With Autonomy, H-P Bought An Old-Fashioned Accounting Scandal. Here's How It Worked.

HP Shares Plunge After A $8.8 Billion Writedown Of Accounting Problems At Autonomy- Abram Brown 11/20/2012

Whitman: $8.8 billion worth of vaporware:-

The story was first told to me late last year, and like a lot of stories of financial impropriety inside a huge company, it was almost impossible to nail down. Hewlett-Packard‘s Autonomy division, my source told me, was vaporware writ large: A $10 billion software company with an overhyped flagship product that was literally being given away because customers didn’t have a use for it.

Today, Meg Whitman admitted as much. H-P announced it was writing off 88% of the purchase price for Autonomy and accused “some former members of Autonomy’s management team” of using “accounting improprieties, misrepresentations and disclosure failures” to hide the software company’s true performance and value.

In the release, H-P identified one of the oldest accounting tricks in the book, a variation on the one “Chainsaw Al” Dunlap used to accelerate revenue at Sunbeam — by getting customers to “buy” products now, under terms that really just borrowed from the future.

I spoke to my source again this morning and he detailed what he saw at H-P, from his position deep within the 300,000-employee company.

“What I saw was exactly what Meg Whitman wrote in her internal memo to employees,” my source said. “There was really sketchy accounting going on.”

Autonomy was founded as Cambridge Neurodynamics in 1991 by Michael Lynch, a Cambridge-educated computer scientist, according to this flattering profile by the Guardian after he left H-P in May. The company was based on the then-hot concept of Bayesian search, named after 18th-century mathematician Thomas Bayes, and ultimately developed an all-encompassing software package it called IDOL — Intelligent Data Operating Layer.

H-P today said it stands behind IDOL and well it should. Otherwise it would have to write off the entire $10 billion it paid for Autonomy. But my source doesn’t think much of the product, which is supposed to find all of a company’s data, wherever it resides, and whether or not it can be identified by specific words. (Typical example: Finding documents that contain the phrase “flightless bird” when you’re looking for “penguin.”)

“It’s the primary smoke and mirrors that Autonomy has used to make people think they’ve got something very impressive,” he told me. “It’s a fancy search engine.”
I attempted to reach Lynch this morning, unsuccessfully. His spokeswoman told Reuters he is still  reviewing H-P’s allegations. H-P said it has referred the information it uncovered in a forensic accounting to fraud officials in the U.S. and the U.K.

Here’s what my source observed personally. Autonomy grew through acquisitions, buying everything from storage companies like Iron Mountain to enterprise software firms like Interwoven. They’d then go to customers and offer them a deal they couldn’t refuse. Say a customer had $5 million and four years left on a data-storage contract, or “disk,” in the trade. Autonomy would offer them, say, the same amount of storage for $4 million but structure it as a $3 million purchase of IDOL software, paid for up front, and $1 million worth of disk. The software sales dropped to the bottom line and burnished Autonomy’s reputation for being a fast-growing, cutting-edge software company a la Oracle, while the revenue actually came from the low-margin, commodity storage business.

“They would basically give them software for free but shift the costs around to make it look like they got $3 million in software sales,” said my source, who directly observed such deals.

Lynch’s management team also was practiced at the art of wringing attractive-looking growth out of a string of ho-hum acquisitions. The typical strategy was to bolt IDOL and other software onto a company’s existing products and try and convince customers to pay more for the “new” products. If that failed, they’d milk the existing customer base by halting development and outsourcing support, my source says, using the cash from the runoff business to fund more acquisitions.

“Mike Lynch was famous for saying Autonomy never put an end of life on any product,” said my source. “But the customers were screaming.”

Now, my source has never been a Mike Lynch fan. In sales meetings, he says, Lynch “loved to do vague and theoretical academic-type presentations to show what a visionary he was.”

And Autonomy may have some powerful features my source didn’t appreciate. The Defense Department reportedly is a customer. But from his perch within the company, it looked like a lot of vaporware wrapped up in fancy Cambridge talk and the kind of accounting tricks managers have engaged in since the dawn of publicly traded stock.

With its announcement today, H-P seems to agree. The company accused former managers of “a willful effort” “to inflate the underlying financial metrics of the company in order to mislead investors and potential buyers. These misrepresentations and lack of disclosure severely impacted HP management’s ability to fairly value Autonomy at the time of the deal.”

Calling customers wouldn’t necessarily have uncovered the problem, my source says.

“I think these companies are embarrassed to admit they spent $10 million on software that doesn’t actually work,” he said.

http://www.forbes.com/sites/danielfisher/2012/11/20/with-autonomy-h-p-bought-an-old-fashioned-accounting-scandal/