Shares of C3.ai (NYSE:AI) stock are plunging lower by more than 20% after short seller Kerrisdale Capital penned a letter to C3.ai’s audit committee; Deloitte, the company’s auditor; and the Securities and Exchange Commission (SEC). In the letter, Kerrisdale Chief Investment Officer (CIO) Sahm Adrangi points out several accounting issues at the artificial intelligence ( ) company.
“In our opinion, C3.ai has utilized highly aggressive accounting to inflate its income statement metrics in order to meet sell-side analyst estimates for revenue and certain profit metrics, and to conceal significant deterioration in its underlying operations,” explained Adrangi.
The accounting concerns noted by Adrangi include misclassifying subscription revenue, costs of revenue and “highly conspicuous growth in unbilled receivables.” Let’s get into the details.
AI Stock Stumbles on Kerrisdale Letter
First, Adrangi notes that C3.ai’s total accounts receivable has more than doubled over the past year, while quarterly revenue has declined. This has resulted in a cumulative cash flow entry of negative $76 million due to changes in accounts receivable. Meanwhile, days sales outstanding (DSO) has risen to 197 days, “a level unheard of among software companies.”
Adrangi believes that rising receivables is attributed to rising unbilled receivables. In the quarters prior to April 2022, unbilled receivables were always less than $10 million. In the most recent quarter, the figure has reached $88 million, primarily due to one customer: Baker Hughes (NASDAQ:BKR). Baker accounts for 91% of total unbilled receivables.
“Thus, unbilled receivables from Baker Hughes have increased 5x since being first reported, yet actual revenue is growing at a low single digit rate?” questioned Adrangi.
Alleged Red Flags at C3.ai
Adrangi also questions the accounting tactics used in the arrangement with C3.ai and Baker. The subscription revenue that Baker pays C3.ai is being recognized at an over 99% gross margin, which the short seller alleges is inflated. Adrangi believes that this is done to make it seem as if C3.ai is a software-as-a-service (SaaS) company instead of a services-intensive consulting business. SaaS companies are generally rewarded a higher revenue multiple due to recurring subscription revenue.
Finally, Adrangi states that C3.ai has cycled through four chief financial officers (CFOs) in the past four years, which should be a “clear red flag” for Deloitte.
“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,” concluded Adrangi.
On the date of publication, Eddie Pan did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.