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 US companies such as HP use US 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 US 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.
Hardware
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 per cent to 15 per cent 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 per cent 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.
Resellers
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 US 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.
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