C3.AI, INC. DISCUSSION AND ANALYSIS OF MANAGEMENT’S FINANCIAL POSITION AND PERFORMANCE (Form 10-Q)
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and the related notes and the discussion under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" for the fiscal year endedApril 30, 2022 included in the Annual Report on Form 10-K for the fiscal year endedApril 30, 2022 , which was filed with theSecurities and Exchange Commission , orSEC , onJune 23, 2022 . This discussion, particularly information with respect to our future results of operations or financial condition, business strategy and plans, and objectives of management for future operations, includes forward-looking statements that involve risks and uncertainties as described under the heading "Special Note Regarding Forward-Looking Statements" in this Quarterly Report on Form 10-Q. You should review the disclosure under the heading "Risk Factors" in this Quarterly Report on Form 10-Q for a discussion of important factors that could cause our actual results to differ materially from those anticipated in these forward-looking statements. Unless the context otherwise requires, all references in this report to "C3.ai ," "C3 AI," the "Company", "we," "our," "us," or similar terms refer toC3.ai, Inc. and its subsidiaries.
overview
C3 AI is an enterprise AI application software company.
We have built an integrated family of software applications that enables our customers to rapidly develop, deploy, and operate large-scale Enterprise AI applications across any infrastructure. Customers can deploy C3 AI solutions on all major public cloud infrastructures, private cloud or hybrid environments, or directly on their servers and processors. We provide five primary families of software solutions, which we collectively refer to as ourC3 AI Software : •The C3 AI Platform, our core technology, is a comprehensive application development and runtime environment that is designed to allow our customers to rapidly design, develop, and deploy Enterprise AI applications of any type. Our C3 AI Platform enables developers to rapidly build applications by using conceptual models of all the elements required by an Enterprise AI application instead of having to write complex, lengthy, structured programming code to define, control, and integrate the many requisite data and microservices components to work together. •C3 AI Applications, built using the C3 AI Platform, include a large and growing family of industry-specific and use-case-specific pre-built AI applications, ready for installation and deployment. •C3 AI Ex Machina, our no-code solution that provides secure, easy access to analysis-ready data, and enables business analysts without data science training to rapidly perform data science tasks such as building, configuring, and training AI models.
•C3 AI CRM is a family of fully AI-enabled CRM solutions that combine data from CRM systems, other enterprise systems and exogenous data sources to enable accurate demand forecasting, customer churn forecasting, cross-selling recommendations and other AI-enabled sales, marketing and service processes.
•C3 AI Data Vision allows analysts to visualize, understand and leverage the relationships between data entities. This product unifies data from across systems to enable exploration and insights, enabling collaborative data analysis using interactive, intuitive graph network visualizations.
These solutions and our patented model-driven architecture enable organizations to simplify and accelerate the development, deployment, and management of enterprise AI applications. We greatly reduce the effort and complexity of the AI software engineering problem.
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How we generate revenue
We generate revenue primarily from the sale of subscriptions, which accounted for 95% and 81% of our total revenue in the three months endedOctober 31, 2022 and 2021, respectively, and 91% and 85% of our total revenue in the six months endedOctober 31, 2022 and 2021, respectively. Our cloud-native software offerings allow us to manage, update, and monitor the software regardless of whether the software is deployed in our public cloud environment, in our customers' self-managed private or public cloud environments, or in a hybrid environment. Our subscription contracts are generally non-cancellable and non-refundable. We define a Customer-Entity as each entity that is the ultimate parent of a party contracting with us. We commonly enter into enterprise-wide agreements with Customer-Entities that include multiple operating units or divisions. We count as a Customer each distinct division, department, business unit, or group within a Customer-Entity that uses our product(s). In situations where our Customer (or Customer-Entity) has developed software using our C3 AI Platform or developed derivative works of our C3 AI Applications and has sold that software or service to its end customer(s), we also include such end customers in our Customer count. In addition, where our software is sold to a third-party under a reseller arrangement, we include the end customer of such arrangement in our Customer count. We only count Customers and Customer-Entities for which there is revenue in the period through a Customer-Entity contract. We exclude free trials from both our Customer-Entity and Customer counts. Our Customer count was 236 and 203 as ofOctober 31, 2022 and 2021, respectively. We primarily recognize revenue from subscriptions on a ratable basis over the contract term or on a usage basis for consumption-based arrangements. In addition, customers typically pay a usage-based runtime fee for production use of ourC3 AI Software for specified levels of capacity. Customers who choose to run the software in our cloud environment pay the hosting costs charged by our cloud providers. Our subscriptions also include our maintenance and support services. Additionally, we offer premium stand-ready support services through ourC3 AI Center of Excellence , or COE, which are included as part of the subscription when purchased. We also generate revenue from professional services, which primarily include implementation services, training and prioritized engineering services. Professional services revenue represented 5% and 19% of our total revenue for the three months endedOctober 31, 2022 and 2021, respectively, and 9% and 15% of our total revenue in the six months endedOctober 31, 2022 and 2021, respectively. Our professional services are provided both onsite and remotely, and can include training, application design, project management, system design, data modeling, data integration, application design, development support, data science, and application andC3 AI Software administration support. Professional services fees are based on the level of effort required to perform the specified tasks and the services are typically provided under a fixed-fee engagement with defined deliverables and a duration of less than 12 months. We recognize revenue from our professional services over the period of delivery as services are performed. We are growing rapidly, with total revenue of$62.4 million and$127.7 million for the three and six months endedOctober 31, 2022 , representing a 7% and 15% increase compared to the same periods last year, respectively. Our subscription revenue grew to$59.5 million and$116.5 million for the three and six months endedOctober 31, 2022 , representing a 26% and 25% increase compared to the same periods last year. Go-to-Market Strategy Our go-to-market strategy has been focused on large organizations recognized as leaders in their respective industries or public sectors, and who are attempting to solve complicated business problems by digitally transforming their operations. These large organizations, or lighthouse customers, include companies and public agencies within the oil and gas, power and utilities, aerospace and defense, industrial products, life sciences, and financial services industries, among others. This has resulted in C3 AI powering some of the largest and most complex Enterprise AI applications worldwide. These lighthouse customers serve as proof points for other potential customers in their particular industries. As a result, we have a customer base of a relatively small number of large organizations that generate high average total subscription contract value, but we expect that, over time, as more customers adopt our technology based on the proof points provided by these lighthouse customers, the revenue represented by these customers will decrease as a percentage of total revenue. As our C3 AI Platform and much of our otherC3 AI Software is industry agnostic, we also expect to expand into other industries as we grow. 29
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In the second quarter of fiscal year 2023, we announced a change to our go-to-market strategy. The change includes a way for new customers to utilize our products at a smaller initial contract size and pay for services based on their monthly consumption of vCPU hours. Customers will begin with a two-quarter-long pilot which includes the necessary resources required to introduce the C3 AI Platform, C3 AI Applications and a desired product into their environment and receive necessary training to operate and maintain the product in production. Following the pilot period, customers will pay a minimum monthly fee and overage charges on a metered basis using vCPU hours as the metric to derive payment. Customers will be able to secure lower vCPU rates per hour by choosing a one, two or three year deal term. Customers will be able to realize business value immediately after the conclusion of the pilot and grow at their pace over subsequent quarters. We expect that total revenue growth for fiscal year 2023 will be lower than historical rates until a meaningful number of customers have concluded pilots and ongoing revenue driven by consumption. Acquiring new customers and expanding our business with our existing customers is the intent of our go-to-market effort and is what drives our growth. Making new and existing customers successful is critical to our long-term success. After we help our customers solve their initial use cases, they typically identify incremental opportunities within their operations and expand their use of our products. The increased engagement is measured by a combination of increased vCPU usage, increasedC3 AI Software subscriptions and through subscription to the C3 AI Platform for in-house AI application development. The size and sophistication of our customers' businesses demonstrate the flexibility, speed, and scale of our products, and maximize the potential value to our customers. To be a credible partner to our customers, who often are industry leaders, we deploy a motivated and highly educated team of C3 AI personnel and partners. We go-to-market primarily leveraging our direct sales force. We also complement and supplement our sales force with a number of go-to-market partners.
•Industry partners. We have developed an alliance program to work with recognized market leaders in their respective industries such as:
•Hyperscale Cloud and Infrastructure. We have formed global strategic go-to-market alliances with hyperscale cloud providers includingAmazon Web Services , Microsoft Azure, and Google Cloud. In addition, we have strategic alliances with leading hardware infrastructure providers to deliver our software optimized for their technology. These partners include Hewlett Packard Enterprise and Intel. These partners supply infrastructure solutions, data management and processing services, or hardware and networking devices (e.g., IoT gateways) to support C3 AI product implementations and complement C3 AI's products.
•Advice and
•Independent Software Vendors. We partner with Independent Software Vendors who develop, market, and sell application solutions that are natively built on or tightly integrated with the C3 AI Platform.
Important business metric
We monitor remaining performance obligations, or RPO, as a key metric to help us evaluate the health of our business, identify trends affecting our growth, formulate goals and objectives, and make strategic decisions. RPO is not necessarily indicative of future revenue growth because it does not account for the timing of customers' consumption or their consumption of more than their contracted capacity. Moreover, RPO is influenced by several factors, including the timing of renewals, the timing of purchases of additional capacity, average contract terms, and seasonality. Due to these factors, it is important to review RPO in conjunction with revenue and other financial metrics disclosed elsewhere in this Quarterly Report on Form 10-Q. RPO was$417.3 million and$477.4 million as ofOctober 31, 2022 andApril 30, 2022 , respectively. We successfully completed our transition from a subscription-based pricing model to a consumption-based pricing model for new customers. While the immediate-term effect of this transition lowers revenue growth and decreases RPO, we believe the medium and long term effect provides a substantial accelerator to revenue growth and RPO. RPO represents the amount of our contracted future revenue that has not yet been recognized, including both deferred revenue and non-cancellable contracted amounts that will be invoiced and recognized as revenue in future periods. Our RPO as ofOctober 31, 2022 is comprised of$30.6 million related to deferred revenue and$386.7 million of commitments from non-cancellable contracts. Our RPO as ofApril 30, 2022 is comprised of$49.1 million related to deferred revenue and$428.3 million of commitments from non-cancellable contracts. 30
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RPO excludes amounts related to performance obligations and usage-based royalties that are billed and recognized as they are delivered. This primarily consists of monthly usage-based runtime and hosting charges in the duration of some revenue contracts. RPO also excludes any future resale commitments by our strategic partners until those end customer contracts are signed. Cancellable backlog, not included in RPO, was$36.2 million and$39.4 million as ofOctober 31, 2022 andApril 30, 2022 , respectively.
Factors affecting our performance
We believe that our future success and financial performance depend on a number of factors that present significant opportunities for our business but also pose risks and challenges, including those discussed below and in the section of this Quarterly Report on Form 10-Q in Part II, Item 1A titled "Risk Factors", that we must successfully address to sustain our growth, improve our results of operations, and establish and maintain profitability.
Customer acquisition, retention and expansion
We are focused on continuing to grow our customer base, retaining existing customers and expanding customers' usage of ourC3 AI Software by addressing new use cases across multiple departments and divisions, adding users, and developing and deploying additional applications. All of these factors increase the adoption and relevance of ourC3 AI Software to our customers' business and, as an outcome, increases their runtime usage. We have built a customer-focused culture and have implemented proactive programs and processes designed to drive customer success. These include a robust customer support and success function. For example, as part of our subscription offerings, we provide our customers with the ability to establish a COE, accessing our experienced and specialized resources in key technical areas like application development, data integration, and data science to accelerate and ensure our customers' success developing applications on our C3 AI Platform. We closely monitor the health and status of every customer account through multiple activities, including real-time monitoring, daily and weekly reports to management, as well as quarterly reviews with our customers. We also intend to attract new customers across multiple industries where we have limited meaningful presence today, yet represent very large market opportunities such as telecommunications, pharmaceuticals, smart cities, transportation, and healthcare, among others. Historically, we have had a relatively small number of customers with large total subscription contract values. As a result, revenue growth can vary significantly based on the timing of customer acquisition, changes in product mix, and contract durations, renewals, or terminations. We expect the number of customers to increase compared to prior fiscal years as organizations address the importance of digital transformation. The average total subscription contract value as well as the revenue represented by our lighthouse customers as a percentage of total revenue is decreasing and we expect them to continue to decrease as we have restructured our sales organization and expanded our market-partner ecosystem to effectively address small, medium, and large enterprise sales opportunities. Going forward, we expect to attract new customers who prefer to subscribe to the C3 AI Platform and Applications with a consumption-based pricing model. Customers can get started at a lower initial price point to start a two quarter pilot and then have the ability to manage their expenses as consumption grows over time. This arrangement is similar to the pricing a customer would expect to see from other software vendors and cloud providers. As customers subscribe to new C3 AI products and build their own products, we expect to see increases in overall vCPU consumption and related revenue growth. 31
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technology innovation
We intend to continue to invest in our research and development capabilities to extend ourC3 AI Software , to expand within existing accounts, and to gain new customers. Our investments in research and development drive core technology innovation and bring new products to market. Our model-driven architecture enables us and our customers to rapidly address new use cases by building new applications and extending and enhancing the features and functionality of currentC3 AI Software . By investing to make it easier to develop applications on our C3 AI Platform, our customers have become active developers. With our support, our customers have developed and deployed almost two-thirds of the applications currently in production and running on the C3 AI Platform. Research and development spending has fueled enhancements to our existing C3 AI Platform. We expect to maintain high levels of investment in product innovation over the coming years as we continue to introduce new applications which address new industry use cases, and new features and functionality for theC3 AI Software . As our business scales over a longer-term horizon, we anticipate research and development spend as a percent of total revenue to decline.
brand awareness
We believe we are in the early stages of a large and expanding market for AI enabled digital transformation. We spent significantly on brand awareness over the past few years to great success. We have reduced our spend on brand awareness, but continue to invest in market education, strategic paid media, and thought leadership. We engage the market through digital, radio, outdoor, airport, and print advertising; virtual and physical events, including our C3 Transform annual user conference; and C3 AI Live, a series of livestreamed events featuring C3 AI customers, C3 AI partners, and C3 AI experts in AI, machine learning, and data science. In the near term, we expect marketing spend to decline as a percent of total revenue as we make ongoing progress in establishing C3 AI's brand and reputation and as our business scales.
Expand our go-to-market and partnership ecosystem
In addition to the activities of our field sales organization, our success in attracting new customers will depend on our ability to expand our ecosystem of strategic partners and the number of industry verticals that they serve. Our strategic go-to-market alliances vastly extend our reach globally. Some of our most notable partners includeBaker Hughes , FIS, Microsoft, and Google. Each strategic partner is a leader in its industry, with a substantial installed customer base and extensive marketing, sales, and services resources that we can leverage to engage and serve customers anywhere in the world. Using our C3 AI Platform as the development suite, we leverage our model-driven architecture to efficiently build new cross-industry and industry-specific applications based on identifying requirements across our customer base of industry leaders and through our industry partners. Our strategy with strategic partners is to establish a significant use case and prove the value of our C3 AI Platform with a flagship customer in each industry in which we participate. We have done this with our strategic vertical industry partner in oil and gas,Baker Hughes , as well as with our iconic global customers, some of whom are deploying C3 AI technology to optimize thousands of critical assets globally across their upstream, midstream, and downstream operations. We establish formal sales and marketing plans with each partner, including specific sales goals and dedicated budgets, and we work closely with these partners to identify specific target accounts. We intend to grow the business we do with each partner and to add more partners as we expand the vertical markets we serve. We also offer revenue generating trials of our applications as part of our customer acquisition strategy. 32
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InJune 2019 , we entered into a three-year arrangement withBaker Hughes as both a leading customer and as a partner in the oil and gas industry. This arrangement included a subscription to our C3 AI Platform for their own operations (which we refer to below as direct subscription fees), the exclusive right forBaker Hughes to resell our offerings worldwide in the oil and gas industry, and the non-exclusive right to resell our offerings in other industries. Under the arrangement,Baker Hughes made minimum, non-cancellable, total revenue commitments to us of$50.0 million ,$100.0 million , and$170.0 million , for each of the fiscal years endingApril 30, 2020 , 2021, and 2022, respectively.Baker Hughes revenue commitments were inclusive of their direct subscription fees of$39.5 million per year with the remainder to be generated from the resale of our solutions by the Baker Hughes sales organization. During the fiscal year endedApril 30, 2020 , we recognized as revenue the full value of the first year of the direct subscription agreement and the value of deals brought in byBaker Hughes through the reseller arrangement. This arrangement was revised inJune 2020 to extend the term by an additional two years, for a total of five years, with an expiration date in the fiscal year endingApril 30, 2024 and to modify the annual amount ofBaker Hughes' commitments to$53.3 million ,$75.0 million ,$125.0 million , and$150.0 million , over the fiscal years endingApril 30, 2021 , 2022, 2023, and 2024, respectively. We are obligated to payBaker Hughes a sales commission on subscriptions to our products and services offerings it resells in excess of these minimum revenue commitments. We andBaker Hughes further revised these agreements inOctober 2021 to extend the term by an additional year, for a total of six years, with an expiration date in the fiscal year endingApril 30, 2025 , to modify the amount ofBaker Hughes' annual commitments to$85.0 million in the fiscal year endingApril 30, 2023 ,$110.0 million in the fiscal year endingApril 30, 2024 , and$125.0 million in the fiscal year endingApril 30, 2025 , and to revise the structure of the arrangement to further incentivizeBaker Hughes' sales of our products and services. Beginning in the fiscal year endingApril 30, 2023 ,Baker Hughes' annual commitments will be reduced by any revenue we generate from certain customers. The revenue recorded forBaker Hughes will be reviewed quarterly and adjusted, as needed, to reflect our current assumptions. Pursuant to the revised arrangement, we acknowledged thatBaker Hughes had met its minimum annual revenue commitment for the fiscal year endedApril 30, 2022 and recognized$16.0 million of sales commission as deferred costs during the fiscal quarter endedOctober 31, 2021 related to this arrangement, which will be amortized over an expected period of five years. Our RPO related toBaker Hughes , which includes both direct subscriptions and reseller arrangements, is comprised of$0.4 million related to deferred revenue and$184.5 million of commitments from non-cancellable contracts as ofOctober 31, 2022 and$2.3 million related to deferred revenue and$212.9 million from non-cancellable contracts as ofApril 30, 2022 .
away
We purchase services fromBaker Hughes from time to time to support our end customers in relation to our contracts with those customers. These costs are recorded as cost of subscription revenue in the condensed consolidated statement of operations. International Expansion The international market opportunity for Enterprise AI software is large and growing, and we believe there is a significant opportunity to continue to grow our international customer base. We believe that the demand for ourC3 AI Software will continue growing as international awareness of the benefits of digital transformation and Enterprise AI software grows. We plan to continue to make investments to expand geographically by increasing our direct sales team in international markets and supplementing the direct sales effort with strategic partners to significantly expand our reach and market coverage. We derived approximately 23% and 25% of our total revenue for the three months endedOctober 31, 2022 and 2021, respectively, and 22% and 28% of our total revenue for the six months endedOctober 31, 2022 and 2021, respectively, from international customers.
Effects of the ongoing COVID-19 pandemic
The ongoing COVID-19 pandemic has caused general business disruption worldwide beginning inJanuary 2020 . The full extent to which the COVID-19 pandemic will directly or indirectly impact our business, results of operations, cash flows, and financial condition will depend on future developments that are uncertain. As a result of global business disruption, the COVID-19 pandemic had a significant adverse impact on our conclusion of new and additional business agreements in 2022, 2021 and 2020 and may continue to pose challenges until the effects of the pandemic abate. 33
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As a result of the COVID-19 pandemic, we temporarily closed our headquarters and other offices, required our employees and contractors to work remotely, and implemented travel restrictions, all of which represented a significant change in how we operate our business. We have undertaken effort to return our employees to their offices, subject to local laws and regulations and, as of the date of this report, our employees have returned to the office and such travel restrictions have been relaxed. The operations of our partners and customers have likewise been altered and may continue to be disrupted. While the duration and extent of the COVID-19 pandemic depends on future developments that cannot be accurately predicted at this time, such as the extent and effectiveness of containment actions, the emergence and spread of current and future variants of the COVID-19 virus, and the effectiveness, acceptance, and availability of vaccines against the COVID-19 virus and its variants, the COVID-19 pandemic has already had an adverse effect on the global economy and the ultimate societal and economic impact of the COVID-19 pandemic remains unknown. In particular, the conditions caused by this pandemic are likely to affect the rate of global IT spending and could adversely affect demand for ourC3 AI Software , lengthen our sales cycles, reduce the value or duration of subscriptions, reduce the level of subscription renewals, negatively impact collections of accounts receivable, reduce expected spending from new customers, cause some of our paying customers to go out of business, limit the ability of our direct sales force to travel to customers and potential customers, and affect contraction or attrition rates of our paying customers, all of which could adversely affect our business, results of operations, and financial condition during the fiscal year 2023 and potentially future periods. We will continue to evaluate the nature and extent of the impact of the COVID-19 pandemic on our business. For further discussion of the potential impacts of the ongoing COVID-19 pandemic on our business, operating results, and financial condition, see the section titled "Risk Factors" included in Part II, Item 1A of this Quarterly Report on Form 10-Q. Other factors affecting our performance are discussed below, although we caution you that the ongoing COVID-19 pandemic may also further impact these factors.
Components of the earnings situation
revenue
Subscription Revenue. Our subscription revenue is primarily comprised of term licenses, stand-ready COE support services, trials of our applications, and software-as-a-service offerings. Sales of our term licenses grant our customers the right to use our software, either on their own cloud instance or their internal hardware infrastructure, over the contractual term. We also offer a premium stand-ready service through our COE. Sales of our software-as-a-service offerings include a right to use our software over the contractual term. Our subscription contracts are generally non-cancellable and non-refundable, and we recognize revenue over the contract term on a ratable basis. In addition, customers pay a usage-based runtime fee for ourC3 AI Software for specified levels of capacity. Our subscriptions also include our maintenance and support services, which include critical and continuous updates to the software that are integral to maintaining the intended utility of the software over the contractual term. Our software subscriptions and maintenance and support services are highly interdependent and interrelated and represent a single distinct performance obligation within the context of the contract. We currently have a small number of public utility customers that license our offerings under a perpetual license model, and we expect that may continue for the foreseeable future for certain customers due to their specific contracting requirements. Professional Services Revenue. Our professional services revenue primarily includes implementation services, training and prioritized engineering services. We offer a complete range of professional service support both onsite and remotely, including training, application design, project management, system design, data modeling, data integration, application design, development support, data science, and application andC3 AI Software administration support. Professional services fees are based on the level of effort required to perform the specified tasks and are typically a fixed-fee engagement with defined deliverables and a duration of less than 12 months. We recognize revenue for our professional services over the period of delivery as services are performed.
cost of sales
Cost of Subscription Revenue. Cost of subscription revenue consists primarily of costs related to compensation, including salaries, bonuses, benefits, stock-based compensation and other related expenses for the production environment, support and COE staff, hosting of ourC3 AI Software , including payments to outside cloud service providers, and allocated overhead and depreciation for facilities. 34
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Cost of Professional Services Revenue. Cost of professional services revenue consists primarily of compensation, including salaries, bonuses, benefits, stock-based compensation and other related costs associated with our professional service personnel, third-party system integration partners, and allocated overhead and depreciation for facilities.
Gross Profit and Gross Margin
Gross profit is total revenue less total cost of revenue. Gross margin is gross profit expressed as a percentage of total revenue. Our gross margin has fluctuated historically and may continue to fluctuate from period to period based on a number of factors, including the timing and mix of the product offerings we sell as well as the geographies into which we sell, in any given period. Our gross margins are lower when we provide hosting services to our customers as compared to when a customer hosts our software in their self-managed private or public cloud environments. Our subscription gross margin may experience variability over time as we continue to invest and continue to scale our business. Our professional services gross margin may also experience variability from period to period due to the use of our own resources and third-party system integration partners in connection with the performance of our fixed price agreements. Operating Expenses Our operating expenses consist of sales and marketing, research and development, and general and administrative expenses. We expect our operating expenses as a percentage of total revenue to increase as we continue to invest to grow our business. Over the long-term, we expect those percentages to stabilize and then move lower as our business matures. Sales and Marketing. Sales and marketing expenses consist of expenditures related to advertising, media, marketing, promotional events, brand awareness activities, business development, customer success and corporate partnerships. Sales and marketing expenses also include employee-related costs, including salaries, bonuses, benefits, stock-based compensation, and commissions for our employees engaged in sales and marketing activities, and allocated overhead and depreciation for facilities. We expect our sales and marketing expenses will increase in absolute dollar amounts as we expect to hire additional sales personnel to increase sales coverage of target industry vertical and geographic markets. We have reduced our spend on brand awareness, but continue to invest in market education, strategic paid media, and thought leadership. Consequently, we anticipate that sales and marketing expense as a percent of total revenue to decline over time. Research and Development. Our research and development efforts are aimed at continuing to develop and refine ourC3 AI Software , including adding new features and modules, increasing functionality and speed, and enhancing the usability of ourC3 AI Software . Research and development expenses consist primarily of employee-related costs, including salaries, bonuses, benefits, and stock-based compensation for our employees associated with research and development related activities. Research and development expenses also include cloud infrastructure costs related to our research and development efforts, and allocated overhead and depreciation for facilities. Research and development costs are expensed as incurred. We expect research and development expense to increase in absolute dollars as we continue to invest in our existing and future product offerings. We may experience variations from period to period with our total research and development expense as a percentage of revenue as we develop and deploy new applications targeting new use cases and new industries. Over a longer horizon, we anticipate that research and development expense as a percent of total revenue to decline. General and Administrative. General and administrative expense consists primarily of employee-related costs, including salaries, bonuses, benefits, stock-based compensation and other related costs associated with administrative services such as executive management and administration, legal, human resources, accounting, and finance. General and administrative expense also includes facilities costs, such as depreciation and rent expense, professional fees, and other general corporate costs, including allocated overhead and depreciation for facilities. We expect our general and administrative expense to increase in absolute dollars as we continue to grow our business. We have incurred and expect to continue to incur additional expenses as a result of operating as a public company, including expenses necessary to comply with the rules and regulations applicable to companies listed on a national securities exchange and related to compliance and reporting obligations pursuant to the rules and regulations of theSEC , as well as higher expenses for general and director and officer insurance, investor relations, and professional services. We expect that general and administrative expense as a percent of total revenue will decline over the long-term as we benefit from the scale of our business infrastructure. 35
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interest income
Interest income consists primarily of interest income earned on our cash, cash equivalents, and available-for-sale marketable securities. It also includes amortization of premiums and accretion of discount related to our available-for-sale marketable securities. Interest income varies each reporting period based on our average balance of cash, cash equivalents, and available-for-sale marketable securities during the period and market interest rates.
Other (expense) income, net
Other (expense) income, net consists primarily of foreign currency exchange gains and losses, gains from legal settlements, losses from impairment of investments, and realized gains and losses on sales of available-for-sale marketable securities. Our foreign currency exchange gains and losses relate to transactions and asset and liability balances denominated in currencies other than theU.S. dollar. We expect our foreign currency gains and losses to continue to fluctuate in the future due to changes in foreign currency exchange rates. Provision for Income Taxes Our income tax provision consists of an estimate of federal, state, and foreign income taxes based on enacted federal, state, and foreign tax rates, as adjusted for allowable credits, deductions, uncertain tax positions, changes in the valuation of our deferred tax assets and liabilities, and changes in tax laws. We maintain a full valuation allowance on our federal and state deferred tax assets as we have concluded that it is not more likely than not that the deferred tax assets will be realized.
operating results
The following tables present our condensed consolidated income statement for the periods presented:
Three Months Ended October 31, Six Months Ended October 31,
2022 2021 2022 2021
(in thousands) (in thousands)
Revenue
Subscription $ 59,508 $ 47,408 $ 116,534 $ 93,530
Professional services 2,900 10,855 11,182 17,139
Total revenue 62,408 58,263 127,716 110,669
Cost of revenue
Subscription (1) 19,165 11,392 33,257 20,605
Professional services (1) 1,587 4,579 5,901 8,391
Total cost of revenue 20,752 15,971 39,158 28,996
Gross profit 41,656 42,292 88,558 81,673
Operating expenses
Sales and marketing (1) 44,936 46,166 87,923 82,988
Research and development (1) 50,051 36,523 105,928 63,235
General and administrative (1) 18,635 15,279 39,882 27,643
Total operating expenses 113,622 97,968 233,733 173,866
Loss from operations (71,966) (55,676) (145,175) (92,193)
Interest income 4,224 322 6,762 667
Other (expense) income, net (945) (1,372) (1,966) (2,271)
Net loss before provision for income taxes (68,687) (56,726) (140,379) (93,797)
Provision for income taxes 163 13 342 401
Net loss $ (68,850) $ (56,739) $ (140,721) $ (94,198)
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(1) Includes stock-based compensation expense as follows:
Three Months Ended October 31, Six Months Ended October 31,
2022 2021 2022 2021
(in thousands) (in thousands)
Cost of subscription $ 5,486 $ 2,364 $ 9,758 $ 3,185
Cost of professional services 479 685 1,550 1,287
Sales and marketing 19,080 13,555 35,859 19,690
Research and development 23,905 10,256 49,122 13,014
General and administrative 7,063 5,680 16,354 9,276
Total stock-based compensation expense
The following table sets forth our condensed consolidated statements of
operations data expressed as a percentage of revenue for the periods indicated:
Three Months Ended October 31, Six Months Ended October 31,
2022 2021 2022 2021
Revenue
Subscription 95 % 81 % 91 % 85 %
Professional services 5 19 9 15
Total revenue 100 100 100 100
Cost of revenue
Subscription 31 20 26 19
Professional services 2 8 6 8
Total cost of revenue 33 27 31 26
Gross profit 67 73 69 74
Operating expenses
Sales and marketing 72 79 69 75
Research and development 80 63 83 57
General and administrative 30 26 32 25
Total operating expenses 183 168 184 157
Loss from operations (116) (96) (114) (83)
Interest income 7 1 5 1
Other (expense) income, net (2) (2) (2) (2)
Net loss before provision for income taxes (111) (97) (109) (85)
Provision for income taxes - - - -
Net loss (111) % (97) % (109) % (85) %
Comparison of the completed three and six months
Revenue
Three Months Ended October 31, Six Months Ended October 31,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
(in thousands) (in thousands)
Revenue
Subscription $ 59,508 $ 47,408 $ 12,100 26 % $ 116,534 $ 93,530 $ 23,004 25 %
Professional services 2,900 10,855 (7,955) (73) % 11,182 17,139 (5,957) (35) %
Total revenue $ 62,408 $ 58,263 $ 4,145 7 % $ 127,716 $ 110,669 $ 17,047 15 %
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Subscription revenue accounted for 95% and 81% of our total revenue for the three months endedOctober 31, 2022 and 2021, respectively. Subscription revenue increased by$12.1 million , or 26%, for the three months endedOctober 31, 2022 , compared to the same period last year. Approximately 17% and 14%, respectively, of the total subscription revenue was attributable to growth from new customers, and the remaining 83% and 86%, respectively, was attributable to net growth from existing customers for the three months endedOctober 31, 2022 and 2021, respectively. The net growth from existing customers included an increase in revenue of$9.2 million related to the Baker Hughes arrangement for the three months endedOctober 31, 2022 , compared to the same period last year. Subscription revenue accounted for 91% and 85% of our total revenue for the six months endedOctober 31, 2022 and 2021, respectively. Subscription revenue increased by$23.0 million , or 25%, for the six months endedOctober 31, 2022 , compared to the same period last year. Approximately 15% and 12%, respectively, of the total subscription revenue was attributable to growth from new customers, and the remaining 85% and 88%, respectively, was attributable to net growth from existing customers for the six months endedOctober 31, 2022 and 2021, respectively. The net growth from existing customers included an increase in revenue of$15.3 million related to the Baker Hughes arrangement for the six months endedOctober 31, 2022 , compared to the same period last year. Professional services revenue decreased by$8.0 million , or 73%, for the three months endedOctober 31, 2022 , compared to the same period last year, predominantly due to decrease in revenue of$5.9 million related to the Baker Hughes arrangement mainly driven by the decline in prioritized engineering services, and the timing and mix of service projects for existing C3 AI Platform and C3 AI Applications customers. Professional services revenue decreased by$6.0 million , or 35%, for the six months endedOctober 31, 2022 , compared to the same period last year, predominantly due to decrease in revenue of$7.8 million related to the Baker Hughes arrangement mainly driven by the decline in prioritized engineering services, partially offset by increase in professional services to other customers due to the timing and mix of service projects for existing C3 AI Platform and C3 AI Applications customers. Cost of Revenue Three Months Ended October 31, Six Months Ended October 31, 2022 2021 $ Change % Change 2022 2021 $ Change % Change (in thousands) (in thousands) Cost of revenue Subscription$ 19,165 $ 11,392 $ 7,773 68 %$ 33,257 $ 20,605 $ 12,652 61 % Professional services 1,587 4,579 (2,992) (65) % 5,901 8,391 (2,490) (30) % Total cost of revenue$ 20,752 $ 15,971 $ 4,781 30 %$ 39,158 $ 28,996 $ 10,162 35 % The increase in cost of subscription revenue for the three months endedOctober 31, 2022 compared to the same period last year was primarily due to higher personnel related costs of$4.6 million as a result of increased headcount and overall costs to support the growth in our business, and increased stock-based compensation primarily related to additional equity awards granted to current and new employees, higher third-party outsourcing costs of$1.0 million , higher amortization of capitalized software costs of$1.0 million , and higher overhead costs of$0.9 million . The increase in cost of subscription revenue for the six months endedOctober 31, 2022 compared to the same period last year was primarily due to higher personnel related costs of$8.1 million as a result of increased headcount and overall costs to support the growth in our business, and increased stock-based compensation primarily related to additional equity awards granted to current and new employees, higher third-party outsourcing costs of$1.6 million , higher amortization of capitalized software costs of$1.0 million , and higher overhead costs of$1.1 million . The decrease in cost of professional services revenue for the three months endedOctober 31, 2022 compared to the same period last year was primarily due to lower personnel related costs of$1.2 million , lower third-party outsourcing costs of$1.1 million and lower overhead costs of$0.8 million . The decrease in cost of professional services revenue for the six months endedOctober 31, 2022 compared to the same period last year was primarily due to lower third-party outsourcing costs of$1.9 million , and lower overhead costs of$0.4 million . 38
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Gross Profit and Gross Margin
Three Months Ended October
31, Six Months Ended October 31,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
(in thousands) (in thousands)
Gross profit $ 41,656 $ 42,292 $ (636) (2) % $ 88,558 $ 81,673 $ 6,885 8 %
Gross margin
Subscription 68 % 76 % 71 % 78 %
Professional services 45 % 58 % 47 % 51 %
Total gross margin 67 % 73 % 69 % 74 %
The decrease in total gross margins for the three months ended October 31, 2022
compared to the same period last year was driven by decline in subscription
margin and professional service margin. The subscription margin for the three
months ended October 31, 2022 decreased due to higher personnel-related costs as
a result of increased headcount and overall costs to support the growth in our
business, and increased stock-based compensation primarily related to additional
equity awards granted to current and new employees, compared to the same period
last year. The professional service margin for the three months ended
October 31, 2022 decreased primarily due to the mix of professional services
provided, including a decrease in prioritized engineering services, which
generally have higher margins, compared to the same period last year.
The decrease in total gross margins for the six months ended October 31, 2022
compared to the same period last year was driven by decline in subscription
margin and professional service margin. The subscription margin for the six
months ended October 31, 2022 decreased due to higher personnel-related costs as
a result of increased headcount and overall costs to support the growth in our
business, and increased stock-based compensation primarily related to additional
equity awards granted to current and new employees, compared to the same period
last year. The professional service margin for the six months ended October 31,
2022 decreased primarily due to the mix of professional services provided,
including a decrease in prioritized engineering services, which generally have
higher margins, compared to the same period last year.
Operating Expenses
Three Months Ended October 31, Six Months Ended October 31,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
(in thousands) (in thousands)
Operating expenses
Sales and marketing $ 44,936 $ 46,166 $ (1,230) (3) % $ 87,923 $ 82,988 $ 4,935 6 %
Research and development 50,051 36,523 13,528 37 % 105,928 63,235 42,693 68 %
General and administrative 18,635 15,279 3,356 22 % 39,882 27,643 12,239 44 %
business expenses
16 %$ 233,733 $ 173,866 $ 59,867 34 % Sales and Marketing. The decrease in sales and marketing expense for the three months endedOctober 31, 2022 compared to the same period last year was primarily due to lower advertising spend of$13.7 million , partially offset by higher personnel-related costs as a result of$8.0 million as a result of increased headcount and overall costs to support the growth in our business, and increased stock-based compensation primarily related to additional equity awards granted to current and new employees, higher marketing costs of$2.3 million , higher overhead costs of$1.2 million and higher commission expense of$0.8 million . The increase in sales and marketing expense for the six months endedOctober 31, 2022 compared to the same period last year was primarily due to higher personnel-related costs of$19.2 million as a result of increased headcount and overall costs to support the growth in our business, and increased stock-based compensation primarily related to additional equity awards granted to current and new employees, higher marketing costs of$4.6 million , higher commission expense of$1.6 million , and higher overhead costs of$1.3 million , partially offset by lower advertising spend of$22.8 million . 39
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Research and Development. The increase in research and development expense for the three months endedOctober 31, 2022 compared to the same period last year was primarily due to higher personnel-related costs of$15.9 million as a result of increased headcount and overall costs to support the growth in our business, and increased stock-based compensation primarily related to additional equity awards granted to current and new employees, and higher hosting costs of$2.4 million , partially offset by lower C3.ai DTI contributions of$5.7 million . The increase in research and development expense for the six months endedOctober 31, 2022 compared to the same period last year was primarily due to higher personnel-related costs of$40.1 million as a result of increased headcount and overall costs to support the growth in our business, and increased stock-based compensation primarily related to additional equity awards granted to current and new employees, higher hosting costs of$5.6 million , and higher facilities costs of$2.2 million , partially offset by lower C3.ai DTI contributions of$5.6 million , and lower professional services costs of$1.1 million . General and Administrative. The increase in general and administrative expense for the three months endedOctober 31, 2022 compared to the same period last year was primarily due to higher personnel-related costs as a result of headcount growth of$1.7 million as a result of increased headcount and overall costs to support the growth in our business, and increased stock-based compensation primarily related to additional equity awards granted to current and new employees, higher professional services costs of$1.4 million , and higher overhead costs of$0.3 million . The increase in general and administrative expense for the six months endedOctober 31, 2022 compared to the same period last year was primarily due to higher personnel-related costs of$9.1 million as a result of increased headcount and overall costs to support the growth in our business, and increased stock-based compensation primarily related to additional equity awards granted to current and new employees, higher professional services costs of$1.9 million , and higher overhead costs of$0.7 million . Interest Income Three Months Ended October 31, Six Months Ended October 31, 2022 2021 $ Change % Change 2022 2021 $ Change % Change (in thousands) (in thousands) Interest income$ 4,224 $ 322 $ 3,902 1212 %$ 6,762 $ 667 $ 6,095 914 %
The increase in interest income for the past three months
compared to the prior-year period was primarily due to investments in securities with higher expected yields, such as corporate debt.
The increase in interest income for the past six months
compared to the prior-year period was primarily due to investments in securities with higher expected yields, such as corporate debt.
Other (expense) income, net
Three Months Ended October
31, Six Months Ended October 31,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
(in thousands) (in thousands)
Other (expense)
income, net $ (945) $ (1,372) $ 427 (31) % $ (1,966) $ (2,271) $ 305 (13) %
The decrease in other income (expense), net, for the past three months
The decrease in other (expense) income, net for the six months endedOctober 31, 2022 compared to the same period last year was primarily due to foreign currency losses on the remeasurement of Euro-denominated cash and accounts receivable balances. 40
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Provision for income taxes
Three Months Ended October Six Months Ended October
31, 31,
2022 2021 $ Change % Change 2022 2021 $ Change % Change
(in thousands) (in thousands)
Provision for income
taxes $ 163 $ 13 $ 150 1154 % $ 342 $ 401 $ (59) (15) %
The accrual change for the three and six months ended
compared to the same period of the previous year mainly related to foreign and state tax expenses.
Non-GAAP Financial Measure In addition to our financial results determined in accordance with generally accepted accounting principles inthe United States , or GAAP, we believe free cash flow, a non-GAAP financial measure, is useful in evaluating liquidity and provides information to management and investors about our ability to fund future operating needs and strategic initiatives. We calculate free cash flow as net cash used in operating activities less purchases of property and equipment and capitalized software development costs. Free cash flow has limitations as an analytical tool, and it should not be considered in isolation or as a substitute for analysis of other GAAP financial measures, such as net cash used in operating activities. This non-GAAP financial measure may be different than similarly titled measures used by other companies. Additionally, the utility of free cash flow is further limited as it does not represent the total increase or decrease in our cash balances for a given period. The following table below provides a reconciliation of free cash flow to the GAAP measure of net cash used in operating activities for the periods presented. Six Months Ended October 31, 2022 2021 (in thousands) Net cash used in operating activities$ (90,845) $ (17,876) Less: Purchases of property and equipment (39,978) (1,429) Capitalized software development costs (1,000) (500) Free cash flow$ (131,823) $ (19,805) Net cash provided by investing activities $ 30,532$ 70,849 Net cash (used in) provided by financing activities $
(1,593)
liquidity and capital resources
Since inception, we have financed operations primarily through sales generated from our customers and sales of equity securities. As ofOctober 31, 2022 andApril 30, 2022 , we had$277.6 million and$339.5 million of cash and cash equivalents and$581.1 million and$652.7 million of investments, respectively, which were held for working capital purposes. Our short-term and long-term investments generally consist of high-gradeU.S. treasury securities, certificates of deposit,U.S. government agency securities, commercial paper and corporate debt securities. We have generated operating losses from our operations as reflected in our accumulated deficit of$682.1 million as ofOctober 31, 2022 and negative cash flows from operations. We expect to continue to incur operating losses and generate negative cash flows from operations for the foreseeable future due to the investments we intend to make in our business, and as a result we may require additional capital to execute on our strategic initiatives to grow the business. 41
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We believe that existing cash and cash equivalents and investments will be sufficient to support working capital and capital expenditure requirements for at least the next 12 months. We believe we will meet longer-term expected future cash requirements and obligations through a combination of cash flows from operating activities and available cash balances. Our principal uses of cash in recent periods have been funding our operations and investing in capital expenditures. Our future capital requirements will depend on many factors, including our revenue growth rate, the timing and the amount of cash received from customers, the expansion of sales and marketing activities, the timing and extent of spending to support development efforts, expenses associated with our international expansion, the introduction ofC3 AI Software enhancements, and the continuing market adoption of ourC3 AI Software . In the future, we may enter into arrangements to acquire or invest in complementary businesses, products, and technologies. We may be required to seek additional equity or debt financing. If we require additional financing, we may not be able to raise such financing on terms acceptable to us or at all. If we are unable to raise additional capital or generate cash flows necessary to expand our operations and invest in continued innovation, we may not be able to compete successfully, which would harm our business, results of operations, and financial condition.
The following table summarizes our cash flows for the periods presented:
Six Months Ended October 31,
2022 2021
(in thousands)
Cash used in operating activities $ (90,845) $ (17,876)
Cash provided by investing activities $ 30,532 $ 70,849
Cash (used in) provided by financing activities $ (1,593) $ 11,200
Net (decrease) increase in cash, cash equivalents, and restricted cash $
(61,906)
Operating Activities. Net cash used in operating activities of$90.8 million for the six months endedOctober 31, 2022 was due to our net loss of$140.7 million adjusted for certain non-cash items, primarily consisting of stock-based compensation of$112.6 million , depreciation and amortization of$2.4 million , and non-cash operating lease cost of$1.1 million . The$65.9 million cash outflows related to changes in operating assets and liabilities was primarily attributable to a decrease in accounts payable of$28.2 million , a decrease to deferred revenue of$18.5 million inclusive of a decrease in related party balances of$0.3 million , an increase in accounts receivable of$14.7 million inclusive of an increase in related party balances of$18.0 million , an increase in prepaid expenses, other current assets and other assets of$3.2 million , a decrease in other liabilities of$0.9 million , and a decrease to accrued compensation and employee benefits of$1.1 million . This was partially offset by cash inflows related to an increase in lease liabilities of$0.7 million . Net cash used in operating activities of$17.9 million for the six months endedOctober 31, 2021 was due to our net loss of$94.2 million adjusted for non-cash charges for stock-based compensation of$46.5 million , depreciation and amortization of$2.4 million , and non-cash operating lease cost of$1.1 million . The$26.9 million cash inflow related to changes in operating assets and liabilities was primarily attributable to a decrease in accounts receivable of$39.0 million inclusive of an increase in related party balances of$5.8 million , and an increase in other liabilities of$13.6 million . This was partially offset by cash outflows related to an increase in prepaid expenses, other current assets and other assets of$15.1 million , a decrease to accrued compensation and employee benefits of$5.4 million , a decrease to deferred revenue of$2.3 million inclusive of an increase in related party balances of$9.8 million , a decrease in accounts payable of$1.7 million , and a decrease in lease liabilities of$1.2 million . Investing Activities. Net cash provided by investing activities of$30.5 million for the six months endedOctober 31, 2022 was primarily attributable to maturities and sales of investments of$455.5 million , partially offset by purchases of investments of$384.0 million and capital expenditures of$41.0 million mainly related to the leasehold improvements associated with the new leased space. Net cash provided by investing activities of$70.8 million for the six months endedOctober 31, 2021 was primarily attributable to the maturities and sales of investments of$461.6 million , partially offset by purchases of investments of$388.9 million and capital expenditures of$1.9 million . Financing Activities. Net cash used in financing activities of$1.6 million during the six months endedOctober 31, 2022 was due to$3.4 million of taxes paid related to net share settlement of equity awards, partially offset by$1.8 million of proceeds from the exercise of stock options for Class A common stock. 42
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Net cash provided by financing activities of$11.2 million during the six months endedOctober 31, 2021 was primarily due to$11.3 million of proceeds from the exercise of stock options for Class A common stock.
Contractual Obligations and Commitments
Our contractual obligations and commitments primarily consist of operating lease commitments for our facilities and non-cancellable purchase commitments related to third-party cloud hosting services. For additional information, refer to Note 6. Commitments and Contingencies to our unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q. Except as already disclosed in Note 6. Commitments and Contingencies to our condensed consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, there has been no other material change in our contractual obligations and commitments other than in the ordinary course of business since our fiscal year endedApril 30, 2022 . See our Annual Report on Form 10-K for the fiscal year endedApril 30, 2022 , which was filed with theSEC onJune 23, 2022 , for additional information regarding our contractual obligations.
Critical Accounting Policies and Estimates
Our unaudited condensed consolidated financial statements and the accompanying notes thereto included elsewhere in this Quarterly Report on Form 10-Q are prepared in accordance with GAAP. The preparation of condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from our estimates. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations, and cash flows will be affected.
There were no material changes to our critical accounting policies and estimates compared to the critical accounting policies and estimates discussed in the Annual Report on Form 10-K for the current fiscal year
Recently Adopted Accounting Pronouncements
See Note 1. Summary of Business and Significant Accounting Policies to our
unaudited condensed consolidated financial statements included elsewhere in this
Quarterly Report on Form 10-Q for more information regarding recently issued
accounting pronouncements.
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