Open letter from Mike Lynch to the shareholders of Hewlett-Packard

Dear Shareholder,

As you are aware, Hewlett Packard remains locked in dispute with a group of its own shareholders and with the former management team of Autonomy over its purchase of Autonomy. I write to you today to raise serious concerns about the way HP has conducted this affair, and to put forward a number of questions that HP management should answer. The evidence shows that HP is not just smearing us, but also misleading you, its shareholders. I ask you to help put things right.

On November 20th 2012, HP made a series of serious and damaging allegations about the management team of Autonomy. It couched alleged misdeeds in general, rather than specific terms. We emphatically denied all suggestions of wrongdoing.

In the 16 months that have followed, HP has not provided information or evidence to the Autonomy team to substantiate any allegation. Instead, it has selectively leaked documents and information to the international media, frequently using material taken out of context to create false impressions and smear our reputations.

Since the last HP shareholder meeting, reports in the media have demonstrated that HP has documents in its possession that show beyond doubt that statements it made on November 20th were misleading. Further, these reports have shown that senior people at HP knew these statements were misleading long before they were made.

On the basis of recent reports, there are a number of material questions HP needs to answer:

  • HP has repeatedly declined to show the Autonomy management team the allegations or evidence against them, on the grounds that the issue is “with the regulators”. Yet it has engaged in selective disclosure of these documents and emails to the media. How does HP justify that?
  • HP claimed Autonomy’s auditors had “missed” certain items and been misled. All the evidence in the public domain shows Autonomy was fully open and transparent with its auditors (Financial Times, 17th February 2014). If HP has any alternative evidence, why does it not reveal it?
  • HP claims to have been in the dark until a “whistleblower” stepped forward. Articles in the Financial Times have established that the most senior managers of HP fully understood Autonomy’s accounting methods from when they took over the company in October 2011. Does HP deny that senior managers had prior knowledge?
  • Does HP deny that it knew how Autonomy recognised hardware sales and that these sales were reported in full by its auditors, and that HP continued the same sales of Dell hardware after it took over Autonomy?
  • Does HP deny that it was aware of how Autonomy recognised reseller transactions? And that it sought to use the differences between IFRS and US GAAP applicable to reseller sales to its own advantage after the acquisition?
  • HP’s independent advisers carried out several valuation reports of Autonomy after the acquisition, which explicitly included Autonomy’s hardware sales and confirmed the value of the company at c$11Bn? Does HP management deny this? Will they disclose these reports to shareholders?
  • Why did HP’s management fail to disclose these valuations at the time? Why do they not release them now?
  • Why won’t HP release its calculation for the write down?
  • HP says it “eventually learned that a portion of Autonomy’s revenue were related to hardware sales”. Yet documents show that HP knew about Autonomy’s hardware sales from October 2011. Does HP still maintain it knew nothing before June 2012?

I urge you to continue to seek answers to these questions. Meg Whitman has made incendiary and defamatory accusations on behalf of her company. She should now present the detailed evidence that justifies those allegations and a $5.5bn write-down in the value of your company.

You and I have a shared ambition to see this situation resolved as soon as possible. I hope your questions today can bring us nearer to that resolution.

Yours respectfully,

Mike Lynch

Statement regarding HP’s changing position on hardware sales

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:

  1. That Autonomy “sold negative-margin, low-end hardware” and represented this as software revenue (HP statement)
  2. That up to 10-15 per cent of Autonomy’s sales were such hardware sales, and this was a “wilful effort…to inflate the underlying financial metrics of the company” (HP statement)
  3. John Schultz, Chief Legal Officer said, “They used low end hardware sales, but put out that it was a pure software company” (John Schultz, New York Times)
  4. That “critical documents were missing from the obvious places and it required that we look in every nook and cranny” (John Schultz, Reuters)
  5. That there was “active concealment”, and Deloitte, Autonomy’s auditor, “obviously didn’t catch these issues at the time” (John Schultz, Bloomberg)

However, the FT revelations now show that HP and its senior management were well aware of Autonomy’s hardware sales and its legitimate practice of sometimes selling hardware as a loss leader, and that all of these sales had been fully disclosed to Deloitte and appropriately reviewed and treated.

In response to these revelations HP issued a statement on 17th February 2014 that it had “eventually” become aware of the hardware sales before the so-called whistleblower made its allegations in May 2012. The documents cited by the FT show that this information was available and known to HP immediately upon acquisition, if not before, and the practice of selling hardware at a loss was well known by HP executives long before the “whistleblower” came forward.

Given that hardware accounted for over $160 of the $200m disputed revenue, this new information must seriously question the stated basis of HP’s write down.

We note that the FT has included some details of a transaction between Autonomy and Morgan Stanley, presumably from emails leaked to the FT by HP, which is presented as indicative of Autonomy’s hardware sales. The emails show that Autonomy did indeed sell hardware to Morgan Stanley at a slight loss, something Autonomy has always fully explained to its auditors and, indeed, directly to HP. The audit packs cited by the FT show that this was fully disclosed to the auditors, and accounted for in the appropriate manner.

Reaction to Financial Times article

From Mike Lynch:

“Meg Whitman accused Autonomy of “active concealment” but these revelations prove we were open and transparent with our auditors who continue to stand by the accounts. Meg Whitman must answer to her shareholders with what she knew, when she knew it and how she and her senior colleagues made such factually incorrect and serious statements that were so easy to check from the audit packs.

“Why would Meg say we had withheld information from our auditors? She should explain or resign.”


Meg Whitman accused us of “active concealment” but these revelations prove we were open and transparent with our auditors. These revelations not only confirm this, but show that a large number of Hewlett Packard staff and their advisers were familiar and comfortable with Autonomy accounting practices for over a year before HP made its announcement. We now ask that Meg Whitman explain to her shareholders what she knew, when she knew it and how her senior colleagues could have made factually incorrect statements that were so easy to check from the Deloitte audit packs.

In November 2012, Meg Whitman and her senior management team told the world they had discovered that Autonomy had been selling hardware and booking it as high-margin software and that it had inappropriately booked value-added reseller (VAR) sales where there had been no sell-through. She further stated that these facts were so well hidden that they came to light only when a whistle-blower surfaced in June 2012, a position untenable now that details of Deloitte’s audit packs have emerged. Deloitte has stated it “categorically denies any knowledge of any accounting improprieties or misrepresentations in Autonomy’s financial statements.”

Despite waiting a year and HP trawling through thousands of deals we are presented with three examples of value of about $24m out of $2.1bn, and a couple of out-of-context email quotes. We now see why, as the FT puts it, “her standing is increasingly blemished by HP’s failure to provide convincing evidence” to substantiate a $5bn write-down.

There is another explanation for the failure of Autonomy to meet the financial expectations in place at the time of its takeover by HP. It is entirely to do with HP’s failure to properly integrate the company it bought. That failure became clear early in the process and is recorded in the documents revealed today. Given that there were early indications of these difficulties, reported to Ms Whitman and her team by senior figures at Autonomy, we ask why she waited until November 2012 until informing her shareholders of a write-down in value.

Whilst we are pleased that light has been shed on this situation, Meg Whitman now has some very serious questions to answer. And we ask that HP no longer pursue this matter through partial leaks, information out of context and spin.

Further Analysis on HP’s Restated Accounts for Autonomy 2009 – 2010

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:

Auditor Comment

Upon closer reading, the accounts show this to be PR spin and misdirection. Firstly, Ernst & Young have publicly refused to sign off these accounts in any way whatsoever. However, the HP directors, including Christopher Yelland, under Company Law have certified the accounts as being “true and fair”, even though Ernst and Young gave a complete disclaimer “we do not express an opinion on these financial statements”.

Hardware and VAR Accounting

One of the most salient points to emerge from these accounts, is that they treat hardware and reseller sell-through in exactly the same way Autonomy always did, despite the fact that HP called raised issues with these practices in November 2012. It is interesting to note that in these restated accounts, HP reports as one operating segment – the fact it is one operating segment is what controls the disclosure rules and negates the need to break out hardware as a separate line item. “All turnover relates to one business segment, being the sale of software are related services, and originates in the United Kingdom.” (p19)

External Valuation Report

Ernst & Young, in the ACL accounts also make reference to an external valuation report dated July 2012 – HP did not inform of the presence of this report until November, despite the impact it had on the underlying accounts. HP’s Q3 accounts stated in Autonomy “the fair value of Autonomy approximated the carrying value” (p. 16, HP Q3’12 10Q).

Changes in Accounting Policy

The changes in the accounts are directly due to changes in accounting policies and practices, which HP introduced. The accounts are not done under IFRS. A direct comparison of the previous audited and the current unaudited accounting policies can be seen in the attached appendix.

Under this new policy, revenue and profits have been moved to later periods and possibly to overseas companies. Thus it is wholly inaccurate to conclude that 81% of profit has disappeared.

Absence of Fundamental Errors

The accounting policy changes allow HP to make decisions based on judgement, with the benefit of hindsight – which is not good accounting practice. Furthermore, there is no disclosure of bad debt charges in 2010. These points, combined with the fact that there haven’t been any changes in cash means that there are likely no fundamental errors in the original accounts and that there is little justification for them to have been restated.

Cash Balance

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.

Tax Rebate

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.

“Barter-type” Transactions

In common with most technology companies Autonomy from time to time bought products or services from its customers. Such transactions in the industry are entirely proper and in fact HP itself engages in them at a much higher level. For the audited periods all the relevant details were given to Deloitte who applied the appropriate fair value checks.

Collectability of Cash

Autonomy applied a series of checks for collectability, a process which was reviewed and checked by Deloitte. The fact that HP now may be using different tests and incorrectly applying hindsight to a small number of deals where ultimately payment was not received does note change the accounting. Autonomy’s bad debt levels were in line with the industry.

Revenue Deferred not Disappeared

We note from the accounts for example ASL direct sales that of the £19m which appears to have disappeared, £16m is in fact just deferred to later periods under the different accounting policies that HP has adopted.



Comparison of ASL Turnover Accounting Policy Note in 2010 and 2011 accounts

The passages of text below show the changes made to ASL’s accounting policy for turnover in its accounts for 10 months to 31 October 2011 compared to year ended 31 December 2010.

Key to text:
 (BLACK = unchanged / BLUE = 2011 added / [RED = 2010 removed]

i) Sale of goods

The company sells its products as licenses to resellers, OEMs and direct to end-users together with associated support and maintenance. In addition, the company also sells some of its products on a subscription basis.

Turnover from software license agreements is recognised where there is persuasive evidence of an agreement with a customer (contract and/or binding purchase order), delivery of the software has taken place, collectability is probable and the fee has been contractually agreed and is not subject to adjustment or refund (i.e. is fixed and determinable). If an acceptance period is required, turnover is recognised upon the earlier of customer acceptance or the expiration of the acceptance period. [2010: Turnover is recognized on contracts providing that the customer passes defined creditworthiness checks.]If significant post- delivery obligations exist or if a sale is subject to customer acceptance, turnover is deferred until no significant obligations remain or acceptance has occurred.

The company enters into OEM and reseller arrangements that typically provide for fees payable to the company based on licensing of the company’s software to third party customers. Sales are [2010: generally] recognised [2010: as reported by the OEM or reseller and is] based on the amount of product sold subject to the criteria above. [2010: Sales are recognised if all products subject to resale are delivered in the current period, no right of return policy exists, collection is probable and the fee is fixed and determinable.]

ii) Support and Maintenance

Turnover from customer support and maintenance is recognised rateably over the term of the support period. If customer support and maintenance is included free or at a discount in a multiple element arrangement, these amounts arc allocated out of the license fee at their fair market value based on the value established by independent sale of the customer support and maintenance to customers. Support and maintenance consists primarily of the supply of products, such as patches and updates, to the standard software.

iii) Rendering of services

Consulting and training turnover is included within rendering of services.

Turnover from consulting and training services is recognised as services are performed. If a transaction includes both license and service elements, license fee turnover is recognised upon shipment of the software, provided services do not include significant customisation or modification of the base product and the payment terms for licenses are not subject to acceptance criteria and the fair value of the service element can be determined. In cases where license fee payments are contingent upon the acceptance of services, turnover from both the license and the service elements is deferred until the acceptance criteria are met.

If services include significant customisation or modification, then revenue is recognised as the services are performed and stage of completion is determined by reference to the costs incurred as a proportion of the total estimated costs of the service project. If  a contract cannot be reliably estimated,revenue is recognised only to the extent that costs have been incurred. Provision is made as soon as a loss is foreseen.

iii) Managed Service Turnover

Turnover for managed services is recognised as the services are delivered. The services may comprise of a combination of hosted services and software as part of a multiple element arrangement, as described below, and where applicable an assessment is performed to determine whether software elements can be separated from on-going service elements. In the situation where the elements cannot be the license turnover is recognised rateably over the service period

iv) Multiple element arrangements

The Company evaluates the elements of a transaction to identify the appropriate accounting elements so that revenue recognition criteria may be applied to separately identifiable elements of a single transaction, and when appropriate, the recognition criteria may be applied to two or more transactions when their economic substance cannot be understood individually.

For those transactions with multiple elements, if the Company has determined that the undelivered elements of that contract have fair value, the Company records the revenue associated with the delivered elements (generally the software license) at an amount that represents the fee for the transaction less the fair value of any undelivered e1ement and defers the fair value of undelivered elements of the transaction (generally the support and maintenance and services).

v) Revenues from fellow group undertakings

The Company earns income through a share of the earnings of fellow group undertakings. The earnings of the fellow group undertakings arc derived from the sale of software and related services incorporating intellectual property owned or licensed by the Company, and from the sale of other products, including hardware.


Response to HP’s restatement of Autonomy’s accounts

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 posts analysis of HP/Autonomy accounting issues

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:



Note on the Letter from the United States Air Force

Over the past few days, several media outlets have reported on a private letter dated September 2013 from the US Air Force to members of the former senior management of Autonomy and others. The letter concerns the USAF conducting a review of potential future commercial relationships with the former senior management of Autonomy. The USAF letter cites allegations made against the Autonomy management team by Hewlett Packard on 20th November 2012 as the basis for this review. This is an understandable precaution for the US Air Force to take, given the nature of such public allegations made by HP.

We strongly reject HP’s allegations. The few examples seen to date in support of its allegations, such as those cited in the USAF letter, show that HP appears to have had a fundamental misunderstanding of IFRS accounting practices, and we vehemently deny anything improper.

Autonomy was fully transparent with its auditors and correctly represented its accounts. Autonomy’s transactions were entirely properly accounted for under IFRS and reviewed by Autonomy’s auditors as appropriate.

Moreover, in relation to the scale of the $5 billion write down taken by HP on the basis of these allegations, the deals cited in the USAF letter constitute a tiny number of deals of low materiality in the context of Autonomy’s size. Even if these deals had in some way been questionable, they would have had no effect to justify the write-down.

A year on from HP’s initial allegations, despite repeated requests we have still not received detailed allegations or the supporting evidence for them. Rather what we see from HP is unsupported accusations, leaks and PR spin rather than a direct conversation based on the facts.

We have responded to the US Air Force letter addressing the concerns they have raised. This is a private correspondence and it would not be appropriate to discuss it, or any specific issues contained within it, in public. However, given that these issues are being reported in the international media we feel it is important to make clear a couple of general points of fact in relation to the matters at hand:

Summary of Background and Our Response to the US Air Force

The allegations made by HP against Autonomy are false.  Autonomy’s auditor, Deloitte LLP (“Deloitte”), has publicly denied any knowledge of improprieties. Deloitte’s audit reports show that Autonomy was transparent with it and that it reviewed the matters now under consideration in detail.

Autonomy’s disclosure and revenue recognition practices were proper and fully consistent with the standards under which it reported – the International Financial Reporting Standards (“IFRS”) and International Accounting Standards (“IAS”).  Those standards differ from U.S. GAAP and, in many cases, allow for the recognition of revenue earlier than under U.S. GAAP.

As Autonomy’s outside auditor, Deloitte conducted full scope annual audits and limited scope quarterly reviews. As part of its review, it was Deloitte’s policy to review all sales contracts or invoices over $1 million and a sample of contracts worth more than $100,000.

Sales to Value-Added Resellers

Autonomy, like many other companies in the software industry, sold its products to value added resellers, or VARs. The term VARs frequently refers to companies that buy a product (such as software) and then resell that product to an end user together with other products or services.

Under IFRS, for revenue recognition purposes, the VAR is the customer of Autonomy, rather than any potential ultimate end user who might buy the software from the VAR. There is no IFRS revenue recognition requirement that, following the sale to a VAR, there be a subsequent sale from the VAR to an end user, or even that an end user be identified at the time of a sale to a VAR. The VAR assumes the risk of resale, which may occur at any time in the future.

The relevant accounting procedure is governed by IAS 18. Revenue from a sale by an entity such as Autonomy to a VAR buyer may be recognized so long as the five elements of IAS 18 are satisfied, as follows:

(a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;

(b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

(c) the amount of revenue can be measured reliably;

(d) it is probable that the economic benefits associated with the transaction will flow to the entity; and

(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.

The propriety of any revenue recognition decision is assessed based on the knowledge and circumstances at the time of the recognition decision, not with the benefit of hindsight.

Consistent with IFRS and IAS 18, Autonomy’s revenue-recognition policy provided that sales of IDOL product to a VAR were recognized when the software licenses subject to the sale had been “delivered in the current period, no right of return policy exist[ed], collection [wa]s probable and the fee [wa]s fixed and determinable.” The policy did not require sell-through to an end user before recognizing revenue from a sale to a VAR.  This policy was approved by Deloitte and the Audit Committee and disclosed in the ‘Notes to Consolidated Financial Statements’ section of Autonomy’s Annual Report.

Post Revenue Recognition Events

On a few occasions, following a sale to a VAR and the decision to recognize revenue, a VAR unexpectedly did not ultimately complete its anticipated onward sale.  This could occur because no end user purchased the software.  Those subsequent events do not invalidate the appropriateness of recognizing revenue at the time of sale to the VAR.

This is because, as discussed above, there is no end user requirement for revenue recognition and because the propriety of revenue recognition is assessed based on the circumstances at the time of recognition, and not in hindsight.

Purchases from VARs

As an initial matter, it is common for companies in the technology sector to both sell to, and buy from, other technology companies.  Indeed, it is our understanding that HP itself engages in such transactions.  On the small number of occasions when Autonomy did so, it properly accounted for them.  IAS 18 permits revenue recognition in these circumstances based on the fair value of consideration received for a sale. Deloitte ensured that the relevant elements were met on purchases from customers.