The former management of Autonomy announces today they will file claims against HP for loss and damage caused by false and negligent statements made against them by HP on 20 November 2012 and in HP’s subsequent smear campaign. Former Autonomy CEO Mike Lynch’s claim, which is likely to be in excess of £100 million, will be filed in the UK.
We welcome the SFO’s decision to close its investigation. As we have always said, HP’s allegations are false, and we are pleased that after a two-year review of the material presented by HP, the SFO has concluded that there is not a case to pursue.
Let’s remember, HP made allegations of a $5 billion dollar fraud, and presented the case in public as a slam dunk. HP now faces serious questions of its own about its conduct in this case and the false statements it has made.
When Meg Whitman wrote off nearly $9 billion of the value of HP in November 2012, she alleged that more than $5 billion of that write down was a result of fraud at Autonomy before it was acquired by HP. We have now seen conclusive proof that this allegation is false.
The Financial Times has published excerpts from an internal HP document, known as a “rebasing exercise”, that details how the $5 billion Autonomy write down was calculated; the FT states that this document has been verified by HP. The document shows the write down was due to HP’s changes in accounting policy and it’s own business decisions, not fraud.
“In response to the findings of the Rebasing Exercise, PWC’s investigation, and Autonomy’s performance, HP created a new three year budget in order to develop a revised operational plan for the Autonomy business unit to execute. The Company also created a ten year forecast for Autonomy that would project cash flows in order to inform HP’s goodwill impairment analysis.” (DRC report page 45, filed in July 2014)
In simple terms, HP’s own paperwork shows that all Autonomy deals were recorded and accounted for. There are contracts and revenue entries. There is no missing money. The only differences are over interpretation of accounting standards.
We have been asking to see these documents for over two years since the original allegations were made, but HP has always withheld them. Now we have seen the original material, we believe that HP’s own calculations show that HP has made false and misleading public statements to the market about how and why it wrote down Autonomy and what really happened. We will be passing a copy of this document and other information to the relevant regulatory authorities for their review.
Meg Whitman must now withdraw her allegations against the former management team of Autonomy. If she has any decency she will then make a formal apology and resign.
HP’s Rebasing Exercise
The rebasing calculations were undertaken by HP to bring the accounts of Autonomy, reported under IFRS (International Financial Reporting Standards, the system commonly used in the UK), into line with the US GAAP system (the Generally Accepted Accounting Principles used in the United States), after it was acquired.
The FT reports that, through this rebasing exercise, HP concluded that under a US accounting jurisdiction certain revenues could be reported in different periods. HP subsequently removed this revenue from Autonomy’s 2010 and 2011 accounts, and simply moved it to be recognized in later periods. In the document, HP stipulates that these decisions were taken on the basis of management judgement and interpretation of IFRS standards. Audit evidence shows that the revenue HP removed was from legitimate contracts with large multinational customers that had been fully audited and approved. However, in November 2012 HP alleged to the market that this revenue did not exist or had been misrepresented.
This is a summary of the document that the FT has reported and which shows HP’s decision-making process for removing bona fide revenue from Autonomy’s accounts – and none of it was fraud. It also shows no money was missing. The run rate revenue was at the time around a billion dollars.
When you look at these adjustments, the two biggest categories are hardware and hosted deals. If we consider each of these in turn, firstly hardware.
It is hard to know on what accounting basis one does not count this as revenue: it was sold and fully paid for by customers and there is nothing wrong in selling hardware. In fact, HP has now confirmed was well aware of Autonomy’s hardware sales long before the “whistleblower” came forward.
HP misrepresented its own knowledge regarding Autonomy’s hardware sales to the market. Over time its position has evolved from the original statements in November 2012 when HP claimed it did not know about the mischaracterization of revenue from “negative-margin, low-end hardware sales” until a “whistleblower” came forward in June 2012 all the way to today’s stance where, in court filings in September HP stated that, although it knew Autonomy sold hardware prior to the acquisition, Autonomy management had indicated that such sales were “either ‘appliance sales’ or ‘strategic sales’ designed to further purchases of Autonomy software”.
The next largest category of adjustments are hosted deals. They have taken out all of these deals, including from companies such as BP, JPMorgan Chase, Deutsche Bank, and so on. These are noted in the adjustment column as being “US management judgement” ie they are not being removed for fraud, but for different accounting policies.
HP made these aggressive revenue adjustments even though HP was aware, prior to the acquisition, that Autonomy sold hybrid hosted deals and understood the associated accounting.
- The accounting of these deals was covered in Autonomy’s annual report, audit packs, analyst calls and reports.
- KPMG HP’s due diligence advisor in August 2011 asked many questions on accounting for hosted deals showing it understood the approach.
- HP reviewed numerous Autonomy contracts for hybrid hosted sales, which articulate the actual products sold, in advance of the acquisition;
- Internal HP emails, many of which involve the highest levels of HP management, evidence HP’s own knowledge and acceptance of Autonomy’s accounting policy for such deals
- Documents make clear that when HP abandoned this exercise in 2012, it did on account of its own internal accounting policy and strategic objectives
The document shows that, for example, revenue from Autonomy’s hosted business was removed due to “management judgment / US Gaap difference”, not fraud.
Critically, the rebasing exercise in question was completed a month after HP made its allegations about Autonomy, which appears to suggest that the allegations were made before the facts had actually been investigated.
Moreover, HP was aware of the transactions addressed in the document before completing the acquisition of Autonomy, and did not raise any concerns. The column headings in the document purely address whether or not valid transactions were reported under IFRS, or could be open to interpretation. Where HP considered there was a possibility to classify revenue differently, they did so. This shows that HP arbitrarily adjusted whole categories of deals it already knew about and did not question before it made the acquisition.
HP’s shareholders deserve an honest explanation and an end to this charade.
Three years on, after accusations of multi-billion dollar fraud, is this it? HP produces some out of context information, twisted to support false assumptions which is easily explained. There is no fraud.
• Under IFRS, MicroTech was Autonomy’s customer. This was a fully-completed sale for which we received most of the money. The remainder was written off by HP, not Autonomy
• HP reviewed the actual paperwork on this deal pre-acquisition as part of due diligence
• In the industry, where resellers are involved in transaction chains they may often not meet the final end user. It is irrelevant
• We have published information that shows that hardware was clearly recorded as hardware, not software, in the books of the company
• Since making its original allegations in November 2012, HP has revised its statements regarding hardware several times, from claiming total ignorance that Autonomy sold any hardware, then saying that they “eventually” knew about hardware sales, to saying that they had been told in due diligence those sales were “strategic accounts” and “appliance sales”. There is clear back-tracking in their statements
• The “strategic accounts” that we sold hardware to included Bloomberg, Citibank, Bank of America, Morgan Stanley, JPMorgan Chase, all long-standing strategic customers
• The definition of OEM, which was in Autonomy’s annual report, makes it clear that not all OEMs are royalty deals
• Did HP read the annual report?
• Autonomy’s hosting contracts were completely properly structured, reviewed by Deloitte and by HP before the acquisition
• Autonomy complied with Deloitte’s recommendations and Autonomy’s accounting and disclosures were ticked off by Deloitte
• HP is looking at the recommendation documents without checking what was then done and agreed in the light of those recommendations
• If all of the write down was the standalone vale of Autonomy, then HP is alleging that Autonomy’s value before they acquired the company was zero, which is obviously absurd
In November 2012, HP accused the former management of Autonomy of accounting misrepresentations and wrote off $8.8 billion of the value of its acquisition of the company. Since then, HP has consistently avoided providing any specific details in support of its allegations. On Friday, 5th September 2014, HP filed paperwork to a US court that sheds a lot of light on what went on.
The document submitted by HP’s lawyers, is the Independent Committee’s Resolution Regarding Shareholder Derivative Claims and Demands, commissioned by Meg Whitman and the Board of HP. The filing of this report went unnoticed as HP buried it in a mass of documents supplemental to their original filing, which they used to divert press attention with an out-of-context email.
This report, together with some accompanying evidence released today by the former management of Autonomy, reveals the truth about the circumstances of the purchase. It also provides evidence that HP claims that it was unaware that Autonomy derived part of its revenue from the sale of hardware are no longer supportable.
We can also prove today that HP included those hardware sales in its own valuation of Autonomy.
In addition, the document reveals that:
- HP’s aggressive assumptions led it to believe it could find some $7.4 billion in synergies
- KPMG found no “material issues” with Autonomy’s accounting
- HP had Autonomy on its acquisition target list from 2006
- HP conducted a speedy but thorough due diligence process because they were afraid of competitive bids
- The HP “whistleblower” was not knowledgeable about how Autonomy did its accounting in the UK, or the IFRS accounting rules Autonomy reported under
- HP’s CFO and General Counsel opposed the acquisition of Autonomy
The Real Reason for the Write-Down
The new information received makes clear the real reason for the write down was because of the unprecedented level of synergies assumed in the deal by HP.
The report filed on 5 September 2014, reveals for the first time that HP built into its valuation of Autonomy “$7.4 billion in revenue synergies” (p33). At the time of the purchase, Autonomy had a stand-alone market value of approximately $6 billion.
The filing goes on to reveal that $5.3 billion of the “originally projected synergies” (p45) of $7.4 billion, was written off. This accounts for the majority of the write down. A further $3.6 billion write down was described by HP as being “linked to the recent trading value of HP stock and headwinds against anticipated synergies and marketplace performance” (20 November 2012 HP press release). Nothing, therefore, to do with Autonomy. The write down is quantified at $8.9 billion purely from synergy loss and and a decline in stock value. This is a reversal of the original statements in November 2012 that the “majority” of the write down (more than $5 billion) was due to “accounting misrepresentations”. The total write down on the day was $8.8 billion of the purchase price of $11 billion.
Not surprisingly, the new information also reveals that “E&Y could not “audit” quantification of Autonomy’s accounting errors” (p47).
The filing informs us that CFO Cathy Lesjak foretold this when she opposed the deal “HP’s history of not executing on its major acquisitions” (p34).
Autonomy’s management cannot be held responsible for HP’s excessive forecasting of synergies. The write off is due to HP’s own recklessness and not due to any accounting improprieties.
The synergies were predicated on taking sales people from HP to expand the Autonomy salesforce, taking services people from HP to increase Autonomy services, and closer integration between Autonomy products and the hardware divisions. The new information shines further light on the sources of the synergies: “HP’s footprint could be leveraged from a sales, customer, geographical and technology perspective to maximize revenue synergies” (p37).
CFO Opposed Acquisition of Autonomy
The report reveals CFO Cathy Lesjak’s opposition to the acquisition:
“The Board’s non-management directors met on August 17, 2011, principally to consider in executive session the opposition/concerns expressed at the August 16 meeting by HP’s CFO Lesjak that, while the strategic vision underlying the Autonomy acquisition should be respected and embraced, she opposed the acquisition of Autonomy at that time because (i) the size of the premium would concern shareholders, (ii) HP’s bankers had underestimated the impact of the acquisition on HP’s stock price, as well as the likely negative shareholder sentiment and that (iii) HP’s history of not executing on its major acquisitions did not counsel proceeding with the acquisition at that time. The General Counsel agreed.” (p.34)
In its original allegations of November 20, 2012, Hewlett-Packard expressed surprise that Autonomy sold hardware, accused the company of accounting for it wrongfully and of deceiving its auditors on this matter. HP claimed this amounted to much of the $150-200 million of sales over two years it claimed was “mischaracterized” by Autonomy. Once HP started down this path even as information has come to light showing it was wrong, and HP itself had knowledge that it was wrong, but it has been forced to continue.
When HP accused the former management of Autonomy of accounting irregularities, it blamed the majority of these on “hardware booked as software”, and claimed that it was unaware that Autonomy was anything other than a software-only company until a “whistleblower” came forward to point it out.
However, what this report now proves categorically, is that HP knew about Autonomy’s hardware sales well over a year before they made their public accusation.
In public class action filings, HP have admitted that senior HP accounting staff, KPMG and E&Y reviewed a number of documents in November 2011 without recorded surprise or alarm. The new information reveals the following:
- “E&Y’s November 2 – 4 2011 review of Deloitte work papers ….identified Autonomy’s hardware revenue, which E&Y reported to HP” (p40)
- “In the course of E&Y’s exposure to Deloitte’s work papers for the purpose of establishing an opening balance sheet…E&Y noted that Autonomy sold material quantities of hardware. E&Y reported its observation to HP management”. (p57)
- “KPMG’s post-Acquisition identification of $41 million in pre-Acquisition “Pass – through” hardware sales was appropriately conveyed by both KPMG and HP management to Autonomy management for explanation……Autonomy’s management ultimately responded that Autonomy procured hardware as well as software for certain strategic accounts” (p39)
- ”In its post-closing balance sheet review, KPMG found evidence of hardware sales and made inquiries about them” (p56)
Documents show that senior officers of Hewlett-Packard were, in fact, well aware of Autonomy’s hardware sales, and the accounting of these, from day one almost a year before the announcement of its write down of Autonomy. These statements, and others made on that day, are untrue, as is shown by the documents posted below.
To recap, on 20th November 2012, senior management of Hewlett-Packard made a series of allegations that these documents show to be misleading. John Schultz, HP General Counsel, said Autonomy, “resold desktop computers … and recorded those sales so they appeared to be software revenue,” that there was “active concealment” and that there wasn’t “a set of well-maintained books … critical documents were missing from the obvious places”.
Meg Whitman said that HP, “relied on audited financials, audited by Deloitte, not brand X accounting firm, but Deloitte and, by the way, during our very extensive due diligence process, we hired KPMG to audit Deloitte, and neither of them saw what we now see after someone came forward to point us in the right direction.” Speaking to reporters that same day, CFO Cathy Lesjak said the “hardware sales were frequently reported as licenses.” These allegations were repeated in last Friday’s filing.
In fact, Autonomy was fully open and transparent with its auditors, and all financial documents, including audit committee reports were kept at the company’s headquarters in Cambridge. The most important financial documents in the Company are the quarterly financial audit review packs. HP and its advisors had access to these from day one.
Hardware in Audit Packs
The first three documents are examples from Deloitte’s quarterly presentations to Autonomy’s audit committee – the very same working papers that were reviewed by E&Y and HP – from when Autonomy was listed on the London Stock Exchange (of 10 such quarterly presentations that took place during the period in question by Hewlett-Packard’s allegations). In these, Deloitte discussed Autonomy’s hardware sales, how they were accounted for (including accounting for some of the discount as a marketing expense), and discussed the disclosure of this information to the market. The documents show that the auditors were completely aware of the hardware sales, which were in no way concealed or booked as software and were referred to as “hardware”. These audit packs were the most concise summary of each quarter’s accounting and were available to Hewlett Packard from the day they acquired the company (being a whole year before the announcement of the write-down).
Deloitte’s report to the Autonomy Audit Committee Q1 2011 clearly showing hardware sales as hardware, their amount, the fact that they are taken at a loss and the associated accounting
Deloitte’s report to the Autonomy Audit Committee Q2 2011 clearly showing hardware sales as hardware, their amount, the fact that they are taken at a loss and the associated accounting
Hardware booked as software?
On November 20th 2012, John Schultz made the statement that Autonomy had “booked hardware as software revenue.” While this is clearly not the case from the Deloitte audit committee reports, it is also not true when one looks at the ‘Trial Balance’ (TB) or formal ledgers of the company recording all items bought and sold. In the excerpts from the Trial Balances below, you can see the entry line 470000 “hardware revenue” and the corresponding revenue. Line 570000 shows the cost of goods of hardware. Thus, it is clear that hardware is being booked as hardware, and not software and it shows the amounts involved.
Ledger entry October 31, 2011 showing hardware bought and sold including cost of goods
Emails show senior HP accounting staff using this Trial Balance for many operations from November 2011 onwards. It was obvious to these staff members that Autonomy sold these amounts of hardware. Furthermore, these trial balances are also shown in a number of emails being used by KPMG taking on accounting work on behalf of HP.
Autonomy’s hardware sales were also well known amongst the leadership team of HP. Dave Donatelli, at the time head of ESSN (Enterprise Software and Server Networking) and a member of the Executive Committee, was well aware of the resale of EMC and Dell hardware well before any whistleblower came forward and 10 months before the write down in November 2012.
Email from Autonomy employee to HP employee showing Dave Donatelli, head of ESSN, had awareness of Autonomy hardware transactions.
It was also clearly known that Autonomy sometimes sold hardware to its customers at a loss for strategic reasons. Chris Yelland, who reported directly to Cathy Lesjak HP’s CFO, was one of the most senior accountants in HP’s software division. He sent an email on March 22, 2012 discussing payment to Dell for hardware explained as “hardware orders that we source from them and sell to our customers at a loss of 10%.”
Email exchange dated March 2012 among HP employees showing they discussed Autonomy hardware transactions. Chris Yelland was a senior HP finance employee who was transferred to Autonomy in April 2012.
On 3rd May 2012, there is another email exchange between Mr Yelland and an employee that also makes explicit reference to hardware.
Email dated early May 2012 showing a senior HP accountant knew about, and was happy with, Autonomy hardware transactions.
Similarly, an email dated January 6, 2012 from Meeta Sunderwala, a senior member of HP’s mergers and acquisitions accounting team, explicitly discusses Dell payables and explains that for many strategic accounts Autonomy procured hardware as well as software. There are many more such emails showing that senior HP staff were well aware of Autonomy’s hardware business, how it was accounted and booked long before the alleged whistleblower came forward.
Email dated January 2012 showing a senior HP accountant was fully aware of Autonomy’s hardware transactions.
In short, the above are just three examples from the many hundreds of documents showing that many senior HP staff and HP’s advisors knew that the statement made by John Schultz on 20th November 2012 expressing surprise at Autonomy’s hardware sales, at the fact that some of them were made at a loss, were untrue. They also show that these were not hidden from Autonomy’s auditors and it is also untrue to say that they were booked as software. These documents show that HP lied about its knowledge of hardware sales and the associated accounting. It was well aware of the facts at some of the most senior levels of the company well before the “whistleblower” on May 25, 2012.
Autonomy valuation by HP included hardware
HP has said that one of the reasons for the write down in the value of the company was that it did not realize that hardware was being sold. The report filed on 5th September, however, shows clearly that it was well aware of hardware sales and it also shows that the valuation of the company included hardware.
- “In the course of E&Y’s exposure to Deloitte’s work papers for the purpose of establishing an opening balance sheet…E&Y noted that Autonomy sold material quantities of hardware. E&Y reported its observation to HP management”. (p57)
- “The Autonomy purchase price allocation was prepared by Duff & Phelps. E&Y then audited that allocation were disclosed in HP’s FY 2011 Report on Form 10K” (p57). The 10K was signed by HP directors on December 14 2011.
What this shows is that the value of the company at $11 billion fully included hardware sales therefore it is clear that six months later these same hardware sales cannot be used to justify a change in the valuation.
Economic Partners (EP) was a firm that HP employed to conduct a tax valuation of Autonomy. It included the hardware, and came out at $11.19 billion. This valuation was used for various statutory purposes, and was reviewed by HP and E&Y.
This email exchange from February 2012 shows that Economic Partners’ third-party valuation of Autonomy, which included the hardware, was used by HP with tax authorities.
This filing on September 5th also shows that HP’s basis for its valuation was built on discounted cashflow: “On September 13, 2011, Apotheker stated: “we have a pretty rigorous process inside HP that we follow for all of our acquisitions, which is a DCF-based model, and we try to take a very conservative view at this… we have and are running an extremely tight and very professional due diligence process…Autonomy is a publicly-traded company in the UK and they are, therefore, audited like any other FTSE company, and they’re being audited on very professional standards.” (p36).
From HP’s re-filed Autonomy accounts for 2010 we see that they are in agreement that there has been no change in Autonomy’s historic cash flows as a result of the allegations. The new information shows the that number which has been changed is HP’s estimate of future prospects for the company, not its past accounting. The change in future prospects is dominated by the inability to deliver the synergies and the loss of most of the significant talent in the business due to the mismanagement.
Anatomy of the Deal
This report shows that HP had been considering an acquisition of Autonomy as early as 2006 (p29) and had considered it a “[target] to be aggressively pursued” (p29).
That they had not done so until 2011 was largely due to Autonomy’s value. It was Leo Apotheker who considered the acquisition of Autonomy to be “transformational opportunity” (p29), a “game-changer” that would be “financially accretive” for the company. HP’s bankers also recommended the acquisition on the basis that Autonomy was “a crucial offensive move toward [HP’s] strategic vision and that [HP] should pursue the acquisition expeditiously” (p30).
This belies HP’s suggestion that Autonomy’s management was desperate to offload the company.
Autonomy was not driving the sale to HP
In its September 5th filing, HP presented one email, dated 10 December 2010, out of 17.5 million emails without giving its context to imply that Autonomy was “in a financial plane crash” and thus a radical solution was to sell the business to HP.
This is completely misleading as the emails around this date show, and which HP did not disclose. Autonomy, far from being in a financial meltdown was ahead of targets and, just two weeks later, delivered record results with operating profits of $376 million. The use of this email, out of context, by HP was dishonest in the extreme. Autonomy was not in financial free-fall, nor did it consider selling the company a necessity. Qatalyst Partners, the bank that handled the sales process, was not engaged by Autonomy until June 2011. The email below, just four days later from HP’s twisted version of events, shows that Autonomy’s forecast was on track to exceed analyst expectations for the quarter.
This email shows that Autonomy was forecasting revenue of $252 million on 14 December 2010, which was in excess of analyst expectations for Q4 2010, which were set at $241 million.
Fear of Competitive Bids
In July 2011, HP’s board granted its approval for the HP’s management to proceed with its due diligence process, which new information shows followed standard market procedures. The data, according to KPMG, “were comparable to those available in other acquisitions involving large UK public companies” (P56) and “UK due diligence experts confirmed “access to due diligence materials reflected standard UK market practices for acquisitions of FTSE 100 Companies” (P56). HP’s bankers had warned of “interloper interest” (p31), which were identified as “including IBM, Oracle, Google, EMC and SAP” (p31).
On 17 August, KPMG and HP held a “one-hour” call with Deloitte in which Autonomy’s auditor responded to a series of questions about “revenue recognition, instances of fraud, control weaknesses, significant issues communicated to Autonomy’s board, disagreements with management and unadjusted audit differences” (p32). This was the only conversation that took place with Deloitte in the due diligence process. KPMG considered there were “no material issues” as a result of this conversation, although they failed to update a draft report to the board that had been prepared on August 9. Just 24 hours after that call with Deloitte, HP publicly announced their intent to acquire Autonomy.
Despite their thorough due diligence, when HP’s shareholders reacted negatively to the announcements HP made in its Q3 earnings, “HP asked certain of its advisors whether HP could back out of the deal” (p10 HP amended answer 5 June 2014 court filing).
Shortly after the acquisition, and in panic mode, HP fired Leo Apotheker and Shane Robison, architects of the deal. With nobody left to sponsor the integration, is it any wonder, then that Cathy Lesjak’s warning that HP “acquisitions did not meet performance expectations” were close to coming true?
The identity of the “whistleblower”
The document reveals that the “whistleblower” who met with HP’s management almost a year later, on 25th May 2012, was “a legacy Autonomy US official” (p2). All of Autonomy’s accounting books and accounting policies operated centrally in the UK office. We do not believe that Autonomy US had any qualified accountants employed at the time and certainly nobody with knowledge of IFRS.
Furthermore, we note from the document that the informant was commenting from a US GAAP perspective: “transaction involving Value Added Resellers that could pose questions under US Generally Accepted Accounting Principles” (p2). Autonomy reported under a different set of rules: International Financial Reporting Standards.
HP has consistently stated that Autonomy management sold hardware that HP did not know about and booked it as software. And that this was so well hidden that it was not known until the whistle blower came forward.
The above documents do not reflect these statements. Not only was the hardware clearly disclosed to the auditors, but the audit packs and related trial balance ledgers showing hardware were used by a large number of KPMG, HP E&Y accounting staff from day one without comment.
The new revelations also show the primary reason for the write down was HP’s inability to deliver on recklessly optimistic synergies and its inability to deliver those, not accounting issues at Autonomy.
By using partial leaks, HP continues to try to duck these issues and avoid the errors of its mismanagement and the errors of its 20th November statement coming to light.
 Leo Apotheker at the Deutsche Bank Technology Conference on 13th September 2011: “Autonomy will be, on day one, accretive to HP. For FY 2012, Autonomy, once we integrate it, is accretive to HP…… Now, we have identified five synergy possibilities– five synergy leverages on how we can build up the Autonomy business and how we can synergize it between HP and Autonomy.”
2] Bloomberg: “HP’s Accounting Claims are Seen as Cover for Bad Deals” 21 November 2012
 Bloomberg: “HP Plunges on $8.8 Billion Charge From Autonomy Write down” 20 November 2012
 Reuters: “HP alleges Autonomy wrongdoing, takes $8.8 billion charge” 20 November 2012
 Hewlett-Packard Q4 2012 Earnings Call
 AllThingsD: “What Exactly Happened at Autonomy” 20 November 2012
HP memorandum in support of the settlement and in opposition to the motions to intervene and sever, filed in California September 5, 2014 p.ii & p.12
HP today published an email from former Autonomy CFO Sushovan Hussain to former CEO Mike Lynch, from 10 December 2010, which it claims is evidence of a “CFO in panic” about the performance of the business. It contends this situation caused Mr Lynch to decide to sell the whole company to HP.
This email is taken wildly out of context, reflecting the CFO’s frustrations about the forecasting by parts of the sales force, and how that tracked against internal forecasts. HP has purposefully not shown other emails in the series, showing that Autonomy was on track to meet its expected revenues for the quarter, and indeed did so.
Analyst expectations for Q4 2010 were for revenue of $241 million. The following email shows that the forecast for Q4 on 13 December, despite the concerns in the U.S. identified on 10 December, was still $252 million:
The final result for the quarter came in at $244.5 million, reflecting the fact that some of the revenue had not come in as indicated in the mail of 10 December, but still ahead of market expectations. Below is a copy of the final financial statement that was released to the market:
HP is taking an isolated incident to try to paint a picture of a company that was in some way in trouble. The email it has posted actually shows that Autonomy was trying hard to beat market expectations by a significant distance, and the frustrated overreaction of a stressed executive to the management of its internal sales forecasts. It has overlooked the fact that Autonomy delivered on market expectations, and the revenue was converted into cash.
Further, HP is suggesting that this situation led Mike Lynch to take the “radical action” of selling the whole company to HP. This is insanity. Not least because HP had already approached Autonomy about buying it!
This approach by HP is shameful and purposefully misleading. The full facts show that everything was handled properly, nothing was hidden and Autonomy was a strong business performing well. It is HP’s allegation of a “multi billion dollar fraud” that is imaginary.
Responding to a court filing made by HP today, a spokesperson for the former Autonomy management team said:
“What we see here is one email taken out of context. The emails around it, which HP has decided not to disclose, show that, although Mr Hussain was extremely frustrated with the unreliability of forecasting of certain sections of the sales force, the company’s forecast for the quarter, even taking out these deals, was still ahead of target. And indeed, the quarter was successfully delivered three weeks later. It is not hard, when going through hundreds of thousand of emails to pick a misleading example if you are prepared not to release other emails around it. The radical action referred to, was the termination of the unreliable sales reps.”
“HP is trying to smear us by leaking partial information and half-truths, here behind the defamation shield of a court filing. After three years, when HP finally starts putting out a case, it turns out to be built on a handful of assumptions that can all be explained, have never been put to the Autonomy team, and prove absolutely nothing. A large number of documents they have chosen not to release show the reality of the situation: that Autonomy was completely open with its auditors, and all accounting details were known to HP and its advisers long before they decided to take a write down. The real story here is HP’s utter mismanagement of Autonomy, which Meg Whitman is attempting to cover up through an increasingly bitter attack campaign. We will not be her scapegoat.”
Response to details in the filing:
HP has posted a long court filing containing many partial pieces of information, taken out of context and used to draw false conclusions. Much of this information has already been selectively leaked to the media. (It should be noted that this information has nothing to do with the actual issue before the court, which is whether HP should be allowed to pay up to $48 million to a group of lawyers to settle a case against it by HP’s shareholders, a settlement Sushovan Hussain has challenged as corrupt.)
Within the document, four further things are mentioned that we respond to below:
The due diligence information was provided to HP in the format it requested. It was not interested in which resellers’ deals had gone through, but the industries of the intended end users.
Vatican and VAR deals
The fact that a VAR had not sold through to its intended end user is not relevant under IFRS. The VAR decided to become part of this deal so that when the project got underway, it could undertake the services contracts. The Vatican project was substantive and well publicized by the Vatican at the time, including on TV. To claim that the Vatican deal was fake is unsupportable: emails show a large amount of work with the Vatican and that at the time, they were on the verge of signing the deal.
The handling of hosted contracts was fully and transparently handled by Deloitte, who concurred with the accounting treatment. Furthermore, the methodology by which these were recognized was discussed with HP and its advisors in detail before the acquisition. Emails show that HP’s CFO and other senior accounting staff were also intimately aware of how Autonomy accounted for hosted deals early on in the acquisition, and played active roles in discussing how this would be converted using US GAAP. The HP CFO expressed no concern about the accounting treatment.
The definition of OEM is made clear in Autonomy’s annual report and is not the definition now being used by HP. Furthermore, this was discussed in detail with HP before the acquisition.
We know that in compiling its adjustments to revenue HP has excluded Autonomy’s hardware sales. This is at odds with its own version of the Autonomy accounts filed with the UK statutory regulator, in which they handled the hardware in exactly the same way. Furthermore, a number of emails and documents show that the highest levels of HP management were well-aware of Autonomy’s hardware sales long before any alleged whistleblower came forward. HP also continued to do the same after it owned the company. The hardware sales were fully disclosed to the auditors and covered in the audit packs, which HP and its advisers had access to. In fact, prior to the acquisition, HP even supplied some of the hardware Autonomy re-sold.
The ledgers of the company and the audit packs show that hardware was correctly booked as “hardware” under the heading “hardware”. These ledgers were reviewed in detail by Hewlett Packard and its advisers.
In short, on 20 November 2012, HP made unsubstantiated allegations in order to justify a rushed write down within that financial year. But it simply hadn’t substantiated those allegations at the time and now can’t back out of that story. HP’s own version of the Autonomy accounts shows that there is no cash missing. This is the simplest fact that shows these allegations are untrue. This was real business and Autonomy got paid for it. On 20 November 2012, HP claimed the alleged wrongdoing was incredibly well-concealed. Since then, many internal HP emails have surfaced showing they were well aware of Autonomy’s accounting practices, and were comfortable with them. The Autonomy audit packs, which HP had access to immediately and were reviewed by it and its advisers, also surfaced all of these items in full clarity.
What we see here is a resumption of partial leaking and smear tactics, which have characterized HP’s behaviour from the outset. We note that Deloitte continues to state that it is fully confident in its work in relation to Autonomy.
It seems Meg Whitman will be using a large sum of HP’s money to avoid explaining in court why she made false allegations regarding Autonomy in November 2012. We continue to reject HP’s allegations, and note that over recent months a number of documents have emerged that prove Meg Whitman misled her shareholders. We hope this matter will now move beyond a smear campaign based on selective disclosure and HP will finally give a full explanation.
As you are aware, Hewlett Packard remains locked in dispute with a group of its own shareholders and with the former management team of Autonomy over its purchase of Autonomy. I write to you today to raise serious concerns about the way HP has conducted this affair, and to put forward a number of questions that HP management should answer. The evidence shows that HP is not just smearing us, but also misleading you, its shareholders. I ask you to help put things right.
On November 20th 2012, HP made a series of serious and damaging allegations about the management team of Autonomy. It couched alleged misdeeds in general, rather than specific terms. We emphatically denied all suggestions of wrongdoing.
In the 16 months that have followed, HP has not provided information or evidence to the Autonomy team to substantiate any allegation. Instead, it has selectively leaked documents and information to the international media, frequently using material taken out of context to create false impressions and smear our reputations.
Since the last HP shareholder meeting, reports in the media have demonstrated that HP has documents in its possession that show beyond doubt that statements it made on November 20th were misleading. Further, these reports have shown that senior people at HP knew these statements were misleading long before they were made.
On the basis of recent reports, there are a number of material questions HP needs to answer:
- HP has repeatedly declined to show the Autonomy management team the allegations or evidence against them, on the grounds that the issue is “with the regulators”. Yet it has engaged in selective disclosure of these documents and emails to the media. How does HP justify that?
- HP claimed Autonomy’s auditors had “missed” certain items and been misled. All the evidence in the public domain shows Autonomy was fully open and transparent with its auditors (Financial Times, 17th February 2014). If HP has any alternative evidence, why does it not reveal it?
- HP claims to have been in the dark until a “whistleblower” stepped forward. Articles in the Financial Times have established that the most senior managers of HP fully understood Autonomy’s accounting methods from when they took over the company in October 2011. Does HP deny that senior managers had prior knowledge?
- Does HP deny that it knew how Autonomy recognised hardware sales and that these sales were reported in full by its auditors, and that HP continued the same sales of Dell hardware after it took over Autonomy?
- Does HP deny that it was aware of how Autonomy recognised reseller transactions? And that it sought to use the differences between IFRS and US GAAP applicable to reseller sales to its own advantage after the acquisition?
- HP’s independent advisers carried out several valuation reports of Autonomy after the acquisition, which explicitly included Autonomy’s hardware sales and confirmed the value of the company at c$11Bn? Does HP management deny this? Will they disclose these reports to shareholders?
- Why did HP’s management fail to disclose these valuations at the time? Why do they not release them now?
- Why won’t HP release its calculation for the write down?
- HP says it “eventually learned that a portion of Autonomy’s revenue were related to hardware sales”. Yet documents show that HP knew about Autonomy’s hardware sales from October 2011. Does HP still maintain it knew nothing before June 2012?
I urge you to continue to seek answers to these questions. Meg Whitman has made incendiary and defamatory accusations on behalf of her company. She should now present the detailed evidence that justifies those allegations and a $5.5bn write-down in the value of your company.
You and I have a shared ambition to see this situation resolved as soon as possible. I hope your questions today can bring us nearer to that resolution.
In the Financial Times articles of 17th February 2014 a number of new pieces of information came to light regarding Autonomy’s sales of hardware. The treatment of hardware sales is central to HP’s allegations of accounting impropriety against the former Autonomy management team, given that it constitutes the significant majority of the revenue HP has indicated is under dispute.
The new information provided by the FT shows that HP keeps on changing its position on these allegations. Whenever actual evidence becomes available, HP backtracks.
We would note that on November 20th and 21st 2012 HP made the following statements:
- That Autonomy “sold negative-margin, low-end hardware” and represented this as software revenue (HP statement)
- That up to 10-15 per cent of Autonomy’s sales were such hardware sales, and this was a “wilful effort…to inflate the underlying financial metrics of the company” (HP statement)
- John Schultz, Chief Legal Officer said, “They used low end hardware sales, but put out that it was a pure software company” (John Schultz, New York Times)
- That “critical documents were missing from the obvious places and it required that we look in every nook and cranny” (John Schultz, Reuters)
- That there was “active concealment”, and Deloitte, Autonomy’s auditor, “obviously didn’t catch these issues at the time” (John Schultz, Bloomberg)
However, the FT revelations now show that HP and its senior management were well aware of Autonomy’s hardware sales and its legitimate practice of sometimes selling hardware as a loss leader, and that all of these sales had been fully disclosed to Deloitte and appropriately reviewed and treated.
In response to these revelations HP issued a statement on 17th February 2014 that it had “eventually” become aware of the hardware sales before the so-called whistleblower made its allegations in May 2012. The documents cited by the FT show that this information was available and known to HP immediately upon acquisition, if not before, and the practice of selling hardware at a loss was well known by HP executives long before the “whistleblower” came forward.
Given that hardware accounted for over $160 of the $200m disputed revenue, this new information must seriously question the stated basis of HP’s write down.
We note that the FT has included some details of a transaction between Autonomy and Morgan Stanley, presumably from emails leaked to the FT by HP, which is presented as indicative of Autonomy’s hardware sales. The emails show that Autonomy did indeed sell hardware to Morgan Stanley at a slight loss, something Autonomy has always fully explained to its auditors and, indeed, directly to HP. The audit packs cited by the FT show that this was fully disclosed to the auditors, and accounted for in the appropriate manner.
From Mike Lynch:
“Meg Whitman accused Autonomy of “active concealment” but these revelations prove we were open and transparent with our auditors who continue to stand by the accounts. Meg Whitman must answer to her shareholders with what she knew, when she knew it and how she and her senior colleagues made such factually incorrect and serious statements that were so easy to check from the audit packs.
“Why would Meg say we had withheld information from our auditors? She should explain or resign.”
Meg Whitman accused us of “active concealment” but these revelations prove we were open and transparent with our auditors. These revelations not only confirm this, but show that a large number of Hewlett Packard staff and their advisers were familiar and comfortable with Autonomy accounting practices for over a year before HP made its announcement. We now ask that Meg Whitman explain to her shareholders what she knew, when she knew it and how her senior colleagues could have made factually incorrect statements that were so easy to check from the Deloitte audit packs.
In November 2012, Meg Whitman and her senior management team told the world they had discovered that Autonomy had been selling hardware and booking it as high-margin software and that it had inappropriately booked value-added reseller (VAR) sales where there had been no sell-through. She further stated that these facts were so well hidden that they came to light only when a whistle-blower surfaced in June 2012, a position untenable now that details of Deloitte’s audit packs have emerged. Deloitte has stated it “categorically denies any knowledge of any accounting improprieties or misrepresentations in Autonomy’s financial statements.”
Despite waiting a year and HP trawling through thousands of deals we are presented with three examples of value of about $24m out of $2.1bn, and a couple of out-of-context email quotes. We now see why, as the FT puts it, “her standing is increasingly blemished by HP’s failure to provide convincing evidence” to substantiate a $5bn write-down.
There is another explanation for the failure of Autonomy to meet the financial expectations in place at the time of its takeover by HP. It is entirely to do with HP’s failure to properly integrate the company it bought. That failure became clear early in the process and is recorded in the documents revealed today. Given that there were early indications of these difficulties, reported to Ms Whitman and her team by senior figures at Autonomy, we ask why she waited until November 2012 until informing her shareholders of a write-down in value.
Whilst we are pleased that light has been shed on this situation, Meg Whitman now has some very serious questions to answer. And we ask that HP no longer pursue this matter through partial leaks, information out of context and spin.
On 31st January, HP submitted restated accounts for Autonomy Corporation Limited (ACL) and its UK subsidiary Autonomy Systems Limited (ASL) for 2009 – 2010, which were leaked to the press before becoming available in Companies House. HP presented the accounts as evidence that 81% of Autonomy’s profits had disappeared and that this was due to the effects of HP’s allegations of accounting issues. HP’s spokesman Michael Thacker said “these restatements, and the reasons for them, are consistent with HP’s previous disclosures regarding accounting improprieties in Autonomy’s pre-acquisition financials.”
A close review of the documents indicates that the restated accounts are an exercise in misdirection by HP, do not contain any evidence to support HP’s allegations and instead need to show HP is using accounting techniques of its own to move figures around.
There are a number of areas worth highlighting in the restated accounts:
Upon closer reading, the accounts show this to be PR spin and misdirection. Firstly, Ernst & Young have publicly refused to sign off these accounts in any way whatsoever. However, the HP directors, including Christopher Yelland, under Company Law have certified the accounts as being “true and fair”, even though Ernst and Young gave a complete disclaimer “we do not express an opinion on these financial statements”.
Hardware and VAR Accounting
One of the most salient points to emerge from these accounts, is that they treat hardware and reseller sell-through in exactly the same way Autonomy always did, despite the fact that HP called raised issues with these practices in November 2012. It is interesting to note that in these restated accounts, HP reports as one operating segment – the fact it is one operating segment is what controls the disclosure rules and negates the need to break out hardware as a separate line item. “All turnover relates to one business segment, being the sale of software are related services, and originates in the United Kingdom.” (p19)
External Valuation Report
Ernst & Young, in the ACL accounts also make reference to an external valuation report dated July 2012 – HP did not inform of the presence of this report until November, despite the impact it had on the underlying accounts. HP’s Q3 accounts stated in Autonomy “the fair value of Autonomy approximated the carrying value” (p. 16, HP Q3’12 10Q).
Changes in Accounting Policy
The changes in the accounts are directly due to changes in accounting policies and practices, which HP introduced. The accounts are not done under IFRS. A direct comparison of the previous audited and the current unaudited accounting policies can be seen in the attached appendix.
Under this new policy, revenue and profits have been moved to later periods and possibly to overseas companies. Thus it is wholly inaccurate to conclude that 81% of profit has disappeared.
Absence of Fundamental Errors
The accounting policy changes allow HP to make decisions based on judgement, with the benefit of hindsight – which is not good accounting practice. Furthermore, there is no disclosure of bad debt charges in 2010. These points, combined with the fact that there haven’t been any changes in cash means that there are likely no fundamental errors in the original accounts and that there is little justification for them to have been restated.
The accounts show that the cash balance remained unchanged. This is crucial in that it shows that there was no change to the real business in the company. And in fact the cash position now precedes the profit under the new policy.
It is clear that the effect of these changes is to provide a headline figure in the apparent profitability of the company. This profit reduction is being used as an attempt to make claim of tax from the UK government.
In common with most technology companies Autonomy from time to time bought products or services from its customers. Such transactions in the industry are entirely proper and in fact HP itself engages in them at a much higher level. For the audited periods all the relevant details were given to Deloitte who applied the appropriate fair value checks.
Collectability of Cash
Autonomy applied a series of checks for collectability, a process which was reviewed and checked by Deloitte. The fact that HP now may be using different tests and incorrectly applying hindsight to a small number of deals where ultimately payment was not received does note change the accounting. Autonomy’s bad debt levels were in line with the industry.
Revenue Deferred not Disappeared
We note from the accounts for example ASL direct sales that of the £19m which appears to have disappeared, £16m is in fact just deferred to later periods under the different accounting policies that HP has adopted.
Comparison of ASL Turnover Accounting Policy Note in 2010 and 2011 accounts
The passages of text below show the changes made to ASL’s accounting policy for turnover in its accounts for 10 months to 31 October 2011 compared to year ended 31 December 2010.
Key to text: (BLACK = unchanged / BLUE = 2011 added / [RED = 2010 removed]
i) Sale of goods
The company sells its products as licenses to resellers, OEMs and direct to end-users together with associated support and maintenance. In addition, the company also sells some of its products on a subscription basis.
Turnover from software license agreements is recognised where there is persuasive evidence of an agreement with a customer (contract and/or binding purchase order), delivery of the software has taken place, collectability is probable and the fee has been contractually agreed and is not subject to adjustment or refund (i.e. is fixed and determinable). If an acceptance period is required, turnover is recognised upon the earlier of customer acceptance or the expiration of the acceptance period. [2010: Turnover is recognized on contracts providing that the customer passes defined creditworthiness checks.]If significant post- delivery obligations exist or if a sale is subject to customer acceptance, turnover is deferred until no significant obligations remain or acceptance has occurred.
The company enters into OEM and reseller arrangements that typically provide for fees payable to the company based on licensing of the company’s software to third party customers. Sales are [2010: generally] recognised [2010: as reported by the OEM or reseller and is] based on the amount of product sold subject to the criteria above. [2010: Sales are recognised if all products subject to resale are delivered in the current period, no right of return policy exists, collection is probable and the fee is fixed and determinable.]
ii) Support and Maintenance
Turnover from customer support and maintenance is recognised rateably over the term of the support period. If customer support and maintenance is included free or at a discount in a multiple element arrangement, these amounts arc allocated out of the license fee at their fair market value based on the value established by independent sale of the customer support and maintenance to customers. Support and maintenance consists primarily of the supply of products, such as patches and updates, to the standard software.
iii) Rendering of services
Consulting and training turnover is included within rendering of services.
Turnover from consulting and training services is recognised as services are performed. If a transaction includes both license and service elements, license fee turnover is recognised upon shipment of the software, provided services do not include significant customisation or modification of the base product and the payment terms for licenses are not subject to acceptance criteria and the fair value of the service element can be determined. In cases where license fee payments are contingent upon the acceptance of services, turnover from both the license and the service elements is deferred until the acceptance criteria are met.
If services include significant customisation or modification, then revenue is recognised as the services are performed and stage of completion is determined by reference to the costs incurred as a proportion of the total estimated costs of the service project. If a contract cannot be reliably estimated,revenue is recognised only to the extent that costs have been incurred. Provision is made as soon as a loss is foreseen.
iii) Managed Service Turnover
Turnover for managed services is recognised as the services are delivered. The services may comprise of a combination of hosted services and software as part of a multiple element arrangement, as described below, and where applicable an assessment is performed to determine whether software elements can be separated from on-going service elements. In the situation where the elements cannot be the license turnover is recognised rateably over the service period
iv) Multiple element arrangements
The Company evaluates the elements of a transaction to identify the appropriate accounting elements so that revenue recognition criteria may be applied to separately identifiable elements of a single transaction, and when appropriate, the recognition criteria may be applied to two or more transactions when their economic substance cannot be understood individually.
For those transactions with multiple elements, if the Company has determined that the undelivered elements of that contract have fair value, the Company records the revenue associated with the delivered elements (generally the software license) at an amount that represents the fee for the transaction less the fair value of any undelivered e1ement and defers the fair value of undelivered elements of the transaction (generally the support and maintenance and services).
v) Revenues from fellow group undertakings
The Company earns income through a share of the earnings of fellow group undertakings. The earnings of the fellow group undertakings arc derived from the sale of software and related services incorporating intellectual property owned or licensed by the Company, and from the sale of other products, including hardware.
Any allegation of misrepresentation, disclosure failure, fraud or accounting impropriety against Autonomy in relation to its accounts is completely false.
The restated 2009 and 2010 figures for Autonomy companies submitted to Companies House on 31st January 2014 contain no new material information. All that they reflect are differences in accounting treatment between the policies used by Hewlett-Packard and the international accounting rules that Autonomy used as an independent company. Moreover, HP’s current auditors, Ernst & Young, have refused to give an opinion on the restated accounts, citing a lack of “appropriate audit evidence.”
A close reading of these accounts shows that the changes in Autonomy Systems sales were mainly a matter of deferred timing under the new HP accounting policies, deferring revenue out of 2010 and into future years. HP’s intimation that this revenue has in some way disappeared is false.
Worryingly, it also appears that HP’s restatement of Autonomy Systems’ accounts may have more to do with minimizing the company’s UK tax obligations, since it includes disclosure that Hewlett-Packard has asked HMRC for a £37.4m tax refund on the back of these restated results. As an independent company, Autonomy was a good corporate citizen. It always paid its proper share of UK tax and the company did not resort to any exotic accounting treatments in order to avoid paying tax.
Hewlett-Packard undertook extensive due diligence on Autonomy and its accounts before the 2011 takeover. Since then, it has consistently failed to substantiate its allegation that Autonomy in any way inflated its sales and profits. It has never provided the former Autonomy management team with any documents supporting its claims. The reason for that is simple: there was no misrepresentation of the numbers and Hewlett-Packard’s claims simply do not add up.
Accountancy Age has published a concise analysis of the crucial differences in the treatment of revenue recognition under IFRS and US GAAP accounting standards. The author notes that under IFRS standards, revenue from sales to a reseller can be immediately recognised by the manufacturer:
“It is worth noting that there is no explicit prohibition in IAS 18 on the recognition of revenue immediately on a sale from a manufacturer to a reseller. IFRS is much less detailed and prescriptive than US GAAP, which has specific guidance on software sales – SOP 97-2. Indeed, it is these differences that the IASB’s joint revenue recognition project with the FASB sets out to fix.”
The full article can be read here: http://www.accountancyage.com/regulation
Over the past few days, several media outlets have reported on a private letter dated September 2013 from the US Air Force to members of the former senior management of Autonomy and others. The letter concerns the USAF conducting a review of potential future commercial relationships with the former senior management of Autonomy. The USAF letter cites allegations made against the Autonomy management team by Hewlett Packard on 20th November 2012 as the basis for this review. This is an understandable precaution for the US Air Force to take, given the nature of such public allegations made by HP.
We strongly reject HP’s allegations. The few examples seen to date in support of its allegations, such as those cited in the USAF letter, show that HP appears to have had a fundamental misunderstanding of IFRS accounting practices, and we vehemently deny anything improper.
Autonomy was fully transparent with its auditors and correctly represented its accounts. Autonomy’s transactions were entirely properly accounted for under IFRS and reviewed by Autonomy’s auditors as appropriate.
Moreover, in relation to the scale of the $5 billion write down taken by HP on the basis of these allegations, the deals cited in the USAF letter constitute a tiny number of deals of low materiality in the context of Autonomy’s size. Even if these deals had in some way been questionable, they would have had no effect to justify the write-down.
A year on from HP’s initial allegations, despite repeated requests we have still not received detailed allegations or the supporting evidence for them. Rather what we see from HP is unsupported accusations, leaks and PR spin rather than a direct conversation based on the facts.
We have responded to the US Air Force letter addressing the concerns they have raised. This is a private correspondence and it would not be appropriate to discuss it, or any specific issues contained within it, in public. However, given that these issues are being reported in the international media we feel it is important to make clear a couple of general points of fact in relation to the matters at hand:
Summary of Background and Our Response to the US Air Force
The allegations made by HP against Autonomy are false. Autonomy’s auditor, Deloitte LLP (“Deloitte”), has publicly denied any knowledge of improprieties. Deloitte’s audit reports show that Autonomy was transparent with it and that it reviewed the matters now under consideration in detail.
Autonomy’s disclosure and revenue recognition practices were proper and fully consistent with the standards under which it reported – the International Financial Reporting Standards (“IFRS”) and International Accounting Standards (“IAS”). Those standards differ from U.S. GAAP and, in many cases, allow for the recognition of revenue earlier than under U.S. GAAP.
As Autonomy’s outside auditor, Deloitte conducted full scope annual audits and limited scope quarterly reviews. As part of its review, it was Deloitte’s policy to review all sales contracts or invoices over $1 million and a sample of contracts worth more than $100,000.
Sales to Value-Added Resellers
Autonomy, like many other companies in the software industry, sold its products to value added resellers, or VARs. The term VARs frequently refers to companies that buy a product (such as software) and then resell that product to an end user together with other products or services.
Under IFRS, for revenue recognition purposes, the VAR is the customer of Autonomy, rather than any potential ultimate end user who might buy the software from the VAR. There is no IFRS revenue recognition requirement that, following the sale to a VAR, there be a subsequent sale from the VAR to an end user, or even that an end user be identified at the time of a sale to a VAR. The VAR assumes the risk of resale, which may occur at any time in the future.
The relevant accounting procedure is governed by IAS 18. Revenue from a sale by an entity such as Autonomy to a VAR buyer may be recognized so long as the five elements of IAS 18 are satisfied, as follows:
(a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
(b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
(c) the amount of revenue can be measured reliably;
(d) it is probable that the economic benefits associated with the transaction will flow to the entity; and
(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.
The propriety of any revenue recognition decision is assessed based on the knowledge and circumstances at the time of the recognition decision, not with the benefit of hindsight.
Consistent with IFRS and IAS 18, Autonomy’s revenue-recognition policy provided that sales of IDOL product to a VAR were recognized when the software licenses subject to the sale had been “delivered in the current period, no right of return policy exist[ed], collection [wa]s probable and the fee [wa]s fixed and determinable.” The policy did not require sell-through to an end user before recognizing revenue from a sale to a VAR. This policy was approved by Deloitte and the Audit Committee and disclosed in the ‘Notes to Consolidated Financial Statements’ section of Autonomy’s Annual Report.
Post Revenue Recognition Events
On a few occasions, following a sale to a VAR and the decision to recognize revenue, a VAR unexpectedly did not ultimately complete its anticipated onward sale. This could occur because no end user purchased the software. Those subsequent events do not invalidate the appropriateness of recognizing revenue at the time of sale to the VAR.
This is because, as discussed above, there is no end user requirement for revenue recognition and because the propriety of revenue recognition is assessed based on the circumstances at the time of recognition, and not in hindsight.
Purchases from VARs
As an initial matter, it is common for companies in the technology sector to both sell to, and buy from, other technology companies. Indeed, it is our understanding that HP itself engages in such transactions. On the small number of occasions when Autonomy did so, it properly accounted for them. IAS 18 permits revenue recognition in these circumstances based on the fair value of consideration received for a sale. Deloitte ensured that the relevant elements were met on purchases from customers.
Today HP will hold its annual shareholder meeting. This meeting provides a moment of accountability for HP’s Board of Directors to all its stakeholders, and is an appropriate time for the Board to address material questions.
A significant issue for HP’s stakeholders is the allegations HP has made against the former management team of Autonomy in relation to the acquisition of that company, and the related impairment charge of $8.8 billion taken against shareholder funds. As a member of the former management team of Autonomy I have a shared interest with the shareholders of HP (of which I am not one) in getting to the bottom of those allegations, understanding exactly what happened within HP related to this situation and resolving it as soon as possible.
We therefore put forward some questions that we believe HP’s Board of Directors needs to answer at the shareholder meeting:
1. Can the Board provide details and evidence of the allegations it has made against the former management team of Autonomy to shareholders and to the people it has accused, so that everyone can understand the allegations that are being made and how it relates to the decisions and statements the Board has made? Can the Board confirm when it first became aware of these specific allegations? Will the Board provide the report from PwC on which its allegations are based to the former Autonomy management team so that this issue can move toward resolution? Will the Board also make available the conclusions of the findings of the recently appointed committee investigating the circumstances of the acquisition?
2. How did HP calculate the impairment charge it has taken against Autonomy? Several qualified commentators, including a former Chief Accountant of the SEC, have questioned how the alleged irregularities in Autonomy’s accounting could generate such a large write-down. How much of the impairment charge was related to the operating performance of Autonomy post-acquisition?
3. Did HP approach the UK Takeover Panel at any stage in an attempt to rescind its offer to buy Autonomy before completion? If so what was the reason it gave and why was this material change of view not communicated to shareholders?
4. The former management of Autonomy began alerting Ms Whitman as early as December 2011 to significant problems with the integration of Autonomy into HP that were negatively impacting its performance. When did Ms Whitman acknowledge that Autonomy was not performing against expectations? Why was this not communicated to shareholders at that time?
5. Will HP commit to behaving in a transparent manner in providing information about these allegations and the legal processes that have been set in motion? This includes not pre-empting announcements by regulatory authorities and not waiting long periods to disclose information.
We continue to reject the allegations made against us by HP and believe it is in the interests of all parties that these questions be addressed directly by the Board so this issue can be resolved as swiftly as possible. HP has acted in an aggressive and unusual manner throughout this episode, making highly damaging public accusations without providing any supporting evidence, either to the public or to the people they have accused.
As we have said before, we believe the problem with the Autonomy acquisition by HP lies in the mismanagement of that business by HP under its ownership, making it impossible for Autonomy to deliver on HP’s expectations. Autonomy’s accounts were fully audited by Deloitte throughout the period in question and Deloitte has confirmed that it conducted its audit work in full compliance with regulation and professional standards. We refuse to be a scapegoat for HP’s own failings.
Dr. Mike Lynch
We note the announcement by the UK’s Financial Reporting Council (FRC) that it has begun an investigation of the financial reporting of Autonomy for the period from 1 January 2009 to 30 June 2011. As a member of the FTSE 100 the accounts of Autonomy have previously been reviewed by the FRC, including during the period in question, and no actions or changes were recommended or required.
We welcome this investigation. Autonomy received unqualified audit reports throughout its life as a public company. This includes the period in question, during which Autonomy was audited by Deloitte. We are fully confident in the financial reporting of the company and look forward to the opportunity to demonstrate this to the FRC.
“In a message posted on this website a week ago today, we urged Meg Whitman to use HP’s annual 10-K filing to provide a full explanation of the allegations of alleged accounting impropriety at Autonomy which she made on November 20. Unfortunately, she did not do so. HP finally filed its 10-K yesterday, more than a week later than usual, but again failed to provide any detailed information on the alleged accounting impropriety, or how this could possibly have resulted in such a substantial write down.
HP’s failure to provide us and its own shareholders with clarity on these crucial issues does not come as much of a surprise. Ever since putting out those very serious but non-specific allegations last month, HP has refused to disclose either the substance of its allegations or any supporting evidence.
In fact, HP’s 10-K filing appears to raise many more questions than it answers. Having had further time to study HP’s filing since it was released near midnight last night (UK time), it is apparent that a number of the statements contained within the filing are materially different from HP’s previous commentary on these issues. It also appears that the company is back-tracking on a number of key points that under-pinned its original allegations:
1. How much of the Autonomy write down is actually being blamed on alleged accounting improprieties?
In its November 20 statement, HP stated that “The majority of [the Autonomy] impairment charge, more than $5 billion, is linked to serious accounting improprieties, misrepresentation and disclosure failures” committed by “former members of Autonomy’s management team”. However, HP’s 10-K filing refers much more equivocally to a $5.7 billion goodwill impairment charge that “incorporates” the alleged accounting improprieties at Autonomy. So, how much of the $5.7 billion is being directly attributed by HP to alleged accounting improprieties, and how much should in fact be attributed to other changes in business performance, earnings projections and discount rate?
2. Does HP have facts or beliefs?
In its November 20 statement, HP was definitive in accusing “former members of Autonomy’s management team” of “serious accounting improprieties, misrepresentation and disclosure failures”, stating these matters as fact. However, HP’s 10-K filing is materially weaker, referring to its interpretation of alleged accounting improprieties which it “believes” to have taken place at Autonomy. Why did it make such definitive assertions before any independent assessment of the matter, and why is it less confident now than it was a month ago?
3. Why does the 10-K contain less detail than its last statement?
HP’s November 20 statement clearly leveled the accusations at “former members of Autonomy’s management team”. However, HP’s 10-K filing does not repeat – let alone expand upon – this specific detail, or indicate who it is accusing of wrongdoing. Every time we ask for more information, we get less.
Today we renew the call for HP to release the PwC report on which its allegations are based, along with any other relevant supporting evidence that was behind the statements of November 20, and explain the material differences between those statements and the 10-K.
It is time for Meg Whitman to stop making allegations and to start offering explanations.”
“It is extremely disappointing that HP has again failed to provide a detailed calculation of its $5 billion write down of Autonomy, or publish any explanation of the serious allegations it has made against the former management team, in its annual report filing today.
Furthermore, it is now less clear how much of the $5 billion write down is in fact being attributed to the alleged accounting issues, and how much to other changes in business performance and earnings projections. This appears to be a material change in HP’s allegations.
Simply put, these allegations are false, and in the absence of further detail we cannot understand what HP believes to be the basis for them.
We also do not understand why HP is raising these issues now given that Autonomy reported into the HP Finance team from the day the acquisition completed in October 2011, there was an extensive due diligence process and Autonomy was audited as a public company for many years.
We would particularly make the following points:
* HP’s CFO Cathie Lesjak and her team, plus a number of outside advisors, had access to all Autonomy accounts and documents from October 2011 onwards, and raised no issues.
* Beginning in November 2011, HP and KPMG reviewed Autonomy’s closing balance sheet in detail, and Ernst & Young reviewed Deloitte’s audit work papers.
* Beginning in October 2011, HP studied in detail Autonomy’s tax structure and transfer pricing as well as its revenue recognition practices (led by Paul Curtis, HP’s worldwide head of revenue recognition).
* An independent third party valuation of Autonomy’s assets was carried out in January 2012.
* Quarterly business reviews were held with Autonomy management, Meg Whitman and Cathie Lesjak to discuss Autonomy’s financial performance.
* HP has continued to sell and account for hardware alongside Autonomy software in the same way that Autonomy did for the year since the acquisition completed.
* Regarding differences between IFRS and US GAAP accounting standards, which appear to have a role in some of the allegations HP has made, Autonomy’s accounting policies were made clear in Autonomy’s 2010 annual report.
We also note the statement in HP’s annual report that it received confirmation from the US Department of Justice on 21 November 2012 (the day after HP’s first public statement), that the Department had opened an investigation. We can confirm that we have as yet had no contact from any regulatory authority. We will co-operate with any investigation and look forward to the opportunity to explain our position.
We continue to reject these allegations in the strongest possible terms. Autonomy’s financial accounts were properly maintained in accordance with applicable regulations, fully audited by Deloitte, and available to HP during the due diligence process.
We remain deeply concerned about how this process has been conducted, and believe it is in everyone’s interests for it to be resolved as soon as as possible.”
Thank you for coming to this site over the past few weeks. It has now been over a month since Meg Whitman, the CEO of Hewlett Packard, launched a series of allegations against me and my former colleagues. This site will remain the place where we post information that is relevant for the outside world as we continue to reject these allegations.
I’m glad that people have taken the time to hear from me directly. I would also like to take this moment to thank everyone for the huge amount of support and friendly messages you have sent to us through the site. This has been a very difficult time and we appreciate your support a great deal.
Ever since Meg Whitman launched these accusations we have been asking what she meant. I’m sorry to say we have got no further and we are still waiting for her to explain her claims and provide the material on which they are based.
As I have said before, we do not understand the allegations, or how they could possibly add up to a write down of over $5 billion.
In the absence of greater clarity from Meg, we are looking now to HP’s 10-K filing that is due before the end of the year. This document should contain information about finances and management that all American businesses are required to lodge each year with the U.S. Securities and Exchange Commission. We look forward to HP providing in it a comprehensive disclosure and explanation of its position and calculations.
I won’t go into the detail of our rebuttal again, for it is set out clearly in the open letter published here on the site. All I will say is that I look forward to this situation being resolved as soon as possible.
The technology industry remains one of the most exciting areas in the world to live and work in. New innovations are taking place every day, all around us. I am looking forward to 2013 being another year of tremendous progress.
Thank you again for your interest and support.
Open Letter from Dr Mike Lynch to the Board of Directors of Hewlett-Packard
27 November 2012
To: The Board of Directors of Hewlett-Packard Company
On 20 November Hewlett-Packard (HP) issued a statement accusing unspecified members of Autonomy’s former management team of serious financial impropriety. It was shocking that HP put non-specific but highly damaging allegations into the public domain without prior notification or contact with me, as former CEO of Autonomy.
I utterly reject all allegations of impropriety.
Autonomy’s finances, during its years as a public company and including the time period in question, were handled in accordance with applicable regulations and accounting practices. Autonomy’s accounts were overseen by independent auditors Deloitte LLC, who have confirmed the application of all appropriate procedures including those dictated by the International Financial Reporting Standards used in the UK.
Having no details beyond the limited public information provided last week, and still with no further contact from you, I am writing today to ask you, the board of HP, for immediate and specific explanations for the allegations HP is making. HP should provide me with the interim report and any other documents which you say you have provided to the SEC and the SFO so that I can answer whatever is alleged, instead of the selective disclosure of non-material information via background discussions with the media.
I believe it is in the interest of all stakeholders, and the public record, for HP to respond to a number of questions:
- Many observers are stunned by HP’s claim that these allegations account for a $5 billion write down and fail to understand how HP reaches that number. Please publish the calculations used to determine the $5 billion impairment charge. Please provide a breakdown of the relative contribution for revenue, cash flow, profit and write down in relation to:
- The alleged “mischaracterization” of hardware that HP did not realize Autonomy sold, as I understand this would have no effect on annual top or bottom lines and a minor effect on gross margin within normal fluctuations and no impact on growth, assuming a steady state over the period;
- The alleged “inappropriate acceleration of revenue recognition with value-added resellers” and the “[creation of] revenue where no end-user customer existed at the time of sale”, given their normal treatment under IFRS; and
- The allegations of incorrect revenue recognition of long-term arrangements of hosted deals, again given the normal treatment under IFRS.
- In order to justify a $5 billion accounting write down, a significant amount of revenue must be involved. Please explain how such issues could possibly have gone undetected during the extensive acquisition due diligence process and HP’s financial oversight of Autonomy for a year from acquisition until October 2012 (a period during which all of the Autonomy finance reported to HP’s CFO Cathie Lesjak).
- Can HP really state that no part of the $5 billion write down was, or should be, attributed to HP’s operational and financial mismanagement of Autonomy since the acquisition?
- How many people employed by Autonomy in September 2011 have left or resigned under the management of HP?
- HP raised issues about the inclusion of hardware in Autonomy’s IDOL Product revenue, notwithstanding this being in accordance with proper IFRS accounting practice. Please confirm that Ms Whitman and other HP senior management were aware of Autonomy’s hardware sales before 2012. Did Autonomy, as part of HP, continue to sell third-party hardware of materially similar value after acquisition? Was this accounted for by HP and was this reported in the Autonomy segment of their accounts?
- Were Ms Whitman and Ms Lesjak aware that Paul Curtis (HP’s Worldwide Director of Software Revenue Recognition), KPMG and Ernst & Young undertook in December 2011 detailed studies of Autonomy’s software revenue recognition with a view to optimising for US GAAP?
- Why did HP senior management apparently wait six months to inform its shareholders of the possibility of a material event related to Autonomy?
Hewlett Packard is an iconic technology company, which was historically admired and respected all over the world. Autonomy joined forces with HP with real hopes for the future and in the belief that together there was an opportunity to make HP great again. I have been truly saddened by the events of the past months, and am shocked and appalled by the events of the past week.
I believe it is in the best interests of all parties for this situation to be resolved as quickly as possible.
I am placing this letter in the public domain in the interests of complete transparency.
Dr. Michael R. Lynch
20 November 2012
HP has made a series of allegations against some unspecified former members of Autonomy Corporation PLC’s senior management team. The former management team of Autonomy was shocked to see this statement today, and flatly rejects these allegations, which are false.
HP’s due diligence review was intensive, overseen on behalf of HP by KPMG, Barclays and Perella Weinberg. HP’s senior management has also been closely involved with running Autonomy for the past year.
It took 10 years to build Autonomy’s industry-leading technology and it is sad to see how it has been mismanaged since its acquisition by HP.