Darktrace has disputed claims from a US hedge fund that the cyber security group appears to be creating “fictitious clients” to inflate sales figures, defending itself against short seller attacks.
The FTSE 250 company announced on Wednesday that it would buy back up to £75 million of shares a day after New York-based Quintessential Capital Management published a detailed report on Tuesday alleging irregular accounting practices at Darktrace.
Quintessential allegations include: Darktrace appears to have simulated or anticipated sales to “phantom” customers through “a network of willing resellers”; which seems to have mistakenly booked hardware sales as software; and also has misrepresented the nature of the revenue.
Poppy Gustafsson, chief executive of Darktrace, described Quintessential’s allegations as “baseless inferences”. “I stand by the team and the business it represents,” he said in a statement on Wednesday, arguing that the company has strong accounting and auditing practices.
Darktrace’s share price fell 12 percent when Quintessential first disclosed its short position on Monday and a further 8 percent on Tuesday after the hedge fund released the report, although it had gained 3 percent on Wednesday following the share buyback announcement.
The short seller claims that Darktrace has adopted similar sales tactics to Autonomy, a British software company with which Darktrace has many ties. Autonomy has been accused of irregular accounting practices in connection with its $11.7bn sale to Hewlett-Packard in 2011.
Gustafsson, who was previously Autonomy’s corporate controller, helped set up Darktrace using funds from former Autonomy chief Mike Lynch.
Lynch is fighting extradition to the US to face fraud charges after the High Court found in 2022 that he and his finance director defrauded HP by falsifying Autonomy’s accounts to increase the company’s value. He has denied the allegations.
Sushovan Hussain, the former chief financial officer, was jailed in the US after being convicted of fraud in connection with the sale.
“None of Darktrace or its acting executives have ever been the target of these court proceedings,” Darktrace told the Financial Times.
Among Quintessential’s allegations is that Darktrace appears to have repeatedly asked retailers to acquire products before buyers were fully committed in order to boost sales figures – a practice known as channel stuffing.
The hedge fund described the practice of “turning tomorrow’s earnings into today’s books” as “illegitimate and unsustainable”.
The most serious allegations of the short seller relate to episodes where the end user in question walked out of anticipated transactions, including a case where Darktrace appears to have sponsored a marketing event in order to recover a sale that never happened.
Darktrace said it only recognizes agreements made by retailers that meet strict criteria developed ahead of a public listing in 2021. The company added that contracts that do not meet these standards have not been included in the IPO prospectus or annual report.
Darktrace also said that it is typical to co-host marketing events with partners and retailers, and it has not found evidence of any unusual practices surrounding any of these events.
Quintessential also claims to have found some cases where, at least until 2020, Darktrace appears to have sold – rather than loaned – hardware to customers, but may have kept the device on its books as an asset, thus increasing its profit margins. and earnings.
Inaccurate accounting of hardware sales is also central to the court case brought against Autonomy and its executives.
Darktrace argued that in the majority of its contracts, it was lending rather than selling equipment to customers. The company adds hardware devices as depreciable assets over a five-year period. Darktrace said in the case of cases where it sells appliances to customers, following the correct accounting process, recognizing all revenue and costs in front.
Quintessential said that Darktrace’s deferred revenue – payments for software contracts before delivering the service – fell from 33 percent in 2018 to 9 percent in 2022. It has suggested that Darktrace may “seek to inflate revenue figures” by “booking unearned revenue as sales real”.
Darktrace has responded that it is now rare for customers to pay the full contract value before 12 months. The company also said it had never been contacted by the author of the Quintessential report for information or comment.