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HP fraud claims seen as cover for bad deal

Hewlett Packard chief executive and president Meg Whitman

Hewlett Packard chief executive and president Meg Whitman in 2012. Credit: AP

Hewlett-Packard's claims of financial improprieties at Autonomy Corp. have accounting experts questioning whether the allegations are an attempt to divert attention from yet another bad acquisition.

Hewlett-Packard said Tuesday it recorded an $8.8 billion write-down related to its purchase last year of Autonomy, the British software maker. More than $5 billion of that impairment charge was the result of accounting practices at Autonomy, Hewlett-Packard said in a statement. About $200 million of Autonomy's revenue had been recorded prematurely or improperly, according to Hewlett-Packard's general counsel.

"How does that translate into a $5 billion write-off?" said Lynn Turner, former chief accountant of the Securities and Exchange Commission and a managing director at LitiNomics, an economic and forensic consulting firm. "The big issue isn't the fraud they're talking about. The big issue is that HP has made acquisitions that have turned out to be a disaster."

A second write-down

The write-down follows Hewlett-Packard's August announcement that it would take a charge of $9.2 billion, largely related to its purchase of Electronic Data Systems Corp.

When companies make an acquisition, the difference between the value of the target's hard assets and the purchase price is known as goodwill. That gets carried on the company's balance sheet as an asset and is reviewed periodically by public companies.

The Autonomy and EDS write-downs together total $18 billion, while Hewlett-Packard's balance sheet as of April showed almost $45 billion in goodwill.

"Those were decisions approved by the board and they raise serious questions about the competency of the board and management team," Turner said.

Former Hewlett-Packard chief executive Leo Apotheker agreed to buy Autonomy in August 2011 for $10.3 billion to expand into data-search software for corporations and then left in September 2011 after less than a year on the job. Current  chief executive Meg Whitman and chairman Ray Lane served on the board when it signed off on the deal.

Michael Thacker, a spokesman for Hewlett-Packard, didn't return calls seeking comment.

Hewlett-Packard accusations

Hewlett-Packard alleges Autonomy mischaracterized some revenue from "negative margin" hardware sales and improperly included it as "license revenue," according to a company statement. The hardware comprised an estimated 10 percent to 15 percent of Autonomy's revenue, Hewlett-Packard said.

Hewlett-Packard also said in its statement that Autonomy used licensing transactions with resellers to inappropriately accelerate revenue recognition "or worse, create revenue where no end-user customer existed at the time of sale."

Autonomy accelerated, miscategorized and "created" more than $200 million in revenue over a two-year period beginning in 2009, said John Schultz, Hewlett-Packard's general counsel in an interview. That would equate to about 12 percent of Autonomy's $1.61 billion in revenue for 2009 and 2010, based on the company's 2010 annual report.

Autonomy resold Dell desktop and laptop computers, and computer mice, and recorded those sales so they appeared to be software revenue, Schultz said. He also said Autonomy fabricated some sales through resellers.

Deloitte, Autonomy's auditor, "obviously didn't catch these issues at the time" Schultz said.

Deloitte "categorically denies" any knowledge of improper accounting or misrepresentations in Autonomy's financial reports, it said in a statement Wednesday. The firm said it didn't provide due diligence related to the takeover by Hewlett-Packard and its most recent audit opinion was for 2010.

Autonomy generated most of its sales in 2010 through more than 400 resellers, including Accenture, International Business Machines, Cap Gemini and Wipro, according to the 2010 annual report.

Allegation from inside

Hewlett-Packard became aware of the situation after an executive who still works there stepped forward after former Autonomy chief executive and founder Mike Lynch departed in May.

Autonomy's former top management team "flatly rejects" the allegations, according to Vanessa Colomar, a spokeswoman for Lynch. Autonomy has been mismanaged by Hewlett-Packard, she said.

Lynch said in an interview on CNBC that he wasn't contacted by Hewlett-Packard before the company made its allegations public.

The world's biggest technology companies often stumble in acquisitions because they fail to understand what they're buying, said Stephen Arnold, president of Harrod's Creek, Ky.-based Arnold Information Technology, which advises clients on search and content processing.

"The arrogance of the buying company is they believe they are smarter and can do a better job," he said. "For that big a deal, you don't do this kind of detail after you've owned them. You take your time and do it first."

Echo of accounting scandals

Hewlett-Packard's allegations of aggressive revenue recognition echo accounting scandals of the late 1990s and early 2000s, said Jack Ciesielski, publisher of The Analyst's Accounting Observer and former adviser to the Financial Accounting Standards Board.

Back then, companies including Computer Associates International and Lucent Technologies were investigated over their revenue recognition practices.

Turner, the former SEC accountant, said that while there have been specific rules governing software revenue recognition since 1997, Silicon Valley companies have a track record of trying to make themselves look more profitable.

Deloitte last December issued a 208-page "road map" devoted to navigating the various accounting standards governing the recognition of software revenue.

Calculating when to book revenue at software companies is complex, Ciesielski said.

"It's not like somebody just shipped a bunch of cans of lima beans to a store and they're ready to go," he said. That's because the contracts typically include physically delivering products and also providing services, maintenance and customization.

As a result, "it's not a hard thing to obfuscate, let's put it that way," he said. "There are tons of ways to make it difficult for the accountants."

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