On the Record with Michael Lynch

No one likes tearing their hair out searching for data on the corporate intranet. Managing unstructured data is definitely big business, but is it worth $4.5 billion?

Autonomy CEO Dr. Michael Lynch sure thinks so, although some investors suddenly seem to not be so sure. Shares of the Cambridge, UK based software infrastructure company have now dropped over 40% from its old highs. With the continued choppiness on Nasdaq, slowing sequential revenue growth and an eye popping P/E of over 500 definitely isn’t helping Autonomy’s case.

On the other hand, with gross margins of 95% and over 70% of the company’s sales coming from third party licensing deals, it is easy to see why many are still so excited about the company’s long-term profit potential. Autonomy recently reported third quarter sales of $17.6 million, a 21% sequential increase, and net income of $6.5 million. Yes, Autonomy is a Net software shop that is already posting profits.

In addition, Autonomy’s client and partnership list continues to read like a Who’s Who of the Global 2000. New blue chip clients picked up during the quarter include Ford Motor and France Telecom
, as well as BP Amoco and the World Bank. Existing technology partners include consulting and computer heavyweights like Anderson Consulting, KPMG Consulting, Compaq and Hewlett Packard .

However, even with a highly scaleable business model, an impressive proprietary technology, and strong client list, the Autonomy story all comes back to valuation. Is there really anything the company can say or do at this point to justify a market capitalization of over $4.5 billion?

We recently sat down with Autonomy chief Michael Lynch to find out.

ISR: Let’s start things off with a brief overview of Autonomy’s business today.

Lynch: Autonomy was founded in June of 1996 and was spun out from a company called Neurodynamics, who themselves were founded in 1990 by researchers from Cambridge University. We were spun out in 1996 with an initial valuation of $45 million and are now an international software company with a market cap of around $4.5 billion. Autonomy was really spun out to capitalize on looking at all human friendly data and to be able to make sense of text, graphics and images.

ISR: What is the simplest way to explain what Autonomy’s software actually does?

Lynch: At the most simplistic level, we enable computers to understand the sort of information that you and I deal with very easily like prose or voice. But of course, you put that information in front of a computer and it has no idea what to do. It’s just bits and bytes to it. So Autonomy enables computers to make sense of human friendly information. Once you can do that, you can do an enormous amount of things with automating all of the key operations of that sort of information.

ISR: What would be an example of the kinds of customers that you have today?

Lynch: Our clients range from Global 2000 companies like Reuters , who everyday uses Autonomy to categorize a million and a half real time news stories, as well as the new media plays and large technology companies. For example, Hewlett Packard , use Autonomy software everyday to root and understand all of the sales and marketing information across its worldwide sales force. General Motors uses Autonomy everyday to organize automatically all of the information across its intranet sites. Really, the customers that Autonomy can have are anyone whose business is founded on information or has to utilize information.

ISR: Okay. What is Autonomy doing that really different and superior from corporate search solutions that companies like Inktomi and Verity offer?

Lynch: Typically, that sort of approach is really dodging the is

sue. It’s pretending that the solution to the world’s problems is all about making people search for things using single words. In reality, the much higher value task is to enable the computer to understand the bits of information and then understand what should be done with it. So for instance, General Motors on its intranet site had a search engine that it was utilizing, but the problem was that they still couldn’t find out where things were. A search engine really didn’t fulfill the problem.

ISR: So in effect, Autonomy’s software is allowing companies to organize and manage “unstructured data” without having to utilize traditional search technologies?

Lynch: Exactly. It’s not even just about eliminating search, though. For instance, Ericsson uses Autonomy’s technology for its senior management group to understand information from a business intelligence perspective. It automatically delivers applications by wireless to the company’s senior business people. So they don’t even have to think about it. This information just comes in each day to them.

ISR: What does the revenue model look like?

Lynch: It’s really straightforward. We really have two sides to the business. One side is where we create applications that third parties re-sell on our behalf. Third parties like KPMG, Razorfish , Agency.com , PricewaterhouseCoopers and those sorts of people do almost all of this sales work. Also, last year we made the technology available to other technology companies to embed within their products so that they can also process the unstructured data. So our revenue for this quarter was $17.6 million with about 70% generated by third parties. More importantly, for a company with a valuation of $4.5 billion dollars, we only employ 170 people. For us to scale our business, we don’t have to employ more people because the model is highly leveraged to utilize third party channels.

ISR: That brings up the question of valuation. What do you say to skeptics that look at your current revenue run rate and question how you are ever going to justify your lofty market cap?

Lynch: Well, valuation is not my call, really. But to give you an idea of how we believe this growth can be sustained, we are all about leveraging third parties to drive revenues. We simply do one thing, which is to license our software to other people. That’s why as of this quarter, our gross margins are 95%. We do almost no services or consultancy, which is very rare for a software company. So to double our revenues, we can simply send out more CDs. But more importantly, it means that we can actually scale the business much more quickly than traditional software companies who always have to employ more consultants and sales people.

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