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.

Mike Lynch publishes an open letter to Hewlett-Packard

Open Letter from Dr Mike Lynch to the Board of Directors of Hewlett-Packard

27 November 2012

To: The Board of Directors of Hewlett-Packard Company

On 20 November Hewlett-Packard (HP) issued a statement accusing unspecified members of Autonomy’s former management team of serious financial impropriety. It was shocking that HP put non-specific but highly damaging allegations into the public domain without prior notification or contact with me, as former CEO of Autonomy.

I utterly reject all allegations of impropriety.

Autonomy’s finances, during its years as a public company and including the time period in question, were handled in accordance with applicable regulations and accounting practices. Autonomy’s accounts were overseen by independent auditors Deloitte LLC, who have confirmed the application of all appropriate procedures including those dictated by the International Financial Reporting Standards used in the UK.

Having no details beyond the limited public information provided last week, and still with no further contact from you, I am writing today to ask you, the board of HP, for immediate and specific explanations for the allegations HP is making. HP should provide me with the interim report and any other documents which you say you have provided to the SEC and the SFO so that I can answer whatever is alleged, instead of the selective disclosure of non-material information via background discussions with the media.

I believe it is in the interest of all stakeholders, and the public record, for HP to respond to a number of questions:

  • Many observers are stunned by HP’s claim that these allegations account for a $5 billion write down and fail to understand how HP reaches that number. Please publish the calculations used to determine the $5 billion impairment charge. Please provide a breakdown of the relative contribution for revenue, cash flow, profit and write down in relation to:
    • The alleged “mischaracterization” of hardware that HP did not realize Autonomy sold, as I understand this would have no effect on annual top or bottom lines and a minor effect on gross margin within normal fluctuations and no impact on growth, assuming a steady state over the period;
    • The alleged “inappropriate acceleration of revenue recognition with value-added resellers” and the “[creation of] revenue where no end-user customer existed at the time of sale”, given their normal treatment under IFRS; and
    • The allegations of incorrect revenue recognition of long-term arrangements of hosted deals, again given the normal treatment under IFRS.
  • In order to justify a $5 billion accounting write down, a significant amount of revenue must be involved. Please explain how such issues could possibly have gone undetected during the extensive acquisition due diligence process and HP’s financial oversight of Autonomy for a year from acquisition until October 2012 (a period during which all of the Autonomy finance reported to HP’s CFO Cathie Lesjak).
  • Can HP really state that no part of the $5 billion write down was, or should be, attributed to HP’s operational and financial mismanagement of Autonomy since the acquisition?
  • How many people employed by Autonomy in September 2011 have left or resigned under the management of HP?
  • HP raised issues about the inclusion of hardware in Autonomy’s IDOL Product revenue, notwithstanding this being in accordance with proper IFRS accounting practice. Please confirm that Ms Whitman and other HP senior management were aware of Autonomy’s hardware sales before 2012. Did Autonomy, as part of HP, continue to sell third-party hardware of materially similar value after acquisition? Was this accounted for by HP and was this reported in the Autonomy segment of their accounts?
  • Were Ms Whitman and Ms Lesjak aware that Paul Curtis (HP’s Worldwide Director of Software Revenue Recognition), KPMG and Ernst & Young undertook in December 2011 detailed studies of Autonomy’s software revenue recognition with a view to optimising for US GAAP?
  • Why did HP senior management apparently wait six months to inform its shareholders of the possibility of a material event related to Autonomy?

Hewlett Packard is an iconic technology company, which was historically admired and respected all over the world. Autonomy joined forces with HP with real hopes for the future and in the belief that together there was an opportunity to make HP great again. I have been truly saddened by the events of the past months, and am shocked and appalled by the events of the past week.

I believe it is in the best interests of all parties for this situation to be resolved as quickly as possible.

I am placing this letter in the public domain in the interests of complete transparency.

Yours faithfully,

Dr. Michael R. Lynch