C3.ai stock falls on disappointing subscription growth. Time to buy dip?

Stock prices of C3. have (AI 0.85%) sank after the artificial intelligence (AI) software company’s subscription revenue growth in its latest quarter disappointed investors. The stock is now down nearly 26% this year.

Let’s take a closer look at the tech company’s recent report and see if the selloff is an overreaction.

Disappointing subscription growth and guidance

For the first quarter of fiscal year 2025, C3.ai saw its revenue grow 21% year-over-year to $87.2 million, which was a slight acceleration from the 20% growth seen in the last quarter. Total revenue was between the $84 million and $89 million that management had previously forecast. Subscription revenue rose 20% year-over-year to $74.5 million, but that total was below C3.ai’s 41% growth in Q1. Subscription revenue growth has accelerated every quarter for the past year, so the big drop in growth was a disappointment.

The company had gross margins of 59.8%, which is low compared to most software companies, which often have gross margins of 75% or more. Its adjusted gross margins, which strip out stock-based compensation expense, were around 70%. Meanwhile, gross subscription margins were just 54.7% for the quarter, down from 56.4% in Q4 but an improvement from 50.4% a year ago.

Image source: Getty Images.

C3.ai remains unprofitable, with the company reporting a loss of $0.05 in adjusted earnings per share (EPS). The company generated $7.1 million in free cash flow. However, it said free cash flow will be negative in Q2 and Q3 of 2025 as it invests in its businesses, before turning positive in Q4. Free cash flow is expected to be positive for the full year.

It ended the quarter with $762.5 million in cash and marketable securities and no debt.

Looking ahead, C3.ai management expects fiscal second quarter revenue to range between $88.6 million and $93.6 million, representing growth of 22% to 29%. For the full fiscal year, it forecast revenue to rise between 18% and 27% to a range of $370 million to $395 million. This was unchanged from previous guidance.

The company has transitioned from a subscription model, or software as a service (SaaS), to a more consumption-based model, which seems to add both blackness and less predictability. However, there were some good signs in the quarter about future growth. The company closed 71 deals this quarter. That was a 122% increase from the 32 it signed last year, and also from the 47 it signed in Q4 and 50 in Q3.

Meanwhile, pilots are up 117% year-over-year to 52 deals. These are short-term contracts of three to six months, during which customers can try out its services. Of the 224 pilots signed, 191 are still active, either being converted to full contracts, being negotiated, or still in the pilot period.

Investors should buy the dip

Following the share price decline, C3.ai is trading at a forward price-to-sales (P/S) ratio of approximately 7, based on analyst estimates for the current fiscal year. Given the estimated revenue growth of 20% to half, this is not expensive.

AI PS Ratio data (before) by YCharts

That being said, there are a few things I don’t like about C3.ai’s story. One is that its gross margins are lower than most software companies, especially on the subscription side of its business. Meanwhile, the shift to a consumption-based model has made it much more difficult for the company to forecast its results. This will likely lead to more volatility at the time of earnings.

In addition, the company’s use of stock compensation is aggressive and highly dilutive to shareholders. Its stock-based compensation of $54.7 million represented 62.7% of its Q1 revenue of $87.2 million. In the past year, the number of C3.ai shares increased from 118.2 million to 127 million, an increase of 7.4%.

While I think the C3.ai story remains on track, I would like to see improvements in the areas of gross margins and share dilution to want to buy the stock. As such, I would stay on the sidelines.