Darktrace adjustments undermine investor confidence

Earlier this year, short seller Quintessential Capital Management accused Darktrace (DARK) of beefing up its revenue by selling products to resellers even when they didn’t have customers lined up.

Darktrace has rebutted the claims, but putting this debate aside the company doesn’t do itself any favours with the size of its adjustments. In the six months to December, adjusted operating profits (Ebit) increased 25.9 per cent to $32.4mn (£27.4mn). However, its reported operating profit fell 92 per cent to just $577,000, after stripping out $27.7mn of share-based payment charges.  

Darktrace says these payments will normalise because the share-based payments promised at IPO have now vested. However, financing this was an expensive business, with cash spent on share buybacks increasing from $13.5mn to $33.9mn. Cash swung from an inflow of $26mn to an outflow of $15mn.

If you ignore the shifting floors of the adjusted figures, then some of Darktrace’s numbers look promising. Annual recurring revenue grew 37 per cent to $557mn. This growth is down from 46 per cent last year, but still impressive.

Darktrace said new customer acquisition did slow in the second half of the year due to the macroeconomic conditions. To offset this, it has been trying to upsell its existing customers and it has reiterated its full-year guidance, although free cash flow will be lower than the January guidance because of taxes owed on IPO share awards. 

Other than this year when share buybacks hit cash flow, Darktrace is usually very cash generative. Management expects annual free cash flow to be between 75 per cent and 105 per cent of adjusted cash profit (Ebitda). Brokers agree, which means it is trading on an affordable FactSet consensus 2024 free cash flow yield of 5 per cent.

If you trust management’s promises, there is cheap growth on offer here. But we would like to see some consistency first. Hold.

Last IC View: Hold, 336p, 08 Sep 2022