramani with Piper Sandler. Hi. Um, thanks for taking my question. Um, you, I had a question on, uh, some of your, uh, kind of partnerships or alliances to help drive, uh, sales. Um, yeah. Are, are you able to kind of dimension how much of your, um, kind of new sales, uh, are bookings, uh, come from.

In-house sales teams versus your partners. Um, I’m sure it’s probably pretty difficult to, to kind of bifurcate the two. Uh, but if you’re able to do that, that’d be great. And on the same topic of of of partnerships, uh, you know, are the margins higher or lower on, uh, sales that are brought in by, by some of your partners?

Hi, it’s Tom. Uh, virtually all of our sales today, we’re selling with a partner, not through a partner. Okay? And so that would be a hundred percent. We’re, we’re, we’re, we’re, we’re, we’re selling with them. Now, they may introduce us to the account. They may bring the executive team over here, uh, as Google has, as, as Booz Allen, I’m sorry, as, uh, bigger Hughes has, uh, as m Microsoft has in the past like many, many times.

But we’re actively engaged Okay. In, in the sales process. Now we are just now. , you know, putting our products on the marketplaces of the various hyperscalers. And so that dynamic might change going forward, but there’s, there’s no, there’s no margin difference cause there’s virtually no case where they’re selling independently of us.

All right. Uh, perfect. Thank, thank you.

Thank you. And our next question and our last question comes from the line of Michael with KeyBank. Hi, this is Michael. I’m Michael. And my question, could you just talk about in the, and then to start out November for fiscal three.

So , are you talking about like deal velocity in the end of the quarter or what are you, what are you asking about? Yeah, I just, was it, you know, month to month, you know, how did deals trend, was it a constant uptick through each throughout the quarter or was it stronger, you know, back end of the quarter or the beginning of the quarter?

Well, did we see activity all throughout the quarter, but it’s not unusual in this business, whereas you approach quarter ends, you have slightly more.

Okay. And then just a quick follow up on a vertical standpoint, particularly energy, have you seen like an uptick in deals in that area? I think which areas besides federal are you seeing particular strength in at this time? Thanks.

So if your question is relating to the diversification of industries, we see continued diversification, which we’re very excited about. Yes, there’s deals in energy, but, uh, defense, as we discussed is, is, is really exciting for us as many other, other industries as well. And we continue to expect more diversification with the consumption based, uh, pricing and scores of new.

Okay. I guess that was our last question. And, uh, gentlemen, uh, thank you for your thoughtful questions and uh, and we appreciate the courtesy of your participating in our call. And we thank you all very much for your time. Ladies and gentlemen, this concludes today’s conference call. Thank you for participating, and you may now disconnect.

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