Mike Lynch says HP's allegations don't add up, attempts to reconcile some of the allegations

Consumer and enterprise electronics giant Hewlett-Packard Comp. (HPQ) is on a collision course with the former owners of its new subsidiary, Autonomy Corp., and their accountants.  At HP's behest, UK authorities, the U.S. Federal Bureau of Investigation, and the U.S. Security and Exchange Commission are investigating claims of a $5B USD accounting fraud scheme at the purchase.  But amid that unofficial probe, ex-Autonomy chief, co-owner, and co-founder Mike Lynch is speaking out, arguing HP's accusations don't add up.

I. Autonomy Founder Speaks Out

HP says it’s basing its claims on the account of an unnamed whistleblower within Autonomy's upper accounting echelon.  And it says a forensic audit by PricewaterhouseCoopers LLP confirmed these claims.  HP claims that Autonomy "invented" nearly $200M USD in bogus revenue over a two year period starting in 2009, a factor that led -- in part -- to its overvaluation.

Dr. Mike Richard Lynch, fired in May 2012 by HP after the merger, was among the owners of Autonomy to pocket a rich profit from the $10.3B USD sale.  A pioneer in adaptive pattern recognition Dr. Lynch received his Ph.D. in signal processing and communications research from Cambridge University.  He went on to found several startups, eventually creating the enterprise software giant-to-be Autonomy.

Autonomy CEO, Mike Lynch
Unsurprisingly, Dr. Lynch views the situation in a far different light and defends Autonomy's accounting, while stopping short of saying there were no mistakes.  Lynch says the accusations are "utterly wrong" and points out that under the looser International Financial Reporting Standards (IFRS) guidelines, published by the The International Accounting Standards Board (IASB), some kinds of revenue can be reported before deals are closed.

He comments to Reuters, "All of these deals went through (Autonomy's auditors) Deloitte themselves.  Deloitte apply the test independently of us, and it is a standard test, and it is explicitly stated in the annual report and accounts."

Revenue (or lack thereof) is one of the key bones of contention between HP and Autonomy's former owners -- HP claims Autonomy cooked the books to make it look like it had more revenue than it really had.

HP and other American companies tend to follow the stricter Generally Accepted Accounting Principles (GAAP).  Lynn E. Turner, former chief accountant of the Securities and Exchange Commission, told Reuters, that the problem could indeed merely be in part that Autonomy was following the looser rule IAS 18 standards in IFRS, which govern vendor revenue, versus the stricter VSOE, or vendor-specific objective evidence guideline, in GAAP.

Autonomy poster
HP claims it was blindsided by Autonomy's "hidden" downsides. [Image Source: Autonomy]

He remarks, "It shouldn't be a surprise this issue is coming up. It shows how loosey-goosey IFRS is."

Deloitte LLP, one of the world's top accounting firms, defends its track record, in a comment to Reuters stating, "[All Autonomy accounting was done] in full compliance with regulation and professional standards."

It "categorically denies" HP's accusations of impropriety, as far as its work is concerned.

II. IFRS v. GAAP -- When "Boring" Accounting Becomes Billions

Among the key GAAP and IFRS differences is how to handle licensing revenue.  When a company sells licenses to a reseller, the terms of the contract sometimes allow the reseller to be refunded if it can't move the licenses.  

Under GAAP revenue can only be recorded in such cases after the reseller resells the license.  But under IFRS the revenue can be recorded immediately.

The distinction is important, in the eyes of Autonomy's former owners, as they were operating by the IFRS rules.  As resellers like International Business Machines, Inc. (IBM) and Wipro Ltd. (WIPRO) are major business partners to Autonomy, the distinction could swing revenue by a small amount.

IBM sign
Mr. Lynch argues resellers like IBM moved 90 percent of the licenses, and that it was reasonable to count unsold licenses as revenue. [Image Source: Andrew Havis]

HP accuses Autonomy of selling to resellers with no end user yet found.  But Mr. Lynch says this wasn't misleading; the reseller could decide simply to use the product itself, internally.  

He also claims that 90 percent of Autonomy's licenses that are distributed to third parties are indeed sold.  Thus, he argues, the distinction is largely a moot point.

III. HP, ex-Autonomy Owners on Collision Course Amid Criminal Probes

Mr. Lynch tackles another key claim -- that Autonomy misrepresented hardware sales as software sales.  He defends the practice of calling sales of software/hardware bundles (with hardware often sold at a loss), saying that the package is built on Autonomy's software and thus it made sense to categorize it as "software" revenue.

He comments that the distinction "moves the gross margin a percent or two", but does not affect the company's overall profitability.

And he says that at cases where hardware was sold at a loss, Autonomy received compensatory marketing from the client -- a type of goodwill.  HP, however, sees things differently, arguing that 10 to 15 percent of Autonomy's revenue came from hardware and that it was a major impropriety to account for that stream as software revenue which may have padded the losses.

he said, she said
The war of words between Mr. Lynch, et al. and HP is likely to get uglier. [Image Source: NBC]

But Mr. Lynch argues that Autonomy has long been transparent that it sells hardware.  He points to reports HP had access to that show that in 2009-2010 hardware accounted for approximately 8 percent of the firm's revenue.  In other words, HP should have realized that hardware was part of the equation, from his perspective.

At the end of the day, Mr. Lynch argues that the "impropriety" is on HP's part and that the write-down and accusations just don't add up.  He comments, "There is nothing there that you can warrant such a big effect in terms of write-down."

With HP already committed to a write-down and pursuing potentially criminal accounting misconduct accusations against Autonomy and its accountants in both the U.S. and Britain, the two divergent views appear to be on a collision course that could have serious repercussions for either HP (on the one side) or Mr. Lynch and his co-owners (on the other side).

Source: Reuters

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