Quarterly Report

 

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark one)

ý              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended April 30, 2005

OR

 

o             TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                   to                  

 

Commission file number 0-29911

 

THE SCO GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

355 South 520 West

Suite 100

Lindon, Utah 84042

(Address of principal executive offices and zip code)

 

(801) 765-4999

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days.

 

YES ý NO o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

 

YES o NO ý

 

As of May 27, 2005, there were 17,923,510 shares of the Registrant’s common stock, $0.001 par value per share, outstanding.

 

 

The SCO Group, Inc.

 

Table of Contents

 

 

 

PART I.	FINANCIAL INFORMATION
Item 1.	Unaudited Financial Statements
	Condensed Consolidated Balance Sheets as of April 30, 2005 and October 31, 2004
	Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and six months ended April 30, 2005 and 2004
	Condensed Consolidated Statements of Cash Flows for the six months ended April 30, 2005 and 2004
	Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures About Market Risk
Item 4.	Controls and Procedures
	Forward-Looking Statements
	Risk Factors
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Changes in Securities and Use of Proceeds
Item 5.	Other Information
Item 6.	Exhibits
Item 7.	Signatures

 

2

 

THE SCO GROUP, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(in thousands)

 

		April 30,			October 31,
		2005			2004
		(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	8,145		$	12,693
Restricted cash		7,974			8,283
Available-for-sale securities		6,047			18,756
Accounts receivable, net of allowance for doubtful accounts of $149 and $136, respectively		6,325			6,638
Other current assets		2,288			1,870
Total current assets		30,779			48,240
PROPERTY AND EQUIPMENT:
Computer and office equipment		2,025			2,991
Leasehold improvements		390			406
Furniture and fixtures		29			103
		2,444			3,500
Less accumulated depreciation and amortization		(1,865		)	(2,851		)
Net property and equipment		579			649
OTHER ASSETS:
Intangibles, net		4,060			5,413
Other assets		1,134			1,098
Total other assets		5,194			6,511
Total assets		$	36,552		$	55,400
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable		$	1,424		$	7,854
Payable to Novell, Inc.		4,007			3,283
Accrued compensation to law firms		—			7,956
Accrued payroll and benefits		2,761			3,369
Accrued liabilties		3,606			3,855
Deferred revenue		4,896			4,877
Other royalties payable		309			354
Taxes payable		1,287			1,279
Total current liabilities		18,290			32,827
LONG-TERM LIABILITIES		342			343
COMMITMENTS AND CONTINGENCIES (Note 5)
COMMON STOCK SUBJECT TO RESCISSION (Note 6)		851			528
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value; 45,000 shares authorized, 18,208 and 17,956 shares outstanding, respectively		18			18
Additional paid-in capital		246,528			246,273
Common stock held in treasury; 290 shares, respectively		(2,414		)	(2,414		)
Warrants outstanding		1,099			1,099
Deferred compensation		—			(22		)
Accumulated other comprehensive income		977			964
Accumulated deficit		(229,139		)	(224,216		)
Total stockholders' equity		17,069			21,702
Total liabilities and stockholders' equity		$	36,552		$	55,400

 

See accompanying notes to consolidated financial statements.

 

3

---

 

 THE SCO GROUP, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

 (in thousands, except per share data)

 

 

		Three Months Ended April 30,						Six Months Ended April 30,
		2005			2004			2005			2004
		(unaudited)						(unaudited)
REVENUE:
Products		$	7,838		$	8,415		$	15,142		$	18,127
SCOsource licensing		30			11			100			31
Services		1,390			1,711			2,881			3,371
Total revenue		9,258			10,137			18,123			21,529
COST OF REVENUE:
Products		563			818			1,207			1,623
SCOsource licensing (inclusive of amortization of intangibles of $84, $83, $167, and $166, respectively)		2,889			4,567			6,382			8,090
Services		746			1,073			1,495			2,395
Total cost of revenue		4,198			6,458			9,084			12,108
GROSS MARGIN		5,060			3,679			9,039			9,421
OPERATING EXPENSES:
Sales and marketing (exclusive of stock-based compensation of $7, $29, $14, and $47, respectively)		2,963			4,698			5,900			9,719
Research and development (exclusive of stock-based compensation of $0, $12, $8, and $23, respectively)		2,117			2,868			4,197			5,575
General and administrative (exclusive of stock-based compensation of $0, $122, $0, and $528, respectively)		2,036			1,710			3,799			3,904
Loss on impairment of long-lived assets		—			2,139			—			2,139
Severance and exit costs		—			682			—			682
Amortization of intangibles		593			593			1,186			1,380
Stock-based compensation		7			163			22			598
Total operating expenses		7,716			12,853			15,104			23,997
LOSS FROM OPERATIONS		(2,656		)	(9,174		)	(6,065		)	(14,576		)
EQUITY IN INCOME OF AFFILIATE		17			37			70			74
OTHER INCOME (EXPENSE):
Interest income		98			242			135			512
Change in fair value of derivative		—			2,300			—			5,924
Other income (expense), net		702			(120		)	1,174			(251		)
Total other income (expense), net		800			2,422			1,309			6,185
LOSS BEFORE INCOME TAXES		(1,839		)	(6,715		)	(4,686		)	(8,317		)
PROVISION FOR INCOME TAXES		(123		)	(966		)	(237		)	(1,094		)
NET LOSS		(1,962		)	(7,681		)	(4,923		)	(9,411		)
DIVIDENDS ON REDEEMABLE CONVERTIBLE PREFERRED STOCK		—			(7,045		)	—			(7,801		)
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS		$	(1,962	)	$	(14,726	)	$	(4,923	)	$	(17,212	)
BASIC AND DILUTED NET LOSS PER COMMON SHARE		$	(0.11	)	$	(1.04	)	$	(0.28	)	$	(1.23	)
WEIGHTED AVERAGE BASIC AND DILUTED COMMON SHARES OUTSTANDING		17,913			14,100			17,831			13,960
OTHER COMPREHENSIVE LOSS
Net loss		$	(1,962	)	$	(7,681	)	$	(4,923	)	$	(9,411	)
Unrealized gain (loss) on available-for-sale securities		12			(99		)	9			(118		)
Foreign currency translation adjustment		(58		)	138			4			148
COMPREHENSIVE LOSS		$	(2,008	)	$	(7,642	)	$	(4,910	)	$	(9,381	)

 

See accompanying notes to consolidated financial statements.

 

4

 

THE SCO GROUP, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

		Six Months Ended April 30,
		2005			2004
		(unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss		$	(4,923	)	$	(9,411	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of intangibles		1,353			1,546
Depreciation and amortization		184			435
Stock-based compensation		22			598
Loss on impairment of long-lived assets		32			2,139
Equity in income of affiliates		(70		)	(74		)
Change in fair value of derivative		—			(5,924		)
Changes in operating assets and liabilities:
Restricted cash		1,033			—
Accounts receivable, net		313			2,471
Other current assets		(418		)	(81		)
Other assets		34			(201		)
Accounts payable		(6,430		)	853
Accrued payroll and benefits		(608		)	(884		)
Compensation to law firms		(7,956		)	(2,600		)
Accrued liabilities		(249		)	3,371
Deferred revenue		19			2,053
Other royalties payable		(45		)	(214		)
Taxes payable		8			690
Other long-term liabilities		(1		)	27
Net cash used in operating activities		(17,702		)	(5,206		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment		(145		)	(186		)
Purchase of available-for-sale securities		(8,200		)	(41,234		)
Proceeds from available-for-sale securities		20,909			5,025
Purchase of minority interest in Japanese subsidiary		—			(209		)
Net cash provided by (used in) investing activities		12,564			(36,604		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock through employee stock purchase program		373			370
Proceeds from exercise of common stock options		205			559
Offering costs incurred in connection with Series A-1 issuance		—			(212		)
Purchase of common stock		—			(2,414		)
Net cash provided by financing activities		578			(1,697		)
EFFECT OF FOREIGN EXCHANGE RATES ON CASH		12			121
NET DECREASE IN CASH AND CASH EQUIVALENTS		(4,560		)	(43,507		)
CASH AND CASH EQUIVALENTS, beginning of period		12,693			64,428
CASH AND CASH EQUIVALENTS, end of period		$	8,145		$	21,042
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for taxes		$	248		$	274
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Dividend in connection with exchange of Series A-1 for Series A shares		$	—		$	6,305
Accretion of dividends		$	—		$	1,496
Common stock subject to rescission		$	323		$	188

 

See accompanying notes to consolidated financial statements.

 

5

 

THE SCO GROUP, INC. AND SUBSIDIARIES

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

(1) ORGANIZATION AND DESCRIPTION OF BUSINESS

The business of The SCO Group, Inc. (the “Company”) focuses on marketing reliable, cost-effective UNIX software products and related services for the small-to-medium sized business market.  In January 2003, the Company established its SCOsource business and launched its first of several SCOsource initiatives to review and enforce its intellectual property surrounding the UNIX operating system. The Company acquired certain intellectual property rights surrounding UNIX and UNIX System V source code from The Santa Cruz Operation (now Tarantella, Inc.) in May 2001.

During the six months ended April 30, 2005, the Company used cash of $17,702,000 in its operations.  The majority of this cash was used to pay accounts payable, accrued liabilities and ongoing expenses related to the Company’s intellectual property litigation.  As of April 30, 2005, the Company had a total of $14,192,000 in cash and cash equivalents and available-for-sale securities and an additional $7,974,000 in restricted cash, of which $3,967,000 is designated to be used as payments for experts, consultants and other expenses in the SCO Litigation.  As a result of the Engagement Agreement between the Company and the law firms representing it in its intellectual property litigation, the Company anticipates using cash of approximately $7,000,000 in the defense of its intellectual property litigation during the remainder of the year ending October 31, 2005, which would leave the Company approximately $11,159,000 in cash for its business operations as of October 31, 2005.  The Company expects that its UNIX business will generate sufficient cash in the year ending October 31, 2005 to cover its internal costs related to its SCOsource initiatives and intellectual property litigation, and believes that it will have sufficient cash resources to fund its operations through October 31, 2005.

In the event that cash required to fund operations and strategic initiatives exceeds the Company’s current cash resources and cash generated from operations, the Company will be required to reduce costs and perhaps raise additional capital.  The Company may not be able to reduce costs in a manner that does not impair its ability to maintain its UNIX business and pursue its SCOsource initiatives.  The Company may also have difficulty raising capital.  If additional equity financing is available, it may not be available to the Company on attractive terms and may be dilutive to the Company’s existing stockholders.  In addition, if the Company’s stock price declines, it may not be able to access the public equity markets on acceptable terms, if at all.  The Company’s ability to effect acquisitions for stock would also be impaired.

(2) SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) on a basis consistent with the Company’s audited annual financial statements, and, in the opinion of management, reflect all adjustments, consisting of normal recurring adjustments, necessary to present fairly the financial information set forth therein.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to SEC rules and regulations, although the

 

6

 

Company believes that the following disclosures, when read in conjunction with the audited annual financial statements and the notes thereto included in the Company’s most recent annual report on Form 10-K, are adequate to make the information presented not misleading.  Operating results for the three and six months ended April 30, 2005 are not necessarily indicative of the results that may be expected for the year ending October 31, 2005.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from these estimates.  The Company’s critical accounting policies and estimates include, among others, revenue recognition, allowances for doubtful accounts receivable, severance and exit costs, impairment of long-lived assets, and valuation allowances against deferred income tax assets.

Revenue Recognition

The Company recognizes revenue in accordance with Statement of Position (“SOP”) 97-2, as modified by SOP 98-9.  The Company’s revenue is primarily from three sources: (i) product license revenue, primarily from product sales to resellers, end users and original equipment manufacturers (“OEMs”); (ii) technical support service revenue, primarily from providing technical support and consulting services to end users; and (iii) licensing revenue from its SCOsource intellectual property initiative.

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

The Company recognizes product revenue from OEMs when the software is sold by the OEM to an end-user customer.  Revenue from technical support services and consulting services is recognized as the related services are performed.  Revenue for maintenance is recognized ratably over the maintenance period.

The Company considers an arrangement with payment terms longer than the Company’s normal business practice, which do not extend beyond 12 months, not to be fixed and determinable and revenue is recognized when the fee becomes due.  The Company typically provides stock rotation rights for sales made through its distribution channel and sales to distributors are recognized upon shipment by the distributor to end users.  For direct sales not through the Company’s distribution channel, sales are typically non-refundable and non-

 

7

 

cancelable.  The Company estimates its product returns based on historical experience and maintains an allowance for estimated returns, which is recorded as a reduction to accounts receivable.

The Company’s SCOsource licensing revenue to date has been primarily generated from license agreements to utilize the Company’s UNIX source code as well as from intellectual property compliance licenses.  The Company recognizes revenue from SCOsource licensing agreements when a signed contract exists, the fee is fixed and determinable, collection of the receivable is probable and delivery has occurred.  If the payment terms extend beyond the Company’s normal payment terms, revenue is recognized as the payments become due.

Pro Forma Fair Value of Stock-based Compensation

The Company accounts for stock options issued to directors, officers and employees under Accounting Principles Board (“APB”) No. 25, “Accounting for Stock Issued to Employees, and Related Interpretations.”  Under APB No. 25, compensation expense is recognized if an option’s exercise price on the measurement date is below the fair market value of the Company’s common stock.  The Compensation expense, if any, is amortized to expense over the vesting period.

SFAS No. 148, “Accounting for Stock-Based Compensation,” requires pro forma information regarding net income (loss) as if the Company had accounted for its stock options granted under the fair value method prescribed by SFAS No. 123, “Accounting for Stock-Based Compensation.”  The fair value for the Company’s stock options is estimated on the date of grant using the Black-Scholes option-pricing model.

With respect to stock options and restricted stock awards granted and shares purchased pursuant to the Company’s 2000 Employee Stock Purchase Plan (the “ESPP”) during the three and six months ended April 30, 2005 and 2004, the assumptions used in the Black-Scholes option-pricing model are as follows: 

		Three Months Ended April 30,				Six Months Ended April 30,
		2005		2004		2005		2004
Risk-free interest rate		3.7	%	2.9	%	3.6	%	2.6	%
Expected dividend yield		0.0	%	0.0	%	0.0	%	0.0	%
Volatility		51.5	%	91.5	%	72.4	%	82.4	%
Expected exercise life (in years)		2.7		3.0		2.7		3.0

 

8

 

For purposes of the pro forma disclosure, the estimated fair value of stock options, restricted stock awards and ESPP shares are amortized over the vesting period of the award.  The following is the pro forma disclosure and the related impact on net loss to common stockholders and the net loss to common stockholders per diluted common share for the three and six months ended April 30, 2005 and 2004 (in thousands, except per share amounts):

 

		Three Months Ended April 30,						Six Months Ended April 30,
		2005			2004			2005			2004
Net loss applicable to common stockholders:
As reported		$	(1,962	)	$	(14,726	)	$	(4,923	)	$	(17,212	)
Stock-based compensation included in reported net loss		7			163			22			598
Stock-based compensation under fair value method		(403		)	(476		)	(597		)	(1,283		)
Pro forma net loss applicable to common stockholders		$	(2,358	)	$	(15,039	)	$	(5,498	)	$	(17,897	)
Net loss applicable to common stockholders per basic and diluted common share:
As reported		$	(0.11	)	$	(1.04	)	$	(0.28	)	$	(1.23	)
Pro forma		$	(0.13	)	$	(1.07	)	$	(0.31	)	$	(1.28	)

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment, an amendment of FASB Statements Nos. 123 and 95,” which requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in the Consolidated Statements of Operations and Comprehensive Loss.  The accounting provisions of SFAS No. 123R are effective for fiscal years beginning after June 15, 2005 and the Company will adopt SFAS No. 123R in the first quarter of fiscal year 2006.  The above disclosure for the three and six months ended April 30, 2005 and 2004 shows the pro forma net loss and net loss per share as if the Company had used a fair-value-based method similar to the methods required under SFAS No. 123R to measure compensation expense for employee stock incentive awards.  Although the Company has not yet determined whether the adoption of SFAS No. 123R will result in future amounts that are similar to the current pro forma disclosure under SFAS No. 123, the Company is evaluating the requirements under SFAS No. 123R and expects that the adoption could have a material impact on the Company’s results of operations.

Cash and Cash Equivalents

The Company considers all investments purchased with original maturities of three or fewer months to be cash equivalents.  Cash equivalents were $5,298,000 and $2,633,000 as of April 30, 2005 and October 31, 2004, respectively.  Cash was $2,847,000 and $10,060,000 as of April 30, 2005 and October 31, 2004, respectively.

Available-for-Sale Securities

Available-for-sale securities are recorded at fair market value, based on quoted market prices, and unrealized gains and losses are recorded as a component of comprehensive income (loss).  Realized gains and losses, which are calculated based on the specific-identification method, are recorded in operations as incurred.

 

9

 

Available-for-sale securities totaled $6,047,000 as of April 30, 2005 and consisted of government agency securities and corporate notes.  Any available-for-sale securities in an unrealized loss position as of April 30, 2005 were not impaired at acquisition and the decline in fair value is primarily attributable to interest rate fluctuations.  A decline in the market value of any available-for-sale security below cost that is deemed other than temporary results in a charge to earnings and establishes a new basis for the security.

Earnings per Share

Basic net income (loss) per common share (“Basic EPS”) is computed by dividing net income (loss) by the weighted average number of common shares outstanding.  Diluted net income (loss) per common share (“Diluted EPS”) is computed by dividing net income (loss) by the sum of the weighted average number of common shares outstanding and the dilutive potential common share equivalents then outstanding.  Potential common share equivalents consist of the weighted average of shares issuable upon the exercise of outstanding stock options, restricted stock awards, warrants to acquire common stock and preferred stock convertible into common shares.  If dilutive, the Company computes Diluted EPS using the treasury stock method.

The following table is a reconciliation of the numerator and denominator of Basic EPS to the numerator and denominator of Diluted EPS for the three and six months ended April 30, 2005 and 2004 (in thousands, except per share amounts):

		Three Months Ended April 30,						Six Months Ended April 30,
		2005			2004			2005			2004
Numerator:
Net loss applicable to common stockholders		$	(1,962	)	$	(14,726	)	$	(4,923	)	$	(17,212	)
Denominator:
Weighted average common shares outstanding		17,913			14,100			17,831			13,960
Stock options		—			—			—			—
Restricted stock		—			—			—			—
Warrants		—			—			—			—
Weighted average diluted common shares outstanding		17,913			14,100			17,831			13,960
Basic and diluted EPS		$	(0.11	)	$	(1.04	)	$	(0.28	)	$	(1.23	)
Excluded anti-dilutive common share equivalents		3,696			6,665			3,696			6,665

 

The excluded anti-dilutive common share equivalents are not included in the computation of Diluted EPS as their inclusion would be anti-dilutive to the loss per share.

Income Taxes

                In October 2004, the American Jobs Creation Act (the “AJCA”) was signed into law.  The AJCA includes a deduction of 85 percent of certain foreign earnings that are repatriated in the AJCA.  The Company may elect to apply this provision to qualifying earnings repatriations in fiscal year 2005.  The Company does not believe that it will have any foreign earnings repatriation under the AJCA during fiscal year 2005.

 

10

 

Reclassifications

                Certain reclassifications have been made to the prior period amounts to conform to the current period presentation.  The reclassifications had no effect on net income for the prior periods.

(3) INTANGIBLE ASSETS

The following table shows the activity related to amortized intangible assets for the six months ended April 30, 2005 as well as the remaining unamortized balances as of April 30, 2005 (in thousands):

		As of October 31, 2004			Six Months Ended April 30, 2005						As of April 30, 2005
		Net Book Value			Amortization Expense			Impairment Loss			Net Book Value
Amortizable intangible assets:
Distribution/reseller channel		$	4,636		$	(1,160	)	$	—		$	3,476
Acquired technology		673			(167		)	—			506
Trade name		104			(26		)	—			78
Total intangible assets		$	5,413		$	(1,353	)	$	—		$	4,060

 

Of the $1,353,000 in amortization expense, $1,186,000 was classified as amortization of intangible assets in operating expenses and the remaining $167,000 was classified as cost of SCOsource licensing revenue.

(4) INVESTMENTS

Sale of Troll Tech Shares

In December 1999, the Company and The Canopy Group, Inc. (“Canopy”), a former holder of the Company’s common stock, entered into an agreement with Troll Tech AS (“Troll Tech”) and its stockholders.  Pursuant to the agreement, the Company acquired shares of Troll Tech in exchange for shares of the Company, and Canopy acquired shares of Troll Tech in exchange for $1,000,000.  The Company recorded its investment in Troll Tech’s common stock at $400,000, based on the cash price per share paid by Canopy.  The Company determined that the cash price per share paid by Canopy was the most reliable evidence of the value of Troll Tech’s common stock.  During fiscal year 2001, management determined that the carrying value of the investment in Troll Tech of $400,000 would most likely not be recoverable, and the investment was written down to $0.

During the second quarter of fiscal year 2005, the Company received notice from Troll Tech that a third-party investor was interested in acquiring the Company’s shares of Troll Tech.  On March 14, 2005, the Company received proceeds of $779,100 for the Troll Tech shares.  The Company accounted for the sale and proceeds of the Troll Tech shares in the second quarter of fiscal year 2005 when it received the proceeds from the shares.  All amounts related to the book value of the shares had been written off during fiscal year 2001, and the Company recorded the proceeds received as a component of other income in its statements of operations for the three and six months ended April 30, 2005.

 

11

 

(5) COMMITMENTS AND CONTINGENCIES

Litigation

The following includes updated information relating to certain of the Company’s material legal proceedings as previously reported in the Company’s annual report on Form 10-K for fiscal year 2004, and previously updated in the Company’s quarterly report on Form 10-Q for the fiscal quarter ended January 31, 2005.

IBM Corporation

On or about March 6, 2003, the Company filed a complaint against IBM Corporation (“IBM”).  This action is pending in the United States District Court for the District of Utah, under the title The SCO Group, Inc. v. International Business Machines Corporation, Civil No. 2:03CV0294.  This action includes, among other things, Company claims against IBM for breach of contract, copyright infringement, tortious interference, and unfair competition relating to IBM’s alleged use and distribution of information concerning the UNIX source code and derivative works in connection with its efforts to promote the Linux operating system.  IBM has responded to the Company’s claims and made counterclaims against the Company.

Following a hearing on October 19, 2004, on January 19, 2005, the United States Magistrate Judge overseeing the case issued an order granting in part and denying in part discovery applications that the Company had made.  The Court ordered IBM to produce much of the information, including source code, revision information, and programmer contribution information, that the Company had previously requested.  The court also struck the Amended Scheduling Order and directed the parties to submit a proposed amended scheduling order to the court, which both parties have done.  The District Court heard argument on the proposed schedules on April 21, 2005 and took the matter under advisement.  It is anticipated that the Court will issue a new scheduling order in the near future.

In response to the Magistrate Court’s Order, IBM filed, on February 11, 2005, a Motion for Reconsideration of the portion of the Order that required IBM to produce programmer-contribution information for 3,000 people.  IBM also filed, on March 9, 2005,  a Motion for a 45-day Extension of Time to Comply with the Court’s January 18 Order as it applies to materials that are not the subject of IBM’s above-referenced Motion for Reconsideration.  On March 16, 2005, the Court granted the extension and entered an order requiring IBM to produce those materials by May 3, 2005.  With respect to the materials covered by IBM’s Motion for Reconsideration, the Court granted IBM’s request to stay its discovery obligations pending the Court’s resolution of its motion.

On April 19, 2005, the Magistrate Court ruled on IBM’s reconsideration motion.  The Court declined to strike its prior requirement that IBM produce documents from the files of the 3,000 individuals who made the most contributions and changes to the development of AIX and Dynix.  The Court reiterated its requirement that IBM produce programmer’s notes, design documents, white papers, comments and notes, contact information, specific changes made to code, and all relevant non-privileged documents from the files of the 100 individuals who made the most contributions and changes to the development of AIX and Dynix; ordered IBM to provide a privilege log for any documents withheld from the files of those 100 individuals; and required IBM to comply within 90 days.  The Court deferred the remainder of IBM’s required production pending the Company’s review of the above-described discovery.  The Court also reiterated that IBM is required to produce all non-public Linux contribution information and directed IBM to produce all such information within 75 days.

 

12

 

                On February 9, 2005, the United States District Judge ruled on several pending dispositive motions.  The Court denied the three motions for partial summary judgment that IBM had filed on the Company’s contract claims, on IBM’s eighth counterclaim for copyright infringement, and on IBM’s tenth counterclaim for a declaration of non-infringement of the Company’s copyrights.  The Court denied each of those motions without prejudice to IBM’s renewing or refiling the motions after discovery is complete.  The Court also denied the Company’s motion to stay or dismiss IBM’s tenth counterclaim.  The Court ordered that no further dispositive motions could be filed until the close of discovery, except by stipulation of the parties, and vacated its prior order, dated September 30, 2004, to the extent that order had granted permission to file dispositive motions before the close of discovery.

Additional discovery motions that the Company has filed are also pending before the Court.  On January 12, 2005, the Company filed its Motion to Compel IBM to produce IBM CEO Samuel J. Palmisano for Deposition.  The parties have fully briefed this motion, and the Court heard argument on that motion on April 21, 2005.  The Court took the matter under advisement.  The parties have also now fully briefed the Company’s December 23, 2004 Renewed Motion to Compel Discovery, which seeks to compel IBM’s compliance with prior Court orders relating to IBM’s obligation to produce (1) all documents pertaining to Linux from the files of high-level IBM executives and board members; and (2) to compel IBM to produce witnesses to testify on several topics in two deposition notices that SCO has served on IBM.  The Court has not set a hearing date for this motion.

In addition to the materials that have been publicly filed with the Court, certain information has been filed under seal in accordance with the protective order entered in the case.  On November 30, 2004, a third party moved to intervene in the case for the purpose of challenging the sealing of certain documents filed with the Court, and additional groups subsequently joined in that motion.  Following argument on April 26, 2005, by Order dated April 28, 2005, the Court denied the intervention motion.  In its Order, the Court set forth various procedures to minimize the risk that documents would be improperly filed under seal.

The Company has also filed a motion for leave to file a third amended complaint in order to assert an additional copyright claim against IBM in the case.  The Court heard argument on that fully briefed motion on April 21, 2005 and took the matter under advisement.

In support of its pending motion to amend, the Company argued that IBM would not be prejudiced by the proposed amendment because, among other things, the Company’s new claim pertained to issues already covered by IBM’s own Ninth Counterclaim, which seeks a broad declaratory judgment of non-infringement relating to AIX.  On February 18, 2005, IBM filed a Motion for Entry of Order Limiting the Scope of Its Ninth Counterclaim.  That motion has also been briefed, but no argument date has been set.

Discovery is continuing in the case.  The Company is reviewing that discovery and currently anticipates that it will seek to amend its complaint in the near future in order to assert additional claims against IBM.

Red Hat, Inc.

On August 4, 2003, Red Hat, Inc. (“Red Hat”) filed a complaint against the Company.  The action is pending in the United States District Court for the District of Delaware under the case caption Red Hat, Inc. v. The SCO Group, Inc., Civil No. 03-772.  Red Hat asserts that the Linux operating system does not infringe on the Company’s UNIX intellectual property rights and seeks a declaratory judgment for non-infringement of copyrights and no misappropriation of trade secrets.  In addition, Red Hat claims the Company has engaged in false advertising in violation of the Lanham Act, deceptive trade practices, unfair competition, tortious interference

 

13

 

with prospective business opportunities, trade libel and disparagement.  On April 6, 2004, the court denied the Company’s motion to dismiss this case; however, the court stayed the case and requested status reports every 90 days regarding the case against IBM.  Red Hat filed a motion for reconsideration, which the Court denied on March 31, 2005.  The Company intends to vigorously defend this action.  In the event the stay is lifted and Red Hat is allowed to pursue its claims, we will likely assert counterclaims against Red Hat.

Novell, Inc.

On January 20, 2004, the Company filed suit in Utah state court against Novell, Inc. (“Novell”) for slander of title seeking relief for its alleged bad faith effort to interfere with the Company’s ownership of copyrights related to its UNIX source code and derivative works and its UnixWare product.  The case, after removal to federal court, is pending in the United States District Court for the District of Utah under the caption The SCO Group, Inc. v. Novell, Inc., Civil No. 2:04CV00139.  In the lawsuit, the Company requested preliminary and permanent injunctive relief as well as damages.  Through these claims, the Company seeks to require Novell to assign to the Company all copyrights that it believes Novell has wrongfully registered, prevent Novell from representing any ownership interest in those copyrights and require Novell to retract or withdraw all representations it has made regarding its purported ownership of those copyrights.

Novell has filed a motion to dismiss claiming, among other things, that Novell’s false statements were not uttered with malice and are privileged under the law.  That motion has been briefed by the parties and the Court heard the argument on the motion on May 25, 2005.  The Court took the matter under advisement.  The Company intends to continue to vigorously pursue its claims against Novell.

DaimlerChrysler Corporation

On or about March 3, 2004, the Company brought suit against DaimlerChrysler Corporation (“DaimlerChrysler”) for its alleged violations of its UNIX license agreement with the Company.  The lawsuit alleges that DaimlerChrysler breached its UNIX software agreement by failing to provide an adequate or timely certification of its compliance with that agreement as the Company requested.  The lawsuit, filed in Oakland County Circuit Court in the State of Michigan, requests the court to declare that DaimlerChrysler has violated the certification requirements of its UNIX software agreement, permanently enjoin DaimlerChrysler from further violations of the UNIX software agreement, issue a mandatory injunction requiring DaimlerChrysler to remedy the effects of its past violations of the UNIX software agreement and award the Company damages in an amount to be determined at trial together with costs, attorneys’ fees and any such other or different relief that the court may deem to be equitable and just.

In response to DaimlerChrysler’s motion to dismiss, the court granted DaimlerChrysler’s motion as to the substance of DaimlerChrysler’s certification, but denied the motion as to whether the certification was timely.  Based on this ruling, the Company filed a motion to stay the case pending the clarification of certain issues in the IBM litigation.  The court denied the motion to stay.  Based on a stipulation of the parties, however, the court signed an order of dismissal without prejudice.  The appellate court has dismissed the Company’s appeal of the July 21, 2004 ruling finding that the order was not a final, appealable order; the Company is evaluating its options regarding the appellate court’s ruling.

AutoZone, Inc.

                On or about March 2, 2004, the Company brought suit against AutoZone, Inc. (“AutoZone”) for its alleged violations of the Company’s UNIX copyrights through its use of Linux.  The lawsuit alleges copyright infringement by AutoZone by, among other things, running versions of the Linux

 

14

 

operating system that contain proprietary material from UNIX System V.  The lawsuit, filed in United States District Court in Nevada, requests injunctive relief against AutoZone’s further use or copying of any part of the Company’s copyrighted materials and also requests damages as a result of AutoZone’s infringement in an amount to be proven at trial.  In response to AutoZone’s motion to transfer the case to Tennessee or stay the case, the federal court in Nevada granted AutoZone’s motion to stay the case, with 90-day status reports to the court, and denied without prejudice AutoZone’s motion to transfer the case to Tennessee.  The federal court allowed the parties to take limited expedited discovery relating to the issue of preliminary injunctive relief which discovery was concluded in May 2005.

The Company has concluded the initial discovery allowed by the court and filed its report with the court on May 27, 2005.  Contrary to AutoZone’s own statements to the court, the Company found through discovery, including depositions and other admissions of AutoZone, many instances of copying of programs containing SCO OpenServer code.  AutoZone has represented that it has now removed all of the SCO code and proprietary information it copied or used in its migration to Red Hat Linux.  Because AutoZone represents it has removed or otherwise is not using SCO code and proprietary information, the Company currently does not intend to move for a preliminary injunction.  AutoZone does not admit that it violated the Company’s rights or caused the Company damage in that migration process, which are still points of dispute between the parties.  Given the stay issued by the Court in the case, the Company reserves the right to pursue infringement and damages in the future based on these issues and other issues stayed by the Court.

IPO Class Action Matter

The Company is an issuer defendant in a series of class action lawsuits involving over 300 issuers that have been consolidated under In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS).  The consolidated complaint alleges, among other things, certain improprieties regarding the underwriters’ conduct during the Company’s initial public offering and the failure to disclose such conduct in the registration statement in violation of the Securities Act of 1933, as amended.

The plaintiffs, the issuers and the insurance companies have negotiated an agreement to settle the dispute between the plaintiffs and the issuers.  All parties, including the plaintiffs, issuers and insurance companies, have executed this settlement agreement and the settlement agreement has been submitted to the court for approval.  If the settlement agreement is approved by the court, and if no cross-claims, counterclaims or third-party claims are later asserted, this action will be dismissed with respect to the Company and its directors.

The Company has notified its underwriters and insurance companies of the existence of the claims.  Management believes, after consultation with legal counsel, that the ultimate outcome of this matter will not have a material adverse effect on the Company’s results of operations or financial position and will not exceed the $200,000 self-insured retention already paid or accrued by the Company.

Other Matters

In April 2003, a former Indian distributor of the Company filed a claim in India, requesting summary judgment for payment of $1,428,000, and an order that the Company trade in India only through the distributor and/or give a security deposit until the claim is paid.  The distributor claims that the Company is responsible to repurchase certain software products and to reimburse the distributor for certain other operating costs.  The distributor additionally requested that the Indian courts grant interim relief in the form of attachment of local assets.  Management does not believe that the Company is responsible to reimburse the distributor for any operating

 

15

 

costs and also believes that the return rights related to any remaining inventory have lapsed.  Discovery has commenced and hearings on the requests for interim relief have been held and are ongoing.  The Company intends to vigorously defend this action.

Pursuit and defense of the above-mentioned matters will be costly, and management expects the costs for legal fees and related expenses will be substantial.  The ultimate outcome or potential effect on the Company’s results of operations or financial position of the above-mentioned matters is not currently known or determinable.

                The Company is a party to certain other legal proceedings arising in the ordinary course of business.  Management believes, after consultation with legal counsel, that the ultimate outcome of such legal proceedings will not have a material adverse effect on the Company’s results of operations or financial position.

Grants of Unregistered Stock Options; Potential Interest and Penalties Related to Rescission Rights

                The Company believes certain shares and options granted under its 1998 Stock Option Plan, 1999 Omnibus Stock Option Plan, the ESPP, 2002 Omnibus Stock Incentive Plan, and 2004 Omnibus Stock Incentive Plan (collectively, the “Equity Compensation Plans”) were issued without complying with registration or qualification requirements under federal securities laws and the securities laws of certain states.  As a result, certain plan participants have a right to rescind their purchases of shares under the Equity Compensation Plans or recover damages if they no longer own the shares or hold unexercised options, subject to applicable statutes of limitations.  Additionally, regulatory authorities may require the Company to pay fines or impose other sanctions.  Although the Company continues to evaluate the possible actions it may take, the Company may make a rescission offer to certain plan participants entitled to rescission rights subject to obtaining required regulatory approvals.

                The Company believes certain of its stock option grants made since February 2003 may have also violated applicable securities laws in California, Georgia and possibly other states even though holders have not exercised such options.  Although the Company is continuing to evaluate its potential rescission risk to option holders, the Company is considering making a rescission offer to certain option holders.  Because the options in question have not been exercised, no amounts are recorded in permanent equity.  There are a number of factors that must be considered in determining what a rescission offer to option holders may involve.  At the current time, the Company is unable to determine and quantify all of the key factors for a potential rescission offer.

                The Company believes that it is reasonably possible that some option holders may accept a rescission offer, but the Company is unable to estimate the number of participants who might accept a rescission offer and the amount of potential damages that it would be required to pay under a rescission offer.  Since any loss is considered reasonably possible but not estimable, the Company has not recorded a liability for this contingency.

                The Company may also be required to pay interest and penalties up to statutory limits in connection with plan participants making rescission claims or in connection with any rescission offer.  The Company believes that it is reasonably possible that it may be required to pay interest and penalties, but it is not able to estimate an amount.

 

16

 

(6) COMMON STOCK SUBJECT TO RESCISSION

As described in Note 5, certain participants in the Equity Compensation Plans have a right to rescind their purchases of shares under the Plans or recover damages if they no longer own the shares or hold unexercised options, subject to applicable statutes of limitations.

Accounting Series Release (“ASR”) No. 268 and Emerging Issues Task Force (“EITF”) Topic D-98 require that stock subject to rescission or redemption requirements outside the control of the Company to be classified outside of permanent equity.  The exercise of the rescission right is at the holders’ discretion, but exercise of that right may depend in part on the fair value of the Company’s common stock, which is outside of the Company’s and the holders’ control.  Consequently, common stock subject to rescission is classified as temporary equity.  If the Company’s possible rescission offer is made and accepted by plan participants holding shares acquired under the Equity Compensation Plans or otherwise entitled to recover damages from the Company in respect of such shares they have sold, or such plan participants otherwise make rescission claims against the Company, the Company could be required to make aggregate payments to these plan participants of up to $851,000 in the aggregate, excluding interest and other possible fees, based upon shares outstanding under the Equity Compensation Plans as of April 30, 2005.

In the event the Company completes a rescission offer or plan participants otherwise exercise rescission rights, any amounts the Company may pay to plan participants, excluding interest and other possible charges, will be deducted from common stock subject to rescission, and, in the event a plan participant declines a rescission offer or otherwise is determined to no longer have a rescission right, any remaining amounts recorded to common stock subject to rescission will be recorded as permanent equity.

(7) STOCKHOLDERS’ EQUITY

Stock Options

During the three and six months ended April 30, 2005, the Company granted options to purchase 0 and 631,000 shares of common stock with an average exercise price of $4.71, respectively, per share.  None of these stock options were granted with an exercise price below the quoted market price on the date of grant.  During the three and six months ended April 30, 2005, options to purchase approximately 7,000 and 142,000 shares of common stock were exercised with an average exercise price of $0.95 and $1.47, respectively, per share.  As of April 30, 2005, there were approximately 3,437,000 stock options outstanding with a weighted average exercise price of $4.32 per share.

Change in Control Agreements

On December 10, 2004, the Company entered into Change in Control Agreements with the following executive officers:  Darl C. McBride; Bert B. Young; Christopher Sontag; Jeff F. Hunsaker; and Ryan E. Tibbitts (each, an “Officer”).  Each agreement is effective as of December 10, 2004.

Pursuant to the terms of each Agreement, the Officer agrees that he or she will not voluntarily leave the employ of the Company in the event any individual, corporation, partnership, company or other entity takes certain steps to effect a Change in Control (as defined in the Agreement) of the Company, until the attempt to effect a Change in Control has terminated, or until a Change in Control occurs.

If the Officer is still employed by the Company when a Change in Control occurs, any stock, stock option or restricted stock granted to the Officer by the Company that would have

 

17

 

become vested upon continued employment by the Officer shall immediately vest in full and become exercisable notwithstanding any provision to the contrary of such grant and shall remain exercisable until it expires or terminates in accordance with its terms.  Each Officer shall be solely responsible for any taxes that arise or become due pursuant to the acceleration of vesting that occurs pursuant to the Agreement.

The adoption of the Change in Control Agreements allows for accelerated vesting on all outstanding shares of common stock and represents a modification to the underlying stock option award.  In accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 44 “Accounting for Certain Transactions Involving Stock Compensation,” the Company has calculated the total intrinsic value of the awards of $2,012,000 which represents the value of the awards that were subject to the acceleration.  During the three and six months ended April 30, 2005, this amount had not been recorded in the condensed consolidated financial statements as an event to trigger the acceleration was not considered probable.

Stockholder Rights Plan

                On August 10, 2004, the Company’s Board of Directors adopted a Stockholder Rights Plan (the “Rights Plan”) designed to deter coercive takeover tactics, including accumulation of the Company’s shares in the open market or through private transactions and to prevent an acquirer from gaining control of the Company without offering a fair price to all of the Company’s stockholders.

                Under the terms of the Rights Plan, Series A Junior Participating Preferred Stock purchase rights were distributed as a dividend at the rate of one right for each share of common stock of the Company held by stockholders of record as of the close of business on August 30, 2004, and will be distributed to holders of subsequently issued shares of common stock.  The Rights Plan would be triggered if a person or group acquired beneficial ownership of 15 percent or more of the Company’s common stock other than pursuant to a board-approved tender or exchange offer or commences, or publicly announces an intention to commence, a tender or exchange offer upon consummation of which such person or group would beneficially own 15 percent or more of the Company’s common stock.  The value of the purchase rights is immaterial as of April 30, 2005.

Transfer of Stock Ownership by The Canopy Group to Ralph J. Yarro III

 

Effective March 11, 2005, The Canopy Group (“Canopy”) transferred all of its shares of the Company’s common stock to Ralph J. Yarro III, the Chairman of the Company’s Board of Directors.

(8) CONCENTRATION OF RISK

As of April 30, 2005 and October 31, 2004, the Company had no customers who made up more than 10 percent of the ending accounts receivable balance.

During the three and six months ended April 30, 2005 and 2004, no single customer accounted for more than 10 percent of total revenue.

 

18

 

(9) RELATED PARTY TRANSACTIONS

As of October 31, 2004, Canopy owned approximately 31 percent of the Company’s issued and outstanding common stock.  As described in Note 7, on March 11, 2005, Canopy transferred all of its shares of common stock to Ralph J. Yarro III.

On April 30, 2003, the Company and Center 7, Inc. (“C7”) entered into a Marketing and Distribution Master Agreement (the “Marketing Agreement”) and an Assignment Agreement.  On October 2, 2003, C7 assigned the Assignment Agreement to Vintela, Inc. (“Vintela”) and Vintela and the Company entered into a new marketing agreement (the “Vintela Agreement”).  Both C7 and Vintela are majority owned by Canopy.  Under the Vintela Agreement, the Company was appointed as a worldwide distributor for Vintela products to co-brand, market and distribute these products.

Under the Assignment Agreement, the Company assigned the copyright applications, patents and contracts related to Volution Manager, Volution Authentication, Volution Online and Volution Manager Update Service (collectively, the “Assigned Software”).  As consideration for this assignment, C7 issued, and Vintela assumed, a $500,000 non-recourse promissory note payable to the Company, secured by the Assigned Software.  This note was originally due on April 30, 2005 with interest payable at a rate of one percent above the prime rate as reported in the Wall Street Journal.

In late November 2004, the Company entered into discussions with Vintela with respect to the cancellation of the Marketing Agreement and repayment of the Note.  It was later determined and decided once Vintela had received funding from an outside third party, the Company agreed with Vintela to forego any interest charges on the promissory note in return for an immediate payment of the $500,000.  On December 9, 2004, the Company received the $500,000 payment from Vintela and forgave the outstanding interest charges associated with the promissory note.

At the time the promissory note was executed, the Company had no recorded basis in the Assigned Software.  Because the transfer of the Assigned Software was to a related party in exchange for a promissory note and there was substantial doubt concerning the ability of C7 to repay the debt as they were not profitable and being funded by Canopy, no gain was recognized by the Company until payment was received on December 9, 2004.  The Company recorded the $500,000 received as a component of other income in its statement of operations for the six months ended April 30, 2005.

(10) SEGMENT INFORMATION

The Company’s resources are allocated and operating results managed to the operating income (loss) level for each of the Company’s segments: UNIX and SCOsource.  Both segments are based on the Company’s UNIX intellectual property.  The UNIX business sells and distributes UNIX products and services through an extensive distribution channel and to corporate end-users and the SCOsource business enforces and protects the Company’s UNIX intellectual property.

During fiscal year 2004, in an effort to maximize the assets and resources of the UNIX and SCOsource business segments and to best represent management’s view of business operations, the Company directed resources and reviewed financial information for its UNIX and SCOsource segments.

 

19

 

Segment disclosures for the Company are as follows for the three and six months ended April 30, 2005 (in thousands):

 

 

 

 

 

20

 

 

Intangible assets, which consist of the Company’s reseller channel, trade name and technology, have been assigned to the Company’s UNIX and SCOsource segments and consist of the following as of April 30, 2005 and October 31, 2004 (in thousands):

 

21

 

ITEM 2.                                                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other parts of this quarterly report on Form 10-Q contain forward-looking statements that involve risks and uncertainties.  Forward-looking statements can also be identified by words such as “intends,” “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms.  Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements.  Factors that might cause such differences include, but are not limited to, those set forth below under “Forward-Looking Statements” and “Risk Factors” and elsewhere in this Form 10-Q.  The following discussion should be read in conjunction with our consolidated financial statements and notes thereto included in this Form 10-Q and our annual report on Form 10-K for the year ended October 31, 2004 filed with the Securities and Exchange Commission, including the audited financial statements and management’s discussion and analysis contained therein.  All information presented herein is based on the three and six months ended April 30, 2005.  We assume no obligation to revise or update any forward-looking statements for any reason, except as required by law.

Overview

Historical Background.  We originally incorporated as Caldera Systems, Inc., a Utah corporation (“Caldera Systems”), and reincorporated as a Delaware corporation on March 6, 2000.  In March 2000, we completed an initial public offering of our common stock.  On May 7, 2001, we formed a new holding company in Delaware under the name of Caldera International, Inc. to acquire substantially all of the assets and operations of the server and professional services groups of The Santa Cruz Operation (now Tarantella, Inc.).  In connection with this acquisition, Caldera Systems became a wholly-owned subsidiary of Caldera International, Inc.  Former holders of shares and options to purchase shares of Caldera Systems received an equal number of shares and options to purchase shares in Caldera International, Inc .  On May 16, 2003, our stockholders approved our corporate name change to The SCO Group, Inc.  As used herein, “we,” “us” and “the Company” refer to The SCO Group, Inc.

Recent Developments.   As described elsewhere in this Form 10-Q, we issued shares and granted options under our 1998 Stock Option Plan, our 1999 Omnibus Stock Incentive Plan, the 2000 Employee Stock Purchase Plan (the “ESPP”), our 2002 Omnibus Stock Incentive Plan, and our 2004 Omnibus Stock Incentive Plan (collectively, the “Equity Compensation Plans”) without complying with registration or qualification requirements under federal securities laws and the securities laws of certain states.  As a result, certain plan participants have a right to rescind their purchases of shares under the Equity Compensation Plans or recover damages if they no longer own the shares or hold unexercised options, subject to applicable statutes of limitations.  Although we are evaluating the possible actions we may take in response to these securities law compliance issues, we may make a rescission offer to certain plan participants entitled to rescission rights subject to obtaining required regulatory approvals.  If our potential rescission offer is made and accepted by all plan participants holding certain ESPP shares and all shares acquired from the exercise of stock options, or such participants otherwise make rescission claims against us, we could be required to make aggregate payments to these plan participants of up to $851,000.  This amount is based on shares issued pursuant to the ESPP and shares issued upon the exercise of stock options that have been retained by plan participants as of April 30, 2005 and excludes interest and other charges we may be required to pay since any loss is considered reasonably possible but not estimable.  We may face additional rescission liability to plan participants holding unexercised stock options in California, Georgia and possibly other states, and regulatory authorities also may require us to pay fines or impose other sanctions on us.

 

22

---