HP Alleges Fraud In Autonomy Deal; Shares At 10-Year Low

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Date: Tuesday November 20, 2012 09:23:12 am
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    HP Alleges Fraud In Autonomy Deal; Shares At 10-Year Low

    Hewlett-Packard this morning asserted that there were substantial instances of financial fraud in connection with its acquisition of the software company Autonomy in 2011 for $11.1 billion.


    The company also reported October quarter profits slightly ahead of Street estimates, but cautioned that January quarter profits will be below consensus estimates.

    Specifically, HP today disclosed $8.8 billion in non-cash charges “linked to serious accounting improprieties, disclosure failures and outright misrepresentations at Autonomy … that occurred prior to HP’s acquisition of Autonomy and the associated impact of those improprieties, failures and misrepresentations on the expected future financial performance of the Autonomy business over the long-term.” In effect, the company is writing down close to 90% of the value of the transaction.

    The company noted that it has referred the matter to securities regulators in both the U.S. and the U.K., and added that it intends to pursue civil charges against some individuals who had a role in the transactions.

    HP said it began an internal probe of the situation “after a senior member of Autonomy’s leadership team came forward, following the departure of Autonomy founder Mike Lynch, alleging that there had been a series of questionable accounting and business practices at Autonomy prior to the acquisition by HP.” Hp added that this person “provided numerous details about which HP previously had no knowledge or visibility.”

    The company added that it ”now believes that Autonomy was substantially overvalued at the time of its acquisition due to the misstatement of Autonomy’s financial performance, including its revenue, core growth rate and gross margins, and the misrepresentation of its business mix.”

    Update: HP issued a statement with further comments on the writedown:

        “HP is extremely disappointed to find that some former members of Autonomy’s management team used accounting improprieties, misrepresentations and disclosure failures to inflate the underlying financial metrics of the company, prior to Autonomy’s acquisition by HP. These efforts appear to have been a willful effort to mislead investors and potential buyers, and severely impacted HP management’s ability to fairly value Autonomy at the time of the deal. We remain 100 percent committed to Autonomy and its industry-leading technology.”

    The deal was originally reached under previous CEO Leo Apotheker, and closed under current CEO Meg Whitman.

    The company made the disclosure in connection with its financial results for its fiscal fourth quarter ended October 31.

    In the quarter, HP posted revenue of $30 billion, down 7% from a year ago, or 4% adjusted for currency, and a bit below the Street consensus at $30.4 billion. Non-GAAP profits were $1.16 a share, two cents better than the Street at $1.14. On a GAAP basis, the company lost $6.8 billion or $3.49 a share, including $9.1 billion in charges, including the large hit related to the Autonomy deal.

    For FY Q1 ending in January, the company sees non-GAAP profits of 68-71 cents a share, well below the Street at 85 cents.

    For all of FY 2013, the company sees non-GAAP EPS of $3.40 to $3.60 a share, in line with previous forecasts.

    In the latest quarter, the company saw difficult conditions in most sectors:

        Personal Systems revenue was down 14% year over year. Commercial revenue decreased 13%, and consumer revenue declined 16%. Total units were down 12% with both desktops and notebooks units down 12%.
        Printing revenue declined 5% year over year. Total hardware units were down 20% year over year. Commercial hardware units were down 15% year over year, and consumer hardware units were down 22% year over year.
        Services revenue declined 6% year over year. Technology Services revenue was down 4% year over year, Application and Business Services revenue was down 7% year over year, and IT Outsourcing revenue declined 6% year over year.
        Enterprise Servers, Storage and Networking revenue declined 9% year over year. Networking revenue was up 7%, Industry Standard Servers revenue was down 7%, Business Critical Systems revenue was down 25%, and Storage revenue was down 13% year over year.
        Software revenue grew 14% year over year, including the results of Autonomy. Software revenue was driven by 9% license growth, 9% support growth, and 48% growth in services.
        HP Financial Services revenue grew 1% year over year.

    There are lots of unanswered questions here. For starters, who is responsible? Former Autonomy CEO Mike Lynch, recently booted out of HP by Whitman? Former CEO Apotheker? The HP board? The bankers who worked on the transaction? All of the above? And will any government agencies in the U.S. and/or the U.K. decide to conduct a formal investigation? Will the situation taint current CEO Whitman? And with HP’s shares tumbling to fresh lows, can HP survive as currently structured – or will it be sold or broken apart?

    HP this morning is down $1.52, or 11.4%, to $11.78. The stock now trades at the lowest level since 2002.

    Update: Here’s HP’s detailed statement on the nature of the Autonomy allegations:

        HP today announced a non-cash impairment charge of $8.8 billion related to Autonomy in the fourth quarter of its 2012 fiscal year. The majority of this impairment charge, more than $5 billion, is linked to serious accounting improprieties, misrepresentation and disclosure failures discovered by an internal investigation by HP and forensic review into Autonomy’s accounting practices prior to its acquisition by HP. The balance of the impairment charge is linked to the recent trading value of HP stock and headwinds against anticipated synergies and marketplace performance.

        HP launched its internal investigation into these issues after a senior member of Autonomy’s leadership team came forward, following the departure of Autonomy founder Mike Lynch, alleging that there had been a series of questionable accounting and business practices at Autonomy prior to the acquisition by HP. This individual provided numerous details about which HP previously had no knowledge or visibility.

        HP initiated an intense internal investigation, including a forensic review by PricewaterhouseCoopers of Autonomy’s historical financial results, under the oversight of John Schultz, executive vice president and general counsel, HP.

        As a result of that investigation, HP now believes that Autonomy was substantially overvalued at the time of its acquisition due to the misstatement of Autonomy’s financial performance, including its revenue, core growth rate and gross margins, and the misrepresentation of its business mix.

        Although HP’s investigation is ongoing, examples of the accounting improprieties and misrepresentations include:

            The mischaracterization of revenue from negative-margin, low-end hardware sales with little or no associated software content as “IDOL product,” and the improper inclusion of such revenue as “license revenue” for purposes of the organic and IDOL growth calculations.The use of licensing transactions with value-added resellers to inappropriately accelerate revenue recognition, or worse, create revenue where no end-user customer existed at the time of sale. This negative-margin, low-end hardware is estimated to have comprised 10-15% of Autonomy’s revenue.
            The use of licensing transactions with value-added resellers to inappropriately accelerate revenue recognition, or worse, create revenue where no end-user customer existed at the time of sale.

        This appears to have been a willful effort on behalf of certain former Autonomy employees to inflate the underlying financial metrics of the company in order to mislead investors and potential buyers. These misrepresentations and lack of disclosure severely impacted HP management’s ability to fairly value Autonomy at the time of the deal.

        HP has referred this matter to the US Securities and Exchange Commission’s Enforcement Division and the UK’s Serious Fraud Office for civil and criminal investigation. In addition, HP is preparing to seek redress against various parties in the appropriate civil courts to recoup what it can for its shareholders. The company intends to aggressively pursue this matter in the months to come.

    http://www.washingtonpost.com/business
    HP takes $8.8B hit on fictitious accounting

    Hewlett-Packard says it’s the victim of fictitious accounting at company it acquired

    NEW YORK — Hewlett-Packard Co. said that a British company it bought for $9.7 billion last year lied about its finances, resulting in a massive write-down of the value of the business.

    CEO Meg Whitman avoided calling it a fraud, but said Tuesday that there were “serious accounting improprieties, disclosure failures and outright misrepresentations at Autonomy Corporation PLC.”

    HP is taking an $8.8 billion charge in its latest quarter largely to align the accounting value of Autonomy with its real value.

    The revelation is another blow for HP, which is struggling to reinvent itself as PC and printer sales shrink. Its shares hit a 10-year low in morning trading.

    Among other things, Autonomy makes search engines that help companies find vital information stored across computer networks. Acquiring it was part of an attempt by HP to strengthen its portfolio of high-value products and services for corporations and government agencies. The deal was greenlighted by Whitman’s predecessor, Leo Apotheker, but closed in Oct. 2011, three weeks into Whitman’s tenure.

    Whitman said Autonomy’s financial illusion started to unravel after founder and CEO Mike Lynch left on May 23. A senior Autonomy executive then volunteered information about the accounting shenanigans, prompting an internal investigation, she said.

    The case has been referred to the U.S. Securities and Exchange Commission and the UK’s Serious Fraud Office, she said. The company will also try to recoup some of the cash it paid for Autonomy through lawsuits.

    On a conference call with Whitman following the earnings report, analyst Ben Reitzes of Barclays Capital asked who will be held responsible internally for the disastrous acquisition.

    Whitman answered that the two executives that should have been held responsible — Apotheker and strategy chief Shane Robinson — are gone. But the deal was also approved, essentially, by the current board.

    “Most of the board was here and voted for this deal, and we feel terribly about that,” Whitman said. “What I will say is that the board relied on audited financials. Audited by Deloitte — not ‘Brand X’ accounting firm, but Deloitte. During our very extensive due diligence process, we hired KPMG to audit Deloitte. And neither of them saw what we now see after someone came forward to point us in the right direction.”

    Efforts to reach Deloitte, Lynch and Apotheker for comment were not immediately successful.

    HP shares traded down $1.74, or 13 percent, at $11.56 in morning trading. Just after the open, they hit $11.35, the lowest level since 2002.

    HP’s net loss for the fiscal fourth quarter, which ended Oct. 31, amounted to $6.85 billion, or $3.49 per share. That compares with net income of $239 million, or 12 cents per share, in the same period last year.

    It was the second mammoth loss in a row for HP. In the third fiscal quarter, it lost a record $8.86 billion, or $4.49 per share. That was due to a charge for another acquisition — that of Electronic Data Systems, a technology consulting service that it bought for $13 billion in 2009. In that case, HP didn’t blame improper accounting, just results that didn’t live up to expectations.

    Excluding the charges in the latest quarter, HP earned $1.16 per share in the latest quarter, just above the average analyst forecast of $1.14 per share, as polled by FactSet.

    HP’s revenue was $30.0 billion, down 7 percent from last year. That was below analyst expectations at $30.5 billion.

    The Palo Alto, Calif., company stuck to its previously given earnings forecast for the fiscal year that just started, but it issued a forecast for this quarter that was well below analyst expectations. It expects earnings, excluding items, to be 68 cents to 71 cents per share, while analysts were looking for 85 cents, according to FactSet.

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