Here’s Why HP’s Autonomy Fraud Allegations Are Unraveling

Source: yat fai ooi / Flickr

Source: yat fai ooi / Flickr

In the fourth-quarter of 2012, Hewlett-Packard’s (NYSE:HPQ) financial results showed the personal computer company had taken an $8.8 billion accounting writedown for the three-month period, attributing more than $5 billion to the enterprise software division Autonomy, which had been purchased for $11.1 million in 2011. Soon after the revelation was made, experts opined that HP had most likely been far too accepting of Autonomy’s published and audited accounts detailing its sales figures, while the company alleged it had been misled about the true state of Autonomy’s financial position; the writedown was only made after a whistle blower alerted the company to the accounting improprieties. In the wake of HP’s accusations of accounting fraud, Autonomy’s former Chief Executive Officer Mike Lynch said that HP had mismanaged Autonomy, a maker of enterprise software, after its acquisition.

Until now, the truth behind HP’s $5-billion Autonomy writedown was clothed in the allegations. But through a collection of audit papers, accounting documents, internal emails, and interviews with people familiar with the deal, the Financial Times gained some insight into the web of claims and counterclaims surrounding the Autonomy acquisition, and from these sources, it seems that HP was aware of that Autonomy was selling hardware at a loss before the acquisition was made.

It has come to light that Autonomy — whose main business was enterprise software — had sold hardware at a loss to compensate for shortfalls in the company’s revenues, and Automony’s loss-making hardware sales were a main focus of the dispute with HP. The problem is that these loss-making sales — made to institutions ranging from the Vatican to Morgan Stanley (NYSE:MS) to the Veterans Administration — were transactions considered not to be commercially valid.

But while HP said it eventually became aware of the hardware sales, the company maintained it did not know about the accounting improprieties until a whistleblower came forward. “Our investigation has shown that Autonomy often resold generic hardware at a loss in the last few days of the quarter with the sole purpose of masking its real financial performance,” HP said in a statement obtained by Reuters. “In addition, Autonomy engaged in improper transactions with certain value-added resellers to create the appearance of software licensing revenue at the end of each quarter. In some instances, these transactions were used to accelerate revenue, and on numerous occasions, these were fabricated transactions with no real end-user.”

The stress that Autonomy was under was clear in a late 2010 email from Autonomy Chief Financial Officer Sushovan Hussain to Lynch. “Really don’t know what to do Mike. As I guessed revenue fell away completely. There are swaths of reps with nothing to do,” he wrote. “So radical action is required, really radical. We can’t wait any more.” Of course, this kind of stress is not uncommon with software manufacturers; they rely on closing a small number of big deals at the end of each quarter to meet sales targets, and often clients hold out for good deals. For Autonomy, selling hardware at loss was the radical action taken to boost revenue.

According to documents obtained by the Financial Times, HP was made aware about that loss-making sales practice in the seven months between when the deal was closed and May 2012, when a whistleblower brought the tactic to light and to the attention of shareholders. In fact, emails made clear that Autonomy’s practice of selling hardware at a loss was disclosed in audit documents and a report provided to HP after the purchase was made. Audits show that Autonomy regularly reported large hardware sales; a document from December 2010 stated hardware generated 9 percent of sales in the previous six months, slightly below the 10 to 15 percent HP later cited as a sign of the size of Autonomy’s alleged misleading accounting.

But several emails obtained by the publication prove that HP executives — even on at least one occasion, Chief Executive Officer Meg Whitman — were involved in communications that detailed the hardware sales. One particular email from October 2011 explained the difficulties Autonomy was having in selling HP hardware. As the Financial Times wrote, this proved to Autonomy’s supporters “that HP condoned hardware sales as a normal part of Autonomy’s business, whatever it was later to say.”

Although it is true that the full scale and nature of the actual transactions were not revealed, the fact that Hewlett-Packard did know about the hardware sales before the acquisition was made could undermine the company’s claims that Autonomy concealed its business problems.

Deloitte — Autonomy’s auditor — has categorically denied to the Financial Times “any knowledge of any accounting improprieties or misrepresentations in Autonomy’s financial statements,” adding that the firm “conducted its audit work in full compliance with regulation and professional standards.” The audit documents were only made available to HP management after the acquisition was complete, as a person familiar with the company’s finances told the publication.

Lynch has repeatedly denied HP’s accusations. In response to the publication’s description of events, he issued a statement noting that the emails and documents obtained by the Financial Times showed Autonomy had been open with its auditors. “Meg Whitman accused Autonomy of ‘active concealment’ but these revelations prove we were open and transparent with our auditors who continue to stand by the accounts,” he said. “Meg Whitman must answer to her shareholders with what she knew, when she knew it, and how she and her senior colleagues made such factually incorrect and serious statements that were so easy to check from the audit packs.”

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