Q2 2023 C3.ai Inc Earnings Call
The conference will begin shortly to raise your hand during Q&A you can dial star one one.
[music].
Okay.
Hello, and thank you for standing by and welcome to the <unk> second quarter fiscal year.
Earnings Conference call at this time, all participants are in a listen only mode.
After the speaker presentation, there will be a question and answer session to ask a question. During this session you will need to press star one one.
Telephone.
It is now my pleasure to introduce.
Violations Rubin.
Thank you Andrew and good afternoon, and welcome to <unk> earnings call for the second quarter of fiscal year 2023, which ended on October 31, 2022. My name is Reuben Gallegos, Vice President of Investor Relations with me on the call today is Tom Siebel, Chairman and Chief Executive Officer and <unk>.
Little parking and 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.
Each of which can be accessed through the Investor Relations section of our website at IR Dot C. Three thought 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 it 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 state.
Rents are subject to a variety of risks and uncertainties that could cause actual results to differ materially from expectations for.
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.
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 to the dynamics of our business or quarterly results. Please be advised that we may or may not.
<unk> to provide this additional detail in the future and with that let me turn the call over to Tom. Thanks.
Thank you everyone.
Hello, everyone. Thank you for joining us.
I'm here with you all parking.
<unk> financial officer.
And we are most pleased to share our results with 74 for fiscal year 'twenty three.
Bottom line it was a solid quarter in which we delivered our stated objectives.
Expectations.
Despite rocky.
The rocky economic situation and that generally.
Melrose the condition of the markets.
In the last earnings call, we described choose strategic initiatives for 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 for that subscription based pricing model to a consumption based pricing model.
Im happy to report these initiatives have been successfully completed in the second quarter.
I would I will explain these actions in some detail, but first I'll comment on our financial results.
And some of the successes that we achieved during the quarter.
Great 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 count grew 16% year over year to 236.
Current RVO of $164 5 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 100% increase year over year.
Our average contract value in the second quarter was just over $800000 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 both revenue and bookings.
Our new consumption based pricing model was well received by our customers or prospects are partners and by our sales organization.
We expect this new model to increase the number of customers with which we are engaged.
Any given quarter by an order of magnitude.
As these customers continually increase their usage over time, we expect the compound effect about revenue growth to be quite significant.
Our customers and prospects filed the new consumption based pricing easier to understand.
Is it a contract.
Our market partners find this new pricing model, well aligned with how they price their own services and one that facilitates very successfully selling Cta ad products.
I'm happy to report that our transition to this new consumption based pricing model is now complete.
Simultaneously last quarter, we completed a transition of a similar magnitude with the right composition of our global sales team. We are now growing our team of highly qualified well trained technologically expert sales professionals, who are engaging with prospective customers and sell.
Pilots and expanding production usage with existing customers.
There is no question.
There is pervasive economic uncertainty in the global business community they continue to.
Could provide.
Bookings headwinds.
This has been especially significant in the tech markets that are express.
<unk>, a bloodbath in equity prices with significant layoffs at companies, including Amazon Salesforce, Google Snap and many others.
I believe this is just the start.
What will be a significant tech market correction.
Layoffs at established companies will accelerate.
And many of series a b C and D companies that are hemorrhaging cash will simply not survive.
Every other tech recession that where youre seeing the human capital at the piece parts companies.
Be redistributed.
To those companies that survive.
Okay.
We are confident in our business outlook, especially with the nearly $600 billion market addressable market opportunity that we have before us with.
We continue to invest in our products.
And then 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.
In the last quarter to over 850.
Sequential increase of 83, and we continue to hire 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 <unk> sustainability for manufacturing at two of their key offshore platforms in the Gulf of Mexico.
We also successfully concluded the ESG trial with shell.
Focused on leveraging NLP to generate targeted insights on the rapidly evolving ESG priorities of shells key stakeholders.
Charlotte has already addressed and communicated that they are really they are realizing massive economic value annually by deploying our cta applications across the enterprise upstream downstream midstream renewables.
We're just getting started.
There is a large and growing pipeline of enterprise applications that challenge is building testing and deploying.
Using the <unk> platform.
Realizing.
Realizing the strategic value of our partnership.
And the fulfillment.
The digital transfer formation.
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 can 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 machine that has enormous.
Humanitarian ramifications and we're proud to participate with Cargill and this important mission.
Lastly, we are proud to say that we've continued to expand our relationship with United States Air Force working closely with them to improve aircraft availability.
And efficiency of readiness programs have the entire fleet of over 3700 aircrafts.
AI capabilities that we're putting into operation today offer the potential to improve readiness rates last year to 20%.
To reduce the cost of maintenance for up to $4 billion per year.
Let me address our.
Partner ecosystem.
In recent weeks there has been something of a seismic shift.
Enterprise AI software space.
Additionally, the primary competition to purchase loans Cta enterprise applications. What's the license was for a company to license IP alternative <unk> was there a company to license a large number of tools from the Hyperscale piece.
<unk> parts, so I'll provide areas like Cogs their pivotal data for edge data robot and then many of the scores of other point solution providers and then engage in a long and expensive science experiment.
You have to build a custom enterprise AI platform.
No one to acknowledge ever succeeded is that now the market is clearly changing.
<unk>.
Sure.
J&J and demonstrating an increased desire for production tried tested proven enterprise AI solutions.
All of the Hyperscale orders have acknowledged this within the last few months.
Thomas Fran at Google Cloud was the leader.
Announcing the GCB wood wood.
With lead in the market.
Not with key spots.
But we're trying to keep production enterprise applications from C. III.
Then last week, Adam Solecki CEO of AWS announced that their customers were now demanding Cherokee applications not toolkit.
This was followed the next day by Scott.
<unk> EVP of Microsoft Azure, all announced that their customers are telling them.
No longer want a tool kits to build applications. They now want functional turnkey AI applications that accrue immediate value.
With a growing family of 42 production enterprise <unk> AI applications in the market that serve the needs of financial services utilities Health manufacturing defense intelligence and other industries CPA AI is well positioned to capitalize on this now clearly recognized market require.
We sell with GCT, we sell with Azure, we sell with AWS as we saw with Baker Hughes, we sat with Booz Allen Hamilton, and we are well positioned to help our partners to deliver to their customers the solutions they're demanding.
C J AIG, Google cloud are continuing to jointly invest industry applications with the launch of two new enterprise AI applications last quarter optimize our DCP. Our sales teams are actively co selling today.
300 accounts around the world.
Last quarter, we closed an expansion with a large transportation company.
We signed one of the top 50 retailers in the world.
The license our supply chain applications and signed several new deals in the financial services and oil and gas industries are GCE joint selling activity is quite brisk.
And as a result TCP.
Our fastest growing installed base.
That being said AWS remains <unk> largest installed base constituting about 50.
<unk>, 56% of our customer base.
C C.
C J and Microsoft continue to close deals, particularly in the energy and manufacturing sectors.
<unk> remains our second largest installed base.
Constituting a passionate lately.
97% of our customer base.
Okay.
We announced a number of new product enhancements and of 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 at our at their debt and increase performance should these existing applications.
Let me talk for a minute about human capital.
<unk> continues to be recognized as a great place to work.
In the second quarter, we received over 23000 job applications. We interviewed over 2200 of these applicants and we hired 90.
One of the secular changes of this tech down churn 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 excellent is expected to be between 63% and $65 million.
And we are reaffirming our full year fiscal year 'twenty three revenue guidance.
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 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 at a cash positive operations by the end of fiscal year 'twenty four.
At this time, we do not see our cash balances below.
So our cash balances following below $700 million before that inflection.
Final comments on the Big picture.
C III.
<unk> is addressing a 600 billion dollar addressable AI software market.
If not the largest one of the largest providers of these applications globally.
Our business is exactly on track with what we have communicated to you all.
Our goal remains to establish and maintain the globe global leadership position in enterprise AI software.
In the short one.
We believe the 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 he 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 2020 for AI will be CRE AI will be bigger stronger cash positive profitable the 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 Yu Ho Park for a summary of our financials and additional commentary.
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.
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 is noteworthy that deals under 1 million grew 167% year over year in Q2 now.
Now turning to our PEO in bookings, we reported <unk> of $417 3 million, which met our expectations as we continue to convert.
As we continue convert to consumption based deals current <unk> 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 lease and we will not have a meaningful impact on our path to profitability normalized.
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.
Assumption 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 targets, 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 our <unk> related to the Buildout of our new headquarters and investments in our business, we expect our cash.
The investment balance to bottom out in fiscal 'twenty four before we see improving free cash flow and improving cash balances thereafter as a reminder, one of our most significant cash usage has been further build out of our new headquarters, which only got really high tech companies, we actually be occupying we are on track.
We achieved positive non-GAAP operating margin in the fourth quarter of 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.
I expect it to remain in their current contract terms as such we expect <unk> to decline as our new deals will not require a significant upfront noncancelable arrangement, but rather a consumption based usage arrangement.
Assumptions, we provided last quarter for modeling for consumption based business remain unchanged. In summary, we are focused on forgiving profitable growth to our shareholders and we continue to expect achieving non-GAAP profitability in the fourth quarter of fiscal 'twenty four while growing the top line in excess of 30% with these remarks I would like to.
Opening the call up for questions operator.
Yes.
Thank you.
A reminder, ladies and gentlemen to ask a question you will need to press star one one on your telephone please standby, while we compile the Q&A roster.
And our first question comes from the line of Brad Zelnick with Deutsche Bank.
Well. Thanks, so much guys I really appreciate you taking my questions.
Sure.
I guess my first one is either for you Tom or for you, though just as we think about the plan that you've laid out and its nice to see the progress relative to what you told us last quarter, but traditional metrics, obviously don't tell the full story.
So what's the right metric for us to track the progress quarter to quarter that youre, making what are the milestones 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 sales force accountable too.
And incentivize demand. So we can just get a sense quarter to quarter.
In addition to customers obviously, they eventually translate to $1, but.
Any insight there is helpful and then I've got a follow up thanks.
Hello, Brad Hi, Brad its Tom.
The bottom line is when we go to this model.
We're looking at number of customers, okay. So how much.
Any new pilots.
Or closing every quarter, we would expect in the outer quarters. I mean, this should be an order of magnitude larger than we're doing now I think we did what 13% or 15 last quarter and roughly half a quarter, because we announced the transition to this model about halfway through the quarter and we did.
About half of where it sits basically.
It's really number.
Really look at a number of customers Brad and then and then we're looking at how far how.
How rapidly their gross to grow the use of their products.
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 with model that's very carefully.
We get out there 345 quarters. This revenue line should accelerate pretty dramatically Bryan Bryan just one thing to add to that.
So we guided in our original model too.
Analyst community to expect five.
<unk> targets for the quarter, we actually closed 13.
Which was a combination of trials and pilots. So we are quite excited about how well just started this kicked off.
Thank you for that you have it's helpful and maybe just one follow up.
Appreciating the accelerated path to profitability.
And naturally just given what's going on in the World you guys are in a.
Pretty interesting position for sure.
What would need to happen to get you to positive free cash flow ahead of the fiscal 'twenty four.
Expectation.
Maybe can you just clarify for US is that an exit rate is that for the full year.
How do we how do we measure that and what circumstances would would maybe cause you to accelerate that and not that you need to you got plenty of cash but.
This is this is clearly the discipline that the world wants to see.
Brad.
Simple.
Distribute cash positive and profitable.
Honestly within 90 days.
Just laugh about 40% of the workforce okay.
Thanks.
Maybe some analysts happy.
Make shareholder happy, but it's absolutely not in the best interest of the shareholders to employees, who are the customers and but it's.
So we have basically stopped all marketing expenses at last 40% of the people.
I don't know, whether its 40% or 50% of 35%.
It's.
Hart, Scott, it's cash positive and profitable like next quarter.
No.
I don't think that would be irresponsible and I don't think it's anybody's interest, but you asked the question. We gave you. The answer you all do you have any further light on our only thing Brad.
The way that we've modeled our path to profitability through contract around that and we stick to that.
Got it so just to clarify the expectation, though it is for the full year is at an exit rate when you say fiscal 'twenty for us that'd be great at two for FY 'twenty four.
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 cycles with Needham <unk> Company.
Hey, guys. Thanks, Thanks for getting me on here I did want to circle up on some of the customer count dynamics, just because I know that he is going to be one of the metrics. We're looking at what you guys are going through this transition.
I think you guys had cited $2 36.
Up from $2 28 last quarter and I just wanted to see what has the customer behavior been like since you guys announced the transition and what I really would be interested in hearing.
I know you guys are not forcing your customers to migrate down to the consumption model, but curious to hear have you seen customers.
<unk> down to the consumption model since you announced the transition and then the second question. There is have you seen any changes in customer behavior from a churn perspective.
Hi, Mark its Tom.
No customer existing customer has requested to convert to the conversion based pricing.
The consumption based pricing model understanding these customers are huge I mean, if you get into the shower and you're getting.
Sure.
Our Coke Baker Hughes.
Very very large relationships now and you can imagine they are licensed in catch up pretty favorable and you need for that.
And we see it.
A significant change in customer churn.
I appreciate I appreciate the color there and then.
For the follow up I did want to I guess look back at what we had spoken about last quarter with deals getting pushed out just given the current environment. So specifically.
Called out 66 deals last quarter getting pushed.
Have you closed any of those deals in the interim.
And do we still see a similar order of magnitude for deals getting pushed.
Sure.
Given that you guys have made this transition or are you, hoping to streamline the adoption process for those customers and accelerating those those sales cycles.
Yes, so we did close.
Some of those deals that were pushed out of last quarter and like we expected from our revenue guidance.
The macroeconomic climate.
Was tougher for the second after Q1, but it has stabilized and in particular with our new consumption based pricing I think our customers and potential new customers are reacting well to that strategy.
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 1 billion. This quarter. So thanks, a lot guys ill step back into the queue.
Okay.
Thank you and our next question comes from the line of pendulum bore with JP Morgan.
Pardon me pendulum. Your line is now open please check your mute button.
No I was talking to myself.
Hey, guys. Thank you for taking my question.
I wanted to ask about the subscription revenue outperformance seems like a big outperformance in the quarter or was that largely because of the outperformance in the number of pilot that youre doing.
Because.
Even if you have closed some of the deals that got pushed.
I wouldn't have thought that you would recognize a ton of revenue from the sale.
I understand that.
Well I think you've kind of got it there were some previous transactions that who are that we're not based on consumption based pricing that did close in the quarter.
Did contribute to that.
I think he called it accurately pesos.
Okay. So it was because of the deals that close okay. Tom.
High level, maybe you can maybe help us understand what are you hearing from Ceos in terms of IP budgets for next year.
People, you kind of called out obviously the headwinds in the macro but are you hearing people kind of resetting their budgets for next year next calendar year, what are you hearing.
I think it is.
It's a really good question and it varies from company to company.
There are a lot of companies that see this as an organization and the federal government and by the way I didn't comment on our federal business, but our federal business is really strong.
Particularly in the defense sector.
If you saw the defense budget.
He is flying through today has increased I think almost.
$200 million.
Over I'm, sorry, $200 billion over last year.
If I'm not mistaken so that's a big business.
I think theres kind of two categories. There is companies that are like bearing down and using these technologies to figure out how to save money that would include shell that will include the air Force.
Okay, and then Theres companies.
Whose name I will not mention that.
It's absolutely going to the mat and slashing expenses and everything that goes into the bunkers and theyre going into recession mode, and we will see some customer churn from that okay hard stop okay.
Cutting to the bone.
And so there's kind of two classes of companies out there.
Those who are investing in savings and those who are just kind of going into a knee jerk.
Perfectly rational response to a COO and.
Pending recession, and then just slashing op costs and so.
See both.
I don't know how long. This last you guys should approach this whether it's 12 or 24 months, but.
When it's over or if they'll be here plugging away at it.
But it's it's.
You cannot deny that.
I mean, it is rocky out there.
Yeah understood. Thank you 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.
Yes.
I wanted to a couple of sort of financial ones to start with if that's okay. So gross margin if I'm looking at it right non-GAAP was <unk> 77 down from 81 last quarter or is there anything.
Worth noting there.
Hi, Pat if you hold the only thing to call out there.
The trials and pilots as Tom mentioned on the opening remarks, there is more higher cost and dose in the ongoing subscription so as as we see increased of pilots and trials even in the coming quarters.
We are expecting some pressure on gross margins before it climbs back up to historical levels.
Okay. So as I look forward should idea around this.
77 <unk>.
Level I think you should you should expect a little bit more of a pressure as we increase the pilot as a proportion of total total deals and by the time, we were back at Q4 FY 'twenty four we should be back up these rates are higher.
Okay.
The subscription fee, 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.
Services is a direct result of our transition to these pilots and our new consumption based pricing model. There are minimal upfront big professional services deals associated with these 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 surfaces to return back to the 10% to 20% of our total revenues.
Oh for Q3, it would be 10% to 20% of total revenue.
I'm, saying for the back half of the year. So it could be somewhere in that range for Q3 on higher lower in Q4.
Okay.
Then.
If you look at the subscription revenue of $59 million.
And change.
Notes is 32% of that is from related parties do you mind, just explain that for people because I do get that question quite a bit.
Just the related parties regarding to Baker Hughes. So Baker Hughes. These are of course still a significant shareholder obviously three AI any revenues that we interact with Baker Hughes to direct purchases, we called them out in the financials.
And so Tom the bear case would be that in some way is of lower quality revenue what would your response to that.
Oh boy it sure.
Sure you have one.
Okay.
Okay.
Okay.
Okay.
Yes.
I don't know I don't want to risk I don't know how to respond Pat.
The we're going to be doing a lot more deals with a lot of our customers. We're going to cover a lot more of them into production and they are going to grow just like shell Baker Hughes.
Coke and everybody else has grown in.
No.
There is.
So right now things, probably looking pretty promising I think we're right on track.
Okay, Great and last one and this is.
This 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 department of Defense, How would you say, it's gone so far versus your original expectations.
The Dod is really big.
I think year over year Vod grew by what percent.
100%.
Roughly a 100%.
In terms of bookings Vod is.
He is a real bright point Pat.
Youre talking specifically at MDA, the MTA agreement it applies to all of <unk> by the way Okay. And then we are in now.
$101 million of agreement with RSO.
And you will announce proved out in this release, but tomorrow morning, as you'd be announcements about a big partnership.
We are doing with with Booz Allen Hamilton.
And in.
All of the federal government, particularly Vod, but.
That business is looking strong.
Alright, great. Thank you very much.
Thank you.
Thank you.
And our next.
Question <unk> seen with Morgan Stanley .
Excellent. Thank you this is still to answer <unk>.
I really just want to touch on sort of the consumption growth that you're seeing especially with the X makena product.
Just if you can sort of provide any color on.
One how you see consumption trending with those customers and then how you expect that going forward and maybe you sort of related to this environment how are customers using it maybe differently than they have before.
Okay, Great. This is Tom.
And I would say of the various products that we have in the marketplace today, Okay of which we have I think 42 production products ex market being one of them okay.
Are underperforming on the execution of <unk> market sales it is a dramatically superior product too.
Two.
Other products that are out there in the marketplace that being said, it's kind of order of a 1000 dollar thing, okay and we again.
In terms of a unit, okay, and we really haven't pushed the sales motion together to do that at scale now we've taken the objective is to get after it but I cannot look you in the eye and say that we're hitting that ball over the last field fats because we're not okay.
It's a great product our customers love it we have to have somebody in the quarter. We have three customers that much greater consensual, whether we're talking about a baker Hughes and corner Bagger Dave's almost 900% increase 300% increase there, but can I to looking and I would tell you that we're killing it but we are realizing the potential of that product that product can be an entire separate company.
Okay.
Eric our CRM product could be an entire separate company, our ESG product could be an entire fabry 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.
Your commentary sounds worse than the 270%.
Function increase that you're seeing there.
Any any color instead of on whats, enabling that increase in consumption and then two how are.
Are you in your other products like trying to enable similar consumption rates was there anything sort of to highlight that you're doing differently there to get to those kind of trends that you're seeing in this product, although you're not highlighting it specifically.
You'll have focused on the next marker or water or is it about that market or is this rather overall products.
This is more broadly.
Ah broadly go ahead.
I mean, just let me just kind of add onto that so so for X market just with Thompson.
We're still very early stages on that so yes, we see those dose those key customers that started earlier with us massive increase in consumption. Yes, we're excited about that but the entire that entire product is completely.
In its infancy, and we have high expectation side.
The other point on other consumption. So remember again, we start these pilots.
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 phases are complete so that question and as we start talking about consumption under the all of the other deals that we do we will start reporting on discussing that more.
Detailed probably in Q1 next year.
Okay got it thank you.
Thank you.
Thank you and our next question comes from the line of Kingsley Crane with Canaccord Genuity.
Hi, Thanks for fitting me in.
It looks like Theres strong traction and department of defense, New and expanded deals with numerous agencies imagine the air Defense Forum with the helpful Touch point to close the so how would you characterize momentum in this sector and then are these companies embracing the new consumption models are they preferring to commit more upfront no legacy model.
And I'm showing our next question comes from the line of Kingsley Crane. Please go ahead, yes. This was going through.
Hi.
Yes could you hear me.
No because it's one more time please vote.
Okay right. So for Tom It looks like there was really strong traction in department of defense.
Our expanded deals with numerous agencies.
How would you characterize the momentum in this sector compared to three years ago, and then are these companies.
Looking at the consumption model or the.
Primarily sticking to the current model.
Great question.
It takes time to really get traction in DRP, Okay, and we've been working on that since 2014, okay.
Yes.
The level of the secretary of the Army and the Secretary of the Air Force and the joint Chiefs and.
And we've really been working it hard and I think we have 12 projects.
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 they are kind of used to seeing these.
Multibillion dollar juggernaut projects from the Lockheed Martin for the World or these.
Or other providers and we're coming in where he will bring the project live for a million Bucks and after that 55 cents per CPU hour.
Where do I sign so there.
It's it's it's been very well received with end market.
Okay. Thank you that's really great to hear and then for your home just wanted to touch again on the services revenue.
Understandable that it would be lower given some of the trial activity.
Since we expect trials to continue in the new consumption model.
Just trying to get a better handle on how quickly services should ramp back up to that 10% to 20%.
Well again, there is a component of the ongoing relations with our existing customers.
Potential services engagements with them and then our expectation of services engagements as these playa pilot deals convert to consumption deals. So well what I was alluding to earlier to <unk> 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.
Okay.
Thank you and our next question comes from the line of <unk> <unk> with Wolfe Research.
Alright. This is our spending on for Gal and I think on the call. You said there were 13 consumption wins in the quarter and maybe that was maybe better than you. Initially expected is that a run rate youre comfortable with going into the end of the.
Fiscal year, the back half and any particular call outs for sectors, where the consumption models, maybe getting better traction than you initially expected. Thank you.
So sorry, the second half of your question.
It was a good I'm unclear, but let me address the first one yes, what we're excited at the beginning of this so we did 13 pilots and trials. So there is a combination of some of the trials in there, but we do expect them to convert to a consumption based arrangement at the end of the trial period.
Do not.
We would not want to increase any of our assumptions in the.
Model, we shared with you got quarter, so even though we said, 5% this quarter and we came in at 13.
I want to keep the model as it was that we provided last quarter.
Great and then just a brief follow up in terms of stock based compensation I think it is the second consecutive quarter, where stock based compensation as a percentage of sales is above 85% I think Q1, we talked about maybe that was a lot to do with share repurchase and I wanted to see what the dynamic was that happened in Q2 and what level of stock based.
So investments become comfortable with moving forward. Thank you.
I think broadly speaking you see this.
Across the industry by stock based compensation under GAAP is stuck with the grant date fair value of the underlying equity instruments.
As you, obviously know the history of the entire tech sector and <unk> in the past year and a half we are carrying significant stock based compensation cost per awards that were granted when the share price was much higher than it is today. So unfortunately, there is nothing we can do about that.
The underlying employee decides to see for other opportunities so for now.
Until the end of these vesting terms for these awards, we are going to be carrying these pretty pretty high stock based compensation costs.
Four thank you.
Correct.
Realized by the person who was granted stock options.
Sure.
Never.
No time soon.
Thank you.
Thank you.
One moment please for our next question.
And our next question comes from the line of Adam.
Many of America.
Yes.
Hey, Great. This is Adam on for Ed.
Thanks for taking our question.
You have for you can you talk a bit about the shape of the revenue curve for next year I guess naturally we expect that to kind of increase sequentially every quarter, given the new sequential given the new consumption model.
Is there a chance there is still some lumpiness in that.
Larger customers may renew on.
It sounds like the non consumption.
Yes, I think the short answer to that is yes.
What we guided last quarter, we beat it for this quarter our guidance for next quarter, you see sequentially increase and it does have to Q4.
As an increase to data with respect to the implied guidance.
The revenue curve is flattening as a result of the consumption based pricing.
Our business model, but as we entered into in the short in the short term and as we enter into FY 'twenty, four and especially the second half of FY 'twenty four you should start seeing that the graph to get steeper and steeper.
Aligned with the presentation, we shared last quarter.
Okay. That's helpful and then a gallon just like the gross margin.
Did you guys call out when that might top out and what.
Kind of like the level of that might be.
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 assume there would be a pressure in the gross margin. When we provided the operating margin and operating profit guide.
Path to profitability. So we are expecting pressure on it but it doesn't change our path to profitability one bit.
<unk>.
I cannot tell you exactly where I think it will dip down too, but I think in your models as you prepare the business.
Back in FY 'twenty, sorry back when we hit FY 'twenty for Q4, we should be back at 77, plus gross margin. So it may go down 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 Arvind <unk> with Piper Sandler.
Hi.
For taking my question I.
I had a question on some of your kind of partnerships or alliances to help drive sales.
Are you able to kind of diamonds and how much of your.
New sales.
Bookings come from it.
In house sales team as far as your partners and I'm sure, it's probably pretty difficult to.
So kind of bifurcate the two.
But if you're able to do that that'd be great and on the same topic.
Partnerships.
Are the margins higher or lower.
On sales.
That are brought in by by some of your partners.
Hi, Guy Hi, its Tom.
Virtually all of our sales today, we are selling with a partner not through a partner okay.
So that would be 100%, where or who are selling with them now they may introduce us to the couch. They may bring the executive team over here as Google has has as Booz Allen I'm sorry <expletive>.
There is as.
As macro hat, Microsoft has in the past like many many times, but we're actively engaged.
In the sales process now we are just now putting our products on the marketplaces of the various hyperscale edge and so that dynamic might change going forward, but there's no. There's no margin difference because there is virtually no case, where they are selling independently of us.
Alright, perfect. Thank you.
Thank you and our next question and our last question comes from the line of Michael <unk> with Keybanc.
Hi, This is Michael the Diavik on for Michael.
For taking my question could you just talk about linearity in the quarter and then trends youre seeing to start up in November for fiscal <unk>.
Okay.
So we're getting it already are you talking about like deal velocity in the quarter or what are you. What are you asking about yes. It was.
Got it.
Once a month you know how to deal with trend with a constant uptake to reach throughout the quarter or the stronger.
Back end of the quarter it was beginning of the quarter.
But do we see activity all throughout the quarter, but it's not unusual in this business, where you approach quarter ends youll have a slightly more activity.
Okay, and then just a quick follow up on the vertical standpoint, particularly energy have you seen like an uptick in deals in that area.
Whats areas Federal are you seeing particular strength and at this time.
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.
Defense as we discussed.
It's really exciting for us as many other other industries as well and we continue to expect more diversification with the consumption based.
Missing in scores of new customers.
Okay, I guess that was our last question and.
Gentlemen.
Thank you for your thoughtful questions and.
And we appreciate the courtesy of your participating in our call.
And 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.
The conference will begin shortly to raise Johan during Q&A, you can dial star one one.
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