Updated from 3:43 p.m. EST

Already under fire for changing its accounting practices last month,


(HPQ) - Get Report

came under renewed criticism Thursday for overstating its cash flow from operations by $144 million in its fiscal first quarter.

The problem first surfaced in a research note from Merrill Lynch analyst Steven Milunovich, who said Hewlett-Packard should have posted operating cash flow of $647 million, not $791 million as was originally reported.

Hewlett CFO Bob Wayman said the accounting error was uncovered as part of its normal controls process in preparation for the official 10-Q filing. "We obviously regret this error and the confusion caused," he said. "We are reviewing our procedures for preparing preliminary statements."

The important takeaway for investors, Wayman said, is that the firm's gross cash position of $13.2 billion "is strong and unchanged." He added that revenue is up 3% year over year so far, with two months still left to go in the fiscal second quarter. Investors were surprised that H-P missed sales estimates in the fiscal first quarter, but Wayman said that for the fourth calendar quarter, the firm's revenues were up 9% sequentially, which is in line with its peers.

Milunovich said the error was most likely "an honest mistake" caused by "a misallocation of proceeds from an investment disposition into the operating section instead of the investing section." But he also noted that the timing of the mistake is poor, given "investor jitters over segment accounting changes disclosed in the previous release."

New Standards

Late last month, Hewlett-Packard said it had changed its accounting practices, which essentially made some of its units look more profitable than they really were in the first quarter. In calculating its earnings for various segments, H-P excluded certain expenses, such as research and development and corporate governance costs, which had been included in results for prior quarters. These expenses are now listed in a separate category.

Although the changes don't affect the bottom line, some analysts were disappointed that the firm had adopted Compaq's seemingly less transparent policies. Indeed, Goldman Sachs analyst Laura Conigliaro recently downgraded the stock to in-line from outperform.

H-P defended the changes, saying that the newly excluded charges are not ones that segment managers can control and because the firm provides incentives based on controllable performance, exclusion of noncore items makes sense. But some analysts still aren't convinced.

"I think it would be better for investors if the company would just break out the operating expenses per segment" as they were before, said Eric Ross, an analyst at Investec. He has a hold rating on H-P.

Ross said he was surprised in January that the firm's PC business had improved so much because he knew the company had been aggressively pricing PCs in an attempt to recapture market share. "My feeling was we'd see break-even at best. Now it turns out I was closer to being right than I'd thought."

Despite his concerns about the reclassification of expenses, Ross said he believes the accounting error announced Thursday was a genuine mistake and not an attempt to mislead investors. "I don't think it's as sinister as it sounds," he said. "I don't think it's meaningless, though, because a lot of investors look at cash flow and cash has been king."


Marty Shagrin, an analyst at Victory Capital Management, which owned 8.6 million H-P shares as of Dec. 31, agrees that the firm was probably not trying to mislead investors when it originally reported operating cash flow results.

"I don't view this as a sign that they were trying to be disingenuous," he said. "This is an environment where everyone is looking for dishonest accounting."

Shagrin said if the firm really were trying to deceive investors, it would have put out a better number than $790 million originally, which he said was a disappointment to most analysts anyway.

He also believes that the firm's explanation for the reclassifications of its expenses last month were fine, but to avoid any suspicion, he believes the company should have reported first-quarter results in the same way it had before and then simply announced it would change accounting practices going forward.

"I think the point the company should have been making is that they continue to make progress in their PC business but they allowed that point to get lost," he said.

Still, Richard Chu, an analyst at SG Cowen, is more bullish on H-P. He said he was glad to see the firm reclassify expenses, which he said have distorted segment performance in the past. He also noted that Thursday's revision to operating cash flow doesn't change H-P's overall cash position. Furthermore, he said, many analysts don't measure H-P on its operating cash flow performance.

"I don't think they should be penalized for a metric that they're not measured on," he said.

Shares of H-P fell 3.7%, or 59 cents, to $14.99 in afternoon trading.