S-1 1 a05-22209_1s1.htm REGISTRATION STATEMENT FOR FACE-AMOUNT CERTIFICATE COMPANIES

As filed with the Securities Exchange Commission on December 22, 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

 

7372

 

87-0662823

(State or other jurisdiction of
incorporation or organization)

 

(Primary Standard Industrial
Classification Code Number)

 

(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:

From time to time after this Registration Statement becomes effective.

 

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. o

 

If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. o

 

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(2)

 

Amount of
Registration
Fee

 

Common Stock, $0.001 par value per share(3)

 

2,852,449

 

$

3.95

 

$

11,267,173.55

 

$

1,205.59

 


(1)                                  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)                                  Estimated based upon the average of the high and low sales prices of the Registrant’s common stock on December 20, 2005, as reported by the Nasdaq Capital Market, pursuant to Rule 457(c) promulgated under the Securities Act of 1933, as amended.

 

(3)                                  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 prospectus 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 prospectus 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 December 22, 2005

 


 

THE SCO GROUP, INC.

 

2,852,449 SHARES OF COMMON STOCK

 


 

This prospectus relates to the sale, transfer or distribution of up to 2,852,449 shares of the common stock, par value $0.001 per share, of The SCO Group, Inc. by the selling stockholders described herein.  The price at which the selling stockholders may sell the shares will be determined by the prevailing market price for the shares or in negotiated transactions.  We will not receive any proceeds from the sale or distribution of the common stock by the selling stockholders.

 

Our common stock is quoted on The Nasdaq Capital Market under the trading symbol “SCOX.”  On December 20, 2005, the last price for our common stock, as reported by The Nasdaq Capital Market, was $3.95.

 


 

The shares of common stock offered or sold under this prospectus involve a high degree of risk.  You should carefully consider the risk factors beginning on page 4 of this prospectus before purchasing any of the shares of common stock offered under this prospectus.

 

The shares of common stock may be sold through broker-dealers or in privately negotiated transactions in which commissions and other fees may be charged.  These fees, if any, will be paid by the selling stockholders.  The SCO Group, Inc. has no agreement with a broker-dealer with respect to these shares and is unable to estimate the commissions that may be paid in any given transaction.

 

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 prospectus.  Any representation to the contrary is a criminal offense.

 

The information in this prospectus is not complete and may be changed.  The selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective.  This prospectus 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.

 


 

The date of this prospectus is                , 2005

 



 

TABLE OF CONTENTS

 

PROSPECTUS SUMMARY

 

RISK FACTORS

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

USE OF PROCEEDS

 

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

 

SELLING STOCKHOLDERS

 

PLAN OF DISTRIBUTION

 

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 prospectus.  We have not, and the selling stockholders 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, and the selling stockholders are not, making an offer to sell these securities in any jurisdiction where the offer or sale is not permitted.  You should assume that the information appearing in this prospectus is accurate only as of the date on the front cover of this prospectus.  Our business, financial condition, results of operations and prospects may have changed since that date.

 

As used in this prospectus, “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.

 



 

PROSPECTUS SUMMARY

 

This summary does not contain all of the information you should consider before investing in our common stock.  You should read the entire prospectus, including the risks discussed under the caption “Risk Factors” and our consolidated financial statements and the related notes included elsewhere in this prospectus, for important information regarding our company and our common stock before making the decision to invest.

 

THE SCO GROUP, INC.

 

Unix Business

 

Our UNIX business primarily serves the needs of small-to-medium sized businesses, including replicated site franchisees of Fortune 1000 companies, by providing reliable, cost effective UNIX software technology for distributed, embedded and network-based systems.  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 companies 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 quarters 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.

 

SCOsource Business

 

During the year ended October 31, 2003, 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 fees for services, distribution and maintenance.  The Linux operating system competes directly with our UNIX 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 agreements 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 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.

 

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.  Based on similar violations, we also sent termination letters to Sequent and Silicon Graphics.  We have also commenced litigation against Novell and others to protect our intellectual property and contractual rights.

 

Recent Developments

 

We discovered in 2005 that we had 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 had a right to rescind their purchases of shares under the ESPP or recover damages if they no longer owned the shares, subject to applicable statutes of limitations.

 

1



 

In December 2005, we offered to rescind a total of 337,289 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 represented all of the ESPP shares we issued to residents of these states for which a purchaser could claim a rescission right.  The rescission offer was intended to address our 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 or recover damages, as the case may be.

 

Our rescission offer is expected to conclude on January 20, 2006.  As a result of the rescission offer, we believe we will extinguish our liability to anyone to whom the rescission offer was made for noncompliance with the registration or qualification requirements of federal and state securities laws as they relate to the shares issued under our ESPP.

 

The Offering

 

Common stock offered by the selling stockholders

 

2,852,449 shares

 

Use of proceeds

 

We will not receive any proceeds from the sale of the common stock by the selling stockholders.

 

Risk factors

 

See “Risk Factors” and the other information included in this prospectus for a discussion of the factors you should consider carefully before deciding to invest in shares of our common stock.

 

Nasdaq Capital 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 prospectus.

 

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 prospectus.

 

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 prospectus. The selected financial data as of July 31, 2005 and for the nine months ended July 31, 2005 and 2004 have been derived from unaudited financial statements in this prospectus. 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 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.

 

 

 

Nine Months
Ended
July 31,

 

Years Ended October 31,

 

 

 

2005

 

2004

 

2004

 

2003

 

2002

 

2001

 

2000

 

 

 

(In thousands, except per share data)

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

27,476

 

$

32,734

 

$

42,809

 

$

79,254

 

$

64,241

 

$

40,441

 

$

4,274

 

Gross margin

 

$

13,912

 

$

11,611

 

$

15,711

 

$

59,332

 

$

45,925

 

$

25,518

 

$

253

 

Income (loss) from operations

 

$

(8,307

)

$

(21,963

)

$

(28,573

)

$

3,436

 

$

(24,176

)

$

(133,636

)

$

(31,999

)

Net income available (loss applicable) to common stockholders

 

$

(7,295

)

$

(9,711

)

$

(16,227

)

$

5,304

 

$

(24,877

)

$

(131,357

)

$

(39,176

)

Basic net income (loss) per common share

 

$

(0.41

)

$

(0.67

)

$

(1.07

)

$

0.43

 

$

(1.93

)

$

(10.92

)

$

(4.76

)

Diluted net income (loss) per common share

 

$

(0.41

)

$

(0.67

)

$

(1.07

)

$

0.34

 

$

(1.93

)

$

(10.92

)

$

(4.76

)

Weighted average basic common shares

 

17,885

 

14,389

 

15,155

 

12,261

 

12,893

 

12,024

 

8,231

 

Weighted averaged diluted common shares

 

17,885

 

14,389

 

15,155

 

15,679

 

12,893

 

12,024

 

8,231

 

 

2



 

 

 

As of July 31,

 

As of October 31,

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

2000

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

6,526

 

$

12,693

 

$

64,428

 

$

6,589

 

$

20,541

 

$

36,560

 

Working capital (deficit)

 

11,063

 

15,413

 

37,168

 

(6,332

)

14,401

 

88,680

 

Total assets

 

29,008

 

55,400

 

94,952

 

37,406

 

74,859

 

107,518

 

Long-term liabilities

 

340

 

343

 

508

 

1,625

 

5,925

 

 

Redeemable preferred stock

 

 

 

29,671

 

 

 

 

Common stock subject to rescission

 

1,104

 

528

 

 

 

 

 

Total stockholders’ equity

 

14,698

 

21,702

 

19,516

 

8,177

 

34,604

 

102,215

 

 

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RISK FACTORS

 

An investment in our common stock involves significant risks.  You should read and analyze these risk factors carefully before deciding whether to invest in our company.  The following is a description of what we consider our key challenges and risks.

 

We do not have a history of profitable operations.

 

Our year ended October 31, 2003 was the first full year we were profitable in our operating history. Our profitability for the year ended October 31, 2003 resulted primarily from our SCOsource initiatives. For the year ended October 31, 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 nine months ended July 31, 2005 we incurred a loss from operations of $8,307,000 and as of July 31, 2005 had an accumulated deficit of $231,511,000.

 

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.

 

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. 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 action 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 its 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

 

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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.

 

Our engagement agreement with the law firms representing us in the SCO Litigation will require us to spend a significant amount of cash during the year ending October 31, 2005 and could harm our liquidity position.

 

As of July 31, 2005, we had a total of $12,602,000 in cash and cash equivalents and available-for-sale securities and an additional $3,579,000 of 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 three months ending October 31, 2005 we anticipate spending approximately $3,250,000 to fund our SCO Litigation costs. We expect that our UNIX business will generate sufficient cash for the year ending October 31, 2005 to cover our internal costs related to our SCOsource initiatives and SCO Litigation. However, if our UNIX business does not generate cash or we spend additional cash on the SCO Litigation or additional matters, our cash position would be negatively impacted, and our ability to pursue our UNIX business objectives and our SCO Litigation could be harmed.

 

Our future SCOsource licensing revenue is uncertain.

 

We initiated the SCOsource licensing effort in the year ended October 31, 2003 to review the status of UNIX licensing and sublicensing agreements. This effort resulted in the execution of two significant vendor license agreements and generated $25,846,000 in revenue. During the year ended October 31, 2004, our SCOsource licensing revenue declined significantly and was only $829,000 and during the nine months ended July 31, 2005, our SCOsource licensing revenue was only $132,000. 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.

 

5



 

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.

 

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 efforts to establish our intellectual property rights; 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.

 

6



 

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 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. Although under the engagement agreement our obligations to such law firms are limited to approximately $26,000,000 related to certain previously accrued and all future attorney fees and the escrow of $5,000,000 for the payment of any expert, consulting and other expenses to pursue the SCO Litigation, the engagement agreement provides that such 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

 

7



 

                                          seasonal reductions in business activity.

 

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, which 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 three months ended April 30, 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. We have filed an appeal with the Tax Department and believe that our packaged software does not qualify for treatment as royalties and therefore would not be 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 our ESPP that were subject to our 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 $3.95 on December 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 November 30, 2005, we have issued and outstanding options to purchase up to approximately 3,813,000 shares of common stock with an average exercise price of $4.17 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 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 resale of common shares by the selling stockholders may have an adverse impact on the market value of our stock and the existing holders of our common stock.

 

8



 

The shares that may be sold or distributed pursuant to this registration statement, upon being declared effective by the SEC, will represent approximately 14 percent of our outstanding common stock. The sale of the block of stock to be covered by this 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 our company to be acquired when the acquisition is opposed by our Board of Directors.

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

This prospectus 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 “Prospectus 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 belief that our OpenServer and UnixWare products will continue to provide a future revenue stream 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 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;

 

9



 

                                          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 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;

 

                                          Our intention to continue to review the status of our existing UNIX license agreements with UNIX vendors and pursue large vendor contracts such as those completed during the year ended October 31, 2003;

 

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

 

                                          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 belief that competition from Linux and other operating systems will continue in 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 intention to use our cash and equivalents and available-for-sale securities, as well as the proceeds from this offering to maintain our UNIX business and pursue our SCO Litigation;

 

                                          Our belief that our facilities are adequate for our business; and

 

                                          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.

 

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 prospectus, which reflect our beliefs and expectations only as of the date of this prospectus. 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.

 

10



 

USE OF PROCEEDS

 

The shares of common stock offered by this prospectus will be sold or distributed by the selling stockholders, and the selling stockholders will receive all of the proceeds, if any, from the sales of such shares by them.  We will not receive any proceeds from the sale or distribution of the common stock by the selling stockholders.

 

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 Capital 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 Capital Market, as applicable, for the last three fiscal years.

 

 

 

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

 

Quarter ended July 31, 2005

 

4.22

 

3.50

 

Quarter ended October 31, 2005

 

4.93

 

3.75

 

 

 

 

 

 

 

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 December 20, 2005, the closing sales price for our common stock as reported by The Nasdaq Capital Market was $3.95.  As of December 20, 2005, there were 396 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 prospectus 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 prospectus.

 

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 prospectus. The selected financial data as of July 31, 2005 and for the nine months ended July 31, 2005 and 2004 have been derived from unaudited financial statements in this prospectus. 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 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.

 

11



 

 

 

Nine Months Ended
July 31,

 

Years Ended October 31,

 

 

 

2005

 

2004

 

2004

 

2003

 

2002

 

2001

 

2000

 

 

 

(In thousands, except per share data)

 

Statement of Operations Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

27,476

 

$

32,734

 

$

42,809

 

$

79,254

 

$

64,241

 

$

40,441

 

$

4,274

 

Gross margin

 

$

13,912

 

$

11,611

 

$

15,711

 

$

59,332

 

$

45,925

 

$

25,518

 

$

253

 

Income (loss) from operations

 

$

(8,307

)

$

(21,963

)

$

(28,573

)

$

3,436

 

$

(24,176

)

$

(133,636

)

$

(31,999

)

Net income available (loss applicable) to common stockholders

 

$

(7,295

)

$

(9,711

)

$

(16,227

)

$

5,304

 

$

(24,877

)

$

(131,357

)

$

(39,176

)

Basic net income (loss) per common share

 

$

(0.41

)

$

(0.67

)

$

(1.07

)

$

0.43

 

$

(1.93

)

$

(10.92

)

$

(4.76

)

Diluted net income (loss) per common share

 

$

(0.41

)

$

(0.67

)

$

(1.07

)

$

0.34

 

$

(1.93

)

$

(10.92

)

$

(4.76

)

Weighted average basic common shares

 

17,885

 

14,389

 

15,155

 

12,261

 

12,893

 

12,024

 

8,231

 

Weighted averaged diluted common shares

 

17,885

 

14,389

 

15,155

 

15,679

 

12,893

 

12,024

 

8,231

 

 

 

 

As of July 31,

 

As of October 31,

 

 

 

2005

 

2004

 

2003

 

2002

 

2001

 

2000

 

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

6,526

 

$

12,693

 

$

64,428

 

$

6,589

 

$

20,541

 

$

36,560

 

Working capital (deficit)

 

11,063

 

15,413

 

37,168

 

(6,332

)

14,401

 

88,680

 

Total assets

 

29,008

 

55,400

 

94,952

 

37,406

 

74,859

 

107,518

 

Long-term liabilities

 

340

 

343

 

508

 

1,625

 

5,925

 

 

Redeemable preferred stock

 

 

 

29,671

 

 

 

 

Common stock subject to rescission

 

1,104

 

528

 

 

 

 

 

Total stockholders’ equity

 

14,698

 

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 prospectus.

 

Business Focus

 

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

 

UNIX Business. Our UNIX business primarily serves the needs of small-to-medium sized businesses, including replicated site franchisees of Fortune 1000 companies, by providing reliable, cost effective UNIX software technology for distributed, embedded and network-based systems. 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 quarters 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 nine months ended July 31, 2005 and 2004 (in thousands):

 

12



 

 

 

Three Months Ended July 31,

 

Nine Months Ended July 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

Revenue

 

$

9,321

 

$

10,527

 

$

27,344

 

$

32,025

 

Cost of revenue

 

1,395

 

1,619

 

4,097

 

5,637

 

Gross margin

 

7,926

 

8,908

 

23,247

 

26,388

 

Sales and marketing

 

2,935

 

3,740

 

8,681

 

12,868

 

Research and development

 

1,843

 

2,361

 

5,838

 

7,838

 

General and administrative

 

1,556

 

1,761

 

5,094

 

5,643

 

Other

 

593

 

863

 

1,801

 

5,662

 

Total operating expenses

 

6.927

 

8,725

 

21,414

 

32,011

 

Income (loss) from operations

 

$

999

 

$

183

 

$

1,833

 

$

(5,623

)

 

Revenue from our UNIX business decreased by $1,206,000, or 11 percent, for the three months ended July 31, 2005 compared to the three months ended July 31, 2004 and decreased by $4,681,000, or 15 percent, for the nine months ended July 31, 2005 compared to the nine months ended July 31, 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 declines and our UNIX business is unable to generate positive cash flow, our results of operations 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 $8,725,000 for the three months ended July 31, 2004 to $6,927,000 for the three months ended July 31, 2005 and decreased from $32,011,000 for the nine months ended July 31, 2004 to $21,414,000 for the nine months ended July 31, 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 224 as of July 31, 2004, to 163 as of July 31, 2005. We have taken these headcount reductions and reduced other discretionary spending while still maintaining a worldwide presence. 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 year ended October 31, 2005 was the release of the next major upgrade to our OpenServer product, OpenServer 6, which was completed in June 2005. OpenServer 6 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 year ended October 31, 2003, 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 fees for services, distribution and maintenance. The Linux operating system competes directly with our UNIX 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 agreements 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 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.

 

The following table shows the operating results of the SCOsource business for the three and nine months ended July 31, 2005 and 2004 (in thousands):

 

 

13



 

 

 

Three Months Ended July 31,

 

Nine Months Ended July 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

Revenue

 

$

32

 

$

678

 

$

132

 

$

709

 

Cost of revenue

 

3,085

 

7,396

 

9,467

 

15,486

 

Gross deficit

 

(3,053

)

(6,718

)

(9,335

)

(14,777

)

Sales and marketing

 

 

493

 

154

 

1,084

 

Research and development

 

97

 

231

 

299

 

329

 

General and administrative

 

91

 

128

 

352

 

150

 

Total operating expenses

 

188

 

852

 

805

 

1,563

 

Loss from operations

 

$

(3,241

)

$

(7,570

)

$

(10,140

)

$

(16,340

)

 

Revenue from our SCOsource business decreased from $678,000 for the three months ended July 31, 2004 to $32,000 for the three months ended July 31, 2005 and decreased from $709,000 for the nine months ended July 31, 2004 to $132,000 for the nine months ended July 31, 2005. Revenue in the above-mentioned periods was primarily attributable to sales of our SCOsource IP agreements. Because of the uncertainties related to our SCOsource business, we are unable to estimate the amount and timing of future SCOsource 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 $7,396,000 in the three months ended July 31, 2004 to $3,085,000 in the three months ended July 31, 2005 and decreased from $15,486,000 in the nine months ended July 31, 2004 to $9,467,000 in the nine months ended July 31, 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 three and nine months ended July 31, 2005 from the three and nine months ended July 31, 2004, which was primarily 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

 

                    Allowance for doubtful accounts.

 

Revenue Recognition. We recognize revenue in accordance with Statement of 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

 

14



 

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 the year ended October 31, 2001, we have undertaken significant restructuring activities to reduce our ongoing cost of operations. All restructurings that occurred prior to the year ended October 31, 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 the year ended October 31, 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 July 31, 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 value of the long-lived asset.

 

If the operating trends for our UNIX or SCOsource businesses 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 years ended October 31, 2005, 2004 and 2003. Our allowance for doubtful accounts, which is determined based on our historical experience and a specific review of customer balances, was $109,000 as of July 31, 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.

 

15



 

Results of Operations

 

The following table presents our results of operations for the three and nine months ended July 31, 2005 and 2004 (in thousands):

 

 

 

Three Months Ended July 31,

 

Nine Months Ended July 31,

 

Statement of Operations Data:

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

Products

 

$

7,953

 

$

8,929

 

$

23,095

 

$

27,056

 

SCOsource licensing

 

32

 

678

 

132

 

709

 

Services

 

1,368

 

1,598

 

4,249

 

4,969

 

Total revenue

 

9,353

 

11,205

 

27,476

 

32,734

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

Products

 

695

 

741

 

1,902

 

2,364

 

SCOsource licensing

 

3,085

 

7,396

 

9,467

 

15,486

 

Services

 

700

 

878

 

2,195

 

3,273

 

Total cost of revenue

 

4,480

 

9,015

 

13,564

 

21,123

 

Gross margin

 

4,873

 

2,190

 

13,912

 

11,611

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Sales and marketing

 

2,935

 

4,233

 

8,835

 

13,952

 

Research and development

 

1,940

 

2,592

 

6,137

 

8,167

 

General and administrative

 

1,647

 

1,889

 

5,446

 

5,793

 

Loss on disposition of long-lived assets

 

 

 

 

2,139

 

Severance and exit costs

 

 

 

 

682

 

Amortization of intangibles

 

593

 

593

 

1,779

 

1,973

 

Stock-based compensation

 

 

270

 

22

 

868

 

Total operating expenses

 

7,115

 

9,577

 

22,219

 

33,574

 

Loss from operations

 

(2,242

)

(7,387

)

(8,307

)

(21,963

)

Equity in income (losses) of affiliate

 

(19

)

41

 

51

 

115

 

Other income, net

 

(27

)

99

 

1,282

 

6,284

 

Provision for income taxes

 

(84

)

(176

)

(321

)

(1,270

)

Net loss

 

(2,372

)

(7,423

)

(7,295

)

(16,834

)

Contributions from (dividends on) redeemable convertible preferred stock

 

 

14,924

 

 

7,123

 

Net income attributable (loss applicable) to common stockholders

 

$

(2,372

)

$

7,501

 

$

(7,295

)

$

(9,711

)

 

THREE AND NINE MONTHS ENDED JULY 31, 2005 AND 2004

 

Revenue

 

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Revenue

 

$

9,353,000

 

(17

)%

$

11,205,000

 

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Revenue

 

$

27,476,000

 

(16

)%

$

32,734,000

 

 

Revenue for the three months ended July 31, 2005 decreased by $1,852,000, or 17 percent, from the three months ended July 31, 2004, and revenue for the nine months ended July 31, 2005 decreased by $5,258,000, or 16 percent, from the nine months ended July 31, 2004. These decreases were primarily attributable to a continued decline in the revenue generated from our UNIX business and a decline in revenue from our SCOsource business.

 

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

 

16



 

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

UNIX revenue

 

$

9,321,000

 

(11

)%

$

10,527,000

 

Percent of total revenue

 

100

%

 

 

94

%

SCOsource revenue

 

32,000

 

(95

)%

678,000

 

Percent of total revenue

 

0

%

 

 

6

%

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

UNIX revenue

 

$

27,344,000

 

(15

)%

$

32,025,000

 

Percent of total revenue

 

100

%

 

 

98

%

SCOsource revenue

 

132,000

 

(81

)%

709,000

 

Percent of total revenue

 

0

%

 

 

2

%

 

The decrease in revenue in the UNIX business of $1,206,000 for the three months ended July 31, 2005 compared to the three months ended July 31, 2004 and the decrease in UNIX revenue of $4,681,000 for the nine months ended July 31, 2005 compared to the nine months ended July 31, 2004 was primarily attributable to continued competition from other operating systems, particularly Linux. We anticipate that for future periods our UNIX business and the related revenue from the UNIX business will face significant competition from Linux and other operating systems. The decrease in SCOsource revenue for the three and nine months ended July 31, 2005 compared to the three and nine months ended July 31, 2004 was primarily attributable to decreased sales of SCO IP agreements.

 

Sales of our UNIX products and services during the three and nine months ended July 31, 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.

 

Products Revenue

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Products revenue

 

$

7,953,000

 

(11

)%

$

8,929,000

 

Percent of total revenue

 

85

%

 

 

80

%

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Products revenue

 

$

23,095,000

 

(15

)%

$

27,056,000

 

Percent of total revenue

 

84

%

 

 

83

%

 

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 $976,000 from the three months ended July 31, 2005 compared to the three months ended July 31, 2004 and the decrease in products revenue of $3,961,000 from the nine months ended July 31, 2005 compared to the nine months ended July 31, 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 will continue during in 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:

 

17



 

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

OpenServer revenue

 

$

4,309,000

 

(4

)%

$

4,496,000

 

Percent of products revenue

 

54

%

 

 

50

%

UnixWare revenue

 

2,085,000

 

(30

)%

2,984,000

 

Percent of products revenue

 

26

%

 

 

34

%

Other products revenue

 

1,559,000

 

8

%

1,449,000

 

Percent of products revenue

 

20

%

 

 

16

%

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

OpenServer revenue

 

$

12,987,000

 

(9

)%

$

14,278,000

 

Percent of products revenue

 

56

%

 

 

53

%

UnixWare revenue

 

6,606,000

 

(20

)%

8,240,000

 

Percent of products revenue

 

29

%

 

 

30

%

Other products revenue

 

3,502,000

 

(23

)%

4,538,000

 

Percent of products revenue

 

15

%

 

 

17

%

 

OpenServer revenue for the three and nine months ended July 31, 2005 decreased compared to the three months ended July 31, 2004 and this decrease was primarily attributable to continued competition. UnixWare revenue for the three and nine months ended July 31, 2005 was lower than the three and nine months ended July 31, 2004 primarily as a result of decreased project business. The increase in other products revenue from the three months ended July 31, 2005 compared to the three months ended July 31, 2004 was primarily attributable to the recognition of certain previously deferred amounts for upgrade revenue that were recognized upon the release and shipment of OpenServer 6.  The decrease in other products revenue for the nine months ended July 31, 2005 compared to the nine months ended July 31, 2004 was primarily attributable to decreased maintenance sales.

 

SCOsource Licensing Revenue

 

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

SCOsource licensing revenue

 

$

32,000

 

(95

)%

$

678,000

 

Percent of total revenue

 

0

%

 

 

6

%

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

SCOsource licensing revenue

 

$

132,000

 

(81

)%

$

709,000

 

Percent of total revenue

 

0

%

 

 

2

%

 

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 $32,000 in the three months ended July 31, 2005 compared to revenue of $678,000 generated in the three months ended July 31, 2004. SCOsource licensing revenue was $132,000 in the nine months ended July 31, 2005 compared to revenue of $709,000 in the nine months ended July 31, 2004. Our SCOsource licensing revenue was primarily generated from the sales of SCO IP agreements. During the three and nine months ended July 31, 2004, we entered into one large transaction with a customer for a total of $500,000.

 

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 July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Services revenue

 

$

1,368,000

 

(14

)%

$

1,598,000

 

Percent of total revenue

 

15

%

 

 

14

%

 

18



 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Services revenue

 

$

4,249,000

 

(14

)%

$

4,969,000

 

Percent of total revenue

 

16

%

 

 

15

%

 

Services revenue consists primarily of 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 $230,000, or 14 percent, from the three months ended July 31, 2004 as compared to the three months ended July 31, 2005 and the decrease in services revenue of $720,000, or 14 percent, from the nine months ended July 31, 2004 as compared to the nine months ended July 31, 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.

 

Cost of Products Revenue

 

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Cost of products revenue

 

$

695,000

 

(6

)%

$

741,000

 

Percentage of products revenue

 

9

%

 

 

8

%

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Cost of products revenue

 

$

1,902,000

 

(20

)%

2,364,000

 

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 $46,000, or 6 percent, in the three months ended July 31, 2005 as compared to the three months ended July 31, 2004 and decreased by $462,000, or 20 percent, in the nine months ended July 31, 2005 compared to the nine months ended July 31, 2004. This decrease in the dollar amount of cost of products revenue was primarily attributable to lower products revenue, lower manufacturing costs, and lower amortized technology costs.

 

Cost of SCOsource Licensing Revenue 

 

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

Cost of SCOsource licensing revenue

 

$

3,085,000

 

(58

)%

$

7,396,000

 

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

Cost of SCOsource licensing revenue

 

$

9,467,000

 

(39

)%

$

15,486,000

 

 

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 $4,311,000 during the three months ended July 31, 2005 as compared to the three months ended July 31, 2004 and decreased by $6,019,000 during the nine months ended July 31, 2005 as compared to the nine months ended July 31, 2004. The decrease in costs in the three months ended July 31, 2005 compared to the three months ended July 31, 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.

 

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.

 

19



 

Cost of Services Revenue

 

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Cost of services revenue

 

$

700,000

 

(20

)%

$

878,000

 

Percentage of services revenue

 

51

%

 

 

55

%

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Cost of services revenue

 

$

2,195,000

 

(33

)%

$

3,273,000

 

Percentage of services revenue

 

52

%

 

 

66

%

 

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 $178,000, or 20 percent, for the three months ended July 31, 2005 compared to the three months ended July 31, 2004 and decreased by $1,078,000, or 33 percent, for the nine months ended July 31, 2005 compared to the nine months ended July 31, 2004. This decrease was primarily attributable to reduced employees and related costs.

 

Sales and Marketing

 

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Sales and marketing expense

 

$

2,935,000

 

(31

)%

$

4,233,000

 

Percentage of total revenue

 

31

%

 

 

38

%

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Sales and marketing expense

 

$

8,835,000

 

(37

)%

$

13,952,000

 

Percentage of total revenue

 

32

%

 

 

43

%

 

Sales and marketing expense primarily consists 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 $1,298,000, or 31 percent, from the three months ended July 31, 2004 compared to the three months ended July 31, 2005 and the decrease of $5,117,000, or 37 percent, from the nine months ended July 31, 2004 compared to the nine months ended July 31, 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 73 as of July 31, 2004 to 53 as of July 31, 2005.

 

Research and Development

 

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Research and development expense

 

$

1,940,000

 

(25

)%

$

2,592,000

 

Percentage of total revenue

 

21

%

 

 

23

%

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Research and development expense

 

$

6,137,000

 

(25

)%

$

8,167,000

 

Percentage of total revenue

 

22

%

 

 

25

%

 

20



 

Research and development expense primarily consists of the salaries and benefits of software engineers, consulting expenses and corporate allocations. Research and development expense decreased by $652,000, or 25 percent, from the three months ended July 31, 2005 compared to the three months ended July 31, 2004 and decreased by $2,030,000, or 25 percent, from the nine months ended July 31, 2005 compared to the nine months ended July 31, 2004 and was primarily attributable to work force reductions. Our research and development full-time equivalent employees decreased from 75 as of July 31, 2004 to 50 as of July 31, 2005.

 

General and Administrative

 

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

General and administrative expense

 

$

1,647,000

 

(13

)%

$

1,889,000

 

Percentage of total revenue

 

18

%

 

 

17

%

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

General and administrative expense

 

$

5,446,000

 

(6

)%

$

5,793,000

 

Percentage of total revenue

 

20

%

 

 

18

%

 

General and administrative expense primarily consists 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 decreased by $242,000, or 13 percent, during the three months ended July 31, 2005 as compared to the three months ended July 31, 2004 and decreased by $347,000, or 6 percent, during the nine months ended July 31, 2005 as compared to the nine months ended July 31, 2004. The decrease in general and administrative expense during the three months ended July 31, 2005 compared to the three months ended July 31, 2004 was primarily attributable to decreased personnel and related costs offset by higher legal and accounting costs. The decrease in general and administrative expense for the nine months ended July 31, 2005 compared to the nine months ended July 31, 2004 was primarily attributable to lower personnel and related costs offset by the increased costs for legal and accounting related to the restatement of our quarterly financial statements. Our general and administrative full-time equivalent employees decreased from 41 as of July 31, 2004 to 29 as of July 31, 2005.

 

Loss on Impairment of Long-lived Assets

 

We recorded a loss on impairment of long-lived assets totaling $2,139,000 for the nine months ended July 31, 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 our Vultus assets will 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 three or nine months ended July 31, 2005.

 

Severance and Exit Costs

 

Severance and exit costs were $0 for the three months ended July 31, 2005 and 2004, respectively, and were $0 and $682,000 for the nine months ended July 31, 2005 and 2004, respectively. The costs incurred in the nine months ended July 31, 2004 were primarily attributable to headcount reductions.

 

The following table shows the activity related to the accrual for severance and exit costs for the nine months ended July 31, 2005 (in thousands):

 

21



 

 

 

Balance at
November 1, 2004

 

Additions

 

Payments

 

Balance at
July 31, 2005

 

 

 

 

 

 

 

 

 

 

 

Ongoing severance and other

 

$

401

 

$

 

$

(401

)

$

 

 

Amortization of Intangibles

 

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Amortization of intangibles

 

$

593,000

 

0

%

$

593,000

 

Percentage of total revenue

 

6

%

 

 

5

%

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Amortization of intangibles

 

$

1,779,000

 

(10

)%

$

1,973,000

 

Percentage of total revenue

 

6

%

 

 

6

%

 

During the three months ended July 31, 2005 and 2004, we recorded $593,000 for the amortization of intangible assets with definite lives. For the nine months ended July 31, 2005 and 2004, we recorded $1,779,000 and $1,973,000, respectively, in amortization. The decrease of $194,000, or 10 percent, from the nine months ended July 31, 2005 compared to the nine months ended July 31, 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 the year ended October 31, 2004.

 

Stock-based Compensation

 

 

 

Three Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

$

 

n/a

 

$

270,000

 

Percentage of total revenue

 

0

%

 

 

2

%

 

 

 

Nine Months Ended July 31,

 

 

 

2005

 

Change

 

2004

 

 

 

 

 

 

 

 

 

Stock-based compensation

 

$

22,000

 

(97

)%

$

868,000

 

Percentage of total revenue

 

0

%

 

 

3

%

 

Stock-based compensation consisted of the following components for the three and nine months ended July 31, 2005 and 2004:

 

 

 

Three Months Ended July 31,

 

Nine Months Ended July 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Amortization of stock-based compensation

 

$

 

$

51,000

 

$

22,000

 

$

274,000

 

Options, warrants and shares for services

 

 

219,000

 

 

502,000

 

Modifications to options

 

 

 

 

92,000

 

Total

 

$

 

$

270,000

 

$

22,000

 

$

868,000

 

 

As of July 31, 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 and comprehensive loss. As of July 31, 2005, the carrying value of our investments was related to our 30 percent ownership in a Chinese company.

 

During the three months ended July 31, 2005 and 2004, we recorded ($19,000) and $41,000, respectively, that related to equity in income (losses) of this entity, and during the nine months ended July 31, 2005 and 2004, we recorded $51,000 and $115,000 of equity in income of this entity, respectively.

 

22



 

Other Income (Expense), net

 

Other income (expense), net, consisted of the following components for the three and nine months ended July 31, 2005 and 2004:

 

 

 

Three Months Ended July 31,

 

Nine Months Ended July 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Interest income

 

$

122,000

 

$

186,000

 

$

257,000

 

$

698,000

 

Change in fair value of derivative

 

 

 

 

5,924,000

 

Other income (expense), net

 

(149,000

)

(87,000

)

1,025,000

 

(338,000

)

Total

 

$

(27,000

)

$

99,000

 

$

1,282,000

 

$

6,284,000

 

 

Interest income decreased by $64,000 from the three months ended July 31, 2004 to the three months ended July 31, 2005 and decreased by $441,000 from the nine months ended July 31, 2004 to the nine months ended July 31, 2005 and was primarily attributable to a decrease in our cash and available-for-sale securities balances.

 

The income recorded on the change in fair value of derivative of $5,924,000 for the nine months ended July 31, 2004 related to the decrease in fair value of this instrument and marking it to market at each balance sheet date. The derivative financial instrument was eliminated during the three months ended April 30, 2004.

 

The increase in other income (expense), net, for the nine months ended July 31, 2005 compared to the nine months ended July 31, 2004 was primarily attributable to two items: (1) the collection of a note receivable from Vintela, Inc. as described in more detail in Note 9 to our unaudited condensed consolidated financial statements below in “Financial Statements and Supplementary Data”, which note receivable was originally received in April 2003, but because we received the note receivable in exchange for the transfer of certain software to a related party and there was substantial doubt concerning the ability of Vintela to repay the note, no gain was recognized until the three months ended January 31, 2005 when we received payment; and (2) the sale of shares we held in Troll Tech AS as described in more detail in Note 4 to our unaudited condensed consolidated financial statements below in “Financial Statements and Supplementary Data”. The Troll Tech shares had been written off in the year ended October 31, 2001, but because they were sold during the three months ended July 31, 2005, we recorded income on the proceeds received.

 

Provision for Income Taxes

 

The provision for income taxes was $84,000 in the three months ended July 31, 2005 and $176,000 in the three months ended July 31, 2004. The provision for income taxes was $321,000 in the nine months ended July 31, 2005 and $1,270,000 in the nine months ended July 31, 2004. Our provision for income taxes is primarily related to earnings in foreign subsidiaries and withholding taxes on revenue generated in certain locations. The decrease in the provision for income taxes for the nine months ended July 31, 2005 as compared to the nine months ended July 31, 2004 is attributable to an accrual for withholding taxes of approximately $710,000 that was made in the three months ended April 30, 2004, which taxes were estimated to be paid in connection with the operations of the Indian branch of our United Kingdom subsidiary, SCO Group, Ltd.

 

Dividends Related to Series A Convertible Preferred Stock

 

The following table details the components of dividends related to convertible preferred stock for the three and nine months ended July 31, 2005 and 2004:

 

 

 

Three Months Ended July 31,

 

Nine Months Ended July 31,

 

 

 

2005

 

2004

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

 

Accrual of dividends

 

$

 

$

(551,000

)

$

 

$

(2,047,000

)

Exchange of Series A shares for Series A-1 shares

 

 

 

 

(6,305,000

)

Repurchase of Series A-1 shares from BayStar

 

 

15,475,000

 

 

15,475,000

 

Total

 

$

 

$

14,924,000

 

$

 

$

7,123,000

 

 

YEARS ENDED OCTOBER 31, 2004, 2003 AND 2002

 

The following table presents our results of operations for the years ended October 31, 2004, 2003 and 2002 (in thousands):

 

23



 

 

 

Years Ended October 31,

 

Statement of Operations Data:

 

2004

 

2003

 

2002

 

Revenue:

 

 

 

 

 

 

 

Products

 

$

35,352

 

$

45,028

 

$

52,975

 

SCOsource licensing

 

829

 

25,846

 

 

Services

 

6,628

 

8,380

 

11,266

 

Total revenue

 

42,809

 

79,254

 

64,241

 

Cost of revenue:

 

 

 

 

 

 

 

Products

 

3,221

 

4,068

 

7,558

 

SCOsource licensing

 

19,743

 

9,500

 

 

Services

 

4,134

 

6,354

 

10,758

 

Total cost of revenue

 

27,098

 

19,922

 

18,316

 

Gross margin

 

15,711

 

59,332

 

45,925

 

Operating expenses:

 

 

 

 

 

 

 

Sales and marketing

 

17,038

 

24,392

 

29,554

 

Research and development

 

10,612

 

11,012

 

17,558

 

General and administrative

 

7,626

 

6,230

 

9,307

 

Severance and exit costs

 

3,168

 

498

 

6,728

 

Amortization of intangibles

 

2,566

 

3,190

 

2,853

 

Loss on disposition and impairment of long-lived assets

 

2,355

 

164

 

1,796

 

Write-off of investments

 

 

250

 

1,180

 

Stock-based compensation

 

919

 

1,204

 

1,125

 

Compensation to law firms

 

 

8,956

 

 

Total operating expenses

 

44,284

 

55,896

 

70,101

 

Income (loss) from operations

 

(28,573

)

3,436

 

(24,176

)

Equity in income (losses) of affiliates

 

111

 

(62

)

(50

)

Other income (expense), net

 

6,507

 

2,827

 

(168

)

Provision for income taxes

 

(1,395

)

(774

)

(483

)

Net income (loss)

 

(23,350

)

5,427

 

(24,877

)

Contributions from (dividends on) redeemable convertible preferred stock

 

7,123

 

(123

)

 

Net income available (loss applicable) to common stockholders

 

$

(16,227

)

$

5,304

 

$

(24,877

)

 

Revenue

 

 

 

2004

 

Change

 

2003

 

Change

 

2002

 

Revenue

 

$

42,809,000

 

(46

)%

$

79,254,000

 

23

%

$

64,241,000

 

 

Revenue for the year ended October 31, 2004 decreased by $36,445,000, or 46 percent, from the year ended October 31, 2003. This decrease was primarily attributable to significantly lower SCOsource licensing revenue in the year ended October 31, 2004 compared to the year ended October 31, 2003 as well as a continued decline in our UNIX business. Revenue for the year ended October 31, 2003 increased by $15,013,000, or 23 percent, from the year ended October 31, 2002, and this increase was primarily attributable to vendor license fees generated from our SCOsource licensing initiatives offset by decreases in UNIX products and services revenue.

 

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

 

 

 

2004

 

Change

 

2003

 

Change

 

2002

 

UNIX revenue

 

$

41,980,000

 

(21

)%

$

53,408,000

 

(17

)%

$

64,241,000

 

Percent of total revenue

 

98

%

 

 

67

%

 

 

100

%

SCOsource revenue

 

829,000

 

(97

)%

25,846,000

 

n/a

 

 

Percent of total revenue

 

2

%

 

 

33

%

 

 

0

%

 

The decrease in revenue in the UNIX business of $11,428,000 for the year ended October 31, 2004 compared to the year ended October 31, 2003 and the decrease of $10,833,000 for the year ended October 31, 2003 compared to the year ended October 31, 2002 was primarily attributable to continued competition from other operating systems, particularly Linux. We anticipate that for the year ended October 31, 2005 our total UNIX revenue will decline from UNIX revenue generated in the year ended October 31, 2004.

 

24



 

The decrease in SCOsource licensing revenue of $25,017,000 in the year ended October 31, 2004 from the year ended October 31, 2003 was primarily attributable to minimal vendor licensing revenue in the year ended October 31, 2004 compared to significant vendor licensing revenue generated in the year ended October 31, 2003 as a result of two large vendor licenses.

 

Sales of our UNIX products and services during the year ended October 31, 2004 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.

 

Products Revenue

 

 

 

2004

 

Change

 

2003

 

Change

 

2002

 

Products revenue

 

$

35,352,000

 

(21

)%

$

45,028,000

 

(15

)%

$

52,975,000

 

Percent of total revenue

 

83

%

 

 

57

%

 

 

82

%

 

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 $9,676,000 from the year ended October 31, 2004 compared to the year ended October 31, 2003 and the decrease of $7,947,000 from the year ended October 31, 2003 compared to the year ended October 31, 2002 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 will continue in  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:

 

 

 

2004

 

Change

 

2003

 

Change

 

2002

 

OpenServer revenue

 

$

18,467,000

 

(17

)%

$</