Red Hat Rebuffed on Restatement

No one is ever particularly happy when earnings need to be restated, especially in the litigious United States.

On Tuesday, Linux vendor Red Hat on the advice of its auditor restated three years worth of financial results, an act that caused its share price to decline and sparked at least seven different class action law suits.

The suits began rolling on Wednesday by Goodkind Labaton Rudoff & Sucharow LLP, Chitwood & Harley LLP. These were followed by additional suits filed on Thursday by Milberg Weiss Bershad & Schulman LLP, Berger & Montague, P.C, Lerach Coughlin Stoia & Robbins LLP. On Friday Schiffrin & Barroway, LLP and Scott + Scott, LLC joined the fray as well.

The suits vary a bit, though the gist essentially remains the same across the class action filings. Both CEO Matthew Szulik and former CFO Kevin B. Thompson are named as defendants in most cases with a few including Red Hat General Counsel Mark Webbink as well. The suits generally allege that Red Hat in some way mislead investors in the events leading up to its restatement of earnings earlier this week, an event that resulted in a price drop for Red Hat shares.

“The complaint alleges that Defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder. Specifically, the complaint alleges that Defendants disseminated materially false and misleading statements to the market and concealed material adverse facts concerning the Company’s financial performance,” stated Goodkind Labaton Rudoff & Sucharow LLP. “In particular, the Company’s Form 10-K filed with the Securities & Exchange Commission (“SEC”) for the fiscal years 2002, 2003, 2004 and the first quarter of fiscal 2005, and the press releases announcing the financial and business performance were materially false
and misleading by omitting to state that it had improperly recognized revenues in its subscription business.”

A spokesperson for the Raleigh, N.C.-based Linux vendor was not immediately available to comment on the class action suits.

Red Hat’s restatement of earnings on Tuesday changed the way it recognized revenues from its software subscription model. The company has now changed from a monthly basis to a daily basis. The difference in accounting practices does not affect the actual amount of revenue the company received though it has a significant impact on how it reports its subscription income. As the results of the change that is reflected in the restatement, subscription revenue is now booked when it is sold as opposed to having a pro-rated amount of an annual subscription reported as income on a monthly basis. In dollars and cents that means that in certain quarters where net income was reported, there was in fact a net loss. (ie. quarter ended Nov. 30 2002 before restatement net income of $214,000 after restatement a loss of $440,000).

A few of the lawsuits also mention the resignation of CFO Thompson a month ago,
which also caused Red Hat shares to fall.

Despite the restatements however, Red Hat still has shown positive growth over the last year by any measure and at least according to one survey has the company still dominating the Linux space.

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