HP’s War of Words Escalates With Autonomy’s Founder

Former Autonomy CEO Lynch Rejects Hewlett-Packard Allegations
Mike Lynch, the former chief executive officer of Autonomy Corp., said he rejects “all allegations of impropriety” that were made against him last week by Hewlett-Packard Co. Photographer: Chris Ratcliffe/Bloomberg

Hewlett-Packard Co. and the founder of the software company it accused of accounting misstatements escalated a war of words over who is to blame for an $8.8 billion writedown.

Former Autonomy Corp. Chief Executive Officer Mike Lynch, in an open letter, challenged Hewlett-Packard’s board to explain allegations that former Autonomy managers misled investors and prospective acquirers with falsified statements. Hewlett-Packard, which bought Autonomy last year, rejected the request, saying it has uncovered extensive evidence of improper bookkeeping and that it’s leaving the matter with government officials.

The appeal to Hewlett-Packard’s board adds to pressure on CEO Meg Whitman to show how the alleged wrongdoing justified so big a writedown. Accountants have questioned whether Hewlett-Packard is using its claims deflect attention from a botched acquisition, and investors said the failure to detect chicanery earlier undermines confidence in the board and management. Regulators will need to determine whether Autonomy violated accounting standards to dress up results.

“It happens a lot in software because it’s hard to count what the software is,” said Michael Cusumano, a professor at Massachusetts Institute of Technology’s Sloan School of Management. “It’s not like you’re shipping automobiles out the door and you can count them.”

Hewlett-Packard said on Nov. 20 that Autonomy managers misreported finances to make the company appear more successful than it was.

Allegations Rejected

“Autonomy’s finances, during its years as a public company and including the time period in question, were handled in accordance with applicable regulations and accounting practices,” Lynch wrote. “I utterly reject all allegations of impropriety.”

The Federal Bureau of Investigation, responding to an inquiry by the U.S. Securities and Exchange Commission, is looking into Hewlett-Packard’s allegations, a person familiar with the matter said last week. Hewlett-Packard said yesterday that the matter is also in the hands of authorities, including the U.K. Serious Fraud Office and the SEC’s Enforcement Division.

Whatever the outcome of these inquiries, even some managers within Autonomy had misgivings about the company’s accounting before its sale to Hewlett-Packard, according to a former employee. Advisers on the acquisition considered some of Autonomy’s methods aggressive, according to another person who has knowledge of the transaction.

Arcpliance Accounting

In one example of methods that raised concerns, Autonomy booked sales of a hardware device called Arcpliance as software, according to the person with knowledge of the matter, who asked not to be identified because the deals aren’t public.

Autonomy introduced Arcpliance in 2009, billing it as a machine that encompassed both hardware and software to archive e-mail, audio files and Microsoft Corp. SharePoint documents.

In its sales of the device, Autonomy purchased low-margin hardware from Dell Inc. and EMC Corp., then booked the resulting sale as more profitable software revenue, according to the former Autonomy executive. Customers often used the servers and storage devices for other purposes, and Arcpliance wasn’t widely deployed, this person said.

Lynch, in an interview, denied that the practices had the effect of inflating margins.

‘Accounting Improprieties’

Hewlett-Packard said last week that $5 billion of the writedown was related to “accounting improprieties,” including booking hardware revenue to appear as more profitable software. The company said it found $200 million in wrongly categorized or falsified sales.

Lynch, in a letter sent yesterday to news organizations, asked Hewlett-Packard’s board for “immediate and specific explanations” of its claims, along with supporting documents.

Hewlett-Packard announced Lynch’s departure in May, citing a “significant decline in license revenue” at Autonomy.

Michael Thacker, a spokesman for Palo Alto, California-based Hewlett-Packard, declined to comment. David Frink, a spokesman for Round Rock, Texas-based Dell, and Dave Farmer, a spokesman for Hopkinton, Massachusetts-based EMC, didn’t respond to requests for comment.

Lynch also encouraged clients to buy Dell computers through Autonomy at a discount, rather than from Dell itself, according to another person with knowledge of sales practices at Autonomy, who asked not be identified because the details haven’t been made public. Lynch said such practices were legal and properly accounted for in Autonomy’s financial statements.

Bang, Buck

“Essentially we would offer a discount on hardware, especially if people were buying software or a big long-term partner,” Lynch said of the Dell sales.

Software companies have often used timing of revenue recognition to make their results look better, according to Dana Basney, director of due diligence and forensic accounting services at CBIZ MHM LLC in San Diego.

“You get more bang for the buck” by moving up recognition of revenue, Basney said.

Autonomy stepped up timing of revenue recognition with software obtained through the $375 million acquisition of Zantaz in 2007, the former executive said. The program, which customers could rent over the Web, is used by banks and law firms to archive computer files for compliance purposes.

In deals with banks including Morgan Stanley, Deutsche Bank AG and JPMorgan Chase & Co., Autonomy offered big discounts on the software -- which customers ordinarily would rent for periodic payments -- in exchange for upfront payments that customers could then amortize as a capital expense, this person said.

Pressuring Advisers

The practices had the effect of sacrificing long-term revenue, the person said. Lynch said this didn’t happen, and that it wasn’t possible under accounting rules.

Lynch personally pressed investment-banking advisers to buy more software, according to another person with knowledge of those relationships. Asked about pressuring investment banks to buy software, Lynch said he would “encourage anyone we met to buy our software.”

“We’d certainly put pressure on anyone to buy more” though it wouldn’t be a condition of employment, he said.

A representative from JPMorgan Chase didn’t respond to requests for comment. Sandra Noonan, a spokeswoman at Morgan Stanley, and Ari Cohen, a spokesman at Deutsche Bank, declined to comment.

Credibility Questioned

Marc Geall, another former Autonomy executive who had become an analyst at Deutsche Bank, also raised questions about Autonomy’s growth prospects and the difficulty in assessing its revenue sources as early as 2010. He published a research report in October of that year saying the company had prioritized profit margins over sales growth, raising “concerns about management credibility.”

“The management structure, control, and systems at Autonomy are more representative of a startup than a major global player,” Geall wrote.

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