H-P Says It Was Duped, Takes $8.8 Billion Charge

This is embarrassing regardless. Aivars Lode avantce

H-P Says It Was Duped, Takes $8.8 Billion Charge

By BEN WORTHEN

Hewlett-Packard Co. HPQ -13.58% said on Tuesday it had been duped into overpaying for one of its largest acquisitions, contributing to an $8.8 billion write-down and a huge quarterly loss.

In an interview with The Wall Street Journal, Autonomy founder Mike Lynch said he wasn't aware Hewlett was preparing these allegations and that they are "utterly wrong." Ben Rooney has details on The News Hub. Photo: Bloomberg.

Hewlett-Packard leveled serious accusations against a software company it bought last year, saying it would take a $8.8 billion write-down after it claimed Autonomy's leadership misrepresented its performance. Scott Austin reports on Markets Hub. Photo: Reuters.

Hewlett-Packard's shares sank to the lowest levels in ten years on as the company took an $8.8 billion charge on its Autonomy acquisition. S&P Capital IQ senior analyst Angelo Zino joins digits to discuss. Photo: Getty Images.

The technology giant said that an internal investigation had revealed "serious accounting improprieties" and "outright misrepresentations" in connection with U.K. software maker Autonomy, which H-P acquired for $11.1 billion in October 2011.

"There appears to have been a willful sustained effort" to inflate Autonomy's revenue and profitability, said Chief Executive Meg Whitman. "This was designed to be hidden."

Michael Lynch, Autonomy's founder and former CEO, fired back hours later, denying improper accounting and accusing H-P of trying to hide its mismanagement. "We completely reject the allegations," said Mr. Lynch, who left H-P earlier this year. "As soon as there is some flesh put on the bones we will show they are not true."

H-P said Tuesday it alerted the U.S. Securities and Exchange Commission and the U.K. Serious Fraud Office and requested that they open investigations. The SEC and Federal Bureau of Investigation are launching inquiries, according to people familiar with the probes.

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The accounting-fraud claim adds to a string of recent setbacks and controversies for Palo Alto, Calif.-based H-P, whose board faced criticism over its handling of the departures of its last two chief executives. Mark Hurd resigned in 2010 after he acknowledged having a personal relationship with a company contractor. His successor, Leo Apotheker, who spearheaded the Autonomy purchase, was forced out in 2011 and replaced by Ms. Whitman.

H-P General Counsel John Schultz said the internal investigation into the Autonomy deal began in May when he told Ms. Whitman he had just spoken with a senior executive in the Autonomy software business, who had alleged that executives at Autonomy had been cooking the books before the acquisition. The identity of that senior executive couldn't be determined.

A spokesman for Autonomy's accounting firm, Deloitte LLP, said Tuesday: "Deloitte UK categorically denies that it had any knowledge of any accounting improprieties or any misrepresentations in Autonomy's financial statements, or that it was complicit in any accounting improprieties or misrepresentations."

Mr. Lynch, the former Autonomy CEO, said H-P is "completely and utterly wrong." He said of Autonomy: "It is a business we spent 10 years building. It was a world leader. It was destroyed in less than a year by the petty infighting at H-P."

The accounting-fraud allegations punctuated another grim set of financial results for H-P, one of the world's largest sellers of personal computers, printers and other technology products and services. In recent years, it has been hurt by executive turnover, cost cuts, mounting debt and slowing demand for some products.

H-P said Tuesday it swung to a $6.9 billion loss for its fiscal fourth quarter ended Oct. 31, while revenue fell 7% from a year earlier. The charge for writing down Autonomy totaled $8.8 billion, of which more than $5 billion is related to the accounting issues, with the balance related partly to the unit's performance. Revenue fell across H-P's PC, printer, services, and server and networking divisions.

Hewlett-Packard has claimed that the leadership at Autonomy, the software firm it acquired last year, misrepresented its performance as the deal was being negotiated. WSJ's Ben Rooney profiles the company and its founder, Mike Lynch. Photo: Bloomberg

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Previously

It was the technology giant's fifth straight quarter of big declines, a trend Ms. Whitman said is likely to continue.

H-P's stock, which was already trading near a 10-year low, ended 4 p.m. trading at $11.71, down $1.59, or 12%, on the New York Stock Exchange.

When the deal was announced in August 2011, Autonomy was Britain's biggest software company and second-largest in Europe, after Germany's SAP SAP.XE +2.06% AG. Its customers include intelligence agencies, big corporations, banks and law firms. H-P said then that Autonomy was key to its transformation into a higher-margin seller of software.

H-P said Tuesday that Autonomy, before it was acquired, had mischaracterized some sales of low-margin hardware as software and had recognized some deals with partners as revenue, even when a customer never bought the product.

At least one year before the H-P acquisition, an Autonomy executive brought concerns about the company's accounting practices to U.S. regulators including the SEC, according to people familiar with the matter. Autonomy didn't trade on U.S. exchanges prior to the H-P deal, so it is unclear whether U.S. agencies had jurisdiction.

H-P's internal team was aware of talk about accounting irregularities at the time the deal was struck, people familiar with the matter have said. At the time, one of these people said, H-P was looking for a way to unwind the deal before it closed, but couldn't find any material accounting issues.

Mr. Lynch, in an interview at the time, denied any accounting irregularities. On Tuesday, he blamed any problems at Autonomy on poor management by H-P and executive turnover.

Ms. Whitman said Tuesday the company relied on Autonomy's regular auditor Deloitte and had hired KPMG for an additional review before the deal closed. Neither firm found any irregularities then, she said. KPMG declined comment.

Mr. Schultz, H-P's general counsel, said H-P was shown "significant documentation from former Autonomy executives refuting the allegations" of any accounting issues. In hindsight, "it's fair to say those refutations were questionable," he said.

After H-P completed the deal, Autonomy's sales suffered. On several occasions, H-P said the unit didn't meet expectations.

In May 2012, Mr. Lynch left H-P. Shortly after, the unidentified Autonomy senior executive approached Mr. Schultz. Mr. Schultz said that during a phone call to discuss other matters, the Autonomy executive asked to speak with him in person.

The pair met in a conference room at H-P's Palo Alto headquarters, where the executive provided an outline of the alleged accounting fraud, Mr. Schultz said. The executive later provided some emails and financial information that Mr. Schultz said substantiated the claim.

Working with auditing firm PricewaterhouseCoopers LLP, an H-P team re-created Autonomy's books. People familiar with the investigation said that the team found that for at least two years, Autonomy booked sales of low-margin hardware products as software and would label the cost of that hardware as marketing or other expenses, which made products appear faster growing and more profitable than they really were.

In late June 2012, Mr. Lynch met with H-P to discuss issues including "transition and obligations to the company," said Mr. Lynch's spokeswoman. She added that at the meeting, he was asked about the operation of a small number of deals, which he explained.

Mr. Lynch, who founded Autonomy in 1996 and took it public in 1998, said Tuesday he was saddened by the allegations and that he hasn't been contacted by regulatory authorities.

Ms. Whitman, who was on H-P's board when the Autonomy deal was announced, blamed the acquisition on her predecessor, Mr. Apotheker, and the company's former strategy chief, Shane Robison. "The two people who should have been held responsible are gone," she said. Mr. Robison didn't respond to requests for comment.

In a statement, Mr. Apotheker said he was "both stunned and disappointed" to learn of H-P's allegations. He said "the due diligence process was meticulous and thorough, and included two of the world's largest and most respected auditing firms working on behalf of H-P." He added that he will assist H-P and the authorities "to get to the bottom of this."

—Ben Rooney, Joann S. Lublin, Justin Scheck 

Write to Ben Worthen at ben.worthen@wsj.com