Autonomy Trial With the Autonomy trial well and truly under way, what is each side saying about auditors' reports and due diligence? The Register has been through the legal papers to distil it down.
The state of Autonomy's auditing and pre-buyout due diligence forms an important part of HPE's pleaded case against ex-Autonomy chief exec Mike Lynch and former CFO Sushovan Hussain.
Auditor KPMG, asserts HPE, was misled by Autonomy as to what the British software company was accounting for in its revenues. Its argument goes that because KPMG and HP's in-house due diligence teams didn't flag up anything about hardware sales, they must have been misled.
Contained within the thousands of pages of legalese are examples of what HP claims are lies told by Lynch and Hussain during the due diligence process, which will be explored in depth later this year as key witnesses give evidence.
Broadly speaking, HP has said it didn't know that a significant portion of Autonomy's revenues were being generated by hardware sales until after the buyout completed. Lynch and Hussain, however, argue that HP had the evidence it needed to spot those hardware sales. The two argue that HP mismanaged Autonomy after the buyout and is now pursuing them as vengeance for having to write down the value of the business by $8.8bn.
The two sides do not agree about how long HP spent looking over Autonomy's books before saying "yes". HP argues that "the due diligence process, including financial due diligence, was intensive and extensive – to the extent that Autonomy management complained about it at the time", while Lynch, with whom Hussain agrees, claims: "The due diligence of Autonomy's finances was limited and largely consisted of four conference calls lasting approximately 1 to 1.5 hours."
Leo Apotheker, former CEO of HP and boss of the firm at the time of the acquisition, said in his witness statement that Deloitte, "a reputable accounting firm", had "opined that the [Autonomy] financial statements gave a true and fair view of Autonomy's affairs as at December 31, 2010", and that Deloitte had stated it "received all of the information and explanations" it needed for its audit.
He also said KPMG completed its financial review of Autonomy with "no material issues found", praising them as "experienced outside consultants".
Apotheker admitted he hadn't read Autonomy's quarterly accounts for the two periods in 2011 immediately before HP acquired the company – and neither did he read KPMG's draft due diligence report, no final report having been submitted. During cross-examination he stated that he had relied on HP's internal "traffic light" systems to pick up anything in the due dil to which he needed to pay personal attention.
Which companies were advising on the Autonomy buyout?
"For HP, BarCap [Barclays Capital], Perella, KPMG, Freshfield Bruckhaus Deringer, and Gibson Dunn & Crutcher; for Autonomy, Qatalyst and Slaughter and May," said HP in its filings. Lynch and Hussain named the same firms.
Auditing Autonomy was Deloitte, which signed off its accounts. KPMG prepared the draft due diligence report for HP. As we know from former HP CEO Leo Apotheker's testimony in the case, KPMG never got round to delivering a final report.
In its 894-page written submission, HP argued that it "never crossed the minds" of KPMG's due dil team "that Autonomy was making substantial sales of third party hardware on a standalone basis (i.e. pure hardware sales)". It also stated that HP's then-chief strategy and tech officer, Shane Robison – one of the two C-suite execs at HP who supported the Autonomy buyout – "is clear in his evidence that he knew about Autonomy's appliance sales, but that at no point did anyone from Autonomy tell him that Autonomy was reselling third party software as part of its business". HP claimed that this would have been a deal-breaking "red flag" had it known.
"Neither the [hybrid] contracts nor KPMG's [due diligence] report revealed that Autonomy was improperly accelerating revenue recognition or including non-recurring revenue in IDOL Cloud," it asserted in a written submission to the court.
Lynch and Hussain's defence
"Buying Autonomy and its product was seen by Mr Apotheker, Mr Robison and HP's Board as its route to higher margin, higher growth business," said Lynch in legal filings seen by The Register. "As a result, the due diligence was essentially a confirmatory process to be carried out in a very short window."
Emphasising that the due diligence timetable "was set by HP, not Autonomy", Lynch and Hussain want to convince the High Court that HP rushed through its due diligence, having decided to announce the Autonomy buyout on a fixed date (18 August 2011) and thus rushed everything to ensure it met that date.
"While KPMG had been contracted to provide a number of services in relation to the due diligence, HP's tight timetable meant that by this point they had not carried out all of the tasks which they had been engaged to carry out," continued Lynch's legal filings, referring to KPMG not having submitted more than a draft due diligence report: "HP chose the amount of due diligence it pursued and it also decided to announce the bid before all of the work KPMG had contracted to undertake had been completed."
Lynch and Hussain also accuse HP of not having understood that Autonomy's accounting system was subtly different from the American megalith's practices:
KPMG noted that Autonomy had different accounting policies than HP with respect to sales to VARs [value-added resellers], and in particular that Autonomy "recognises revenue for license sales upon sell-in to its VARs rather than on a sell-through basis to end customer[s]… Autonomy recognised revenue on sale to the VAR, as its customer, and not the ultimate end-user. Further, as part of that due diligence process, KPMG reviewed the terms and conditions of 40 VAR contracts."
The court is also to hear in-depth evidence about a number of VAR transactions, as well as descriptions of Autonomy's flagship IDOL software product. This week Autonomy's one-time head of R&D, Sean Blanchflower, is giving evidence.
The case continues. ®
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