C3.ai Falls After Short Seller Discloses “Fictional Accounting”

Kerrisdale Capital Management shared on Tuesday the letter it wrote auditing firm Deloitte & Touche, in which the investment management firm aimed to bring about the “highly aggressive accounting” that C3.ai (NYSE: AI) used to inflate its income statement. The letter was part of a larger short report issued by the firm.

“Please examine the contents of this letter as you engage in your review, to ensure that the company cannot use fraudulent accounting conventions to mislead investors and damage the integrity of the public markets,” the firm wrote Deloitte.

One of the points Kerrisdale highlighted is the questionable ballooning of C3.ai’s receivables, adding that total accounts receivable has more than doubled while quarterly revenue has declined.

“This has led to a cumulative negative cash flow statement entry of -$76m owing to changes in accounts receivable over the past four quarters,” the investment firm noted. “Given C3.ai generated last-twelve months revenue of just $267m, this cash flow discrepancy due to growing receivables accounted for over a quarter of revenue, a material sum.”

The firm explained that the surge in receivables is a result of growth in “unbilled receivables”, growing from less than $10 million in each quarter prior to April 2022 to $88 million in the most recent quarter. This is said to be primarily driven by one client – Baker Hughes.

Baker Hughes is a Texas-based multinational company that provides products and services for the oil and gas industry. The company was formed in 1987, when Baker International and Hughes Tool Company merged.

Kerrisdale also questioned how C3.ai reported $56 million of related party subscription revenue over the past nine months tied to Baker Hughes but no corresponding cost of revenue was recorded, pushing up the company’s gross margin.

“Why does C3.ai want to inflate its gross margin? We believe it does so because it regularly pretends to be a software-as-a-service company instead of the services-intensive consulting business that we believe it really is,” Kerrisdale alleged.

The investment firm also tried to clarify that the software company is inflating its gross margins by recording its cost of revenues under research and development expenses.

“Its motivation for doing so seems obvious,” the firm argued in the letter. “These higher multiples translate to higher share prices and thus greater compensation for C3.ai management, which rewards itself generously with stock options and restricted stock units.”

Labeling their sales generated from subscription revenue was also questioned, with Kerrisdale saying because of the highly customized nature of C3.ai’s offerings, its sales “seem to [them] as mainly services and consulting projects.”

High CFO turnover

Kerrisdale also connected the accounting concerns it brought up with C3.ai’s high turnover for chief financial officers, having four different persons serving the role just over the last four years.

“Equally as striking, the qualifications of its chief financial officers, in terms of stature, depth of experience and even age, have deteriorated over time, in lockstep with the decline in the quality of C3’s financial reporting,” Kerrisdale noted.

In comparison, days sales outstanding was at 72 when Levine was the CFO. Currently, during the tenure of “former CFO of nothing Juho Parkinnen”, the company reports days sales outstanding of 197 and a research and development expense greater than its gross profit.

Twitter user Todd Fernandez even highlighted that the software firm has 9 CFOs since it was founded in 2009, averaging a tenure of a little over a year each.

“Deloitte doesn’t need to rubber stamp fraudulent accounting. Either require the company to come clean in its upcoming audit or resign and let C3.ai management sully the reputation of a lesser audit firm,” Kerrisdale pled to the auditing firm.

Kerrisdale, however, clarified that it is short shares of C3.ai. Following the report, an unidentified trader was able to make millions by placing puts on the company’s shares before the close.

“In reality, C3.ai isn’t merely overvalued – it’s most likely worthless. Burning $200m+ cash a year, with an additional $200m+ of stock compensation expense, on less than $300m of revenue, the company hasn’t demonstrated an ability to provide an attractive solution that enough customers want, need or find competitive relative to alternatives,” the investment firm said in its report.

Information for this briefing was found via the sources mentioned. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.

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