Nutanix: Employees Fired For ‘Intentional Misconduct’ In Software Misuse Probe
“We identified a material weakness in our internal control over financial reporting and are working on remedial measures to address the identified weakness and help prevent that from happening again,” said Nutanix CEO Rajiv Ramaswami.
An undisclosed number of Nutanix employees were fired after an internal investigation found that they engaged in “intentional misconduct” to conceal the unauthorized use of an estimated $11 million in third-party software, according to the company.
“We identified a material weakness in our internal control over financial reporting and are working on remedial measures to address the identified weakness and help prevent that from happening again,” Nutanix CEO Rajiv Ramaswami told analysts during an earnings call Wednesday. “We have also held the responsible employees accountable. This matter had no material impact on our historical financials, and we believe it will have minimal impact going forward.”
The Audit Committee of Nutanix’s board of director conducted an investigation—which launched sometime after October 2022— and found that since 2014 the company had not accurately reported expenses for software licenses and support.
“The Audit Committee found that individual departments within our company procured software licenses without appropriate coordination with other departments and without ensuring that such licenses were sufficient for or consistent with the intended uses of the software, and as a result, evaluation software from two of our third-party providers was used in a non-compliant manner for interoperability testing, validation, customer proofs of concept, training and customer support over a multi-year period,” the company said in a 10-Q filing with the Securities and Exchange Commission.
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The Audit Committee said it has “evaluated the materiality of this error and determined that the impact is not material” to previously issued financial statements. As a result, the company has “prospectively corrected” financial statements for the affected periods to reflect the “correction of this error.”
As a result of the investigation, Nutanix said it is recording “cumulative estimated expenses” of $11 million as of its second fiscal quarter which represents the estimated amount of future payment for the “non-compliant” use of the software from two unnamed-third party software providers.
Nutanix management discovered the software misuse as part of a software purchase review, said Ramaswami. Both brands of software are still in use by the company for “non production use cases,” he said.
‘Commercial Resolution’ Sought Between Vendors
Nutanix CFO Rukmini Sivaraman said the company is “in contact” with both vendors and is working towards a “commercial resolution” of the unauthorized use of software.
The internal investigation by the Nutanix Audit Committee concluded that “certain employees engaged in intentional misconduct to conceal use of evaluation software with respect to one of our third-party providers” in violation of the company’s code of business conduct, ethics and other policies, Sivaraman said.
“We have terminated employment for certain employees who were found to be primarily responsible for the intentional misconduct,” she said.
Nutanix said in a 10-Q filing that no current member of company leadership or any part of its “finance, legal, or accounting departments” were involved in the misuse of software.
“The Audit Committee has completed its investigation, which found no evidence of wrongdoing by current senior management or by any members of the finance, legal, or accounting departments,” Nutanix said in the filing, noting that outside council and other advisors assisted the committee in its investigation.
In the 10-Q filing, the Audit Committee said it “terminated certain employees who were found to be primarily responsible for the intentional misconduct.” What’s more, the Audit Committee said, it “identified actions of certain other employees that were inconsistent with our code of business conduct and ethics and other policies and referred these matters to management for appropriate action.”
First Disclosed In March
The unauthorized use of third-party software was first disclosed by the company in March when Ramaswami told investors that Nutanix had uncovered software licensing misuse that would prevent it from filing its full financial report on time as mandated by the NASDAQ Exchange.
The company said the software misuse resulted in an “immaterial understatement” of operating expenses, accrued expenses and other current liabilities for prior periods beginning in August 2014.
In the wake of the Audit Committee report, Nutanix said it has “corrected the prior period financials presented in the Form 10-Q for its second quarter of fiscal 2023,” which was filed on Wednesday.
Nutanix said its expects the “incremental ongoing annual impact to operating expenses” of the third-party software usage to be “approximately in the low-single-digit millions of dollars.”
Further, Nutanix said it expects to implement “remedial measures, including remedial measures to address the material weakness and strengthen its overall internal control over financial reporting.”
In the 10-Q, the Audit Committee said the Board of Directors has directed management to “(1)enhance policies and procedures to reinforce ethical conduct across our company, (2) improve training regarding appropriate third-party software procurement and usage practices, (3) enhance processes to identify, document and track third-party software license procurement, usage, and compliance, and (4) enhance risk assessment processes with respect to financial reporting related to software licensing acquisition and usage.”
We have determined to prospectively correct our previously issued financial statements to reflect the correction of this error rather than record a cumulative out-of-period adjustment for this error in the current period.
More Pentalties Could Be Upcoming
Nutanix has warned that it could still face “significant penalties,” possible injunctions, a cease-and-desist order and “other equitable remedies,” from the U.S. Securities and Exchange Commission or other regulators over its failure to file financial forms on time, and for years of misreporting its financials.
“To date, we have incurred significant expenses related to legal, accounting, and other professional services associated with the Audit Committee’s investigation and related matters and may continue to incur significant additional expenses with regard to these matters and related remediation efforts,” the company wrote. “If the SEC were to commence an investigation, we could incur significant additional time and expense, including expenses related to accounting, legal and other professional services, in connection with the investigation, the outcome of which would be difficult to predict.”
Ramaswami, for his part, said the company is “pleased” the internal investigation is completed.
Nutanix Posts Better Than Expected Earnings
The end of the Audit Committee investigation came with Nutanix reporting better than expected results for its third fiscal quarter, ended April 30, sending shares up 16 percent to $29.37 in trading on Thursday.
For the quarter, Nutanix reported non-GAAP third quarter earnings of four cents per share, up from the Zacks consensus estimate of two cents per share.
Nutanix reported sales for the quarter up 11 percent from the year ago period to $448.6 million compared with the Zacks consensus estimate of $431.6 million.
Nutanix annual contract value billings were up 17 percent to $239.8 million compared with $204.7 million in the year ago quarter.
“Against an uncertain macro backdrop, we delivered a solid third quarter with results that came in ahead of our guidance and saw continued strong performance in our renewals business,” said Ramaswami.
Even as businesses prioritized digital transformation and data center modernization, there was “some increased inspection of deals by customers” related to the uncertain macro-economic environment, which is driving a “modest elongation” in sales cycles, said Ramaswami.
“While the macro environment remains uncertain, we are encouraged that the compelling value proposition of our cloud platform and the strength of our business model, which enables us to raise our fiscal year topline outlook and bottom line outlook,” said Ramaswami. “We remain focused on delivering innovation for our customers now and in the future, while continuing to drive sustainable, profitable growth.”