* Alleges 'serious accounting improprieties'
* Takes charge for Autonomy software purchase
* Refers matter to SEC, UK Serious Fraud Office
* Former Autonomy CEO calls allegations 'false'
By Poornima Gupta and Nicola Leske
SAN FRANCISCO/NEW YORK, Nov 20 Hewlett-Packard
Co has levelled an accusation of dodgy accounting at
Autonomy, the British software company it bought last year, and
is taking an $8.8 billion charge in the latest of a string of
HP has discovered "serious accounting improprieties" and "a
wilful effort by Autonomy to mislead shareholders" after a
whistleblower came forward, the company said on Tuesday.
It has alerted regulators on both sides of the Atlantic.
Irish-born mathematics whiz Mike Lynch, who led the firm he
had co-founded when it was sold to HP last year for a hefty
$11.1 billion, denied the allegations. He blamed mismanagement
by its new owners for shredding its value.
"We are shocked, this is a big surprise, it's completely and
utterly wrong and we reject it completely," he told Reuters by
telephone. "We have not heard anything from HP, they have not
been in touch and we don't know what they are on about."
Lynch left HP's employment in May.
HP's announcement on Tuesday sent the company's shares
plunging 12 percent to a 10-year low of $11.71. HP, which for
decades was synonymous with technical excellence and innovation
as one of the bedrock companies of Silicon Valley, has seen its
market value sink to roughly $20 billion from $155 billion in
April of 2000.
CEO Meg Whitman took the helm at HP a little over a year ago
when her predecessor, Leo Apotheker, was fired after less than a
year on the job.
Apotheker's big strategic move during his brief tenure was
the acquisition of Autonomy, intended to hasten HP's
transformation into a software and services company -- but which
was criticized by many analysts at the time as over-priced.
Analyst Paul Morland at Peel Hunt said at the time that HP
shareholders should be worried about the high price agreed,
contracting margins and single-digit profit growth.
Whitman told an analyst call: "Most of the board was here
and voted for this deal, and we feel terribly about that."
Tuesday's announcement came just three months after the
company took a write-down of almost $11 billion on its EDS
HP has for years relied on deal-making, acquiring businesses
ranging from EDS to Compaq to Palm, but has largely failed to
articulate a clear strategy or establish a strong position in
growth businesses like computer services or mobile computing.
"To put it bluntly ... this story has been an unmitigated
train wreck, and it seems every time management speaks to the
Street, there is new negative incremental information
forthcoming," said ISI Group analyst Brian Marshall.
HP said it has referred the alleged accounting wrongdoing
at Autonomy to the U.S. Securities and Exchange Commission's
enforcement division and the UK's Serious Fraud Office for civil
and criminal investigation. HP also said it would take legal
action to recoup "what we can for our shareholders."
Both agencies declined to comment.
Whitman said the investigation of Autonomy's finances - both
external and internal - will take multiple years as it wends it
way through the courts in both countries.
She defended the board's handling of the acquisition and
blamed HP's auditors for failing to detect the problems.
"The board relied on audited financials, audited by
Deloitte. Not Brand X accounting firm, but Deloitte," she said,
adding that KPMG was hired to audit Deloitte.
"Neither of them saw what we now see after someone came
forward to point us in the right direction," Whitman said.
On Tuesday, a person familiar with the situation told
Reuters that the Federal Bureau of Investigation was probing the
HP-Autonomy allegations in concert with the Securities and
Exchange Commission, although the inquiry was at an early stage.
HP and Autonomy were not available to comment on the FBI
probe, and the FBI declined to comment.
The alleged accounting issues also put a spotlight on the
investment banks and law firms involved in the acquisition.
Autonomy was represented by Frank Quattrone, an investment
banker who was the target of widespread criticism - and criminal
prosecution - for his activities during the first dot-com boom.
After one trial ended in a hung jury and a second ended in a
guilty verdict that was overturned on appeal, the charges were
HP's lead adviser was Perella Weinberg, a boutique
investment bank with little experience in big tech deals. Its
attorneys included the blue-chip firms Gibson, Dunn & Crutcher;
Freshfields Bruckhaus Deringer; Drinker Biddle & Reath; and
Skadden, Arps, Slate, Meagher & Flom, which advised the board.
INFLATED SALES, REVENUE
Whitman on Tuesday stood by Autonomy's technology and
products, saying the unit would still be the growth engine for
HP. The sprawling company, which employs more than 300,000
people globally, aims to focus more on enterprise services in
the mold of International Business Machines Corp.
But the former eBay CEO and California gubernatorial
candidate has yet to overcome years of management turmoil and
strategic missteps, including a plan to sell the personal
computer unit that was later dropped.
HP disclosed the Autonomy allegations in conjunction with
its fourth-quarter earnings, which showed a 6.7 percent decline
in revenues as well as a $6.85 billion loss.
It took $8.8 billion in charges in the quarter, with over $5
billion tied to the problems at Autonomy. The rest of the charge
related to the "recent trading value of HP stock and headwinds
against anticipated synergies and marketplace performance," HP
said without elaborating.
HP had embarked on its own internal investigation, including
a forensic review of Autonomy's historical results by
PricewaterhouseCoopers and HP General Counsel John Schultz.
It accuses Autonomy's former management of inflating revenue
and gross margins to mislead potential buyers. It said Autonomy
executives mischaracterized revenue from low-end hardware sales
as software sales and booked some licensing deals with partners
as revenue, even though no customer bought products.
It said Autonomy claimed its gross margins were in the 40 to
45 percent range while realistically they were in the 28 to 30
Moreover, Autonomy always represented itself as a software
firm but 10 percent to 15 percent of its revenue came from
money-losing sales of low-end hardware, HP said.
The company also claimed that Autonomy was booking licensing
revenue upfront before deals closed.
Schultz said since the accounting troubles occurred prior to
the acquisition of Autonomy, it took a long time before HP was
in a position to make the news public.
"Not surprisingly, Autonomy did not have sitting on a shelf
somewhere a set of well-maintained books that would walk you
through what was actually happening from a financial perspective
inside the company," he said. "Indeed critical documents were
missing from the obvious places, and it required that we look in
every nook and cranny."
Yet there had been rumblings in the industry for years that
Autonomy's results might not be quite what they seemed.
As early as 2009, hedge fund manager Jim Chanos had
identified Autonomy as a shorting opportunity, according to a
source familiar with his views.
Chief among his concerns, according to the source, was that
Autonomy was claiming a 40 percent market share against the
likes of Microsoft Corp, International Business
Machines Corp and EMC Corp in the field of
Autonomy's stated margins of around 50 percent did not seem
to translate proportionately into cash flow; and it was
reporting double-digit organic growth in software license
revenue while rivals battled shrinking sales, the person said.
During a presentation a few weeks ago entitled 'Faking
Reported Income 101' at the Santangel's Investor Forum in New
York, hedge fund manager John Hempton of Sydney, Australia-based
Bronte Capital highlighted items on Autonomy's balance sheet
that raised his concerns.
"Is it odd that in a software company you have receivables
of 4.5 months? Or that deferred revenue is under half
receivables?" asked Hempton, who has a short position on HP.
Last year, software firm Oracle Corp said it had
looked at Autonomy but passed on it.
Whitman said Tuesday that her predecessor, Apotheker, and
former Chief Strategy and Technology Officer Shane Robison were
the key people behind the Autonomy acquisition. Robison left
shortly after Apotheker was ousted in September 2010.
In a statement, Apotheker said he was "stunned and
disappointed" by the revelations and offered to help HP and the
authorities to get to the bottom of the matter.
Robert Enderle, a tech analyst at the Enderle Group, said he
has never seen such a potential misrepresentation of financials.
"You have to rely on what the firm gives you during due
diligence and I've never seen a misstatement at this level,"
If the charges are true, it could result in a huge punitive
damages award for HP, Enderle said.
But Darren Robbins, a San Diego-based plaintiff lawyer who
represents shareholders, said he fielded several calls on
Tuesday from institutional investors about HP. The tech icon
spent billions on a company without undertaking proper due
diligence, Robbins said.
Other analysts hoped it was the end of the bad news for HP.
"This kind of feels like the last of the bad news,"
Forrester analyst Frank Gillett said.
In announcing its quarterly results, HP said net revenue
fell to $29.96 billion for the quarter ended Oct. 31, from
$32.12 billion a year earlier. Analysts, on average, had
expected $30.43 billion, according to Thomson Reuters I/B/E/S.
Revenue from its main business units declined, with the
personal computer division recording the steepest drop at 14
percent. Revenue from printing fell 5 percent.
HP reported a quarterly net loss of $3.49 a share, versus a
profit of $239 million, or 12 cents, a year earlier.