C3.ai (AI -26.34%) inventory plunged on Tuesday after it was slammed by short-seller Kerrisdale Capital for the second time in a month.
In a scathing letter to C3.ai auditor Deloitte & Touche, on which the Securities and Alternate Fee (SEC) was copied, Kerrisdale accused the corporate of a number of accounting irregularities, making the case that C3.ai was inflating its income and gross margin with a purpose to seem as if it is a software program subscription firm, although it is actually a consulting services-oriented enterprise.
As Kerrisdale argues, subscription software program companies are inclined to commerce at a lot increased multiples than consulting companies so it is in C3.ai administration’s curiosity to inflate the a number of and the valuation as a result of executives are compensated largely with inventory and choices.
The letter additionally focuses on the corporate’s difficult relationship with strategic associate Baker Hughes and the way it accounts for income from the oil companies firm.
C3.ai inventory fell as a lot as 29% on Tuesday after Kerrisdale launched its letter.
A query about receivables
Kerrisdale’s case facilities across the firm’s abstruse relationship with Baker Hughes and the best way it handles its receivables accounting.
Via the primary three quarters of its fiscal yr, C3.ai’s income has been comparatively flat, even declining in its most up-to-date quarter. Nonetheless, on the similar time, accounts receivable jumped from $80.2 million to $143.7 million, whereas income rose from simply $62.4 million to $66.7 million.
AI Income (Quarterly) knowledge by YCharts
Since accounts receivable represents income that has been recorded however not but collected, it is odd to see receivables rising a lot sooner than income. Usually, you’d anticipate them to develop at the same tempo, barring any change in billing practices or issue in amassing payments.
Moreover, a lot of these receivables had been unbilled. As C3.ai says in its personal 10-Q submitting, it had $79.6 million in unbilled receivables from Baker Hughes as of Jan. 31, up from $16.5 million three quarters earlier.
C3.ai makes no rationalization for the sizable quantity of unbilled receivables, although it does observe that Baker Hughes accounted for 45% of its income in the latest quarter, a uniquely excessive diploma of buyer focus for a publicly traded firm.
Due to the ballooning unbilled receivables from its shut strategic associate, Kerrisdale concludes that “C3.ai is reserving fictional income with a purpose to meet consensus analyst estimates and canopy up the truth that, in actuality, its merchandise are unable to get traction with prospects and its enterprise is failing.” Primarily, Kerrisdale is saying that it is inventing income that it then reviews as an unbilled receivable with a purpose to account for it on the steadiness sheet and money movement assertion.
There is not any clear reply to the query of why the corporate has not invoiced 30% of its reported income over the past 9 months.
A software program or a companies enterprise?
Kerrisdale’s different most important argument is that C3.ai is a consulting enterprise masquerading as a software program enterprise with a purpose to earn the next valuation a number of.
For instance, C3.ai reported $55.9 million of associated celebration subscription income for the primary three quarters of fiscal 2023, however no associated price of income, implying that the subscription software program enterprise related to Baker Hughes has a 100% gross margin.
In accordance with Kerrisdale, the corporate is doing that to persuade the market that it is a software-as-a-service firm somewhat than a services-intensive consulting enterprise. Kerrisdale additionally noticed that analysis and growth bills exceeded gross revenue within the final three quarters, main it to imagine the corporate is recording price of income as analysis and growth bills to assist its monetary numbers appear to be these of a software program enterprise.
What it means for buyers
As a inventory, C3.ai has had a banner yr with shares having tripled at one level this yr and up greater than 100% yr to this point even after Tuesday’s sell-off.
Nonetheless, the efficiency of the enterprise itself stays wanting. Income truly declined within the third quarter, falling 4.4% to $66.7 million and the corporate continues to be extremely unprofitable on a typically acceptable accounting rules (GAAP) foundation with a lack of $63.1 million within the third quarter and a free-cash-flow lack of $202 million by the primary three quarters of the yr.
Kerrisdale is brief the inventory so it has an curiosity within the share worth is falling, however its arguments are credible, and it would not should be proper about every little thing to ensure that C3.ai to be pressured into restating its books, or worse. Buyers ought to anticipate a response from C3.ai quickly.
Contemplating the substitute intelligence inventory nonetheless trades at a lofty price-to-sales valuation of round 12, the inventory may have much more room to fall particularly if Kerrisdale’s claims achieve traction.
Maintain your eye on upcoming information out on the report, together with C3.ai’s rebuttal, as these accusations aren’t simply going to go away on their very own.