Accounting expert told judge Autonomy was wrong not to disclose hardware sales HPE's accounting expert told the High Court that making "significant sales of hardware" and burying them in its accounts meant Mike Lynch's Autonomy may have given "the impression" sales growth "was in its core software business". As the dust settles from the Autonomy trial itself, The Register has taken a look at the expert …
Hardware sales should have been broken out.
OTOH, HPE should have asked for this as soon as they realised that hardware sales were even a thing, which should have happened during due diligence.
I guess the judge will be deciding whether stupidity or sharp practice is the bigger sin.
However, if you hare hoofing in the hardware sales with the software, then the overall average margin comes down.
It's not like you can pretend that the hardware also has an 85% margin. Your "cost of sales" will show this up immediately.
Like the judge says, if the hardware is an enabler for the software sales, then why break it out separately?
That depends if the cost of the hardware is accurately reflected in the cost of sale, if they are doing something really funky like using the hardware sales to inflate revenue numbers but hiding the actual cost of the hardware somewhere like a marketing budget then it could perhaps result in average margins looking significantly more healthy than they actually are.
A previous employer of mine who shall remain nameless was found out to be doing lots of dodgy things like side letters and large contra deals, stuffing the channel etc. and having to write off quite a lot of bad deals, they then buried those costs in goodwill related to the acquisitions they were doing, they were eventually found out and some people went to prison off the back of it.
"For this sort of stuff, most of the money is from support contracts, and you have to employ a lot of highly paid people to service them."
This is a common misconception from stuff lower down in the depths of the channel, where the sale of the licenses is distinct from the ongoing support. At this end of the market (i.e. the "how many millions are you planning to spend with us this quarter" end) the two are integral - a customer without support is a customer that doesn't come back.
>where the sale of the licenses is distinct from the ongoing support.
The issue is surely: what is being accounted for as 'software' sales within the constraints of IFRS & IAS18.
For enterprise clients over the years, where I have been involved in the procurement, they have tended to pay peanutsrelatively little for software and hardware (ie. goods), but lots in annual licenses and maintenance and support fees (ie. services).
“Working Papers” are the detail from the audit team’s investigation, which will then be summarised (by the audit manager) into a note for the Audit Partner to sign off/reject with a request for further info to be gathered. This will be filed at the end of the audit to provide the audit trail for the audit opinion, should it be needed (and for internal audit QA).
In my day (pre-1993) it was all paper, but will now be largely electronic/document managed.
I would be inclined to go with MacGregor as he has seen the working papers and can hence follow the logic on the opinion on the Accounting treatment, rather than Holgate who has been briefed by HPE (but not seen them).
With the audit trail at least you can see WHY the Deloitte opinion was arrived at, whether or not you agree with it.
OK, so if HP are right, why didn't their auditors pick this up and explain it to them during the due-diligence? I mean HP are basing their *whole* case on them not doing the due-diligence properly? Unless Autonomy lied or obstructed the auditors, which I have seen no evidence they did through the regs coverage. From the beginning of this case, it's confused me.
HP are basically saying that autonomy over inflated their sales, given the cost of the take over you would think the financial auditors would have picked this up before the sale, if not surely they weren't doing their job properly (so HP should be suing them - I suspect this might be part II). And yet magically after the deal doesn't look so good for HP they suddenly discover that the same financials they had access to show something totally different?
The whole thing stinks of buyers remorse, I am not sure how HP have managed to get it this far.
According to a witness statement HP knew about the hardware sales and that it was predominantly a loss-leader to drive hardware sales, and HP themselves said it was all "product" and so shouldn't be separated.
https://www.theregister.co.uk/2020/01/06/autonomy_hardware_accounted_marketing_witness/
All the stories I've read about this (via El Reg's highly entertaining articles and even more entertaining responses from commentards) suggest that HP's argument is based on that they did not receive any orders and Captain Blackadder did not shoot this delicious plump breasted pigeon.
... if HP are right, why didn't their auditors pick this up and explain it to them during the due-diligence?
Due diligence?
After all that I've read about this, it does not seem to me that HPE knew or had a clue as to what due-diligence actually means.
Or maybe they knew but did not give a shit.
And just wanted to (for whatever reason) go ahead with the deal.
O.
It isn't at all uncommon for people to pull out of deals at the due dil stage. That was the final nail in the coffin for Enron, for example.
Auditing, on the other hand, is just widely misunderstood. It doesn't do what people think it does, and when something comes out that people think should be, but isn't actually supposed to be covered by auditing, people criticise the auditors.
An audit checks that a set of accounts fairly and accurately represents a business's stated financial position. It doesn't check whether that position has been fraudulently mis-stated.
Correct - “a true and fair view” which is itself an opinion, within the constraints of the relevant GAAP/IFRS/etc.
UK GAAP leaves room for judgement, rather than defining a set of account codes in micro detail against which transactions are posted. The flip side to this is that the judgement can be subjective (but based on available evidence obtained which could be fabricated), rather than “this widget invoice should have gone to line 12345 as per regulation 24.4b” (star fleet officers may not urinate in the lift at weekends, I think).
The purpose of an audit is NOT to detect fraud. This was drummed in from the equivalent of Audit 101 when I began my audit training in 1990 at C&L).
The auditors can not control whether company officers are presenting false information, but fraud could be detected (as a by-product) if evidence does not stack up, or the opinion could be “qualified” if sufficient information cannot be obtained to back up material items (I.e. those that would alter the opinion).
HPE are alleging that Lynch etc. acted fraudulently, and Lynch etc. are saying that it was nothing of the sort.
Deloitte (via their audit opinion) appear to back up Lynch so HPE seem to be clutching at straws...
I'm thinking of the $60 crap HP printer that my grandparents bought themselves because it had "3x Higher Print Quality" and half-a-dozen stupidly-named "technologies" like ColorMagic or NanoNozzle or whatever. I'm thinking about how it printed around ten pages on the included cartridges, and then required another $60 worth of ink to be "usable" again. And I'm thinking about how it failed not two months after the warranty expired.
From where I sit, maybe Autonomy did write something like "100x More Profitable!" on the outside of the box. Maybe the Autonomy technology just boiled down to a bunch of buzzwords. Maybe HP bought a real @#$& printer that seemed like a good value, but made them feel ripped-off after a week or two.
Well, at least I know what HP would do, if it happened to them.
You're right, in much the same way as somebody stealing my car when I'm not looking isn't exactly my fault.
But if I'm buying a car from someone, and it's bright yellow and covered in Chiquita stickers, it should be a reasonable clue that it is, in fact, a banana with wheels on it. If Autonomy just had the figures laid out, without obviously malicious obfuscation, and in a way that an independent accountant could look through them and establish (within reason) what was what, then it falls upon HPE to understand what they're purchasing.
Anyway, that's my opinion. The important opinion is that of the Court.
That’s true in the case of clear fraud, which is why so much effort is being spent by both sides to position that this either is or isn’t within the acceptable bounds of accounting.
If it is, even if it’s teetering on the margin, then caveat emptor applies and this is why due diligence exists.
If it’s deemed to be actual fraudulent accounting then HP’s case has merit, although even then the judge may decide that the material impact of the fraud doesn’t justify the size of HP’s suit and cut down the penalty.
"my opinions are given on the basis of the facts I have been instructed to assume".
The HPE expert witness was told to assume there was dodgy dealing.
The Lynch expert accounting witness actually read the operational accounting policies for Autonomy.
If you were a wearer of a big powdery wig - who would you give more weight to?
Peter Holgate: - "my opinions are given on the basis of the facts I have been instructed to assume"
i.e. I was given facts that made Lynch look guilty, instructed to instructed to assume them and in my expert opinion, he looks guilty
Does HPE think anyone is fooled?
I so look forward to the judge's comments on this.
Based on this comment by Justice Hildyard "The judge continued, addressing HPE's legal team: "Your expert recognised that whilst it's not what he thinks he would have done, that it wasn't improper in the sense of being beyond what a reasonable auditor could have imagined, in which case, that's that, isn't it?""
I think I can see where he may be going and that he is no fool.
No. He was an expert witness on acceptable accounting practises under IFRS. Normally UK courts only appoint one for both defence and prosecution, but in this case they weren’t going to. But both agreed that accounting for HW sales this way was both legal and acceptable. The difference is whether it makes a material difference to the accounts.
How about the poor judge? I know it’s his job, but even so. I’m surprised he’s not taken one of the many opportunities HPE have given him to reach an instant decision...
Jury trials for these kind of cases were abandoned because no one could assemble a jury willing to sit for this long.
I know of a small businessman in my home town who nearly went bust having been called up for a complex case. He narrowly avoided bankruptcy by walking out of the case, the 28 days in jail he was given for contempt being financially preferable to months more jury time.
There was also the perception that a jury no longer cared a damn one way or other after months of incomprehensible mumbo jumbo, and would more often than not acquit simply to punish the prosecuting authorities.
Having been a juror myself for only a two week stint I’m not convinced that objectivity survives in the minds of all jurors for even that short period of time. IMHO our jury system completely sucks. The French do it far, far better.
"I know of a small businessman in my home town who nearly went bust having been called up for a complex case. He narrowly avoided bankruptcy by walking out of the case, the 28 days in jail he was given for contempt being financially preferable to months more jury time."
Really?! He would be entitled to be excused service under those circumstances. If he had informed the court, he'd either have been excused altogether or put on a short case.
In any case, there's only a £1k fine for refusing at the outset. Perhaps 28 days for contempt, for walking out halfway through a trial, but that's a ludicrous sentence - 24 hours for contempt is considered extreme.
acquit simply to punish the prosecuting authorities
Quite right too. Though to be fair, the prosecuting authorities are merely doing their job.
Having been a juror myself for only a two week stint I’m not convinced that objectivity survives in the minds of all jurors for even that short period of time.
If objectivity survives a day, it means the barristers are failing in their job of detaching you from the real world - and naïve ideas like truth or justice that you abandon when you embark on the practice of law.
" Far easier to just send him to the US and be done with it."
So what if he has done nothing wrong, that he was in England and broke no english laws. He embarassed a large american company and rich americans will suffer if they don't find a foreign scapegoat, so he has to pay.
It is the way that the americans think and act but it is not something we should accept.
Anon,
It's not a criminal prosecution. The Crown Prosecution Services didn't pursue a trial on the grounds of insufficient evidence / chances of getting a conviction.
This is a civil action on the part of HPE against the directors of Autonomy on the lower standard of evidence required in civil trials - i.e. "in the balance of probabilities" rather than "beyond reasonable doubt" (as required in criminal law).
I used to work for a Medium sized consultancy, (that it turns out wanted to get bought) selling mostly Services. Occasionally customers would ask us to procure small bits of hardware or software on their behalf. We'd stick a markup of a out 10% on it.
One day a customer asked us to do it for about 500k worth of hardware, but our accounts team refused to put it through the books. I thought it was madness at the time. The easiest 50k you'll ever earn, why would you turn it down?
This story now gives me some insight into why that might have been.
Because you risk making a loss of £450k if the customer doesn't pay up.
Hardware sales companies have credit insurance in place to deal with this, and the insurance company has to OK the sale before it gets shipped out. Your consultancy almost certainly wouldn't be geared up of that sort of thing.
I think I'd walk away too...
Been there, done that, when its small bits of kit - and you make a few extra crumbs along the way. Generally for the customer they are wanting to buy something but the actual supplier is not a preferred supplier, so they come to you, their friendly prefered supplier, on the basis that paying an extra $50 saves them the hassle of spending 2 weeks getting yet another preferred supplier agreement in place through purchasing, and they want the kit this week. That makes business sense.
When its a $500k order though, that needs multiple layers of signoff and will have the purchasing team involved. they are coming to you because they cannot buy direct. Perhaps they couldn't get the credit terms, perhaps they have maxed their credit limit with that supplier. Without knowing with 99% confidence why they cannot go direct, this ain't a runner.
Finally, theres the downside consequences of doing the deal. As the smaller business, you will inevitably need to pay the 500K to the supplier before you receive the 550K back from your customer. Is 500K a small enough sum that it wont affect your cash flow? What happens if your customer then doesn't pay your invoice? can you swallow the loss?
This kind of a deal only makes sense if it's small enough that it can go bad with you holding the loss, and you can shrug your shoulders and carry on. Perhaps $1K at a time.
kipwoo,
There's no accounting reason not to put £500k through the books - and just report it as some other kind of revenue.
However if you put £500k through the books for hardware sales - you're going to need a significant provision for if that hardware fails. Plus a bad debt provision, if they're buying it on credit. And if it fails before they've paid for it, the two issues can interact in complex and expensive ways, like them refusing to pay up.
When I worked in finance I think the average bad debt provision was about 2% of total invoiced amount. A reasonable seeming provision for hardware failure might be 5-10%? So your profit is £50k if all goes right, but you'd need financial provisions for if something went wrong of at least half that - which obviously are moved to profit if nothing goes wrong, but it does show you the risks you're taking.
If you're the contracted seller of said hardware, then you're obviously the people contracted to fix it - even though you may have your own contract with who you bought it from to get them to. So for a small sale, you might not care - for a large one, you might start to get nervous about this risk. As working on a percentage provision is like insurance. The idea is that taking a little from all your jobs insures you against the risk of the one going wrong. But if you only have one £500k hardware sale, and that goes totally titsup, you're on the hook for the whole £500k - with no other profits to offset against it.
So I'd guess they were just being cautious, and deciding £50k wasn't worth the risk.
I'm still struggling with this. HP weren't "duped" into ACTUALLY buying Autonomy. They may have been "duped" into thinking it was an attractive proposition prior to any due-diligence, but the overarching and common thread across the whole trial being that it seems that they didn't do that proper and formal due-diligence prior to handing over the cheque. Leo himself hilariously confirmed that under oath if I remember correctly.
I love this case, it shows so completely why most CEOs should never be allowed to run companies.
As an accountant the key for me here is how big were the Hardware sales, were they small compared to the software sales, and really just add ons, then they should not be separated, or were they big and had nothing to do with the software sales in which case they should be separate. My guess is that in reality they were somewhere between the 2, and probably towards the smaller end given Autonomy was a "software" company. Where things are grey of course Lynch is going to say do it in the way that makes the accounts look best, no CEO of a listed company would do otherwise.
The thing to remember with a company especially is that it really is only worth what people are willing to pay, and given how much HPE were willing to pay that is how much Autonomy was worth, the fact they couldn't realise that worth having paid for it is, in my view, down to their own stupidity. I know they didin't have access to all the accounts of Autonomy, but they did have professional advisors, legal, financial, and accounting I assume, and they should have warned HPE about the risks prior to purchase, added to which the board of HPE should have been professionals knowing what they were doing. The fact that HPE so massively overpaid looks like negligence on their part, and as a result they are now trying to shift the blame away from themselves. They should have acted on their due diligence and walked away if they couldn't get all the information they needed to support the value/risk of the acquisition.
I was always taught the assumption is the mother of all F**K Ups, and clearly even now HPE are making whoppers and guess what, they're still making whopping great F**K Ups.
I agree, it looks to me like two relatively successful but badly managed companies getting into bed together, each under the assumption that the "marriage" will fix their problems. It illustrates what we see everywhere these days - companies are run to make their corporate managers wealthy, everything else is irrelevant to the managers.
I can't believe you sneakily led me to click on the screenshot from the "International Bean Counters Journal of Obfuscation Techniques" or whatever it's called ...
I am not an accountant but I actually read some of it accidentally. Is accountancy catching? Can I get cream for the itch and will my hair still fall out? Look at that nice speadsheet over there ... ARGGHHHH!
Just wrong, so wrong.
....HPE's expert, said he hadn't seen, writing that "my opinions are given on the basis of the facts I have been instructed to assume"
I think it's quite obvious what he was instructed to assume.
The judge continued, addressing HPE's legal team: "Your expert recognised that whilst it's not what he thinks he would have done, that it wasn't improper in the sense of being beyond what a reasonable auditor could have imagined, in which case, that's that, isn't it?"
Yet again the judge schools the legal team of HPE.
It's good to see a judge who can see through the smoke and mirrors.
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