By Anjuli Davies
LONDON | Fri Nov 23, 2012 7:19am EST
(Reuters) – Mike Lynch, mathematics whiz and former boss of Autonomy, said he can’t see how accusations leveled by Hewlett-Packard Co of dodgy accounting add up to a $5 billion writedown on the software business he sold them last year.
HP said on Tuesday it would write $8.8 billion off its $11.1 billion purchase of the British company, $5 billion of it due to “serious accounting improprieties” and “a wilful effort by Autonomy to mislead shareholders” revealed by a whistleblower and a forensic audit by accountants PricewaterhouseCoopers.
It has alerted regulators on both sides of the Atlantic.
Mike Lynch says he has yet to hire a lawyer and has not spoken to either HP or any investigators, but he has sat down with past accounts of the firm he founded in an attempt to answer the accusations laid out in HP’s public statements.
HP’s general counsel John Schultz claimed Autonomy created more than $200 million in revenue over a two-year period from 2009, which would amount to 12.5 percent of Autonomy’s $1.6 billion in revenues in their annual accounts for 2009 and 2010.
While denying the allegations as “utterly wrong”, Lynch said there were three areas where accounting rules gave scope for differences of interpretation.
Accounting rule setters have been working on plans for a decade for common global accounting rules so regulators and investors can compare company accounts, but until that task is complete, there are competing standards that can produce different results for companies doing broadly the same thing.
The International Accounting Standards Board (IASB) has devised International Financial Reporting Standards (IFRS), used in more than 100 countries, and the basis for Autonomy’s accounts prior to HP’s acquisition.
But many U.S. companies such as HP use U.S. Generally Accepted Accounting Principles (GAAP), which can differ from IFRS, notably in respect of software revenue recognition.
One of the accusations HP levels against Autonomy’s former management is that the company was booking licensing revenue upfront before deals closed, thereby inflating revenue.
“Revenue recognition for software vendors can be complicated, to say the least,” accountants Grant Thornton wrote in a note.
This is because software companies often bundle products and services such as licenses, installation, training and maintenance support into a single contract.
Under accounting rules, a company can establish a model for pricing different parts of the contract so that some revenue can be taken up front and the rest over the period of the contract.
Under IFRS this is governed by rule IAS 18. Under U.S. GAAP there are more stringent conditions to satisfy, requiring what is called VSOE, or vendor-specific objective evidence.
“It shouldn’t be a surprise this issue is coming up. It shows how loosey-goosey IFRS is,” said Lynn E. Turner, former chief accountant of the Securities and Exchange Commission, who was running the SEC department that issued Staff Accounting Bulletin 101, which set a lot of the specific rules around revenue recognition.
Lynch believes that HP might not have yet established its own VSOE model and therefore might not be recognizing revenues upfront, which might result in a restatement of Autonomy revenues.
“All of these deals went through (Autonomy’s auditors) Deloitte themselves,” said Lynch. “Deloitte apply the test independently of us, and it is a standard test, and it is explicitly stated in the annual report and accounts.”
Autonomy would submit every single invoice to Deloitte each quarter as part of the auditing process, added Lynch.
Deloitte said it conducted its audit work “in full compliance with regulation and professional standards”, and “categorically denied” any knowledge of improprieties or misrepresentations in Autonomy’s financial statements.
Another allegation HP has stated in public is that Autonomy mischaracterized revenue from low-margin hardware sales as software sales.
Autonomy always represented itself as a software firm but 10 percent to 15 percent of its revenue came from money-losing sales of low-end hardware, HP said.
Lynch said it was not a secret that Autonomy sells hardware. In company reports for 2009-2010, hardware sales accounted for around 8 percent of revenue. Occasionally, if a customer wanted a desktop, Autonomy would provide a package that might include desktops, for example, along with the software.
In terms of money-losing sales, Lynch acknowledged that in a small number of cases, deals were struck at a slight loss, in exchange for the client agreeing to market Autonomy products.
In those cases, the transaction would be charged as a marketing expense, not a direct cost of sales, but overall accounted for less than 2 percent of total revenues, Lynch said.
Though this “moves the gross margin a percent or two”, it doesn’t affect profit, he added.
Another allegation made by HP is that Autonomy booked some licensing deals with partners as revenue, even though no customer bought products.
Autonomy generates most of its sales revenues through deals with over 400 clients including IBM and Wipro who resell the software to end-users.
Under IFRS, revenue can be recognized if sales are delivered in the current period, there is no right of return policy, collection is probable and the fee is fixed and determinable.
Lynch said only deals that fulfilled these criteria were booked as revenue.
Under U.S. GAAP, if Autonomy’s sale was contingent on the reseller’s sale, the latter must be completed before Autonomy can claim it as revenue.
Even so, Lynch said over 90 percent of resellers completed sales. In some cases, he said, it was perfectly reasonable to sell to a reseller with no end user as they might use the software themselves.
While these accounting differences could have an impact, Lynch believes it is hard to reach the dizzying figures that HP has come up with.
“There is nothing there that you can warrant such a big effect in terms of writedown,” he insisted.
(Reporting By Anjuli Davies, additional reporting by Nanette Byrnes; Editing by Will Waterman)
There are so many problems with Accounting standards, from registration of a patent, accessing the rights of the patent, the value of patents, standards for accounting of revenue from software, both projected, realised and completed, so there is also a question of funding, the rights involved in the funding and a whole list of IPRs that need to be defined before you can solve disclosure standards of Accounting, so right now, HP cannot sue for any accounting mis-representation because the laws have not been written, but just a big conflict of interest, it will not be difficult to prove the intent and conduct. Let me give you an example ;
When registering a patent you need to list down everything of your patent, a general 3D Search engine where 3D is so common it cannot be patented, you need to complete all the views of software, but nobody will penalise you, if you cannot complete everything within 1 year, your registration will be removed. How to value a patent? You need to know exactly what the patent will be used, the extend of market penetration and the likely revenue it will derive. If I want to patent 3D printer technology, I need to know the greatest potential of 3D printing technology, it will unlikely exceed Apple’s marketshare of printing as they are the pioneers of design, as such nobody will finance you beyond the value of Apple design’s marketshare, and revenue will be calculated from projected, realised and completed, a lot depends on the terms of the funding, if there is participation interests of course you can get higher funding, but you will lose out on profit sharing, I am sure a good lawyer can separate all the accounting practices to give a good understanding on the revenues expected, and the different paths to take, and the right contract to enforce. Another example what is Google’s marketshare at present? What will 3D search do if Google possess it, what about the other top 5 search websites? What if other softwares and websites incorporate 3D search, what is the potential? What about access to all files and databases? Subscription services? Research work? The potential to add knowledge for education? I guarantee you it will be the greatest invention with share value beyond Apple, Google, and Microsoft combined. It is the greatest con of the century, when you grant a credit line based on patents which has not realised it’s full value, the rate of default is as high as 99%, if you do not have processes to contain the abuses, no matter how much money I can put into the world economy will all be drained away, that is the reason I will not sell any of my inventions due to foul play, I will never be tricked into anything. Even at bank branches all data entry is not recorded and monitored, merging your computer data screen with a live video input, if your staff is corrupt there is no way you can find out, I will close every single loophole in every country, even secret bank accounts, nobody will ever dare to play games with me ever.
– Contributed by Oogle.