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Published: Wednesday November 21, 2012 MYT 7:42:00 AM
Updated: Wednesday November 21, 2012 MYT 8:50:41 AM

HP alleges massive accounting scandal at British unit, will cost US$8.8bil in charges(2nd update)

NEW YORK: Hewlett-Packard stunned Wall Street by alleging a massive accounting scandal at its British software unit Autonomy that will cost the company the majority of US$8.8 billion in charges.

It was the latest in a string of reversals that have renewed questions about the basic competence of the storied company's board and senior managers.

HP said on Tuesday it discovered "serious accounting improprieties" and "a willful effort by Autonomy to mislead shareholders," after a whistleblower came forward following the ouster of Autonomy's then-chief executive, Mike Lynch, in May.

The charge follows a nearly $11 billion writedown last quarter for the company's EDS services division.

The technology company has been roiled in the past few years by a revolving door of CEOs, overall management turnover and challenges in its core personal computer and printer businesses.

HP's stock slid to a 10-year low, dropping 12 percent to $11.71 in regular trading on Tuesday. Shares are down nearly 50 percent year to date.

Lynch "flatly rejected" HP's allegations and said he was "shocked" but confident he would be absolved of any wrongdoing.

He had not been notified by HP about the allegation before it was made public, nor had he been contacted by any authorities, Lynch said in an interview with Reuters.

HP took $8.8 billion in charges in the quarter, with $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.

HP said it has referred the matter to the U.S. Securities and Exchange Commission's enforcement division and the UK's Serious Fraud Office for civil and criminal investigation. It said it would take legal action to recoup "what we can for our shareholders."

Both agencies declined to comment.

HP Chief Executive Meg Whitman, who voted for the deal while she was on HP's board, said the investigation of Autonomy's finances - both external and internal - will take multiple years as it makes it way through the courts in both countries.

"Most of the board was here and voted for this deal, and we feel terribly about that," said Whitman on a call with analysts. "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.

INFLATED SALES, REVENUE

HP alleged that Autonomy's former management inflated 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.

HP said Autonomy claimed its gross margins were in the 40 percent to 45 percent range while realistically they were in the 28 percent to 30 percent range.

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.

HP has embarked on an internal investigation, including a forensic review by PricewaterhouseCoopers of Autonomy's historical financial results, under HP General Counsel John Schultz after the whistleblower came forward in May.

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."

Whitman said her predecessor, Leo Apotheker and the former chief strategy officer, Shane Robison, were the key people behind the Autonomy acquisition.

Apotheker bought Autonomy to diversify HP's business and beef up its portfolio to provide one-stop shopping for corporations. The $11 billion acquisition of Autonomy - heavily criticized by investors as too costly - was a key part of the plan to transform HP.

Apotheker was ousted as CEO in September 2011 after just 11 months on the job and Robison left soon after.

In a statement, Apotheker said he was "stunned and disappointed" by the revelations and offered to make himself available to HP and the authorities to get to the bottom of the matter.

Whitman on Tuesday stood by Autonomy's technology and products despite the allegations, saying it will be the growth engine for HP. The former California gubernatorial candidate has been trying to move beyond some of HP's past controversies, which includes the ouster of the past two CEOs, a haphazard product strategy and a plan to sell its PC unit that was later dropped.

HP has been running Autonomy since the acquisition closed in October 2011, but it didn't find the accounting problems on its own. The company investigated only after a senior Autonomy executive came forward to detail the financial metrics surrounding Autonomy.

Advisers working on behalf of Autonomy included Qatalyst Partners, the investment bank run by technology investment banker Frank Quattrone; UBS; Goldman Sachs; Citigroup; JPMorgan Chase, and Bank of America. Perella Weinberg Partners and Barclays Capital advised for HP.

Law firms for Autonomy were Slaughter & May and Morgan Lewis. The firms for HP included Gibson, Dunn & Crutcher; Freshfields Bruckhaus Deringer; Drinker Biddle & Reath; and Skadden, Arps, Slate, Meagher & Flom.

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," Enderle said.

If the charges are true, it could result in a massive punitive damages award for HP, Enderle 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.

FOURTH-QUARTER LOSS

The Autonomy allegations and announcement of the charge coincided with the reporting of a fiscal fourth-quarter loss for HP.

HP said net revenue fell 6.7 percent to $29.96 billion for the quarter, ended October 31, from $32.12 billion a year earlier. Analysts, on average, expected $30.43 billion, according to Thomson Reuters I/B/E/S.

Revenue from all of its main business units declined, with the personal computer division recording the steepest drop, at 14 percent while revenue from printing fell 5 percent.

HP reported a quarterly net loss of $6.85 billion, or $3.49 a share, versus a profit of $239 million, or 12 cents, a year earlier.

The sprawling company, which employs more than 300,000 people globally, is undergoing a restructuring aimed at focusing on enterprise services in the mold of International Business Machines Corp .

"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. - Reuters

Factbox - HP's waning star, by the numbers

NEW YORK: Hewlett-Packard stunned Wall Street by alleging a massive accounting scandal at its British software unit Autonomy and announced an $8.8 billion writedown, the latest in a string of reversals that renewed questions about the competence of the storied company's board and senior managers.

The massive non-cash charge deals the latest blow to a company counted as one of the founding members of Silicon Valley but now greatly diminished and trying to regain its dominance of the industry through an internal overhaul.

Here's a look at how HP's star is waning:

- HP still ranks among the world's largest technology corporations by sales, with more than $120 billion in revenue in 2012. But sales dipped in four of its five major divisions in fiscal 2012, and Apple Inc now claims the crown with more than $150 billion in revenue in its fiscal 2012.

2012 sales vs 2011

Personal Systems $35.65 bln down 10.0 pct

Services $34.92 bln down 2.2 pct

Printing $24.49 bln down 6.5 pct

Enterprise, Storage,

Servers, networking $20.49 bln down 7.1 pct

Software $ 4.06 bln up 20.6 pct

- Stock: With Tuesday's 12-percent decline, the share price is now at a decade low. At its trough during regular trading, it hit $11.35 a share, its lowest since October 10, 2002 when it hit $11.14 a share.

- Market value: HP's capitalization now stands just north of $22 billion, a far cry from its peak in April 2000 of about $155 billion. As recently as November 2010, HP was worth $100 billion.

- Valuation:

The company now trades at 3.3 times forward earnings, a sliver of the U.S. computer hardware sector's 23 times average, according to Thomson Reuters data. By comparison, Apple Inc trades at 11 times projected earnings.

HP's shares trade at 0.7 times the company's book value, versus rival Dell Inc's 1.5 times.

- Market position now:

HP has led the industry in personal computer sales for years. But in October, Gartner estimated that China's Lenovo Group Ltd had edged out the Silicon Valley icon for the top spot worldwide in the third quarter.

Rival IT research outfit IDC estimated that HP clung to its lead in the quarter, but remained ahead of the Asian firm by less than half a percentage point.

- Acquisition spending:

Autonomy adds to HP's worsening acquisition track record. In August the company wrote down nearly $11 billion of the value of its services business, much of which it acquired four years ago with its $14 billion purchase of EDS.

In 2002, it bought PC maker Compaq for $25 billion after a highly public internal rift. It also expanded HP's footprint vastly in a personal computing industry that years later is struggling to grow. - Reuters

Former Autonomy boss denies HP allegations

LONDON: The former head of software firm Autonomy denied on Tuesday that there were accountancy problems at the company he co-founded, after new owner Hewlett Packard blamed irregularities in Autonomy's books for a massive $5 billion charge.

Irish-born mathematics whiz Mike Lynch, who led the firm when it was sold to HP last year for $11.1 billion, said mismanagement of Autonomy by its new owners was to blame for the decline in its value.

HP said earlier on Tuesday it had taken an $8.8 billion charge in the fourth quarter, most in the form of a $5 billion write-down related to the acquisition of Autonomy. It said it had discovered "serious accounting improprieties" in the software firm's books and a "wilful effort by Autonomy to mislead shareholders" after a whistleblower came forward.

In an interview with Reuters, Lynch said he was confident he would be absolved on any wrongdoing. He said he had not been notified by HP about the allegation before it was made public, nor had he been contacted by any authorities.

"We are shocked, this is a big surprise, it's completely and utterly wrong and we reject it completely," he said in a phone interview from a London office where he was meeting with other former Autonomy executives, including its former chief financial officer.

"We have not heard anything from HP, they have not been in touch and we don't know what they are on about," he said. "I fear that this is a bit of a distraction on the day when they produce their worse set of results in the 70-year history of the company."

Lynch said the size of the writedown suggested it was impossible that HP could have missed problems with the accounts during its examination of the books before the transaction.

"Look at the size of the writedown. If you've done meticulous due diligence with 300 people you can't get it that wrong."

Lynch, who has a PhD in signal processing from Britain's Cambridge University, received about 465 million pounds from the sale of his stake in Autonomy to HP last year.

He co-founded the firm in 1996, using technology based on advanced mathematics known as Bayesian probability theory to develop algorithms that can search through e-mails and phone calls. He had grown the Cambridge-based company into a supplier of search software to multinationals and governments worldwide.

However, last year when news of the planned acquisition by HP broke, many financial analysts questioned the deal, with some raising questions about Autonomy's organic growth, its cash conversion and its deferred revenue.

Analyst Paul Morland at Peel Hunt said after the HP bid was announced in August 2011 that it "seemed to defy logic".

"We believe HP shareholders should be worried," Morland said then. "Even before you consider the very high price, what are they going to think when they realise that margins have been contracting, profits are growing in single digits and for some reason those profits aren't converting into as much cash as they should?"

The purchase of Autonomy was the centrepiece of former HP CEO Leo Apotheker's bid to make HP a force in software. Lynch came as part of the takeover, with a remit to build HP's software division. But his relationship with Meg Whitman, Apotheker's successor, soured, and he left HP in May 2012.

He said the real problem was poor management of Autonomy and other acquisitions by HP.

"There was a coup d'etat and you ended up with a lot of internal infighting - which there has been a long history of within HP - and Autonomy got caught in that, and it got buffeted to the point where it lost hundreds of its staff and ultimately its top management team," he said. "They've managed the assets since that point and the results have gone down and down."

HP declined to comment on Lynch's remarks and referred to its earlier statement about the causes of its writedown.

Lynch said he needed to find out what evidence had led to the charge of accounting problems, once the distraction of the earnings report had died down.

"It's really sad for us at Autonomy to have seen the company so poorly managed over the last year, to see so much value destroyed," he said. - Reuters

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