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Stardate 20010816.1039 (On Screen): They're changing the accounting rules on how "Goodwill" will be accounted. This badly named line-item refers to the amount of excess money which was spent in an acquisition for something beyond its real worth. If you acquire another company whose assets are worth $20 million and you actually pay $50 million for it, then you have $30 million worth of Goodwill on your books. It's a real expense and traditionally it ws amortized over a long period of time, representing a quarterly deduction. In essence, you're paying for that excess over time.

Under the new rules, once a year the value of those assets will be calculated, and the company will write off the total loss in value immediately, with no amortization. If those assets appreciate, presumably that will show up as a net gain in "stockholder equity", so it's not lost.

This article discusses how the new rules will affect a number of companies, but doesn't mention two in particular: Redhat and VA Linux. Both companies are currently carrying huge backlogs of "Goodwill" on their books. As of the last SEC quarterly filing, Redhat had $25.6 million in gross revenues, a gross profit of $14.5 million, a $16.5 million amortization of goodwill, and after other expenses had a net loss of $27.6 million. As of its most recent filing, VA Linux had revenue of $20.3 million, a $24 million dollar amortization of goodwill, and a net loss of $109.7 million (much of which was due to one-time losses). From that it should be obvious that removing the goodwill amortization from the books will substantially change the resulting report.

But the only way to do that is to take a whopping one-time writeoff, which is what the new rules will demand. Redhat still carries goodwill of $130.9 million on its books, while VA Linux is worse at $296.6 million. That's $0.77 and $5.98 per share, respectively.

It's all funny money, actually. The real way to determine if a company is prospering or dying is to watch it's cash on hand. It's always possible to rig the books to show a profit, but if the bank account is dwindling, then you're going broke. So, the following chart:

The numbers are represented differently in the 10-K and I can't do a comparable calculations for those quarters. What you're seeing here is the "Total current assets" line item minus the "Total current liabilities" line item. What you're not seeing is it drift up. And you're not seeing a big war chest relative to losses. Discounting amortized goodwill and one-time expenses, and doing what is sort of known as "pro forma" calculations, VA Linux in its most recent quarter had a loss of about $43 million. At that rate it will run out of money in the first quarter of next year.

Which means that this accounting change will make Redhat and VA Linux announce one truly awful quarter, then a series of much better sounding ones -- but won't change the fundamental fact that neither company is actually making money.
(discussion in progress)