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Investors Sue Red Hat

Investors slapped the Linux supplier with six class-action suits after it said it would restate earnings and change accounting methods.
Investor anger surfaced last week after Red Hat Inc. changed how it books software subscription revenue, setting the stage for courtroom battles on whether company officials profited from the switch in accounting methods.

Investors filed six class-action lawsuits against the Linux supplier two days after it said it would restate earnings and move to a daily, instead of monthly, method of accounting for its software subscription revenue.

The suits charge company executives with violating various infractions of securities laws and misleading of investors. One suit charged that company officials profited from the sale of stock between March 19, 2002, and last Monday, when the monthly accounting method was in force. Red Hat didn't respond to a request for a comment.

Red Hat shares, which hit a four-year high of $29.06 in June, closed at $15.15 on Friday, down $5.34 for the week, or 26%. Until Thursday, when shares rose slightly, the stock had been on a slide since the unexpected resignation of CFO Kenneth Thompson on June 14, followed by lower-than-expected earnings projections June 17.

Officials named in the suits include Thompson and chairman and CEO Matthew Szulik.

Monthly accounting of subscription revenue is more common among software companies than daily accounting. Daily-based accounting is a "more-conservative method," says Dion Cornett, managing director at the equity-research firm Decatur Jones Equity Partners LLC.

The shift to daily from monthly revenue accounting for subscriptions has the effect of moving revenue that was previously recognized in the first quarter of a subscription into the final quarter of the agreement, Red Hat officials said. The firm's auditors, PricewaterhouseCoopers, recommended the change in June.

"Investors have beaten up the stock. It's been hammered," says Cornett, who considers it a good value for long-term investors.

As a result of the accounting change, Red Hat will restate earnings for its 2002, 2003, and 2004 fiscal years, which ended the last day of February.

The restatement "isn't expected to reflect any material difference in the meaningful, historical trends of our business," Szulik said in a statement. He added that it will result in "significant percentage differences" in quarterly operating profit and net income across quarters within a given year.

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