What happened
Shares of C3.ai (AI 1.18%) were falling today after short seller Kerrisdale Capital, which had announced a short position in the stock a month ago, released a letter accusing the company of "serious accounting and disclosure issues."
As of 11:24 a.m. ET, C3.ai stock was down 23.9%.
So what
In a letter addressed to C3.ai's auditors, Deloitte & Touche, Kerrisdale's Chief Investment Officer Sahm Adrangi claimed that C3.ai was using "highly aggressive" accounting tactics to inflate revenue and certain profit metrics in order to meet analyst estimates.
In particular, Adrangi pointed out "highly conspicuous growth in unbilled receivables" to abnormal levels for a software company, and said C3.ai's disclosures related to Baker Hughes, its biggest customer and strategic partner, were "opaque, confusing, and highly concerning."
The letter also said the company improperly recorded direct revenue costs as R&D expenses to inflate gross margins, and classified professional services revenue as subscription revenue.
The most concerning of the claims is that the company's accounts receivables have soared while revenue actually declined in its most recent quarter. Accounts receivables represent recorded revenue that hasn't been received as cash yet, so it's odd to have receivables grow without corresponding growth in revenue.
In C3.ai's own 10-Q filing, the company acknowledged that its unbilled receivables rose from $19.9 million on April 30, 2022, to $87.9 million on Jan. 1, 2023. C3.ai also said that $79.6 million of those unbilled receivables is related to Baker Hughes.
Kerrisdale noted that the $80 million in unbilled receivables represents nearly 30% of its total revenue, and concluded by saying, "It appears to us that C3.ai is booking fictional revenue in order to meet consensus analyst estimates and cover up the fact that, in reality, its products are unable to get traction with customers and its business is failing."
Now what
Kerrisdale first said it was short shares of the AI stock back on March 6, saying, among other things, that the stock had surged merely on the hype around ChatGPT, and that the underlying business was experiencing serious financial pressure.
C3.ai did not respond to the initial report, but Kerrisdale didn't accuse the company of accounting irregularities like it is now. C3.ai's stock only moved modestly lower then.
Investors should expect a response from C3.ai as these are serious allegations. Even if there is nothing fraudulent about its accounting, the practice of leaving nearly a third of its revenue as unbilled receivables warrants an explanation.
Given the stock's lofty valuation, C3.ai could still have a lot further to fall.
