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Red Hat Changes Revenue Recognition, Restates Earnings

It's changing the basis by which it recognizes software subscription revenue from a monthly to a daily accounting method.
After a month of turmoil affecting its stock, Red Hat Inc. is changing the basis by which it recognizes software subscription revenue from a monthly to a daily accounting method. As a result of the accounting change, Red Hat will restate earnings for the fiscal years ended Feb. 29, 2004, Feb. 28, 2003, and Feb. 28, 2002.

The Linux vendor's shift is to a "more conservative accounting method. We know of only one other company in the industry that's doing this," said Dion Cornett, managing director of Decatur Jones Equity Partners LLC.

The shift from monthly to daily 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 Tuesday.

Red Hat's stock has been roiled by the resignation of its CFO on June 14, followed by a projection of revenue June 17 for upcoming quarters that disappointed investors. At the same time as its quarterly earnings were announced, Red Hat disclosed that it was answering a Securities and Exchange Commission inquiry concerning its revenue. "Investors have beaten up the stock. It's been hammered," says Cornett, who now considers Red Hat a good value for long-term investors. The stock's price has fallen from more than $28 per share to about $16.

There's no scandal behind either the CFO's resignation or the SEC inquiry, Cornett says. Red Hat's own auditors, PricewaterhouseCoopers, suggested the accounting change and the company announced that it would adopt it in the June 17 quarterly earnings briefing, Cornett says, adding that "it was an unfortunate confluence of events."

The restatement "isn't expected to reflect any material difference in the meaningful, historical trends of our business," Matthew Szulik, Red Hat's chairman and CEO, said in a statement. It will "also assure that future comparisons to past periods are made on a consistent basis."

The effect of using the new method is "to defer a portion of the revenue that had been previously recognized in the month of commencement of a subscription to the month in which the subscription ends," the company said in its statement.

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