After rocketing higher on fiscal 2024 third-quarter results in late February, C3.ai (NYSE:AI) stock now trades 15% below where it stood before earnings came out. In fact, it took only two days for the euphoria over the artificial intelligence (AI) shop to wear off.
Was it profit-taking that spurred the decline or have investors had a chance to delve more deeply into C3.ai stock’s finances and got worried about what they found? Probably both. However, AI is going to be printing millionaires as it comes into its own and C3.ai promises to turn free cash flow positive in the fourth quarter (and for all of fiscal 2025). With the stock sharply lower, is this the opportunity investors have waited for to get in on a good deal?
Ramping up customers and sales
Revenue is growing smartly. Sales of $78.4 million was 18% ahead of the year ago period while subscription revenue accounted for 90% of the total, or $70.4 million. That’s a 23% year-over-year increase.
Likely that was due to the increase in customers C3.ai stock signed on. It announced an 85% jump in agreements by closing 50 separate transactions, more than half of which were new pilot programs, or 29 in all. That’s a 71% year-over-year increase.
However, that’s sequentially lower than what C3.ai saw in the second quarter. Then it closed 62 agreements, 36 of which were pilot programs. So the company closed 26 new agreements in Q2 and 21 in Q3.
That’s important because the pilot programs are trial runs of C3.ai’s technology. They are essentially try-before-you-buy freebies where companies get to decide whether the software is a good fit for them. While there can be a bit of seasonality involved, which may make quarter-to-quarter comparisons and apples-to-oranges view, ideally you want you company consistently growing.
What this may signify is that customers caught up in the AI hype signed on in greater numbers to test out C3.ai’s software but as the environment settles fewer are responding. Investors should keep an eye on this in future quarters.
Expenses are growing just as fast
Although revenue surged in the latest period so did C3.ai’s expenses. The AI stock’s cost of revenue rose 48% to $33.1 million. That’s over two-and-a-half times faster than revenue’s rise. Moreover, where C3.ai’s revenue rose by $11.7 million from last year, costs were up $10.8 million. So for every dollar it made in sales it cost nearly $1 to make it. That’s undoubtedly because its sales and marketing expenses soared 33% from last year.
And yet we see operating expenses only rose by 10% from the year ago period. Why? Because C3.ai stock cut back on research and development (R&D). It cut R&D costs by more than 10%. Last quarter these expenses were essentially flat. They were down 9% in Q1 as well.
Has C3.ai perfected its software to such a degree that it can keep cutting it? Maybe, but if we look at similarly situated Palantir Technologies (NYSE:PLTR) results from the same period, we see R&D spending jumped 33% and is up 12% yer-to-date. C3.ai’s R&D expenses are down 6% through the first three quarters of fiscal 2024.
Masking the true costs
C3.ai continues to burn through cash but manages to mask the full effect because it pays its employees with stock. A lot of stock. It paid out $54.8 million in stock-based compensation in the third quarter, or 78% of total revenue. Year to date it’s paid out $159 million in stock-based compensation, or 80% of its $198 million in sales.
If employees were receiving their full salaries as cash and not stock, C3.ai’s cash burn would be horrifically worse. As a result, the AI outfit’s outstanding shares have grown to 120.5 million from 106.4 million in April 2023 and 56.8 million in 2021. That’s almost 30% a year, meaning shareholders are also suffering dramatic dilution.
As C3.ai’s potential for profitability gets pushed further out into the future, it cuts necessary costs to make expenses seem reasonable and masks the true effects of how bad its cashburn really is, a reckoning will come for the stock.
That might arrive sooner rather than later. C3.ai stock trades at over 10 times sales. It might seem a better value than Palantir at 22x but at least Palantir is profitable. I continue to caution investors about this company and wouldn’t want to be holding C3.ai stock heading into the next earnings report.
On the date of publication, Rich Duprey did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.