http://www.guardian.co.uk/business/2012/nov/23/hewlett-packard-autonomy-mike-lynch
Hewlett-Packard's Autonomy claims inconceivable, says Mike Lynch
Autonomy founder says he will not be HP's scapegoat after $5bn writedown on value of software firm
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Mike Lynch, founder of Autonomy Corporation. Photograph: Matt LLoyd/Rex Features
Autonomy founder Mike Lynch has attempted to turn the tables on his accusers at Hewlett-Packard, saying it is "inconceivable" that the level of false accounting claimed could have led to a $5bn (£3bn) writedown on the value of his software firm.
The world's largest PC maker bought Autonomy for $10.3bn last year in an effort to transform itself into a fast growing software company. On Tuesday it said the Cambridge-based firm was worth half of what it paid and blamed the discrepancy on "accounting improprieties" by Autonomy's management team.
"It is inconceivable how, from $100m of revenue that just changes classification, you could possibly have a writedown as big as $5bn," Lynch said.
The row coincided with a disastrous financial update showing HP's revenues down 14% year on year. It is suffering from falling demand for its PCs as consumers save for tablets and smartphones.
Lynch said: "They've had to do a very big writedown and they tried to blame it on the accounting but obviously something else is going on. People realise I'm certainly not going to be used as HP's scapegoat when it's got itself in a mess."
Lynch admitted that Autonomy did occasionally sell hardware at a loss and report it as a marketing expense. He said Autonomy would sometimes sell desktop computers alongside software.
This was the most detailed of HP's claims, that Autonomy classified revenue from hardware sales as being from software, while booking the loss as a marketing expense. Such sales were said by HP to represent 10% to 15% of Autonomy revenues estimated at $1bn last year – adding up to $100m to $150m.
A small number of deals were struck at a loss, Lynch told Reuters, if the client agreed to market Autonomy products, and in those cases the transaction would be charged as a marketing expense.
"Even if you took HP's argument, which is inaccurate … it would make no difference to the bottom line or the top line," he said. "All of those deals went to our auditors who also agreed to the treatment. It's no great secret that Autonomy sells hardware."
A spokeswoman for Lynch denied accusations of "channel stuffing", a practice which has led to companies including McAfee and Bristol Myers Squibb being fined millions of dollars by the US authorities. Channel stuffing involves booking as revenue products passed on to resellers when no income has been received or is likely to be.
HP claimed Autonomy had improperly booked revenues for products it had transferred to middlemen, known as resellers, which they had not yet sold to customers.
"There's no problem with how we do that," said Lynch. He pointed out that the accounting rules followed by Autonomy and most other British companies, known as international financial reporting standards (IFRS) were different from those commonly used in the US, generally accepted accounting principles (GAAP).
"There are very stringent rules about how we recognise revenues with resellers," he said. "They could be found in the annual report." Autonomy's annual report states that sales are only recognised "if all products subject to resale are delivered in the current period, no right of return policy exists, collection is probable and the fee is fixed and determinable".
In a third charge, made on a conference call with journalists, HP chief executive Meg Whitman said Autonomy had been inflating its revenues by converting long-term deals to host digital archives for businesses, like banks or law firms, into short term licensing deals.
A spokeswoman for Lynch said Autonomy had handed all receipts to its accountant, Deloitte, on a quarterly basis, even though it was not obliged to do so. The accountant had to approve every invoice over €100,000. "All of these deals went through Deloitte themselves," said Lynch. "Deloitte apply the test independently of us, and it is a standard test, and it is explicitly stated in the annual report and accounts."
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http://www.bloomberg.com/news/2012-11-21/hp-s-explanation-still-makes-no-sense.html?cmpid=yhoo.view
HP’s Explanation Still Makes No Sense
My Bloomberg colleague Jesse Drucker has an article today that puts some numbers onHewlett-Packard Co. (HPQ)’s allegations of book-cooking at Autonomy Corp. HP says the financial-reporting improprieties at Autonomy caused more than $5 billion of the $8.8 billion writedown that it disclosed yesterday.
The article underscores how HP’s explanation doesn’t make sense. About $200 million of Autonomy’s revenue had been recorded prematurely or improperly over a two-year period beginning in 2009, HP’s general counsel, John Schultz, said in an interview for Drucker’s story. Autonomy’s former executives deny HP’s claims. That would be equivalent to about 12 percent of Autonomy’s revenue for 2009 and 2010 combined.
This is the only hard number quantifying the supposed accounting errors that HP has disclosed so far. Let’s assume for the moment that what Schultz said is true. That doesn’t explain more than $5 billion of writedowns. Some writedowns, perhaps. But not more than $5 billion worth. Maybe HP will eventually provide a more thorough explanation.
The real story here is that HP grossly overpaid -- again -- for an acquisition. The $11 billion purchase price was more than 11 times Autonomy’s $931 million of revenue for the 12 months ended June 30, 2011.
In other words: HP was the sucker. Now it’s trying to shift the blame elsewhere, which shouldn’t come as a surprise. Here are some other observations on the HP mess:
-- The $200 million revenue issue is one of two examples HP has given of “accounting improprieties and misrepresentations” at Autonomy. In its statementyesterday, HP said the other was “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.”
HP said “this negative-margin, low-end hardware is estimated to have comprised 10-15% of Autonomy’s revenue.”
That doesn’t seem like an accounting issue; it wouldn’t change the numbers Autonomy reported before it was bought. Autonomy’s income statement showed only one revenue line, which didn’t distinguish between types of revenue. Even if HP is correct to call this a misrepresentation, it still doesn’t explain how Autonomy’s financial-reporting improprieties were responsible for more than $5 billion of the writedowns at HP last quarter.
-- During a conference call with investors yesterday, HP Chief Executive Officer Meg Whitman said this about Autonomy’s outside accounting firm, Deloitte LLP in the U.K.: “The board relied on audited financials -- audited by Deloitte -- not Brand X accounting firm but Deloitte.”
Brand X may look good compared with what the Public Company Accounting Oversight Board said about Deloitte & Touche LLP, the Big Four accounting firm’s U.S. affiliate, in a May 2008 inspection report. The report was released in October 2011. Quality-control problems included “a firm culture that allows, or tolerates, audit approaches that do not consistently emphasize the need for an appropriate level of critical analysis and collection of objective evidence, and that rely largely on management representations.”
Autonomy’s reputation for aggressive accounting wasn’t a secret. Dan Mahoney, who heads the accounting-research firm CFRA in New York, said in an e-mail this morning that, “from 2001 through 2010, our firm wrote 14 reports and four notes on Autonomy raising questions about its accounting and disclosure practices.” At CFRA, he said, “the reaction was not one of surprise but more ’what took so long?’”
-- The Deloitte partner who signed the firm’s audit report on Autonomy’s year-end 2010financial statements is Nigel Mercer of Cambridge, England. In the U.S., accounting firms at publicly traded companies don’t name the partners responsible for their audit reports. But in some countries, such as the U.K., they do.
The accounting oversight board for years has been floating the idea of requiring U.S. audit firms’ partners to identify themselves by name when they vouch for companies’ financial statements. This is information that investors clearly should be told. But the board’s proposal has gone nowhere, partly because of opposition by the accounting profession.
You can bet there are short sellers and other investors out there checking to see what other audits Mercer may have been in charge of.
-- HP is making a big fuss about how it purportedly got duped by Autonomy’s accounting practices. At the same time, it’s also suggesting that investors disregard the $8.8 billion writedown when they analyze the company’s financial results.
The first number cited in HP’s earnings release yesterday was “fiscal 2012 non-GAAP diluted earnings per share of $4.05.” Translation: earnings before bad stuff. HP had a fiscal 2012 net loss of $12.7 billion, or $6.41 a share, under generally accepted accounting principles. That included a $6.9 billion loss for the fourth quarter.
HP’s earnings spin is so patently ridiculous, you have to wonder: Why bother?
-- Autonomy showed $3.5 billion of total assets as of June 30, 2011, which was the last time it disclosed a balance sheet as a public company. The figure included $1.5 billion of goodwill, which is the bookkeeping entry a company records when it buys another company for a premium. HP, for its part, recorded $6.9 billion of the $11 billion purchase price for Autonomy as goodwill.
What we have here is one serial acquirer blowing up after buying another serial acquirer. It’s a classic roll-up story. HP’s core business has been horrible for years. So it has relied on high-priced acquisitions -- such as Compaq Computer, Electronic Data Systems, and Palm -- to fuel its growth. It made one bad deal after another, repeatedly overpaying. Finally HP hit a wall, just like many roll-ups of the past -- everything from Citigroup and Bank of America during the financial crisis to Waste Management and WorldCom more than a decade ago.
-- Even if HP hadn’t identified any accounting improprieties at Autonomy, writedowns of the magnitude disclosed yesterday were predictable. The need to record them was obvious, as I wrote in an Oct. 4 blog post.
HP finished the fiscal third quarter with $32 billion of shareholder equity. Its balance sheet showed $36.8 billion of goodwill (which isn’t a saleable asset) and $8 billion of other intangible assets. By comparison, HP finished the fiscal fourth quarter on Oct. 31 with a stock-market value of $27.2 billion.
In other words, on paper, HP’s goodwill supposedly was worth more than the company as a whole. The market knew big writedowns were necessary. Investors saw that Autonomy was a disaster. They were just quicker to acknowledge the reality than HP was.
That’s why the company’s market capitalization fell only $3.2 billion yesterday, or 12 percent, on news of a $6.9 billion quarterly net loss. Much of that red ink had been anticipated.
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