unpacking the c3.ai ipo filing

My most recent recollection concerning C3.ai (C3) involved noticing its prominent billboards in the San Francisco area and wondering about the precise nature of the company’s operations and the extent of its investment in large-scale outdoor marketing.

My initial assessment proved inaccurate. The company submitted its initial public offering filing on Friday, and contrary to expectations of substantial cash expenditure and reliance on industry jargon, C3 demonstrates a solid financial standing, consistently increasing its recurring software revenues and achieving positive cash flow during certain periods.

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While C3’s expansion isn’t consistently paced, the company maintains a favorable gross margin and occasionally reports net income. Consequently, its financial status is generally positive, though with some considerations that we will examine.

What specific services does C3 provide, who are its investors, and what insights can be gained from a detailed review of its financial data? These were the exact questions I sought to answer when reviewing its filing.

You can access the document here, and we will now proceed to analyze the figures.

A Deep Dive into a Contemporary AI Firm

Let's begin by defining C3. This former startup identifies itself as an enterprise artificial intelligence (AI) company, providing software solutions that assist large organizations in developing AI applications “of substantial scale and intricacy, delivering noteworthy societal and economic advantages,” as stated in its S-1 filing.

The company distributes its software in two primary formats: a development platform enabling clients to create, implement, and operate their AI applications on a cloud environment of their choosing, and a collection of pre-configured applications that users can quickly deploy. Were C3 a nascent company, one would question the effectiveness of its AI tools; however, given its $3.3 billion valuation and substantial revenue, it has clearly developed a functional offering.

Numerous venture capital firms have invested in C3, with the company securing over $360 million in funding throughout its history, according to PitchBook data. BlackRock spearheaded its Series H round, FS Investors led its Series G, TPG directed its $100 million Series F, Breyer Capital led its Series E, and TPG Growth led its Series D. Earlier funding rounds, specifically Series C and prior, are less clearly documented, though Makena Capital Management and Interwest Partners appear to have been involved during that period.

Regarding ownership structure, founder and CEO Thomas Siebel holds slightly under 34% of the company, TPG owns 22.6%, and Baker Hughes possesses approximately 15%. The company’s voting control is concentrated in its Class B stock, which is primarily controlled by Siebel.

But, fundamentally, how viable is the business itself?

Financial Performance

C3 operates on a unique fiscal year, concluding on April 30th. Therefore, when discussing its recent fiscal years, we are referring to the four-quarter periods ending April 30, 2019, and April 30, 2020. We will then examine the July 31st quarter, representing the most current data available.

Over those two fiscal years, C3 increased its revenue from $91.6 million to $156.7 million, representing a 71.1% increase. This demonstrates strong growth at its current scale. However, consistent with many high-growth companies, C3’s losses expanded alongside its revenue, with its fiscal 2019 net loss of $33.1 million more than doubling to $69 million by the fiscal year ending April 30, 2020.

While these net loss figures are noteworthy, they are not necessarily alarming for a company experiencing such rapid expansion. Furthermore, in its most recent quarter—the three months ending July 31, 2020—the company reported GAAP net income of $150,000, a significant improvement from the $323,000 loss recorded in the same period of 2019.

Before delving further into the latest quarter’s results, let’s analyze revenue quality. From 2018 through the initial quarters of 2019, C3 maintained blended gross margins in the 60s. Starting with the quarter ending July 31, 2019, these margins rose into the mid-70s, where they have remained.

C3 provides a breakdown of its services revenue, allowing us to observe its gross margins specifically from software income. These margins have increased from the mid-70s to the high-70s, reaching a peak of 81% in the quarter ending April 30, 2020, before decreasing by 200 basis points in the most recent period. Nevertheless, C3 can highlight a general trend of improving gross margins as it grows, which is a positive indicator.

However, its growth pattern is somewhat irregular, with revenue increases occurring in distinct phases. To illustrate this, a chart is provided for reference. While typically avoiding the promotional material found in company S-1 filings, in this instance, it proves insightful.

Here is a visual representation of C3’s revenue growth over time:

This pattern is unusual for a Software-as-a-Service (SaaS) company, isn’t it?

Revenue remained largely unchanged in fiscal years 2017 and 2019 and has once again stabilized. Only fiscal year 2018 exhibited consistent sequential revenue growth, a characteristic commonly observed in contemporary software businesses. Fiscal year 2020 showed better sequential growth than most years, but an increase from $39 million to $42 million over two quarters is not exceptionally strong.

Then came a surprising development. The fourth quarter of 2020 corresponds to April 30th, as previously noted. Data for the July 31, 2020 period is also available. What transpired during that time? C3’s revenue declined to just $40.5 million. This was unexpected.

The company only presents full fiscal years in the chart above, so I will refrain from criticizing it for omitting this revenue decrease. However, the drop in top-line revenue—which C3 attributes to “primarily a decrease in subscription revenue of $3.6 million due to the Baker Hughes contract modification that occurred during the three months ended July 31, 2020”—is concerning and could potentially dampen investor enthusiasm for C3’s short-term growth plans.

Despite this, C3 does not require additional funding. With its short-term investments and cash reserves, it holds over a quarter billion dollars in liquidity, equivalent to approximately four years of operating expenses at its fiscal 2020 burn rate. Therefore, the company is pursuing an initial public offering by choice.

The pricing of the IPO remains uncertain, but with a current run rate of around $160 million and a valuation of $3.3 billion to uphold, C3 will need to aim for a revenue multiple of approximately 20x to justify its valuation. It will need to exceed this multiple to surpass it.

Further updates will be provided as they become available.