C3.ai (AI 0.39%) posted its latest earnings report on Wednesday, Dec. 7. For the second quarter of fiscal 2023 (which ended on Oct. 31), the enterprise AI software company's revenue rose 7% year over year to $62.4 million, which exceeded its previous guidance for 3%-6% growth and beat analysts' estimates by $1.6 million.

But on a GAAP (generally accepted accounting principles) basis, C3.ai's net loss widened from $56.7 million to $68.9 million. On a non-GAAP basis (which excludes its stock-based compensation and other one-time expenses), its net loss narrowed from $23.6 million to $11.8 million, or $0.11 per share, and cleared the consensus forecast by a nickel.

An android's head shatters.

Image source: Getty Images.

C3.ai's headline numbers cleared Wall Street's low bar, but it still expects its revenue to drop 7%-10% year over year in the third quarter and rise just 1%-2% for the full year, which is well below its previous full-year revenue guidance for 1%-7% growth. It also expects its non-GAAP operating losses to widen year over year in the third quarter and the full year.

That gloomy outlook suggests that C3.ai's stock deserves to stay about 70% below its IPO price. But with an enterprise value of $540 million, it also looks cheap at 2 times this year's sales. Is it finally time to take the contrarian view on C3.ai?

How does C3.ai make money?

C3.ai develops AI algorithms that can be integrated into a company's existing software to streamline its operations, reduce its expenses, improve employee safety, and detect fraud. It also provides these services as stand-alone applications.

It generates most of its revenue from the industrial, energy, and financial sectors. Its largest client, the energy giant Baker Hughes, accounts for nearly a third of its total revenue through a joint venture. The upcoming expiration of that partnership in fiscal 2025, which Baker isn't guaranteed to renew, has cast dark clouds over C3.ai's long-term future.

C3.ai has been trying to reduce its dependence on Baker Hughes by securing new partnerships with Alphabet's Google Cloud, Microsoft, and the U.S. military. However, none of those deals have meaningfully boosted its revenue yet.

Why did C3.ai's growth stall out?

C3.ai initially pursued large customers and charged recurring subscription fees for its services. But over the past year, it started to target smaller customers and pivot toward consumption-based fees. CEO Tom Siebel said those changes could diversify its customer base, alleviate its customer concentration issues, and give it more pricing options during economic downturns.

But if we examine C3.ai's year-over-year growth in remaining performance obligations (RPO), or the remaining value of its existing contracts that haven't been booked as revenue yet, and its total revenue over the past year, we'll see that its growth has stalled out.

Metric

Q2 2022

Q3 2022

Q4 2022

Q1 2023

Q2 2023

RPO (Non-GAAP) Growth (YOY)

74%

81%

50%

39%

(14%)

Revenue Growth (YOY)

41%

42%

38%

25%

7%

Data source: C3.ai. YOY = Year over year.

C3.ai blames that slowdown on macro headwinds, which caused many enterprise customers to rein in their spending on big software upgrades. Its surprising shift from subscriptions to consumption-based fees also reduced its RPO (since those new customers aren't locked into recurring fees) and made it tough to gauge the market's near-term demand for its products. 

The company's grim guidance indicates those headwinds won't dissipate anytime soon, but Siebel insisted that it can "return to a growth rate of greater than 30% year-over-year within the next 18 months" during the company's latest conference call.

Unfortunately, C3.ai has repeatedly overpromised and underdelivered on its promises before. At the end of fiscal 2022, it predicted its revenue would rise 22%-25% in fiscal 2023. But now it's bracing for nearly flat revenue growth.

The company is also on its third CFO in just two years, and it's repeatedly changed its key growth metrics (including its customer count) under those three leaders. Its insiders have also sold more than six times as many shares as they bought over the past three months, which suggests they aren't as confident as Siebel in the company's near-term turnaround.

Shrinking margins and a sea of red ink

C3.ai's non-GAAP gross margin fell by a percentage point year over year to 77% in the third quarter, which suggests its pricing power remains limited even after shifting to consumption-based fees. Its non-GAAP operating margin also remains negative and should continue to drown in red ink for the foreseeable future.

As interest rates continue to rise and the bear market drags on, macro-sensitive tech companies like C3.ai that face cooling sales growth and persistent losses will remain out of favor. Moreover, C3.ai's customer concentration issues, jarring changes to its original business model, constant CFO changes, and broken promises make it even less appealing than many other burnt-out hypergrowth stocks. Simply put, investors should avoid C3.ai and buy more promising software stocks instead.