ChatGPT 4o illustrates an audit team discovering anomalies in a company’s accounting practices.
Commentary by Randall Scott Newton
Earlier this year the Autodesk board of directors launched an internal investigation “regarding the company’s free cash flow and non-GAAP operating margin practices.” The results of the investigation, announced May 31, feels like an example of the old phrase “history doesn’t repeat itself, but it does rhyme.”
The board reported that no quarterly results will be restated, but CFO Deborah L. Clifford is being reassigned to the role of Chief Strategic Officer; Autodesk board member Elizabeth Rafael will serve as interim chief financial officer. Rafael was also a member of the board’s audit committee.
The roots of this investigation into how Autodesk accrues and reports revenue go back to 2017, when the company changed its business model from selling software and maintenance services to essentially renting, with most revenue considered as Subscription, paid in advance. At the time, this reporter questioned the value of such an approach, as it seemed to be a bit of accounting obscuration and legerdemain. The approach did not line up with Generally Accepted Accounting Principles (GAAP), so Autodesk started reporting both GAAP results and its new metrics with every quarterly report.
The company’s new metrics pointed to Annual Recurring Revenue (ARR) that could not be claimed all at once. In the first quarter Autodesk used the new metrics (2Q18), GAAP revenue was down 9 percent, for a net loss of $144 million. It was the ninth consecutive quarter of losses. Yet by using their new metrics for reporting revenue, Autodesk claimed revenue was up 94 percent.
Then and now: Autodesk CEO Andrew Anagnost. (Source: Autodesk)
New CEO Andrew Anagnost (who still leads the company today), said at the time, “During Autodesk’s business model transition, revenue is negatively impacted as more revenue is recognized ratably [proportionally] rather than up front and as new offerings generally have a lower initial purchase price.”
In announcing the end of the internal investigation, Autodesk said the audit committee found the company was engaging in programs to incentivize customers to accept multi-year upfront billing, renew early, and pay before the fiscal year ended, in order to meet free cash flow targets. The board also said that while Autodesk had disclosed its practice of incentivizing multi-year upfront billing, the audit committee noted the company did not quantify the free cash flow attributable to this practice until fiscal year 2024.
The value of free cash flow
Free cash flow (FCF) is an important metric. It is the amount of money a company has left after paying for its operating and capital expenses. It is considered a key indicator of a company’s profitability and financial health. When Autodesk started minimizing GAAP statements regarding financial health during its transition from maintenance to subscriptions, it emphasized both the size and growth of FCF.
The audit committee noted that an increased emphasis on free cash flow in the company led it to move from annual billing for its largest customers, to multi-year billing. This caused a substantial uptick in fiscal 2023 free cash flow, boosting FCF above historic levels.
The board also noted that such an emphasis influenced decisions regarding discretionary spending, collections, and accounts payable. In a karma-bites-back moment, the board also noted that multi-year upfront billings of enterprise customers in fiscal year 2024 was substantially lower than in the previous two fiscal years.
The audit committee proposed “certain remedial measures” including: reviewing certain processes around financial communications and disclosures; assessing certain company organizational functions and responsibilities; and adopting and enhancing policies and processes related to the matters investigated. We expect there to be a ripple effect in both performance and staff in the coming month.
Shades of the old PTC
This incident was not the first time an engineering software got into trouble over its accounting practices, and specifically how revenue was recognized. In 2011 PTC announced it would restate several years’ worth of financial results due to issues with the way it recognized revenue from its software licensing agreements. This set off alarm bells with investors and regulators.
An internal investigation found that PTC had prematurely recognized revenue from software licensing deals before all criteria were met for revenue recognition under accounting rules. Basically, it booked revenue too early.
As a result, PTC had to restate results going back to 2008, reducing its recognized revenue by over $200 million during that period. This led to the company paying $16.5 million to settle charges by the SEC that it violated anti-fraud, reporting, and record-keeping provisions.
Longtime PTC CEO Dick Harrison resigned in 2011 amid the restatement issues. Several other top executives also departed during the accounting scandal fallout. New CEO James Heppelmann (recently retired) was charged with establishing new revenue recognition controls and procedures. It took PTC until 2014 to become current with its financial reporting again after the lengthy restatement process. There was no recurrence of accounting irregularities during the years Heppelmann ran PTC.
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