Further analysis of 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:
Upon closer reading, the accounts show this to be PR spin and misdirection. Firstly, Ernst & Young have publicly refused to sign off these accounts in any way whatsoever. However, the HP directors, including Christopher Yelland, under Company Law have certified the accounts as being “true and fair”, even though Ernst and Young gave a complete disclaimer “we do not express an opinion on these financial statements”.
Hardware and VAR Accounting
One of the most salient points to emerge from these accounts, is that they treat hardware and reseller sell-through in exactly the same way Autonomy always did, despite the fact that HP called raised issues with these practices in November 2012. It is interesting to note that in these restated accounts, HP reports as one operating segment – the fact it is one operating segment is what controls the disclosure rules and negates the need to break out hardware as a separate line item. “All turnover relates to one business segment, being the sale of software are related services, and originates in the United Kingdom.” (p19)
External Valuation Report
Ernst & Young, in the ACL accounts also make reference to an external valuation report dated July 2012 – HP did not inform of the presence of this report until November, despite the impact it had on the underlying accounts. HP’s Q3 accounts stated in Autonomy “the fair value of Autonomy approximated the carrying value” (p. 16, HP Q3’12 10Q).
Changes in Accounting Policy
The changes in the accounts are directly due to changes in accounting policies and practices, which HP introduced. The accounts are not done under IFRS. A direct comparison of the previous audited and the current unaudited accounting policies can be seen in the attached appendix.
Under this new policy, revenue and profits have been moved to later periods and possibly to overseas companies. Thus it is wholly inaccurate to conclude that 81% of profit has disappeared.
Absence of Fundamental Errors
The accounting policy changes allow HP to make decisions based on judgement, with the benefit of hindsight – which is not good accounting practice. Furthermore, there is no disclosure of bad debt charges in 2010. These points, combined with the fact that there haven’t been any changes in cash means that there are likely no fundamental errors in the original accounts and that there is little justification for them to have been restated.
The accounts show that the cash balance remained unchanged. This is crucial in that it shows that there was no change to the real business in the company. And in fact the cash position now precedes the profit under the new policy.
It is clear that the effect of these changes is to provide a headline figure in the apparent profitability of the company. This profit reduction is being used as an attempt to make claim of tax from the UK government.
In common with most technology companies Autonomy from time to time bought products or services from its customers. Such transactions in the industry are entirely proper and in fact HP itself engages in them at a much higher level. For the audited periods all the relevant details were given to Deloitte who applied the appropriate fair value checks.
Collectability of Cash
Autonomy applied a series of checks for collectability, a process which was reviewed and checked by Deloitte. The fact that HP now may be using different tests and incorrectly applying hindsight to a small number of deals where ultimately payment was not received does note change the accounting. Autonomy’s bad debt levels were in line with the industry.
Revenue Deferred not Disappeared
We note from the accounts for example ASL direct sales that of the £19m which appears to have disappeared, £16m is in fact just deferred to later periods under the different accounting policies that HP has adopted.
Comparison of ASL Turnover Accounting Policy Note in 2010 and 2011 accounts
The passages of text below show the changes made to ASL’s accounting policy for turnover in its accounts for 10 months to 31 October 2011 compared to year ended 31 December 2010.
Key to text: (BLACK = unchanged / BLUE = 2011 added / [RED = 2010 removed]
i) Sale of goods
The company sells its products as licenses to resellers, OEMs and direct to end-users together with associated support and maintenance. In addition, the company also sells some of its products on a subscription basis.
Turnover from software license agreements is recognised where there is persuasive evidence of an agreement with a customer (contract and/or binding purchase order), delivery of the software has taken place, collectability is probable and the fee has been contractually agreed and is not subject to adjustment or refund (i.e. is fixed and determinable). If an acceptance period is required, turnover is recognised upon the earlier of customer acceptance or the expiration of the acceptance period. [2010: Turnover is recognized on contracts providing that the customer passes defined creditworthiness checks.] If significant post- delivery obligations exist or if a sale is subject to customer acceptance, turnover is deferred until no significant obligations remain or acceptance has occurred.
The company enters into OEM and reseller arrangements that typically provide for fees payable to the company based on licensing of the company’s software to third party customers. Sales are [2010: generally] recognised [2010: as reported by the OEM or reseller and is] based on the amount of product sold subject to the criteria above. [2010: Sales are recognised if all products subject to resale are delivered in the current period, no right of return policy exists, collection is probable and the fee is fixed and determinable.]
ii) Support and Maintenance
Turnover from customer support and maintenance is recognised rateably over the term of the support period. If customer support and maintenance is included free or at a discount in a multiple element arrangement, these amounts arc allocated out of the license fee at their fair market value based on the value established by independent sale of the customer support and maintenance to customers. Support and maintenance consists primarily of the supply of products, such as patches and updates, to the standard software.
iii) Rendering of services
Consulting and training turnover is included within rendering of services.
Turnover from consulting and training services is recognised as services are performed. If a transaction includes both license and service elements, license fee turnover is recognised upon shipment of the software, provided services do not include significant customisation or modification of the base product and the payment terms for licenses are not subject to acceptance criteria and the fair value of the service element can be determined. In cases where license fee payments are contingent upon the acceptance of services, turnover from both the license and the service elements is deferred until the acceptance criteria are met.
If services include significant customisation or modification, then revenue is recognised as the services are performed and stage of completion is determined by reference to the costs incurred as a proportion of the total estimated costs of the service project. If a contract cannot be reliably estimated,revenue is recognised only to the extent that costs have been incurred. Provision is made as soon as a loss is foreseen.
iii) Managed Service Turnover
Turnover for managed services is recognised as the services are delivered. The services may comprise of a combination of hosted services and software as part of a multiple element arrangement, as described below, and where applicable an assessment is performed to determine whether software elements can be separated from on-going service elements. In the situation where the elements cannot be the license turnover is recognised rateably over the service period.
iv) Multiple element arrangements
The Company evaluates the elements of a transaction to identify the appropriate accounting elements so that revenue recognition criteria may be applied to separately identifiable elements of a single transaction, and when appropriate, the recognition criteria may be applied to two or more transactions when their economic substance cannot be understood individually.
For those transactions with multiple elements, if the Company has determined that the undelivered elements of that contract have fair value, the Company records the revenue associated with the delivered elements (generally the software license) at an amount that represents the fee for the transaction less the fair value of any undelivered e1ement and defers the fair value of undelivered elements of the transaction (generally the support and maintenance and services).
v) Revenues from fellow group undertakings
The Company earns income through a share of the earnings of fellow group undertakings. The earnings of the fellow group undertakings arc derived from the sale of software and related services incorporating intellectual property owned or licensed by the Company, and from the sale of other products, including hardware.