UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark one)
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x |
QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(d) OF
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For the quarterly period ended July 31, 2006
OR
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o |
TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF
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For the transition period from to
Commission file number 0-29911
THE SCO GROUP, INC.
(Exact name of registrant as specified in its charter)
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Delaware |
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87-0662823 |
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(State or other jurisdiction of |
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(I.R.S. Employer Identification Number) |
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incorporation or organization) |
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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 such filing requirements for the past 90 days. YES x NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One): Large Accelerated Filer o Accelerated filer o Non-accelerated Filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). (Check one): YES o NO x
As of September 11, 2006, there were 21,093,981 shares of the Registrant’s common stock, $0.001 par value per share, outstanding.
The SCO Group, Inc.
Table of Contents
2
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FINANCIAL INFORMATION |
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UNAUDITED FINANCIAL STATEMENTS |
THE SCO GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
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July 31,
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October 31,
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ASSETS |
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CURRENT ASSETS: |
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Cash and cash equivalents |
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$ |
8,861 |
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$ |
4,272 |
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Restricted cash |
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2,010 |
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5,690 |
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Available-for-sale marketable securities |
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5,099 |
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6,165 |
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Accounts receivable, net of allowance for doubtful accounts of $97 and $144, respectively |
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4,072 |
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6,343 |
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Other |
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1,720 |
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2,454 |
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Total current assets |
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21,762 |
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24,924 |
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PROPERTY AND EQUIPMENT: |
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Computer and office equipment |
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2,184 |
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2,224 |
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Leasehold improvements |
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316 |
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345 |
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Furniture and fixtures |
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79 |
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96 |
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2,579 |
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2,665 |
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Less accumulated depreciation and amortization |
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(1,969 |
) |
(2,087 |
) |
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Net property and equipment |
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610 |
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578 |
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OTHER ASSETS: |
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Definite-lived intangibles, net |
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677 |
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2,707 |
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Other |
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423 |
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739 |
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Total other assets |
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1,100 |
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3,446 |
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Total assets |
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$ |
23,472 |
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$ |
28,948 |
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LIABILITIES AND STOCKHOLDERS’ EQUITY |
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CURRENT LIABILITIES: |
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Accounts payable |
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$ |
2,239 |
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$ |
2,197 |
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Payable to Novell, Inc. |
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449 |
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2,815 |
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Accrued payroll and benefits |
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1,734 |
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2,656 |
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Accrued liabilities |
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3,087 |
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3,118 |
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Deferred revenue |
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2,875 |
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3,841 |
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Royalties payable |
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272 |
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406 |
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Income taxes payable |
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1,235 |
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1,222 |
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Total current liabilities |
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11,891 |
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16,255 |
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LONG-TERM LIABILITIES |
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227 |
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338 |
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COMMITMENTS AND CONTINGENCIES (Note 4) |
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COMMON STOCK SUBJECT TO RESCISSION (Note 5) |
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— |
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1,018 |
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STOCKHOLDERS’ EQUITY: |
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Common stock, $0.001 par value; 45,000 shares authorized, 21,391 and 18,331 shares outstanding, respectively |
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21 |
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18 |
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Additional paid-in capital |
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259,780 |
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246,985 |
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Common stock held in treasury; 297 and 290 shares, respectively |
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(2,446 |
) |
(2,414 |
) |
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Warrants outstanding |
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856 |
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856 |
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Accumulated other comprehensive income |
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940 |
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834 |
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Accumulated deficit |
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(247,797 |
) |
(234,942 |
) |
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Total stockholders’ equity |
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11,354 |
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11,337 |
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Total liabilities and stockholders’ equity |
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$ |
23,472 |
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$ |
28,948 |
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See accompanying notes to condensed consolidated financial statements.
3
THE SCO GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share data)
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Three Months Ended July 31, |
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Nine Months Ended July 31, |
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2006 |
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2005 |
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2006 |
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2005 |
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REVENUE: |
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Products |
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$ |
6,201 |
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$ |
7,953 |
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$ |
17,904 |
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$ |
23,095 |
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SCOsource licensing |
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31 |
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32 |
|
95 |
|
132 |
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Services |
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1,189 |
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1,368 |
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3,891 |
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4,249 |
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Total revenue |
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7,421 |
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9,353 |
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21,890 |
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27,476 |
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COST OF REVENUE: |
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Products |
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478 |
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695 |
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1,559 |
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1,902 |
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SCOsource licensing |
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2,315 |
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3,085 |
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10,087 |
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9,467 |
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Services |
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666 |
|
700 |
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2,012 |
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2,195 |
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Total cost of revenue |
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3,459 |
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4,480 |
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13,658 |
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13,564 |
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GROSS MARGIN |
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3,962 |
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4,873 |
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8,232 |
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13,912 |
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OPERATING EXPENSES: |
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Sales and marketing |
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3,111 |
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2,935 |
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8,656 |
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8,849 |
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Research and development |
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2,029 |
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1,940 |
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5,786 |
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6,145 |
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General and administrative |
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1,829 |
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1,647 |
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5,139 |
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5,446 |
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Amortization of intangibles |
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593 |
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593 |
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1,778 |
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1,779 |
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Total operating expenses |
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7,562 |
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7,115 |
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21,359 |
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22,219 |
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LOSS FROM OPERATIONS |
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(3,600 |
) |
(2,242 |
) |
(13,127 |
) |
(8,307 |
) |
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EQUITY IN INCOME (LOSS) OF AFFILIATE |
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— |
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(19 |
) |
(8 |
) |
51 |
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OTHER INCOME, NET: |
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Interest income |
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191 |
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122 |
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542 |
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257 |
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Other income (expense), net |
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(64 |
) |
(149 |
) |
46 |
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1,025 |
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Total other income (expense), net |
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127 |
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(27 |
) |
588 |
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1,282 |
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LOSS BEFORE PROVISION FOR INCOME TAXES |
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(3,473 |
) |
(2,288 |
) |
(12,547 |
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(6,974 |
) |
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PROVISION FOR INCOME TAXES |
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(107 |
) |
(84 |
) |
(308 |
) |
(321 |
) |
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NET LOSS |
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$ |
(3,580 |
) |
$ |
(2,372 |
) |
$ |
(12,855 |
) |
$ |
(7,295 |
) |
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BASIC AND DILUTED NET LOSS PER COMMON SHARE |
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$ |
(0.17 |
) |
$ |
(0.13 |
) |
$ |
(0.62 |
) |
$ |
(0.41 |
) |
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WEIGHTED AVERAGE BASIC AND DILUTED COMMON SHARES OUTSTANDING |
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21,063 |
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17,993 |
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20,703 |
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17,885 |
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OTHER COMPREHENSIVE LOSS: |
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Net loss |
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$ |
(3,580 |
) |
$ |
(2,372 |
) |
$ |
(12,855 |
) |
$ |
(7,295 |
) |
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Unrealized gain on available-for-sale marketable securities |
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4 |
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5 |
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49 |
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14 |
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Foreign currency translation adjustment |
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37 |
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(128 |
) |
57 |
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(124 |
) |
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COMPREHENSIVE LOSS |
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$ |
(3,539 |
) |
$ |
(2,495 |
) |
$ |
(12,749 |
) |
$ |
(7,405 |
) |
See accompanying notes to condensed consolidated financial statements.
4
THE SCO GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
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Nine Months Ended July 31, |
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2006 |
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2005 |
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CASH FLOWS FROM OPERATING ACTIVITIES: |
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Net loss |
|
$ |
(12,855 |
) |
$ |
(7,295 |
) |
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Adjustments to reconcile net loss to net cash used in operating activities: |
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Amortization of
intangibles (including $252 and $251 classified as cost of SCOsource
|
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2,030 |
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2,030 |
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Depreciation and amortization |
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226 |
|
271 |
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Stock-based compensation |
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1,323 |
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22 |
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Loss on disposal of assets |
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8 |
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32 |
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Equity in (income) loss of affiliate |
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8 |
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(51 |
) |
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Changes in operating assets and liabilities: |
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Restricted cash |
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1,314 |
|
1,421 |
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Accounts receivable, net |
|
2,271 |
|
1,691 |
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||
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Other current assets |
|
734 |
|
(506 |
) |
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Other assets |
|
— |
|
31 |
|
||
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Accounts payable |
|
42 |
|
(6,517 |
) |
||
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Accrued payroll and benefits |
|
(922 |
) |
(1,099 |
) |
||
|
Compensation to law firms |
|
— |
|
(7,956 |
) |
||
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Accrued liabilities |
|
(31 |
) |
(676 |
) |
||
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Deferred revenue |
|
(966 |
) |
(856 |
) |
||
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Royalties payable |
|
(134 |
) |
(43 |
) |
||
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Income taxes payable |
|
13 |
|
44 |
|
||
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Long-term liabilities |
|
(111 |
) |
(3 |
) |
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Net cash used in operating activities |
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(7,050 |
) |
(19,460 |
) |
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CASH FLOWS FROM INVESTING ACTIVITIES: |
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Purchase of property and equipment |
|
(265 |
) |
(233 |
) |
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Dividend received |
|
308 |
|
— |
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Purchase of available-for-sale marketable securities |
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(6,441 |
) |
(8,224 |
) |
||
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Proceeds from sale of available-for-sale marketable securities |
|
7,507 |
|
20,904 |
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Net cash provided by investing activities |
|
1,109 |
|
12,447 |
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CASH FLOWS FROM FINANCING ACTIVITIES: |
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Proceeds from sale of common stock through employee stock purchase plan |
|
613 |
|
720 |
|
||
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Proceeds from exercise of common stock options |
|
35 |
|
235 |
|
||
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Repurchase of common stock |
|
(32 |
) |
— |
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Proceeds from sale of common stock in a private placement, net of offering costs |
|
9,809 |
|
— |
|
||
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Net cash provided by financing activities |
|
10,425 |
|
955 |
|
||
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NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS |
|
4,484 |
|
(6,058 |
) |
||
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EFFECT OF FOREIGN EXCHANGE RATES ON CASH AND CASH EQUIVALENTS |
|
105 |
|
(109 |
) |
||
|
CASH AND CASH EQUIVALENTS, beginning of period |
|
4,272 |
|
12,693 |
|
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CASH AND CASH EQUIVALENTS, end of period |
|
$ |
8,861 |
|
$ |
6,526 |
|
|
|
|
|
|
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: |
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Cash paid for income taxes |
|
$ |
247 |
|
$ |
259 |
|
|
|
|
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SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES: |
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|
|
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|
||
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|
|
|
|
|
|
||
|
Increase (decrease) in common stock subject to rescission |
|
$ |
(1,018 |
) |
$ |
576 |
|
See accompanying notes to condensed consolidated financial statements.
5
THE SCO GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
The business of The SCO Group, Inc. (the “Company”, “we”, “us” or “our”) focuses on marketing reliable, cost-effective UNIX software products and related services for the small-to-medium sized business market, including replicated site franchises of Fortune 1000 companies. The Company has operations in a number of countries that provide support services to customers and resellers. During the year ended October 31, 2003, the Company initiated its SCOsource business to protect and defend its UNIX intellectual property. The Company acquired certain intellectual property rights surrounding UNIX and UNIX System V source code in May 2001 from The Santa Cruz Operation, which changed its name to Tarantella, Inc., and was subsequently acquired by Sun Microsystems.
The Company incurred a net loss of $12,855,000 for the nine months ended July 31, 2006 and during that same period used cash of $7,050,000 in its operating activities. A significant portion of the net loss and the cash used in operating activities was associated with the Company protecting and defending its intellectual property rights. As of July 31, 2006, the Company had a total of $8,861,000 in cash and cash equivalents, $5,099,000 in available-for-sale marketable securities, and $2,010,000 in restricted cash, of which $1,561,000 is designated to pay for experts, consultants and other expenses in the SCO Litigation, and the remaining $449,000 of restricted cash is payable to Novell for its retained binary royalty stream.
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 only 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 U.S. generally accepted accounting principles have been condensed or omitted pursuant to SEC rules and regulations, although the 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 nine months ended July 31, 2006 are not necessarily indicative of the operating results that may be expected for the year ending October 31, 2006.
The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 periods. Actual results could differ from these estimates. The Company’s critical accounting policies and estimates include, among others, revenue recognition, allowances for
6
doubtful accounts receivable, impairment and useful lives of long-lived assets, litigation reserves, and valuation allowances against deferred income tax assets.
The Company recognizes revenue in accordance with Statement of Position (“SOP”) 97-2, as modified by SOP 98-9. The Company’s revenue has historically been 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) revenue from SCOsource licensing.
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 not to be fixed or 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-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 revenue to date has been primarily generated from agreements to utilize the Company’s UNIX source code as well as from intellectual property compliance agreements. The Company recognizes revenue from SCOsource agreements when a signed contract exists, the fee is fixed or 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.
7
Cash and Cash Equivalents
The Company considers all investments purchased with original maturities of three months or less to be cash equivalents. Cash equivalents were $4,986,000 and $1,528,000 as of July 31, 2006 and October 31, 2005, respectively. Cash was $3,875,000 and $2,744,000 as of July 31, 2006 and October 31, 2005, respectively.
Available-for-Sale Marketable Securities
Available-for-sale marketable securities are recorded at fair market value, based on quoted market prices, and unrealized gains and losses are recorded as a component of comprehensive loss. Realized gains and losses, which are calculated based on the specific-identification method, are recorded in operations as incurred.
Available-for-sale marketable securities totaled $5,099,000 as of July 31, 2006. Any available-for-sale marketable securities in an unrealized loss position as of July 31, 2006 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 marketable security below cost that is deemed other than temporary results in a charge to earnings and establishes a new basis for the security.
Net Loss per Common Share
Basic net loss per common share (“Basic EPS”) is computed by dividing net loss by the weighted average number of common shares outstanding. Diluted net income per common share (“Diluted EPS”), if any, is computed by dividing net income 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 number of shares issuable upon the exercise of outstanding stock options and warrants to acquire common stock. If dilutive, the Company computes Diluted EPS using the treasury stock method.
Due to the fact that for all periods presented the Company has incurred net losses, common share equivalents of 5,080,000 and 3,982,000 for the three and nine months ended July 31, 2006 and 2005, respectively, are not included in the calculation of diluted net loss per common share because they are anti-dilutive.
(3) DEFINITE-LIVED INTANGIBLE ASSETS
The following table presents the activity related to definite-lived intangible assets for the nine months ended July 31, 2006 as well as the remaining unamortized balances as of July 31, 2006:
|
|
|
Carrying Value
|
|
Amortization
|
|
Carrying Value
|
|
|||
|
Definite-lived intangible assets: |
|
|
|
|
|
|
|
|||
|
Distribution/reseller channel |
|
$ |
2,318,000 |
|
$ |
(1,739,000 |
) |
$ |
579,000 |
|
|
Acquired technology |
|
337,000 |
|
(252,000 |
) |
85,000 |
|
|||
|
Trade name |
|
52,000 |
|
(39,000 |
) |
13,000 |
|
|||
|
Total definite-lived intangible assets |
|
$ |
2,707,000 |
|
$ |
(2,030,000 |
) |
$ |
677,000 |
|
8
Of the $2,030,000 in amortization expense for the nine months ended July 31, 2006, $1,778,000 was classified as amortization of intangible assets in operating expenses and the remaining $252,000 was classified as cost of SCOsource licensing revenue.
(4) COMMITMENTS AND CONTINGENCIES
Litigation
IBM Corporation
On or about March 6, 2003, the Company filed a civil complaint against IBM 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. In this action, the Company claims, among other things, that IBM breached its UNIX source code licenses (both the IBM and Sequent Computer Systems, Inc. “Sequent” licenses) by disclosing restricted information concerning the UNIX source code and derivative works and related information in connection with its efforts to promote the Linux operating system. The Company’s complaint includes, among other things, claims for breach of contract, unfair competition, tortious interference and copyright infringement. As a result of IBM’s actions, the Company is requesting damages in an amount to be proven at trial and seeking injunctive relief.
On or about March 6, 2003, the Company notified IBM that IBM was not in compliance with the Company’s UNIX source code license agreement and on or about June 13, 2003, the Company delivered to IBM a notice of termination of IBM’s UNIX source code license agreement, which underlies IBM’s AIX software. On or about August 11, 2003, the Company sent a similar notice terminating the Sequent source code license. IBM disputes the Company’s right to terminate those licenses. In the event the Company’s termination of those licenses is valid, the Company believes IBM is exposed to substantial damages and injunctive relief claims based on its continued use and distribution of the AIX operating system. On June 9, 2003, Novell sent the Company a notice purporting to waive the Company’s claims against IBM regarding its license breaches. The Company does not believe that Novell had the right to take any such action relative to the Company’s UNIX source code rights.
On February 27, 2004, the Company filed a second amended complaint which alleges nine causes of action that are similar to those set forth above, adds a new claim for copyright infringement and removes the claim for misappropriation of trade secrets. IBM filed an answer and 14 counterclaims. Among other things, IBM has asserted that the Company does not have the right to terminate IBM’s UNIX license and IBM has claimed that the Company has breached the GNU General Public License and has infringed certain patents held by IBM. IBM’s counterclaims include claims for breach of contract, violation of the Lanham Act, unfair competition, intentional interference with prospective economic relations, unfair and deceptive trade practices, promissory estoppel, patent infringement and a declaratory judgment claim for non-infringement of copyrights. On October 6, 2005, IBM voluntarily dismissed with prejudice its claims for patent infringement.
On February 9, 2005, the court denied 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.
9
On July 1, 2005, the court issued a revised Scheduling Order establishing, among other things, discovery and motion deadlines over the next 18 months with a five-week jury trial to commence on February 26, 2007.
Pursuant to the court’s July 1, 2005 Scheduling Order, the Company filed its Interim Disclosure of Material Misused by IBM on October 28, 2005. The Company’s report included a matrix that identified 217 separate technology disclosures that it contends IBM improperly made to enhance Linux in violation of one or more contractual prohibitions governing IBM’s use of the Company’s proprietary material. The Company continued to review relevant materials, including evidence IBM has produced in discovery, and filed an updated report on December 22, 2005 detailing IBM’s misuse of the Company’s proprietary material. The Company’s December 22, 2005 report included 294 total disclosures which the Company claims violate its contractual rights and copyrights. These reports and the disclosures identified are the result of analysis from experienced outside technical consultants.
On February 13, 2006, IBM filed a motion with the court seeking to limit the Company’s claims. IBM argues that of the 294 items identified by the Company in the December 22, 2005 filing, 201 did not meet the level of specificity required by the court. IBM requested that the Company be limited to 93 items set forth in the December 22, 2005 filing which IBM claims meet the required level of specificity. On June 28, 2006, the Magistrate Judge issued a ruling striking over 180 of the Company’s technology disclosures from the case. Although this ruling is a significant limitation of the number of technology disclosures the Company challenged in its December 22, 2005 filing, it also means that over 100 of our challenged items remain in the case. On July 13, 2006, the Company filed objections to the Magistrate Judge’s order with the district court; those objections challenge the process and the result embodied in the Magistrate Judge’s order and the Company expects a hearing to be set in the near future.
On June 8, 2006, IBM filed a motion to confine the Company’s claims to, and strike allegations in excess of, the final disclosures. In this motion, IBM claims that the Company’s technology expert reports go beyond the disclosures contained in the Company’s December 22, 2005 submission to the court and that those expert reports should be stricken to that extent. No hearing has been set on that motion and no ruling has been made. The Company believes that the motion lacks merit and has filed its opposition to the motion.
Both parties have filed expert reports and expert discovery is under way.
Novell, Inc .
On January 20, 2004, the Company filed suit in Utah state court against Novell, Inc. for slander of title seeking relief for its alleged bad faith effort to interfere with the Company’s ownership of copyrights related to the Company’s UNIX source code and derivative works and the Company’s UnixWare product. The case 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 the Company 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 and UNIX itself.
Novell has filed two motions to dismiss claiming, among other things, that Novell’s false statements were not uttered with malice and are privileged under the law. The court denied both of Novell’s motions to dismiss. On July 29, 2005, Novell filed its answer and counterclaims against the Company, asserting counterclaims for the Company’s alleged breaches of the Asset
10
Purchase Agreement between Novell and the Company’s predecessor-in-interest, The Santa Cruz Operation, Inc., for slander of title, restitution/unjust enrichment, an accounting related to Novell’s retained binary royalty stream, and for declaratory relief regarding Novell’s alleged rights under the Asset Purchase Agreement. On December 6, 2005, a scheduling order was entered by the court setting a schedule of discovery and motions leading up to a trial in June 2007. On or about December 30, 2005, the Company filed a motion for leave to amend its complaint to assert additional claims against Novell including copyright infringement, unfair competition and a breach of Novell’s limited license to use the Company’s UNIX code. Novell has consented to the Company’s filing of these additional claims.
On or about April 10, 2006, Novell filed a motion to stay the case in Utah pending a request for arbitration that Novell and SuSE Linux, GmbH (“SuSE”) filed on the same date in the International Court of Arbitration in France. Through these proceedings, Novell claims that the Company granted SuSE the right to use its intellectual property through the Company’s participation in the UnitedLinux initiative in 2002 and through its acquisition of SuSE, Novell acquired SuSE’s rights as a member of UnitedLinux. On May 26, 2006, the Company filed a response to Novell’s motion to stay, and on June 27, 2006, we responded to Novell’s request for arbitration. On August 21, 2006, the court ordered that the claims relating to the SuSE arbitration should be stayed but the other claims in the case should proceed.
The three-person arbitration panel has been selected for the SuSE arbitration in Switzerland, and that process will be commencing in the near future. The Company does not yet know the schedule of the proceedings.
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. If the settlement agreement is not approved by the court, the matter will continue unless another settlement agreement is reached.
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.
Red Hat, Inc.
On August 4, 2003, Red Hat, Inc. 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
11
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 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, the Company will likely assert counterclaims against Red Hat.
Other Matters
In April 2003, the Company’s former Indian distributor filed a claim in India, requesting summary judgment for payment of approximately $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. Management does not believe that the Company is responsible to reimburse the distributor for any operating costs and also believes that the return rights related to any remaining inventory have lapsed. The distributor additionally requested that the Indian courts grant interim relief in the form of attachment of local assets. These requests for interim relief have failed in the court, and discovery has commenced and hearings on the main claims 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.
A material, negative impact on the Company’s results of operations or financial position from the Red Hat, Inc., IPO Class Action, or Indian Distributor matters, or the IBM or Novell counterclaims is neither probable nor estimable.
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 these legal proceedings will not have a material adverse effect on the Company’s results of operations or financial position.
(5) COMMON STOCK SUBJECT TO RESCISSION
The Company believes certain shares and options granted under its 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 had 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. Additionally, regulatory authorities may require the Company to pay fines or impose other sanctions.
Accounting Series Release (“ASR”) No. 268 and Emerging Issues Task Force (“EITF”) Topic D-98 require 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.
12
In December 2005, the Company offered to rescind a total of 337,289 shares of common stock issued under its 2000 Employee Stock Purchase Plan (the “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 the Company issued to residents of these states for which a purchaser could claim a rescission right. The rescission offer was intended to address the Company’s rescission liability relating to its 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 the Company or recover damages, as the case may be.
The rescission offer concluded on January 20, 2006. As of that date, 14 offerees accepted the Company’s offer to rescind the purchase of approximately 7,300 shares. The Company made aggregate payments to such offerees of approximately $41,500, which included approximately $31,800 for the purchase of the shares and approximately $9,700 in statutory interest and damages. As a result of the rescission offer, the Company believes it has extinguished its state rescission liability and mitigated its federal rescission 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 the ESPP. Upon the close of the rescission offer, the Company reclassified the remainder of the common stock subject to rescission which totaled $1,018,000 as additional paid-in capital in permanent equity.
(6) STOCKHOLDERS’ EQUITY
Issuance of Common Stock
On November 29, 2005, the Company entered into a Common Stock Purchase Agreement (“Purchase Agreement”) with several institutional investors and one member of the Company’s board of directors. On November 30, 2005, the Company sold to the investors approximately 2,852,000 shares of the Company’s common stock for gross proceeds of approximately $10,005,000. The costs to facilitate the private placement of the common stock were approximately $196,000. The shares issued to the institutional investors were issued at $3.50 per share and the shares issued to the board member were issued at $3.92 per share. Pursuant to the Purchase Agreement, the Company agreed to use its best efforts to file a registration statement with the SEC covering the resale of this common stock, and to use its commercially reasonable efforts to have such registration statement declared effective. On May 25, 2006, this registration statement was declared effective by the SEC.
Equity Plans
The Company has established the 1998 Stock Option Plan (the “1998 Plan”), 1999 Omnibus Stock Incentive Plan (the “1999 Plan”), the 2002 Omnibus Stock Incentive Plan (the “2002 Plan”) and the 2004 Omnibus Stock Incentive Plan (the “2004 Plan”) for the award of stock options, stock appreciation rights, restricted stock, phantom stock rights, and stock bonuses to employees, executive officers, members of the Board of Directors and outside consultants. The Compensation Committee of the Board of Directors has the ability to determine the terms of the option, the exercise price, the number of shares subject to each option, and the exercisability of the options. The Company’s current practice is for the Compensation Committee to recommend option grants subject to the approval and ratification of the entire Board of Directors at regularly scheduled board meetings. Under the terms of the 1998, 1999, 2002 and 2004 Plans, options generally expire 10 years from the date of grant or within 90 days of termination. Options granted under these plans generally vest 25 percent after the completion of one year of service and then 1/36 per month for the remaining three years and become fully vested at the end of four years. Pursuant to the terms of their grant agreements, certain of the options granted under these plans may be subject to accelerated vesting upon a change in control of the Company.
13
The Company has also established the ESPP, which is designed to allow eligible employees of the Company and its participating subsidiaries to purchase shares of the Company’s common stock, at semi-annual intervals, through periodic payroll deductions.
Prior to October 31, 2005, as permitted under Statement of Financial Accounting Standards (“SFAS”) No. 123, the Company accounted for its stock option plans following the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock issued to Employees,” and related interpretations. Accordingly, no stock-based compensation expense had been reflected in the Company’s statements of operations as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant and the related number of shares granted was fixed at that point in time.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), “Share Based Payment.” This statement revised SFAS No. 123 by eliminating the option to account for employee stock options under APB No. 25 and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards.
Effective November 1, 2005, the Company adopted the fair value recognition provisions of SFAS No. 123(R) using the modified prospective application method. Under this transition method, the Company recorded compensation expense on a straight-line basis for the three and nine months ended July 31, 2006, for: (a) the vesting of options granted prior to November 1, 2005 (based on the grant-date fair value estimated in accordance with the original provisions of SFAS No. 123, and previously presented in the pro-forma footnote disclosures), and (b) stock-based awards granted subsequent to November 1, 2005 (based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R)). In accordance with the modified prospective application method, results for the three and nine months ended July 31, 2005 have not been restated.
The effect of accounting for stock-based awards under SFAS No. 123(R) for the three and nine months ended July 31, 2006 was to record $490,000 and $1,323,000, respectively, of stock-based compensation expense. For the three and nine months ended July 31, 2006 and 2005, the Company has allocated stock-based compensation expense to the following statement of operations captions:
|
|
|
Three Months Ended July 31, |
|
Nine Months Ended July 31, |
|
||||||||
|
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Cost of products |
|
$ |
5,000 |
|
$ |
— |
|
$ |
12,000 |
|
$ |
— |
|
|
Cost of SCOsource licensing |
|
61,000 |
|
— |
|
171,000 |
|
— |
|
||||
|
Cost of services |
|
17,000 |
|
— |
|
46,000 |
|
— |
|
||||
|
Sales and marketing |
|
102,000 |
|
— |
|
261,000 |
|
14,000 |
|
||||
|
Research and development |
|
41,000 |
|
— |
|
97,000 |
|
8,000 |
|
||||
|
General and administrative |
|
264,000 |
|
— |
|
736,000 |
|
— |
|
||||
|
Total stock-based compensation |
|
$ |
490,000 |
|
$ |
— |
|
$ |
1,323,000 |
|
$ |
22,000 |
|
The following pro-forma information, as required by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123,” is presented for comparative purposes and illustrates the effect on net loss and net loss per common share for the three and nine months ended July 31, 2005 as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation prior to November 1, 2005:
14
|
|
|
Three Months Ended
|
|
Nine Months Ended
|
|
||
|
|
|
|
|
|
|
||
|
Net loss: |
|
|
|
|
|
||
|
As reported |
|
$ |
(2,372,000 |
) |
$ |
(7,295,000 |
) |
|
Stock-based compensation included in reported net loss |
|
— |
|
22,000 |
|
||
|
Stock-based compensation under fair value method |
|
(569,000 |
) |
(1,166,000 |
) |
||
|
Pro forma net loss |
|
$ |
(2,941,000 |
) |
$ |
(8,439,000 |
) |
|
Net loss per basic and diluted common share: |
|
|
|
|
|
||
|
As reported |
|
$ |
(0.13 |
) |
$ |
(0.41 |
) |
|
Pro forma |
|
$ |
(0.16 |
) |
$ |
(0.47 |
) |
With respect to stock options granted during the three and nine months ended July 31, 2006 and 2005, the assumptions used in the Black-Scholes option-pricing model are as follows:
|
|
|
Three Months Ended July 31, |
|
Nine Months Ended July 31, |
|
||||
|
|
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
|
Risk-free interest rate |
|
5.0 |
% |
4.1 |
% |
4.8 |
% |
3.7 |
% |
|
Expected dividend yield |
|
0.0 |
% |
0.0 |
% |
0.0 |
% |
0.0 |
% |
|
Volatility |
|
66.2 |
% |
47.1 |
% |
63.4 |
% |
65.0 |
% |
|
Expected exercise life (in years) |
|
5.0 |
|
2.7 |
|
5.0 |
|
2.7 |
|
The estimated fair value of stock options and ESPP shares are amortized over the vesting period of the award.
During the nine months ended July 31, 2006, the Company granted options to purchase approximately 1,065,000 shares of common stock with an average exercise price of $3.84 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 nine months ended July 31, 2006, options to purchase approximately 29,000 shares of common stock were exercised with an average exercise price of $1.21 per share. As of July 31, 2006, there were approximately 4,845,000 stock options outstanding with a weighted average exercise price of $4.11 per share.
(7) CONCENTRATION OF CREDIT RISK
As of July 31, 2006 and October 31, 2005, the Company had no customers who made up more than 10 percent of the accounts receivable balance.
During the three and nine months ended July 31, 2006 and 2005, no single customer accounted for more than 10 percent of total revenue.
15
(8) 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 develops, sells and distributes UNIX server and mobile 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. Segment disclosures for the Company are as follows:
|
|
|
Three Months Ended July 31, 2006 |
|
|||||||
|
|
|
UNIX |
|
SCOsource |
|
Total |
|
|||
|
|
|
|
|
|
|
|
|
|||
|
Revenue |
|
$ |
7,390,000 |
|
$ |
31,000 |
|
$ |
7,421,000 |
|
|
Cost of revenue |
|
1,144,000 |
|
2,315,000 |
|
3,459,000 |
|
|||
|
Gross margin (deficit) |
|
6,246,000 |
|
(2,284,000 |
) |
3,962,000 |
|
|||
|
Sales and marketing |
|
3,111,000 |
|
— |
|
3,111,000 |
|
|||
|
Research and development |
|
1,932,000 |
|
97,000 |
|
2,029,000 |
|
|||
|
General and administrative |
|
1,781,000 |
|
48,000 |
|
1,829,000 |
|
|||
|
Amortization of intangibles |
|
593,000 |
|
— |
|
593,000 |
|
|||
|
Total operating expenses |
|
7,417,000 |
|
145,000 |
|
7,562,000 |
|
|||
|
Loss from operations |
|
$ |
(1,171,000 |
) |
$ |
(2,429,000 |
) |
$ |
(3,600,000 |
) |
|
|
|
Three Months Ended July 31, 2005 |
|
|||||||
|
|
|
UNIX |
|
SCOsource |
|
Total |
|
|||
|
|
|
|
|
|
|
|
|
|||
|
Revenue |
|
$ |
9,321,000 |
|
$ |
32,000 |
|
$ |
9,353,000 |
|
|
Cost of revenue |
|
1,395,000 |
|
3,085,000 |
|
4,480,000 |
|
|||
|
Gross margin (deficit) |
|
7,926,000 |
|
(3,053,000 |
) |
4,873,000 |
|
|||
|
Sales and marketing |
|
2,935,000 |
|
— |
|
2,935,000 |
|
|||
|
Research and development |
|
1,843,000 |
|
97,000 |
|
1,940,000 |
|
|||
|
General and administrative |
|
1,556,000 |
|
91,000 |
|
1,647,000 |
|
|||
|
Amortization of intangibles |
|
593,000 |
|
— |
|
593,000 |
|
|||
|
Total operating expenses |
|
6,927,000 |
|
188,000 |
|
7,115,000 |
|
|||
|
Income (loss) from operations |
|
$ |
999,000 |
|
$ |
(3,241,000 |
) |
$ |
(2,242,000 |
) |
|
|
|
Nine Months Ended July 31, 2006 |
|
|||||||
|
|
|
UNIX |
|
SCOsource |
|
Total |
|
|||
|
|
|
|
|
|
|
|
|
|||
|
Revenue |
|
$ |
21,795,000 |
|
$ |
95,000 |
|
$ |
21,890,000 |
|
|
Cost of revenue |
|
3,571,000 |
|
10,087,000 |
|
13,658,000 |
|
|||
|
Gross margin (deficit) |
|
18,224,000 |
|
(9,992,000 |
) |
8,232,000 |
|
|||
|
Sales and marketing |
|
8,655,000 |
|
1,000 |
|
8,656,000 |
|
|||
|
Research and development |
|
5,501,000 |
|
285,000 |
|
5,786,000 |
|
|||
|
General and administrative |
|
4,994,000 |
|
145,000 |
|
5,139,000 |
|
|||
|
Amortization of intangibles |
|
1,778,000 |
|
— |
|
1,778,000 |
|
|||
|
Total operating expenses |
|
20,928,000 |
|
431,000 |
|
21,359,000 |
|
|||
|
Loss from operations |
|
$ |
(2,704,000 |
) |
$ |
(10,423,000 |
) |
$ |
(13,127,000 |
) |
16
|
|
|
Nine Months Ended July 31, 2005 |
|
|||||||
|
|
|
UNIX |
|
SCOsource |
|
Total |
|
|||
|
|
|
|
|
|
|
|
|
|||
|
Revenue |
|
$ |
27,344,000 |
|
$ |
132,000 |
|
$ |
27,476,000 |
|
|
Cost of revenue |
|
4,097,000 |
|
9,467,000 |
|
13,564,000 |
|
|||
|
Gross margin (deficit) |
|
23,247,000 |
|
(9,335,000 |
) |
13,912,000 |
|
|||
|
Sales and marketing |
|
8,695,000 |
|
154,000 |
|
8,849,000 |
|
|||
|
Research and development |
|
5,846,000 |
|
299,000 |
|
6,145,000 |
|
|||
|
General and administrative |
|
5,094,000 |
|
352,000 |
|
5,446,000 |
|
|||
|
Amortization of intangibles |
|
1,779,000 |
|
— |
|
1,779,000 |
|
|||
|
Total operating expenses |
|
21,414,000 |
|
805,000 |
|
22,219,000 |
|
|||
|
Income (loss) from operations |
|
$ |
1,833,000 |
|
$ |
(10,140,000 |
) |
$ |
(8,307,000 |
) |
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 July 31, 2006 and October 31, 2005:
|
|
|
July 31,
|
|
October 31,
|
|
||
|
Intangible assets: |
|
|
|
|
|
||
|
UNIX (reseller channel and trade name) |
|
$ |
592,000 |
|
$ |
2,370,000 |
|
|
SCOsource (UNIX technology) |
|
85,000 |
|
337,000 |
|
||
|
Total intangible assets |
|
$ |
677,000 |
|
$ |
2,707,000 |
|
17
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 Factors that May Affect Future Results and Financial Condition” and Part II, Item 1A – Risk Factors and elsewhere in this Form 10-Q. The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and notes thereto included in this Form 10-Q and our audited consolidated financial statements included in our annual report on Form 10-K for the year ended October 31, 2005 filed with the Securities and Exchange Commission and management’s discussion and analysis contained therein. All information presented herein is based on the three and nine months ended July 31, 2006 and 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”), on August 21, 1998, 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. (“Caldera International”) to acquire substantially all of the assets and operations of the server and professional services groups of The Santa Cruz Operation. In connection with this acquisition, Caldera Systems became a wholly owned subsidiary of Caldera International. 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 . On May 16, 2003, our stockholders approved our corporate name change to The SCO Group, Inc.
Business Focus
UNIX Business. Our UNIX business serves the needs of small-to-medium sized businesses, including replicated site franchisees of Fortune 1000 companies, by providing reliable, cost effective UNIX operating systems and software products to power computers running on Intel architecture. Our largest source of UNIX business revenue is derived from existing customers through our worldwide, indirect, leveraged channel of partners which includes distributors and independent solution providers. We have operations 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 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 (“OEMs”). Our sales of UNIX products and services during the last several fiscal years 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.
18
The following table shows the operating results of the UNIX business for the three and nine months ended July 31, 2006 and 2005:
|
|
|
Three Months Ended July 31, |
|
||||
|
|
|
2006 |
|
2005 |
|
||
|
|
|
|
|
|
|
||
|
Revenue |
|
$ |
7,390,000 |
|
$ |
9,321,000 |
|
|
Cost of revenue |
|
1,144,000 |
|
1,395,000 |
|
||
|
Gross margin |
|
6,246,000 |
|
7,926,000 |
|
||
|
Sales and marketing |
|
3,111,000 |
|
2,935,000 |
|
||
|
Research and development |
|
1,932,000 |
|
1,843,000 |
|
||
|
General and administrative |
|
1,781,000 |
|
1,556,000 |
|
||
|
Amortization of intangibles |
|
593,000 |
|
593,000 |
|
||
|
Total operating expenses |
|
7,417,000 |
|
6,927,000 |
|
||
|
Income (loss) from operations |
|
$ |
(1,171,000 |
) |
$ |
999,000 |
|
|
|
|
Nine Months Ended July 31, |
|
||||
|
|
|
2006 |
|
2005 |
|
||
|
|
|
|
|
|
|
||
|
Revenue |
|
$ |
21,795,000 |
|
$ |
27,344,000 |
|
|
Cost of revenue |
|
3,571,000 |
|
4,097,000 |
|
||
|
Gross margin |
|
18,224,000 |
|
23,247,000 |
|
||
|
Sales and marketing |
|
8,655,000 |
|
8,695,000 |
|
||
|
Research and development |
|
5,501,000 |
|
5,846,000 |
|
||
|
General and administrative |
|
4,994,000 |
|
5,094,000 |
|
||
|
Amortization of intangibles |
|
1,778,000 |
|
1,779,000 |
|
||
|
Total operating expenses |
|
20,928,000 |
|
21,414,000 |
|
||
|
Income (loss) from operations |
|
$ |
(2,704,000 |
) |
$ |
1,833,000 |
|
Revenue from our UNIX business decreased by $1,931,000, or 21%, for the three months ended July 31, 2006 compared to the three months ended July 31, 2005 and decreased by $5,549,000, or 20%, for the nine months ended July 31, 2006 compared to the nine months ended July 31, 2005. The revenue from this business has been declining over the last several periods primarily as a result of increased competition from alternative operating systems, particularly Linux. We believe the inclusion of our UNIX code and derivative works in Linux has been a contributor to the decline in our UNIX business because users of Linux generally do not pay for the operating system itself, but pay for services and maintenance. The Linux operating system competes directly with our OpenServer and UnixWare products and has taken significant market share from these products.
Operating costs for our UNIX business increased from $6,927,000 for the three months ended July 31, 2005 to $7,417,000 for the three months ended July 31, 2006 and this increase was primarily attributable to stock-based compensation as a result of our adoption of SFAS No. 123 (R). Operating costs decreased slightly from $21,414,000 for the nine months ended July 31, 2005 to $20,928,000 for the nine months ended July 31, 2006 and was primarily attributable to reduced headcount and related costs offset by an increase in stock-based compensation.
The decline in our UNIX business revenue may be accelerated if industry partners withdraw their support for our products. The decline in our UNIX business and our SCOsource business may cause industry partners, developers and hardware and software vendors to choose
19
not to support or certify to our UNIX operating system products. This would lead to an accelerated decline in revenue and negative cash flows from our UNIX business.
SCOsource Business. During the year ended October 31, 2003, we became aware that our UNIX code and derivative works had been inappropriately included by others in the Linux operating system. We believe the inclusion of our UNIX code and derivative works in Linux has been a contributor to the decline in our UNIX business because users of Linux generally do not pay for the operating system itself, but pay for services and maintenance. The Linux operating system competes directly with our OpenServer and UnixWare products and has taken significant market share from these products.
In an effort to protect and defend our UNIX intellectual property, we initiated our SCOsource business. Our SCOsource revenue for the years ended October 31, 2005 and 2004 was significantly lower than revenue generated during the year ended October 31, 2003, and we believe and allege our revenue and related revenue opportunities have been adversely impacted by Novell’s claim of UNIX copyright ownership, which may have caused potential customers to delay or forego licensing with us 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, 2006 and 2005 (in thousands):
|
|
|
Three Months Ended July 31, |
|
||||
|
|
|
2006 |
|
2005 |
|
||
|
|
|
|
|
|
|
||
|
Revenue |
|
$ |
31,000 |
|
$ |
32,000 |
|
|
Cost of revenue |
|
2,315,000 |
|
3,085,000 |
|
||
|
Gross deficit |
|
(2,284,000 |
) |
(3,053,000 |
) |
||
|
Research and development |
|
97,000 |
|
97,000 |
|
||
|
General and administrative |
|
48,000 |
|
91,000 |
|
||
|
Total operating expenses |
|
145,000 |
|
188,000 |
|
||
|
Loss from operations |
|
$ |
(2,429,000 |
) |
$ |
(3,241,000 |
) |
|
|
|
Nine Months Ended July 31, |
|
||||
|
|
|
2006 |
|
2005 |
|
||
|
|
|
|
|
|
|
||
|
Revenue |
|
$ |
95,000 |
|
$ |
132,000 |
|
|
Cost of revenue |
|
10,087,000 |
|
9,467,000 |
|
||
|
Gross deficit |
|
(9,992,000 |
) |
(9,335,000 |
) |
||
|
Sales and marketing |
|
1,000 |
|
154,000 |
|
||
|
Research and development |
|
285,000 |
|
299,000 |
|
||
|
General and administrative |
|
145,000 |
|
352,000 |
|
||
|
Total operating expenses |
|
431,000 |
|
805,000 |
|
||
|
Loss from operations |
|
$ |
(10,423,000 |
) |
$ |
(10,140,000 |
) |
Revenue from our SCOsource business decreased slightly from $32,000 for the three months ended July 31, 2005 to $31,000 for the three months ended July 31, 2006 and decreased from $132,000 for the nine months ended July 31, 2005 to $95,000 for the nine months ended July 31, 2006. Revenue in the above mentioned periods was primarily attributable to sales of our SCOsource IP agreements.
Cost of revenue, which primarily includes legal and professional fees incurred in connection with the SCO Litigation, decreased from $3,085,000 for the three months ended July
20
31, 2005 to $2,315,000 for the three months ended July 31, 2006. The decrease in cost of revenue was primarily attributable to the absence of the $2,000,000 quarterly payment for Boies, Schiller & Flexner LLP, Kevin McBride and Berger Singerman (the “Law Firms”) (which quarterly payments ended during the three months ended January 31, 2006), offset by increases in legal services provide by technical, industry, damage and other experts in connection with the SCO Litigation. Cost of revenue increased from $9,467,000 for the nine months ended July 31, 2005 to $10,087,000 for the nine months ended July 31, 2006. This increase was primarily attributable to significant work performed by technical, damage and industry experts and other consultants in connection with the SCO Litigation during the nine months ended July 31, 2006, offset by a reduction in expense associated with the quarterly payments made to the Law Firms as only two quarterly payments were made during the nine months ended July 31, 2006 as compared to three quarterly payments made during the nine months ended July 31, 2005. Because of the unique and unpredictable nature of the SCO Litigation, the occurrence and timing of certain expenses such as damage, industry and technical review and other consultants is difficult to predict, and it will be difficult to predict the total cost of revenue for the upcoming quarters.
Because of the uncertainties related to our SCOsource business, we are unable to estimate the amount and timing of future SCOsource licensing revenue. We are unlikely to generate significant revenue from our SCOsource business unless and until we prevail in our SCO Litigation. Additionally, the success of the SCOsource business may depend on the strength of our intellectual property rights and claims regarding UNIX, including our claims against Novell and the strength of our claim that unauthorized UNIX source code and derivative works are contained in Linux.
Critical Accounting Policies
Our critical accounting policies and estimates include the following:
· Revenue recognition;
· Deferred income tax assets and related valuation allowances;
· Litigation reserves;
· Impairment and useful lives of long-lived assets; and
· Allowances for doubtful accounts receivable.
Revenue Recognition . We recognize revenue in accordance with Statement of Position (“SOP”) 97-2, as modified by SOP 98-9. Our revenue has historically been from three sources: (i) product license revenue, primarily from product sales to resellers, end users and OEMs; (ii) technical support service revenue, primarily from providing technical support and consulting services to end users; and (iii) revenue from SCOsource licensing.
We recognize 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 our revenue transactions relate to product-only sales. On occasion, we have revenue transactions that have multiple elements (such as software 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 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. We recognize revenue when the criteria for product revenue recognition set forth above have been met. If VSOE of all undelivered elements exists, but VSOE does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of
21
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 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.
We consider an arrangement with payment terms longer than our normal business practice, not to be fixed or determinable and revenue is recognized when the fee becomes due. We typically provide stock rotation rights for sales made through our distribution channel and sales to distributors are recognized upon shipment by the distributor to end users. For direct sales not through our distribution channel, sales are typically non-refundable and non-cancelable. We estimate our product returns based on historical experience and maintain an allowance for estimated returns, which is recorded as a reduction to accounts receivable.
Our SCOsource revenue to date has been primarily generated from agreements to utilize our UNIX source code as well as from intellectual property compliance agreements. We recognize revenue from SCOsource agreements when a signed contract exists, the fee is fixed or determinable, collection of the receivable is probable and delivery has occurred. If the payment terms extend beyond our normal payment terms, revenue is recognized as the payments become due.
Deferred Income Tax Assets 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, if any, and other future events, the effects of which cannot be determined. We have provided a valuation allowance of $69,239,000 against our entire net deferred income tax assets as of October 31, 2005. The valuation allowance was recorded because of our history of net operating losses and the uncertainties regarding our future operating profitability and taxable income.
Litigation Reserves. We are party to a number of legal matters described in more detail elsewhere in this quarterly report on Form 10-Q. Pursuit and defense of these matters will be costly, and management expects the costs for legal fees and related expenses will be substantial. A material, negative impact on our results of operations or financial position from the Red Hat, Inc., IPO Class Action, or Indian Distributor matters, or the IBM and Novell counterclaims is neither probable nor estimable. Because these matters are not probable or estimable, we have not recorded any reserves or contingencies related to these legal matters. In the event that our assumptions used to evaluate these matters as neither probable nor estimable changes in future periods, we may be required to record a liability for an adverse outcome, which could have a material adverse effect on our results of operations and financial position.
Impairment and Useful Lives of Long-lived Assets . We review our long-lived tangible and intangible assets for impairment when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. We evaluate, at each balance sheet date, whether events and circumstances have occurred which indicate possible impairment. The carrying value of a long-lived asset is considered impaired when the anticipated cumulative undiscounted cash flows of the related asset or group of assets is less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the estimated fair market value of the long-lived asset. Economic useful lives of long-lived assets are assessed and adjusted as circumstances dictate.
22
Write-downs of intangible assets may be necessary if the future fair value of these assets is less than carrying value. If the operating trends for our UNIX or SCOsource businesses continue to decline, we may be required to record an impairment charge in a future period related to the carrying value of our long-lived assets.
Allowance for Doubtful Accounts Receivable . 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 apply these policies consistently. Our allowance for doubtful accounts receivable, which is determined based on our historical experience and a specific review of customer balances, was $97,000 as of July 31, 2006. 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, w hich may have an adverse impact on our future accounts receivable and cash position.
Results of Operations
The following table presents our results of operations for the three and nine months ended July 31, 2006 and 2005:
|
|
|
Three Months Ended July 31, |
|
Nine Months Ended July 31, |
|
||||||||
|
Statement of Operations Data: |
|
2006 |
|
2005 |
|
2006 |
|
2005 |
|
||||
|
|
|
|
|
|
|
|
|
|
|
||||
|
Revenue: |
|
|
|
|
|
|
|
|
|
||||
|
Products |
|
$ |
6,201,000 |
|
$ |
7,953,000 |
|
$ |
17,904,000 |
|
$ |
23,095,000 |
|
|
SCOsource licensing |
|
31,000 |
|
32,000 |
|
95,000 |
|
132,000 |
|
||||
|
Services |
|
1,189,000 |
|
1,368,000 |
|
3,891,000 |
|
4,249,000 |
|
||||
|
Total revenue |
|
7,421,000 |
|
9,353,000 |
|
21,890,000 |
|
27,476,000 |
|
||||
|
Cost of revenue: |
|
|
|
|
|
|
|
|
|
||||
|
Products |
|
478,000 |
|
695,000 |
|
1,559,000 |
|
1,902,000 |
|
||||
|
SCOsource licensing |
|
2,315,000 |
|
3,085,000 |
|
10,087,000 |
|
9,467,000 |
|
||||
|
Services |
|
666,000 |
|
700,000 |
|
2,012,000 |
|
2,195,000 |
|
||||
|
Total cost of revenue |
|
3,459,000 |
|
4,480,000 |
|
13,658,000 |
|
13,564,000 |
|
||||
|
Gross margin |
|
3,962,000 |
|
4,873,000 |
|
8,232,000 |
|
13,912,000 |
|
||||
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
||||
|
Sales and marketing |
|
3,111,000 |
|
2,935,000 |
|
8,656,000 |
|
8,849,000 |
|
||||
|
Research and development |
|
2,029,000 |
|
1,940,000 |
|
5,786,000 |
|
6,145,000 |
|
||||
|
General and administrative |
|
1,829,000 |
|
1,647,000 |
|
5,139,000 |
|
5,446,000 |
|
||||
|
Amortization of intangibles |
|
593,000 |
|
593,000 |
|
1,778,000 |
|
1,779,000 |
|
||||
|
Total operating expenses |
|
7,562,000 |
|
7,115,000 |
|
21,359,000 |
|
22,219,000 |
|
||||
|
Loss from operations |
|
(3,600,000 |
) |
(2,242,000 |
) |
(13,127,000 |
) |
(8,307,000 |
) |
||||
|
Equity in income (loss) of affiliate |
|
— |
|
(19,000 |
) |
(8,000 |
) |
51,000 |
|
||||
|
Other income (expense), net |
|
127,000 |
|
(27,000 |
) |
588,000 |
|
1,282,000 |
|
||||
|
Provision for income taxes |
|
(107,000 |
) |
(84,000 |
) |
(308,000 |
) |
(321,000 |
) |
||||
|
Net loss |
|
$ |
(3,580,000 |
) |
$ |
(2,372,000 |
) |
$ |
(12,855,000 |
) |
$ |
(7,295,000 |
) |
23
THREE AND NINE MONTHS ENDED JULY 31, 2006 AND 2005
|
|
|
Three Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Revenue |
|
$ |
7,421,000 |
|
(21 |
)% |
$ |
9,353,000 |
|
|
|
|
Nine Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Revenue |
|
$ |
21,890,000 |
|
(20 |
)% |
$ |
27,476,000 |
|
Revenue for the three months ended July 31, 2006 decreased by $1,932,000, or 21%, from the three months ended July 31, 2005, and revenue for the nine months ended July 31, 2006 decreased by $5,586,000, or 20%, from the nine months ended July 31, 2005. These decreases were primarily attributable to a continued decline in our UNIX business as a result of continued competitive pressure from competing operating systems, particularly Linux.
Revenue generated from our UNIX business and SCOsource business is as follows:
|
|
|
Three Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
UNIX revenue |
|
$ |
7,390,000 |
|
(21 |
)% |
$ |
9,321,000 |
|
|
Percent of total revenue |
|
100 |
% |
|
|
100 |
% |
||
|
SCOsource revenue |
|
31,000 |
|
(3 |
)% |
32,000 |
|
||
|
Percent of total revenue |
|
0 |
% |
|
|
0 |
% |
||
|
|
|
Nine Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
UNIX revenue |
|
$ |
21,795,000 |
|
(20 |
)% |
$ |
27,344,000 |
|
|
Percent of total revenue |
|
100 |
% |
|
|
100 |
% |
||
|
SCOsource revenue |
|
95,000 |
|
(28 |
)% |
132,000 |
|
||
|
Percent of total revenue |
|
0 |
% |
|
|
0 |
% |
||
The decrease in revenue in the UNIX business of $1,931,000, or 21%, for the three months ended July 31, 2006 compared to the three months ended July 31, 2005 and the decrease in revenue of $5,549,000, or 20%, for the nine months ended July 31, 2006 compared to the nine months ended July 31, 2005 was primarily attributable to continued competition from other operating systems, particularly Linux. We anticipate that for the remainder of the year ending October 31, 2006 our UNIX business and the related revenue from the UNIX business will face significant competition from Linux and other operating systems.
Sales of our UNIX products and services during the three and nine months ended July 31, 2006 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 decrease 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.
24
Products Revenue
|
|
|
Three Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Products revenue |
|
$ |
6,201,000 |
|
(22 |
)% |
$ |
7,953,000 |
|
|
Percent of total revenue |
|
84 |
% |
|
|
85 |
% |
||
|
|
|
Nine Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Products revenue |
|
$ |
17,904,000 |
|
(22 |
)% |
$ |
23,095,000 |
|
|
Percent of total revenue |
|
82 |
% |
|
|
84 |
% |
||
Our products revenue consists of software licenses for UNIX products such as OpenServer and UnixWare, as well as sales of UNIX-related products. Products revenue also includes revenue derived from OEMs, distribution partners and large accounts. We rely heavily on our two-tier distribution channel and any disruption in our distribution channel could have an adverse impact on future revenue.
The decrease in products revenue of $1,752,000, or 22%, for the three months ended July 31, 2006 compared to the three months ended July 31, 2005 and the decrease in products revenue of $5,191,000, or 22%, for the nine months ended July 31, 2006 compared to the nine months ended July 31, 2005 were primarily attributable to decreased sales of OpenServer and other products revenue primarily resulting from increased competition in the operating system market, particularly from Linux.
Our products revenue was derived primarily from sales of our OpenServer and UnixWare products. Other products revenue consists mainly of product maintenance and other UNIX-related products. Revenue for these products was as follows:
|
|
|
Three Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
OpenServer revenue |
|
$ |
3,184,000 |
|
(26 |
)% |
$ |
4,309,000 |
|
|
Percent of products revenue |
|
51 |
% |
|
|
54 |
% |
||
|
UnixWare revenue |
|
2,592,000 |
|
24 |
% |
2,085,000 |
|
||
|
Percent of products revenue |
|
42 |
% |
|
|
26 |
% |
||
|
Other products revenue |
|
425,000 |
|
(73 |
)% |
1,559,000 |
|
||
|
Percent of products revenue |
|
7 |
% |
|
|
20 |
% |
||
|
|
|
Nine Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
OpenServer revenue |
|
$ |
10,176,000 |
|
(22 |
)% |
$ |
12,987,000 |
|
|
Percent of products revenue |
|
57 |
% |
|
|
56 |
% |
||
|
UnixWare revenue |
|
5,901,000 |
|
(11 |
)% |
6,606,000 |
|
||
|
Percent of products revenue |
|
33 |
% |
|
|
29 |
% |
||
|
Other products revenue |
|
1,827,000 |
|
(48 |
)% |
3,502,000 |
|
||
|
Percent of products revenue |
|
10 |
% |
|
|
15 |
% |
||
The decrease in revenue for OpenServer for the three and nine months ended July 31, 2006 compared to the three and nine months ended July 31, 2005 is primarily the result of continued competition from other operating systems, particularly Linux. The increase in UnixWare revenue for the three months ended July 31, 2006 compared to the three months ended
25
July 31, 2005 is primarily the result of increased sales to end-user customers. The decrease in other products revenue is primarily attributable to decreased sales of UNIX-related products and decreased sales of product maintenance.
SCOsource Licensing Revenue
|
|
|
Three Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
SCOsource licensing revenue |
|
$ |
31,000 |
|
(3 |
)% |
$ |
32,000 |
|
|
|
|
Nine Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
SCOsource licensing revenue |
|
$ |
95,000 |
|
(28 |
)% |
$ |
132,000 |
|
We initiated our SCOsource business for the purpose of protecting and defending our intellectual property rights in our UNIX source code and derivative works. SCOsource licensing revenue was $32,000 for the three months ended July 31, 2005 compared to $31,000 for the three months ended July 31, 2006 and SCOsource licensing revenue was $132,000 for the nine months ended July 31, 2005 compared to $95,000 for the nine months ended July 31, 2006. Revenue in the above mentioned periods was primarily attributable to sales of our SCOsource IP agreements.
We are unable to predict the amount and timing of future SCOsource licensing revenue, and if generated, the revenue will be sporadic.
Services Revenue
|
|
|
Three Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Services revenue |
|
$ |
1,189,000 |
|
(13 |
)% |
$ |
1,368,000 |
|
|
Percent of total revenue |
|
16 |
% |
|
|
15 |
% |
||
|
|
|
Nine Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Services revenue |
|
$ |
3,891,000 |
|
(8 |
)% |
$ |
4,249,000 |
|
|
Percent of total revenue |
|
18 |
% |
|
|
16 |
% |
||
Services revenue consists primarily of technical support fees, engineering services fees, professional services fees and consulting fees. These fees are typically charged and invoiced separately from UNIX products sales. The decrease in services revenue of $179,000, or 13%, for the three months ended July 31, 2006 as compared to the three months ended July 31, 2005 and the decrease in services revenue of $358,000, or 8%, for the nine months ended July 31, 2006 as compared to the nine months ended July 31, 2005 was primarily attributable to a decrease in professional services revenue as well as from a decrease in support and engineering services contracts.
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.
26
Cost of Products Revenue
|
|
|
Three Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Cost of products revenue |
|
$ |
478,000 |
|
(31 |
)% |
$ |
695,000 |
|
|
Percent of products revenue |
|
8 |
% |
|
|
9 |
% |
||
|
|
|
Nine Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Cost of products revenue |
|
$ |
1,559,000 |
|
(18 |
)% |
$ |
1,902,000 |
|
|
Percent of products revenue |
|
9 |
% |
|
|
8 |
% |
||
Cost of products revenue consists of manufacturing costs, royalties to third-party vendors, technology costs and overhead costs. Cost of products revenue decreased by $217,000, or 31%, for the three months ended July 31, 2006 as compared to the three months ended July 31, 2005 and cost of products revenue decreased by $343,000, or 18%, for the nine months ended July 31, 2006 as compared to the nine months ended July 31, 2005. The decrease in the dollar amount of cost of products revenue was primarily attributable to lower products revenue as margins did not vary considerably.
For the three months ending October 31, 2006, we expect the dollar amount of our cost of products revenue to be generally consistent with the cost of products revenue incurred during the three months ended July 31, 2006 and that cost of products revenue as a percent of products revenue for the three months ending October 31, 2006 will be generally consistent with that incurred during the three months ended July 31, 2006.
Cost of SCOsource Licensing Revenue
|
|
|
Three Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Cost of SCOsource licensing revenue |
|
$ |
2,315,000 |
|
(25 |
)% |
$ |
3,085,000 |
|
|
|
|
Nine Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Cost of SCOsource licensing revenue |
|
$ |
10,087,000 |
|
7 |
% |
$ |
9,467,000 |
|
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 $770,000, or 25%, during the three months ended July 31, 2006 as compared to the three months ended July 31, 2005. The decrease in cost of SCOsource licensing revenue was primarily attributable to the absence of the $2,000,000 quarterly payment and related expense for the Law Firms (which quarterly payments ended during the three months ended January 31, 2006), offset by increases in legal services provided by technical, industry, damage and other experts in connection with the SCO Litigation. Cost of SCOsource licensing revenue increased by $620,000, or 7%, during the nine months ended July 31, 2006 as compared to the nine months ended July 31, 2005. This increase was primarily attributable to significant work performed by technical, damage and industry experts and other consultants in connection with the SCO Litigation during the nine months ended July 31, 2006, offset by a reduction in expenses associated with the quarterly payments made to the Law Firms
27
as only two quarterly payments were made during the nine months ended July 31, 2006 as compared to three quarterly payments made during the nine months ended July 31, 2005.
Because of the unique and unpredictable nature of the SCO Litigation, the occurrence and timing of certain expenses is difficult to predict, and will be difficult to predict for the upcoming quarters. We will continue to make payments for technical, damage and industry experts, consultants and for other fees. However, future legal fees may include contingency payments made to the Law Firms as a result of a settlement, judgment, or a sale of our Company, which could cause the cost of SCOsource licensing revenue for the three months ending October 31, 2006 to be higher than the costs incurred for the three months ended July 31, 2006.
Cost of Services Revenue
|
|
|
Three Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Cost of services revenue |
|
$ |
666,000 |
|
(5 |
)% |
$ |
700,000 |
|
|
Percent of services revenue |
|
56 |
% |
|
|
51 |
% |
||
|
|
|
Nine Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Cost of services revenue |
|
$ |
2,012,000 |
|
(8 |
)% |
$ |
2,195,000 |
|
|
Percent of services revenue |
|
52 |
% |
|
|
52 |
% |
||
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 $34,000, or 5%, for the three months ended July 31, 2006 compared to the three months ended July 31, 2005 and decreased by $183,000, or 8%, for the nine months ended July 31, 2006 as compared to the nine months ended July 31, 2005. This decrease was primarily attributable to reduced numbers of employees and related costs.
For the three months ending October 31, 2006, we expect the dollar amount of our cost of services revenue to be generally consistent with the cost of services revenue incurred during the three months ended July 31, 2006 and that cost of services revenue as a percent of services revenue for the three months ending October 31, 2006 will be generally consistent with that incurred during the three months ended July 31, 2006.
Sales and Marketing
|
|
|
Three Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Sales and marketing expenses |
|
$ |
3,111,000 |
|
6 |
% |
$ |
2,935,000 |
|
|
Percent of total revenue |
|
42 |
% |
|
|
31 |
% |
||
|
|
|
Nine Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Sales and marketing expenses |
|
$ |
8,656,000 |
|
(2 |
)% |
$ |
8,849,000 |
|
|
Percent of total revenue |
|
40 |
% |
|
|
32 |
% |
||
Sales and marketing expenses consist of the salaries, commissions and other personnel costs of employees involved in the revenue generation process, as well as advertising and corporate allocations. The increase in sales and marketing expenses of $176,000, or 6%, for the three months ended July 31, 2006 compared with the three months ended July 31, 2005 was
28
primarily attributable to increased travel costs, increased marketing costs associated with the release of our mobile services product offerings and from stock-based compensation. The decrease in sales and marketing expense of $193,000, or 2%, for the nine months ended July 31, 2006 compared with the nine months ended July 31, 2005 was primarily attributable to decreased spending on co-operative advertising and decreased discretionary spending, offset by increases in spending related to the release of our mobile services product offerings and from stock-based compensation. Included in sales and marketing expenses for the three months ended July 31, 2006 and 2005 was $102,000 and $0, respectively, for stock-based compensation. Included in sales and marketing expenses for the nine months ended July 31, 2006 and 2005 was $261,000 and $14,000, respectively, for stock-based compensation.
For the three months ending October 31, 2006, we anticipate that the dollar amount of sales and marketing expenses will be generally consistent with that incurred during the three months ended July 31, 2006.
Research and Development
|
|
|
Three Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Research and development expenses |
|
$ |
2,029,000 |
|
5 |
% |
$ |
1,940,000 |
|
|
Percent of total revenue |
|
27 |
% |
|
|
21 |
% |
||
|
|
|
Nine Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
Research and development expenses |
|
$ |
5,786,000 |
|
(6 |
)% |
$ |
6,145,000 |
|
|
Percent of total revenue |
|
26 |
% |
|
|
22 |
% |
||
Research and development expenses consist of the salaries and benefits of software engineers, consulting expenses and corporate allocations. Research and development expenses increased by $89,000, or 5%, for the three months ended July 31, 2006 compared with the three months ended July 31, 2005. The increase in research and development expenses was primarily attributable to increased travel costs and from stock-based compensation. Research and development expenses decreased by $359,000, or 6%, for the nine months ended July 31, 2006 compared with the nine months ended July 31, 2005, which was primarily attributable to decreased personnel and personnel-related costs, offset by an increase in stock-based compensation. Included in research and development expenses for the three months ended July 31, 2006 and 2005 was $41,000 and $0, respectively, of stock-based compensation. Included in research and development expenses for the nine months ended July 31, 2006 and 2005 was $97,000 and $8,000, respectively, of stock-based compensation.
For the three months ending October 31, 2006, we anticipate that the dollar amount of research and development expenses will be generally consistent with that incurred during the three months ended July 31, 2006.
29
General and Administrative
|
|
|
Three Months Ended July 31, |
|
||||||
|
|
|
2006 |
|
Change |
|
2005 |
|
||
|
|
|
|
|
|
|
|
|
||
|
General and administrative expenses |
|
$ |
1,829,000 |
|
11 |
% |
$ |
1,647,000 |
|
|
| |||||||||