Summary of High Court proceedings
In March 2020, Bloomberg journalist Jonathan Browning summarised the High Court proceedings in an in-depth article that details evidence heard over the course of the 10 month trial.
In March 2020, Bloomberg journalist Jonathan Browning summarised the High Court proceedings in an in-depth article that details evidence heard over the course of the 10 month trial.
|Length of trial||93 days over 10 months|
|Number of witnesses||58|
|Length of MRL’s questioning||22 days in the witness box over six weeks — the longest cross-examination of the last 25 years (and one of the longest ever in British legal history)|
|Length of Opening Submissions (total for all parties)||1,067 pages|
|Length of Closing Submissions (total for all parties)||4,494 pages|
|Number of documents in the corpus||11.3 million|
|Number of lawyers||30+|
|Number of barristers||14, of which 4 are leading QCs|
|Costs (estimated)||£40+ million|
Mike Lynch has submitted himself for arrest, a formality required as part of the extradition process initiated by the US Department of Justice (DOJ).
This case has wider implications for British business. The US claims concern alleged conduct in the UK. Dr Lynch is a British citizen who ran a British company listed on the London Stock Exchange, governed by English law and UK accounting standards. This extradition request reflects yet another example of the DOJ's attempts to exert extraterritorial jurisdiction over non-US conduct. The forum bar in the UK Extradition Act was enacted by the UK Parliament to protect British citizens from such a scenario.
Dr Lynch vigorously rejects all the allegations against him and is determined to continue to fight these charges.
Since Hewlett-Packard (HP) first raised these allegations more than seven years ago, Dr Lynch has steadfastly denied them and has worked hard to properly respond and set the record straight. The UK Serous Fraud Office previously investigated and did not pursue the allegations. Dr Lynch has now answered HP’s claims in the appropriate forum, the High Court in London, where he attended court every day of the 10-month trial. During that trial, Dr Lynch testified about all of these allegations for more than 20 days. He has not hidden, nor has he shied away from defending his conduct. Having patiently and diligently defended the case in England for several years, he awaits the civil trial judgment. The US DOJ should not have commenced extradition proceedings prior to the judgment of the English High Court.
Alex Bailin QC, said in court:
Dr. Lynch categorically denies all the allegations against him and will be resisting extradition on the basis of the forum bar. These matters concern a British citizen, UK-based conduct, a UK listed plc, culminating in a UK civil trial in which judgment is pending – these matters unquestionably belong here in the UK. The forum bar exists to provide real protection against this interventionist type of action and this, we will say, is a paradigm forum bar case.
I can also say that the superseding indictment, reaching back and spanning almost a decade, is breathtakingly broad. The jurisdictional claim here is unwarranted and immediately raises questions about whether this court's process is being abused and issues of dual criminality.
Mr. Hussain defrauded no one and acted at all times with the highest standards of honesty, integrity and competence. It is a shame that the United States Department of Justice lent its support to HP’s campaign to blame others for its own catastrophic failings.” John Keker, lawyer for Sushovan Hussain.
Defense evidence of Hewlett-Packard's conduct in the year following the acquisition, which would have shown the jury that HP was not in fact misled at all, was excluded from evidence and will be one basis for the appeal.
Sushovan Hussain is innocent of wrongdoing. He defrauded no one and, as Autonomy’s CFO, acted at all times with the highest standards of honesty, integrity and competence. He will be acquitted at trial.
It is a shame that the Department of Justice is lending its support to HP’s attempts to blame others for its own catastrophic failings. Mr. Hussain is a U.K. citizen who properly applied U.K. accounting rules for a U.K. company. This issue does not belong in a U.S. criminal court.
It’s especially galling that the Justice Department is pursuing this case on behalf of HP, a company that went out of its way to employ a web of offshore shell companies to acquire Autonomy with the specific intent of avoiding payment of U.S. taxes.
We look forward to trial.
Finally, after fighting in court to suppress its publication, HP has been forced to make public KPMG’s due diligence report, which it had given to HP and its board prior to the acquisition of Autonomy. In it, KPMG pointed out Autonomy’s accounting practices.
The KPMG report is 44 pages in total. We have juxtaposed some of HP’s public statements with the relevant section of the due diligence report:
HP SAID: “The mischaracterization of revenue from negative-margin, low-end hardware sales with little or no associated software content as ‘IDOL product,’ and the improper inclusion of such revenue as ‘license revenue’ for purposes of the organic and IDOL growth calculations.” HP Statement Regarding Autonomy Impairment Charge, 20 Nov 2012
HP SAID: “These hardware sales were frequently reported as licenses.” Cathie Lesjak, 20 Nov 2012, AllThingsD, “What Exactly Happened at Autonomy?”
HP SAID: “While HP eventually learned that a portion of Autonomy’s revenues were related to hardware sales, we knew nothing of the accounting improprieties, misrepresentations and disclosure failures related to such sales until after … an extensive investigation.” HP spokesperson, 17 Feb 2014, Financial Times, “HP/Autonomy investigation: Tangled web of hardware and resellers”
|KPMG reported to HP’s board that: “In limited situations, Target will ship its software pre-installed on hardware to its customers. Target recognizes revenue for the hardware in conjunction with the software license, when it is delivered.” KPMG Report, “Supporting analysis, Revenue recognition – delivery models (1)”||
HP SAID: “The VAR sales were reported as licenses, and they weren’t, in some sense, real sales, because there was no end user.” Cathie Lesjak, 20 Nov 2012, AllThingsD, “What Exactly Happened at Autonomy?”
HP SAID: “The use of licensing transactions with value-added resellers to inappropriately accelerate revenue recognition, or worse, create revenue where no end-user customer existed at the time of sale.” HP Statement Regarding Autonomy Impairment Charge, 20 Nov 2012
HP SAID: “In Autonomy’s case, certain VARs were used to fabricate or accelerate what was then held out by Autonomy to be revenue and profits.” HP Claim No. HC-2015-001324, 17 Apr 2015, pg. 11, 18.104.22.168
|KPMG’s report to the HP Board specifically noted: “Sell in vs sell through: Target recognizes revenue for license sales upon sell-in to its VARs rather than on a sell-through basis to end customers.” KPMG Report, “Executive Summary, Key Findings – 2”||
HP SAID: “The structuring, or restructuring, of these [hosting] arrangements [...] was not genuinely in the furtherance of Autonomy’s business, but instead was for the improper purpose of providing a pretext for accelerating the recognition of revenue and profits so that the same were recognised at the commencement, or at the time of the restructuring, of the arrangement.” HP Claim No. HC-2015-001324, 17 April 2015, pg. 61, 103
|KPMG reported to HP’s Board license/hosted arrangements, and Autonomy’s different accounting processes, with Autonomy’s growth rates and revenue recognition to be affected by the acquisition.i. “Hosted: Target sells its software as a hosted service that can be accessed via the internet and is installed on Target’s servers that are dedicated to the specific customer … These arrangements are comprised of a license to use the software via the Internet (usage based, pay as you go) over a specific term (usually three to five years). Some customers also have the option to take possession of the software, converting the arrangement into an on-premise solution.” KPMG Report, “Supporting analysis, Revenue recognition – delivery models (1)”
|GROWTH RATES DIFFERENT
HP SAID: “Autonomy was smaller, less profitable and slower-growing than we were led to believe.” Meg Whitman, 3 March 2013, Sunday Times, “HP sheriff rides out in hot pursuit of Autonomy”
|HP was told by KPMG that differences between IFRS and US GAAP would impact historic growth rates: “we believe there may be differences which could impact the historical growth rate and the timing of revenue recognition post-closing. … When data becomes available, consider US GAAP differences on historical growth rates and the potential impact on revenue recognition in immediate post-acquisition period” KPMG Report, “Executive summary, Key findings – 2”||
HP SAID: “You have active concealment,” John Schultz, HP’s General Counsel, said. “[Deloitte] obviously didn’t catch these issues at the time. It was difficult, if not impossible for HP to catch them.” 20 Nov 2012, Bloomberg, “HP Plunges on $8.8 Billion Charge From Autonomy Writedown”
HP SAID: “[T]here were severe disclosure failures,” John Schultz, HP’s General Counsel, said. 20 Nov 2012, AllThingsD, “What Exactly Happened at Autonomy?”
HP SAID: “Not surprisingly, Autonomy did not have sitting on a shelf somewhere a set of well-maintained books that would walk you through what was actually happening from a financial perspective inside the company,” he said. “Indeed critical documents were missing from the obvious places, and it required that we look in every nook and cranny.” John Schultz, HP’s General Counsel, 20 Nov 2012, Reuters, “HP alleges Autonomy wrongdoing, takes $8.8 billion charge”
HP SAID: “HP launched its internal investigation into these issues after a senior member of Autonomy’s leadership team came forward … This individual provided numerous details about which HP previously had no knowledge or visibility.” HP Press Release, 20 Nov 2012
|All of Autonomy’s accounting practices are outlined in the KPMG report, which details accounting treatment of hardware, resellers, hosted, growth rates, etc.
|Concerns over intervention from Oracle and its potential access to due diligence driven by UK disclosure requirements: “Was particular concern Oracle would take actions to interfere w/ acquisition – even if not a serious bidder:
Autonomy Acquisition UK Overlay, pg. 236.
|Email from Shane Robison to Leo Apotheker, 9 July 2011: “We need to be careful about obtaining any non public information.” Autonomy Acquisition UK Overlay, pg. 237.||
|Email from Shane Robison to Marge Breya on 15 July 2011: “At this point […] we don’t want to see any non public information. We can talk live if necessary.” Autonomy Acquisition UK Overlay, pg. 237.||
|Email to Shane Robison from Andy Johnson (HP Corporate Development) sent 15 July 2011: “I asked Barclay’s to do some analysis of how the O company [Oracle] might interfere with our process…O[racle] can say they are interested after we announce and get access to all the diligence we have received so the takeaway is to be careful about our diligence so we don’t enable O[racle] to get a deep dive on sensitive data.” Autonomy Acquisition UK Overlay, pg. 236||
|Cathy Lesjak email to Shane Robison and Leo Apotheker on 1 September 2011: “I wanted to make sure you had it, too. We believe this is just negative tactics by Hurd/Oracle. I am assuming that the due diligence that your team did with KPMG would have picked up any of these types of issues.” Internal HP Emails||
|At the midnight hour, the night before the announcement, Ray Lane receives some “new news”, which leads him to call a last-minute meeting with no executives. No one knows what was discussed at the meeting, but despite concerns, Ray Lane backed the deal on the after Leo Apotheker reassures him. THE BOARD MINUTES FROM THIS MEETING HAVE DISAPPEARED. Proskauer Report, “ATS – August 17, 2011 OD Meeting”||
|Leo Apotheker /Ray Lane argument: Ray Lane is “haunted.” Leo replies “if Autonomy and more software isn’t the solution, what is the alternative?” Ray Lane never replies. Internal HP Emails||
|The Board, Leo Apotheker and Shane Robison never read the KPMG due diligence report. Proskauer Report, “Due Diligence – KPMG Report”||
* Note that the page numbers quoted above relate to the page number of the PDF document not the page number of the report itself.
Following on from the news coverage relating to the documents which were posted on May 5th, and are available below on this blog, there is a thorough and insightful background piece in The Independent today, by its Deputy Business Editor Ben Chu.
His article focuses on the differences in accounting practices between the US and the UK and includes a quote from Melanie McLaren, executive director of codes and standards at the UK’s Financial Reporting Council, in which she says:
“It is a fact that US GAAP and IFRS, in terms of revenue recognition, are currently on different standards.
“Based on what I have read this seems to be what the [HP] dispute is about. It may be that under IFRS, judgements have been made as to what to recognise when that would have been made differently if you’d been following a more prescriptive US GAAP approach.”
As we pointed out on May 5th, our position has always been clear, that HP’s allegations—drafted with the benefit of a nearly three-year investigation—make no case for fraud. Rather, they evidence, at best, a difference of opinion over accounting policies—a disagreement in which two Big Four firms, Deloitte (Autonomy’s auditor) and Ernst & Young (HP’s firm) agree that there is nothing wrong with the pre-acquisition financials.
Today we acknowledge receipt of HP’s civil claim against the former management of Autonomy.
As readers will see from our comments below, we utterly refute the allegations made against us. HP has waged a three-year smear campaign riddled with half-truths and obfuscation. They have intentionally made the claims as complex and convoluted as possible. This is why, in the interests of transparency, we have posted a series of updates to this blog today so that everyone can see the allegations for themselves and fully understand our position.
There are three separate sections, which we set out below, as well as a downloadable PDF version of the letter from our lawyers Clifford Chance.
The links above will take you directly to each specific post, or you can get to them by scrolling down the page.
Dear Mr. Wolinsky:
As you know, we, along with Steptoe & Johnson, represent Dr. Michael Lynch. Hewlett-Packard Company’s (“HP“) decision to file in the referenced action (the “California Action“) the Particulars of Claim (the “Particulars“) filed against our client by various HP subsidiaries in the United Kingdom (the “UK Action“), a proceeding to which, quite notably, HP is not a party, is a continuation of HP’s transparent effort to generate one-sided publicity for its specious claims and false statements, avoid disclosure and engagement on the merits, bury HP’s own malfeasance, and insulate its directors and officers from liability.
We write to you now to make plain—as we have made clear to HP on several previous occasions—that the claims in the Particulars are without basis. While Dr. Lynch looks forward to unmasking the falsity and hypocrisy of these allegations in the courts of England (where, if at all, the matter belongs), in the interest of full disclosure, we request that, once the Particulars are unsealed, you amend your filing in California to include this letter, which sets forth below Dr. Lynch’s preliminary responses to the Particulars. In this way, the court, parties, and the public can have a fair understanding that the allegations in the Particulars are without basis and emphatically denied and that this matter will be fiercely contested in the courts of England.
HP’s (notably unparticular) Particulars make clear that HP has had very good reason for its two and a half years of stalling, misdirection, and evasion regarding the details of its allegations against our client and other members of Autonomy Corporation plc’s (“Autonomy“) former management. Simply put, after two and a half years of apparent investigation—no doubt at a cost of many tens of millions of dollars to the shareholders of HP—it is clear on the face of HP’s own filings that its claims are baseless.
HP’s patchwork tale of alleged misconduct rests on a faulty foundation of false facts, unsupported inferences, and a misunderstanding and misapplication of the relevant legal and accounting standards. Nearly two and a half years after HP announced its write-down, it is clearer than ever before that HP’s claims are merely a tactic to obscure the true source of HP’s and Autonomy’s losses: the wrongdoing and ineptitude of HP’s own directors and officers.
That HP’s claims are without merit is plain from the preliminary response set forth below. But several points omitted from HP’s claims bear noting at the outset. In particular, the evidence shows that at all times:
Accordingly, it should not be surprising that there is not one shred of actual evidence establishing any pre-acquisition misconduct by anyone at Autonomy, let alone evidence of fraud. There are no documents or witnesses—and HP has pointed to none—that demonstrate that any former member of Autonomy’s management acted with anything but honest intentions, good faith, and reliance on the professionals described above. This is hardly the stuff of a legendary fraud. In fact, in 2010 the Financial Reporting Review Panel (the “FRRP“) of the Financial Reporting Council, the regulatory body in England responsible for regulating accounts and accountants, reviewed many of the same transactions at issue here and found no basis for a continuing inquiry—as did Autonomy’s Audit Committee and its external auditors at Deloitte.
Despite the lack of any credible evidence of wrongdoing, HP first surfaced its opaque and spurious claims in November 2012. Around that time, it reportedly brought the allegations to the attention of regulators in the United Kingdom and the United States. Reflective of the dearth of actual evidence, well more than two years on, the UK’s Serious Fraud Office closed its investigation without charges, and Dr. Lynch was dismissed from the only active lawsuit in the United States that named him as a defendant.
Nor can HP’s far-fetched fraud accusations be reconciled with the fact that almost every senior member of Autonomy’s management eagerly stayed on at HP Autonomy after the acquisition. Does HP claim that the fraud was so cleverly hidden that Autonomy management could join HP secure in the knowledge that the misconduct would remain undetected, despite knowing that HP would have full access to Autonomy’s books and records? No. To the contrary, HP’s claims are purportedly based on the very books and records HP controlled the day the acquisition closed. And, regarding those books and records, HP conveniently fails to mention that despite the claimed $5 billion fraud, no cash is missing at Autonomy: Indeed, once all of the supposedly manufactured revenue is removed, Autonomy’s financials show over $450 million cash surplus. How is this fraud?
Yet another unexplained mystery is why it took HP two and a half years of ever-changing allegations to decide on a story that it is willing to tell in a pleading. The only constant in that time is the grinding of HP’s tired wagons circling around its own officers and directors—the very people who actually bear responsibility for the destruction of Autonomy’s value (as well as numerous companies before). Indeed, HP’s campaign of misdirection highlights its fear that its officers and directors will be found liable for the losses, culminating now in a plea to the judge overseeing the shareholder derivative litigation in California to forbid anyone from bringing any Autonomy-related claim against those individuals.
In reality, there is nothing mysterious about any of this. The simple truth is that HP’s losses were not caused by anyone at Autonomy. They were caused by HP’s own incompetence and malfeasance. HP has demonstrated once again its inability to make a potentially transformative acquisition work. It grossly overestimated the projected synergies to be realized from the deal, bungled the integration of Autonomy into HP, and then hid the whole thing from the market for as long as it possibly could. That is the real story of fraud here.
After boardroom scandals, failed acquisitions, and instability in its executive suite, HP looked to the October 2011 acquisition of Autonomy to reverse its fortunes and transform itself from a low-margin hardware provider to a high-margin enterprise software company. In particular, HP anticipated that: (1) Autonomy’s IDOL software, which HP board member (and now CEO) Meg Whitman has called “almost magical,” could be combined with software from HP’s newly acquired structured-data solution, Vertica, to create an industry game-changing technology that could process both structured and unstructured data; (2) HP could leverage its global sales footprint and complementary hardware to drive Autonomy sales around the world; and (3) HP would, overall, use its low-margin legacy assets to drive high-margin Autonomy software sales.
HP was eager to finalize the deal without competition from other potential suitors, or exposing sensitive competitive information to competitors. HP’s bid reflected that. It was aggressive in its pricing, but reflected a reasonable value for Autonomy in the hands of a competent acquirer. However, HP’s officers and directors were well aware that HP was not a competent acquirer. At the time of the Autonomy merger, HP—and only HP—knew that (a) it was about to abandon its Palm operating platform, which it had acquired only a year earlier for $1.8 billion; (b) it was preparing to announce its departure from the PC market, its core business, which accounted for roughly one-third of its revenue; and (c) it was about to release poor earnings results and lowered guidance, which would certainly lead to a drop in the stock price. In fact, these announcements—made the same day the Autonomy acquisition was announced—resulted in a one-day drop of 20% in HP’s share price, reducing its market capitalization by $12 billion.
The architects of the Autonomy acquisition were HP’s then-CEO, Léo Apotheker, and then-Chief Strategy and Technology Officer, Shane Robison. In September 2011, before the Autonomy acquisition was even completed, HP fired Mr. Apotheker and replaced him with Ms. Whitman. Mr. Robison left HP the following month. Thus, Autonomy was left to try to integrate into HP without the very people who had conceived of the acquisition and who were uniquely positioned to execute that integration. There was no handover of the integration plan, and key decisions made pre-acquisition were not implemented. HP did not even hire a new Chief Strategy and Technology Officer to replace Mr. Robison. In short, a period of chaos ensued at a critical time for the integration.
The damage was immediate and severe. Hundreds of key Autonomy employees left in the year following the acquisition. HP never integrated IDOL and Vertica to create the new product on which the acquisition was largely predicated. HP’s preexisting staff actively worked against Autonomy by marketing its competitors’ products, due to dysfunctional internal incentive structures. For example, HP salespeople did not receive “quota credit” or commissions for sales of Autonomy products, as they did for third-party software products, and HP’s Enterprise, Storage, Servers and Networking (“ESSN“) department refused to support Autonomy’s efforts to use ESSN hardware because sales to Autonomy did not count toward ESSN’s sales quota. HP prevented Autonomy from executing its own marketing strategy and repeatedly excluded Autonomy from participating in HP’s public relations events. HP did not provide Autonomy with the necessary sales and services support or staff, and HP’s Software department engaged in a power struggle with Autonomy leadership for control over the direction of HP’s software offerings. HP mishandled the pricing of Autonomy products, sometimes heavily discounting them to incentivize HP’s low-margin hardware sales and at other times marking them up significantly to boost the revenues of lagging HP departments. Perhaps most telling of the internal discord, HP staff refused to sell or recommend Autonomy products until Autonomy was “certified” for HP hardware, a process that was estimated to take a year.
Predictably, these problems caused a sharp drop in Autonomy’s historical close rates. Dr. Lynch provided Ms. Whitman with a presentation in May 2012 analyzing the reasons for this decline, including Ms. Whitman’s failure to control the infighting and dysfunction at HP. A few days later, Dr. Lynch was fired.
Faced with a crisis of its own making, HP chose to write down the value of Autonomy and to make unsubstantiated allegations of accounting irregularities against Autonomy’s former management. Those statements by HP to the market, beginning on November 20, 2012, and continuing to the present day, were false, and HP knows it. Since HP first announced the write-down, HP has struggled to explain the numbers underlying its claim. In that time, HP has busied itself conducting a supposed “investigation,” the result of which was pre-determined from the outset, to support its claims and scapegoat Dr. Lynch, Mr. Hussain, and Autonomy’s former management. That the allegations against former Autonomy management are unsupported is evident from HP’s ever-shifting rationales for its accusations. For example, HP claimed in November 2012 to have been unaware that Autonomy sold any hardware. By September 2014, HP conceded that it had been aware that Autonomy sold hardware but claimed not to have known of the type of hardware that Autonomy sold. In fact, HP knew about Autonomy’s hardware sales all along. Additionally, it appears that HP may be using its allegations against Autonomy’s former management and the accompanying re-characterizations of historical revenue to make improper claims for corporate tax refunds.
While we are still reviewing the Particulars, to which we will respond formally in court in due course, it is clear on the face of the Particulars that they are merely the latest evolution of familiar, and flawed, allegations that HP has pressed for the past two and a half years. What follows is a summary response to some of the core allegations made in the Particulars. We look forward to receiving and reviewing discovery from HP and are certain that documents solely in HP’s possession at the moment will further reveal the true folly of HP’s allegations.
Throughout its life as a public company, Autonomy’s accounts and policies were reviewed by external auditors and judged to be compliant with applicable accounting standards. Specifically, for the years 2005 through 2010, Deloitte audited Autonomy’s annual statements, which were prepared in accordance with International Financial Reporting Standards (“IFRS“) as adopted by the European Union, the regime under which UK listed companies are required to report their accounts. Autonomy’s accounting and disclosure complied with IFRS. Autonomy’s external auditors at Deloitte also reviewed Autonomy’s quarterly and interim financial statements to ensure compliance with the relevant standards and rules. As such, Deloitte reviewed Autonomy’s financial statements for the first six months of 2011 and reported on July 27, 2011—just before the acquisition by HP—that it had no reason to believe that any aspect of the accounts had not been “prepared, in all material respects, in accordance with” the governing standards.
Deloitte’s judgment was based on all of Autonomy’s relevant financial information. Deloitte’s practice was to review all sales contracts and invoices for more than $1 million and a sample of contracts for more than $100,000. In addition, each quarter Autonomy’s management provided a report to the Audit Committee, with a copy to Deloitte, describing (among other things) Autonomy’s financial results, significant events, software and hardware sales, bad debts, and cash collection.
Deloitte reported directly to Autonomy’s independent Audit Committee, which was appointed by the company’s non-executive directors. The committee was responsible for monitoring the company’s financial statements and public announcements relating to financial performance. In 2009, the committee included Barry Ariko, a former Silicon Valley hardware and software executive. In 2010 and 2011, the committee was chaired by Jonathan Bloomer, a chartered accountant, former senior partner at Arthur Andersen, former CEO of Prudential, former Chairman of the Financial Services Practitioner Panel of the Financial Services Authority (“FSA“), and current member of the UK Takeover Panel. Each quarter, Deloitte provided the Audit Committee with a detailed report analyzing all significant accounting decisions for the relevant financial period, and the committee met quarterly with Deloitte to review Autonomy’s financial statements and discuss significant accounting risks, including revenue recognition and disclosure. Each meeting included a “no management present” session with Deloitte. As CEO, Dr. Lynch was not a member of the Audit Committee, did not attend Audit Committee meetings, and was not responsible for accounting decisions.
Notably, revenue recognition was identified as a key focus in Deloitte’s reports to the Audit Committee and, in each case, the Audit Committee approved Autonomy’s financial statements and Deloitte issued unqualified audit opinions.
Nonetheless, HP appears to contend, in paragraph 133.5 of the Particulars, that the location of Dr. Lynch’s and Mr. Hussain’s desks somehow demonstrates a shared awareness of, and responsibility for, all the transactions at issue and their related accounting. The reality is that Dr. Lynch and Mr. Hussain relied on Autonomy’s extremely experienced auditors and Audit Committee, professional sales force, technical team, finance team, and attorneys. This argument seems especially ludicrous given that Dr. Lynch and Mr. Hussain had separate offices, with the exception of one Autonomy location that utilized an open-plan office—far from the den of conspiracy implied by HP.
HP makes much of the fact that Autonomy often closed deals at or near the end of a fiscal quarter. That misplaced emphasis simply illustrates how out of touch HP is with the nature of the software business that it supposedly has been operating for three and a half years now. As everyone who has even a passing familiarity with the software industry knows, it is common for deals to be done toward the end of or on the last day of the quarter. The reason is simple: As in any business, customers prefer to hold out for the best deal for as long as possible, and because software can be delivered instantaneously, these negotiations can continue right up until the closing minutes of a quarter. HP’s ignorance of this is bemusing, especially in light of its purported laser-like focus on accounting rules. This practice is so commonly accepted and well known that it is described in accounting treatises. And, despite HP’s professed ignorance, the truth is it engages in the same practices.
HP also complains (in paragraphs 135.2 and 135.3 of the Particulars) that Autonomy managed its sales pipeline in order to hit its revenue target for each quarter. Again, this allegation evidences a shocking naiveté about the way the software business—and, indeed, any publicly traded company—actually works.
Autonomy was a FTSE 100 company—one of the largest 100 companies listed on the London Stock Exchange (“LSE“) by market capitalization. As with most LSE companies, and especially those in the FTSE 100, market analysts tracked Autonomy’s financial performance and came to a “consensus” regarding the company’s anticipated revenues and share price for each quarter, half-year, and year-end, based both on analysts’ independent research and on Autonomy’s financial announcements. Autonomy, like its peers, monitored these numbers and aimed to hit its projected targets for each quarter, in order to manage market expectations and rationalize growth. Results that fell far short of expectations obviously could lead the market to conclude that the company was in trouble, while an anomalous quarter that far exceeded projections could lead to unduly inflated expectations for future quarters.
Autonomy’s management of its sales pipeline was proper. Indeed, if it had not done so, it would have been vulnerable to allegations of management incompetence. Nor did Autonomy do anything out of the ordinary (much less fraudulent or illegal) to achieve those targets. Indeed, the company’s annual report and accounts repeatedly described its efforts in this regard. For example, in the Financial Review section of the Annual Report for the year ended December 31, 2010, the CFO, Mr. Hussain, disclosed:
The same Financial Review also disclosed (in case anyone might have been unaware of the fact) that late in-the-cycle purchasing was common in the software industry.
Immediately after the Autonomy acquisition was finalized in October 2011, HP hired Ernst & Young (“E&Y“) to perform an independent review of Deloitte’s audit files on Autonomy. Those files included Deloitte’s quarterly reports to Autonomy’s Audit Committee, which described, among other things, Autonomy’s strategic sales of hardware and reseller transactions (discussed in more detail below). HP does not claim, and there is no indication anywhere in the available record, that E&Y identified any concerns or issues regarding Autonomy’s accounts or accounting policies. Rather, E&Y appeared to be comfortable with Autonomy’s accounting.
At around the same time, HP hired KPMG to review Autonomy’s opening balance sheet and past transactions. KPMG, too, expressed no concerns about the propriety of Autonomy’s accounts or policies, and appeared to be comfortable with Autonomy’s accounting. In fact, HP and its outside advisors reviewed Autonomy’s accounts thoroughly enough to determine that it would be acceptable to take a $45 million write-off and promptly did so, yet neither party found anything to suggest that there was any impropriety at Autonomy, let alone a massive fraud.
Autonomy sold hardware to drive software sales. This perfectly legitimate practice was widely known, handled openly within the company, and carefully monitored and approved by Deloitte and the Audit Committee. In 2009, there were three significant developments in the market for Autonomy’s Digital Safe software:
(1) Shift to appliances: Many industry analysts were predicting that traditional sales of software would be replaced by the sale of software pre-loaded on hardware—what became known as an appliance. At around this time, Google developed a search appliance that directly competed with Autonomy’s software products, and Whit Andrews of Gartner, an influential industry analyst, actually de-rated Autonomy for its weakness in the appliance category. Autonomy was in a difficult position because it could not purchase hardware cheaply enough from manufacturers to produce a competitively priced appliance product or optimize appliance performance via customized hardware.
(2) Customers combining hardware and software on-site: Autonomy had been selling hosted Digital Safe archiving to banking customers. As these clients’ archiving needs exploded in an increasingly digital and regulated world, some customers decided to purchase both the software and the necessary hardware (though not necessarily at exactly the same time) and then put the two together on-site as needed.
(3) Strategic supplier status: By 2009, a number of large Autonomy customers were reviewing their IT supply chains to streamline the number of suppliers that they would deal with directly. The trend was to designate the largest vendors as “strategic suppliers,” who would in effect act as general contractors, procuring from smaller vendors whatever products they themselves did not make, and taking for themselves some of the profit on the resale. This shift jeopardized Autonomy’s access to such customers, because it did not sell them enough software to qualify as a strategic supplier. Unless Autonomy could find a way to significantly increase its aggregate sales to these clients, it would have to route its future sales through strategic suppliers, and would therefore have to dramatically reduce its margin in order to maintain an attractive price to the end user despite the intermediary’s markup (typically 30 percent). Or, worse yet, certain larger companies with strategic supplier status—such as EMC or IBM—could have decided to produce directly competing software products, potentially eliminating entire categories of key sales. To ensure strategic supplier status with such customers and thereby protect its software margins and sales opportunities, Autonomy thus sought to increase its aggregate sales volume by offering hardware.
As a result of these three market shifts, Autonomy sought to develop strategic relationships with hardware suppliers in order to: (1) obtain hardware in competitive volumes and at competitive prices and, through such marketing relationships, generate sales of that hardware to in turn generate sales of software; (2) develop relationships with hardware vendors that could help Autonomy find a solution to the strategic threat arising from the industry move toward appliances; and (3) develop relationships with hardware suppliers to foster joint marketing activities. In particular, Autonomy’s management made it a priority to develop closer relationships with key hardware suppliers EMC, Dell, and Hitachi. Autonomy fully disclosed this initiative, and the reasons behind it, to the Audit Committee and Deloitte. Autonomy’s internal Strategic Deals Memorandum, to which HP refers in paragraph 142.9.1 of the Particulars, sets out Autonomy’s rationale for selling hardware.
The strategy was successful: Autonomy entered into strategic hardware agreements in Q3 2009 with Citigroup, Bloomberg, and JPMC. Autonomy initially partnered with EMC to procure this hardware, but shortly after Autonomy began shipping EMC hardware under this arrangement, EMC’s content group acquired an Autonomy competitor, resulting in the termination of the hardware relationship. Autonomy continued to maintain a cordial relationship with EMC, however, and in 2010 Autonomy even considered acquiring EMC’s content division for approximately $2.4 billion. Although the deal fell apart when EMC’s content division repeatedly missed its numbers, the negotiations show that the relationship with EMC was a continuing and potentially beneficial one.
As its hardware relationship with EMC came to an end, Autonomy began to form a closer relationship with Dell, which was in any event better positioned to help Autonomy because Dell, unlike EMC, was able to supply servers as well as storage. As a result, Autonomy used Dell as its hardware supplier from the end of 2009 until 2011.
HP has alleged three broad categories of accounting irregularities:
None of HP’s allegations hold water.
Indeed, HP seems to find its own arguments about hardware less than persuasive, given how many times it has changed its story since it began its public witch-hunt in 2012. First, HP claimed in its November 20, 2012, press release, and in an interview with Bloomberg the same day, that it had “no knowledge or visibility” of Autonomy’s hardware sales until May 2012. But HP has since had to admit that E&Y’s November 2011 review of Deloitte’s work papers “identified Autonomy’s hardware revenue, which E&Y reported to HP,” and that KPMG’s 2011 review likewise identified $41 million in Autonomy hardware sales, which “HP management” discussed with Autonomy at the time.  Indeed, we are confident the evidence will show that not only did HP ask specific questions about Autonomy’s hardware sales, including questions about the type and amount of Dell hardware transactions, but also that Autonomy provided prompt, accurate, and complete responses to those questions. Unable to sustain its initial public claims of ignorance in the face of hard evidence to the contrary, HP then made a new allegation: that although it was aware of the fact and quantity of Autonomy’s hardware sales, it did not know what type of hardware Autonomy sold. But HP was soon forced to abandon this argument too; a September 12, 2014, Wall Street Journal article quoted an HP spokeswoman who admitted that in 2011 Autonomy “described [its hardware sales to HP] as either ‘appliance sales’ or ‘strategic sales’ designed to further purchases of Autonomy software.” Contemporaneous emails confirm this fact.
With its prior false claims about Autonomy’s hardware sales conclusively debunked, HP has retreated to vague and unsupportable generalities, asserting that it never knew that Autonomy sold “pure” hardware (whatever that means). What is clear, however, is that HP was well aware in 2011 that Autonomy sold hardware for the strategic purpose of driving its core software sales. HP nonetheless appears to imply (in paragraph 54 of the Particulars) that if hardware and software sales were not included on the same order, then there could be no link between the sales. This implication is utterly unfounded and flatly wrong. Strategic hardware sales were undertaken to promote not only present but also future software sales; thus, such sales could plainly be linked even though they took place at different times and therefore appeared on separate purchase orders. To use an analogy, on HP’s reasoning the sale of a video game system could not possibly be linked to the future sale of a game to be played on that system because the two sales would not be recorded on the same piece of paper. Such an argument is contrary to plain common sense (a problem that confronts all of HP’s allegations against Autonomy, as will be seen below).
Further evidence that the hardware and software sales were linked—if any further evidence were needed—comes in the form of HP’s own continued resales of Dell hardware to drive Autonomy software sales well into 2012, long after the acquisition was completed and HP’s finance team had taken control of Autonomy’s accounting. Senior HP accountants and advisors inquired about the Dell hardware resales and knew that they were made at a loss. Indeed, the available record suggests that these resales were ultimately terminated not by HP but by Dell.
HP’s numerical estimates of the revenue generated by what it calls “pure” hardware revenue are likewise far off the mark. Despite repeated requests, HP has failed to provide the documentation behind these figures, but from the available information HP appears to include in the category of so-called “pure” hardware revenue (a) profitable sales of hardware, (b) hardware sold with software, (c) hardware sold for combination with Autonomy software on the customer site as part of appliance programs, and (d) hardware sold under agreements where customers explicitly linked hardware and software purchases from Autonomy for calculations of overall discount targets. HP does not explain, of course, how such transactions can possibly be characterized as loss-making sales unconnected to profitable software sales (if, indeed, that is its intended meaning of “pure” hardware sales) and thus even on its own definition HP overestimates the percentages of revenue involved.
Autonomy appropriately accounted for the costs associated with its strategic hardware sales. Contrary to HP’s assertion (in paragraphs 68.3 and 68.4 of the Particulars) that Autonomy improperly accounted for some of those costs as sales and marketing expenses rather than costs of goods sold (“COGS“), IFRS provides no accounting standard governing cost accounting for discounted strategic sales, or the extent to which such costs should be allocated between COGS and sales and marketing costs. Rather, this is an area reserved to the directors’ judgment, subject to the scrutiny of internal and external auditors. Autonomy’s allocation of these costs was at all times reviewed by its Audit Committee and Deloitte, who uniformly approved Autonomy’s accounts.
Under IAS 8.10, the objective of the cost allocation should be to reflect the underlying economic substance of the transaction. Accordingly, the appropriate test is whether and to what extent Autonomy’s strategic hardware sales were made for marketing purposes—i.e., to promote future software sales. Consistent with this principle, Autonomy estimated the COGS component of its hardware costs by looking to the standard cost of such hardware (as provided, for example, by EMC), and then categorized the remainder of its actual costs—i.e., the amount above the standard hardware cost, which could only be attributable to Autonomy’s strategic purpose in undertaking the sales—as a sales and marketing expense. This straightforward and common-sense approach follows the normal accounting and business methods for establishing the value of separate parts of a transaction and, again, was fully overseen by Deloitte, who satisfied itself that this accounting complied with IFRS.
HP’s allegations to the contrary are based on selective quotations taken out of context and mischaracterized. For example, paragraph 142.8.1 of the Particulars alleges that Mr. Hussain misrepresented to the Audit Committee in Q3 2009 that Autonomy and EMC were engaged in a “highly targeted joint marketing program” and that Autonomy had “spent US$20 million on shared marketing costs with EMC” when, in reality, neither the joint marketing program nor the shared marketing expenditure existed. The full quotation from the note reveals, however, that Mr. Hussain was accurately describing movement in quarterly operating costs: “There were 2 large movements. Firstly, in sales and marketing we spent around $20m on sharing marketing costs with EMC and extra marketing on our new product launch (Structured Probabilistic Engine).”
Similarly, in paragraph 142.8.3 of the Particulars, HP provides a misleading selective quotation in support of its claim that Mr. Hussain misrepresented to the Audit Committee in Q2 and Q3 2010 that the costs of hardware had been charged to COGS when, in fact, a portion of those costs had been charged to sales and marketing expenses. Mr. Hussain’s actual statement, however, was critically different from HP’s portrayal: “We have charged the cost of the lower margin sales to the cost of sales line even though we had agreed with our suppliers that the [sic] 50% of the cost would be used for marketing purposes.” This sentence conveyed that costs equal to the amount of the sales were allocated to COGS and the loss on the sales was allocated to the sales and marketing line. Deloitte made this clear in its report:
Management has taken all of the costs associated with the Dell hardware sales to cost of sales with the exception of the loss of approximately $3.8 million which has been allocated to sales and marketing expenses. . . . We have reviewed management’s analysis of the linkage between the loss making strategic hardware sales and subsequent profit making software sales and accept the decision of management to allocate the loss of $3.8 million to sales and marketing.
Finally, Autonomy’s marketing-cost allocation did not mislead the market by distorting its gross margins. The prosaic reality is that the gross-profit metric fluctuated in any event, and any impact of the hardware accounting was insignificant and consistent with the usual variations in this margin, which were highlighted in various analyst calls. In this context, the argument that a variation of a few percentage points in gross margin would have materially affected investors’ views of the company is patently false. Additionally, HP was aware of Autonomy’s hardware accounting immediately following the acquisition, if not sooner, yet made no indication that the accounting was problematic until over one year later.
In short, Autonomy’s hardware resales were precisely targeted, properly accounted for, fully explained to its internal and external auditors, and did not distort either the market’s assessment of Autonomy’s value or HP’s valuation of the company. Contrary to HP’s baseless accusation in paragraph 142.4 of the Particulars, Autonomy was not acting as a generic hardware reseller such as Morse. Autonomy’s hardware sales, typically made at a loss and always designed to benefit the software business, were plainly dissimilar to the business of a generic reseller of hardware.
As HP implicitly concedes in paragraph 30.1 of the Particulars, Autonomy acted in full compliance with IFRS in classifying the income generated by its hardware sales as revenue. There is no proper basis for deducting the hardware transactions from Autonomy’s revenue figures. The hardware transactions took place, hardware was delivered, and revenue and cash were generated in return.
IAS 18 requires disclosure of each significant category of revenue, with significance to be determined as a matter of judgment. Here, Autonomy’s highly qualified accounting executives determined that its hardware sales did not constitute a significant category of revenue for the purposes of IAS 18, and the Audit Committee and Deloitte concurred in the reasonableness of that judgment. Indeed, that judgment was not only reasonable but also patently correct. The discounted hardware sales were merely ancillary to Autonomy’s software sales, and the overall effect was a high-margin software business.
Under IFRS 8, the revenue stream from any particular component of sales should be separately disclosed where two criteria are met:
(a) The component qualifies as an “operating segment” under IFRS 8.5 to 8.10; and
(b) The revenue stream from that component meets the quantitative threshold established by IFRS 8.13.
An operating segment, as defined by IFRS 8.5–8.10, is a corporate component:
(a) That engages in business activities, and may thereby earn revenues and incur expenses;
(b) That has operating results that are regularly reviewed by the chief corporate decision maker; and
(c) For which discrete financial information is available.
A corporate activity whose revenues “are only incidental” to the corporation’s business is not an operating segment.
Autonomy properly applied these principles. Its hardware sales did not qualify as an operating segment because:
(a) Autonomy did not operate a separate hardware sales division;
(b) Hardware sales were not subject to separate review by Dr. Lynch; and
(c) Autonomy’s hardware sales were incidental and made primarily to drive the core software business.
As a result, Autonomy had no obligation to separately disclose its hardware sales under this guidance. Autonomy’s single-segment disclosure was reviewed by its Audit Committee and by Deloitte, who concurred with management’s decision to disclose Autonomy’s revenues as a single segment and properly found that Autonomy’s hardware sales disclosure was consistent with its accounts.
Nor did Autonomy mislead the market by stating that it was a “pure software” company, despite HP’s incessant allegations to the contrary. Indeed, that argument is not only false but also utterly disingenuous: HP is (and was) well aware that the term “pure software” did not signify that Autonomy did not sell hardware, nor did the market ever interpret it to mean any such thing. Autonomy used the term merely to distinguish itself from other software companies that derive a significant portion of their revenue from the provision of professional services, including consultancy.
Autonomy’s business model focused on developing and licensing IDOL software. The company was not designed to be a professional services provider; rather, its model depended on the existence of a community of expert systems integrators and consultants who could customize and implement the relevant IDOL software for each customer’s particular uses. This meaning was clear not only from the very statements of which HP complains, which drew explicit distinctions between Autonomy’s “pure software” approach and the services component of similar companies, but also from the many public sources of information disclosing that Autonomy sold hardware.
Indeed, it is self-evident that software needs hardware to work and, as a result, it is quite common for enterprise software companies to sell some hardware as an essential adjunct to the core business of promoting and procuring software sales. Thus, it simply is not plausible that a prospective buyer that knew anything at all about the software industry could have thought that the words “pure software” meant that Autonomy sold no hardware at all. And, perhaps most tellingly, investment bank analysts’ notes, which HP actually reviewed during its pre-acquisition valuation of Autonomy, made clear that the market understood the term “pure software” to relate to a professional services-lite operation, not an absence of hardware.
In conclusion, Autonomy did nothing wrong in selling hardware, appropriately accounted for its hardware sales in accordance with IFRS, and sufficiently disclosed its hardware sales to its auditors and to the market. Further, the evidence will show that HP was aware of Autonomy’s hardware sales prior to the acquisition and that HP continued to resell Dell hardware post-acquisition. In these circumstances, HP’s allegations of fraud are transparently meritless.
Unsurprisingly, as group CEO, Dr. Lynch had little involvement in negotiating reseller deals or determining the related accounting. As a major player in the industry, however, Dr. Lynch was generally aware of the benefits of reseller deals and the importance of developing a reseller ecosystem.
In common with most software companies, including HP, Autonomy sought to develop and strengthen its reseller ecosystem, and thus often sold through reseller partners. Both Autonomy and the resellers derived commercial benefits from this arrangement. For Autonomy, these sales helped expand the network of providers that understood, marketed, and serviced Autonomy products. Through repeat business, resellers developed a deep understanding of Autonomy products, which enabled them to provide services and support to Autonomy’s customers (lower-margin tasks that Autonomy had little interest in performing itself). Additionally, certain resellers held GSA pricing schedules and/or government and security clearances beyond those held by Autonomy’s own employees. In partnering with these resellers, Autonomy gained access to markets it had not already penetrated. Under IFRS, a reseller was itself Autonomy’s customer for accounting purposes, and thus selling to the reseller amounted to a valid and enforceable sale.
Contrary to paragraph 74.3.6 of the Particulars, resellers could derive numerous commercial benefits from these sales. Such deals gave resellers the opportunity to connect with a new customer, gain a new reference logo, provide services, lock out competitors, and simply make sales and margin. And even where there was an intended end user of the product, the reseller could always negotiate with and sell to a different end user if it thought it could get more favorable terms.
As one means to foster these relationships, Autonomy would occasionally pay a marketing assistance fee (“MAF“) to compensate a reseller for its assistance in a sale or to make up for its lost margin where an end user ultimately elected to purchase directly from Autonomy. Autonomy took such steps voluntarily and in its discretion after a sale was completed. In each instance, such steps advanced Autonomy’s valid commercial interests in the success of its partners, the sale of its products to interested customers, and the related development of an ecosystem around its products. Deloitte reviewed and approved Autonomy’s use of MAFs, and openly discussed them in the Reports to the Audit Committee.
HP’s feigned surprise at finding that Autonomy engaged in reseller deals is especially disingenuous in light of the fact that HP operates a number of its own reseller compensation programs—ranging from opaque “contra” transactions to programs in which an HP reseller is entitled to rebates and referral fees for sales by HP where the partner somehow influenced the sales process. HP’s Reseller PartnerOne EMEA Program Guide, dated November 2012, explains that the PartnerOne program compensates reseller partners for, among other things, referrals: “A referral is when a customer buys directly from HP and the partner has been recognized for their contribution to the closing of that deal via a referral fee.” The guide goes on to list a few examples of such compensable contributions: “Referral fees are discretionary payments made to non-reselling partners, where the partner had demonstrable influence on a deal made directly between HP Software and the customer. Demonstrable influence can refer to: identification of sales opportunity, recommendation of the HP solution, involvement in the sales cycle, proof of concept, solution architecture, or associated return on investment.“
Notwithstanding the frequency of these relationships in the software industry and the well-understood benefits of developing a reseller ecosystem, HP suggests that Autonomy was somehow unique in developing this ecosystem and attempted to conceal its relationships with resellers. Contrary to paragraph 136.5.1 of the Particulars, the fact that Autonomy partnered with resellers was transparent and any decline in Autonomy’s use of resellers after the acquisition was primarily due to HP’s desire to funnel business to its own services arm, HP Enterprise Services.
HP’s allegations regarding reseller transactions are based on its fundamental misunderstanding of IAS 18, Autonomy’s accounting policy, and the nature of the reseller transactions themselves, all of which were legitimate and appropriately accounted for under IFRS. Further, it should be noted that HP singles out only a handful of individual transactions, making the baseless assertion that the resellers were not on risk for those transactions (despite the voluminous documentary evidence making clear that they were), and then desperately tries to extrapolate from these deals to the 23,000 reseller transactions that Autonomy conducted in the relevant period.
HP’s first, and most basic, error is its failure to comprehend that for accounting purposes it is the reseller, not any intended end user, that is Autonomy’s customer. Cathie Lesjak, HP’s CFO, misunderstood this as long ago as November 2012, and HP apparently has never regained its wits on the issue. The naming of an intended end user in the sales documentation with a reseller, although helpful to Autonomy in its management of the business, is not and never was a requirement under IFRS.
HP also misunderstands the concept of “risk” under IAS 18. HP’s allegation that resellers were not “on risk” when Autonomy recognized revenue on its sales to them is unsupported by the evidence and, indeed, flies in the face of the resellers’ repeated and well-documented acknowledgments—in response to inquiries by Deloitte—that they were indeed on risk. Nor was there any pattern of returns or cancellations sufficient to cast doubt on the propriety of revenue recognition upon a sale to any reseller. Deloitte actively reviewed reseller transactions, was alive to the issue of risk transference, and, in each case, approved Autonomy’s accounts.
Consistent with IFRS and IAS 18, Autonomy’s revenue-recognition policy provided for recognition of revenue on sales of IDOL product to resellers when the software licenses at issue 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.” Autonomy’s policy was approved by Deloitte and the Audit Committee, disclosed in Autonomy’s annual report, and led to the appropriate recognition of revenue under the five-element IAS 18 test:
(1) Autonomy transferred the significant risks and rewards of software ownership to each reseller upon executing a purchase order and delivering the software.
(2) Autonomy did not retain continuing managerial involvement to the degree usually associated with ownership or effective control over the goods sold. The reseller had ultimate control over any resale.
(3) Autonomy’s sales to resellers were fixed with regard to price at the time of sale and were not contingent upon future events. As a result, Autonomy was able to reliably measure revenue at the time of each sale.
(4) Autonomy recognized revenue on a sale to a reseller only where it was probable—i.e., more likely than not—that Autonomy would be paid by the reseller. Autonomy assessed collectability according to a number of criteria, including the reseller’s creditworthiness based on third-party credit reports, payment history, and the strength of the reseller’s balance sheet.
(5) Autonomy maintained records of all sales and, as a result, reliably measured costs.
Autonomy transferred the significant risks and rewards of software ownership to each reseller when the contract was executed and the software was made available for delivery. Autonomy transacted with resellers pursuant to non-recourse agreements, under which neither the fixed price for a license nor the obligation to pay was contingent on a reseller’s eventual resale of the license to an end user. As a result, each reseller assumed the risk of not reselling the software to an end user. As a further precaution, it was Deloitte’s policy to obtain written revenue confirmation directly from each reseller before approving Autonomy’s recognition of revenue for deals over $1 million. Those letters confirmed that the resellers were on risk and that no side agreements, written or oral, were in place.
Autonomy did not retain continuing managerial involvement to the degree usually associated with ownership or effective control over the goods sold. Any post-sale involvement by Autonomy did not amount to the type consistent with ownership or control that IAS 18.14 contemplates. Contrary to HP’s insinuations, IFRS does not prohibit contact with an end user after a sale to a reseller; rather, it is not only permitted but also commonplace for software companies to maintain contact with an end user following a sale to a reseller. For example, a reseller may rely on the software company to act as its negotiating agent; a transaction with a reseller may be only one part of a larger contemplated deal; or a software company may have a long-standing relationship with an end user that is important to maintain.
Contrary to HP’s statement in paragraph 74.3.3 of the Particulars, IFRS does not require a reseller to add value in connection with a specific sale to an end user in order for the revenue on the manufacturer’s sale to that reseller to be recognizable. Under IAS 18.14(b), in order to recognize revenue on a sale, a seller may retain neither “continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold.” HP appears to assert that resellers lacked active participation in end-user negotiations following a purchase from Autonomy and that this undermines Autonomy’s satisfaction of this element of the test. It does not. Simply stated, there is no requirement under IFRS that a reseller initiate or take the lead in negotiations on an onward sale to an end user, or otherwise add value to the particular product sold, before revenue can be recognized on the transaction between the seller and the reseller.
The relevant consideration under IAS 18.14(b) is not whether the reseller participates in negotiations with the ultimate end user, but whether the logistics of the resale are within the seller’s ultimate control and whether the seller is responsible for the management of the goods after the sale. Here, Autonomy lacked, and the resellers possessed, control over both the decision to whom and whether the reseller sold the software, and management of the software following the reseller’s purchase. Both features demonstrate that Autonomy relinquished managerial involvement and effective control to the resellers that were its customers.
On infrequent occasions, a reseller’s contemplated onward resale to an end user fell through, either because no end user purchased the software at all, because Autonomy entered into a direct transaction with the anticipated end user, or because the reseller decided to sell to another reseller instead of the originally contemplated end user. Those subsequent events did not, however, undermine the appropriateness of Autonomy’s recognition of revenue at the time of sale to the reseller. Accounting judgments are not made with hindsight. Simply put, a change in circumstances that occurs after a sale, which was not contemplated at the time of the transaction, does not undermine the initial recognition decision. Additionally, Deloitte carefully tracked reseller sales across quarters and clearly understood the fate of these deals.
While, at times, resellers used the failure of an onward resale to try to excuse nonpayment to Autonomy or to negotiate extended payment terms, these unremarkable commercial tactics did not affect a reseller’s obligation to pay or the propriety of Autonomy’s recognition of revenue at the time of the sale to the reseller. Deloitte was aware of these issues and tracked and considered reseller payment histories when assessing the propriety of revenue recognition. For example, the Report to the Audit Committee on the Q1 2010 Review stated:
Management alerted us to the fact that two deals sold to Microtech in Q4 2009 have been credited in this quarter and resold directly to the two end users. This was as a result of the end users wanting to transact directly with Autonomy. This reduced the profit in the period by approximately $4 million. As there is no significant history of deals being reversed in this way, management has recognised the revenue at the point of sale to the reseller. Management has confirmed that these were isolated incidents which are not expected to be repeated in future periods.
On the limited occasions when a reseller deal was cancelled or debt forgiven, Autonomy granted the relevant concession as a business decision and not because this was expected at the outset. Moreover, such rare events in the audited period were known to Deloitte, who ensured that the related accounting treatment was appropriate.
Cash for reseller deals was nearly always received, and the cancellation rate on contracts was low. In its purported restatement of the Autonomy accounts, HP appears to indicate that a significant number of these sales should never have been booked at all, despite the fact that the bulk of the cash was actually received. On the currently available information, out of revenues in the period of around $2.3 billion, HP has removed $140 million of revenue from reseller deals. However, HP itself concedes that cash of $102 million was received against this revenue. HP makes no explanation regarding where this now-surplus cash came from.
While each deal was different and each reseller and end user unique, the following discussion addresses a few of the many glaring deficiencies in HP’s allegations, which highlight HP’s incorrect application of IFRS.
Capax was a key part of the Autonomy ecosystem, and HP still considers it a major HP Autonomy partner to this day. Deloitte was comfortable with Autonomy’s revenue recognition on sales to Capax, as discussed below. Moreover, in 2011, the FRRP considered Capax’s ability to stand by its obligations to Autonomy and concluded as follows, in a letter dated August 22, 2011: “The Panel notes that [Autonomy] started to do business with Capax in early 2009 and that Capax has had an excellent payment record since then. . . . The Panel notes that [Capax's accounts] show Capax to be solvent at 31 December 2008 and to have traded profitably in the year then ended.”
In Q3 2009, Autonomy executed a $4 million deal with Capax for end user Kraft. It is plain that Autonomy’s accounting treatment of this sale was in accordance with IFRS and approved by Deloitte, as demonstrated by the Report to the Audit Committee on the Q3 2009 Review:
Kraft Food Inc (“Kraft”)
This is a $4 million licence deal for a suite of Autonomy software including Zantaz Digital Safe, Aungate and Introspect. Support and maintenance has been charged at $0.2 million which is consistent with fair value on a deal of this size. It should be noted that this deal has been signed through the reseller, Capax Discovery LLP (“Capax”). As Capax are up-to-date with their payment terms with Autonomy, and all other revenue recognition criteria have been met, management has concluded it is appropriate to recognise revenue.
In Q4 2009, for reasons unforeseen at the time of the reseller deal, Autonomy closed a direct deal with Kraft. Thereafter, Autonomy, in an exercise of its discretion and for sound commercial reasons, cancelled the reseller deal and offered Capax compensation for its earlier assistance. HP’s allegations about the Kraft transaction were investigated and dismissed by the FRRP, which in 2011 considered Kraft’s decision to seek a direct agreement with Autonomy and concluded that “Kraft may have felt more comfortable dealing with the key supplier which was also a global company able to provide 24 hour support worldwide.” The FRRP also understood the reasons why Autonomy paid a MAF to Capax on this deal. The FRRP dismissed the allegations concerning the Kraft transaction and declined to pursue the matter further. Having been reviewed and approved by Deloitte, the Audit Committee, and the FRRP, it is clear that the accounting for the deal was proper, despite HP’s desperate attempts to claim otherwise.
HP alleges in paragraph 78 of the Particulars that Autonomy’s sale of software to MicroTech, with the Vatican as the intended end user, lacked commercial purpose. HP is wrong. From approximately 2008/2009 to 2012, Autonomy and the Vatican negotiated a deal to digitize the Vatican Library’s collection of 80,000 manuscripts. Autonomy and the Vatican worked together over many months to develop a full test bed system in Vatican City. This system was the subject of television interviews, and the Vatican issued press releases about the project. In November 2009, Mr. Hussain presented the deal to Autonomy’s board for approval. At the time, Autonomy was to receive €75 million over ten years from the deal, which would be not only lucrative but also high-profile and likely to draw market interest to Autonomy’s cutting-edge solutions.
On March 31, 2010, as negotiations continued, Autonomy sold MicroTech $11.55 million of software to be resold to the Vatican as part of the larger Autonomy/Vatican deal. Autonomy wanted to involve a partner with sufficient Autonomy expertise to write application code. Other partners would in time be required in Italy to help with installation. The auditors were familiar with the MicroTech/Vatican deal, which was discussed and examined during the Q1 2010 review, and confirmed that the accounting was proper.
Negotiations with the Vatican continued into 2012, but HP ultimately decided not to pursue the deal, apparently ceding at least part of it to EMC. The Financial Times reported on January 23, 2015, that the digitization of the Vatican Library was about to take place with NTT DATA as the service provider. In short, it is clear that the Vatican deal was a real opportunity and not, as HP insinuates, a pretext for Autonomy to recognize phantom revenue. Indeed, there is every reason to believe that Autonomy would ultimately have secured the deal for itself had HP not abandoned the negotiations.
The MicroTech deal satisfied all of the revenue-recognition tests under IFRS. MicroTech was on risk for the balance of its debt, regardless of whether a deal closed with the Vatican. Autonomy did not retain effective control over the goods sold. And, indeed, MicroTech made payments in Q4 2010 and Q2 2011 to reduce the Vatican balance that it owed to Autonomy, paying off all but $2.3 million of its $11.55 million balance on the deal prior to the acquisition. HP then wrote off the remaining $2.3 million despite the fact that negotiations with the Vatican were still ongoing at the time.
Contrary to HP’s claim in paragraph 91.1 of the Particulars, FileTek had been reselling Autonomy technology for over a year before the Department of Veterans Affairs (“VA“) transaction of which HP complains. Likewise, Autonomy had been working with the VA for some time. When this particular deal was first considered, evidence was mounting that the VA would be issuing a request for information (“RFI“) with a value of tens of millions of dollars, and that Autonomy was likely to be the chosen technology (since, as mentioned above, the VA was an existing Autonomy customer).
In such situations, there are multiple ways in which a manufacturer or reseller could seek to participate in a sale. First, the reseller could respond to the expected RFI. Second, the reseller could supply the likely bidder or bidders for the RFI. Third, the reseller could sell a stopgap solution directly to the customer, if issuance of the RFI was delayed.
It is unsurprising that Autonomy and FileTek decided to partner on the VA deal, given that FileTek was involved in archiving structured data and was keen to get into the much higher growth area of unstructured data archiving offered by Autonomy. Additionally, Autonomy was a logical partner given the likelihood that Autonomy would be involved in the VA deal, however it was structured. The VA purchase order from FileTek reflects this, stating that the software could be licensed “either directly by [FileTek] or through an agreed to prime contractor to the United States Veterans Administration Authority (the ‘VA’) or to a Alternate Licensee.” FileTek could therefore sell the software to anyone, not just the VA. For example, FileTek could sell the software to a bidder on the VA deal, or as a stopgap to the VA, or to any other party or reseller not related to the VA. It thus appears to have made commercial sense for FileTek to enter into the deal, and FileTek paid Autonomy fully for the deal.
As a matter of common sense, where partners had invested in creating an Autonomy-related business by, for example, building their capacity and knowledge with respect to a particular Autonomy product, it was in Autonomy’s commercial interest to support them in that endeavor by assisting them with implementation, funneling business in their direction, or using them as vendors when Autonomy had a particular need. Where Autonomy made purchases from its customers, it was appropriate under IFRS to account for those purchases in the same way as any other purchase so long as the exchange involved “dissimilar goods,” had “commercial substance,” and the “fair value” of the goods could be measured reliably.
Nonetheless, HP alleges that Autonomy engaged in so-called “reciprocal” purchases, and seeks to improperly remove large swaths of revenue generated by legitimate transactions by “netting” them against distinct sales of dissimilar goods to the same customers. This approach is not only incorrect as a factual matter but also betrays, once again, a fundamental misapprehension of the relevant accounting rules.
Contrary to HP’s claims in paragraph 22.214.171.124 of the Particulars, the theory that Autonomy made purchases to provide customers with cash to pay debts on previous deals fails for four key reasons:
(a) Fair value on each purchase was proved at the time, and in some cases Autonomy sold the acquired item on at a profit;
(b) The resellers often used the cash paid by Autonomy to provide services, and this is well documented;
(c) To net revenue on such transactions would misstate the accounts; and
(d) HP cannot explain why Autonomy would have spent cash on products of no value to it when it would have been much simpler and far more cost-effective to simply introduce the reseller to a new end-user customer for its Autonomy software, which would have been appropriate under IFRS.
The purchases at issue had commercial substance and fair value. IAS 18.10 provides that “[t]he amount of revenue arising on a transaction is usually determined by agreement between the entity and the buyer or user of the asset. It is measured at the fair value of the consideration received or receivable taking into account the amount of any trade discounts and volume rebates allowed by the entity.” Consistent with this rule, when Autonomy entered “exchange transactions,” the related revenue recorded was “measured at the fair value of the goods or services received.”
Autonomy provided its auditors, and Deloitte carefully evaluated, evidence supporting the “fair value” of the goods that Autonomy purchased from its customers. Autonomy normally obtained such evidence by gathering quotes from parties selling competing products. Deloitte considered this information, in conjunction with signed purchase orders, before confirming that fair value had been appropriately established. There can be no question that Deloitte was careful and thorough in its evaluation of these transactions. For example, in assessing Autonomy’s purchase of FileTek software, StorHouse, in Q4 2009, Deloitte went so far as to bring in its own IT people in order to understand the commercial rationale for the purchase.
Further, the instances cited by HP include sale and purchase transactions with the same customer where cash was received and paid. As stated in paragraphs 10 and 11 of IAS 18, “[t]he amount of revenue arising on a transaction is . . . . measured at the fair value of the consideration received or receivable . . . . [and in] most cases . . . is the amount of cash or cash equivalents received or receivable.” In HP’s recent filings in the UK Action, for each of the allegedly reciprocal purchases that involved cash consideration, both the revenue and costs recorded by Autonomy reflected the fair value of the relevant products sold and purchased. Examples of these are addressed below in more detail.
HP’s claim that buy and sell transactions with the same counterparty should be netted against each other is incorrect; under paragraph 12 of IAS 18, dissimilar goods cannot be netted and exchange transactions involving similar goods also are not netted; rather, under paragraph 12 the latter are treated as generating no revenue at all, and thus there is nothing to be netted.
Throughout 2009 and 2010, Autonomy made strides to grow its federal business. With this objective in mind, it set ambitious growth targets for 2011. In order to secure federal contracts, however, Autonomy needed a space that complied with federal clearance requirements in which to demonstrate its capabilities to federal customers. As a possible solution, Autonomy considered partnering with a federally cleared entity.
In November 2010, MicroTech proposed building a federally cleared facility—the Advanced Technology Innovation Center (“ATIC“)—in which to showcase Autonomy solutions to federal customers. MicroTech proposed to both market existing solutions and help Autonomy develop and test new solutions. To do so, MicroTech needed to hire a full-time federally cleared staff, lease a sufficiently large office space, and acquire the necessary technology—and much of this cost would be incurred up front. In light of the substantial investment and construction involved, it was always understood that the facility would not be available until sometime in 2011.
The parties entered into negotiations on the deal on the basis of a comprehensive document. On December 30, 2010, after negotiating price and license terms, including a discount of almost 17 percent for early payment, Autonomy purchased a three-year license for the ATIC. Autonomy paid MicroTech $9.6 million for the license the following day.
Mindful of the fact that MicroTech was a repeat Autonomy partner, Deloitte reviewed the transaction, confirmed that Autonomy paid fair value, and approved the accounting. Specifically, the Report to the Audit Committee on the Q4 2010 Review stated:
In December 2010 a licence was purchased by Autonomy from Microtech for $9.6 million and capitalised on the balance sheet as an intangible asset. This relates to a 3 year license to use a fully US federal government certified demonstration facility which will remain the property of Microtech throughout the licence term. The licence will include six dedicated US federal cleared employees of Microtech who each have many years of experience in dealing with US federal government sales. We understand that these individuals have significant business connections with US federal organisation[s].
Given that Microtech is a regular customer of Autonomy, we have reviewed this transaction to ensure that it makes commercial sense and that there is no indication that this should be considered a barter transaction. . . . We held discussions with Sushovan Hussain and Dr Pete Menell who explained that at present Autonomy struggle[s] to make significant sales into the US Federal government agencies because they do not have the appropriate level of certification.
In June 2011, the ATIC was launched with much marketing fanfare and was made available for Autonomy’s use. Contrary to HP’s claim in paragraph 78.7 of the Particulars, the ATIC was hardly a van (and the fact that HP is making such an assertion after two and a half years of “investigation” is simply astonishing). Rather, the facility included a MicroData Center; Emerging Technologies Center; Test, Evaluation, and Integration Lab; and Mobile data center (which could be used to offer demonstrations to customers off site). These components were specified in a thirty-page document. Because the ATIC was launched in June 2011, however, Autonomy had few opportunities to utilize the facility before being acquired by HP. Following the Autonomy acquisition, HP decided not to use the ATIC after all, and wrote the asset off without informing Autonomy management. HP then introduced a new method of managing federal customers.
HP claims, in yet another misguided attempt to find some justification for the write-down, that Autonomy’s purchases of FileTek’s StorHouse software in Q4 2009 and Q2 2010 were reciprocal transactions and valueless to Autonomy. Even further, HP claims that StorHouse was never successfully integrated with Autonomy’s software, used by the company, or sold on to a third party—all in the face of significant documentary evidence to the contrary (which would have been revealed by even a cursory review of the purchase orders to which HP had full access following the acquisition).
By way of background, Autonomy had established itself as an industry leader in unstructured information, but it had long been a strategic goal to combine that capability with structured data power. In fact, the prospect of creating a unique combined solution was a key motivating factor in HP’s subsequent acquisition of Autonomy. As part of that goal, Autonomy purchased FileTek’s StorHouse software in Q4 2009 and Q2 2010.
Deloitte undertook a comprehensive review of the purchase, with the help of its own IT specialist. Contrary to the statements in paragraphs 88.4 and 146.1 of the Particulars, Deloitte reported the following in the Report to the Audit Committee on the Q4 2009 Review:
We have reviewed the accounting for sale to and the purchase from Filetek. In addition to our standard procedures when auditing revenues, we involved a member of our IT specialists to ensure that the software purchased made commercial sense and was not in any way linked to the sale of Autonomy product to Filetek. We have sighted management’s work on confirming the fair value of this purchase and concur with the accounting treatment applied to the purchase and the sale to Filetek.
As part of the Q4 2010 Review, Deloitte also confirmed that Autonomy paid fair value for the purchase and that the accounting treatment was appropriate.
Deloitte’s statements regarding the demonstration in January 2010 are in direct contradiction to HP’s assertions in paragraph 88.4 of the Particulars that Autonomy did not download the software until April 2010. In fact, shortly after the purchase, engineers in both the United Kingdom and the United States undertook serious and substantial efforts to integrate the FileTek software, in consultation with FileTek’s own team. Autonomy ultimately considered four options for integration and chose the most technically complex and ambitious of these options, which, according to Autonomy engineers, provided the best offering to the customer and used both systems to their full potential. It did so by permitting Autonomy’s software to directly access data from a structured database.
By June 2010, Autonomy engineers confirmed that the FileTek software had been successfully integrated into its Digital Safe platform, with Autonomy presenting an integrated offering to Kraft. Autonomy’s successful integration of FileTek is reflected in: (1) the Report to the Audit Committee on the Q2 2010 Review, which specifically notes Autonomy’s success with Kraft; and (2) subsequent Autonomy contracts, which list FileTek software as part of the Digital Safe 9.0 platform. In July 2010, Autonomy conducted an additional technical demonstration for Deloitte. That demonstration is noted in the Report to the Audit Committee.
Over the next year, Autonomy made a number of significant sales of Digital Safe with integrated FileTek technology, and expanded its use of FileTek software with its archiving product LiveVault and in connection with newly acquired Iron Mountain data centers in the United States and the United Kingdom. Autonomy’s integration of FileTek software into its Iron Mountain data centers, and its use of the software, is well documented. For example, in August 2011, Autonomy circulated a list of its offices and sites that were using FileTek software.
In conclusion, Autonomy’s purchases of FileTek software were consistent with its strategy for entering the structured-data market, acquired at fair value, successfully integrated into Autonomy software, and sold to third parties. The transactions were reviewed by the Audit Committee and Deloitte, and also by the FRRP, and consistently found to be proper.
At paragraph 85.3 of the Particulars, HP entirely mischaracterizes the context in which Autonomy acquired data feeds from Video Monitoring Services (“VMS“). Prior to the VMS transaction, Moreover Technologies Inc. (“Moreover“), then a young company, used Autonomy technology, and in consideration provided Autonomy with news data feeds at no charge, which Autonomy in turn used to demonstrate its own technology. At around the time of the VMS deal, however, Moreover informed Autonomy that it had begun to use an Autonomy competitor’s technology and would no longer supply Autonomy with free data feeds. Thus, Autonomy sought an alternative source for such data feeds, considered quotes from several suppliers, and ultimately executed a deal with VMS.
It appears that HP’s real reason for proposing that these sales be reversed is not that they were part of “reciprocal” transactions, but that HP ultimately wrote off the related receivable balances because VMS went bankrupt in the second half of 2011. Where no cash is ultimately received on a transaction because a reseller’s financial position has deteriorated significantly, this can give rise to a bad-debt provision in accordance with IAS 18 but does not affect the appropriateness of the original revenue recognition by the seller. If “an uncertainty arises about the collectability of an amount already included in revenue,” IAS 18 (paragraph 18) requires that “the uncollectible amount or the amount in respect of which recovery has ceased to be probable is recognised as an expense, rather than as an adjustment of the amount of revenue originally recognised.” With respect to both of the VMS sales at issue, the accounting treatment that HP proposes is clearly inconsistent with IAS 18 and, therefore, wrong.
HP wrongly alleges that Autonomy’s sale of software licenses to VMS for $9 million on June 30, 2009, and Autonomy’s purchase of data licenses from VMS for $13 million on the same day, were “reciprocal” transactions “that as a matter of substance . . . should be analysed as a single transaction and accounted for on a net basis.” As explained above, this claim is based on a misapplication of IAS 18. HP appears to disregard paragraph 12 of IAS 18, which states that “when goods or services are exchanged or swapped for goods or services which are of a similar nature and value, the exchange is not regarded as a transaction which generates revenue.” (emphasis added). VMS used Autonomy software products to power its core information-monitoring services, and Autonomy bought data feeds from VMS to power its portals and social media analytics products and demonstrations (since Autonomy’s existing provider was planning to switch off the data feeds). In short, the respective software bought and sold was clearly not of a “similar nature.”
Further, contrary to HP’s characterization in paragraph 85.3 of the Particulars, the purchase was not limited to data feeds but also included a license to resell VMS’s normally chargeable service to Autonomy customers at no further charge. The cost of Autonomy’s purchase from VMS was comparable to quotes from other suppliers.
These transactions and the related accounting treatments were reviewed by both the Audit Committee and Deloitte. The auditors commented:
This is a $9 million deal to supply VMS with a perpetual licence for a suite of Autonomy software products including TeamSite, LiveSite, Qfiniti and IDOL. Also in the quarter, Autonomy has separately purchased $13 million of software and associated services from VMS. Given that there is clear commercial rationale for the separate transactions, separate contractual arrangements and evidence that both transactions have been made at fair value, management has confirmed and concluded that there are no links between the contracts that would impact the accounting. . . . [W]e examined the terms and conditions of the contract to ensure that no circumstances exist which might impact the recognition of revenue.
Thus, contrary to paragraph 146.2 of the Particulars, Deloitte was plainly aware of both transactions and acquiesced in Autonomy’s accounting treatment.
HP mistakenly claims in paragraph 85.1 of the Particulars that a business plan for the purchase of the license to resell the VMS feeds to Autonomy customers was backdated. Not only is this claim utterly irrelevant, but it also ignores the obvious explanation that any incongruity in the date could have been an innocent oversight. Although HP has not given sufficient specifics, our preliminary analysis shows that the earlier date on the document could simply be a print header not seen on screen and inserted automatically when material is copied from an older document and pasted into a new one. What is clear is that there is absolutely no evidence that anyone at Autonomy was attempting to pass off the business plan as having been created earlier, and HP certainly has provided none.
HP appears to assert that Autonomy’s sales of software and hardware to VMS in Q4 2010, for $4.8 million and $6.0 million respectively, were also part of “reciprocal” transactions and thus should be accounted for on a net basis. Both of these sales and the related accounting treatments were reviewed by the Audit Committee and Deloitte.
In paragraph 86.2 of the Particulars, HP takes out of context a selective quote from an internal email concerning bonus eligibility in which an employee suggested that he could have obtained a higher price in the Q4 2010 VMS deal by more effectively selling the benefits to the customer.
HP incorrectly states in paragraph 137.6 of the Particulars that Autonomy purchased a license and other rights for Vidient that Autonomy did not need or use. To the contrary, the evidence will show that Vidient was available for resale by Autonomy and was bid into multiple deals, as well as being used in a project for a cleared government customer.
In sum, Autonomy’s purchases from its customers were entirely proper. Following the acquisition these purchase volumes declined because HP sought to internally source Autonomy’s technology needs wherever possible.
HP’s allegations concerning hosting transactions are baseless. First, as HP concedes, Autonomy’s accounting treatment is permissible so long as the licenses had independent value and the fair value of the licenses was correct—both of which are in fact true. Second, HP’s senior management and accountants were well aware of the structure of these hosted deals and saw no issue with them. Indeed, the evidence will show that senior members of HP management confirmed that Autonomy’s pre-acquisition accounting policy for hybrid hosted deals was correct.
As part of the due diligence, HP reviewed a number of the major hosting contracts that it has now removed from revenue. Moreover, it appears that HP continued to structure hosted deals in this manner even after Autonomy’s senior management left HP. The market and analysts, too, were well aware of Autonomy’s license plus hosted model—contrary to HP’s allegations that Autonomy’s published information on hosted transactions was misleading.
HP’s allegations regarding hosting are a transparent attempt to scapegoat Autonomy for the losses caused by HP’s officers and directors. This is especially obvious given that HP’s revenue adjustments in paragraph 106 of the Particulars are based on the flawed assumption that in an era when storage costs were falling by orders of magnitude, customers would have renewed deals at the same prices from years earlier, the difference being some notional loss. HP’s purported justification for removing these deals is almost comical—if a customer bought 1TB of storage five years ago for $100,000, but can purchase the same amount of storage today for $50 from you and for $49 from your competitor, is there any chance that the customer will be willing to pay $100,000 for this storage from anyone?
Under IFRS there are three general considerations when accounting for multi-element transactions such as hosting arrangements. First, under IAS 18, a multi-element transaction may be separated into components so long as the separation reflects the substance of the arrangement (i.e., when those elements are, or can be, sold separately in the market). Second, IAS 18.9 and International Financial Reporting Interpretations Committee (“IFRIC“) 13.BC14 require that the revenue for each element of such a transaction be allocated on a fair-value basis, which can be done in multiple ways. Third, once separate components have been identified and the fair value of each is determined, the revenues associated with a particular component can be recognized when all requirements of IAS 18 are met for that particular component.
The licenses did have independent value; they could be used by customers and, as is well documented, they indeed were used by customers. Additionally, the fair value of the licenses was correctly measured by application of the residual method, and revenue from the license sales was recognized in accordance with IAS 18.
Further, the evidence will show that Autonomy’s accounting treatment for these transactions was reviewed and approved by its Audit Committee, and that Deloitte reviewed these transactions and the fair-value analysis carried out by Autonomy’s finance team and ensured that all related accounting complied with IFRS.
After acquiring Zantaz, Autonomy embedded its own IDOL software into Zantaz’s hosted products to create a new product which increased functionality. At the time, storage costs had dropped substantially as data storage had become increasingly less expensive. As a result of these two developments, and in an effort to accommodate customers who might be interested in independently maintaining their own data, Autonomy began to offer customers, including former Zantaz customers, an opportunity to either purchase the new IDOL hosting software alone or the complete data archiving service (which included both the software and hosting component).
Under this model, customers could license the software product from Autonomy with the option to have that software and the associated data hosted by Autonomy, themselves, or another party at a location of their choosing. The license plus hosted model was an attractive option for many customers who wanted protection from potentially sharp rate increases when the Autonomy hosting arrangement came to an end, or the option to independently maintain their own data. Customers were concerned that, given the very large amounts of data involved and the legal and regulatory requirements, it was practically very difficult for them to switch out of Autonomy software. As a result, when the fixed-term hosted agreement came up for negotiation, without ownership of the software, they would be in a weak negotiating position. Ownership of the Autonomy software gave the customer leverage in negotiating a renewal contract with Autonomy as the customer had the possibility of hosting its data elsewhere.
In cases where customers did opt for a license of the software, the separation of components of hosted license sales correctly reflected the substance of the arrangement, as Autonomy sold the hosting and licenses separately. Autonomy recognized the associated revenue as follows: License revenue was recognized at the point the contract commenced and the software was delivered; after-sales support revenue was recognized ratably over the period of the license contract; and archiving revenue was recognized ratably over the contracted period of archiving.
HP’s suggestion that hosting customers could not use the licensed software independently is just plain wrong. Customers could freely transfer their software to their own data centers, should they choose to move their data. Various partners in fact shipped and used the software independently. The evidence will show sales of the on-premise Digital Safe license to some of Autonomy’s largest customers and that Deloitte noted such sales. And, contrary to HP’s somewhat irrelevant claim in paragraph 110 of the Particulars that Digital Safe had no value if only an Autonomy service team could install it on a customer site, there were a number of service companies who could and did install stand-alone Digital Safe at customer sites. Similarly, Autonomy’s eDiscovery was available for on-premise purchase (i.e., a license) and was indeed sold in that form.
Contrary to HP’s purported analysis, under those circumstances it was entirely inappropriate to set the value of the license to zero, as the license had value in its own right and the customer was entitled to keep it at the end of the hosting period.
Autonomy management appropriately determined fair value by using the residual approach of IAS 18.IE11, whereby the value of one element is the difference (or residue) between the total value of the sale and the fair value of another separately identifiable component. Here, the value of the hosting element was calculated with reference to the standard rate for data storage. Autonomy’s finance department analyzed the fair value of the hosting element on a reasonable basis, with the fair value of the license calculated based on the residual value of the complete contract.
Specifically, for each deal a cost analysis was performed to capture the costs of the hosting portion. The analysis did not take into account the effect of the future precipitous fall in storage cost that was usual in the industry, and thus this model’s estimate as to the value of the license was conservative. Although Autonomy was able to perform this type of work at a lower cost than HP—because of its advanced sector-leading technology, lower overhead costs and less bureaucracy, and reengineered Zantaz system (which had sixteen times more storage per server)—Autonomy’s hosting contracts did not use bargain-basement pricing, as evidenced by the fact that Autonomy was, on occasion, underbid by competitors.
Contrary to paragraphs 102.1, 102.2, and 107 of the Particulars, which assert that these deals should have been renewed at their original prices from three to five years earlier, prices were lower for the following reasons:
(i) There has been a precipitous fall in storage costs (as every PC purchaser, and HP as a PC manufacturer, knows perfectly well); and
(ii) The fact that Autonomy reengineered the Zantaz system to have sixteen times more storage per server, thus further reducing cost.
Autonomy recognized revenue on each element of these hosting agreements in accordance with IAS 18, as Autonomy deferred revenue associated with any undelivered product or ongoing obligation. Further, Autonomy’s accounting treatment of its hosting transactions was reviewed and approved by its Audit Committee and by Deloitte, who ensured that all related accounting complied with IFRS. Autonomy fully disclosed its accounting policies for hosted sales, regardless of how they occurred, and accounted for such sales in compliance with those policies.
HP is incorrect in arguing that Autonomy’s accounting treatment of the revenue associated with the Digital Safe and eDiscovery licenses for hosting arrangements was inconsistent with statements made in its published information regarding the nature of the revenue streams derived from hosting arrangements. The hosting transactions included a hosted element which produced a revenue stream that amounted to a long-term annuity stream.
The accounting policies note to the 2010 Annual Report states:
Revenues from software license agreements are 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 significant post-delivery obligations exist or if a sale is subject to customer acceptance, revenues are deferred until no significant obligations remain or acceptance has occurred.
* * *
Product revenues from the hosted business are separated, using the residual method, into capture and archiving. Revenues for capture are recognised in the period in which they are delivered. Revenues for archiving are recognised over the period that the customers have access to the group’s software and proprietary storage technology. Product revenues from the hosted business relate to the execution of production operations on computers which the company runs in its data centres. Revenues are generated from the use of our software and computers and from us maintaining the data. Customers commit for periods between one month and up to three years. Revenues are generated in two different ways:
HP could, therefore, have been under no misapprehension as to how Autonomy accounted for its hosted contracts. Indeed, the five transactions highlighted in the Particulars are referred to in the Reports to the Audit Committee and were considered by Deloitte. The evidence will also show that HP reviewed a number of contracts for Autonomy’s hosted deals during the due-diligence process and was therefore aware of the structure and terms of the deals.
HP Finance itself was made aware of, and approved, Autonomy’s hosting-related accounting. Autonomy continued to structure hosting transactions post-acquisition in the same manner as pre-acquisition, and the appropriate accounting for such deals was considered and discussed by HP Finance and with other key HP personnel, who took no issue with Autonomy’s pre-acquisition hosting accounting.
HP’s 2011 Form 10-K disclosed HP’s accounting policy for hosting sales as follows:
In accordance with the specific guidance for recognizing software revenue, where applicable, HP recognizes revenue from perpetual software licenses at the inception of the license term assuming all revenue recognition criteria have been met. Term-based software license revenue is recognized on a subscription basis over the term of the license entitlement. HP uses the residual method to allocate revenue to software licenses at the inception of the license term when VSOE of fair value for all undelivered elements exists, such as post-contract support, and all other revenue recognition criteria have been satisfied. Revenue generated from maintenance and unspecified upgrades or updates on a when-and-if-available basis is recognized over the period such items are delivered. HP recognizes revenue for software hosting or software-as-a-service (SaaS) arrangements as the service is delivered, generally on a straight-line basis, over the contractual period of performance. In software hosting arrangements where software licenses are sold, the associated software revenue is recognized according to whether perpetual licenses or term licenses are sold, subject to the above guidance. In SaaS arrangements where software licenses are not sold, the entire arrangement is recognized on a subscription basis over the term of the arrangement.
What this shows is that HP accounted for revenue from licenses sold in software hosting arrangements in the same way that Autonomy did. While HP Finance ultimately departed from and changed Autonomy’s recognition policy, the evidence will show that it did so for business, not accounting, reasons.
HP is wrong in its assertion that members of Autonomy’s senior management falsely classified revenue as OEM revenue. While it bears repeating that Dr. Lynch was not involved in the classification of revenue and acted in good faith in relying on others to determine the correct classification, Dr. Lynch always understood—and believes today—that the classification was appropriate. The allegations set out in HP’s Particulars reflect a failure to appreciate the distinction between an OEM sale and OEM-derived revenue. Once this difference is understood, it becomes clear that Autonomy’s classification of OEM revenue was proper.
While there is no official OEM revenue accounting definition, Autonomy properly disclosed the basis for its OEM revenue reporting in its accounts, and the market was aware that Autonomy’s OEM revenue figures captured all sales that “derived” from OEM sales.
HP appears to believe that OEM-derived revenue is (and can only be) revenue resulting from a software company (and only a software company) including IDOL in its own product and then selling on that product and paying Autonomy a royalty. This is not correct. An OEM sale is one in which a company licenses technology—in this case, Autonomy’s—in order to embed that technology in its own products or services. Given the nature of Autonomy’s core product, IDOL, described by HP’s Ms. Whitman as “almost magical,” other companies frequently sought to embed Autonomy’s technology in their own products through a variety of contractual arrangements. OEM customers would typically license a small subset of the many functions in IDOL.
Following these sales, Autonomy would have the opportunity to “up-sell” additional functionality either to the original OEM purchaser (i.e., the entity that embedded a subset of IDOL functions into its own product) or directly to an entity that had purchased the product from an Autonomy OEM customer. Autonomy considered and accounted for any follow-on license sale—whether to the original OEM customer or to an OEM customer’s customer—as OEM-derived revenue, because the follow-on sale occurred as a result of (i.e., was derived from) the initial OEM sale. Such models were discussed extensively in analyst reports from the earliest days of the company, including analyst reports from the same firms used by HP for its valuation calculations.
As defined by Autonomy in its public reports, OEM-derived revenue included revenue made possible by Autonomy’s OEM program. Thus, Autonomy did not have to transact with an OEM customer itself to generate revenue classified as OEM-derived revenue. For example, if a customer bought software from Autonomy that linked to a product that already had Autonomy’s technology embedded in it, Autonomy could have recognized revenue from that sale as OEM-derived revenue. Likewise, if Autonomy sold a connector that connected to a product that had Autonomy software embedded within it, this too could have been recognized as OEM-derived revenue.
This policy, which was reviewed by Deloitte, was entirely appropriate. First, when Autonomy described the source of its OEM revenue, it appropriately disclosed that OEM revenue was generated in a variety of ways, including through license arrangements. Second, when Autonomy reported OEM revenue figures, it properly disclosed that such revenues captured all sales that “derived” from OEM sales. Third, Autonomy disclosed to the market that its classification of OEM-derived revenue was a matter of accounting judgment. These disclosures ensured that the market understood the basis for Autonomy’s OEM revenue reporting.
When Autonomy acquired the digital archiving assets and technology of Iron Mountain, the terms of the deal provided for Iron Mountain to continue archiving certain data, for which it needed licenses to the relevant software. Iron Mountain was therefore required to buy back a license for this purpose. Contrary to paragraph 115.1 of the Particulars, Autonomy valued the OEM component of this transaction in cooperation with Deloitte and as described by Deloitte to the Audit Committee, as clearly demonstrated by the Report to the Audit Committee on the Q2 2011 Review:
Management has also performed a fair value analysis on a $1.5 million IDOL licence sale made by Autonomy to Iron Mountain at the time of the acquisition, which was deemed to be at less than fair market value. In accordance with the paragraph B50 of IFRS 3 (2008) management has determined that this transaction is linked to the business combination. Therefore, in accordance with paragraph 38 of IFRS 3 (2008), the asset transferred must be fair valued and included as part of the total consideration paid to Iron Mountain. This has resulted in a $5.5 million increase to the fair value of the consideration paid (and therefore goodwill) and total post acquisition revenue of $7.0 million recognised. Management has determined fair value with reference to seven similar sized licence deals. An average licence value was calculated for sales where IDOL search was the core product offering. This generated a value of $10.6 million, but did include one significant outlier. Excluding this outlier the revised average was $7.4 million. Management has therefore determined that an appropriate estimation of fair value is $7.0 million.
We concur that management’s treatment is in line with the guidance in IFRS 3 (2008) and that fair value has been determined on a reasonable basis, using a comparative group of similar sized deals to similar sized organisations.
Once again, HP’s allegations to the contrary are without merit.
In 2010, an employee based on the West Coast of the United States raised issues concerning the treatment of reseller and so-called reciprocal transactions. These issues were investigated and referred to the Audit Committee and Deloitte. Contrary to paragraph 147.2 of the Particulars, upon being contacted by this employee, Dr. Lynch followed good corporate procedure and promptly referred the matter to the head of the Audit Committee and the non-executive Chairman of the Board. Dr. Lynch’s involvement in the investigation was in response to the Audit Committee’s requests for information. The issues raised were the same or very similar to those that HP is now repeating. Deloitte appointed a team, which Deloitte itself referred to as “independent,” to review the issues. After review, Deloitte concluded that the employee’s concerns were based on partial information and a misunderstanding of the relevant accounting rules, and confirmed that all of the transactions about which the employee had expressed concern had received appropriate accounting treatment.
In its Report to the Audit Committee on the Q2 2010 Review, Deloitte stated:
On the basis of management’s detailed review of the matters raised . . . they have concluded that there is no new material information provided that would have affected their key judgments taken at the time of preparing and presenting the 31 December 2009 financial statements. Management have therefore concluded that these matters raised have no material impact on the Group’s 2009 financial statements. Based on our discussions with management, and the review work we have carried out, we concur with this view.
Additionally, the employee referred his issues to the FSA in London, which in turn referred the issues to the FRRP, whose remit includes setting the standards framework within which auditors, actuaries, and accountants operate in the United Kingdom, while monitoring the implementation of these standards and promoting best practice. The FRRP investigated the very issues and allegations that HP now advances concerning resellers and so-called reciprocal transactions and, in August 2011, declined to pursue any of the matters further. HP conveniently fails to mention this.
The evidence will show that the employee did not understand IFRS and that his conclusions were based on partial information. Contrary to paragraph 147.6 of the Particulars, the employee was terminated by the company’s independent chairman.
In sum, the issues raised by HP have already been analyzed, considered, and rejected not only by Autonomy’s auditors and an independent internal committee but also by the responsible regulatory body, which is uniquely positioned to understand and investigate these issues.
All of the matters of which HP complains were transparently disclosed to Deloitte, as recorded in the quarterly reports to the Audit Committee. Further, many of these matters were then reviewed by the FRRP, the regulatory body directly responsible for monitoring the implementation of proper accounting standards and practices in the United Kingdom. None of these entities found any problem with Autonomy’s accounts.
Nonetheless, HP purports to be the victim of a $5 billion fraud (while making no attempt to explain the basis of this extraordinary loss and while failing to reconcile its position with the fact that none of the cash is missing). In reviewing HP’s latest filings in the UK Action, it is clear that for numerous deals:
For all these reasons, the evidence will show that HP’s allegations are baseless and that its filing of the Particulars in the California Action was an improper attempt to generate publicity for its specious claims, avoid disclosure and engagement on the merits, and persuade the Court to approve its collusive settlement.
Very truly yours,
Christopher J. Morvillo
Clifford Chance US LLP
Reid H. Weingarten
Michelle L. Levin
Steptoe & Johnson LLP
Attorneys for Dr. Michael Lynch
 HP’s concerted effort to deny Dr. Lynch and his counsel access to the documents underlying the most basic allegations in the Particulars makes it impossible for Dr. Lynch to fully respond at this time. As a result, Dr. Lynch reserves the right to amend or expand his responses contained herein in connection with his formal response to the Particulars in the UK Action, which will be provided once the full record of relevant documents is produced and Dr. Lynch has had an adequate opportunity to review this information. Additionally, much of the information contained in this response—including the analysis of the applicable accounting principles—is the result of investigation that has occurred subsequent to HP’s public disclosure of its allegations. Accordingly, nothing in this letter constitutes an admission or acknowledgement that Dr. Lynch was aware of the particular fact or accounting principle prior to HP’s announcement of its allegations in November 2012.
 Katherine Rushton, HP Boss Meg Whitman Admits Autonomy Row Hit Morale, The Telegraph (Apr. 10, 2013), http://www.telegraph.co.uk/finance/newsbysector/mediatechnologyandtelecoms/electronics/9984271/HP-boss-Meg-Whitman-admits-Autonomy-row-hit-morale.html.
 Quentin Hardy & Michael J. de la Merced, Hewlett’s Loss: A Folly Unfolds, by the Numbers, N.Y. Times (Nov. 20, 2012), http://dealbook.nytimes.com/2012/11/20/h-p-takes-big-hit-on-accounting-improprieties-at-autonomy/?_r=0.
 Contrary to paragraphs 18.1, 18.2, and 19 of the Particulars, Dr. Lynch did not serve as president of Autonomy Inc. during the period, nor was he a shadow director or “de facto director” of any of the various subsidiaries named by HP. The argument that the group CEO of a FTSE 100 company should be deemed to be a shadow director or “de facto director” of the group’s subsidiaries by virtue of his CEO group-level role is not credible, and even less so when some of those subsidiaries are based 6,000 miles away with an eight-hour time zone difference and have their own CEO, COO, CTO, CMO, and GC.
 In the United Kingdom, interim financial reporting is governed by International Accounting Standard (“IAS“) 34 and particular listing rules, and quarterly reports (i.e., those for Q1 and Q3) are governed solely by particular listing rules. As a result, Autonomy’s quarterly reports were governed by the rules associated with the London Stock Exchange.
 For example, the American Institute of Certified Public Accountants Audit Guide states: “The pressure to meet quarterly or annual earnings expectations creates a strong incentive for entities to complete transactions by the end of the reporting period. . . . Customers can take advantage of this desire to meet revenue expectations by forcing software vendors to lower prices or provide more liberal sales terms in contracts negotiated near the end of a reporting period. For these reasons, it is common for software vendors to have a significant number of sales near the end of a reporting period.” American Institute of Certified Public Accountants Audit Guide: Auditing Review in Certain Industries [AAF-REV] 2011, at 2.14.
 The fact that sales of EMC hardware could be beneficial not only to Autonomy and its customers, but also to individual members of Autonomy staff if they reached their performance targets, apparently strikes HP as offensive. See paragraphs 135.5–135.6 of the Particulars (discussing a proposed bonus to incentivize Mr. Sullivan in his negotiations with EMC). However, the details of an individual bonus—not to speak of an individual email or its compatibility (or lack thereof) with HP’s sense of humor (or lack thereof)—certainly do not suffice to establish a years long systematic fraud on the order of billions of dollars.
 Aaron Ricadela & Amy Thompson, HP Plunges on $8.8 Billion Charge From Autonomy Writedown, Bloomberg (Nov. 20, 2012), http://www.bloomberg.com/news/articles/2012-11-20/hewlett-packard-profit-forecast-8-8-billion-charge; Press Release, HP Issues Statement Regarding Autonomy Impairment Charge (Nov. 20, 2012), http://www8.hp.com/us/en/hp-news/press-release.html?id=1334263.
 DRC Report at 40 (emphasis added); see also DRC Report at 57 (“E&Y noted that Autonomy had sold material quantities of hardware . . . [and] reported its observation to HP management.” (emphasis added)).
 Lisa Fleisher, Former Autonomy Execs Turning to Unusual Strategy in Fight with Hewlett-Packard, Wall St. J. (Sept. 12, 2014), http://blogs.wsj.com/digits/2014/09/12/former-autonomy-execs-turning-to-unusual-strategy-in-fight-with-hewlett-packard/. (emphasis added).
 Further, contrary to paragraph 142.9.2 of the Particulars—which states that there was no strategic partnership between Autonomy and Dell, and no development by Dell of an appliance consisting of Dell hardware and Autonomy software—the evidence will show that Autonomy and Dell worked together to develop an appliance, an appliance was marketed and sold, and Dell proved to be a helpful partner. Discussions in November 2009 included technical meetings on the appliance subject, demonstrations to senior executives at Dell, and OEM arrangements regarding Dell products.
 Even if HP’s novel meaning of “pure” is taken as true (without admission and purely for the sake of argument), excluding some obviously inapplicable examples alone affects the alleged numbers considerably. By our estimates, and contrary to the statements in paragraph 61.1 of the Particulars, in 2009 the amount of loss-making so-called “pure hardware” would have been less than six percent of revenues, and in 2010 the amount of loss-making so-called “pure hardware” would have been less than nine percent of revenues.
 Contrary to paragraph 61.4 of the Particulars, inclusion of hardware in the gross-margin calculation could be viewed in various ways depending on the relevant period. For example, its small effect is to deflate, not inflate, apparent growth in the period H1 2010 to H1 2011. Similarly, the inclusion of the hardware revenue reduced the amount of profit.
 For example, during the April 21, 2010, analyst call, management stated: “[W]e’d expect to see [gross margins] continue to fluctuate by plus or minus 2 percentage points, as many of you are used to seeing over the years.” And during the February 1, 2011, analyst call, management noted that “there are natural fluctuations in the gross margin rate quarter on quarter” and added: “One thing I would be very careful about, for those of you that have watched Autonomy for many years, you will be used to the fact that there is, on a quarterly basis, pretty damn random plus or minus 2% on the gross margin.”
 As Autonomy’s 2010 Annual Report explained: “Autonomy is one of the very rare examples of a pure software model. Many software companies have a large percentage of revenues that stem from professional services, because they have to do a lot of customisation work on the product for every single implementation. In contrast, Autonomy ships a standard product that requires little tailoring, with the necessary implementation work carried out by approved partners such as IBM Global Services, Accenture and others.” Autonomy Corporation plc, Annual Report and Accounts for the Year Ended 31 December 2010, at 13. And, as further noted in the same document: “Autonomy operates a rare ‘pure software’ model under which our goal is that most implementation work is carried out by approved partners.” Id. at 16.
 See Arik Hesseldahl, What Exactly Happened at Autonomy?, Wall St. J. (Nov. 20, 2012), http://allthingsd.com/20121120/what-exactly-happened-at-autonomy/ (quoting Ms. Lesjak as saying, “The VAR sales were reported as licenses, and they weren’t, in some sense, real sales, because there was no end user.”).
 For example, the Report to the Audit Committee on the Q2 2010 Review stated, at page 5: “We highlight to the Audit Committee that there is a large licence deal on which we reported in Q1 2010 with Microtech where the end user is the Vatican ($11.5 million). . . . As part of our Q2 2010 procedures we received confirmation from Microtech of the amount outstanding and the absence of any side agreements or ongoing performance criteria.”
 As a general matter, and contrary to paragraph 144.1 of the Particulars, it should be noted that although Autonomy referred internally to reseller deals by the names of the intended end users, as a way of differentiating among multiple deals with the same reseller, the Reports to the Audit Committee make clear that the Audit Committee and Deloitte were well aware that the customers in these deals were resellers, not end users.
 MicroTech leased office space in Virginia and, as the proposal made clear, equipped the facility with advanced technology, including extensive multiprocessor server farm, storage, and other cloud related systems; software infrastructure; multiple displays; a security system; virtual enterprise management software; and other advanced components.
 Specifically, Deloitte stated:
The most significant revenues recognized in the quarter were with . . . Filetek Inc ($7.5 million) . . . . Autonomy has separately purchased $10.4 million of software and associated services from Filetek Inc (“Filetek”) in the quarter. Given that there is a clear commercial rationale for the separate transactions, separate contractual arrangements and evidence that both transactions have been made at fair value, management has confirmed and concluded that there are no links between the contracts that would impact that accounting. The cost of the software purchased by Autonomy has been capitalised on the balance sheet as an intangible asset and is to be amortised to the income statement over its useful economic life of five years.
Id. at 3.
 In the words of HP’s CEO, Meg Whitman, in an interview published on April 10, 2013, IDOL software is “almost magical technology. What it allows customers to do [is] to understand all the unstructured data, the application to legal and compliance—it is terrific technology . . . .” Katherine Rushton, HP Boss Meg Whitman Admits Autonomy Row Hit Morale, The Telegraph (Apr. 10, 2013), http://www.telegraph.co.uk/finance/news/bysector/mediatechnologyandtelecoms/electronics/9984271/HP-boss-Meg-Whitman-admits-Autonomy-row-hit-morale.html.
HP’s allegations have changed significantly since its announcement of the write-down on 20th of November 2012. As HP’s initial false interpretation of the relevant accounting standards has been replaced by a more sober understanding of the facts, it has attempted to retrofit a new set of allegations to justify its massive write-down. Gone are the original accusations that hardware was booked as software and costs were not counted, as well as the idea that the reseller deals were not real (which has been replaced with mere timing allegations). The hosted and OEM allegations likewise cannot support any credible claim of loss. And the tiny number of deals at issue could not, under any circumstances, justify a $5 billion write-down.
In short, even the latest carefully crafted allegations—drafted with the benefit of a nearly three-year investigation—make no case for fraud. Rather, they evidence, at best, a difference of opinion over accounting policies (as exemplified in the rebasing exercise reported by the FT)—a disagreement in which two Big Four firms, Deloitte (Autonomy’s auditor) and Ernst & Young (HP’s firm) agree that there is nothing wrong with the pre-acquisition financials.
The allegations break into four categories:
Autonomy made all required disclosures. Hardware was not a separate business unit and there was no requirement that it be separately disclosed. The gross margin judgement was reasonable and was cleared by Deloitte. And, in any event, the differences in gross margin alleged by HP, which result in at most a variance of 4%, could not have materially affected the valuation of the company.
Many sources made clear that Autonomy sold hardware, as HP well knew. HP continued to make what it calls ‘pure’ hardware sales after the acquisition, and HP’s accountants approved the practice. HP’s claims about what it knew and how it valued Autonomy are contradicted by the evidence and by common sense. This is especially true given that HP’s own valuation of Autonomy considered hardware sales.
Note: we have moved away from the original allegations of hardware booked as software and that hardware revenues should not be counted as revenue. Now that it has emerged that HP knew about hardware, the argument has shifted to the sales being of the wrong type of hardware.
HP has detailed its allegations as to a grand total of just 6 reseller deals with an aggregate value of approximately $40m (out of the $5 billion write-down). And even with regard to these 6, HP provides no actual evidence to support its claim that the resellers were not on risk. Indeed, the documentary evidence explicitly shows that the resellers were on risk and that almost all the cash was received on these deals. Nor can HP’s claims of acceleration be credited, as they rely on a failure to understand that under IFRS, the reseller—not the reseller’s intended end user purchaser—is Autonomy’s customer.
Note: we have moved away from the original allegation of the issue being no sell through or problems with the end user. Now it is solely an issue of timing of revenue recognition as Autonomy received cash on almost all of the deals.
HP claims that Autonomy channelled funds to 5 of its reseller customers by buying goods from those customers that Autonomy did not value or use. This allegation pertains to about $50 million in transactions, which, as the schedules show, encompass essentially every product Autonomy ever bought from a customer. In other words, HP has concluded that Autonomy never had a valid reason to make a purchase from any of its customers—despite the fact that HP makes such purchases from its customers as a matter of course. In reality, all items that Autonomy purchased from customers were checked by Deloitte for fair value, and most of the items are mis-described by HP and are well documented as having been used or sold on at a profit.
At the time of the acquisition, HP and the market were well aware of how Autonomy structured its hosted deals: many analysts covered the topic and it was discussed in Autonomy’s annual reports. Deloitte approved the structure of such deals. HP reviewed several hosting contracts pre-acquisition, and HP’s own accountants agreed with the method and used it themselves at HP. All of the cash was received on these deals, which were mainly with blue-chip clients.
Notably, HP does not claim that the hosted deals were not real; rather, it argues that Autonomy should have renewed all of these deals as service contracts only, rather than including a license component, on the theory that the former would have brought a higher price. This allegation neglects the fact that storage costs had declined sharply in recent years, making it impossible to maintain historical prices on hosting-service contracts. In any event, Autonomy’s pricing was a commercial decision well within management’s reasonable discretion, and HP saw some of the contracts in due diligence and thus cannot seriously contend that it was unaware of Autonomy’s pricing policies.
HP purposefully confuses OEM and OEM-derived revenues by, for example, only counting revenue from software companies as recognizable OEM-derived revenue. The definition Autonomy used for OEM revenue is included in the annual report and is stated as an estimate. HP has no credible basis for its allegation that Autonomy’s OEM-related accounting violated IFRS or was somehow fraudulent.
HP has proffered no explanation as to how its allegations lead to a $5 billion write-down, especially as the allegations have no impact on the cash flow, which was the basis of HP’s valuation of Autonomy.
The comments to the schedules make clear the real reason deals were removed: accounting policy differences, not fraud. Whole classes of deals were removed, as in the rebasing exercise, with no individual analysis. Deals were removed for reasons of hindsight, for example where HP failed to conclude an implementation and had to repay customers—but hindsight is not the applicable accounting standard, as HP well knows.
HP is silent on the fact that all these matters were reviewed and agreed with by Deloitte.
There are many factual inaccuracies, such as statements regarding Autonomy’s use of purchased items, which can easily be rebutted.
Autonomy’s business was real and customers paid for it. If all of the revenue challenged by HP is removed, the result is more than $400 million in surplus cash over the period. If not from legitimate business, then where did this cash come from?
Autonomy was valued by HP on cash flow, and the cash flow has not changed under HP’s allegations.
Almost all of the challenged items were well documented and reviewed by Deloitte. However, the allegations hardly mention Deloitte, much less explain why Deloitte’s conclusions are being challenged. Deloitte is not being sued and stands by its work.
After three years of Meg Whitman’s stonewalling, is this it?
HP’s claim is finally laid bare for what it is – a desperate search for a scapegoat for its own errors and incompetence.
The contents of the claim are a simple re-hash of previous leaks and insinuations that add up to one long disagreement over accounting treatments, and have nothing to do with fraud.
Looking at the detail, out of 23,000 deals and $2.2 billion in revenue that took place at Autonomy during the period, Whitman makes assertions concerning only six specific reseller transactions, which add up to under $40million in revenue, and for which almost all the cash was, in fact, received. Whitman provides scant supporting evidence even for these few assertions. She raises questions over fully-paid hosted deals, the form of which HP’s own accountants approved, and in a structure HP itself also used. She now admits that hardware sales were correctly recorded as revenue and that HP was fully aware of this when they valued the company at $11 billion. Whitman also questions purchases from customers, despite the evidence showing that Autonomy bought from them at the correct price and for good commercial reason.
There are two critical points she conveniently ignores:
Meg Whitman has been playing a delaying game, promising a smoking gun that has never materialised, hoping to confuse people by misstating IFRS rules, smearing individuals and avoid being called to account. Now that she is forced into being specific, that waiting game is coming to an end and we look forward to hearing her answers in court.
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.
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 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.
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:
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).
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:
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.
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
Deloitte’s report to the Autonomy Audit Committee Q2 2010
Extract from Hewlett Packard court filing in California 5 June 2014. Paul Curtis was HP’s head of worldwide revenue recognition who scrutinised Autonomy’s accounts without raising any issues.
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.
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.
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.
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.
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.
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 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.
The full court filing can be found at:
 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.”
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.
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:
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:
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.
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”.
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)
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).
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.
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.
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.
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.
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]
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.]
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.
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.
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.
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).
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:
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.
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.
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.
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:
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:
- 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?
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?
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.Mike Lynch
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.Mike Lynch
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:
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
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.
This website is maintained by Dr Mike Lynch on behalf of the former management team of Autonomy. It is a portal providing relevant information pertaining to the accusations made by Hewlett Packard (HP) of alleged financial impropriety at Autonomy. The former management team of Autonomy strongly rejects the accusations made by HP.
If you have any questions, please use the submission form on the Contact section.