Darktrace lowers Ebitda forecasts after commission change

Darktrace (DARK) has made changes to how it accounts for its sales commissions, a move that will hit adjusted Ebitda in the short term. The cyber security company looks to be trying to win back market confidence, but the immediate result will take some assessment by investors.

Darktrace’s new plan is to pay its salespeople 100 per cent of their commission upfront rather than half at the beginning of the contract and half a year later. It is also now capitalising 100 per cent of these commissions, whereas before these were allocated 50/50 between costs and capitalisation. Spreading the amortisation out would have improved adjusted profit, but Darktrace has decided to include the cost all at once upfront.

The end result is the 2024 adjusted Ebitda (cash profit) forecast has been lowered from 22 per cent growth to between 17 per cent and 19 per cent. Also, because it has to pay out all its sales teams upfront, next year free cash flow is expected to fall to 60 per cent of adjusted cash profit. But it will return to 100 per cent in the following years.

As usual with Darktrace, once you ignore the wave of adjustments the top line growth looks impressive. Over the year, annual recurring revenue (ARR) rose 29.6 per cent to $628m (£494mn). This growth was a drop from 42.3 per cent the year before, but management has guided for ARR growth to stay above 20 per cent next year as well. This is impressive compared with some peers: cyber business NCC (NCC) only expects single-digit growth because of “lengthening of the sales cycles”.

Despite the increase in revenue, free cash flow did slip 6 per cent to $93.8mn, meaning cash conversion fell just below its target range of 75 per cent to 105 per cent. In part this was because of an increase in working capital, which Darktrace put down to timings. In the medium term, it expects cash flow to rise to nearer 100 per cent, but admits there could be some variability.

It looks like the aim of these more conservative accounting adjustments is to win back confidence after short-seller accusations of channel stuffing earlier this year. Accountant E&Y has since come in and given Darktrace a clean bill of health, but the company may still need to win back some investors.  

It will take a while for the market to digest these changes. Investors don’t like change because they want a clear picture of how a company is performing. But with 20 per cent top-line growth and a free cash flow yield of 4 per cent, the shares look attractive. Darktrace would be worth a pop for some, but we need to see more consistency on the accounting front before we get back on board. Stick to hold.

Last IC View: Hold, 270p, 8 Mar 2023