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HP, Autonomy investigation: Tangled web of hardware and resellers

Daniel Thomas, Richard Waters
Tuesday, 18 Feb 2014 | 8:14 AM ET

Three weeks before Autonomy was due to close its books at the end of 2010, Sushovan Hussain, the company's chief financial officer, was feeling the pressure.

In an email to Mike Lynch, the UK software company's chief executive, and seen by the FT, he wrote: "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 ended with a plea: "So radical action is required, really radical. We can't wait any more."

(Read more: HP details Autonomy allegations)

David Paul Morris | Bloomberg | Getty Images

In software companies that rely on closing a small number of big deals at the end of each quarter, this kind of extreme stress is nothing new. Knowing the pressure companies are under to hit their sales targets, customers often hold off placing an order until the last minute to force the biggest possible discount.

But since the dust settled on Autonomy's books, some of the 11th-hour transactions that helped it make its numbers at the end of various quarters have become the focus of alleged fraud. In 2012, barely a year after paying $11.1bn for the British company, Hewlett-Packard claimed to have been misled about the true state of Autonomy's business and took a $5bn write down.

(Read more: Autonomy's Lynch hits back at US Air Force's allegations)

A trail of audit papers, accounting documents and internal emails seen by the FT, along with interviews with people familiar with the deals made by Autonomy, sheds light for the first time on the tangle of claims and counter-claims at the heart of the dispute.

Among the findings: Some of the deals at the centre of the allegations were signed off by Autonomy's auditors in documents seen by the FT, with other parts of the audit packs acknowledging the extensive sale of hardware by the British software company. HP has said that it was not aware of the alleged accounting misrepresentations until a whistle blower came forward in May 2012.

Will HP Sell Autonomy, EDS?
Hewlett-Packard is reportedly getting offers for its Autonomy and EDS units. Crawford Del Prete, chief research officer, senior vice president at IDC, weighs in.

Deloitte, Autonomy's auditor, says it "categorically denies any knowledge of any accounting improprieties or misrepresentations in Autonomy's financial statements. Deloitte conducted its audit work in full compliance with regulation and professional standards".

The investigation also revealed fresh details about transactions which HP has said were not commercially valid and which are likely to feature prominently in probes under way at the US Department of Justice and UK Serious Fraud Office.

Mr Lynch claimed the revelations showed HP's chief executive had over-reached with allegations against Autonomy. "Meg Whitman accused us of 'active concealment' but we always knew we were open and transparent with our auditors," he said.

(Read more: Another Investigation Into HP's Autonomy Allegations)

Several new deals have come to light, including transactions with the Vatican, Morgan Stanley and Veterans Administration, which reveal a complex web of transactions that are likely to be seized on by both sides to support their claims.

Mr Lynch and his former colleagues have said that all these transactions were valid deals.They claim that it was only after HP later ran into business problems – caused partly by its "mismanagement" of Autonomy – that it decided to turn on former management.

Loss making hardware sales


Part of the dispute has centred on loss making hardware sales by Autonomy, which HP has claimed were used to make up shortfalls in the software company's revenues. According to documents seen by the FT, HP was put on notice about the existence of hardware sales at Autonomy in the seven months between when it closed the deal and May 2012, when it says its attention was first drawn to the transactions by a whistle blower. It was not until November of that year that the US company went public with its allegations.

Large sales of hardware were routinely acknowledged in Autonomy audit reports seen by the FT. These were received by the audit committee, chaired by former Prudential boss Jonathan Bloomer, and signed off by auditors Deloitte. The audit reports were available to HP management after the acquisition, according to one person familiar with the company's finances.

(Read more: Autonomy's Lynch slams HP concerns, launches fund)

The pack of papers accompanying the audit of the December 2010 accounts, for instance, spells out that hardware accounted for 9 per cent of Autonomy's sales in the previous six months – only slightly less than the 10-15 per cent HP later claimed was an indication of the scale of the alleged misrepresentation.

Several emails seen by the FT also show that HP executives, in one instance up to the level of chief executive Meg Whitman, were included in communications that referred to hardware sales by the UK company – if not the full scale or nature of the actual transactions.

In January 2012, for instance, in response to an email from Meeta Sunderwala, an accountancy manager at HP, about a "Dell payable", a senior Autonomy manager responded that "for certain strategic accounts we also procure hardware as well as software".

Blame Game: HP vs. Autonomy
Hewlett-Packard has responded to Autonomy founder Mike Lynch, saying there was a "willful effort" to mislead investors and potential acquirers of Autonomy in the company's accounting, reports CNBC's Jon Fortt.

Another email in March 2012 seen by the FT from an Autonomy accountant to Chris Yelland, a senior HP executive, asks for approval to pay Dell for hardware. Mr Yelland also received an email in May from another Autonomy manager referencing hardware shipments to UBS.

The FT has also seen an email to Ms Whitman on October 26 2011 which cited difficulties Autonomy was having in selling HP hardware, and which referred to its practice in the past of selling Dell equipment. Autonomy's supporters would argue that such communications lend weight to claims that HP condoned hardware sales as a normal part of Autonomy's business, whatever it was later to say.

While HP refuses to comment directly on the timing, it does not deny that it knew about at least some of the hardware transactions at an earlier stage than it has discussed publicly before.

(Read more: After investigation, air force slams autonomy's bookkeeping)

But it argues that this is beside the point, and that it was the purpose of the sales that had been hidden: "While HP eventually learned that a portion of Autonomy's revenues were related to hardware sales, we knew nothing of the accounting improprieties, misrepresentations and disclosure failures related to such sales until after a senior Autonomy executive came forward and HP conducted an extensive investigation."

Yet the UK company's auditor, Deloitte, was at least aware of some of the hardware sales and accepted representations from Mr Lynch and his team that they had a valid commercial purpose, according to papers seen by the FT.

It was only after HP later ran into business problems – caused partly by its "mismanagement" of Autonomy – that it decided to turn on former management.

(Read more: The silicon valley legend behind HP/Autonomy deal)

Deloitte wrote in an audit report that it "accepted decision of management to allocate [hardware costs] to sales and marketing" – a method that HP later complained was a deliberate attempt to bury costs.

The audit firm also flagged Autonomy's practice of selling hardware at a loss to support its sales and marketing efforts as one of the "key risks" in its report.

This position –that Autonomy's extensive hardware sales were akin to loss-leaders designed to keep customers sweet – was not the one stressed by Mr Lynch when discussing the sales publicly. When analysts repeatedly questioned him about why Autonomy's hardware sales were so high on an earnings call in April 2010, for instance, he talked about how the company sold all-in-one "appliances", or machines that were pre loaded with its software. Deloitte was prepared to accept the alternative explanation.

Use of value-added resellers

Hewlett-Packard CEO So Far Not Ready to Sell Autonomy & EDS: DJ
According to Dow Jones, Hewlett-Packard has received expressions of interest for Autonomy and its EDS businesses, reports CNBC's Jon Fortt.

Papers and communications seen by the FT reveal further detail on a second type of disputed transaction.

These involved sales of software Autonomy had made to resellers, intermediaries who hope to sell it on to end customers. The international accounting rules that governed its books allowed it to count sales to resellers even when no end customer was in sight – but only if the sale was final and there was no comeback if the reseller itself was left holding the bag.

According to papers seen by the FT, the way Autonomy should account for deals like these were discussed in emails involving HP executives after the acquisition, and before the whistle blower is said to have come forward.

In February 2012, for instance, an exchange of emails that included an HP executive concluded that one such deal, for $10.2m, should be shown as "deferred sale". One person familiar with the situation said that exchanges like this only showed that HP was making adjustments to Autonomy's approach to reflect US accounting rules.

Two large deals, extensive details of which have been reviewed by the FT, get to the heart of the dispute, and show how difficult it will be for investigators looking into the allegations to untangle the complex webs of transactions to determine their ultimate purpose.

(Read more: Autonomy made 'willful effort to mislead' HP: CEO Whitman)

One, booked in September 2010, involved the US Veterans Administration. Just a month before, on August 25, Peter Menell, an Autonomy employee, had reacted with surprise at the suggestion that the company might be close to recording a sale to the VA. "Am I missing something on VA?" he wrote to Mr Hussain, Autonomy's chief financial officer, in an email seen by the FT. "Why is it even being considered for Q3?"

The agency had not even issued an RFP – or request for proposal, the starting point in a bidding process – and six consortiums of tech companies were likely to compete for the work, Mr Menell wrote. On the last day of its September quarter, Autonomy booked a $7m sale to a reseller named Filetek for the VA project.

One person familiar with the sale said it was unrelated to the deal that Mr Menell had written about a few weeks before, and was tied instead to a separate purchase by the VA of email software.

The manner in which Autonomy was paid by Filetek is also an area of contention. On 30 June the following year, Autonomy made a payment of about $1.6m to Filetek and received back a slightly smaller sum the same day. A two-way transaction also took place on 2 August, with Autonomy paying $7.5m to Filetek and receiving $6m.

Deals where software companies buy from each other are common, and Autonomy's auditors signed off on these as being arm's length transactions. A purchase order seen by the FT, and contained in Deloitte's audit of the June 2010 figures, records an $11.5m purchase by Autonomy of Filetek software for its own data centres.

(Read more: HP showed 'willful blindness' on autonomy: Chanos)

A second deal,involving a proposal by the Vatican to digitise its library, followed a similar pattern – prompting similar claims and counter-claims. On the last day of the quarter in March, 2010, Autonomy booked a sale of $11m to a reseller, Microtech, to cover software involved in the potential deal. The Vatican was eventually to pick a different software supplier.

Months later, in early 2011, Autonomy paid $9.6m to Microtech and received an identical payment back from the company, according to one person familiar with the investigation.

One person familiar with Autonomy's position said, however, that Microtech made two payments totalling $8.7m, separated by six months.

Autonomy maintained that its purchase from Microtech was entirely unrelated to the Vatican deal, according to papers seen by the FT, with Autonomy recording the money sent to Microtech as payment for a "technology innovation centre" which was used partly to sell Autonomy products.

Whether the UK company got value for money – or whether this was a scheme used to fund payments made back to Autonomy – is typical of the many convoluted questions investigators may now be untangling.

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