S-1 1 a05-13532_1s1.htm S-1

As filed with the Securities Exchange Commission on July 28, 2005
Registration No. 333-

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM S-1

REGISTRATION STATEMENT

UNDER THE SECURITIES ACT OF 1933

 

THE SCO GROUP, INC.

(Exact Name of Registrant as Specified in its Charter)

 

Delaware
(State or other jurisdiction of
incorporation or organization)

 

7372
(Primary Standard Industrial
Classification Code Number)

 

87-0662823
(I.R.S. Employer
Identification No.)

 

355 South 520 West, Suite 100
Lindon, Utah 84042
(801) 765-4999
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

Darl C. McBride
President and Chief Executive Officer
355 South 520 West, Suite 100
Lindon, Utah 84042
(801) 765-4999
(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

Copy to:
Nolan S. Taylor, Esq.
DORSEY & WHITNEY LLP
170 South Main Street, Suite 900
Salt Lake City, Utah 84101-1655
Telephone: (801) 933-7360
Facsimile: (801) 933-7373

 

Approximate date of commencement of proposed sale to the public:

As soon as possible after the effective date of this registration statement.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ý

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

 

If delivery of the offering circular  is expected to be made pursuant to Rule 434, check the following box.  ¨

 

 



 

CALCULATION OF REGISTRATION FEE

 

Title of Shares
to be Registered

 

Amount
to be
Registered(1)

 

Proposed Maximum
Offering Price
per Share(2)

 

Proposed Maximum
Aggregate
Offering Price(3)

 

Amount of
Registration
Fee(4)

 

Common Stock, $0.001 par value per share(5)

 

312,806

 

$

5.21

 

$

672,928

 

$

79.20

 

 


(1)           Consists of shares of common stock issued pursuant to the Registrant’s 2000 Employee Stock Purchase Plan.  Pursuant to Rule 416 under the Securities Act of 1933, as amended, this registration statement also covers such additional number of shares of common stock as may become issuable under any stock split, stock dividend or similar transactions.

 

(2)           Highest price, excluding interest, to be payable per share in connection with the rescission offer covered by this registration statement. The price per share will range from $0.65 to $5.21, depending on the price originally paid by the offeree and excluding interest.

 

(3)           Aggregate purchase price, excluding interest, estimated to be payable if the rescission offer covered by this registration statement is accepted in full with respect to the shares of common stock.  Pursuant to Rule 457(j), this is the aggregate purchase price paid for all shares covered by this rescission offer.

 

(4)           Calculated pursuant to Rule 457(j).

 

(5)           This Registration Statement also relates to rights to purchase shares of Series A Junior Participating Preferred Stock purchase rights of the Registrant which are attached to all shares of common stock issued pursuant to the terms of the Registrant’s Shareholder Rights Agreement dated as of August 10, 2004. Until the occurrence of certain prescribed events, the rights are not exercisable, are evidenced by the certificate for the common stock and will be transferred with and only with such common stock. Because no separate consideration is paid for the rights, the registration fee therefore is included in the fee for common stock.

 

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 



 

The information in this offering circular is not complete and may be changed.  These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective.  This offering circular is not an offer to sell these securities, and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to completion:  Dated July 28, 2005

 

THE SCO GROUP, INC.

 

312,806 SHARES OF COMMON STOCK

 

RESCISSION OFFER

 

      We are offering to repurchase 137,219 shares of common stock purchased pursuant to our 2000 Employee Stock Purchase Plan, or ESPP, during the six-month periods ended November 30, 2004 and May 31, 2005 from our current and former employees who are residents of California, Connecticut, Illinois, New Jersey, Texas, Utah or Washington.

 

      We are also offering to repurchase 175,587 shares of common stock purchased pursuant to the ESPP during the six-month periods ended May 31, 2003, November 30, 2003 and May 31, 2004 from our current and certain former employees who were, at the time of issuance, residents of California and Utah and are now residents of Arizona, California or Utah.

 

      In addition, we are offering to rescind the offer of securities to employees residing in California who enrolled in the ESPP for the offering period that began June 1, 2005 because we have not completed the qualification of the offer and sale of such shares with the Securities Regulation Division of the California Department of Corporations.

 

      The repurchase price for the shares of our common stock subject to the rescission offer ranges from $0.65 to $5.21 per share and is equal to the price paid by those persons who purchased these shares, excluding interest.

 

      If you accept our rescission offer, you will receive simple interest at an annual rate according to your state of residence at the time of purchase, based on the repurchase price described above and calculated from the date you purchased the shares through the date that the rescission offer expires.  We intend to use the legal rates of interest for the repurchase of shares based on your state of residence when you purchased your shares.  These interest rates are as follows:

 

State

 

Interest Rate

 

California

 

7%

 

Connecticut

 

6%

 

Illinois

 

10%

 

New Jersey

 

4%

 

Texas

 

6%

 

Utah

 

12%

 

Washington

 

8%

 

 

      We are making this offer on the terms and conditions set forth in this offering circular.  Our rescission offer will remain open until 5:00 p.m. Utah time on [                     ], 2005.

 

 

Our common stock is quoted on The Nasdaq SmallCap Market under the trading symbol “SCOX.” On July 20, 2005, the last price for our common stock, as reported by The Nasdaq SmallCap Market, was $3.88.

 

You should carefully consider the risk factors beginning on page 8 of this offering circular before accepting or rejecting this rescission offer.

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the adequacy or accuracy of this offering circular.  Any representation to the contrary is a criminal offense.

 

The date of this offering circular is                , 2005

 



 

TABLE OF CONTENTS

 

QUESTIONS AND ANSWERS ABOUT THE RESCISSION OFFER

 

OFFERING CIRCULAR SUMMARY

 

RISK FACTORS

 

RESCISSION OFFER

 

U.S. FEDERAL INCOME TAX CONSEQUENCES

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

MARKET FOR THE REGISTRANT’S COMMON EQUITY

 

DIVIDEND POLICY

 

SELECTED FINANCIAL DATA

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

BUSINESS

 

MANAGEMENT

 

EXECUTIVE COMPENSATION

 

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 

DESCRIPTION OF CAPITAL STOCK

 

LEGAL MATTERS

 

EXPERTS

 

WHERE YOU CAN FIND MORE INFORMATION

 

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

 

You should rely only on the information contained in this offering circular.  We have not authorized any other person to provide you with different information.  If anyone provides you with different or inconsistent information, you should not rely on it.  We are not making an offer to repurchase securities in any jurisdiction where the offer or sale is not permitted.  You should assume that the information appearing in this offering circular is accurate only as of the date on the front cover of this offering circular.  Our business, financial condition, results of operations and prospects may have changed since that date.

 

As used in this offering circular, “SCO” and “OpenServer” are trademarks or registered trademarks of our Company in the United States and other countries. “UNIX” and “UnixWare” are registered trademarks of The Open Group in the United States and other countries. All other brand or product names are or may be trademarks of, and are used to identify the products and services of, their respective owners. Unless the context otherwise requires, when used herein, the “Company,” “SCO,” “us,” “we,” “ours,” and similar terms refer to The SCO Group, Inc. and our operating subsidiaries.

 



 

QUESTIONS AND ANSWERS ABOUT THE RESCISSION OFFER

 

You should read the following questions and answers, together with the more detailed information regarding the rescission offer and the risk factors set forth elsewhere in this offering circular, before deciding whether to accept or reject the rescission offer.

 

General

 

Q:           Why are we making the rescission offer?

 

A:            We have offered and sold shares of our common stock under our 2000 Employee Stock Purchase Plan, or ESPP, without complying with registration or qualification requirements under federal securities laws and the securities laws of California, Utah and possibly other states.  As a result, those current and former employees have a right to rescind their purchases of shares under the ESPP or recover damages if they no longer own the shares, subject to applicable statutes of limitations.  The rescission offer is intended to address these federal and state securities laws compliance issues by allowing the holders of the shares covered by the rescission offer to rescind the underlying securities transactions and sell those securities back to us.

 

Q:           Which shares of common stock are included in the rescission offer?

 

A:            We are offering, upon the terms and conditions described in this offering circular, to rescind the sale of 137,219 shares of common stock purchased during the six-month purchase periods ended November 30, 2004 and May 31, 2005 pursuant to the ESPP from our current and certain former employees who reside in California, Connecticut, Illinois, New Jersey, Texas, Utah or Washington.  These shares are held by 82 persons who purchased shares of our common stock pursuant to the ESPP at prices ranging from $3.38 to $3.52 per share who still retain their shares.

 

We are also offering, upon the terms and conditions described in this offering circular, to rescind the sale of 175,587 shares of common stock purchased during the six-month periods ended May 31, 2003, November 30, 2003 and May 31, 2004 pursuant to the ESPP from our current and certain former employees who, at the time of issuance, resided in California or Utah and are now residing in Arizona, California or Utah.  These shares are held by 56 persons who purchased shares of our common stock pursuant to the ESPP at prices ranging from $0.65 to $5.21 per share.  In addition, we are offering to rescind the offer to participate in the ESPP to employees residing in California who are participating in the ESPP for the period that began on June 1, 2005.  All of these people are current and former employees who still retain their shares.

 

Q:           When does the rescission offer expire?

 

A:            Our rescission offer will expire at 5:00 p.m. Utah time on [                       ], 2005.

 

Q:           What will I receive if I accept the rescission offer?

 

A:            If you accept our rescission offer with respect to the common stock you purchased pursuant to the ESPP, we will repurchase the shares you hold that are subject to the rescission offer at the price per share you paid, plus interest at the current statutory rate per year, from the date of purchase through the date the rescission offer expires.

 

The legal rates of interest for the repurchase of shares will be based on your state of residence when you purchased your shares.  These interest rates are as follows:

 

State

 

Interest Rate

 

California

 

7%

 

Connecticut

 

6%

 

Illinois

 

10%

 

New Jersey

 

4%

 

Texas

 

6%

 

Utah

 

12%

 

Washington

 

8%

 

 

1



 

Q:           Can you give me an example of what I will receive if I accept the rescission offer?

 

A:            We will repurchase outstanding shares of common stock subject to the rescission offer at the price per share you paid, plus interest at the applicable statutory rate per year, from the date of purchase through the date that the rescission offer expires.  For example, if you were a resident of California at the time you purchased the securities subject to the rescission offer and hold 1,000 shares of our common stock that is subject to the rescission offer that you purchased in November 2003 at a per share price of $3.00 and you accept our rescission offer, you would receive:

 

              The original purchase price = 1,000 x $3.00 = $3,000.

 

              Plus simple interest at 7 percent per year = $3,000 x 7 percent x 2 years = $420.

 

              For a total of $3,420.

 

You will not have any right, title or interest to the shares of common stock you will be surrendering upon the closing of the rescission offer, and you will only be entitled to receive the proceeds from our repurchase of your common stock.

 

Q:           Have any officers, directors or five percent stockholders advised SCO whether they will participate in the rescission offer?

 

A:            Two of our officers, who hold a total of 11,408 shares of common stock, all of which shares are subject to rescission, are eligible to participate in the rescission offer.  We have been advised that these officers do not intend to accept the rescission offer.  None of our directors is eligible to participate in this offer.  If our eligible officers do not participate in the rescission offer but all other eligible persons accept the rescission offer in full, our officers and directors would not materially increase their respective ownership interests in SCO.

 

Q:           If I do not accept the offer now, can I sell my shares?

 

A:            If you do not accept the rescission offer, you can sell the shares of common stock that were subject to the rescission offer without limitation as to the number or manner of sale, unless you are an affiliate of SCO within the meaning of Rule 144 or Rule 145 or you are subject to SCO Insider Trading Policy requirements or any other transfer restrictions entered into with respect to your shares.

 

Q:           What do I need to do now to accept or reject the rescission offer?

 

A:            To accept or reject the rescission offer, you must complete and sign the accompanying election form (see Appendix A) and return it in the enclosed return envelope to Dorsey & Whitney LLP, to the attention of Carolyn Peters, Corporate Paralegal, 170 South Main Street, Suite 900, Salt Lake City, UT  84101, as soon as practical but in no event later than [                      ], 2005.  If you are accepting the rescission offer, please also include in your return envelope a stock power representing the shares you are surrendering for repurchase (see Appendix B).

 

Q:           Can I accept the rescission offer in part?

 

A:            Yes.  Simply indicate on your election form and stock power the number of shares you desire SCO to repurchase from you.  You will be deemed to have rejected the rescission offer with regard to the balance of your shares.

 

Q:           What happens if I do not return my rescission offer election form?

 

A:            If you do not return a properly completed election form before the expiration date of our rescission offer, you will be deemed to have rejected our offer.

 

Q:           What remedies or rights do I have now that I will not have after the rescission offer?

 

A:            It is unclear whether or not you will have a right of rescission under federal securities laws after the rescission offer.  The staff of the SEC is of the opinion that a person’s right of rescission created under the Securities Act of 1933 may survive the rescission offer.  However, federal courts in the past have ruled that a person who rejects or fails to accept a rescission offer is precluded from later seeking similar relief.  Generally, the federal

 

2



 

statute of limitations for noncompliance with the requirement to register securities under the Securities Act of 1933 is one year from the date of the violation upon which the action to enforce liability is based.

 

The state remedies and statutes of limitations vary and depend upon the state in which you purchased the shares.  The issuance of common stock under the ESPP was exempt in several of the states listed below.  If you purchased your shares while residing in one of the states in which an exemption applied, you have no remedy under state law.  The following is a summary of the statutes of limitations and the effect of the rescission offer for the states in which the shares covered by this rescission offer were sold.  This summary is not complete. For additional discussion of the various state laws governing rescission rights in the respective states, see “Rescission Offer—Effect of Rescission Offer.”

 

California

 

We did not take the necessary steps required to satisfy the requirements of the California Corporate Securities Law with respect to the offer and sale of common stock to employees residing in California pursuant to our ESPP that are subject to the rescission offer. Consequently, these shares may have been issued in violation of the California Corporate Securities Law. Generally, the California statute of limitations for noncompliance with the requirement to register or qualify securities under the California Corporate Securities Law is the earlier of two years after the noncompliance occurred, or one year after discovery of the facts constituting such noncompliance. Regardless, if the shares that are the subject of the rescission offer were issued to you in California, you will no longer have any right of rescission or repurchase with respect to these securities under Section 25503 of the California Corporate Securities Law after the expiration of our rescission offer.

 

 

 

Connecticut

 

While residents of Connecticut that hold shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the common shares issued by us in the state of Connecticut were issued pursuant to an exemption from registration or qualification under the Connecticut Uniform Securities Act.

 

 

 

Illinois

 

While residents of Illinois that hold shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the common stock issued by us in the state of Illinois were issued pursuant to an exemption from registration or qualification under the Illinois Securities Act of 1953.

 

 

 

New Jersey

 

While residents of New Jersey that hold shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the common stock issued by us in the state of New Jersey was issued pursuant to an exemption from registration or qualification under the New Jersey Uniform Securities Law.

 

 

 

Texas

 

While residents of Texas that hold shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the common stock issued by us in the state of Texas was issued pursuant to an exemption from registration or qualification under the Texas Securities Act.

 

 

 

Utah

 

We did not take the necessary steps required to satisfy the requirements of the Utah Uniform Securities Act with respect to common stock issuances to employees residing in Utah pursuant to our ESPP that are subject to the rescission offer. Consequently, these shares may have been issued in violation of the Utah Uniform Securities Act. Generally, the Utah statute of limitations for noncompliance with the requirement to register or qualify securities under the Utah Uniform Securities Act is the earlier of four years after the noncompliance occurred, or two years after discovery of the facts constituting such noncompliance. Regardless, if the shares that are the subject of the rescission offer were issued to you in Utah, you will no longer have any right of rescission or repurchase with respect to these securities under Section 16-1-22(7)(b) of the Utah Uniform Securities Act after the expiration of our rescission offer.

 

3



 

Washington

 

While residents of Washington that hold shares covered by the rescission offer may have a right of rescission under federal securities laws, we believe that the common stock issued by us in the state of Washington was issued pursuant to an exemption from registration or qualification under the Securities Act of Washington.

 

We believe that your acceptance of the rescission offer will preclude you from later seeking similar relief.  Regardless of whether you accept the rescission offer, we believe that any remedies you may have after the rescission offer expires would not be greater than an amount you would receive in the rescission offer.

 

Q:           How will the rescission offer be funded?

 

A:            The rescission offer will be funded from our existing cash balances.  If all persons eligible to participate in the rescission offer accept our offer to the full extent, our results of operations, cash balances or financial condition will not be affected materially.

 

Q:           Can I change my mind after I have mailed my signed election form?

 

A:            Yes.  You can change your decision about accepting or rejecting our rescission offer at any time before the expiration date.  You can do this by completing and submitting a new election form.  Any new election forms must be received by us prior to the expiration date in order to be valid.  We will not accept any election forms after the expiration date.

 

Q:           Who can help answer my questions?

 

A:            You can call Bert Young, Chief Financial Officer at SCO, at (801) 765-4999, with questions about the rescission offer.

 

Q:           Where can I get more information about SCO?

 

A:            You can obtain more information about SCO from the filings we make from time to time with the SEC.  These filings are available on the SEC’s website at www.sec.gov.

 

4



 

OFFERING CIRCULAR SUMMARY

 

This summary does not contain all of the information you should consider before making the decision to accept or reject our rescission offer. You should read the entire offering circular, including the risks discussed under “Risk Factors” and our consolidated financial statements and the related notes in this offering circular, for important information regarding our company and our common stock before making the decision to accept or reject the rescission offer.

 

THE SCO GROUP, INC.

 

Unix Business

 

We own the UNIX operating system and are a provider of UNIX-based products and services. We generate revenue from sales of our UNIX-based products and services through our UNIX business and from sales of SCOsource intellectual property, or IP, licenses and agreements and vendor licenses of our UNIX technology through our SCOsource business. Our core business is to sell and service our UNIX software products to small-to-medium sized businesses and franchisees or branch offices of Fortune 1000 businesses. Our most significant products that drive the majority of our UNIX revenue are OpenServer and UnixWare. During fiscal year 2004, we released a new version of our UnixWare product, UnixWare 7.1.4, and we intend to continue to maintain our core UNIX business in fiscal year 2005 by continuing our research and development efforts. We released a major upgrade to our OpenServer product, OpenServer 6, in June 2005.

 

SCOsource Business

 

We initiated our SCOsource business as part of our ongoing efforts to establish and protect our intellectual property rights, particularly relating to our ownership of the UNIX source code. In reviewing our intellectual property rights in 2003, we became aware that parts of or modifications made to our proprietary UNIX source code and derivative works have been included in the Linux operating system without our authorization or appropriate copyright attribution. Our SCOsource business now includes seeking to enter into license agreements with UNIX vendors and offering SCOsource IP licenses or agreements to Linux and other end users allowing them to continue to use our UNIX source code and derivative works.

 

In addition to our other SCOsource initiatives, in March 2003, we filed a complaint against International Business Machines Corporation, alleging, in part, that IBM had breached its license agreement with us by, among other things, inappropriately contributing UNIX source code and derivative works to the open source community and seeking to use its knowledge and methods related to UNIX source code and derivative works and modifications licensed to it to decrease the value of the UNIX operating system in favor of promoting the Linux operating system, of which it has been a major backer. Based on these alleged breaches, we delivered to IBM notice of termination of our license agreement with IBM that permitted IBM’s use of our UNIX source code in developing its AIX operating system.

 

In addition to our action against IBM, we have filed other complaints against such companies as Novell, Inc., AutoZone Inc., and DaimlerChrysler Corporation. Red Hat, Inc. has also brought a lawsuit against us asserting that the Linux operating system does not infringe our UNIX intellectual property rights, among other things. We describe our legal actions against these parties and the procedural status of these cases in more detail under “Business—Legal Proceedings.” We generally refer to these cases in this offering circular as the SCO Litigation.

 

5



 

The Rescission Offer

 

Total common stock subject to rescission offer

 

312,806 shares

Use of proceeds

 

We will not receive any proceeds from the rescission offer.

Risk factors

 

See “Risk Factors” and the other information included in this offering circular for a discussion of the factors you should consider carefully before deciding to accept the rescission offer.

Nasdaq SmallCap Market symbol

 

SCOX

 

Corporate Information

 

Our principal executive offices are located at 355 South 520 West, Suite 100, Lindon, Utah 84042. Our telephone number at that location is (801) 765-4999.

 

Summary Historical Consolidated Financial Data

 

The following table summarizes financial data regarding our business and should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes in this offering circular.

 

The selected statement of operations data for the years ended October 31, 2004, 2003 and 2002 and the selected balance sheet data as of October 31, 2004 and 2003 are derived from, and are qualified by reference to, the audited consolidated financial statements and related notes in this offering circular.

 

The selected statement of operations data for the years ended October 31, 2001 and 2000 and the selected balance sheet data as of October 31, 2002, 2001 and 2000 are derived from audited consolidated financial statements not appearing in this offering circular. The selected financial data as of April 30, 2005 and for the six months ended April 30, 2005 and 2004 have been derived from unaudited financial statements in this offering circular. In the opinion of management, these unaudited financial statements have been prepared on a basis consistent with the audited financial statements and include all adjustments, consisting only of normal and recurring adjustments, necessary for a fair presentation of the results for these periods and as of such date. The selected financial data set forth below is not necessarily indicative of our future results of operations or financial performance.

 

 

 

Six Months
Ended
April 30,

 

Years Ended October 31,

 

 

 

2005

 

2004

 

2004

 

2003

 

2002

 

2001

 

2000

 

 

 

(In thousands, except per share data)

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

18,123

 

$

21,529

 

$

42,809

 

$

79,254

 

$

64,241

 

$

40,441

 

$

4,274

 

Gross margin

 

$

9,039

 

$

9,421

 

$

15,711

 

$

59,332

 

$

45,925

 

$

25,518

 

$

253

 

Income (loss) from operations

 

$

(6,065

)

$

(14,576

)

$

(28,573

)

$

3,436

 

$

(24,176

)

$

(133,636

)

$

(31,999

)

Net income available (loss applicable) to common stockholders

 

$

(4,923

)

$

(17,212

)

$

(16,227

)

$

5,304

 

$

(24,877

)

$

(131,357

)

$

(39,176

)

Basic net income (loss) per common share

 

$

(0.28

)

$

(1.23

)

$

(1.07

)

$

0.43

 

$

(1.93

)

$

(10.92

)

$

(4.76

)

Diluted net income (loss) per common share

 

$

(0.28

)

$

(1.23

)

$

(1.07

)

$

0.34

 

$

(1.93

)

$

(10.92

)

$

(4.76

)

Weighted average basic common shares

 

17,831

 

13,960

 

15,155

 

12,261

 

12,893

 

12,024

 

8,231

 

Weighted averaged diluted common shares

 

17,831

 

13,960

 

15,155

 

15,679

 

12,893

 

12,024

 

8,231

 

 

6



 

 

 

As of April 30,

 

As of October 31,

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

2000

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

8,145

 

$

12,693

 

$

64,428

 

$

6,589

 

$

20,541

 

$

36,560

 

Working capital (deficit)

 

12,489

 

15,413

 

37,168

 

(6,332

)

14,401

 

88,680

 

Total assets

 

36,552

 

55,400

 

94,952

 

37,406

 

74,859

 

107,518

 

Long-term liabilities

 

342

 

343

 

508

 

1,625

 

5,925

 

 

Redeemable preferred stock

 

 

 

29,671

 

 

 

 

Common stock subject to rescission

 

851

 

528

 

 

 

 

 

Total stockholders’ equity

 

17,069

 

21,702

 

19,516

 

8,177

 

34,604

 

102,215

 

 

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RISK FACTORS

 

You should carefully consider the risks described below, together with all of the other information included in this offering circular, before making a decision to accept or reject our rescission offer. If any of the following risks actually occurs, our business, financial condition, liquidity or operating results could be materially and adversely affected.

 

Risks Related to the Rescission Offer

 

We may continue to have potential liability even after this rescission offer is made.

 

The Securities Act of 1933 does not provide that a rescission offer will extinguish a holder’s right to rescind the issuance of shares that were not registered or exempt from the registration requirements under the Securities Act of 1933.  Consequently, should any recipients of our rescission offer reject the offer, expressly or impliedly, we may remain liable under the Securities Act of 1933 for the purchase price of the shares issued under the ESPP during the six-month periods ended November 30, 2004 and May 31, 2005 that are subject to the rescission offer.  Additionally, regulatory authorities may require us to pay fines or they may impose sanctions on us, and we may face other claims by participants other than rescission claims.

 

Your federal right of rescission may not survive if you affirmatively reject or fail to accept the rescission offer.

 

If you affirmatively reject or fail to accept the rescission offer, it is unclear whether or not you will have a right of rescission under federal securities laws after the expiration of the rescission offer. The staff of the Securities and Exchange Commission is of the opinion that a person’s right of rescission created under the Securities Act of 1933 may survive the rescission offer.  However, federal courts in the past have ruled that a person who rejects or fails to accept a rescission offer is precluded from later seeking similar relief.

 

We cannot predict whether the amounts you would receive in the rescission offer would be greater than the fair market value of our securities.

 

The amount you would receive in the rescission offer is fixed and is not tied to the fair market value of our common stock at the time the rescission offer closes. As a result, if you accept the rescission offer, you may receive less than the fair market value of the securities you would be tendering to us.

 

If you do not accept the rescission offer, your shares, although freely tradeable, will still remain subject to limitation on resales, if any.

 

If you affirmatively reject the rescission offer or fail to accept the rescission offer before the expiration of the rescission offer, your shares will be registered under the Securities Act of 1933 and will be fully tradeable, subject to any applicable limitations set forth in Rule 144 or Rule 145 under the Securities Act of 1933; provided, however, that you will also remain subject to any applicable terms and conditions of any agreement under which your shares were issued or otherwise relating to your shares.

 

Risks Related to Our Business and Industry

 

We do not have a history of profitable operations.

 

Our fiscal year ended October 31, 2003 was the first full year we were profitable in our operating history.  Our profitability in fiscal year 2003 resulted primarily from our SCOsource licensing initiatives.  For fiscal year 2004, we incurred a loss from operations of $28,573,000 and our accumulated deficit as of October 31, 2004 was $224,216,000.  For the first two quarters of fiscal year 2005 we incurred a loss from operations of $6,065,000 and, as of April 30, 2005, had an accumulated deficit of $229,139,000.

 

If our revenue from the sale of our UNIX products and services continues to decline, we will need to further reduce operating expenses to generate positive cash flow.  We may not be able to further reduce operating expenses without damaging our ability to support our existing UNIX business.  Additionally, we may not be able to achieve profitability through additional cost-cutting actions.

 

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Our UNIX products and services revenue has declined over the last several years primarily as a result of increased competition from alternative operating systems, particularly Linux.  In our quarterly results of operations, we recognize revenue from agreements for support and maintenance contracts and other long-term contracts that have been previously invoiced and are included in deferred revenue.  Our future UNIX revenue may be adversely impacted and may continue to decline if we are unable to replenish these deferred revenue balances with long-term maintenance and support contracts or replace them with other sustainable revenue streams.  If we are unable to generate positive cash flow and profitable operations, our business will be adversely impacted.

 

We may not prevail in our SCO Litigation, which may adversely affect our business.

 

We continue to pursue our SCO Litigation and believe in the merits of our cases.  In our action against IBM, we seek damages for claims generally relating to our allegation that IBM has inappropriately used and distributed our UNIX source code and derivative works in connection with its efforts to promote the Linux operating system.  IBM has responded to our claims and brought counterclaims against us asserting generally that we do not have the right to assert claims based on our ownership of UNIX intellectual property against IBM or others in the Linux market.  Discovery is continuing in the case, and several motions are currently pending before the court.  If we do not prevail in our action against IBM, or if IBM is successful in its counterclaims against us, our business and results of operations would be materially harmed, and we may not be able to continue in business.  The litigation with IBM and others will be costly, and our costs for legal fees have been and will continue to be substantial and may exceed our capital resources. Additionally, the market price of our common stock may be negatively affected as a result of developments in our legal action against IBM that may be, or may be perceived to be, adverse to us.

 

As a result of our SCO Litigation and our other SCOsource initiatives, several participants in the Linux industry and others affiliated with IBM or sympathetic to the Linux movement have taken actions attempting to negatively affect our business and our SCOsource efforts.  Linux proponents have taken a broad range of actions against us, including, for example, attempting to influence participants in the markets in which we sell our products to reduce or eliminate the amount of our products and services they purchase from us.  We expect that similar efforts likely will continue.  There is a risk that participants in our marketplace will negatively view our actions against IBM, Novell, DaimlerChrysler and AutoZone and our other SCOsource initiatives, and we may lose support from such participants.  Any of the foregoing could adversely affect our position in the marketplace, our results of operations and our stock price and our ability to stay in business.

 

As a further response to our SCOsource initiatives and claim that our UNIX source code and derivative works have inappropriately been included in Linux, Novell has publicly asserted its belief that it owns certain copyrights in our UNIX source code, and it has filed 15 copyright applications with the United States Copyright Office related to UNIX.  Novell also claims that it has a license to UNIX from us and the right to authorize its customers to use UNIX technology in their internal business operations.  Specifically, Novell has also claimed to have retained rights related to legacy UNIX SVRx licenses, including the license with IBM.  Novell asserts it has the right to take action on behalf of SCO in connection with such licenses, including termination rights.  Novell has purported to veto our termination of the IBM, Sequent and SGI licenses. We have asserted that we obtained the UNIX business, source code, claims and copyrights when we acquired the assets and operations of the server and professional services groups from The Santa Cruz Operation (now Tarantella, Inc.) in May 2001, which had previously acquired all such assets and rights from Novell in September 1995 pursuant to an asset purchase agreement, as amended.  In January 2004, in response to Novell’s actions, we brought suit against Novell for slander of title seeking relief for Novell’s alleged bad faith effort to interfere with our copyrights and contract rights related to our UNIX source code and derivative works and our UnixWare products.

 

Notwithstanding our assertions of full ownership of UNIX-related intellectual property rights, as set forth above, including copyrights, and even if we are successful in our legal action against Novell and end users such as AutoZone and DaimlerChrysler, the efforts of Novell and the other Linux proponents described above may cause further damage to our business including our ability to monetize our UNIX assets.  These efforts of Linux proponents also may increase the negative view some participants in our marketplace have regarding our SCO Litigation and regarding our SCOsource initiatives and may contribute to creating confusion in the marketplace about the validity of our claim that the unauthorized use of our UNIX source code and derivative works in Linux infringes on our copyrights.  Increased negative perception and potential confusion about our claims in our marketplace could impede our continued pursuit of our SCOsource initiatives and negatively impact our business.

 

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Our engagement agreement with the law firms representing us in the SCO Litigation will require us to spend a significant amount of cash during fiscal year 2005 and could harm our liquidity position.

 

As of April 30, 2005, we had a total of $14,192,000 in cash and cash equivalents and available-for-sale securities and an additional $3,967,000 as restricted cash to be used in our operations and pursue the SCO Litigation.  As a result of the engagement agreement between us and the law firms representing us in the SCO Litigation, including, among others, Boies, Schiller & Flexner LLP, for the remainder of fiscal year 2005 we anticipate spending approximately $7,000,000 in the defense of our SCO Litigation.  If our UNIX business does not generate cash to cover the internal costs of our UNIX business, our SCOsource initiatives and our SCO Litigation, or we spend additional cash on additional matters, our cash position would be negatively impacted, and our ability to pursue our business objectives and our SCO Litigation could be harmed.

 

Our future SCOsource licensing revenue is uncertain.

 

We initiated the SCOsource licensing effort in fiscal year 2003 to review the status of UNIX licensing and sublicensing agreements.  This effort resulted in the execution of two significant vendor license agreements during fiscal year 2003 and generated $25,846,000 in revenue.  During fiscal year 2004, our SCOsource licensing revenue declined significantly and was only $829,000.  Due to a lack of historical experience and the uncertainties related to SCOsource licensing revenue, we are unable to estimate the amount and timing of future SCOsource licensing revenue, if any.  If we do receive revenue from this source, it may be sporadic and fluctuate from quarter to quarter.  Our SCOsource initiatives are unlikely to produce stable, predictable revenue for the foreseeable future.  Additionally, the success of these initiatives may depend on the strength of our intellectual property rights and contractual claims regarding UNIX, including the strength of our claim that unauthorized UNIX source code and derivatives are prevalent in Linux.

 

We may lose the support of industry partners leading to an accelerated decline in our UNIX products and services revenue.

 

The decline in our UNIX business and our SCOsource initiatives may cause industry partners, developers and hardware and software vendors to choose not to support or certify to our UNIX operating system products.  This would lead to an accelerated decline in our UNIX products and services revenue and would adversely impact our results of operations and liquidity.

 

Our claims relating to our UNIX intellectual property may subject us to additional legal proceedings.

 

In August 2003, Red Hat brought a lawsuit against us asserting that the Linux operating system does not infringe on our UNIX intellectual property rights and seeking a declaratory judgment for non-infringement of copyrights and no misappropriation of trade secrets.  In addition, Red Hat claims we have engaged in false advertising in violation of the Lanham Act, deceptive trade practices, unfair competition, tortious interference with prospective business opportunities, and trade libel and disparagement.  Although this case is currently stayed pending the resolution of our suit against IBM, we intend to vigorously defend this action.  However, if Red Hat is successful in its claim against us, our business and results of operations could be materially harmed.

 

In addition, regulators or others in the Linux market and some foreign regulators have initiated or in the future may initiate legal actions against us, all of which may negatively impact our operations and future operating performance.

 

Fluctuations in our operating results or the failure of our operating results to meet the expectations of public market analysts and investors may negatively impact our stock price.

 

Fluctuations in our operating results or our failure to meet the expectations of analysts or investors, even in the short-term, could cause our stock price to decline significantly. Because of the potential for significant fluctuations in our SCOsource licensing revenue in any particular period, you should not rely on comparisons of our results of operations as an indication of future performance.

 

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Factors that may affect our results include:

 

      our ability to successfully negotiate and complete licensing and other agreements related to our intellectual property;

 

      the interest level of resellers in recommending our UNIX business solutions to end users;

 

      the introduction, development, timing, competitive pricing and market acceptance of our products and services and those of our competitors;

 

      changes in general economic conditions, such as recessions, that could affect capital expenditures in the software industry;

 

      results of, or developments in, our SCO Litigation;

 

      changes in business attitudes toward UNIX as a viable operating system compared to other competing systems, especially Linux;

 

      the contingency and other legal fees we may pay to the law firms representing us in our SCO Litigation; and

 

      changes in attitudes of customers and partners due to the decline in our UNIX business and our aggressive position against the inclusion of our UNIX code and derivative works in Linux.

 

We also experience fluctuations in operating results in interim periods in Europe and the Asia Pacific regions due to seasonal slowdowns and economic conditions in these areas.  Seasonal slowdowns in these regions typically occur during the summer months.

 

As a result of the factors listed above and elsewhere, it is possible that our results of operations may be below the expectations of public market analysts and investors in any particular period. This could cause our stock price to decline. If revenue falls below our expectations, and we are unable to quickly reduce our spending in response, our operating results will be lower than expected.  Our stock price may fall in response to these events.

 

We operate in a highly competitive market and face significant competition from a variety of current and potential sources; many of our current and potential competitors have greater financial and technical resources than we do; thus, we may fail to compete effectively.

 

In the operating system market, our competitors include IBM, Red Hat, Novell, Hewlett-Packard, Sun Microsystems, Inc., Microsoft Corporation and other Linux distributors.  These and other competitors are aggressively pursuing the current UNIX operating system market.  Many of these competitors have access to substantially greater resources than we do.  The major competitive alternative to our UNIX products is Linux.  The expansion of our competitors’ offerings may restrict the overall market available for our UNIX products, including some markets where we have been successful in the past.

 

Our future success may depend in part on our ability to continue to meet the increasing needs of our customers by supporting existing and emerging technologies.  If we do not enhance our products to meet these evolving needs, we may not remain competitive and be able to grow our business.  Additionally, because technological advancement in the UNIX operating system market and alternative operating system markets is progressing at an advanced pace, we will have to develop and introduce enhancements to our existing products and any new products on a timely basis to keep pace with these developments, evolving industry standards and changing customer requirements.  Our failure to meet any of these and other competitive pressures may render our existing products and services obsolete, which would have an adverse impact on our revenue and operations.

 

The success of our UNIX business will depend on the level of commitment and certification we receive from industry partners and developers.  In recent years, we have seen hardware and software vendors as well as software developers turn their certification and application development efforts toward Linux and elect not to continue to support or certify to our UNIX operating system products.  If this trend continues, our competitive position will be adversely impacted and our future revenue from our UNIX business will decline.  The decline in our UNIX business

 

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may be accelerated if industry partners withdraw their support from us for any reason, including our SCOsource initiatives.

 

If the market for UNIX continues to contract, our business will be harmed.

 

Our revenue from the sale of UNIX products has declined over the last several years.  This decrease in revenue has been attributable primarily to increased competition from other operating systems, particularly Linux.  Our sales of UNIX products and services are primarily to existing customers.  If the demand for UNIX products continues to decline, and we are unable to develop UNIX products and services that successfully address a market demand, our UNIX revenue will continue to decline, industry participants may not certify to our operating system and products, we may not be able to attract new customers or retain existing customers and our business and results of operations will be adversely affected.  Because of the long adoption cycle for operating system purchases and the long sales cycle of our operating system products, we may not be able to reverse these revenue declines quickly.

 

We rely on our indirect sales channel for distribution of our products, and any disruption of our channel at any level could adversely affect the sales of our products.

 

We have a two-tiered distribution channel. The relationships we have developed with resellers allow us to offer our products and services to a much larger customer base than we would otherwise be able to reach through our own direct sales and marketing efforts.  Some solution providers also purchase solutions through our resellers, and we anticipate they will continue to do so.  Because we usually sell indirectly through resellers, we cannot control the relationships through which resellers, solution providers or equipment integrators purchase our products.  In turn, we do not control the presentation of our products to end users.  Therefore, our sales could be affected by disruptions in the relationships between us and our resellers, between our resellers and solution providers, or between solution providers and end users.  Also, resellers and solution providers may choose not to emphasize our products to their customers.  Any of these occurrences could diminish the effectiveness of our distribution channel and lead to decreased sales.

 

Our engagement agreement with the law firms representing us in our SCO Litigation may reduce our ability to raise additional financing.

 

Our engagement agreement with the law firms representing us in the SCO Litigation could inhibit our ability to raise additional funding if needed.  The engagement agreement provides that the law firms will receive a contingency fee that may range from 20 to 33 percent of the proceeds from specified events related to the protection of our intellectual property rights.  Events triggering a contingency fee may include settlements or judgments related to the SCO Litigation, certain licensing fees, subject to certain exceptions, and a sale of our company.  Future payments payable to the law firms under this arrangement will be significant.  The law firms’ right to receive such contingent payments could cause prospective investors to choose not to invest in our company or limit the price at which new investors would be willing to provide additional funds to our company.

 

Our foreign-based operations and sales create special problems, including the imposition of governmental controls and taxes and fluctuations in currency exchange rates that could hurt our results.

 

We have foreign operations, including development facilities, sales personnel and customer support operations in Europe, Latin America and Asia.  These foreign operations are subject to certain inherent risks, including:

 

      potential loss of developed technology through piracy, misappropriation, or more lenient laws regarding intellectual property protection;

 

      imposition of governmental controls, including trade restrictions and other tax requirements;

 

      fluctuations in currency exchange rates and economic instability;

 

      longer payment cycles for sales in foreign countries; and

 

      seasonal reductions in business activity.

 

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In addition, certain of our operating expenses are denominated in local currencies, creating risk of foreign currency translation losses that could harm our financial results and cash flows. When we generate profits in foreign countries, our effective income tax rate is increased.

 

In Latin America and Asia in particular, several countries have suffered and may be especially susceptible to recessions and economic instability.  These conditions may lead to increased governmental ownership or regulation of the economy, higher interest rates, increased barriers to entry such as higher tariffs and taxes and reduced demand for goods manufactured in the United States, resulting in lower revenue.

 

During the second quarter of fiscal year 2004, our Indian office was given a withholding tax assessment from the Government of India Income Tax Department.  The Tax Department assessed a 15 percent withholding tax on certain revenue transactions in India that the Tax Department deemed royalty revenue under the Income Tax Act.  As of April 30, 2005, we have accrued approximately $595,000 for this assessment.  We have filed an appeal with the Tax Department and believe that our packaged software does not qualify for treatment as royalties and therefore is not subject to withholding tax.  However, we may be unsuccessful in our appeal against the Tax Department and be obligated to pay the assessed taxable amounts.  If other countries in which we have international operations, such as India, continue to develop and begin enforcing their tax regimes, we may be subject to withholding or other taxes.

 

If we are unable to retain key personnel in an intensely competitive environment, our operations could be adversely affected.

 

We need to retain our management, technical and support personnel.  Competition for qualified professionals in the software industry is intense, and departures of existing personnel could be disruptive to our business and might result in the departure of other employees.  The loss or departure of any officers or key employees could harm our ability to implement our business plan and could adversely affect our operations.  Our future success depends to a significant extent on the continued service and coordination of our management team, particularly Darl C. McBride, our President and Chief Executive Officer.

 

We have issued options under our equity compensation plans without complying with registration or qualification requirements under the securities laws of California, Georgia and possibly other states, and, as a result, we may incur rescission liability for such options and may face additional potential claims under state securities laws.

 

In addition to the shares issued under the ESPP that are subject to this rescission offer, we have granted options under our 1999 Omnibus Stock Incentive Plan and 2002 Omnibus Stock Incentive Plan without complying with the registration or qualification requirements under the securities laws of California, Georgia and possibly other states. We may face rescission liability to plan participants holding unexercised stock options in these states. Additionally, regulatory authorities may require us to pay fines or they may impose other sanctions upon us, and we may face other claims by plan participants other than rescission claims.

 

Our stock price is volatile.

 

The trading price for our common stock has been volatile, ranging from a low closing sales price of $1.09 in mid-February 2003, to a high closing sales price of $20.50 per share in October 2003, to a current sales price of $3.88 on July 20, 2005.  The share price has changed dramatically over short periods.  We believe that the changes in our stock price are affected by changing public perceptions concerning the strength of our intellectual property claims and other factors beyond our control.  Public perception can change quickly and without any change or development in our underlying business or litigation position.  An investment in our stock is subject to such volatility and, consequently, is subject to significant risk.

 

There are risks associated with the potential exercise of our outstanding options.

 

As of June 30, 2005, we have issued and outstanding options to purchase up to approximately 3,750,000 shares of common stock with an average exercise price of $4.28 per share.  The existence of such rights to acquire common stock at fixed prices may prove a hindrance to our efforts to raise future equity and debt funding, and the exercise of such rights will dilute the percentage ownership interest of our stockholders and may dilute the value of their ownership.  The possible future sale of shares issuable on the exercise of outstanding options could adversely affect

 

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the prevailing market price for our common stock.  Further, the holders of the outstanding rights may exercise them at a time when we would otherwise be able to obtain additional equity capital on terms more favorable to us.

 

The issuance of common shares to BayStar Capital II, L.P. may have an adverse impact on the market value of our stock and the existing holders of our common stock.

 

We have an effective registration statement on Form S-1 relating to the sale or distribution by BayStar as a selling stockholder of the 2,105,263 shares of common stock issued to BayStar in connection with our repurchase completed in July 2004 of all Series A-1 shares previously held by BayStar.  We will not receive any proceeds from the sales of the shares covered by such registration statement.  The shares that may be sold or distributed pursuant to such registration statement represent approximately 6 percent of our issued and outstanding common stock.  The sale of the block of stock to be covered by such registration statement, or even the possibility of its sale, may adversely affect the trading market for our common stock and reduce the price available in that market.

 

Our stock price could decline further because of the activities of short sellers.

 

Our stock has attracted the interest of short sellers.  The activities of short sellers could further reduce the price of our stock or inhibit increases in our stock price.

 

The right of our Board of Directors to authorize additional shares of preferred stock could adversely impact the rights of holders of our common stock.

 

Our Board of Directors currently has the right, with respect to the 5,000,000 shares of our preferred stock, to authorize the issuance of one or more additional series of our preferred stock with such voting, dividend and other rights as our directors determine.  The Board of Directors can designate new series of preferred stock without the approval of the holders of our common stock. The rights of holders of our common stock may be adversely affected by the rights of any holders of additional shares of preferred stock that may be issued in the future, including without limitation, further dilution of the equity ownership percentage of our holders of common stock and their voting power if we issue preferred stock with voting rights. Additionally, the issuance of preferred stock could make it more difficult for a third party to acquire a majority of our outstanding voting stock.

 

Our stockholder rights plan could make it more difficult for a hostile bid for our company or a change of control transaction to succeed at current market prices for our stock.

 

We have adopted a stockholder rights plan.  The power given to the Board of Directors by the stockholder rights plan may make it more difficult for a change of control of our company to occur or for it to be acquired when the acquisition is opposed by our Board of Directors.

 

RESCISSION OFFER

 

Background

 

Since May 2002, we have issued 1,231,242 shares of our common stock to our current and former employees under our 2000 Employee Stock Purchase Plan, or ESPP, that exceeded the number of shares we had previously registered for issuance with the SEC on Form S-8.  Because the issuance of these shares was not exempt from the registration requirements of the Securities Act of 1933, their issuance did not comply with federal registration requirements.  Our failure to register the issuance of these shares gives the employees who purchased them a right to rescind their purchases, or recover damages if they have sold their shares, for up to one year following their issuance.

 

Since February 2003, we have issued shares of our common stock under our ESPP to current and former employees residing in California, Utah and possibly other states without complying with the registration or qualification requirements of these states.  This group of shares is part of the group of shares that was issued without complying with federal registration requirements as described in the preceding paragraph.

 

Our common stock was listed on The Nasdaq National Market until February 2003.  Section 18 of the Securities Act of 1933, as amended, preempts such securities from the state registration or qualification requirements that would otherwise apply.  When we transferred the listing for our common stock to The Nasdaq SmallCap Market in

 

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February 2003, we no longer qualified for this federal preemption.  As a result, since February 2003, we have inadvertently issued shares under the ESPP without complying with registration or qualification requirements in any state in which an exemption from these requirements did not apply.  In all states other than California and Utah, either an exemption from registration or qualification requirements applied or the applicable statue of limitations has passed.  Our failure to register the shares issued under the ESPP in California and Utah gives the employees who purchased them a right to rescind their purchases or recover damages if they have sold their shares.

 

Our failure to comply with the registration requirements of federal and state securities laws was inadvertent.  Since our noncompliance with such laws was discovered earlier this year, we have filed a Registration Statement on Form S-8, have qualified the offer and sale of shares under the ESPP in Utah, are in the process of applying to qualify the offer and sale of shares under the ESPP in California and are voluntarily making this rescission offer.

 

Rescission Offer and Price

 

We are offering to rescind a total of 312,806 shares of common stock issued under our ESPP to current and former employees while they resided in any of California, Connecticut, Illinois, New Jersey, Utah, Texas or Washington.  These shares represent all of the ESPP shares we issued to residents of the these states for which a purchaser could claim a rescission right.  Such shares:

 

      were purchased within the applicable federal and state statutes of limitation, and

 

      are still held by the current and former employees who originally purchased them.

 

If our rescission offer is accepted by all offerees, we could be required to make an aggregate payment to the holders of these shares of up to approximately $709,000, which includes estimated statutory interest through June 30, 2005.  These shares are held by our current and former employees, including two of our executive officers.  By making this rescission offer, we are not waiving any applicable statutes of limitations.

 

Specifically, this offer is being made to a total of 104 current and former employees who belong to one or more of the following groups:

 

      82 current and former employees who purchased shares of our common stock pursuant to the ESPP during the purchase periods ended November 30, 2004 or May 31, 2005 who are residents of California, Connecticut, Illinois, New Jersey, Texas, Utah or Washington, at prices ranging from $3.38 to $3.52 per share;

 

      56 current and former employees who purchased shares of our common stock pursuant to the ESPP during the purchase periods ended May 31, 2003, November 30, 2003 or May 31, 2004 who were, at the time of issuance, residents of California or Utah and are now residents of Arizona, California or Utah, at prices ranging from $0.65 to $5.21 per share; and

 

      22 employees residing in California who enrolled in the ESPP for the offering period that began June 1, 2005, since we have not yet completed the qualification of the offer and sale of such shares with the Securities Regulation Division of the California Department of Corporations.

 

If you accept our rescission offer and you hold shares of our common stock, we will repurchase the shares you hold that are subject to the rescission offer at the price per share paid, plus interest, from the date of purchase through the date that the rescission offer expires.  We intend to use the legal rates of interest for the repurchase of the shares based on your state of residence when you purchased your shares. These interest rates are as follows:

 

State

 

Interest Rate

 

California

 

7%

 

Connecticut

 

6%

 

Illinois

 

10%

 

New Jersey

 

4%

 

Texas

 

6%

 

Utah

 

12%

 

Washington

 

8%

 

 

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Acceptance

 

You may accept the rescission offer by completing, signing and delivering to us the enclosed election form (see Appendix A) indicating the shares to be repurchased and stock power representing the shares you are surrendering for repurchase (see Appendix B), on or before 5:00 p.m. [                        ], 2005, which date and time we refer to in this document as the expiration date.  All acceptances of the rescission offer will be deemed to be effective on the expiration date and the right to accept the rescission offer will terminate on the expiration date.  Acceptances or rejections may be revoked in a written notice to us, to the attention of Carolyn Peters, Corporate Paralegal, 170 South Main Street, Suite 900, Salt Lake City, Utah  84101, which is received prior to the expiration date. Within 15 business days after the expiration date, we will pay for any securities as to which the rescission offer has been validly accepted.

 

The rescission offer will terminate at 5:00 p.m., Utah time, on the expiration date.  If you submit an election form after that time on the expiration date, regardless of whether your form is otherwise complete, your election will not be accepted, and you will be deemed to have rejected our rescission offer.

 

Neither we nor our officers and directors make any recommendations to you with respect to the rescission offer contained herein. You are urged to read the rescission offer carefully and to make an independent evaluation with respect to its terms.

 

IF PERSONS DESIRING TO ACCEPT THE RESCISSION OFFER INTEND TO MAKE USE OF THE MAIL TO RETURN THEIR STOCK POWERS, INSURED REGISTERED MAIL, RETURN RECEIPT REQUESTED, IS RECOMMENDED.

 

Rejection or Failure to Affirmatively Accept

 

If you fail to accept, or if you affirmatively reject the rescission offer by so indicating on the enclosed election form, you will retain ownership of the shares in accordance with the terms of the ESPP and you will not receive any cash for those securities in connection with the rescission offer. Your shares will be registered and fully tradeable under the Securities Act of 1933, unless you are an affiliate of SCO within the meaning of Rule 144 or Rule 145, as the case may be. Your shares will remain subject to any applicable terms and conditions of the original agreement under which they were issued and any subsequent agreement relating to such shares.

 

Solicitation

 

We have not retained, nor do we intend to retain, any person to make solicitations or recommendations to you in connection with the rescission offer.

 

Effect of Rescission Offer

 

It is unclear whether the rescission offer will terminate our liability, if any, for failure to register or qualify the issuance of securities under federal securities laws. Accordingly, should the rescission offer be rejected by any or all offerees, we may continue to be contingently liable under the Securities Act of 1933 for the purchase price of approximately 57,000 shares subject to the rescission offer up to an aggregate amount of approximately $189,000, which includes estimated statutory interest through June 30, 2005.

 

Regardless of whether you accept the rescission offer, we believe that any remedies you may have after the rescission offer expires for our failure to register or qualify the issuance of securities would not be greater than the amount you would receive in the rescission offer.

 

Below is a discussion of our contingent liability in California and Utah, the states where we have issued shares under our ESPP in violation of registration or qualification requirements and which are covered by the rescission offer.

 

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The holders of our shares that are the subject of this rescission offer who are residents of Connecticut, Illinois, New Jersey, Texas and Washington have a right of rescission under federal securities laws, but we believe that the shares issued by us in these states were issued pursuant to an exemption from registration or qualification available to us under the applicable securities laws of each state resulting in no state-law-based rescission right in these states.  Each state has different laws with respect to rights under common law and fraud and the following discussion of state law does not relate to the antifraud provisions of applicable securities laws or rights under common law or equity.

 

California

 

Under California law, an issuer is civilly liable to a purchaser of its securities sold in violation of the registration or qualification requirements of the California Corporate Securities Law. The purchaser may sue to recover the consideration paid for such securities with interest at 7 percent per year, less the amount of any income received from ownership of the securities, upon the tender of such securities at any time prior to the earlier of the two-year anniversary of the noncompliance with the registration or qualification requirements or the one year anniversary of the discovery by the purchaser of the facts constituting such noncompliance.

 

However, we may terminate the rights of the purchasers to seek additional remedies under the California Corporate Securities Law by making a written rescission offer before suit is commenced by the purchaser, approved as to form by the California Commissioner of Corporations, where the offer:

 

      states the respect in which liability under the registration or qualification requirements may have arisen;

 

      offers to repurchase the securities for a cash price payable upon delivery of the securities or offering to pay the purchaser an amount in cash equal in either case to the amount recoverable by the purchaser, or offering to rescind the transaction by putting the parties back in the same position as before the transaction;

 

      provides that such offer may be accepted by the purchaser at any time within a specified period of not less than 30 days after the date of receipt of the offer unless rejected earlier during such periods by the purchaser;

 

      sets forth the provisions of the rescission offer requirements under the California Corporate Securities Law; and

 

      contains such other information as the California Commissioner of Corporations may require by rule or order.

 

If the purchaser fails to accept such offer in writing within the specified time period of not less than 30 days after the date of receipt of the offer, that purchaser will no longer have any right of rescission under California law.

 

We must also file with the California Commissioner of Corporations, in such form as the California Commissioner of Corporations prescribes by rule, an irrevocable consent appointing the Commissioner of Corporations or its successor in office to be our attorney to receive services of any lawful process in any noncriminal suit, action or proceeding against us or our successor, which arises under California law after the consent has been filed with the same force and validity as if served personally on us.

 

We believe this rescission offer complies in all material respects with the rescission offer requirements of the California Corporate Securities Law.

 

Utah

 

Under Utah law, an issuer is civilly liable to a purchaser of its securities sold in violation of the registration or qualification requirements of the Utah Uniform Securities Act. The purchaser may sue either at law or in equity to recover the consideration paid for such securities, together with interest at the rate of 12 percent per year from the date of payment, costs and reasonable attorneys’ fees, less the amount of any income received on the securities, or for damages if the purchaser no longer owns the securities, at any time prior to the four-year anniversary of the noncompliance with the registration or qualification requirements, or two years after discovery of the facts constituting such noncompliance.

 

17



 

However, we may terminate the rights of the purchasers to seek additional remedies under the Utah Uniform Securities Act by making a written rescission offer, before suit, to refund the consideration paid together with interest at the rate of 12 percent per year from the date of payment, less the amount of any income received on the securities. If the purchaser owns the securities and fails to accept such offer within 30 days of its receipt, that purchaser will no longer have any right of rescission under Utah law. If the purchaser receives such offer at a time when the purchaser does not own the securities, that purchaser will no longer have any right of rescission under Utah law unless the purchaser rejects the offer in writing within 30 days of its receipt.

 

We believe that this rescission offer complies in all material respects with the rescission offer requirements of the Utah Uniform Securities Act.

 

Funding the Rescission Offer

 

The rescission offer will be funded from our existing cash balances.  If all persons eligible to participate accept our offer to repurchase common stock to the full extent, our results of operations, cash balances or financial condition will not be materially adversely affected.

 

Directors, Officers and Major Stockholders

 

Two of our officers, who hold 11,408 shares of common stock, all of which shares are subject to rescission, are eligible to participate in the rescission offer.  We have been advised that these officers do not intend to accept the rescission offer.  None of our directors is eligible to participate in this offer.  If our eligible officers do not participate in the rescission offer but all other eligible persons accept the rescission offer in full, our officers and directors would not materially increase their respective ownership interests in SCO.

 

18



 

U.S. FEDERAL INCOME TAX CONSEQUENCES

 

Scope of this Discussion

 

The following discussion summarizes the material U.S. federal income tax consequences of participating in our rescission offer.  This discussion is for general information purposes only and does not purport to be a complete analysis or listing of all potential U.S. federal income tax consequences that may apply to you as a result of participating in our rescission offer.  In addition, this discussion does not take into account your individual facts and circumstances, which may affect the U.S. federal income tax consequences to you of participating in our rescission offer.  This discussion also does not address the U.S. state and local or foreign tax consequences of participating in our rescission offer.  Accordingly, this discussion is not intended to be, and should not be construed as, legal or U.S. federal income tax advice.  You should consult your own financial advisor, legal counsel, or accountant regarding the U.S. federal, U.S. state and local, and foreign tax consequences of participating in our rescission offer.

 

In addition, this discussion does not address the U.S. federal income tax consequences of participating in our rescission offer if you are subject to special U.S. federal income tax rules, including if (a) you are not a “U.S. person” (e.g., you are a non-resident alien), (b) you are liable for the alternative minimum tax, (c) you are not an individual, (d) you own our shares as part of a straddle, hedging transaction, conversion transaction, constructive sale, or other arrangement involving more than one position, or (e) you hold our shares other than as a capital asset.

 

Authorities

 

This discussion is based on the Internal Revenue Code of 1986, as amended (the “Code”), Treasury Regulations, published IRS rulings, published administrative positions of the IRS, and U.S. court decisions that are applicable and, in each case, in effect and available, as of the date of this document.  Any of the authorities on which this discussion is based could be changed in a material and adverse manner at any time, and any such change could be applied on a retroactive basis.  This discussion does not discuss the potential effects, whether adverse or beneficial, of any proposed legislation that, if enacted, could be applied on a retroactive basis.

 

Treatment as Taxable Redemption

 

For U.S. federal income tax purposes, we intend to treat the purchase of our shares pursuant to our rescission offer as a taxable redemption, with the redemption price being equal to the full amount of cash paid to you (i.e., the sum of the price per share you paid for our shares plus interest).  However, the IRS may take the position that the redemption price should be equal only to the price per share you paid for our shares.  In that event, the portion of the redemption price in excess of the price per share you paid for our shares would be taxable as ordinary interest income to you.

 

Non-Disqualifying Disposition

 

Assuming that your sale of our shares pursuant to our rescission offer does not constitute a “disqualifying disposition” (as discussed below), you should recognize ordinary compensation income in an amount equal to the lesser of (a) the excess of the fair market value of our shares on the date you were granted the right to purchase our shares over the purchase price you paid for our shares or (b) the excess of the redemption price paid in our rescission offer over the purchase price you paid for our shares.  In addition, assuming that one or more of the Section 302(b) Tests (as defined below) is satisfied, you should recognize long-term gain in an amount equal to the excess, if any, of (a) the redemption price paid in our rescission offer over (b) the sum of the purchase price you paid for our shares plus the ordinary compensation income you recognize under the preceding sentence.

 

Under Section 302(b) of the Code, your sale of our shares pursuant to our rescission offer should be treated as a “sale or exchange” by you (rather than as a distribution by us, as discussed below) if the sale (a) results in a complete termination of your interest in us, (b) is substantially disproportionate, or (c) is not essentially equivalent to a dividend (the “Section 302(b) Tests”).

 

      Your sale of our shares pursuant to our rescission offer should result in a “complete termination” of your interest in us if, pursuant to our rescission offer, either (a) we purchase all of our shares that you actually and constructively own or (b) we purchase all of our shares that you actually own and, with respect to any

 

19



 

constructively owned shares, you are eligible to waive (and effectively waive) constructive ownership under the procedures described in Section 302(c)(2) of the Code.

 

      Your sale of our shares pursuant to our rescission offer should qualify as “substantially disproportionate” if (a) your percentage ownership of our voting shares immediately after the sale is less than 80 percent of your percentage ownership of our voting shares immediately before the sale, (b) your percentage ownership of our common stock (whether voting or non-voting) immediately after the sale is less than 80 percent of your percentage ownership of our common stock immediately before the sale, and (c) you own less than 50 percent of the total combined voting power of all classes of our shares immediately after the sale.

 

      Your sale of our shares pursuant to our rescission offer should qualify as “not essentially equivalent to a dividend” if you experience a “meaningful reduction” in the your proportionate interest in us as a result of the sale, which will depend on your individual facts and circumstances.

 

In applying each of the Section 302(b) Tests, you must take into account both shares actually owned by you and any shares considered as owned by you under certain constructive ownership rules set forth in Section 318 of the Code.  Under these constructive ownership rules, you generally should be considered to own (a) shares that you have the right to acquire by the exercise of an option or warrant, (b) shares owned by certain of your family members, and (c) shares owned by certain entities (such as corporations, partnerships, trusts, and estates) in which you own an interest or are a beneficiary.  You should consult your own financial advisor, legal counsel, or accountant regarding the Section 302(b) Tests and the constructive ownership rules of Section 318 of the Code.

 

If your sale of our shares pursuant to our rescission offer does not satisfy any of the Section 302(b) Tests, you should be treated as having received a distribution from us in an amount equal to the redemption price paid to you (without any reduction for the tax basis of our shares that you sold).  Such distribution should be taxable as a dividend to the extent of our current or accumulated “earnings and profits.” To the extent that such distribution exceeds our current and accumulated “earnings and profits,” such distribution (a) should first be treated as a tax-free return of capital to the extent of your tax basis in our shares and, (b) thereafter, should be treated as gain from the sale or exchange of our shares.  A dividend generally should be taxed at the same preferential tax rates applicable to long-term capital gains.

 

Disqualifying Disposition

 

A disposition of our shares should be treated as a “disqualifying disposition” if such disposition occurs prior to (a) two years after the date you were granted the right to purchase our shares or (b) one year after the date you purchased our shares.

 

If your sale of our shares pursuant to our rescission offer constitutes a disqualifying disposition, you should recognize ordinary compensation income in an amount equal to the excess, if any, of (a) the fair market value of our shares on the date you purchased our shares over (b) the purchase price you paid for our shares.  This amount should be recognized as ordinary compensation income by you, even if the fair market value of our shares on the date you purchased our shares exceeds the redemption price paid in our rescission offer.  In addition, assuming that one or more of the Section 302(b) Tests discussed above is satisfied, you should recognize gain (or loss) in an amount equal to the excess (or deficiency), if any, of (a) the redemption price paid in our rescission offer over (b) the fair market value of our shares on the date you purchased our shares.  A capital gain (or loss) will be long-term or short-term, depending on whether you held our shares for more than one year after the date you purchased our shares.

 

No Legal Opinion or IRS Ruling

 

No legal opinion from U.S. legal counsel or ruling from the IRS has been requested, or will be obtained, regarding the U.S. federal income tax consequences of our rescission offer.  This discussion is not binding on the IRS, and the IRS is not precluded from taking a position that is different from, and contrary to, the positions taken in this discussion.  In addition, because the authorities on which this discussion is based are subject to various interpretations, the IRS and the U.S. courts could disagree with one or more of the positions taken in this discussion.

 

Backup Withholding

 

We may be required to backup withhold 28% of the redemption price paid to you pursuant to our rescission offer if we do not currently have your correct U.S. taxpayer identification number or you do not provide us with your correct U.S. taxpayer identification number (generally on Form W-9).

 

20



 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

This offering circular contains forward-looking statements. With the exception of historical facts, the statements contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which reflect our current expectations and beliefs regarding our future results of operations, performance and achievements. The sections entitled “Offering Circular Summary” and “Business” also include forward-looking statements. These statements are subject to risks and uncertainties and are based upon assumptions and beliefs that may or may not materialize. These forward-looking statements include, but are not limited to, statements concerning:

 

                  Our operating strategy to continue to support our existing users of our UNIX operating system products and to pursue SCOsource licensing opportunities and protect our intellectual property rights;

 

                  Our intention to continue to maintain our core UNIX business in fiscal year 2005 by continuing our research and development efforts;

 

                  Our belief that our OpenServer and UnixWare products will continue to provide a revenue stream in fiscal year 2005 and our belief that revenue from such products will continue to decline;

 

                  Our expectation that our sales channel should continue to provide reliable UNIX operating systems for small-to-medium sized business customers;

 

                  Our intention to focus our development resources on our new version of our OpenServer 6 product and maintaining our updated UnixWare products released in fiscal year 2004;

 

                  Our intention to focus development resources on augmenting our current UNIX products and our application products with other products that will solve business problems for our existing installed base of customers;

 

                  Our expectation that hardware and software vendors, as well as software developments, will continue to turn their certification and application development efforts toward Linux and elect not to continue to support or certify to our UNIX operating system products;

 

                  Our expectation that developing a 64-bit version of our operating system technology will give customers confidence in their commitment to our technologies;

 

                  Our intention to continue to pursue our SCOsource initiatives in fiscal year 2005;

 

                  Our belief that the future success of our SCOsource initiatives will depend on our ability to protect our intellectual property;

 

                  Our intention to vigorously defend legal claims and counterclaims brought against us by others;

 

                  Our intention to continue to pursue our litigation against IBM, Novell, AutoZone, and DaimlerChrysler;

 

                  Our expectation that maintaining our strategic alliances with solution providers in fiscal year 2005 will be critical to the success of our UNIX business and the success of our OpenServer 6 product;

 

                  Our intention to keep our relationships with key partners in certain vertical markets;

 

                  Our expectation that product enhancements to improve our UNIX technology will extend the life and improve the functionality of our UNIX products and our belief that such improvements will not result in significant revenue increases;

 

                  Our belief that such product enhancements to our UNIX technology will help prolong our OpenServer revenue stream for future quarters;

 

21



 

                  Our intention to continue to review the status of our existing UNIX license agreements with UNIX vendors in fiscal year 2005 and pursue large vendor contracts such as those completed in fiscal year 2003;

 

                  Our intention to continue to pursue our SCOsource IP licensing initiative against those that may be violating our UNIX copyrights;

 

                  Our expectation that our UNIX business will generate positive cash flow during fiscal year 2005;

 

                  Our belief that our allowance for doubtful accounts receivable will remain consistent with our prior experience;

 

                  The strength of our intellectual property rights and contractual claims regarding UNIX generally and specifically the strength of our claim that unauthorized UNIX source code and derivatives of UNIX source code are contained in Linux;

 

                  Our expectation that total UNIX revenue for fiscal year 2005 will decline from UNIX revenue generated in fiscal year 2004;

 

                  Our belief that competition from Linux and other operating systems will continue in fiscal year 2005 and future periods;

 

                  Our expectation that we will continue to be unable to predict the amount and timing of SCOsource licensing revenue, and when generated, the revenue will be sporadic;

 

                  Our expectation that future services revenue will depend in part on our ability to generate UNIX products revenue from new customers as well as the renewal of annual support and services agreements from existing UNIX customers;

 

                  Our expectation for fiscal year 2005 that the dollar amount of our cost of products revenue will be less than in fiscal year 2004;

 

                  Our expectation for fiscal year 2005 that the dollar amount of our cost of SCOsource licensing revenue will be lower than fiscal year 2004;

 

                  Our expectation for fiscal year 2005 that the dollar amount of our cost of services revenue will be lower than fiscal year 2004;

 

                  Our expectation for fiscal year 2005 that the dollar amount of our sales and marketing expense will be lower than fiscal year 2004;

 

                  Our expectation for fiscal year 2005 that the dollar amount of our research and development expenses will be lower than fiscal year 2004;

 

                  Our expectation for fiscal year 2005 that the dollar amount of our general and administrative expenses will be lower than fiscal year 2004;

 

                  Our expectation for the remaining quarters of fiscal year 2005 that the dollar amount of our cost of products revenue will be generally consistent to that generated in the second quarter of fiscal year 2005;

 

                  Our expectation for the remaining quarters of fiscal year 2005 that the dollar amount of our cost of services revenue will be generally consistent to that generated in the second quarter of fiscal year 2005;

 

                  Our expectation for the remaining quarters of fiscal year 2005 that the dollar amount of our sales and marketing expenses will be generally consistent to that generated in the second quarter of fiscal year 2005;

 

22



 

                  Our expectation for the remaining quarters of fiscal year 2005 that the dollar amount of our research and development expenses will be generally consistent to that generated in the second quarter of fiscal year 2005;

 

                  Our expectation for the remaining quarters of fiscal year 2005 that the dollar amount of our general and administrative expenses will be generally consistent to that generated in the first quarter of fiscal year 2005;

 

                  Our intention to use the cash and equivalents and available-for-sale securities as of April 30, 2005 to maintain our UNIX business and pursue our SCO Litigation;

 

                  Our belief that our legal costs related to the SCO Litigation will decrease in fiscal year 2005 compared to fiscal year 2004, exclusive of any contingent payments;

 

                  Our belief that our legal costs related to the SCO Litigation for the remaining quarters of fiscal year 2005 will be generally consistent to that generated in the first and second quarters of fiscal year 2005, exclusive of any contingent payments;

 

                  Our belief that our facilities are adequate for our business;

 

                  Our belief that certain legal actions to which we are a party will not have a material adverse effect on our results of operations or financial position; and

 

                  Our belief that our UNIX business will generate sufficient cash in fiscal 2005 to cover our internal costs related to our SCOsource initiatives and the SCO Litigation, and that we will have sufficient cash resources to fund our operations through fiscal 2005.

 

We wish to caution readers that our operating results are subject to various risks and uncertainties that could cause our actual results and outcomes to differ materially from those discussed or anticipated, including the success of our SCOsource initiatives, competition from other operating systems, particularly Linux, the amount and timing of SCOsource licensing revenue, our ability to enhance our UNIX operating systems and maintain our UNIX business, and the factors set forth under “Risk Factors” above. We also wish to advise readers not to place any undue reliance on the forward-looking statements contained in this offering circular, which reflect our beliefs and expectations only as of the date of this offering circular. We assume no obligation to update or revise these forward-looking statements to reflect new events or circumstances or any changes in our beliefs or expectations, other than as required by law.

 

MARKET FOR THE REGISTRANT’S COMMON EQUITY

 

Market Price of Our Common Stock

 

Our common stock initially traded on The Nasdaq National Market beginning in March 2000 but has been traded on The Nasdaq SmallCap Market since February 2003. In September 2002, we changed our trading symbol from “CALD” to “SCOX.” The table below sets forth the range of high and low closing prices of our common stock as reported on The Nasdaq National Market and The Nasdaq SmallCap Market, as applicable, for the last two fiscal years and the first and second quarters of fiscal 2005.

 

23



 

 

 

SCO Common Stock

 

 

 

High

 

Low

 

Fiscal Year 2005

 

 

 

 

 

Quarter ended January 31, 2005

 

$

4.99

 

$

2.85

 

Quarter ended April 30, 2005

 

4.60

 

3.42

 

 

 

 

 

 

 

Fiscal Year 2004

 

 

 

 

 

Quarter ended January 31, 2004

 

19.08

 

13.65

 

Quarter ended April 30, 2004

 

14.40

 

6.27

 

Quarter ended July 31, 2004

 

6.34

 

4.03

 

Quarter ended October 31, 2004

 

5.10

 

2.98

 

 

 

 

 

 

 

Fiscal Year 2003

 

 

 

 

 

Quarter ended January 31, 2003

 

1.70

 

1.22

 

Quarter ended April 30, 2003

 

3.27

 

1.09

 

Quarter ended July 31, 2003

 

14.84

 

3.21

 

Quarter ended October 31, 2003

 

20.50

 

9.29

 

 

On July 20, 2005, the closing sales price for our common stock as reported by The Nasdaq SmallCap Market was $3.88. As of July 18, 2005, there were 336 holders of common stock of record.

 

DIVIDEND POLICY

 

We have not historically declared or paid any cash dividends on shares of our common stock and plan to retain our future earnings, if any, to fund the development and growth of our business.

 

SELECTED FINANCIAL DATA

 

The following selected financial data set forth below should be read in conjunction with the consolidated financial statements and the related notes in this offering circular and in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing below. The selected statement of operations data for the years ended October 31, 2004, 2003 and 2002 and the selected balance sheet data as of October 31, 2004 and 2003 are derived from, and are qualified by reference to, the audited consolidated financial statements and related notes in this offering circular.

 

The selected statement of operations data for the years ended October 31, 2001 and 2000 and the selected balance sheet data as of October 31, 2002, 2001 and 2000 are derived from audited consolidated financial statements not appearing in this offering circular. The selected financial data as of April 30, 2005 and for the six months ended April 30, 2005 and 2004 have been derived from unaudited financial statements in this offering circular. In the opinion of management, these unaudited financial statements have been prepared on a basis consistent with the audited financial statements and include all adjustments, consisting only of normal and recurring adjustments, necessary for a fair presentation of the results for these periods and as of such date. The selected financial data set forth below is not necessarily indicative of our future results of operations or financial performance.

 

 

 

Six Months Ended
April 30,

 

Years Ended October 31,

 

 

 

2005

 

2004

 

2004

 

2003

 

2002

 

2001

 

2000

 

 

 

(In thousands, except per share data)

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

18,123

 

$

21,529

 

$

42,809

 

$

79,254

 

$

64,241

 

$

40,441

 

$

4,274

 

Gross margin

 

$

9,039

 

$

9,421

 

$

15,711

 

$

59,332

 

$

45,925

 

$

25,518

 

$

253

 

Income (loss) from operations

 

$

(6,065

)

$

(14,576

)

$

(28,573

)

$

3,436

 

$

(24,176

)

$

(133,636

)

$

(31,999

)

Net income available (loss applicable) to common stockholders

 

$

(4,923

)

$

(17,212

)

$

(16,227

)

$

5,304

 

$

(24,877

)

$

(131,357

)

$

(39,176

)

Basic net income (loss) per common share

 

$

(0.28

)

$

(1.23

)

$

(1.07

)

$

0.43

 

$

(1.93

)

$

(10.92

)

$

(4.76

)

Diluted net income (loss) per common share

 

$

(0.28

)

$

(1.23

)

$

(1.07

)

$

0.34

 

$

(1.93

)

$

(10.92

)

$

(4.76

)

Weighted average basic common shares

 

17,831

 

13,960

 

15,155

 

12,261

 

12,893

 

12,024

 

8,231

 

Weighted averaged diluted common shares

 

17,831

 

13,960

 

15,155

 

15,679

 

12,893

 

12,024

 

8,231

 

 

24



 

 

 

As of April 30,

 

As of October 31,

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

2000

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

8,145

 

$

12,693

 

$

64,428

 

$

6,589

 

$

20,541

 

$

36,560

 

Working capital (deficit)

 

12,489

 

15,413

 

37,168

 

(6,332

)

14,401

 

88,680

 

Total assets

 

36,552

 

55,400

 

94,952

 

37,406

 

74,859

 

107,518

 

Long-term liabilities

 

342

 

343

 

508

 

1,625

 

5,925

 

 

Redeemable preferred stock

 

 

 

29,671

 

 

 

 

Common stock subject to rescission

 

851

 

528

 

 

 

 

 

Total stockholders’ equity

 

17,069

 

21,702

 

19,516

 

8,177

 

34,604

 

102,215

 

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion should be read in conjunction with our consolidated financial statements, the related notes and other financial information appearing elsewhere in this offering circular.

 

Business Focus

 

We generate revenue from sales of product and services from our UNIX business and from sales of SCOsource intellectual property, or IP, licenses and vendor licenses from our SCOsource business.

 

UNIX Business.  Our UNIX business serves the needs of small-to-medium sized businesses, including replicated site franchisees of Fortune 1000 companies, by providing reliable, cost effective UNIX operating systems and software products to power computers running on Intel architecture.  Our largest source of UNIX business revenue is derived from existing customers through our worldwide, indirect, leveraged channel of partners which includes distributors and independent solution providers.  We have a presence in a number of countries that provide support and services to customers and resellers.  The other principal channel for selling and marketing our UNIX products is through existing customers that have a large number of replicated sites or franchisees.

 

We access these corporations through their information technology or purchasing departments with our Area Sales Managers, or ASMs, in the United States and through our reseller channel in countries outside the United States.  In addition, we also sell our operating system products to original equipment manufacturers, or OEMs.  Our sales of UNIX products and services during the last several periods have been primarily to pre-existing UNIX customers and not newly acquired customers.  Our UNIX business revenue depends significantly on our ability to market and sell our products to existing customers and to generate upgrades from existing customers.

 

The following table shows the operating results of the UNIX business for the three and six months ended April 30, 2005 and 2004 (in thousands):

 

 

 

Three Months Ended April 30,

 

Six Months Ended April 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

9,228

 

$

10,126

 

$

18,023

 

$

21,498

 

Cost of revenue

 

1,309

 

1,891

 

2,702

 

4,018

 

Gross margin

 

7,919

 

8,235

 

15,321

 

17,480

 

Sales and marketing

 

2,956

 

4,117

 

5,746

 

9,128

 

Research and development

 

2,027

 

2,797

 

3,995

 

5,477

 

General and administrative

 

1,866

 

1,710

 

3,538

 

3,882

 

Other

 

600

 

3,577

 

1,208

 

4,799

 

Total operating expenses

 

7,449

 

12,201

 

14,487

 

23,286

 

Income (loss) from operations

 

$

470

 

$

(3,966

)

$

834

 

$

(5,806

)

 

25



 

Revenue from our UNIX business decreased by $898,000, or 9 percent, for the second quarter of fiscal year 2005 compared to the second quarter of fiscal year 2004 and decreased by $3,475,000, or 16 percent, for the first two quarters of fiscal year 2005 compared to the first two quarters of fiscal year 2004.  The revenue from this business has been declining over the last several quarters primarily as a result of increased competition from alternative operating systems, particularly Linux.  If revenue from our UNIX business continues to decline and we are unable to generate positive cash flow, our UNIX business will be adversely impacted.

 

In an effort to attain profitability in our UNIX business, we have decreased our operating costs and streamlined our operations.  Operating costs for our UNIX business decreased from $12,201,000 for the second quarter of fiscal year 2004 to $7,449,000 for the second quarter of fiscal year 2005 and decreased from $23,286,000 for the first two quarters of fiscal year 2004 to $14,487,000 for the first two quarters of fiscal year 2005.  These cost reductions have primarily been attributable to reduced headcount, continued operational efficiencies generated in our UNIX business, the elimination of certain write-offs and severance and exit costs, as well as from the consolidation of certain facilities.

 

In our UNIX business, we have reduced the number of full-time equivalent employees from 263 as of April 30, 2004 to 164 as of April 30, 2005.  We have taken these headcount reductions and reduced other discretionary spending while still maintaining a worldwide presence.  Based on our cost-cutting actions, we anticipate that our UNIX business will continue to generate income from operations and positive cash flow throughout fiscal year 2005.

 

The decline in our UNIX business revenue may be accelerated if industry partners withdraw their support as a result of our SCOsource initiatives.  The decline in our UNIX business and our SCOsource initiatives may cause industry partners, developers and hardware and software vendors to choose not to support or certify to our UNIX operating system products.  This would lead to an accelerated decline in revenue from our UNIX business.

 

An important initiative for our UNIX business for the 2005 fiscal year has been the release of the next major upgrade to our OpenServer product, OpenServer 6, in June 2005.  This new version provides increased system reliability, backward compatibility with existing applications and software, increased application and hardware support, integration with widely used internet applications and increased system performance.  We anticipate that these enhancements will not have a direct impact on our short-term OpenServer revenue because of the long adoption cycle for new operating system purchases and our long operating system product sales cycle, but we believe that they will help prolong our OpenServer revenue stream for future quarters.

 

SCOsource Business.  During the 2003 fiscal year, we became aware that our UNIX code and derivative works had been inappropriately included in the Linux operating system.  We believe the inclusion of our UNIX code and derivative works in Linux has been a major contributor to the decline in our UNIX business because users of Linux generally do not pay for the operating system but pay only minimal fees, if any, for service and maintenance.  The Linux operating system competes directly with our OpenServer and UnixWare products and has taken significant market share from these products.

 

In an effort to protect our UNIX intellectual property, we initiated our SCOsource business.  The initiatives of this business include seeking to enter into license agreements with UNIX vendors and offering SCOsource IP licenses to Linux and other end users allowing them to continue to use our UNIX source code and derivative works found in Linux.  We believe that our SCOsource licensing revenue opportunities have been adversely impacted by our outstanding dispute with Novell over our UNIX copyright ownership, which may have caused many potential customers to delay or forego licensing until an outcome in this legal matter has been reached.

 

26



 

During fiscal year 2004, we began assigning direct resources to the SCOsource business for sales and marketing, research and development and general and administrative.  The following table shows the operating results of the SCOsource business for the three and six months ended April 30, 2005 and 2004 (in thousands):

 

 

 

Three Months Ended April 30,

 

Six Months Ended April 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

30

 

$

11

 

$

100

 

$

31

 

Cost of revenue

 

2,889

 

4,567

 

6,382

 

8,090

 

Gross deficit

 

(2,859

)

(4,556

)

(6,282

)

(8,059

)

Sales and marketing

 

7

 

581

 

154

 

591

 

Research and development

 

90

 

71

 

202

 

98

 

General and administrative

 

170

 

 

261

 

22

 

Other

 

 

 

 

 

Total operating expenses

 

267

 

652

 

617

 

711

 

Loss from operations

 

$

(3,126

)

$

(5,208

)

$

(6,899

)

$

(8,770

)

 

Revenue from our SCOsource business increased from $11,000 in the second quarter of fiscal year 2004 to $30,000 for the second quarter of fiscal year 2005 and increased from $31,000 in the first two quarters of fiscal year 2004 to $100,000 for the first two quarters of fiscal year 2005.  Revenue in the above-mentioned periods was primarily attributable to sales of our SCOsource IP licenses.  Because of the uncertainties related to our SCOsource business, we are unable to estimate the amount and timing of future SCOsource licensing revenue.

 

This uncertainty represents a significant risk and challenge for us, both in the short and long term.  If we do receive revenue from this source, it may be sporadic and fluctuate from quarter to quarter.  Our SCOsource initiatives are unlikely to produce a stable or predictable revenue stream for the foreseeable future.  We are unlikely to generate significant revenue from our SCOsource business unless and until we prevail in our SCO Litigation with IBM, Red Hat, Novell, Daimler Chrysler and AutoZone.  Additionally, the success of these initiatives may depend on the strength of our intellectual property rights and contractual claims regarding UNIX, including the strength of our claim that unauthorized UNIX source code and derivative works are prevalent in Linux.

 

Cost of revenue, which primarily includes legal and professional fees incurred in connection with the SCO Litigation, decreased from $4,567,000 in the second quarter of fiscal year 2004 to $2,889,000 in the second quarter of fiscal year 2005 and decreased from $8,090,000 in the first two quarters of fiscal year 2004 to $6,382,000 in the first two quarters of fiscal year 2005.  The decrease in cost of revenue is primarily attributable to our modified fee agreement with the law firms representing us in the SCO Litigation that has significantly reduced our ongoing and future operating expenses.  Operating expenses for sales and marketing, research and development and general and administrative decreased in the second quarter of and first two quarters of fiscal year 2005 from the second quarter and first two quarters of fiscal year 2004, which was attributable to decreased personnel and related costs.

 

Our future success with our SCOsource initiatives and future revenue from SCOsource initiatives will depend on our ability to protect our UNIX intellectual property.

 

Critical Accounting Policies

 

Our critical accounting policies and estimates include the following:

 

                  Revenue recognition;

 

                  Deferred income taxes and related valuation allowances;

 

                  Severance and exit costs;

 

                  Impairment of long-lived assets; and

 

27



 

                  Allowances for doubtful accounts.

 

Revenue Recognition.  We recognize revenue in accordance with Statement of Accounting Position, or SOP, 97-2, as modified by SOP 98-9.  Revenue recognition in accordance with these pronouncements is complex due to the nature and variability of our sales transactions.  We recognize products revenue upon shipment if a signed contract exists, the fee is fixed or determinable, collection of the resulting receivable is probable and product returns are reasonably estimable.

 

The majority of our revenue transactions relate to product–only sales.  On occasion we have revenue transactions that include multiple elements (such as products, maintenance, technical support services and other services).  For software agreements that have multiple elements, we allocate revenue to each component of the contract based on vendor specific objective evidence, or VSOE.  VSOE is established when such elements are sold separately.  We recognize revenue when the criteria for product revenue recognition set forth above have been met.  If VSOE of all undelivered elements exists, but VSOE does not exist for one or more delivered elements, then revenue is recognized using the residual method.  Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the license fee is recognized as revenue in the period when persuasive evidence of an arrangement is obtained assuming all other revenue recognition criteria are met.  We recognize revenue allocated to undelivered products when the criteria for revenue recognition set forth above have been met.

 

Estimates used in revenue recognition include the determination of credit-worthiness of our customers, verification of sales-out reporting to end users through our two-tier distribution channel and the estimation of potential returns.  In addition to these estimates, we also provide reserves against revenue based on historical trends and experience.  To the extent our estimates are incorrect, or we are not able to maintain VSOE, our recognized revenue could be adversely impacted and would harm our results of operations.  Additionally, if our business conditions change or our revenue contracts begin to contain more multiple elements, our revenue recognition in future periods may be impacted because a larger component of revenue may be deferred.

 

Deferred Income Taxes and Related Valuation Allowance.  The amount, and ultimate realization, of our deferred income tax assets depends, in part, upon the tax laws in effect, our future earnings and other future events, the effects of which cannot be determined.  We have provided a valuation allowance of $66,655,000 against our entire net deferred tax asset as of October 31, 2004.  The valuation allowance was recorded because of our history of net operating losses and the uncertainties regarding our future operating profitability and taxable income.

 

Severance and Exit Costs.  Since fiscal year 2001, we have undertaken significant restructuring activities to reduce our ongoing cost of operations.  All restructurings that occurred prior to fiscal year 2003 were accounted for in accordance with Emerging Issues Task Force, or EITF, No. 94-3 “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.”  For restructuring activities initiated beginning with fiscal year 2003, we have accounted for the one-time termination benefits, contract termination costs and other associated costs in accordance with SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.”  Other severance benefits have been accounted for in accordance with SFAS No. 112 “Employers’ Accounting for Postemployment Benefits” and SFAS No. 88 “Employers’ Accounting for Settlements and Curtailments of Defined Benefit Plans and for Termination Benefits.”

 

Each restructuring has required us to make estimates and assumptions related to losses on vacated facilities, provisions for termination benefits, outplacement costs and other costs.  Pursuant to the relevant accounting literature, we may record an accrual for amounts associated with a restructuring that are not paid in the current period.  We regularly evaluate the adequacy of the accruals based on changes in estimates.  We may incur future charges for new restructuring activities.  As of April 30, 2005, we did not have any amounts accrued for severance and exit costs.

 

Impairment of Long-lived Assets.  We review our long-lived assets for impairment when events or changes in circumstances indicate that the book value of an asset may not be recoverable.  We evaluate, at each balance sheet date, whether events and circumstances have occurred which indicate possible impairment.  The carrying value of a long-lived asset is considered impaired when the anticipated cumulative undiscounted cash flows of the related asset or group of assets is less than the carrying value.  In that event, a loss is recognized based on the amount by which the carrying value exceeds the estimated fair market value of the long-lived asset.

 

28



 

Write-downs of intangible assets may be necessary if the future fair value of these assets is less than carrying value.  If the operating trends for our UNIX or SCOsource businesses continue to decline, we may be required to record an impairment charge in a future period related to the carrying value of our long-lived assets.

 

Allowance for Doubtful Accounts.  We offer credit terms on the sale of our products to a majority of our customers and require no collateral from these customers.  We perform ongoing credit evaluations of our customers’ financial condition and maintain an allowance for doubtful accounts based upon our historical collection experience and expected collectibility of all accounts receivable and have applied these policies consistently throughout the last three fiscal years.  Our allowance for doubtful accounts, which is determined based on our historical experience and a specific review of customer balances, was $149,000 as of April 30, 2005.  Our past experience has resulted in minimal differences from the actual amounts provided for bad debts and our recorded estimates.  However, our actual bad debts in future periods may differ from our current estimates and the differences may be material, which may have an adverse impact on our future accounts receivable and cash position.

 

Results of Operations

 

The following table presents our results of operations for the three and six months ended April 30, 2005 and 2004 (in thousands):

 

 

 

Three Months Ended April 30,

 

Six Months Ended April 30,

 

Statement of Operations Data:

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

Products

 

$

7,838

 

$

8,415

 

$

15,142

 

$

18,127

 

SCOsource licensing

 

30

 

11

 

100

 

31

 

Services

 

1,390

 

1,711

 

2,881

 

3,371

 

Total revenue

 

9,258

 

10,137

 

18,123

 

21,529

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

Products

 

563

 

818

 

1,207

 

1,623

 

SCOsource licensing

 

2,889

 

4,567

 

6,382

 

8,090

 

Services

 

746

 

1,073

 

1,495

 

2,395

 

Total cost of revenue

 

4,198

 

6,458

 

9,084

 

12,108

 

Gross margin

 

5,060

 

3,679

 

9,039

 

9,421

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

2,963

 

4,698

 

5,900

 

9,719

 

Research and development

 

2,117

 

2,868

 

4,197

 

5,575

 

General and administrative

 

2,036

 

1,710

 

3,799

 

3,904

 

Loss on disposition of long-lived assets

 

 

2,139

 

 

2,139

 

Severance and exit costs

 

 

682

 

 

682

 

Amortization of intangibles

 

593

 

593

 

1,186

 

1,380

 

Stock-based compensation

 

7

 

163

 

22

 

598

 

Total operating expenses

 

7,716

 

12,853

 

15,104

 

23,997

 

Loss from operations

 

(2,656

)

(9,174

)

(6,065

)

(14,576

)

Equity in income of affiliate

 

17

 

37

 

70

 

74

 

Other income, net

 

800

 

2,422

 

1,309

 

6,185

 

Provision for income taxes

 

(123

)

(966

)

(237

)

(1,094

)

Net loss

 

(1,962

)

(7,681

)

(4,923

)

(9,411

)

Dividends on redeemable convertible preferred stock

 

 

(7,045

)

 

(7,801

)

Net loss applicable to common stockholders

 

$

(1,962

)

$

(14,726

)

$

(4,923

)

$

(17,212

)

 

29



 

THREE AND SIX MONTHS ENDED APRIL 30, 2005 AND 2004

 

Revenue

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Revenue

 

$

9,258,000

 

(9

)%

$

10,137,000

 

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Revenue

 

$

18,123,000

 

(16

)%

$

21,529,000

 

 

Revenue for the second quarter of fiscal year 2005 decreased by $879,000, or 9 percent, from the second quarter of fiscal year 2004, and revenue for the first two quarters of fiscal year 2005 decreased by $3,406,000, or 16 percent, from the first two quarters of fiscal year 2004.  These decreases were primarily attributable to a continued decline in our UNIX business.

 

Revenue generated from our UNIX business and SCOsource business is as follows:

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

UNIX revenue

 

$

9,228,000

 

(9

)%

$

10,126,000

 

Percent of total revenue

 

100

%

 

 

100

%

SCOsource revenue

 

30,000

 

173

%

11,000

 

Percent of total revenue

 

0

%

 

 

0

%

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

UNIX revenue

 

$

18,023,000

 

(16

)%

$

21,498,000

 

Percent of total revenue

 

99

%

 

 

100

%

SCOsource revenue

 

100,000

 

223

%

31,000

 

Percent of total revenue

 

1

%

 

 

0

%

 

The decrease in revenue in the UNIX business of $898,000 for the second quarter of fiscal year 2005 compared to the second quarter of fiscal year 2004 and the decrease in UNIX revenue of $3,475,000 for the first two quarters of fiscal year 2005 compared to the first two quarters of fiscal year 2004 was primarily attributable to continued competition from other operating systems, particularly Linux.  We anticipate that for the remainder of fiscal year 2005 our UNIX business and the related revenue from the UNIX business will face significant competition from Linux and other operating systems.  The increase in SCOsource revenue for the second quarter and first two quarters of fiscal year 2005 compared to the second quarter and first two quarters of fiscal year 2004 was primarily attributable to increased sales of SCO IP licenses.

 

Sales of our UNIX products and services during the second quarter and first two quarters of fiscal year 2005 were primarily to pre-existing customers.  Our UNIX business revenue depends significantly on our ability to market our products to existing customers and to generate upgrades from existing customers.  Our UNIX revenue may be lower than currently anticipated if we are not successful with our existing customers or if we lose the support of any of our existing hardware and software vendors or our key industry partners withdraw their marketing and certification support or direct their support to our competitors.  This may occur as a result of the decline of our UNIX business and our SCOsource initiatives.

 

30



 

Products Revenue

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Products revenue

 

$

7,838,000

 

(7

)%

$

8,415,000

 

Percent of total revenue

 

85

%

 

 

83

%

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Products revenue

 

$

15,142,000

 

(16

)%

$

18,127,000

 

Percent of total revenue

 

84

%

 

 

84

%

 

Our products revenue consists of software licenses for UNIX products such as OpenServer and UnixWare, as well as sales of UNIX-related products.  Products revenue also includes revenue derived from OEMs, distribution partners and large accounts.  We rely heavily on our two-tier distribution channel and any disruption in our distribution channel could have an adverse impact on future revenue.

 

The decrease in products revenue of $577,000 from the second quarter of fiscal year 2005 compared to the second quarter of fiscal year 2004 and the decrease of $2,985,000 from the first two quarters of fiscal year 2005 compared to the first two quarters of fiscal year 2004 was primarily attributable to decreased sales of OpenServer and UnixWare products primarily resulting from increased competition in the operating system market, particularly Linux.  We believe that this competition from Linux and other operating systems will continue for the remainder of fiscal year 2005 and future periods.

 

Our products revenue was derived primarily from sales of our OpenServer and UnixWare products.  Other products revenue consists mainly of product maintenance and other UNIX-related products.  Revenue for these products was as follows:

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

OpenServer revenue

 

$

4,664,000

 

2

%

$

4,580,000

 

Percent of products revenue

 

60

%

 

 

54

%

UnixWare revenue

 

2,391,000

 

(1

)%

2,425,000

 

Percent of products revenue

 

30

%

 

 

29

%

Other products revenue

 

783,000

 

(44

)%

1,410,000

 

Percent of products revenue

 

10

%

 

 

17

%

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

OpenServer revenue

 

$

8,677,000

 

(11

)%

$

9,782,000

 

Percent of products revenue

 

57

%

 

 

54

%

UnixWare revenue

 

4,527,000

 

(12

)%

5,163,000

 

Percent of products revenue

 

30

%

 

 

28

%

Other products revenue

 

1,938,000

 

(39

)%

3,182,000

 

Percent of products revenue

 

13

%

 

 

18

%

 

OpenServer and UnixWare revenue for the second quarter of fiscal year 2005 was essentially flat as compared to the second quarter of fiscal year 2004.  The decrease in other products revenue for the second quarter of fiscal year 2005 compared to the second quarter of fiscal year 2004 was primarily attributable to decreased product maintenance sales.

 

31



 

The decreases in revenue for the first two quarters of fiscal year 2005 as compared to the first two quarters of fiscal year 2004 for OpenServer, UnixWare and other products are all primarily the result of continued competition from other operating systems, particularly Linux.

 

SCOsource Licensing Revenue

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

SCOsource licensing revenue

 

$

30,000

 

173

%

$

11,000

 

Percent of total revenue

 

0

%

 

 

0

%

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

SCOsource licensing revenue

 

$

100,000

 

223

%

$

31,000

 

Percent of total revenue

 

1

%

 

 

0

%

 

We initiated our SCOsource business for the purpose of protecting our intellectual property rights in our UNIX source code and derivative works.  SCOsource licensing revenue was $30,000 in the second quarter of fiscal year 2005 compared to revenue of $11,000 generated in the second quarter of fiscal year 2004.  SCOsource licensing revenue was $100,000 in the first two quarters of fiscal year 2005 compared to revenue of $31,000 in the first two quarters of fiscal year 2004.  Our SCOsource licensing revenue was primarily generated from the sales of SCO IP licenses.

 

We are unable to predict the amount and timing of future SCOsource licensing revenue, and when generated, the revenue will be sporadic.

 

Services Revenue

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Services revenue

 

$

1,390,000

 

(19

)%

$

1,711,000

 

Percent of total revenue

 

15

%

 

 

17

%

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Services revenue

 

$

2,881,000

 

(15

)%

$

3,371,000

 

Percent of total revenue

 

16

%

 

 

16

%

 

Services revenue consists primarily of annual and incident technical support fees, engineering services fees, professional services and consulting fees, and education fees.  These fees are typically charged and invoiced separately from UNIX products sales.  The decrease in services revenue of $321,000, or 19 percent, from the second quarter of fiscal year 2004 as compared to the second quarter of fiscal year 2005 and the decrease in services revenue of $490,000, or 15 percent, from the first two quarters of fiscal year 2004 as compared to the first two quarters of fiscal year 2005, was in part due to the decrease in products revenue, fewer customers renewing services agreements and a decrease in professional services revenue.

 

The majority of our support and professional services revenue continues to be derived from services for UNIX-based operating system products.  Our future level of services revenue depends in part on our ability to generate UNIX products revenue from new customers as well as to renew annual support and services agreements with existing UNIX customers.

 

32



 

Cost of Products Revenue

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Cost of products revenue

 

$

563,000

 

(31

)%

$

818,000

 

Percentage of products revenue

 

7

%

 

 

10

%

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Cost of products revenue

 

$

1,207,000

 

(26

)%

$

1,623,000

 

Percentage of products revenue

 

8

%

 

 

9

%

 

Cost of products revenue consists of manufacturing costs, royalties to third-party vendors, technology costs and overhead costs.  Cost of products revenue decreased by $255,000, or 31 percent, in the second quarter of fiscal year 2005 as compared to the second quarter of fiscal year 2004 and decreased by $416,000, or 26 percent, in the first two quarters of fiscal year 2005 compared to the first two quarters of fiscal year 2004.  This decrease in the dollar amount of cost of products revenue was primarily attributable to lower products revenue, lower manufacturing costs, decreased royalties to third party vendors and lower amortized technology costs.

 

For the remaining quarters of fiscal year 2005, we expect the dollar amount of our cost of products revenue to be generally consistent with cost of products revenue incurred in the second quarter of fiscal year 2005 and that cost of products revenue as a percentage of products revenue for the remaining quarters of fiscal year 2005 will be generally consistent to that incurred in the second quarter of fiscal year 2005.

 

Cost of SCOsource Licensing Revenue 

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Cost of SCOsource licensing revenue

 

$

2,889,000

 

(37

)%

$

4,567,000

 

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Cost of SCOsource licensing revenue

 

$

6,382,000

 

(21

)%

$

8,090,000

 

 

Cost of SCOsource licensing revenue includes legal and professional fees incurred in connection with our SCO Litigation, the salaries and related personnel costs of SCOsource employees, and an allocation of corporate costs.

 

Cost of SCOsource licensing revenue decreased by $1,678,000 during the second quarter of fiscal year 2005 as compared to the second quarter of fiscal year 2004 and decreased by $1,708,000 during the first two quarters of fiscal year 2005 as compared to the first two quarters of fiscal year 2004.  The decrease in costs in the second quarter of fiscal year 2005 compared to the second quarter of fiscal year 2004 was primarily attributable to decreased legal costs incurred in connection with our SCO Litigation as a result of our modified engagement agreement with the law firms representing us in the SCO Litigation.

 

According to the terms of our engagement agreement with the law firms described in more detail below in “—Liquidity and Capital Resources,” we anticipate that the dollar amount of our cost of SCOsource licensing for the remaining quarters of fiscal year 2005 will be generally consistent with the costs incurred in the first and second quarters of fiscal year 2005.  However, future legal fees may include contingency payments made to the law firms as a result of a settlement, judgment, certain licensing fees or a sale of our company, which could cause cost of SCOsource licensing revenue to be higher than anticipated.

 

33



 

Cost of Services Revenue

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Cost of services revenue

 

$

746,000

 

(30

)%

$

1,073,000

 

Percentage of services revenue

 

54

%

 

 

63

%

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Cost of services revenue

 

$

1,495,000

 

(38

)%

$

2,395,000

 

Percentage of services revenue

 

52

%

 

 

71

%

 

Cost of services revenue includes the salaries and related personnel costs of employees delivering services revenue as well as third-party service agreements.  Cost of services revenue decreased by $327,000, or 30 percent, for the second quarter of fiscal year 2005 compared to the second quarter of fiscal year 2004 and decreased by $900,000, or 38 percent, for the first two quarters of fiscal year 2005 compared to the first two quarters of fiscal year 2004.  This decrease was primarily attributable to reduced employee and related costs.

 

For the remaining quarters of fiscal year 2005, we expect the dollar amount of our cost of services revenue to be generally consistent to cost of services revenue incurred in the second quarter of fiscal year 2005 and that cost of services revenue as a percentage of services revenue for the remaining quarters of fiscal year 2005 will be generally consistent to that incurred in the second quarter of fiscal year 2005.

 

Sales and Marketing

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Sales and marketing expense

 

$

2,963,000

 

(37

)%

$

4,698,000

 

Percentage of total revenue

 

32

%

 

 

46

%

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Sales and marketing expense

 

$

5,900,000

 

(39

)%

$

9,719,000

 

Percentage of total revenue

 

33

%

 

 

45

%

 

Sales and marketing expenses primarily consist of the salaries, commissions and other personnel costs of employees involved in the revenue generation process, as well as advertising and corporate allocations.  The decrease in sales and marketing expense of $1,735,000, or 37 percent, from the second quarter of fiscal year 2004 compared to the second quarter of fiscal year 2005 and the decrease of $3,819,000, or 39 percent, from the first two quarters of fiscal year 2004 compared to the first two quarters of fiscal year 2005 was primarily attributable to reductions in sales and marketing employees, reduced travel expenses, less commissions and lower advertising costs.  Our sales and marketing full-time equivalent employees decreased from 82 as of April 30, 2004 to 52 as of April 30, 2005.

 

For the remaining quarters of fiscal year 2005, we anticipate that the dollar amount of sales and marketing expense will be generally consistent to that incurred in the second quarter of fiscal year 2005.

 

Research and Development

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Research and development expense

 

$

2,117,000

 

(26

)%

$

2,868,000

 

Percentage of total revenue

 

23

%

 

 

28

%

 

34



 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Research and development expense

 

$

4,197,000

 

(25

)%

$

5,575,000

 

Percentage of total revenue

 

23

%

 

 

26

%

 

Research and development expenses primarily consist of the salaries and benefits of software engineers, consulting expenses and corporate allocations.  Research and development expense decreased by $751,000, or 26 percent, from the second quarter of fiscal year 2005 compared to the second quarter of fiscal year 2004 and decreased by $1,378,000, or 25 percent, from the first two quarters of fiscal year 2005 compared to the first two quarters of fiscal year 2004 and was primarily attributable to work force reductions.  Our research and development full-time equivalent employees decreased from 85 as of April 30, 2004 to 52 as of April 30, 2005.

 

For the remaining quarters of fiscal year 2005, we anticipate that the dollar amount of research and development expense will be generally consistent to that incurred in the second quarter of fiscal year 2005.

 

General and Administrative

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

General and administrative expense

 

$

2,036,000

 

19

%

$

1,710,000

 

Percentage of total revenue

 

22

%

 

 

17

%

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

General and administrative expense

 

$

3,799,000

 

(3

)%

$

3,904,000

 

Percentage of total revenue

 

21

%

 

 

18

%

 

General and administrative expenses primarily consist of the salaries and benefits of finance, human resources, and executive management and expenses for professional services such as legal and accounting and corporate allocations.  General and administrative expense increased by $326,000, or 19 percent, during the second quarter of fiscal year 2005 as compared to the second quarter of fiscal year 2004 and decreased by $105,000, or 3 percent, during the first two quarters of fiscal year 2005 as compared to the first two quarters of fiscal year 2004.  The increase in general and administrative expense during the second quarter of fiscal year 2005 compared to the second quarter of fiscal year 2004 was primarily attributable to legal and accounting costs incurred in connection with the restatement of our 2004 quarterly financial statements.  The decrease in general and administrative expense for the first two quarters of fiscal year 2005 compared to the first two quarters of fiscal year 2004 was primarily attributable to lower personnel and related costs offset by the increased costs related to the restatement mentioned above.  Our general and administrative full-time equivalent employees decreased from 54 as of April 30, 2004 to 29 as of April 30, 2005.

 

For the remaining quarters of fiscal year 2005, we anticipate that the dollar amount of general and administrative expenses will be generally consistent to that incurred in the first quarter of fiscal year 2005 as the second quarter contained non-recurring costs related to the restatement of our 2004 quarterly financial statements.  However, due to the new compliance and reporting regulations under the Sarbanes-Oxley Act and other new regulatory requirements, general and administrative expenses may vary as we implement policies and procedures to comply with these new requirements.

 

Loss on Impairment of Long-lived Assets

 

We recorded a loss on impairment of long-lived assets totaling $2,139,000 for the second quarter and first two quarters of fiscal year 2004.  The impairment related to goodwill and intangible assets acquired in connection with our acquisition of Vultus, Inc. in June 2003.  We concluded that an impairment triggering event occurred during the three months ended April 30, 2004 as an impending partnership that would solidify the Vultus revenue and cash flow opportunities did not materialize.  Consequently, we concluded that no significant future cash flows related to

 

35



 

our Vultus assets would be realized.  We performed an impairment analysis of our recorded goodwill related to the Vultus reporting unit in accordance with SFAS No. 142.  Additionally, an impairment analysis of the intangible assets was performed in accordance with SFAS No. 144.  As a result of these analyses, we wrote-down the carrying value of our goodwill related to our Vultus acquisition from $1,166,000 to $0, and wrote-down the intangible assets related to our Vultus acquisition from $973,000 to $0.

 

We did not incur any impairment charges in the second quarter or first two quarters of fiscal year 2005.

 

Severance and Exit Costs

 

Severance and exit costs were $0 and $682,000 for the second and first two quarters of fiscal year 2005 and 2004, respectively.  The costs incurred in such periods of fiscal year 2004 were primarily attributable to headcount reductions.

 

The following table shows the activity related to the accrual for severance and exit costs for the first two quarters of fiscal year 2005 (in thousands):

 

 

 

Balance at November 1, 2004

 

Additions

 

Payments

 

Balance at April 30, 2005

 

 

 

 

 

 

 

 

 

 

 

Ongoing severance and other

 

$

401

 

$

 

$

(401

)

$

 

 

Amortization of Intangibles

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Amortization of intangibles

 

$

593,000

 

0

%

$

593,000

 

Percentage of total revenue

 

6

%

 

 

6

%

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Amortization of intangibles

 

$

1,186,000

 

(14

)%

$

1,380,000

 

Percentage of total revenue

 

7

%

 

 

6

%

 

During the second quarter of fiscal years 2005 and 2004, we recorded $593,000 for the amortization of intangible assets with definite lives.  For the first two quarters of fiscal years 2005 and 2004, we recorded $1,186,000 and $1,380,000, respectively, in amortization.  The decrease of $194,000, or 14 percent, from the first two quarters of fiscal year 2005 compared to the first two quarters of fiscal year 2004 was primarily attributable to reduced amortization expense recorded on certain assets acquired from Vultus in June 2003 that were written down to $0 during fiscal year 2004.

 

Stock-based Compensation

 

 

 

Three Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

$

7,000

 

(96

)%

$

163,000

 

Percentage of total revenue

 

0

%

 

 

2

%

 

 

 

Six Months Ended April 30,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

$

22,000

 

(96

)%

$

598,000

 

Percentage of total revenue

 

0

%

 

 

3

%

 

36



 

Stock-based compensation consisted of the following components for the second and first two quarters of fiscal years 2005 and 2004 (in thousands):

 

 

 

Three Months Ended April 30,

 

Six Months Ended April 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Amortization of stock-based compensation

 

$

7

 

$

113

 

$

22

 

$

223

 

Options, warrants and shares for services

 

 

50

 

 

283

 

Modifications to options

 

 

 

 

92

 

Total

 

$

7

 

$

163

 

$

22

 

$

598

 

 

As of April 30, 2005, we had amortized all amounts related to deferred compensation.

 

Equity in Income (Losses) of Affiliate

 

We account for our ownership interests in companies in which we own at least 20 percent and less than 50 percent using the equity method of accounting.  Under the equity method, we record our portion of the entities’ net income or net loss in our consolidated statements of operations.  As of April 30, 2005, the carrying value of our investments was related to our 30 percent ownership in a Chinese company.

 

During the second quarter of fiscal years 2005 and 2004, we recorded $17,000 and $37,000, respectively, that related to equity in income of this entity, and during the first two quarters of fiscal years 2005 and 2004, we recorded $70,000 and $74,000, respectively.

 

Other Income (Expense), net

 

Other income (expense), net consisted of the following components for the second and first two quarters of fiscal years 2005 and 2004 (in thousands):

 

 

Three Months Ended April 30,

 

Six Months Ended April 30,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

98

 

$

242

 

$

135

 

$

512

 

Change in fair value of derivative

 

 

2,300