|Darktrace responds to short seller allegations on accounting practices UK cyber group rebuts claims that it employed tactics similar to Autonomy in order to inflate sales figures |
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Quintessential Capital Management alleges that Darktrace has deployed similar sales tactics to Autonomy, the UK software company with which Darktrace shares many ties
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Darktrace has rebutted claims from a US hedge fund that alleges the cyber security group appears to have created “fictitious clients” in an attempt to inflate sales figures, defending itself from the short seller’s attack.
The FTSE 250 company announced on Wednesday that it would buy back up to £75mn worth of shares a day after New York-based Quintessential Capital Management published a detailed report on Tuesday alleging irregular accounting practices at Darktrace.
Quintessential’s allegations include: Darktrace appears to have simulated or anticipated sales to “phantom” customers through a “network of willing resellers”; that it seems to have incorrectly booked sales of hardware as software; and may have misrepresented the nature of its revenue.
Poppy Gustafsson, Darktrace chief executive, described Quintessential’s allegations as “unfounded inferences”. “I stand by my team and the business I represent,” she said in a statement on Wednesday, arguing the company has robust accounting and auditing practices.
Darktrace’s share price fell 12 per cent when Quintessential first disclosed its short position on Monday and a further 8 per cent on Tuesday after the hedge fund released its report, though it has gained 3 per cent on Wednesday following the share buy-back announcement.
The short seller alleges that Darktrace has deployed similar sales tactics to Autonomy, the UK software company with which Darktrace shares many ties. Autonomy was accused of irregular accounting practices relating to its $11.7bn sale to Hewlett-Packard in 2011.
Gustafsson, previously Autonomy’s corporate controller, helped set up Darktrace using funds in part from former Autonomy chief Mike Lynch.
Lynch is battling against extradition to the US to face fraud charges after the High Court found in 2022 that he and his finance director defrauded HP by manipulating Autonomy’s accounts to inflate the value of the company. He has denied the accusation.
Sushovan Hussain, the former chief financial officer, is serving a prison term in the US after being found guilty of fraud relating to the sale.
“Neither Darktrace nor any of its acting executives has ever been the target of these litigation proceedings,” Darktrace told the Financial Times.
Among Quintessential’s allegations is that Darktrace appears to have repeatedly asked its resellers to acquire a product before a buyer has fully committed in order to inflate its sales figures — a practice known as channel stuffing.
The hedge fund described the practice of “shifting tomorrow’s revenue into today’s books” as “unlawful and unsustainable”.
The short seller’s most serious allegations relate to episodes where the end user in question dropped out of an anticipated transaction, including cases where Darktrace appeared to have sponsored marketing events in order to repay resellers for sales that never happened.
Darktrace said that it only recognises agreements made by resellers that meet rigorous criteria that it developed ahead of its public listing in 2021. The company added that contracts that do not meet its standards have not been included in its IPO prospectus or annual reports.
Darktrace also said it is typical to co-host marketing events with partners and resellers, and that it has not found any evidence of unusual practices surrounding any of these events.
Quintessential also claims it has found several instances where, at least until 2020, Darktrace appeared to have sold — rather than lent — its hardware to customers while it may have kept the devices on its books as assets, allowing it to potentially inflate its profit margins and earnings.
Inaccurate accounting around hardware sales was also central to the court case brought against Autonomy and its executives. Darktrace countered that in the vast majority of contracts, it loans rather than sells appliances to customers. The company added it holds hardware appliances as assets that depreciate over a five-year period.
Darktrace said in the small number of cases where it sells the appliances to customers, it follows the correct accounting processes, recognising all revenue and costs up front.
Quintessential said Darktrace’s deferred revenue — payments for a software contract in advance of delivering the service — decreased from 33 per cent in 2018 to 9 per cent in 2022. It has suggested that Darktrace may have been “striving to inflate its revenue figures” by “booking unearned revenue as actual sales”.
Darktrace has responded that it is currently rare for customers to pay full contract values in advance of 12 months. The company also argued it has never been contacted by the authors of the Quintessential report for information or comment