HP Terse Response To Mike Lynch Open Letter

Hewlett-Packard has issued its response to the 27 November open letter to its board of directors, from former Autonomy CEO Mike Lynch.

In his letter, Lynch asked the board to show evidence of any fraudulent activity that occurred at the company he founded and ran for 17 years.

HP’s rapid response, boiled down a bit: We’ll see you in court, Doc.

Bitter Acquisition

This conflict has been brewing ever since HP acquired UK-based Autonomy for $11.1 billion (£6.9bn) in August 2011, during the brief CEO reign of Dr. Leo Apotheker, who turned out not to be the long-term leader the iconic IT giant needed.

HP revealed in its 20 November earnings report to the Securities and Exchange Commission that it was forced to take a whopping $8.8 billion (£5bn) “intangible asset impairment” charge for the huge acquisition in 2011 that another former HP CEO, Mark Hurd, and Apotheker had advocated. HP cited some serious accounting and credibility problems. Investors and analysts alike were not pleased.

The company said in its quarterly report that the accounting issues took place just before the acquisition and thus accounted for the majority of the charges in the quarter, which totalled more than $5 billion.

Autonomy’s software handles control of unstructured data for enterprises. It makes search engines that help companies find vital information stored across computer networks. Acquiring the company was part of an attempt by HP to strengthen its portfolio of high-value products and services for corporations and government agencies.

HP Allegations

HP’s explanation to the Securities and Exchange Commission of the huge charge-off included allegations of “serious accounting improprieties, disclosure failures and outright misrepresentations at Autonomy that occurred prior to HP’s acquisition of Autonomy and the associated impact of those improprieties, failures and misrepresentations on the expected future financial performance of the Autonomy business over the long term.”

Among the tricks used at Autonomy, CEO Meg Whitman said on the 20 November conference call to analysts and reporters, was that it had been booking the sale of servers as software revenue and claiming the cost of making the machines as a marketing expense. Revenue from long-term contracts also was booked up-front, instead of over time, Whitman said.

Upon hearing of the write-off and that he was basically being scapegoated by HP for all the financial problems because he held tight control of all Autonomy administration, Lynch was reportedly incensed and immediately denied any impropriety.

Open Letter

So Lynch wrote an open letter to the HP board 27 November. Here is the complete text:

To: The Board of Directors of Hewlett-Packard Company

On 20 November Hewlett-Packard (HP) issued a statement accusing unspecified members of Autonomy’s former management team of serious financial impropriety. It was shocking that HP put non-specific but highly damaging allegations into the public domain without prior notification or contact with me, as former CEO of Autonomy.

I utterly reject all allegations of impropriety.

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. Autonomy’s accounts were overseen by independent auditors Deloitte LLC, who have confirmed the application of all appropriate procedures including those dictated by the International Financial Reporting Standards used in the UK.

Having no details beyond the limited public information provided last week, and still with no further contact from you, I am writing today to ask you, the board of HP, for immediate and specific explanations for the allegations HP is making. HP should provide me with the interim report and any other documents which you say you have provided to the SEC and the SFO so that I can answer whatever is alleged, instead of the selective disclosure of non-material information via background discussions with the media.

I believe it is in the interest of all stakeholders, and the public record, for HP to respond to a number of questions:

Many observers are stunned by HP’s claim that these allegations account for a $5 billion write-down and fail to understand how HP reaches that number. Please publish the calculations used to determine the $5 billion impairment charge. Please provide a breakdown of the relative contribution for revenue, cash flow, profit and write-down in relation to:

The alleged “mischaracterization” of hardware that HP did not realize Autonomy sold, as I understand this would have no effect on annual top or bottom lines and a minor effect on gross margin within normal fluctuations and no impact on growth, assuming a steady state over the period;

The alleged “inappropriate acceleration of revenue recognition with value-added resellers” and the “[creation of] revenue where no end-user customer existed at the time of sale”, given their normal treatment under IFRS [International Financial Reporting Standards]; and the allegations of incorrect revenue recognition of long-term arrangements of hosted deals, again given the normal treatment under IFRS.

In order to justify a $5 billion accounting write-down, a significant amount of revenue must be involved. Please explain how such issues could possibly have gone undetected during the extensive acquisition due diligence process and HP’s financial oversight of Autonomy for a year from acquisition until October 2012 (a period during which all of the Autonomy finance reported to HP’s CFO Cathie Lesjak).

Can HP really state that no part of the $5 billion write-down was, or should be, attributed to HP’s operational and financial mismanagement of Autonomy since the acquisition?

How many people employed by Autonomy in September 2011 have left or resigned under the management of HP?

HP raised issues about the inclusion of hardware in Autonomy’s IDOL Product revenue, notwithstanding this being in accordance with proper IFRS accounting practice. Please confirm that Ms. Whitman and other HP senior management were aware of Autonomy’s hardware sales before 2012. Did Autonomy, as part of HP, continue to sell third-party hardware of materially similar value after acquisition? Was this accounted for by HP and was this reported in the Autonomy segment of their accounts?

Were Ms. Whitman and Ms. Lesjak aware that Paul Curtis (HP’s Worldwide Director of Software Revenue Recognition), KPMG and Ernst & Young undertook in December 2011 detailed studies of Autonomy’s software revenue recognition with a view to optimising for US GAAP [generally accepted accounting principles]?

Why did HP senior management apparently wait six months to inform its shareholders of the possibility of a material event related to Autonomy?

Hewlett-Packard is an iconic technology company, which was historically admired and respected all over the world. Autonomy joined forces with HP with real hopes for the future and in the belief that together there was an opportunity to make HP great again. I have been truly saddened by the events of the past months, and am shocked and appalled by the events of the past week.

I believe it is in the best interests of all parties for this situation to be resolved as quickly as possible.

I am placing this letter in the public domain in the interests of complete transparency.

Yours faithfully,

Dr. Mike Lynch

HP Statement

HP responded with this tersely worded statement 27 November:

“HP has initiated an intense internal investigation into a series of accounting improprieties, disclosure failures and outright misrepresentations that occurred prior to HP’s acquisition of Autonomy. We believe we have uncovered extensive evidence of a willful effort on behalf of certain former Autonomy employees to inflate the underlying financial metrics of the company in order to mislead investors and potential buyers.

“The matter is in the hands of the authorities, including the UK Serious Fraud Office, the US Securities and Exchange Commission’s Enforcement Division and the US Department of Justice, and we will defer to them as to how they wish to engage with Dr. Lynch. In addition, HP will take legal action against the parties involved at the appropriate time.

“While Dr. Lynch is eager for a debate, we believe the legal process is the correct method in which to bring out the facts and take action on behalf of our shareholders. In that setting, we look forward to hearing Dr. Lynch and other former Autonomy employees answer questions under penalty of perjury.”

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Originally published on eWeek.