Apptio's (APTI) CEO Sunny Gupta on Q3 2016 Results - Earnings Call Transcript

| About: Apptio (APTI)

Apptio (NASDAQ:APTI)

Q3 2016 Earnings Conference Call

November 2, 2016 5:00 PM ET

Executives

Susanna Morgan - SVP, Finance and Investor Relations

Sunny Gupta - Co-Founder and CEO

Kurt Shintaffer - Co-Founder and CFO

Analysts

John DiFucci - Jefferies LLC

Jesse Hulsing - Goldman Sachs

Brad Sills - Bank of America Merrill Lynch

Matthew Coss - JPMorgan

Raimo Lenschow - Barclays Capital

Ross MacMillan - RBC Capital Markets

Ben McFadden - Pacific Crest Securities

Operator

Good day, ladies and gentlemen, and thank you standing by. Welcome to the Apptio’s Third Quarter 2016 Earnings Conference. At this time all participants are in a listen-only mode to prevent background noise. [Operator Instructions] We will have a question-and-answer session later and instructions will be given at that time. As a reminder, this conference is being recorded.

Now, I’d like to welcome and turn the call to Ms. Susanna Morgan, SVP of Finance and Investor Relations.

Susanna Morgan

Thank you. Good afternoon and welcome to Apptio Q3 2016 earnings call our first as a public company. Joining me on the call today are Sunny Gupta, our CEO; and Kurt Shintaffer, our CFO. Following our prepared remarks, we will take questions.

Our press release was issued after close of market and is posted on our website where this is called being simultaneously webcast. The webcast replay of this call will be available on our website under the Investor Relations link at investors.apptio.com.

Statements made on this call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act from 1995, such as those of the words will, believe, expect, anticipate and similar phrases that denote future expectation or intent, regarding our financial results, applications, customer demand, operations and other matters. These statements are subject to risks, uncertainties and assumptions.

Please refer to the press release and the risk factors in documents filed with the Securities and Exchange Commission, including our final perspective filed with the SEC on September 23, 2016 for information on risks and uncertainties that may cause actual results to differ materially from those set forth in such statements.

In addition during today’s call, we will discuss non-GAAP financial measures. Specifically, some references to gross margins, expense, free cash flow and operating income or loss are stated on a non-GAAP basis. These non-GAAP financial measures which we believe are useful in measuring Apptio performance and liquidity should be considered in addition to, not as a substitute for, or in isolation from GAAP results. Our non-GAAP measures exclude the effect of share-based compensation. We encourage you to review additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP results in our earnings press release and on the Investor Relations page of our website.

With that, I’ll hand it over to Sunny.

Sunny Gupta

Thank you, Susanna, and thanks to all of you for joining this call. It was a pleasure to meet many of you on our recent road show and thanks for your interest in Apptio. We are very appreciative of the warm response that IPO received and are pleased to be sharing our Q3 results with you in our first quarter as a public company.

We have pioneered the next big strategic software category called Technology Business Management or TBM. Apptio is the business system of record for IT and it’s similar to business systems used by finance, sales and human resource executives. Today, we have customers ranging from less than 10 million of IT spend to some of the largest multinationals, including over 40% of the Fortune 100.

The strategic importance of technology resulting in rising technology budgets is fueling this category and the adoption of Apptio solutions. CIOs are being asked to drive digital innovation, move workloads from on-premise to cloud services, and optimize their IT budgets. Despite this increasing complexity, most CIOs are still running their business on spreadsheets.

Apptio provides five applications built on a powerful cloud-based data and analytics platform. These applications allow customers to manage their technology spend, make data-driven decisions like cloud migration, automate IT planning processes, and benchmark themselves against their peers. We are in the early days of this category and are targeting the Global 10000.

We have three paths to growth. First, we will grow by continuing to acquire new customers and expanding our geographic footprint.

Second, we will sell more of our existing applications to current customers and expand IT spend managed through our platform.

Third, we will expand our market by innovating on new applications, monetizing the industry’s most granular IT finance and vendor data, and eventually expanding the use of our platform outside of IT. We will continue to leverage the TBM Council, the community of the world’s leading CIOs to drive standards for IT and accelerate the adoption of Apptio into the broader market. Apptio is well-positioned to capitalize on this huge opportunity.

In our first quarter as a public company, we were delighted to deliver a record Q3 revenues of $40.6 million, including $33.3 million of subscription revenue, up 30% from Q3 of 2015. At the same time, we improved non-GAAP operating margins by 12 points to negative 11% and also improved cash flow significantly.

Now, let me offer some stats with color on the quarter just completed. We were pleased with our Q3 new logo acquisition across both of our Strategic and Enterprise segments. Strategic, which we define as customers with over 20 billion in revenue and enterprise customers with 1 –billion-plus in revenue, or over 30 million in IT spend.

We also added new customers across all the regions we operate, including North America, Europe and Asia Pacific. Cloud adoption and IT transformation continued to be catalyst and we believe the market is hitting our message that TBM is inevitable.

I would like to highlight three significant Q3 wins to show you how Apptio solutions are being embraced across a broad spectrum of customers of varying sizes, industries and used cases. The first, a large multinational chemicals company was a key win in the strategic segment. This customer bought all five Apptio applications to bring to light important Insights useful for service configuration, demand planning, budgeting and forecasting all in an effort to optimize IT spend.

Second, in the Enterprise segment, one of the largest member-owned organizations bought cost transparency and IT planning to help drive its IT transformation. The CIO had gotten tremendous value from Apptio at a private company, a great proof point for the loyalty of our customers.

Finally, a cloud technology company with less than $500 million in revenue bought both our cost transparency and business Insights applications to help make better cloud decisions and understand the costs and utilizations of its technology services. We experienced a significant increase in the adoption of public cloud infrastructure functionality across both our new and existing customer deployments in Q3.

Many of our customers have deployed our cloud capabilities for Insights including, what if decisions to migrate on-premise workloads to the cloud using cost and consumption metrics, financial management and the total cost of ownership of their cloud services, and finally showback/chargeback a public cloud spend to the departments or business units that are consuming cloud services.

To align with these trends and market needs, we continue to strengthen cloud partnerships and expand the adoption of Apptio’s Amazon web Services and Microsoft Jual Connectors, who will allow our customers to manage heterogeneous environments to the existing cost transparency applications. Decisions around cloud are increasingly important to our customers and we are proud that they can find answers with Apptio.

In addition to new customers, as you may recall, we grow our customer annual subscription revenue by expanding IT spend under management by serving additional business units and by making new functionality available to our customers via new applications delivered on our platform.

We typically sell just one or two applications initially, which allow our customers to deploy and realize value more quickly. We then sell additional applications or increase spend under management over time, as the platform becomes embedded in day-to-day decision making.

This strategy really proved successful in Q3, when we saw healthy growth in ourselves from new applications and from expanding customers spend managed through Apptio. For example, one of the largest multinational insurance companies expanded its Apptio annual ascription value by more than 30% for buying an additional application Bill of IT.

Looking at a smaller customer, the university grew its annual – Apptio annual subscription value by approximately 50% by buying IT planning. In Q3, we continued to build on a strong competitive position in the market by driving new product innovation. We recently released significant enhancements to our SAAS platform and cost transparency applications to increase user productive, improve our visual cost modeling, adaptive data management capabilities, and continue loading deployment times.

We also released Apptio Vendor Insights, the newest addition to our business insights application family. Apptio Vendor Insights provides IT leaders with a single location for all vendor spend and contract details. With Vendor Insights, IT leaders are able to minimize risk, while optimizing vendor relationships and costs. This is essential since the IT vendor landscape is rapidly changing with new vendors, contract types and subscription models.

According to Apptio’s proprietary IT data, vendor spend is the largest component of the IT budget. We are getting extremely positive feedback from the market about the value of Vendor Insights.

Finally, I’d like to mention how excited we are for the annual TBM Conference, the only conference dedicated to managing the business of IT. We expect over 1,000 technology leaders to join us next week in San Diego, where we’ll focus on driving business value in the digital economy.

The conference will feature some incredible speakers, such as sea-level executives from FedEx, AIG, KeyBank, and Stanley Black & Decker. We know many of you will join us to witness firsthand momentum around TBM standards and the fashion of our customer base.

While there were other positive developments for a company this quarter, I will turn the presentation over to Kurt to discuss our financial results in more detail.

Kurt Shintaffer

Thank you, Sunny, and let me welcome you all as well. We really appreciate your interest in Apptio ending our business results. I’m pleased to report that in Q3, we continue to see strong subscription revenue growth, robust and expanding gross margins, and improving cash flow.

As Sunny mentioned, Q3 2016 was a strong top line quarter for us. Our subscription revenue, the focus of our growth efforts grew by 30% on a year-over-year basis to $33.3 million, as we executed on our plan to acquire new customers and retain and expand existing customers.

Our Q3 2016 subscription revenue accounted for 82% of total revenue, up from 79% in the third quarter of 2015. Our services revenue increased by 10% on a year-over-year basis to $7.3 million. The lower services growth rate is primarily due to less deployment services needed to implement our offerings. In total, Q3 revenue increased 26% on a year-over-year basis to $40.6 million.

Turning to customer engagement, we continue to deliver compelling ongoing value to our customers, as evidenced by a trailing 12-month net subscription dollar retention rate of approximately 100%. We continue to see stronger net retention performance from our more recent annual cohorts and are pleased by the pace at which our new customers are expanding their application footprint.

As we invest in our customer success in account management teams and further innovate new products, we aim to grow our net retention rate even further. For the remainder of my commentary, unless otherwise noted, I will discuss non-GAAP results, which excludes the impact of stock-based compensation. Please note that a reconciliation of GAAP to non-GAAP results is provided with our earnings press release.

Our total gross margin improved from 61.1% in Q3 2015 to 66.6% in Q3 2016. This increase was driven by a few factors. First, as I mentioned earlier, subscription revenue growth outpaced services growth. This revenue mix shift favorably impacted total gross margins, since subscription gross margins exceed services gross margins.

In addition to the revenue mix shift, we also improved both subscription and services gross margins in Q3. Our subscription gross margin improved from 76.4% in Q3 2015 to 79.9% in Q3 of this year, as we gain leverage from a larger customer base and higher utilization of our existing hosting infrastructure.

Our services gross margin also improved from 2.3% in Q3 of 2015 to 5.9% in Q3 of 2016, as we saw strong execution from our professional services team. We will continue to innovate to celebrate deployment cycles and lower the amount of customer resources required to manage our solutions, which we view as key in driving widespread adoption of TBM.

Moving down the P&L, as Sunny mentioned, we continue to invest to enhance our platform and develop new applications, while demonstrating the leverage of our business model. As a percentage of revenue, R&D. expense in Q3 2016 declined to 21% of revenue versus 23% in last year’s Q3.

Our sales organization continue to show Scalebit benefits. Sales and marketing expense declined to 43% of revenue from 47% in last year’s Q3, even as we continue to build our sales capacity to enable sustained growth and invested in the partner channel.

Finally, even with the investments in personnel and infrastructure necessary to operate as a public company, G&A expense remain flat year-over-year at 14% of revenue. In total, operating loss was $4.5 million in Q3 2016, or a 11% of revenue. This compares to an operating loss of $7.4 million. or 23% of revenue in the third quarter of 2015. We are pleased with this improvement.

Net loss per share was $0.45 in the third quarter of 2016, based on $13.9 million weighted average common shares outstanding and improvement from a net loss per share of $0.61 based on $12.8 million weighted average common shares outstanding in the third quarter of 2015.

Turning to cash flows. At this point in the year, we look at cash flow on a year-to-date basis, because our cash flow has some seasonality. Our net cash used in operating activities was $2.1 million in the nine months ending September 30, 2016, as compared to $8.8 million in the nine months ending September 30, 2015. Including capital expenditures, our free cash flow improved significantly to negative $5.7 million for the nine months ending September 30, 2016, as compared to negative $15.4 million in the comparable period last year. This improvement was largely due to business growth in operating leverage.

For Q3 of 2016, net cash used in operating activities was approximately $800,000, as compared to net cash used in operating activities of $5.4 million in the third quarter of 2015. Free cash flow improved by over 5 million to negative 2 million in the third quarter of 2016.

And finally, looking at the balance sheet, we ended the third quarter with approximately $122.5 million in cash, cash equivalents and marketable securities. Net proceeds from the IPO were approximately $99.1 million after underwriting discounts and other offering costs. We had no outstanding bank debt as of September 30, 2016.

Turning ahead, as you work to update your models, let me offer you some thoughts about Q4. For the fourth quarter of 2016, we expect total revenue of approximately $41.5 million to $42.5 million. We expect subscription revenue to continue to grow and expect an increase in services revenue due to the TBM conference in Q4.

Additionally, we expect non-GAAP operating loss of approximately $8 million to $9 million in Q4. Related to any EPS calculations, we expect approximately 38 million to 39 million weighted average common shares outstanding in the fourth quarter of 2016.

For the 2016 fiscal year, we expect total revenue of approximately $157.7 to one $%158.7 million dollars in a non-GAAP operating loss of approximately $21.9 to $22.9 million. We expect approximately $19 million to $20 million weighted average common shares outstanding in the 2016 fiscal year.

In summary, In addition to our IPO, we maintained our focus on business results and delivered strong Q3 subscription revenue growth, expanding gross margins and improving cash flow. As we continue to invest to capture the immense opportunity ahead, we’ll keep a steady hand our P&L balancing growth opportunities with our drive towards profitability.

And with that, let me turn it back to Sunny for some closing remarks.

Sunny Gupta

Again, I want to thank you all for joining us. We believe TBM is a large and unpenetrated market and that the global adoption of TBM is inevitable. We pioneered this category and are the clear leader today, with a strong and vocal customer base. We believe, our market opportunity is approximately $6 billion with additional expansion vectors.

We are well-positioned to capitalize on this opportunity. To penetrate this large market, we will continue to acquire new customers in the Global 10000 and expand our geographic footprint further into Europe, Asia Pacific, and federal and state government agencies. We will also continue to up-sell more of our applications to current customers and expand the customers IT spend managed through our platform.

We’ll continue innovating including using our anonymized and granular IT data set for benchmarking, insights, and data first applications. We are benefiting from several macroeconomic tailwinds, such as cloud adoption, digitization, and IT as a service. The opportunity ahead is very exciting and, though, it will take work and investment to get there, we believe we are firmly on the right track.

We remain steadfast in our mission to create software that empowers IT leaders to make data-driven decisions about technology investments, capitalize on the cloud transformation and drive business innovation. I want to take this opportunity to call out our amazing employee base that made this all possible.

Just over eight years ago, we were a small startup in the Pacific Northwest. Today, we are the publicly traded leader of an important software category. None of that would have been possible without the tremendous effort and dedication of our incredible employees. I also want to thank our investors for putting your faith in our vision and our team. This is the start of a new journey for Apptio and we are excited to execute on the large opportunity in front of us.

And with that, I would like to open the floor to questions. Operator?

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, as a courtesy to all analysts, please limit your questions to one and one follow-up, and if necessary return to the queue. [Operator Instructions] Our first question comes from the line of John DiFucci with Jefferies. Please go ahead.

John DiFucci

Thank you. Nice job, guys, first quarter out of the box here. I guess, one for Sunny and one for Kurt. Sunny, you talked about significant adoption of infrastructure as a service as a driver here, which I find interesting. I’m wondering, are you seeing – what are you seeing as far as platform as a service? Are you – can you distinguish between the two when you’re monitoring this?

Sunny Gupta

First of all, thank you, John, for asking the question. Yes, really – what we’re really seeing is that, especially it was always the case in the enterprise customers, but even in the large strategic customers, customers are migrating more and more of their infrastructure into the public cloud infrastructure and primarily platforms we are seeing our Amazon as well as Azure. And customers are really using Apptio decisioning engine to make what if decisions from moving from on-premise to the public cloud comparing the pricing models.

And certainly, most of the work is around the infrastructure. But we are seeing some movement around the platform as a service as well as SaaS applications, which is more around managing those bills and license optimization.

John DiFucci

Okay, great. Thank you. And Kurt a follow-up here that you guys mentioned oil deployment times here and that’s something that you’ve been driving towards to increase adoption. I guess, can you provide any quantitative metrics around that, the progress of that perhaps on an year-over-year basis, and how we should think of it going forward? And I guess any any traction with partners helping in this regard?

Kurt Shintaffer

Sure. So we think about the pace of deployments relative to a couple of years ago when we were really delivering a platform to the market. And so our current employment typically takes three to six months, depending on the combination of applications that the customer may buy and that compares to 9 to 12 months, just a couple of years ago. So, our objective with the product development work we’re doing is to continue to drive that down over time.

More specifically to the partner question, we have a number of systems integrator partners we work with, and they’re doing what’s roughly 20% of our implementation work, and that’s held relatively steady throughout the year.

John DiFucci

Okay, great. Thank you very much. Nice job, guys.

Sunny Gupta

Thank you.

Operator

And our next question comes from the line of Jesse Hulsing with Goldman Sachs. Please go ahead.

Jesse Hulsing

Yes, thank you, guys, for taking my question. I have a question for Kurt to start it off. Kurt, you mentioned that 100% net expansion rate, which is in line with what you’ve done in prior quarters. I’m curious what you’re seeing out of more recent cohorts, I know, you guys have been moving towards unbundling the product and trying to be more disciplined with your initial sell-ins. How was expansion trending with your 2014 and 2015 cohorts so far?

Kurt Shintaffer

Yes. So both of those cohorts are trending really well. And it comes back to the point that you really started with which we’re selling really just one to two applications initially with greater opportunity to up-sell. So we really think that model is working.

Jesse Hulsing

Perfect. And then, Sunny, when you look at your pipeline, I’m curious, where IT planning set there, it’s a big up-sell opportunity. It’s been out in the market for about a year, or a year now, and it’s been maturing. I’m wondering if you’re seeing more inbound interest on that from your installed base and if it’s ready for broader adoption? Thank you.

Sunny Gupta

Yes, Jesse. So IT planning, we are seeing great traction of that product within the – within our customer base, both in new customer acquisitions, as well as in up-selling existing applications. We absolutely believe it’s ready for prime time. I mean, costing and planning our two sides of the same coin, and those are very strategic processes integrated together. Specifically, we saw that customers who start with cost transparency are also buying IT planning from a new logo perspective, as opposed to a lot of standalone deals.

And Secondly, in our existing customer base, we are finding that a lot of customers are buying IT planning as the next application after they’ve fully realized value from IT cost transparency. So we’re very excited about the future for IT planning.

Jesse Hulsing

Great. Thank you, guys.

Operator

And our next question comes from the line of Brad Sills with Bank of America. Please go ahead, Brad.

Brad Sills

Hey, guys, thanks for taking my question. Yes, I wonder if you could comment a little bit of about category awareness that just TBM as an offering in the value proposition behind TBM. Are you noticing any change in the sales cycle when you go into a new account, for example, that you’re able to shift your focus away from just explaining what the category is and kind of outlining the value propositions of our meaningful conversations? I guess any commentary on awareness now that’s tracking at the category?

Sunny Gupta

Yes, thanks, Brand for that question. Yes, absolutely, we are seeing great adoption and TBM category is a great catalyst for Apptio to expand our market and go across the Global 10000. And a great group point is, our on-premise, which is coming up next week in San Diego, we’re expecting 1,000-plus IT leaders. And if you think about just a few years ago, we just had a handful of people around the conference room table, and this community has really, really grown. And there are a lot of members on the community, which are not even Apptio customers, so that creates an opportunity. It is still early days of the category.

So it does require a level of education. But the more customers we acquire, the more value they get, the more they evangelize and the more easier we make our products to deploy and adopt and shorten the deployment cycles. That’s having a great effect on our category. And then lastly, I would say, cloud and digitization are great tailwinds for our business, as well.

Brad Sills

Thanks, Sunny. And just one follow-up, if I may. As you guys moved down market into the – that next tier of account below the Global 2000, how is traction going there in generating leads and closing that business, I know it’s a relatively new effort for the company?

Sunny Gupta

Yes, so I would say, a great progress in executing against our strategy of acquiring the next 1,000 customers across the broader Global 10000. We are clearly in the early days as work ahead of us, but we are seeing good results. And some of the key evidence in Q3, which we saw, we had great new customer acquisitions from the Enterprise segment.

I would say that, as we even think about the last three quarters, there’s a – there’s been a meaningful shift in the subscription revenue coming from the Enterprise segment. Strategic segment continues to be strong for us as well. In addition, we did introduce our test drive product for cost transparency, which is a way for customers to evaluate the product on their own without acquiring technical validation. And this has resulted in faster sales cycles in a few of the deals, as well as we see continued growth in our pipeline for the Enterprise segment in addition to continued expansion of our Strategic segment pipeline.

Brad Sills

Great. Thanks, Sunny.

Operator

And our next question comes from the line of Mark Murphy with JPMorgan. Please go ahead.

Matthew Coss

Good afternoon. This is Matt Coss on for Mark Murphy. Congrats, again, on the quarter. Can you talk a little bit about Vendor Insights and sort of the customer profile that’s choosing a Vendor Insights? And is there any specific vertical that maybe get some more value-add that initially that you’ve been able to observe? And then I have one follow-up.

Sunny Gupta

Thank you, Matt. Yes, so really Vendor Insights is our newest release module as a part of our business insights application family. And this product was conceived as a result of kind of deep customer feedback over the last year. And really generally what we are seeing is the vendor landscape within the enterprise IT is exploding, where there’s a shift happening. Customers are doing business with more vendors and there are many, many different varying degrees of subscription terms, models moving from perpetual to cloud models.

And – but generally the number of vendors which our organization is doing business with is increasing. And this is a challenge we are seeing frankly horizontally across every single customer independent of the vertical and independent of the size. And this is a natural extension from our cost transparency application. This application is built upon the same common platform, and it allows us to ingest a lot of the accounts payable data, marry that data with some of the general ledger data, as well as and provide kind of deep insights into the vendor spend categorization of vendor by different categories.

And so we believe this is a great opportunity for us to up-sell this specific module into our existing installed base, as well as we’re going to continue enhancing this, and as well as use it for to drive additional value in our new logo acquisition motion.

Matthew Coss

Understood Thank you very much for that. And then just finally is, you’re becoming public, has that opened up any conversations maybe with other very large customers that maybe you can quite crack the code on getting a foothold in the door?

Sunny Gupta

So becoming a public company was incredible branding for Apptio, as you would expect in Q3. And generally this has bought tremendous amount of awareness to the TBM category and also legitimacy to Apptio as a market leader in this very strategic category.

So as a result of that, yes, we are seeing that customers or CEOs or CFOs are even looking and saying, hey, I need my technology spend to be managed that way and that is definitely opening up opportunities But still there’s a level of education, which is acquired and we just think this is going to be another tailwind, which will help accelerate Apptio into the broader market.

Matthew Coss

Thank you very much, Sunny.

Operator

And our next question comes from the line of Raimo Lenschow with Barclays. Please go ahead. Mr. Lenschow, your line is open.

Raimo Lenschow

Sorry. I was on mute. Thank you. Congratulations from me as well on a first great quarter as a public company. Quick question from me. Sunny, you talked about customer understanding in the sort of last question. If I look – obviously a lot of the bigger companies have understood the value that you offer with over 40 of the Fortune 100 already being customers.

Can you talk a little bit about the thought process that goes on at some of the more smaller accounts in terms of dealing with this issue. I would assume a lot of that everyone has the same issue, but they’re somewhat reluctant, because it does take some effort to kind of put the solution in. Can you see – can you talk a little bit through what you see and what you can do to change or accelerate this process?

Sunny Gupta

Yes, absolutely. So really, what we are seeing is and again, we’ve been selling to enterprise customers as for the record we have customers as little as 10 million in IT budget and we have customers in billions in technology budget. So we – our applications and platform is very broadly applicable to large and small customers. We are seeing a meaningful shift into the Enterprise segment. Some of the things are exactly the same for the smaller customer and some are different one.

We are seeing that that really the smaller customers have really the same challenge. They do not have transparency into the technology spending into investments into new digitalization initiatives they’re trying to embark. They do not understand how to manage their cloud spend. And their challenge is even bigger than large companies are able to deploy tons and tons of labor and human resources are expensive consultants to manage that level of complexity.

But the smaller companies have a bigger challenge, and frankly, there are lot of similarities to the journey, which Kurt went through in T&E space. So really what Apptio can do which is fundamentally their expectations are time to value. How quickly can we deliver upfront value.? How quickly can we ingest their dirty data, disparate data into the platform and deliver kind of real meaningful actionable insights and automate business processes.

And a lot of the work we did even in Q3 around the updates to our cost transparency application and platform are oriented around making that entire process easy continue to shaving down the deployment times and we believe that’s the big sort of catalyst. The other thing is, they’re looking for more predictable value. So lot of meaningful shift, where we’re driving jump starts from a configuration perspective, that’s also a catalyst.

The third area I would find is, we are finding increasingly cloud services adoption within the broader customer base and hence a lot of our deeper investment into the cloud space, we believe that’s a catalyst for that style of a customer as well.

Raimo Lenschow

Perfect, thank you. And then one follow-up, if I may. We talked a lot about a change and Jesse mentioned it about kind of moving from a 100% [indiscernible] net expansion rate to a higher number, because you are selling in more modules and we talked about the strategic planning as well as the I – elements of trying to up-sell the customer base. How do you set up the organization to get this done in terms of, you – in the past you had a sales guy selling the what discrete and kind of moved on to the next account. How do you cut of the segment that’s out now? Is that the existing sales rep kind of trying to revisit the account again, do you do account management team, how do you do that? Thank you.

Sunny Gupta

Yea. So really there were two big evolutions the company started in 2014. Number one was start – rather than selling the platform, we’re selling discrete applications and customer started with one or two applications and that strategies worked out to be really, really excellent for us.

And the second thing is, we bifurcated and segmented our sales force. So we have a new logo sales team and then we have an account management sales team. New logo sales team is segmented into strategic and enterprise. And then once we acquire the customer, we hand that customer over to the account management team. And the charter of the account management team is very simple. They’re really focused on delivering value to the existing customer through adoption which leads to renewals.

And number two, they are charted also with up-selling new modules and applications into that existing customer. And that that is the primary strategy, which we are continuing on. And that account management team is supported by also a customer success organization, which is really helping the customer with best practices around TBM and just helping on the technical part of getting the most value out of our applications and platform.

So the combination of those two organizations are delivering great value to our customers.

Raimo Lenschow

Lovely. Thank you.

Operator

And our next question comes from the line of Ross MacMillan with RBC Capital Markets. Please go ahead.

Ross MacMillan

Thank you very much and Sunny, Kurt and team congratulations from me as well on a strong Q1 at the gate. Maybe I can start, Sunny, just as you think about the enterprise versus the strategic segment, two questions on that. One is what is this sort of sweet spot in terms of an enterprise customer IT spend that you’re kind of going after, obviously, you scaled down to $10 million. But what’s the right way for us to delineate between to the average in enterprise versus the average in strategic?

And then second, the question for Kurt, I know that, you’re obviously focused on reducing deployment times. But what are some of the initiatives you have in place to reduce the sales cycle time and the cost of acquiring an enterprise customer? Thanks.

Sunny Gupta

Yes, thanks, Ross, for that. Yes, really, so the way we segment our market is in these two broad segments strategic, where the revenues are greater than $20 billion, which approximately give or take equates to $750 million of annual IT spend. And then the strategic and that’s around 750 companies in that strategic segment. And we have penetration, but there’s a big opportunity in that strategic segment.

The enterprise segment we define with companies greater than $1 billion in revenue and goes up until $20 billion in revenue. And that’s equates roughly to IT spend of $30 million in IT spend all the way to $750 million. As you would expect in that enterprise, we have a sales force which just sells to the enterprise segment. The upper part of that enterprise segment behaves a little bit more like the strategic segment and the lower part of that enterprise behaves more like the smaller customers. But I would say that’s our sweet spot and we have many, many customers including as evidenced by a strong traction of customer acquisition in that.

And – but by no means, our product is limited to just that set of segment, because we do have customers with as less as 10 million, but all our sales and marketing efforts are really oriented around kind of the $30 million-plus in IT spend.

Kurt Shintaffer

Great. Hey, Ross, I’ll take the other one. So your question about reducing sales cycle times and generally the cost of acquiring customers took a couple of things I point to. Sunny alluded to this the existence of what we call test drives. This is essentially an online evaluation of our software. What that does is it has an opportunity to both reduce sales sales cycle times and limit the amount of technical resources Apptio needs to provide during an evaluation.

And probably the biggest thing that could drive efficiency over time is more up-sells, simply there it’s less expensive to up-sell our customers than it is to acquire new logo, so that becomes a bigger part of our business, we can see efficiencies there. And probably lastly, the TBM Council just continues to be a great opportunity to pull opportunities through the sales cycle faster.

Sunny Gupta

And Ross, one more thing I wanted to add on top of what Kurt said, we have developed along with the TBM Council industry standard cost model, industry standard reporting packs for the CIOs, industry standard data models, and this is where traditionally a lot of the complexity has been in the past, and this is all standard blessed by some of the world’s most leading CIOs.

And this is embedded in our software and we are the only company, which have this. And this is having a pretty meaningful impact in terms of kind of reducing the sales cycle time, because as we approach new customers when there is a standard cost model blessed by the industry, blessed by leading CIOs, that is providing a level of credibility and as a result less kind of technical validation really around our solutions.

Ross MacMillan

That’s helpful. Maybe one quick follow-up. Federal, I know this was an area you started to focus on last year. Obviously, third quarter tends to be a little bit more of a focus spending environment from the federal sector. Any updates on that opportunity at this point? Thank you.

Sunny Gupta

Yes. Ross, I would say, there are two meaningful things on the federal government. I would say, generally, it is early days for us in the federal government. In Q3, we did have good traction, early traction, I would say, in the federal government. We have a handful of agencies now in the federal government and that that’s pretty significant, because what we’ve seen with Apptio as we’ve approached any new market is once we get the handful of customers up and running deployed, that actually drives a network effect and that drives either the referenceability to the other accounts.

So we believe we’re in early days and that should have impact on long-term and medium-term on Apptio going into next year. And number two, I would say, I’m really proud to say that Apptio along with the TBM Council has made a meaningful progress around standardizing the federal cost model. So we commissioned a – along with the federal government CIOs to create a federal version of the cost model and that has been ratified now and getting adopted amongst the federal government CIOs. And we believe that’s big from an Apptio perspective, because that will help drive more traction for Apptio software down the road.

Ross MacMillan

Thank you so much. Congrats again.

Sunny Gupta

Thank you.

Operator

And our next question is from the line Ben McFadden with Pacific Crest Securities. Please go ahead. Ben.

Ben McFadden

Hey, guys. Thanks for taking my questions. Sunny, I want to start with you just from a higher-level competition landscape. I think two of the competing solutions out there made some sort of news within the last couple of months where one larger competitor spun off their solution, and another sort of provided an update or added functionality to theirs.

So just from a broader picture, are you seeing any shift in the competitive threat out there, any shift in win rates or – are their focus on this market, these larger competitors is that changing at all, just any broader thoughts on what you – on your competitive mode as well.

Sunny Gupta

Yes. So generally, our competitive mode remains the same. We’re the market leaders in the strategic category. Our biggest competitor continues to be Excel. Our customers trying to do this through homegrown legacy business intelligence solutions. Spreadsheets, we all know are inadequate and there are a lot of similarities to concur on T&E or ERP, CRM early days.

We just believe IT is so complex that you just cannot manage your technology spending on spreadsheets moving forward. And really the reason why customers choose us is because of our unique data and analytics platform with great data management and [purpose with] [ph] applications, our standard cost model, TBM Council, very loyal customer base and data asset. So on an overall basis, we continue to maintain a strong market leadership and competitive position in the markets.

Ben McFadden

Great. And then Kurt on the call you’ve mentioned the fact of – or Sunny mentioned the fact of you’re selling into these larger or smaller corporations more and more. But I just from – are you seeing any material shift in sort of the customer growth metrics or the ASPs that you’ve disclosed over the last couple of months. And just how you land in these customers, is there any shifts that’s taking place as far as an inflection in either one of those metrics that you want to call out?

Kurt Shintaffer

Yes, Ben, so really there hasn’t been a meaningful shift in those metrics largely, because while we’re selling to more enterprise customers, we’re continuing to expand our strategic customer footprint as well. So we’re sort of the end motion that we may have talked about before. I mean, so in the prospectus we talked about $400,000 average annual contract value that’s remaining about the same.

Ben McFadden

Okay, great. Thanks, guys.

Operator

And ladies and gentlemen, thank you for participating in today’s conference. I will turn the call back to Susanna Morgan for final remarks.

Susanna Morgan

Great. Thanks, everyone. As a reminder, replay of the call will be available as a webcast in the investors section of our website. Thanks so much for joining us today.

Operator

Ladies and gentlemen, this concludes our program for today. You may all disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!