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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
ý ANNUAL REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended
October 31, 2004
o TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from
to .
Commission file number: 0-29911
THE SCO GROUP, INC.
(Exact name of registrant as specified in its charter)
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Delaware
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87-0662823
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(State of incorporation)
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(I.R.S. Employer
Identification No.)
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355 South 520 West
Lindon, Utah 84042
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(801) 765-4999
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(Address of principal executive
offices, including zip code)
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(Registrant’s telephone
number, including area code)
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Securities pursuant to
Section 12(b) of the Act: None
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Securities registered pursuant
to Section 12(g) of the Act:
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Title of Each Class
Common Stock, par value $.001 per share
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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 o NO
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Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the Registrant’s knowledge, in definitive proxy or information statements
incorporated by reference on Part III of this Form 10-K or any
amendment to this Form 10-K. o
Indicate by check mark whether the Registrant is
an accelerated filer (as defined in Rule 12b-2 of the Act). YES o NO
ý
The aggregate market value of the common stock
held by non-affiliates of the Registrant already made $33,021,000 based on the
reported last sale price of common stock on April 30, 2004, which is the
last business day of the Registrant’s most recently completed second fiscal
quarter.
The number of shares of the Registrant’s common
stock outstanding as of March 30, 2005, was 17,915,292.
PART I
Item 1.
Business
The Business
section and other parts of this Annual Report on Form 10-K (“Form 10-K”)
contains forward-looking statements relating to our business and strategy. These forward-looking statements involve
risks and uncertainties. Many
forward-looking statements are located in “Management’s Discussion and Analysis
of Financial Condition and Results of Operations” in Part II, Item 7 of this
Form 10-K. 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 in the section entitled
“Risk Factors” under Part II, Item 7 of this Form 10-K. We assume no obligation
to revise or update any forward-looking statements for any reason, except as
required by law.
As
used in the Form 10-K, “SCO,” and “OpenServer” are trademarks or
registered trademarks of our Company in the United States and other
countries. “UNIX” and “UnixWare” are
registered trademarks of The Open Group in the United States and other countries. All other brand or product names are or may
be trademarks of, and are used to identify the products and services of, their
respective owners. As used herein, the “Company”
or “us,” “we,” “ours,” or similar terms refer to The SCO Group, Inc. and
our operating subsidiaries.
Overview
We
own the UNIX operating system and are a provider of UNIX-based products and
services. We generate revenue from sales
of our UNIX-based products and services through our UNIX business and from
sales of SCOsource intellectual property (“IP”) licenses and vendor licenses of
our UNIX technology through our SCOsource business. Our core business is to sell and service our
UNIX software products to small-to-medium sized businesses and franchisees or
branch offices of Fortune 1000 businesses.
Our most significant products that drive the majority of our UNIX
revenue are OpenServer and UnixWare.
During fiscal year 2004, we released a new version of our UnixWare
product and we intend to continue to maintain our core UNIX business in fiscal
year 2005 by continuing our research and development efforts. We plan to release the next major upgrade to
our OpenServer product during the first half of calendar year 2005.
We developed our SCOsource
initiatives as part of our ongoing efforts to establish and protect our
intellectual property rights, particularly relating to our ownership of the
UNIX source code. In reviewing our
intellectual property rights in 2003, we became aware that parts of or
modifications made to our proprietary UNIX source code and derivative works
have been included in the Linux operating system without our authorization or
appropriate copyright attribution.
In
connection with our SCOsource initiatives, in March 2003, we filed a
complaint against International Business Machines Corporation (“IBM”),
alleging, in part, that IBM had breached its license agreement with us by,
among other things, inappropriately contributing UNIX source code and
derivative works to the open source community and seeking to use its knowledge
and methods related to UNIX source code and derivative works and modifications
licensed to it to decrease the value of the UNIX operating system in favor of
promoting the Linux operating system, of which it has been a major backer. Based on these alleged breaches, we delivered
to IBM notice of termination of our license agreement with IBM that permitted
IBM’s use of our UNIX source code in developing its AIX operating system.
In
addition to our action against IBM, we have filed other complaints against such
companies as Novell, Inc. (“Novell”), AutoZone Inc. (“AutoZone”), and
DaimlerChrysler Corporation (“DaimlerChrysler”). We describe our legal action against these
parties and the procedural status of these cases in more detail below under Part I,
Item 3 of this Form 10-K.
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Historical Information
We
originally incorporated as Caldera Systems, Inc., a Utah corporation (“Caldera
Systems”), in August 1998, and reincorporated as a Delaware corporation in
March 2000, when we completed an initial public offering of our common
stock. In May 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, now known as Tarantella, Inc.
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 from Caldera International, Inc. to The
SCO Group, Inc.
UNIX Business
Background
Our
core business focus is to serve the needs of small-to-medium sized businesses,
including branch offices and franchisees of Fortune 1000 companies, by
providing reliable, cost-effective UNIX operating systems and software products
to power computers based on the Intel architecture. We also provide a full range of pre- and
post-sale technical support for all of our products, primarily focusing on
OpenServer and UnixWare. Additionally,
we provide UNIX-based technical support services and consulting services.
Our
largest source of revenue for our core UNIX business is derived from our
worldwide, indirect, leveraged channel of partners, which includes distributors
and independent solution providers (collectively, “resellers”). We have a presence in a number of countries
that provides support and services to resellers and end-user customers in those
geographic areas. The other principal
channel for selling and marketing our products is through large corporations which
have a large number of branch offices or franchisees. We access these corporations through their
information technology or purchasing departments. In addition, we also sell our UNIX products
to original equipment manufacturers (“OEMs”).
The
UNIX operating system, which we own, was conceived on the premise that an
operating system should be easily adapted to a broad range of hardware
platforms and should provide a simple way of developing programs. Over the years, the UNIX operating system has
been adapted for almost every OEM’s hardware architecture, and today UNIX has
achieved the goal of seamlessly sharing data across heterogeneous
environments. We own a broad and deep
set of intellectual property rights relating to the UNIX operating system which
we intend to continue to enforce and protect through our SCOsource initiatives,
described in more detail below in the subsection entitled “SCOsource
Initiatives” under the section entitled “SCOsource Business.”
UNIX has had a long
history of small business implementation, and has a large and loyal base of
both customers and vendors that provides solutions and applications. On the Intel platform, our OpenServer and
UnixWare products represent a low-cost UNIX operating system available for
business. Our UNIX product offerings
permit businesses, particularly small businesses, to take advantage of the
reliability of UNIX at a relatively low cost.
Current Status
and Strategy
Sales of our UNIX-based products and services
have been declining over the last several years. This decline in revenue has been primarily
attributable to significant competition from alternative operating systems,
particularly Linux.
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We anticipate that our OpenServer and UnixWare
products will continue to provide a future revenue stream for our UNIX
business. Unless there is a change in
the current operating system environment, we expect revenue from these products
will continue to decline. Both of these
UNIX products have a strong and loyal existing customer base and constitute a
well-known brand with a reputation for quality and reliability. We also have a seasoned, mature sales channel
of resellers focused on the small-to-medium sized business market. This channel is a unique asset that should
allow us to continue to provide reliable UNIX operating systems for
small-to-medium sized business customers.
In fiscal year 2005, we intend to focus our
development resources on releasing our next OpenServer product and maintaining
our recently updated UnixWare product.
We anticipate that the benefits of our next OpenServer product will be
increased system reliability and performance, backward compatibility with
existing applications and software, increased application support, increased hardware
support and integration with widely used internet applications. We also plan to focus development resources
on augmenting our current UNIX products and our application products with other
products that will solve business problems for our existing installed base of
customers. Our research and development
efforts are described in more detail below in the subsection entitled “Software
Engineering and Development.”
Competition
We
face direct competition in the operating system market from Linux operating
system providers, other non-UNIX operating system providers and other
UNIX-based operating system providers.
In the operating system market, some of our competitors include IBM, Red
Hat, Novell, Hewlett-Packard, Microsoft, and Sun. Operating systems, primarily Linux, are
aggressively taking market share away from UNIX and our UNIX revenue has
declined over the last several years.
We believe that we
compete favorably with many of our competitors in a number of respects,
including product performance, functionality and price, networking capability
and breadth of hardware compatibility.
Notwithstanding these factors, our revenue has declined over the last
several years. Many of our competitors
are significantly larger than we are and have much greater access to funding,
technical expertise, marketing, and research and development. In addition, many of our competitors have
established brand recognition and market presence that may prevent us from
obtaining or retaining significant market share. Additionally, the assertion of our legal
rights relating to our UNIX ownership and related copyrights and our other
legal actions has resulted in us becoming the focus of a significant amount of
negative publicity from various sources that has hampered our ability to
compete favorably to some degree.
The success of our UNIX
business will, in large measure, depend on the level of commitment and
certification we receive from industry partners and developers. In recent years, we have seen hardware and
software vendors as well as software developers turn their certification and
application development efforts toward Linux and elect not to continue to
support or certify to our UNIX operating system products. This trend continued in fiscal year 2004, and
we believe that it will continue in fiscal year 2005. If this trend does continue as expected, our
competitive position will be adversely impacted and our future revenue from our
UNIX business will decline, possibly at an even faster rate than it has
declined over the last several years.
The decline in our UNIX business may be accelerated if industry partners
withdraw their support from us as a result of our SCOsource initiatives.
Products and
Services
OpenServer. OpenServer
is our UNIX-based offering targeted at small-to-medium businesses. Businesses use OpenServer to simplify and
speed business operations, better understand and respond to their customers’
needs and achieve a competitive advantage.
OpenServer excels at running multi-user, transaction and business
applications, communications gateways, and mail and messaging servers in both
host and client/server environments. We
continue to aggressively support existing users of
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OpenServer, keeping the operating
system current with hardware platforms available in the market. The latest release, OpenServer 5.0.7, began
shipping in February 2003. We
anticipate releasing the next version of OpenServer in the first half of
calendar year 2005.
UnixWare. UnixWare is our UNIX-based offering targeted
at medium-size businesses and enterprise customers. UnixWare is an advanced deployment platform
for industry standard Intel processor systems.
UnixWare is a foundation for solutions where proven scalability,
reliability and affordability are critical.
UnixWare includes enhancements and refinements to the UNIX platform,
representing significant added value for existing UnixWare customers. The latest release of UnixWare, UnixWare
7.1.4, began shipping in May 2004.
SCO Applications. We have released two
application products: SCO Office Server and SCO Web Services Substrate (“WSS”). These products run in conjunction with our
UNIX operating systems. SCO Office
Server provides smaller companies the ability to send and receive e-mail
messages, set calendar appointments, and perform other collaboration tasks
using standard client software. SCO WSS
enables business users to modernize their legacy applications, making them
function with modern systems that more readily share data for improved
efficiency. These application products
represent increased capability and functionality for our UNIX customers.
Technical Support Services. We provide a full range of pre-
and post-sale technical support for all of our products, primarily focusing on
OpenServer and UnixWare.
We
also provide technical support to our partners, including resellers, hardware
and software vendors and solution providers, as well as directly supporting our
end-user customers. Our partners have
the option to direct their customers to us for technical support or to provide
first-level customer support themselves and utilize our technical expertise for
second-tier support.
Technical support
services include a range of options from single incident email and telephone
support to dedicated “enterprise” level support agreements. Customers seeking additional technical
support directly from us may enter into service agreements that best suit their
needs.
Other Services. Our other services include software development
and programming, migration tools and services and assisting customers with
modernizing and integrating legacy applications with web services. We assist our end-user customers and solution
providers in planning, creating, implementing and deploying business
application solutions.
Strategic
Alliances
We
have business alliances with a number of key global industry partners. These relationships encompass product
integration, two-way technology transfers, product certification, channel
partnerships and revenue generating initiatives in areas of product bundling,
OEM agreements and training and education.
The objectives of these partnerships include providing complete hardware
and software UNIX solutions and mutually developing our sales and distribution
channel by coordinating marketing initiatives in creating demand for our
products. We also have alliances with a
number of solution providers who write and develop custom applications to run
on UNIX operating systems. Most of our
small business customers that cannot afford high-end solutions or an
information technology staff rely on one of our channel partners for these
services. Maintaining these strategic
alliances in fiscal year 2005 will be critical to the success of our UNIX
business, and in particular, to the success of our next OpenServer
product. We intend to continue to keep
relationships with key partners in certain vertical markets such as retail,
medical/pharmaceutical, manufacturing and accounting where our UNIX operating
systems have an existing presence. Our
efforts to maintain or expand industry partnerships may be adversely impacted
by our SCOsource initiatives.
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Sales and
Marketing
Our UNIX sales and
marketing or field operations are organized by geographic area: our Americas division and our International
division. Each division includes a sales
organization, field marketing, pre- and post-sales technical support, and local
professional services personnel.
Americas. The
Americas team has field sales and support personnel located around the United
States, Latin America and Canada. This
region delivered approximately 56 percent of the total UNIX revenue for fiscal
year 2004. The sales team is organized
into Area Sales Managers (“ASMs”), who each manage a specific geographic area
and support our resellers and channel partners as well as service our corporate
account customer base, including OEM partners.
ASMs have the following specific roles:
• Channel Sales – ASMs manage our relationships
with our resellers and vertical solution providers. Resellers sell numerous solutions to small
business customers in their geographic territory. Vertical solution providers provide bundled
applications to specific vertical markets, which include retail point of sale,
manufacturing, accounting and medical/pharmaceutical. Many of our resellers and vertical solution
providers purchase operating system platform products directly from us. In order to efficiently support the thousands
of smaller resellers and vertical solution providers, we contract with several
major distributors in a two-tier distribution model.
• Corporate Sales – ASMs also sell directly to
our major corporate accounts with branch offices or franchisees and other large
corporations. Typically, these customers
have an existing suite of third-party or internally developed applications
designed to run on our dependable and scalable OpenServer or UnixWare operating
systems. In many cases, our operating
system and the application are then deployed in an identical fashion across
thousands of branch offices or franchisees.
International. The
International region delivered approximately 44 percent of our UNIX revenue for
fiscal year 2004 and includes EMEA (Europe, the Middle East and Africa) and
Asia Pacific. We have a presence in many
major countries, including the United Kingdom, Germany, France, Italy, Spain,
China, Korea, India, Japan, Australia and Taiwan.
The country sales teams
perform the same functions as the Americas sales team, including
channel sales, corporate account sales and OEM sales. In the International division, particularly
in smaller countries, one sales representative will manage both channel and
major account sales within that country.
The International division also uses local distributors in each location
to process all channel orders.
We consider our indirect
sales channel one of our most valuable assets.
In addition to the current revenue this channel produces, our reseller
partners are valuable for the influence they possess on the purchasing
decisions of small businesses. Our
resellers are often not only the primary point of contact for their small
businesses customers’ purchasing decisions, but their customers’ outsourced
information technology department. The
reach of our network of resellers into the small business community is broad as
evidenced by our large install base of servers running various versions of our
OpenServer and UnixWare operating systems.
A critical key to our future success will depend in part on our ability
to provide additional products and services to our reseller channel and to
communicate our product and corporate strategy to these resellers.
Our marketing efforts support our sales and
distribution efforts, promotions and product introductions, and include
marketing activities to promote our UNIX products. Pull marketing is focused on branding,
solutions, advertising, tradeshows, press releases, white papers and marketing
literature. In particular, our marketing
strategy consists of:
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• branding our UNIX products through public
relations and advertising activities;
• creating an effective partner program to
generate brand awareness and promote our UNIX products; and
• increasing public awareness of our UNIX
products by participating in strategic tradeshows, conferences and technology
forums.
Information regarding
financial data by geographic regions and long-lived assets is set forth in Part II,
Item 8 of this Form 10-K in the notes to consolidated financial
statements.
Software Engineering and
Development
We
have taken steps to improve our UNIX software products to maintain system
reliability, maintain backward compatibility, increase application support,
provide broad hardware support, better integrate widely used internet
applications, improve usability, and increase system performance. While we believe that these product
enhancements will extend the life and improve the functionality of our UNIX
products, they will not result in significant revenue increases in the
short-term due to the long adoption cycle for new operating system purchases
and the length of our operating system product sales cycle. However, we do believe that these
improvements will extend the life of our current UNIX products.
Technology
trends in the central processing unit (“CPU”) market have enabled our 32-bit
operating systems and associated applications to run on 64-bit hardware. These developments have significantly reduced
the entry cost into the 64-bit market.
We have assigned a limited, but skilled amount of resources to develop a
64-bit version of our operating system technology. Our objective in making this investment is to
provide our current and new customers a long-term product roadmap that will
provide them a seamless upgrade path to 64-bit computing. We expect this investment to provide future
returns as we give customers confidence in their commitment to our
technologies.
Our
product development process is modeled to standard, commercial software
engineering practices and we apply these practices to ensure consistent product
quality. As a result, we are able to
offer our platform products to OEM customers in several configurations without
significant additional effort.
SCOsource Business
Background
We
acquired our rights relating to the UNIX source code and derivative works and
other intellectual property rights when we purchased substantially all of the
assets and operations of the server and professional services groups of The
Santa Cruz Operation, Inc. in May 2001. The Santa Cruz Operation (now known as
Tarantella, Inc.) had previously acquired such UNIX source code and other
intellectual property rights from Novell in September 1995, which
technology was initially developed by AT&T Bell Labs. Through this process, we acquired all UNIX
source code, source code license agreements with thousands of UNIX vendors, certain
UNIX intellectual property, all claims for violation of the above mentioned
UNIX licenses and copyrights and other claims, and the control over UNIX
derivative works. The UNIX licenses we
obtained have led to the development of several proprietary UNIX-based
operating systems, including but not limited to our own UnixWare and OpenServer
products, IBM’s AIX, Sequent’s DYNIX/Ptx, Sun’s Solaris, SGI’s IRIX and Hewlett-Packard’s
HPUX. These operating systems are all
derivatives of the original UNIX source code owned by us.
The success of our SCOsource
business depends on our ability to protect and enforce our rights to
proprietary UNIX source code, copyrights and other intellectual property
rights. To protect our
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proprietary rights, we rely primarily on a
combination of copyright laws, contractual rights and a detailed legal
strategy.
In
fiscal year 2003, we commenced our first SCOsource initiative in which we began
reviewing the status of our existing UNIX license agreements with UNIX vendors
and to identify those in the software industry that may be using our intellectual
property without obtaining the necessary licenses. As part of this process, we became aware that
parts of our proprietary UNIX source code and derivative works had been
included in the Linux operating system without attribution or our authorization
in violation of our intellectual property rights. We filed a complaint against IBM in March 2003
alleging that IBM breached its license agreement with us related to its efforts
to promote and support the Linux operating system. In addition to our action against IBM, we
have filed other complaints against Novell, AutoZone, and DaimlerChrysler. In our litigation with Novell, we seek relief
for, among other things, Novell’s alleged bad faith efforts to interfere with
our copyrights related to our UNIX source code.
A related lawsuit was filed against us by Red Hat, Inc. (“Red Hat”).
We describe our legal actions in more detail below under Part I, Item 3 of
this Form 10-K.
SCOsource
Initiatives
Reviewing and Evaluating Existing UNIX Licenses. As
mentioned above, in fiscal year 2003 we began reviewing the status of our
existing UNIX license agreements with UNIX vendors and entered into two
significant vendor license agreements.
This review continued in fiscal year 2004 and will continue in fiscal
year 2005.
SCOsource IP License. In August 2003, we first
offered to Linux and other end users a license to use our UNIX intellectual
property. The SCOsource IP license
permits the use of our UNIX intellectual property, in binary form only, as
contained in the Linux operating system.
By purchasing the license, customers will properly compensate us for our
UNIX intellectual property as currently found in Linux. The SCOsource IP license was created in
response to requests to provide a licensing program for those in the industry using
our UNIX intellectual property to allow them to continue to run their
mission-critical business solutions running in other environments. We will continue to pursue our SCOsource IP
licensing initiative in fiscal year 2005.
Intellectual Property Protection
Our
SCOsource initiatives rely primarily on a combination of contract rights,
copyright laws and an aggressive legal strategy. We also require that our employees and
consultants sign confidentiality and nondisclosure agreements. We also regulate access to, and distribution
of, our documentation and other proprietary information.
We
cannot guarantee the success of our SCOsource initiatives and other efforts to
protect and enforce our intellectual property rights, but we will continue to
seek to enforce and pursue these rights through the legal system. Additionally, we cannot be certain that we
will succeed in preventing the future misappropriation of our proprietary
information including copyrights and other intellectual property rights or that
we will be able to prevent the unauthorized future use of our technology.
Current Status and Strategy
In fiscal year 2004, we
continued to pursue our SCOsource initiatives.
The revenue generated from our SCOsource initiatives in fiscal year 2004
was significantly less than revenue generated in fiscal year 2003. Fiscal year 2004 SCOsource revenue was
primarily generated from SCOsource IP licenses.
For fiscal year 2005, we plan to continue to review and evaluate our
UNIX license agreements and pursue large vendor contracts, such as those
completed in fiscal year 2003, and plan to further pursue our SCOsource
initiatives.
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We also plan to continue
to pursue our litigation against IBM, Novell, AutoZone, and DaimlerChrysler and
defend against the claims asserted by Red Hat.
Employees
As of October 31, 2004, we had a total of
200 full-time equivalent employees. Of
the total employees, 64 were in product development, 46 in sales, 16 in marketing,
21 in customer service and technical support, 10 in customer delivery, 7 in
SCOsource and 36 in administration (which includes finance, human resources,
executive management and information systems).
From time to time, we also engage independent contractors to support our
professional services, product development, sales and marketing
organizations. Our employees are not
represented by any labor union and are not subject to a collective bargaining
agreement, and we have never experienced a work stoppage. In general, we believe our relations with our
employees are good.
Item 2. Properties
We are headquartered in
Lindon, Utah, where we lease administrative, sales and marketing
facilities. We lease additional
facilities for administration, sales and marketing and product development in
Scotts Valley, California and Murray Hill, New Jersey. The leases for our facilities expire at
various dates through fiscal year
2008.
Our international field
operations occupy leased facilities in France, Japan, Germany, India, and the
United Kingdom among others. The leases
for these field operation facilities expire at various dates through fiscal
year 2010.
We believe that our
existing facilities are adequate to meet current business and operating
requirements and that additional office space will be available to meet our
needs if required.
Item 3. Legal
Proceedings
IBM Corporation
On or about March 6, 2003, we filed a complaint against IBM. This action is pending in the United States
District Court for the District of Utah, under the title The SCO Group, Inc.
v. International Business Machines Corporation, Civil No. 2:03CV0294. The initial complaint included claims for
breach of contract, misappropriation of trade secrets, tortious interference,
and unfair competition. The initial
complaint also alleged that IBM had used and distributed information concerning
the UNIX source code and derivative works in connection with its efforts to
promote the Linux operating system. As a
result of IBM’s actions, we are requesting damages in an amount to be proven at
trial, together with additional damages through and after the time of
trial. On or about June 13, 2003,
we delivered to IBM a notice of termination of IBM’s UNIX license agreement,
which underlies IBM’s AIX software.
On or about June 16, 2003, we filed an amended complaint in the
IBM case. The amended complaint
essentially restated and re-alleged the allegations of the initial complaint
and expanded on those claims. Among
other things, the amended complaint raised new allegations regarding IBM’s
breaches (in ways similar to those set forth above) of a UNIX license agreement
involving Sequent Computer Systems, Inc. (“Sequent”), which IBM had
acquired. We have sought damages for
breaches of the Sequent license agreement.
We are also seeking injunctive relief on several claims.
IBM has filed a response and counterclaims to our complaint, including
a demand for a jury trial. We have filed
an answer to the IBM counterclaims denying the claims and asserting affirmative
defenses. On February 4, 2004, we
filed a motion for leave to file amended pleadings in the case proposing to
amend our complaint against IBM and to modify our affirmative defenses to IBM’s
counterclaims. On February 25,
2004, the court granted our motion for leave to amend.
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Our second amended complaint, which was filed on February 27,
2004, 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 fourteen counterclaims.
Among other things, IBM has asserted that we do not have the right to
terminate IBM’s UNIX license and IBM has claimed that we have breached the GNU
General Public License and have 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 March 3, 2004, the U.S. Magistrate Judge issued an
order addressing certain discovery matters relating to both us and IBM.
We thereafter filed motions to amend the scheduling order
and to bifurcate IBM’s patent counterclaims into a separate action. A hearing on those latter two motions was
held on June 8, 2004. The court
issued its ruling on June 10, 2004, granting our motion to amend the
scheduling order, with certain changes.
The court also denied the motion to bifurcate the patent counterclaims
without prejudice to our right to request bifurcation again at a later date.
Following a hearing on October 19, 2004, on January 19,
2005, the Magistrate Judge issued a further order granting in part and denying
in part discovery applications that we had made. In that order, the court ordered IBM to
produce much of the information, including source code and revision
information, we had previously requested.
The court also struck the Amended Scheduling Order and directed the
parties to submit a proposed amended scheduling order which both parties have
done.
On February 9, 2005, the U.S. District Judge ruled on
several pending dispositive motions. The
Court denied the three motions for partial summary judgment that IBM had filed
– on our contract claims, on IBM’s eighth counterclaim for copyright
infringement and on IBM’s tenth counterclaim for a declaration of
non-infringement of our 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 our motion to stay or
dismiss IBM’s tenth counterclaim. The
Court ordered that no further dispositive motions could be filed until the
close of discovery, except by stipulation of the parties, and vacated its prior
order, dated September 30, 2004, to the extent that order had granted
permission to file dispositive motions before the close of discovery.
In addition to the materials that have been publicly filed
with the court, certain information has been filed under seal in accordance
with the protective order entered in the case.
On November 30, 2004, a third party filed a motion to intervene in
the case for the purpose of challenging the sealing of certain documents with
the court. Additional groups have joined
in that motion. That motion has been
scheduled for a hearing on April 26, 2005.
We have also filed a motion for leave to file a third
amended complaint to allege an additional copyright violation against IBM in
the case. We expect that matter to be
heard by the court in the next few months.
Discovery is continuing in the case.
Red Hat, Inc.
On August 4, 2003,
Red Hat filed a complaint against us. The action is pending in the United
States District Court for the District of Delaware under the case caption Red
Hat, Inc. v. The SCO Group, Inc., Civil No. 03–772. Red Hat asserts that the Linux operating
system does not infringe our 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 we have 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.
12
On or about September 15, 2003, we filed a motion to dismiss the
Red Hat complaint. The motion to dismiss
asserted that Red Hat lacks standing and that no case or controversy exists
with respect to the claims seeking a declaratory judgment of non-infringement. The motion to dismiss further asserted that
Red Hat’s claims under the Lanham Act and related state laws are barred by the
First Amendment to the U.S. Constitution and the common law privilege of
judicial immunity. On April 6,
2004, the court issued an order denying our motion to dismiss; however, the
court stayed the case and requested status reports every 90 days regarding the
case against IBM. Red Hat has filed a
motion for reconsideration. No ruling
has been issued on that motion. We
intend to vigorously defend this action.
Novell, Inc.
On January 20,
2004, we filed suit in Utah state court against Novell, Inc. for slander
of title seeking relief for its alleged bad faith effort to interfere with our
ownership of copyrights related to our UNIX source code and derivative works
and our UnixWare product. The case,
after removal to federal court, is pending in the United States District Court
for the District of Utah, under the caption The SCO Group, Inc. v. Novell, Inc.,
Civil No. 2:04CV00139. In the
lawsuit, we requested preliminary and permanent injunctive relief as well as
damages. Through these claims we seek to
require Novell to assign to us all copyrights that we believe Novell has
wrongfully registered, prevent Novell from representing any ownership interest
in those copyrights and require Novell to retract or withdraw all
representations it has made regarding its purported ownership of those
copyrights.
Novell removed the case
to federal court and also filed a motion to dismiss our complaint claiming that
it had never transferred the copyrights to The Santa Cruz Operation (now
Tarantella, Inc.). We filed a
response to Novell’s motion to dismiss and have also filed a motion to remand
the case back to the state court. On June 10,
2004, the court issued a memorandum decision and order which denied our motion
to remand the case to state court. The
memorandum decision also denied in part and granted in part Novell’s motion to
dismiss. The court granted Novell’s
motion to dismiss regarding our allegations of special damages, but granted us
thirty-days leave to amend our complaint to plead special damages with greater
specificity. We have filed our amended
complaint and Novell has responded with another motion to dismiss claiming,
among other things, that Novell’s false statements were not made with malice
and are privileged under the law. That
motion has been briefed by the parties and is scheduled to be argued to the
court on May 25, 2005. We plan to
continue to vigorously pursue our claims against Novell.
DaimlerChrysler Corporation
On or about March 3, 2004, we brought
suit against DaimlerChrysler Corporation for its alleged violations of its UNIX
license agreement. The lawsuit alleges
that DaimlerChrysler breached its UNIX software agreement by failing to provide
an adequate or timely certification of its compliance with that agreement as we
requested. The lawsuit, filed in Oakland
County Circuit Court in the State of Michigan, requests the court to declare
that DaimlerChrysler has violated the certification requirements of its UNIX
software agreement, permanently enjoin DaimlerChrysler from further violations
of the UNIX software agreement, issue a mandatory injunction requiring
DaimlerChrysler to remedy the effects of its past violations of the UNIX
software agreement and award us damages in an amount to be determined at trial
together with costs, attorneys’ fees and any such other or different relief
that the Court may deem to be equitable and just.
On April 15, 2004, DaimlerChrysler filed
a motion to dismiss our claims. DaimlerChrysler’s
motion was heard on July 21, 2004, and the court granted DaimlerChrysler’s
motion as to the substance of DaimlerChrysler’s certification but denied the
motion as to whether the certification was timely. Based on this ruling, we filed a motion to
stay the case pending the clarification of certain issues in the IBM
litigation. The court denied the motion
to stay. Based on a stipulation of the
parties, however, the court signed an order of dismissal without
prejudice. The appellate court has
dismissed our appeal of the
13
July 21, 2004 ruling finding that the order was not a final,
appealable order; we are evaluating our options regarding the appellate court’s
ruling.
AutoZone, Inc.
On or about March 2, 2004, we brought
suit against AutoZone, Inc. for its alleged violations of our UNIX
copyrights through its use of Linux. Our
lawsuit alleges copyright infringement by AutoZone by, among other things,
running versions of the Linux operating system that contain proprietary
material from UNIX System V. The
lawsuit, filed in United States District Court in Nevada, requests injunctive
relief against AutoZone’s further use or copying of any part of our copyrighted
materials and also requests damages as a result of AutoZone’s infringement in
an amount to be proven at trial. On April 23,
2004, AutoZone filed a motion to transfer the case to Tennessee or to stay the
case. On August 6, 2004, the
federal court in Nevada entered an order granting AutoZone’s motion to stay the
case with 90-day status reports to the court.
The court denied without prejudice AutoZone’s motion for a more definite
statement and its motion to transfer the case to Tennessee. The court is allowing the parties to take
limited expedited discovery relating to the issue of preliminary injunctive
relief. We are pursuing that discovery
and continuing to evaluate our claims in that regard.
IPO Class Action Matter
We are 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 our 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 our directors and
us.
We have
notified our underwriters and insurance companies of the existence of the
claims. We believe, after consultation
with legal counsel, that the ultimate outcome of this matter will not have a
material adverse effect on our results of operations or financial position and
will not exceed the $200,000 self-insured retention amount already paid or
accrued by us.
Other
Matters
In April 2003,
a former Indian distributor of ours filed a claim in India, requesting summary
judgment for payment of $1,428,000, and an order that we trade in India only
through the distributor and/or give a security deposit until the claim is paid.
The distributor claims that we are responsible to repurchase certain software
products and to reimburse the distributor for certain other operating
costs. The distributor additionally
requested that the Indian courts grant interim relief in the form of attachment
of local assets. We do not believe that
we are responsible to reimburse the distributor for any operating costs and
also believe that the return rights related to any remaining inventory have
lapsed. Discovery has commenced and
hearings on the requests for interim relief have been held and are
ongoing. We intend to vigorously defend
this action.
We are a party to certain other legal proceedings arising in the
ordinary course of business including legal proceedings arising from our
SCOsource initiatives. We believe, after
consultation with legal counsel, that the ultimate outcome of such legal
proceedings will not have a material adverse effect on our results of
operations or financial position.
14
Item 4. Submission of Matters to a Vote of Security
Holders
There
were no matters submitted to a vote of security holders during the fourth
quarter of fiscal year 2004.
PART II
Item 5. Market for the Registrant’s Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity Securities
Market
Price of Our Common Stock
Our
common stock initially traded on The Nasdaq National Market beginning in March 2000,
but has been traded on The Nasdaq SmallCap Market since February 2003. In September 2002, we changed our
trading symbol from “CALD” to “SCOX.” As
of February 18, 2005, the trading symbol for the common stock was changed
from “SCOX” to “SCOXE” as a result of our failure to make a timely filing of
this Form 10-K. The table below sets forth the range of
high and low closing prices of our common stock as reported on The Nasdaq
National Market and The Nasdaq SmallCap Market, as applicable, for the last two
years.
|
|
|
SCO Common Stock
|
|
|
|
|
High
|
|
Low
|
|
|
Fiscal Year 2004
|
|
|
|
|
|
|
Quarter ended January 31, 2004
|
|
$
|
19.08
|
|
$
|
13.65
|
|
|
Quarter ended April 30, 2004
|
|
14.40
|
|
6.27
|
|
|
Quarter ended July 31, 2004
|
|
6.34
|
|
4.03
|
|
|
Quarter ended October 31, 2004
|
|
5.10
|
|
2.98
|
|
|
|
|
|
|
|
|
|
Fiscal Year 2003
|
|
|
|
|
|
|
Quarter ended January 31, 2003
|
|
$
|
1.70
|
|
$
|
1.22
|
|
|
Quarter ended April 30, 2003
|
|
3.27
|
|
1.09
|
|
|
Quarter ended July 31, 2003
|
|
14.84
|
|
3.21
|
|
|
Quarter ended October 31, 2003
|
|
20.50
|
|
9.29
|
|
On March 29, 2005,
the closing sales price for our common stock as reported by The Nasdaq SmallCap
Market was $3.52. As of March 28, 2005,
there were 340 holders of common stock of record.
Dividend Policy
We have not historically
declared or paid any cash dividends on shares of our common stock and plan to
retain our future earnings, if any, to fund the development and growth of our
business.
Equity Compensation Plans
We
maintain our 1998 Stock Option Plan, our 1999 Omnibus Stock Incentive Plan, our
2002 Omnibus Stock Incentive Plan, our 2004 Omnibus Stock Incentive Plan and
our 2000 Employee Stock Purchase Plan (the “ESPP”). We are no longer granting awards under the
1998 Stock Option Plan, which was superseded by the 1999 Omnibus Stock
Incentive Plan.
15
The
following table provides information about equity awards under our equity
compensation plans as of October 31, 2004:
|
Plan Category
|
|
Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
|
|
Weighted-average
exercise price of
outstanding
options, warrants
and rights
|
|
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in the
first column)
|
|
|
|
|
|
|
|
|
|
|
|
Equity compensation plans approved by
security holders
|
|
3,421,000
|
|
$
|
4.05
|
|
2,077,000
|
(1) (2)
|
|
|
|
|
|
|
|
|
|
(1) The
2004 Omnibus Incentive Plan incorporates an evergreen formula pursuant to which
on each November 1, the aggregate number of shares reserved for issuance
under the 2004 Plan will increase by a number of shares equal to three percent
of the outstanding shares on the day preceding (October 31). The ESPP incorporates an evergreen formula
pursuant to which on January 1 of each year the aggregate number of shares
reserved for issuance under the ESPP will increase by a number of shares equal
to one percent of the outstanding shares on the day preceding (December 31).
(2) Of
these shares, 248,000 shares remain available for purchase under the ESPP.
Recent
Sales of Unregistered Securities
We have issued shares and granted options
under our 1998 Stock Option Plan, 1999 Omnibus Stock Option Plan, the ESPP,
2002 Omnibus Stock Incentive Plan, and 2004 Omnibus Stock Incentive Plan
(collectively, the “Equity
Compensation Plans”) without complying with registration or qualification
requirements under federal securities laws and the securities laws of certain
states. As a result, certain plan
participants have a right to rescind their purchases of shares under the Equity
Compensation Plans or recover damages if they no longer own the shares or hold
unexercised options, subject to applicable statutes of limitations. Additionally, regulatory authorities may
require us to pay fines or impose other sanctions on us. Although we are evaluating the possible
actions we may take in response to these securities law compliance issues, we
may, subject to obtaining required regulatory approvals, make a rescission
offer to certain plan participants that hold unexercised options (in
California, Georgia and possibly other states) or shares acquired under the
Equity Compensation Plans or that otherwise are entitled to recover damages
from us in respect of such shares they have sold.
Issuer
Purchases of Equity Securities
During the fourth quarter of fiscal year 2004, we did not purchase any of
our equity securities.
Item 6. Selected
Financial Data
The following selected financial data set forth below should be read in
conjunction with the consolidated financial statements and the related notes
included elsewhere in this Form 10-K and in conjunction with “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” appearing in Part II, Item 7 of this Form 10-K. The selected statement of operations data for
the years ended October 31, 2004, 2003 and 2002 and the selected balance
sheet data as of October 31, 2004 and 2003 are derived from, and are
qualified by reference to, the audited consolidated financial statements and
related notes in this Form 10-K.
16
The
selected statement of operations data for the years ended October 31, 2001
and 2000 and the selected balance sheet data as of October 31, 2002, 2001
and 2000 are derived from audited consolidated financial statements not
appearing in this Form 10-K.
|
|
|
Years
Ended October 31,
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
2000
|
|
|
|
|
(In thousands, except per share data)
|
|
|
Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
42,809
|
|
$
|
79,254
|
|
$
|
64,241
|
|
$
|
40,441
|
|
$
|
4,274
|
|
|
Gross margin
|
|
15,711
|
|
59,332
|
|
45,925
|
|
25,518
|
|
253
|
|
|
Income (loss) from operations
|
|
(28,573
|
)
|
3,436
|
|
(24,176
|
)
|
(133,636
|
)
|
(31,999
|
)
|
|
Net income available (loss applicable) to
common stockholders
|
|
(16,227
|
)
|
5,304
|
|
(24,877
|
)
|
(131,357
|
)
|
(39,176
|
)
|
|
Basic net income (loss) per common share
|
|
$
|
(1.07
|
)
|
$
|
0.43
|
|
$
|
(1.93
|
)
|
$
|
(10.92
|
)
|
$
|
(4.76
|
)
|
|
Diluted net income (loss) per common share
|
|
$
|
(1.07
|
)
|
$
|
0.34
|
|
$
|
(1.93
|
)
|
$
|
(10.92
|
)
|
$
|
(4.76
|
)
|
|
Weighted average basic common shares
|
|
15,155
|
|
12,261
|
|
12,893
|
|
12,024
|
|
8,231
|
|
|
Weighted averaged diluted common shares
|
|
15,155
|
|
15,679
|
|
12,893
|
|
12,024
|
|
8,231
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of October 31,
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
2001
|
|
2000
|
|
|
|
|
(In thousands)
|
|
|
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
12,693
|
|
$
|
64,428
|
|
$
|
6,589
|
|
$
|
20,541
|
|
$
|
36,560
|
|
|
Working capital (deficit)
|
|
15,413
|
|
37,168
|
|
(6,332
|
)
|
14,401
|
|
88,680
|
|
|
Total assets
|
|
55,400
|
|
94,952
|
|
37,406
|
|
74,859
|
|
107,518
|
|
|
Long-term liabilities
|
|
343
|
|
508
|
|
1,625
|
|
5,925
|
|
—
|
|
|
Redeemable preferred stock
|
|
—
|
|
29,671
|
|
—
|
|
—
|
|
—
|
|
|
Common stock subject to rescission
|
|
528
|
|
—
|
|
—
|
|
—
|
|
—
|
|
|
Total stockholders’ equity
|
|
21,702
|
|
19,516
|
|
8,177
|
|
34,604
|
|
102,215
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Item 7. 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 Form 10-K 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 discussed in the subsection entitled
“Forward Looking Statements and Factors That May Affect Future Results and
Financial Condition” and the subsection entitled “Risk Factors”
below. The following discussion should
be read in conjunction with our consolidated financial statements and notes
thereto included in Part II, Item 8 of this Form 10-K. All information presented herein is based on
our fiscal year ended October 31, 2004.
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 (as
previously defined, “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.
(as previously defined, “Caldera International”) to acquire substantially all
of the assets
17
and operations of the
server and professional services groups of The Santa Cruz Operation (now known
as Tarantella, Inc.). 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.
Recent Developments.
As
described in the section entitled
“Recent Sales of Unregistered Securities” above in Part II, Item 5 of this
Form 10-K, we issued shares and granted options under our Equity Compensation
Plans without complying with registration or qualification requirements under
federal securities laws and the securities laws of certain states. As a result, certain plan participants have a
right to rescind their purchases of shares under the Equity Compensation Plans
or recover damages if they no longer own the shares or hold unexercised
options, subject to applicable statutes of limitations. Although we are evaluating the possible
actions we may take in response to these securities law compliance issues, we
may make a rescission offer to certain plan participants entitled to rescission
rights subject to obtaining required regulatory approvals. If our potential rescission offer is made and
accepted by all plan participants holding certain ESPP shares and all shares
acquired from the exercise of stock options, or such participants otherwise
make rescission claims against us, we could be required to make aggregate payments
to these plan participants of up to $528,000.
This amount is based on ESPP shares and shares issued upon the exercise
of stock options that have been retained by plan participants as of October 31,
2004 and excludes interest and other charges we may be required to pay. We may face additional rescission liability
to plan participants holding unexercised stock options in California, Georgia
and possibly other states, and regulatory authorities also may require us to
pay fines or impose other sanctions on us.
On February 16,
2005, we received a notice from the staff of The Nasdaq Stock Market indicating
that we are subject to potential delisting from The Nasdaq SmallCap Market for
failure to comply with Nasdaq’s requirement to file this Form 10-K for the
fiscal year ended October 31, 2004 in a timely fashion. Receipt of the notice did not result in
immediate delisting of our common stock.
Nasdaq stated that, unless we requested a hearing on Nasdaq’s delisting
notice, our securities would be delisted from The Nasdaq SmallCap Market at the
opening of business on February 25, 2005.
We requested a hearing
with the Nasdaq Listing Qualifications Panel on this matter, which stayed the
delisting pending the hearing and a determination by the Nasdaq Listing Qualifications
Panel. The hearing occurred on March 17,
2005. At the hearing, we outlined for
the Panel our plan for filing this Form 10-K and our Quarterly Report on Form 10-Q
for the first quarter of the current fiscal year (the “Form 10-Q”), which
also was not filed in a timely fashion.
On March 18, 2005, we received another notice from the staff of The
Nasdaq Stock Market regarding our potential delisting as a result of our
failure to file the Form 10-Q in a timely fashion. The notice informed us that the Panel will
consider the filing delinquency of our Form 10-Q in addition to the filing
delinquency of this Form 10-K in rendering its decision regarding our
listing status. We will continue to be
listed on The Nasdaq SmallCap Market under the symbol SCOXE pending the
issuance of the Panel’s decision.
On
October 31, 2004, we entered into an engagement agreement (the “Engagement
Agreement”) with Boies, Schiller & Flexner LLP, Kevin McBride and
Berger Singerman (the “Law Firms”). The
Engagement Agreement supercedes and replaces the original engagement agreement
that was entered into in February 2003.
The Engagement Agreement governs the relationship between us and the Law
Firms in connection with their representation of us in our current litigation
between us and IBM, Novell, Red Hat, AutoZone and DaimlerChrysler (the “SCO
Litigation”), through the end of the current litigation between us and
IBM. This litigation is described in
more detail under Part I, Item 3 of this Form 10-K.
Our
purpose in entering into this Engagement Agreement was to limit the cash
expenditures needed to pursue the SCO Litigation. The Engagement Agreement provides for the
payment of approximately $26,000,000 for certain previously accrued expenses
totaling $13,906,000 at October 31,
18
2004 and all future
attorney fees in connection with the SCO Litigation through the end of the
current litigation between us and IBM and the escrow of at least $5,000,000 for
the payment of any expert, consulting and other expenses. As of October 31, 2004, this $5,000,000
was classified as a component of restricted cash. We paid the $13,906,000 subsequent to October 31,
2004.
Future legal fees
covered under the Engagement Agreement will require us to pay to the Law Firms
$2,000,000 per quarter for each successive quarter beginning September 1,
2004 and ending December 1, 2005 for a total amount of $12,000,000, of
which $10,000,000 will be paid in fiscal year 2005. In the first quarter of fiscal year 2005, we
made the quarterly payments for September 2004 as well as December 2004
for a total of $4,000,000. The payment
of these fees has had and will continue to have a material impact on our cash
position.
In
addition to the cash expenditures mentioned above, we must also pay one or more
contingency fees upon any amount we or our stockholders may receive as a
recovery from our litigation, our intellectual property licensing or a sale of
our company. The contingency fee amounts
payable to the Law Firms will be, subject to certain credits and adjustments,
as follows:
• 33 percent of any aggregate recovery
amounts received up to $350,000,000;
• plus 25 percent of any aggregate recovery
amounts above $350,000,000 but less than or equal to $700,000,000;
• plus 20 percent of any aggregate recovery
amounts in excess of $700,000,000.
The
Engagement Agreement specifically provides that, except for the compensation
obligations specifically described above, we will not be obligated to pay any
legal fees, whether hourly, contingent or otherwise, to the Law Firms, or any
other law firms that may be engaged by the Law Firms, in connection with the
SCO Litigation through the end of the current litigation between us and IBM,
including any appeals.
Business Focus
We
generate revenue from sales of product and services from our UNIX business and from
sales of SCOsource IP licenses and vendor licenses from our SCOsource business.
UNIX Business. Our UNIX business serves the needs of
small-to-medium sized businesses, including replicated site franchisees of
Fortune 1000 companies, by providing reliable, cost effective UNIX operating
systems and software products to power computers running on Intel
architecture. Our largest source of UNIX
business revenue is derived from existing customers through our worldwide,
indirect, leveraged channel of partners which includes distributors and
independent solution providers. We have
a presence in a number of countries that provide support and services to
customers and resellers. The other
principal channel for selling and marketing our UNIX products is through
existing customers that have a large number of replicated sites or franchisees.
We
access these corporations through their information technology or purchasing
departments with our ASMs in the United States and through our reseller channel
in countries outside the United States.
In addition, we also sell our operating system products to 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.
19
The
following table shows the operating results of the UNIX business for fiscal
years 2004, 2003 and 2002 (in thousands):
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
Revenue
|
|
$
|
41,980
|
|
$
|
53,408
|
|
$
|
64,241
|
|
|
Cost of revenue
|
|
7,355
|
|
10,422
|
|
18,316
|
|
|
Gross margin
|
|
34,625
|
|
42,986
|
|
45,925
|
|
|
Sales and marketing
|
|
15,806
|
|
24,392
|
|
29,554
|
|
|
Research and development
|
|
10,126
|
|
11,012
|
|
17,558
|
|
|
General and administrative
|
|
7,385
|
|
6,230
|
|
9,307
|
|
|
Other (1)
|
|
9,008
|
|
5,306
|
|
13,682
|
|
|
Total operating expenses
|
|
42,325
|
|
46,940
|
|
70,101
|
|
|
Loss from operations
|
|
$
|
(7,700
|
)
|
$
|
(3,954
|
)
|
$
|
(24,176
|
)
|
(1) Other costs include
amortization of intangibles, stock-based compensation, loss on disposition and
write-offs of long-lived assets, loss on investments and severance and exit
costs.
Revenue from
our UNIX business decreased by $11,428,000, or 21 percent, for fiscal year 2004
compared to fiscal year 2003 and decreased by $10,833,000, or 17 percent, for
fiscal year 2003 compared to fiscal year 2002.
The revenue from this business has been declining over the last several
fiscal years primarily as a result of increased competition from alternative
operating systems, particularly Linux.
If revenue from our UNIX business continues to decline and we are unable
to generate positive cash flow, our UNIX business will be adversely impacted.
In
an effort to try to reach profitability in our UNIX business, we have decreased
our operating costs and increased our gross margin percentage in each of the last
three fiscal years. Operating costs for
our UNIX business decreased from $70,101,000 for fiscal year 2002 to
$46,940,000 for fiscal year 2003, and then further decreased to $42,325,000 for
fiscal year 2004. These cost reductions
have primarily been attributable to reduced headcount and continued operational
efficiencies generated in our UNIX business as well as from the consolidation
of certain facilities. During fiscal
year 2004, we incurred a charge for severance and exit costs of $3,168,000 and
incurred a loss on disposition and write-off of long lived assets of
$2,355,000. Both of these charges
negatively impacted our loss from operations for fiscal year 2004.
In
our UNIX business, we have reduced the number of full-time equivalent employees
from 340 as of October 31, 2002, to 295 as of October 31, 2003 to 193
as of October 31, 2004. We have
taken these headcount reductions and reduced other discretionary spending while
still maintaining a worldwide presence.
Based on our cost-cutting actions, we anticipate that our UNIX business
will generate positive cash flow during fiscal year 2005.
The
decline in our UNIX business revenue may be accelerated if industry partners
withdraw their support as a result of our SCOsource initiatives. The decline in our UNIX business and our
SCOsource initiatives may cause industry partners, developers and hardware and
software vendors to choose not to support or certify to our UNIX operating
system products. This would lead to an
accelerated decline in revenue from our UNIX business.
An
important initiative for our UNIX business for the 2005 fiscal year will be the
release of a new version of our OpenServer operating system in the first half
of calendar year 2005. This new version
will provide increased system reliability, backward compatibility with existing
applications and software, increased application and hardware support,
integration with widely used internet applications and increased system
performance. These enhancements will not
have a direct impact on our short-term OpenServer revenue because of the long
adoption cycle for new operating system purchases and our long operating system
product sales cycle, but we believe that they will help prolong our OpenServer
revenue stream for future quarters.
SCOsource
Business. During the 2003 fiscal year, we became
aware that our UNIX code and derivative works had been inappropriately included
in the Linux operating system. We
believe the inclusion of our UNIX code and derivative works in Linux has been a
major contributor to the decline in
20
our UNIX business
because users of Linux generally do not pay for the operating system but pay
only minimal fees, if any, for service and maintenance. The Linux operating system competes directly
with our OpenServer and UnixWare products and has taken significant market
share from these products.
In
an effort to protect our UNIX intellectual property, we
initiated our SCOsource business. These
initiatives now include seeking to enter into license agreements with UNIX
vendors and offering SCOsource IP licenses to Linux and other end users
allowing them to continue to use our UNIX source code and derivative works
found in Linux. Our SCOsource efforts
resulted in the execution of two significant vendor license agreements during
fiscal year 2003, but we did not enter into any significant vendor license
agreements in fiscal year 2004. Our
revenue for fiscal year 2004 was significantly lower than revenue generated in
fiscal year 2003. We believe and allege
revenue and related revenue opportunities for fiscal year 2004 were adversely
impacted by our outstanding dispute with Novell over our UNIX copyright
ownership, which may have caused potential customers to delay or forego licensing
until an outcome in this legal matter has been reached.
During fiscal year 2004,
we began assigning direct resources to the SCOsource business for sales and
marketing, research and development and general and administrative. There were no direct costs associated with
selling, marketing, research and development and general and administration for
the 2003 fiscal year and our SCOsource business did not exist during fiscal
year 2002. The following table shows the
results of operations for the SCOsource business (in thousands):
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
829
|
|
$
|
25,846
|
|
$
|
—
|
|
|
Cost of revenue
|
|
19,743
|
|
9,500
|
|
—
|
|
|
Gross margin (deficit)
|
|
(18,914
|
)
|
16,346
|
|
—
|
|
|
Sales and marketing
|
|
1,232
|
|
—
|
|
—
|
|
|
Research and development
|
|
486
|
|
—
|
|
—
|
|
|
General and administrative
|
|
241
|
|
—
|
|
—
|
|
|
Other
|
|
—
|
|
8,956
|
|
—
|
|
|
Total operating expenses
|
|
1,959
|
|
8,956
|
|
—
|
|
|
Income (loss) from operations
|
|
$
|
(20,873
|
)
|
$
|
7,390
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
from our SCOsource business decreased from $25,846,000 in fiscal year 2003 to
$829,000 in fiscal year 2004. During
fiscal year 2003, the revenue generated was primarily attributable to two large
vendor licenses, and we did not close any similar transactions during fiscal
year 2004. Revenue in fiscal year 2004
was primarily attributable to sales of our SCOsource IP licenses. Cost of revenue increased from $9,500,000 in
fiscal year 2003 to $19,743,000 in fiscal year 2004, which was primarily
attributable to increased legal fees incurred in connection with our SCO Litigation. Operating expenses for sales and marketing,
research and development and general and administrative increased in fiscal
year 2004 over fiscal year 2003 as certain employees were dedicated to this
business initiative in fiscal year 2004.
The other expense in fiscal year 2003 of $8,956,000 was attributable to
a contingency fee payable to the Law Firms incurred in connection with the October 2003
issuance of our now retired Series A Convertible Preferred Stock. This fee was not for attorney’s fees for
legal services which fees have been recorded as cost of SCOsource licensing
revenue.
Our
future success with our SCOsource initiatives and future revenue from SCOsource
initiatives will depend on our ability to protect our UNIX intellectual
property.
Because of the
uncertainties related to our SCOsource business, we are unable to estimate the
amount and timing of future SCOsource licensing revenue. This uncertainty represents a significant
risk and challenge for us, both in the short and long term. If we do receive revenue from this source, it
may be sporadic and fluctuate from quarter to quarter. Our SCOsource initiatives are unlikely to
produce a
21
stable or predictable revenue stream for the
foreseeable future. We are unlikely to
generate significant revenue from our SCOsource business unless and until we
prevail in our SCO Litigation.
Additionally, the success of these initiatives may depend on the
strength of our intellectual property rights and contractual claims regarding
UNIX, including the strength of our claim that unauthorized UNIX source code
and derivative works are contained in Linux.
Critical
Accounting Estimates
The preparation of
financial statements and related disclosures in conformity with generally
accepted accounting principles in the United States and our discussion and
analysis of our financial condition and results of operations requires us to
make judgments, assumptions and estimates that affect the amounts reported in
our consolidated financial statements and accompanying notes. Note 1 of the notes to consolidated financial
statements in Part II, Item 8 of this Form 10-K describes the
significant accounting policies and methods used in preparation of our
consolidated financial statements. We
base our estimates on historical experience, current trends, future
projections, and on various other assumptions we believe to be reasonable under
the circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities. Actual results may differ from these
estimates. We believe the following to
be our critical accounting estimates because they are both important to the
portrayal of our financial condition and results and they require us to make
judgments and estimates about matters that are inherently uncertain.
Our
critical accounting policies and estimates include the following:
• Revenue recognition;
• Deferred income taxes and related
valuation allowances;
• Fair value of derivative financial
instrument and our now retired Series A-1 Convertible Preferred Stock;
• Severance and exit costs;
• Impairment of long-lived assets; and
• Allowances for doubtful accounts.
Revenue
Recognition. We recognize revenue in accordance with
Statement of Accounting Position (“SOP”) 97-2, as modified by SOP 98-9. Revenue recognition in accordance with these
pronouncements is complex due to the nature and variability of our sales
transactions. We recognize products
revenue upon shipment if a signed contract exists, the fee is fixed or
determinable, collection of the resulting receivable is probable and product
returns are reasonably estimable.
The majority of our
revenue transactions relate to product–only sales. On occasion we have revenue transactions that
include multiple elements (such as products, maintenance, technical support
services and other services). For
software agreements that have multiple elements, we allocate revenue to each
component of the contract based on vendor specific objective evidence (“VSOE”). VSOE is established when such elements are
sold separately. We recognize revenue
when the criteria for product revenue recognition set forth above have been
met. If VSOE of all undelivered elements
exists, but VSOE does not exist for one or more delivered elements, then
revenue is recognized using the residual method. Under the residual method, the fair value of
the undelivered elements is deferred and the remaining portion of the license
fee is recognized as revenue in the period when persuasive evidence of an
arrangement is obtained assuming all other revenue recognition criteria are
met. We recognize revenue allocated to
undelivered products when the criteria for revenue recognition set forth above
have been met.
22
Estimates used in
revenue recognition include the determination of credit-worthiness of our
customers, verification of sales-out reporting to end users through our
two-tier distribution channel and the estimation of potential returns. In addition to these estimates, we also
provide reserves against revenue based on historical trends and
experience. To the extent our estimates
are incorrect, or we are not able to maintain VSOE, our recognized revenue
could be adversely impacted and would harm our results of operations. Additionally, if our business conditions
change or our revenue contracts begin to contain more multiple elements, our
revenue recognition in future periods may be impacted because a larger
component of revenue may be deferred.
Deferred
Income Taxes and Related Valuation Allowance. The amount, and ultimate realization, of our
deferred income tax assets depends, in part, upon the tax laws in effect, our
future earnings and other future events, the effects of which cannot be
determined. We have provided a valuation
allowance of $66,655,000 against our entire net deferred tax asset as of October 31,
2004. The valuation allowance was
recorded because of our history of net operating losses and the uncertainties
regarding our future operating profitability and taxable income.
Fair
Value of Derivative Financial Instrument and Our Retired Series A-1
Convertible Preferred Stock. In October 2003, we issued 50,000 shares
of our redeemable Series A Convertible Preferred Stock. The terms of the preferred stock included
conversion and a number of redemption provisions that represented a derivative
financial instrument under Statement of Financial Accounting Standards (“SFAS”)
No. 133, “Accounting for Derivative Instruments and Hedging Activities,”
as amended. We determined that the
conversion feature was an embedded derivative financial instrument.
As of October 16,
2003, through the assistance of an independent valuation firm, we determined
the initial fair value of the derivative was classified as a current liability
$18,069,000 and the value of the preferred stock was $29,671,000. We were required to account for the
conversion feature as an embedded derivative since the preferred stock
instrument did not entitle the holders to equity features such as voting rights
and board representation. As of October 31,
2003, the fair value of the derivative was $15,224,000 and the decrease in fair
value of $2,845,000 was recorded as income as a change in fair value of
derivative in other income in the statement of operations for fiscal year
2003. During fiscal year 2004, the fair
value of the derivative decreased and we recorded a total of $5,924,000 as
income as a change in fair value of the derivative in other income.
On February 5,
2004, we completed an exchange transaction in which each outstanding Series A
share was exchanged for one share of redeemable Series A-1 Convertible
Preferred Stock. We received no
additional proceeds in the exchange. The
exchange transaction eliminated the derivative related to the Series A
shares that was initially recorded as a current liability on our balance sheet
and eliminated the charge in our quarterly statements of operations for the
change in the fair value of the derivative related to the Series A shares.
Through the assistance
of an independent valuation firm, we determined the fair value of the Series A-1
shares to be $45,276,000 as of February 5, 2004. We recorded a dividend in the second quarter
of fiscal year 2004 of $6,305,000, which reduced earnings available to common
stockholders, related to the difference between the fair value of the Series A-1
shares and the carrying value of the previously issued Series A shares and
related derivative. This dividend was
only one component of the total dividends recorded in fiscal year 2004.
The estimated fair value
of the Series A-1 shares as of February 5, 2004 was calculated using
a binomial model. Specific assumptions
used included: 2.7 years to maturity, 11
percent equivalent bond yield, risk-free rate of 2.4 percent and volatility of
130 percent. Had different assumptions
been used, the valuation result could have been different than reported, and
that difference could have been material.
As described elsewhere in this filing, we repurchased all outstanding Series A-1
shares on July 21, 2004. As of October 31,
2004, no Series A-1 shares remain outstanding.
23
Severance and Exit Costs. Since fiscal year 2001, we have undertaken
significant restructuring activities to reduce our ongoing cost of
operations. All restructurings that
occurred prior to fiscal year 2003 were accounted for in accordance with
Emerging Issues Task Force (“EITF”) No. 94-3 “Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity.” For restructuring activities initiated
beginning with fiscal year 2003, we have accounted for the one-time termination
benefits, contract termination costs and other associated costs in accordance
with SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal
Activities.” Other severance benefits
have been accounted for in accordance with SFAS No. 112 “Employers’
Accounting for Postemployment Benefits.” and SFAS No. 88 “Employers’
Accounting for Settlements and Curtailments of Defined Benefit Plans and for
Termination Benefits.”
Each restructuring has
required us to make estimates and assumptions related to losses on vacated
facilities, provisions for termination benefits, outplacement costs and other
costs. Pursuant to the relevant
accounting literature, we may record an accrual for amounts associated with a
restructuring that are not paid in the current period. We regularly evaluate the adequacy of the
accruals based on changes in estimates.
We may incur future charges for new restructuring activities.
Impairment
of Long-lived Assets. We review our long-lived assets for
impairment when events or changes in circumstances indicate that the book value
of an asset may not be recoverable. We
evaluate, at each balance sheet date, whether events and circumstances have
occurred which indicate possible impairment.
The carrying value of a long-lived asset is considered impaired when the
anticipated cumulative undiscounted cash flows of the related asset or group of
assets is less than the carrying value.
In that event, a loss is recognized based on the amount by which the
carrying value exceeds the estimated fair market value of the long-lived asset.
We performed an
impairment analysis as of April 30, 2004 in accordance with SFAS No. 142,
“Goodwill and Other Intangible Assets” and SFAS No. 144, “Accounting for
the Impairment or Disposal of Long-Lived Assets,” and determined that the
goodwill and intangible assets related to the Vultus technology, which we
acquired from Vultus, Inc. (“Vultus”) in June 2003, had been
impaired. We concluded that an
impairment-triggering event occurred during the second quarter of fiscal year
2004 as we had a reduction in force that impacted our ability to move the
Vultus initiative forward on a stand-alone basis and an anticipated partnership
that would have solidified the Vultus revenue and cash flow did not
materialize. Consequently, we concluded
that no significant future cash flows related to our Vultus assets would be
realized. As a result of these analyses,
we wrote-down the carrying value of our goodwill related to the Vultus
acquisition from $1,166,000 to $0 and wrote-down intangible assets related to
our Vultus acquisition from $973,000 to $0.
Based on continued
declines in our operating results, we performed an additional impairment
analysis as of October 31, 2004 and determined that the fair value of our
remaining intangible assets was in excess of the current carrying values and
that no impairment had occurred. Judgment
from management is required to determine if a triggering event has occurred and
in forecasting future operating results.
Write-downs of
intangible assets may be necessary if the future fair value of these assets is
less than carrying value. If the operating
trends for our UNIX or SCOsource businesses continue to decline we may be
required to record an impairment charge in a future period related to the
carrying value of our long-lived assets.
Allowance
for Doubtful Accounts. We offer credit terms on the
sale of our products to a majority of our customers and require no collateral
from these customers. We perform ongoing
credit evaluations of our customers’ financial condition and maintain an
allowance for doubtful accounts based upon our historical collection experience
and expected collectibility of all accounts receivable and have applied these
policies consistently throughout the last three fiscal years. Our allowance for doubtful accounts,
24
which is determined based on our historical
experience and a specific review of customer balances, was $136,000 as of October 31,
2004. Our past experience has resulted
in minimal differences from the actual amounts provided for bad debts and our
recorded estimates. However, our actual
bad debts in future periods may differ from our current estimates and the
differences may be material, which may have an adverse
impact on our future accounts receivable and cash position.
Results of Operations
The following table
presents our results of operations for the fiscal years ended October 31,
2004, 2003 and 2002 (in thousands):
|
|
|
Years
Ended October 31,
|
|
|
Statement of Operations Data:
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
Revenue:
|
|
|
|
|
|
|
|
|
Products
|
|
$
|
35,352
|
|
$
|
45,028
|
|
$
|
52,975
|
|
|
SCOsource licensing
|
|
829
|
|
25,846
|
|
—
|
|
|
Services
|
|
6,628
|
|
8,380
|
|
11,266
|
|
|
Total revenue
|
|
42,809
|
|
79,254
|
|
64,241
|
|
|
Cost of revenue:
|
|
|
|
|
|
|
|
|
Products
|
|
3,221
|
|
4,068
|
|
7,558
|
|
|
SCOsource licensing
|
|
19,743
|
|
9,500
|
|
—
|
|
|
Services
|
|
4,134
|
|
6,354
|
|
10,758
|
|
|
Total cost of revenue
|
|
27,098
|
|
19,922
|
|
18,316
|
|
|
Gross margin
|
|
15,711
|
|
59,332
|
|
45,925
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
Sales and marketing
|
|
17,038
|
|
24,392
|
|
29,554
|
|
|
Research and development
|
|
10,612
|
|
11,012
|
|
17,558
|
|
|
General and administrative
|
|
7,626
|
|
6,230
|
|
9,307
|
|
|
Severance and exit costs
|
|
3,168
|
|
498
|
|
6,728
|
|
|
Amortization of intangibles
|
|
2,566
|
|
3,190
|
|
2,853
|
|
|
Loss on disposition and impairment of
long-lived assets
|
|
2,355
|
|
164
|
|
1,796
|
|
|
Write-off of investments
|
|
—
|
|
250
|
|
1,180
|
|
|
Stock-based compensation
|
|
919
|
|
1,204
|
|
1,125
|
|
|
Compensation to law firms
|
|
—
|
|
8,956
|
|
—
|
|
|
Total operating expenses
|
|
44,284
|
|
55,896
|
|
70,101
|
|
|
Income (loss) from operations
|
|
(28,573
|
)
|
3,436
|
|
(24,176
|
)
|
|
Equity in income (losses) of affiliates
|
|
111
|
|
(62
|
)
|
(50
|
)
|
|
Other income (expense), net
|
|
6,507
|
|
2,827
|
|
(168
|
)
|
|
Provision for income taxes
|
|
(1,395
|
)
|
(774
|
)
|
(483
|
)
|
|
Net income (loss)
|
|
(23,350
|
)
|
5,427
|
|
(24,877
|
)
|
|
|
|
|
|
|
|
|
|
|
Dividends on redeemable convertible
preferred stock
|
|
7,123
|
|
(123
|
)
|
—
|
|
|
Net income available (loss applicable) to
common stockholders
|
|
$
|
(16,227
|
)
|
$
|
5,304
|
|
$
|
(24,877
|
)
|
Fiscal Years Ended October 31, 2004, 2003
and 2002
Revenue
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
42,809,000
|
|
(46
|
)%
|
$
|
79,254,000
|
|
23
|
%
|
$
|
64,241,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
for fiscal year 2004 decreased by $36,445,000, or 46 percent, from fiscal year
2003. This decrease was primarily
attributable to significantly lower SCOsource licensing revenue in the 2004
fiscal
25
year compared to the 2003 fiscal year as well
as a continued decline in our UNIX business.
Revenue for fiscal year 2003 increased by $15,013,000, or 23 percent,
from fiscal year 2002, and this increase was primarily attributable to vendor
license fees generated from our SCOsource licensing initiatives offset by
decreases in UNIX products and services revenue.
Revenue
generated from our UNIX business and SCOsource business is as follows:
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
UNIX revenue
|
|
$
|
41,980,000
|
|
(21
|
)%
|
$
|
53,408,000
|
|
(17
|
)%
|
$
|
64,241,000
|
|
|
Percent of total revenue
|
|
98
|
%
|
|
|
67
|
%
|
|
|
100
|
%
|
|
SCOsource revenue
|
|
829,000
|
|
(97
|
)%
|
25,846,000
|
|
n/a
|
|
—
|
|
|
Percent of total revenue
|
|
2
|
%
|
|
|
33
|
%
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The decrease in revenue in the UNIX business of $11,428,000 for fiscal
year 2004 compared to fiscal year 2003 and the decrease of $10,833,000 for
fiscal year 2003 compared to fiscal year 2002 was primarily attributable to
continued competition from other operating systems, particularly Linux. We anticipate that for fiscal year 2005 our
total UNIX revenue will decline from UNIX revenue generated in fiscal year
2004.
The
decrease in SCOsource licensing revenue of $25,017,000 in fiscal year 2004 from
fiscal year 2003 was primarily attributable to minimal vendor licensing revenue
in fiscal year 2004 compared to significant vendor licensing revenue generated
in fiscal year 2003 as a result of two large vendor licenses.
Sales of our UNIX products and services during fiscal year 2004 were
primarily to pre-existing customers. Our
UNIX business revenue depends significantly on our ability to market our
products to existing customers and to generate upgrades from existing
customers. Our UNIX revenue may be lower
than currently anticipated if we are not successful with our existing customers
or if we lose the support of any of our existing hardware and software vendors
or our key industry partners withdraw their marketing and certification support
or direct their support to our competitors.
This may occur as a result of the decline of our UNIX business and our
SCOsource initiatives.
Products Revenue
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products revenue
|
|
$
|
35,352,000
|
|
(21
|
)%
|
$
|
45,028,000
|
|
(15
|
)%
|
$
|
52,975,000
|
|
|
Percent of total revenue
|
|
83
|
%
|
|
|
57
|
%
|
|
|
82
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Our
products revenue consists of software licenses for UNIX products such as
OpenServer and UnixWare, as well as sales of UNIX-related products. Products revenue also includes revenue
derived from OEMs, distribution partners and large accounts. We rely heavily on our two-tier distribution
channel and any disruption in our distribution channel could have an adverse
impact on future revenue.
The
decrease in products revenue of $9,676,000 from fiscal year 2004 compared to
fiscal year 2003 and the decrease of $7,947,000 from fiscal year 2003 compared
to fiscal year 2002 was primarily attributable to decreased sales of
OpenServer and UnixWare products primarily resulting from increased competition
in the operating system market, particularly Linux. We believe that this competition from Linux
will continue in fiscal year 2005 and future periods.
Our products revenue was derived primarily from sales of our OpenServer
and UnixWare products. Other products revenue
consists mainly of product maintenance and other UNIX-related products. Revenue for these products was as follows:
26
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OpenServer revenue
|
|
$
|
18,467,000
|
|
(17
|
)%
|
$
|
22,162,000
|
|
(24
|
)%
|
$
|
29,108,000
|
|
|
Percent of products revenue
|
|
52
|
%
|
|
|
49
|
%
|
|
|
55
|
%
|
|
UnixWare revenue
|
|
11,125,000
|
|
(21
|
)%
|
14,083,000
|
|
(0
|
)%
|
14,154,000
|
|
|
Percent of products revenue
|
|
32
|
%
|
|
|
31
|
%
|
|
|
27
|
%
|
|
Other products revenue
|
|
5,760,000
|
|
(34
|
)%
|
8,783,000
|
|
(10
|
)%
|
9,713,000
|
|
|
Percent of products revenue
|
|
16
|
%
|
|
|
20
|
%
|
|
|
18
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The decreases in revenue for OpenServer, UnixWare and other products
are all primarily the result of increased competition, particularly from Linux
operating system providers.
SCOsource
Licensing Revenue
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SCOsource licensing revenue
|
|
$
|
829,000
|
|
(97
|
)%
|
$
|
25,846,000
|
|
n/a
|
|
$
|
—
|
|
|
Percent of total revenue
|
|
2
|
%
|
|
|
33
|
%
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We
initiated our SCOsource business for the purpose of protecting our intellectual
property rights in our UNIX source code and derivative works. SCOsource licensing revenue was $829,000 in
fiscal year 2004, down significantly from revenue of $25,846,000 generated in
fiscal year 2003. We did not generate
any revenue from this source in fiscal year 2002. The SCOsource revenue in fiscal year 2004 was
primarily attributable to SCOsource IP license sales and the SCOsource
licensing revenue in fiscal year 2003 was primarily attributable to fees
associated with two significant vendor licenses. We believe and allege that our decrease in
revenue in fiscal year 2004 was in part attributable to our outstanding dispute
with Novell over our UNIX copyright ownership, which may have caused potential customers
to delay or forego licensing until an outcome in this legal matter has been
reached.
We
are unable to predict the amount and timing of future SCOsource licensing
revenue, and, when generated, we expect that such revenue will be sporadic.
Services Revenue
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Services revenue
|
|
$
|
6,628,000
|
|
(21
|
)%
|
$
|
8,380,000
|
|
(26
|
)%
|
$
|
11,266,000
|
|
|
Percent of total revenue
|
|
15
|
%
|
|
|
11
|
%
|
|
|
18
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Services
revenue consists primarily of annual and incident technical support fees,
engineering services fees, professional services and consulting fees, and
education fees. These fees are typically
charged and invoiced separately from UNIX products sales. The decrease in services revenue of
$1,752,000, or 21 percent, from fiscal year 2003 as compared to fiscal year
2004 as well as the decrease in services revenue in fiscal year 2002, compared
to fiscal year 2003 of $2,886,000, or 26 percent, was in part due to the
decrease in products revenue as well as fewer customers renewing services
agreements.
The
majority of our support and professional services revenue continues to be
derived from services for UNIX-based operating system products. Our future level of services revenue depends
in part on our ability to generate UNIX products revenue from new customers as
well as to renew annual support and services agreements with existing UNIX
customers.
Cost of Products Revenue
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of products revenue
|
|
$
|
3,221,000
|
|
(21
|
)%
|
$
|
4,068,000
|
|
(46
|
)%
|
$
|
7,558,000
|
|
|
Percentage of products revenue
|
|
9
|
%
|
|
|
9
|
%
|
|
|
14
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
27
Cost
of products revenue consists of manufacturing costs, royalties to third-party
vendors, technology costs and overhead costs.
Cost of products revenue decreased by $847,000, or 21 percent, in fiscal
year 2004 as compared to fiscal year 2003 and decreased by $3,490,000, or 46
percent, in fiscal year 2003 compared to fiscal year 2002. This decrease in cost of products revenue was
primarily attributable to lower products revenue, lower manufacturing costs,
decreased royalties to third party vendors and lower amortized technology
costs.
For
fiscal year 2005, we expect the dollar amount of our cost of products revenue
to be less than in fiscal year 2004 and, as a percentage of products revenue,
to be consistent with the percentage achieved during fiscal year 2004.
Cost of
SCOsource Licensing Revenue
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of SCOsource licensing revenue
|
|
$
|
19,743,000
|
|
108
|
%
|
$
|
9,500,000
|
|
n/a
|
|
$
|
—
|
|
|
Percentage of SCOsource licensing revenue
|
|
2382
|
%
|
|
|
37
|
%
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 increased by $10,243,000, or 108 percent, during
fiscal year 2004 as compared to fiscal year 2003. The increase in costs in fiscal year 2004
compared to fiscal year 2003 was primarily attributable to increased legal
costs incurred in connection with our SCO Litigation.
With the completion of the Engagement
Agreement with the Law Firms representing us in our SCO Litigation as described
elsewhere in this filing, we anticipate that the dollar amount of our cost of
SCOsource licensing for fiscal year 2005 will be lower than fiscal year 2004. However, future legal fees may include
contingency payments made to the Law Firms as a result of a settlement,
judgment, certain licensing fees or a sale of our company, which could cause
cost of SCOsource licensing revenue for fiscal year 2005 to be higher than
fiscal year 2004.
Cost of Services Revenue
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services revenue
|
|
$
|
4,134,000
|
|
(35
|
)%
|
$
|
6,354,000
|
|
(41
|
)%
|
$
|
10,758,000
|
|
|
Percentage of services revenue
|
|
62
|
%
|
|
|
76
|
%
|
|
|
95
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 $2,220,000, or 35 percent, for fiscal year 2004 compared to fiscal
year 2003 and decreased by $4,404,000, or 41 percent, for fiscal year 2003 compared
to fiscal year 2002. This decrease
was attributable to reduced employee and related costs and the elimination of
certain third-party support contracts.
For fiscal year 2005, we expect the dollar amount of our cost of
services revenue to be less than that incurred in fiscal year 2004 and that
cost of services revenue as a percentage of services revenue will be lower in
fiscal year 2005 as compared to fiscal year 2004.
28
Sales and Marketing
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales and marketing expense
|
|
$
|
17,038,000
|
|
(30
|
)%
|
$
|
24,392,000
|
|
(17
|
)%
|
$
|
29,554,000
|
|
|
Percentage of total revenue
|
|
40
|
%
|
|
|
31
|
%
|
|
|
46
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 decrease in sales and marketing expense of $7,354,000, or 30
percent, from fiscal year 2003 to fiscal year 2004 and the decrease from fiscal
year 2002 to fiscal year 2003 of $5,162,000, or 17 percent, was primarily attributable
to reductions in sales and marketing employees, reduced travel expenses, less
commissions and lower advertising costs.
Sales and marketing expense as a percentage of revenue increased during
fiscal year 2004 as compared to fiscal year 2003 as a result of lower revenue
in the 2004 fiscal year. Our sales and
marketing full-time equivalent employees decreased from 133 as of October 31,
2002, to 114 as of October 31, 2003, to 62 as of October 31, 2004.
For
fiscal year 2005, we anticipate that the dollar amount of sales and marketing
expense will decrease from fiscal year 2004.
Research and Development
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research and development expense
|
|
$
|
10,612,000
|
|
(4
|
)%
|
$
|
11,012,000
|
|
(37
|
)%
|
$
|
17,558,000
|
|
|
Percentage of total revenue
|
|
25
|
%
|
|
|
14
|
%
|
|
|
27
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Research
and development expenses consist of the salaries and benefits of software
engineers, consulting expenses and corporate allocations. Research and development expense decreased by
$400,000, or 4 percent, from fiscal year 2004 compared to fiscal year
2003. During fiscal year 2004 our
engineering efforts were focused on the release of UnixWare 7.1.4 and the
continued development of the next release for our OpenServer product. These development efforts required us to
maintain our research and development infrastructure which limited our ability
to cut costs in this area as significantly as we have done in other areas. The decrease in research and development
expense in fiscal year 2003 of $6,546,000, or 37 percent, compared to fiscal
year 2002 was primarily attributable to work force reductions. Research and development expense as a
percentage of revenue increased in fiscal year 2004 as compared to fiscal year
2003 as a result of lower revenue in fiscal year 2004. Our research and development full-time
equivalent employees decreased from 75 for fiscal years ended October 31,
2002 and 2003 to 64 as of October 31, 2004.
For
fiscal year 2005, we anticipate that the dollar amount of research and
development expenses will decrease from fiscal year 2004.
General and Administrative
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative expense
|
|
$
|
7,626,000
|
|
22
|
%
|
$
|
6,230,000
|
|
(33
|
)%
|
$
|
9,307,000
|
|
|
Percentage of total revenue
|
|
18
|
%
|
|
|
8
|
%
|
|
|
14
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
and administrative expenses consist of the salaries and benefits of finance,
human resources, and executive management and expenses for professional
services such as legal and accounting services and corporate allocations. General and administrative expense increased
by $1,396,000, or 22 percent, during fiscal year 2004 as compared to fiscal
year 2003. The increase in general and
administrative expense was primarily attributable to increased legal costs as a
result of corporate and regulatory legal matters not classified as cost of
SCOsource licensing revenue and increased fees from
29
other professional service providers. The decrease in general and administrative
expense from fiscal year 2002 to fiscal year 2003 of $3,077,000, or 33 percent,
was primarily attributable to staff centralization. General and administrative expenses as a percent
of total revenue increased in fiscal year 2004 as a result of increased costs
and lower revenue. Our general and
administrative full-time equivalent employees decreased from 61 as of October 31,
2002, to 55 as of October 31, 2003, to 36 as of October 31, 2004.
For
fiscal year 2005, we anticipate that the dollar amount of general and
administrative expenses will decrease from fiscal year 2004. However, due to the new compliance and
reporting regulations under the Sarbanes-Oxley Act and other new regulatory
requirements, general and administrative expenses may vary as we implement
policies and procedures to comply with these new requirements.
Severance and Exit
Costs
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance and exit costs
|
|
$
|
3,168,000
|
|
536
|
%
|
$
|
498,000
|
|
(93
|
)%
|
$
|
6,728,000
|
|
|
Percentage of total revenue
|
|
7
|
%
|
|
|
1
|
%
|
|
|
10
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During fiscal years 2004, 2003 and 2002, we
recorded severance and exit costs totaling $3,168,000, $498,000 and $6,728,000,
respectively. The severance and exit
costs for fiscal years 2004, 2003 and 2002 were comprised of termination
payments made to employees in connection with reductions in headcount, closure
of certain facilities and adjustments to previously recorded amounts as actual
payments made were less than recorded accruals.
The variation in severance and exit costs from fiscal year 2004 compared
to fiscal year 2003 and from fiscal year 2003 compared to fiscal year 2002 is a
result of the number of terminated employees and the size and number of
facilities closed.
The detail of the severance and exit costs for fiscal years 2004, 2003
and 2002, are as follows (in thousands):
|
Fiscal 2004
|
|
Balance at
November 1, 2003
|
|
Additions
|
|
Adjustments
|
|
Utilization
|
|
Balance at
October 31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-time severance
|
|
$
|
—
|
|
$
|
309
|
|
$
|
—
|
|
$
|
(309
|
)
|
$
|
—
|
|
|
Ongoing severance and other
|
|
—
|
|
2,071
|
|
—
|
|
(1,670
|
)
|
401
|
|
|
Facilities
|
|
348
|
|
788
|
|
—
|
|
(1,136
|
)
|
—
|
|
|
Total
|
|
$
|
348
|
|
$
|
3,168
|
|
$
|
—
|
|
$
|
(3,115
|
)
|
$
|
401
|
|
|
Fiscal
2003
|
|
Balance at
November 1, 2002
|
|
Additions
|
|
Adjustments
|
|
Utilization
|
|
Balance at
October 31, 2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-time severance
|
|
$
|
—
|
|
$
|
198
|
|
$
|
—
|
|
$
|
(198
|
)
|
$
|
—
|
|
|
Ongoing severance and other
|
|
560
|
|
1,388
|
|
(273
|
)
|
(1,675
|
)
|
|
|
|
Facilities
|
|
2,117
|
|
—
|
|
(815
|
)*
|
(954
|
)
|
348
|
|
|
Total
|
|
$
|
2,677
|
|
$
|
1,586
|
|
$
|
(1,088
|
)
|
$
|
(2,827
|
)
|
$
|
348
|
|
* The facilities adjustment of $815,000 was the
result of successfully negotiating out of lease commitments in connection with
our winding down of SCO Group, Ltd. in the United Kingdom.
|
Fiscal
2002
|
|
Balance
at
November 1, 2001
|
|
Additions
|
|
Adjustments
|
|
Utilization
|
|
Balance
at
October 31, 2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance and other
|
|
$
|
692
|
|
$
|
4,053
|
|
$
|
—
|
|
$
|
(4,185
|
)
|
$
|
560
|
|
|
Facilities
|
|
2,052
|
|
4,236
|
|
(1,561
|
)*
|
(2,610
|
)
|
2,117
|
|
|
Total
|
|
$
|
2,744
|
|
$
|
8,289
|
|
$
|
(1,561
|
)
|
$
|
(6,795
|
)
|
$
|
2,677
|
|
30
*The facilities
adjustment of $1,561,000 was the result of successfully re-negotiating an
existing lease commitment.
Amounts to be paid for severance and exit costs are
included as accrued liabilities.
Amortization of Intangibles
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of intangibles
|
|
$
|
2,566,000
|
|
(20
|
)%
|
$
|
3,190,000
|
|
12
|
%
|
$
|
2,853,000
|
|
|
Percentage of total revenue
|
|
6
|
%
|
|
|
4
|
%
|
|
|
4
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During
fiscal years 2004, 2003 and 2002, we recorded $2,566,000, $3,190,000 and
$2,853,000, respectively, for the amortization of intangible assets with finite
lives. The decrease of $624,000, or 20
percent, from fiscal year 2004 compared to fiscal year 2003 was primarily
attributable to reduced amortization expense recorded on certain assets
acquired from Vultus that were written down to $0 during fiscal year 2004 and
therefore were not amortized for the last half of fiscal year 2004. The increase of $337,000 in fiscal year 2003
over fiscal year 2002 was attributed to amortization expense on assets acquired
from Vultus.
Loss on Disposition and Impairment of Long-lived Assets
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss on disposition and write-down of
long-lived assets
|
|
$
|
2,355,000
|
|
1336
|
%
|
$
|
164,000
|
|
(91
|
)%
|
$
|
1,796,000
|
|
|
Percentage of total revenue
|
|
6
|
%
|
|
|
0
|
%
|
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During
fiscal years 2004, 2003 and 2002, we recorded a write down of long-lived
assets of $2,355,000, $164,000 and $1,796,000, respectively. The loss on disposition and write-down of
long-lived assets recorded in fiscal year 2004 primarily related to goodwill
and intangible assets acquired in connection with our acquisition of Vultus in June 2003. We concluded that an impairment triggering
event occurred during fiscal year 2004 as we had a reduction in force that
impacted our ability to move the Vultus initiative forward on a stand-alone
basis and because an anticipated partnership that would have solidified the
Vultus revenue and cash flow opportunities did not materialize. Consequently, we have concluded that no
significant future cash flows related to our Vultus assets will be realized. The loss on disposition and write-down of
long-lived assets recorded in fiscal years 2003 and 2002 were primarily
attributable to assets written off in connection with restructurings that
occurred during each fiscal year.
Write-offs of Investments
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Write-offs of investments
|
|
$
|
—
|
|
n/a
|
|
$
|
250,000
|
|
(79
|
)%
|
$
|
1,180,000
|
|
|
Percentage of total revenue
|
|
0
|
%
|
|
|
0
|
%
|
|
|
2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Management routinely assesses our investments
for impairments and adjusts the carrying amounts to estimated realizable values
when impairment has occurred. During
fiscal year 2004, we did not have any write-offs of investments. During fiscal year 2003, in connection with
the restructuring of our investment in and relationship with Vista.com, Inc.
(“Vista”), we recorded a write-off of our Vista investment and incurred a
charge of $250,000. We had been
accounting for our investment in Vista under the equity method of accounting.
During fiscal year 2002, we determined that
the current carrying value of $1,180,000 related to our investment in Lineo, Inc.
(“Lineo”) would not be recovered and was written off. This write-off was
31
due
to a significant deterioration in the operating results of Lineo and declines
in general economic conditions. This
investment had been accounted for under the cost method.
Stock-based Compensation
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation
|
|
$
|
919,000
|
|
(24
|
)%
|
$
|
1,204,000
|
|
7
|
%
|
$
|
1,125,000
|
|
|
Percentage of total revenue
|
|
2
|
%
|
|
|
2
|
%
|
|
|
2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based compensation consisted of the following components for
fiscal years 2004, 2003 and 2002 (in thousands):
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of stock-based compensation
|
|
$
|
325
|
|
$
|
866
|
|
$
|
986
|
|
|
Reversal of previously recorded expense
related to terminated employees
|
|
—
|
|
—
|
|
(565
|
)
|
|
Options, warrants and shares for services
|
|
502
|
|
296
|
|
631
|
|
|
Modifications to options
|
|
92
|
|
42
|
|
73
|
|
|
Total
|
|
$
|
919
|
|
$
|
1,204
|
|
$
|
1,125
|
|
As of October 31, 2004, there was a balance of approximately $22,000
in deferred compensation that will be amortized to stock-based compensation
during fiscal year 2005.
Compensation to Law Firms
|
|
|
2004
|
|
Change
|
|
2003
|
|
Change
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Compensation to law firms
|
|
$
|
—
|
|
n/a
|
|
$
|
8,956,000
|
|
n/a
|
|
$
|
—
|
|
|
Percentage of total revenue
|
|
0
|
%
|
|
|
11
|
%
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
During fiscal year 2003,
we incurred contingency fees of $8,956,000, or 11 percent of revenue, related
to our arrangement with the Law Firms representing us in the SCO Litigation in
connection with the issuance of shares of our now retired Series A
Convertible Preferred Stock. All
payments to the Law Firms for legal fees incurred in connection with the SCO
Litigation have been classified as cost of SCOsource licensing revenue.
Equity
in Income (Losses) of Affiliate
We account for our
ownership interests in companies in which we own at least 20 percent and less
than 50 percent using the equity method of accounting. Under the equity method, we record our
portion of the entities’ net income or net loss in our consolidated statements
of operations. As of October 31,
2004, the carrying value of our investments was related to our 30 percent
ownership in a Chinese company.
During
fiscal years 2004, 2003 and 2002, we recorded $111,000, ($62,000) and
($50,000), respectively, that related to net income (losses) in these
entities. The income reported in fiscal
year 2004 was attributable to our portion of the net income generated by the
above mentioned Chinese company. The
losses in the 2003 and 2002 fiscal years were primarily attributable to losses
generated from Vista.
Other
Income (Expense), net
Other income (expense) consisted of the following components for fiscal
years 2004, 2003 and 2002 (in thousands):
32
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
Interest income
|
|
$
|
905
|
|
$
|
188
|
|
$
|
377
|
|
|
Interest expense
|
|
—
|
|
(3
|
)
|
(206
|
)
|
|
Change in fair value of derivative
|
|
5,924
|
|
2,845
|
|
—
|
|
|
Other expense, net
|
|
(322
|
)
|
(203
|
)
|
(339
|
)
|
|
Total other income (expense), net
|
|
$
|
6,507
|
|
$
|
2,827
|
|
$
|
(168
|
)
|
Interest income increased by $717,000 from fiscal year 2003 to fiscal
year 2004 and decreased by $189,000 from fiscal year 2003 to fiscal year
2002. The changes in interest income are
the result of changes in our cash and available-for-sale securities balances.
Interest expense decreased by
$203,000 from fiscal year 2002 compared to fiscal year 2003 as a result of
interest expense recorded in the 2002 fiscal year on our outstanding note
payable to The Santa Cruz Operation.
This note payable was paid during fiscal year 2002.
The income recorded on the change in fair value of derivative for
fiscal year 2004 and fiscal year 2003 related to the decrease in fair value of
this instrument and marking it to market at each balance sheet date. The derivative financial instrument was
eliminated during the second quarter of fiscal year 2004.
Provision for Income Taxes
The provision for income taxes was $1,395,000 in
fiscal year 2004, $774,000 in fiscal year 2003 and $483,000 in fiscal year
2002. The increase in the provision for income taxes
of $621,000 in fiscal year 2004 compared to fiscal year 2003 was primarily
attributable to accruals for withholding taxes that are estimated to be paid in
connection with the operations of our Indian operations. Other than the accrual previously mentioned,
our provision for income taxes is primarily related to earnings in foreign
subsidiaries.
As of October 31, 2004, we had net operating
loss carry-forwards for U.S. federal and state income tax reporting purposes of
approximately $121,448,000 that expire at various dates between 2019 and
2024. We had net deferred tax assets,
including net operating loss carry-forwards and other temporary differences
between book and tax deductions, totaling approximately $67,087,000 as of October 31,
2004. We also had net deferred tax
liabilities of approximately $432,000 related to taxes on foreign
earnings. A valuation allowance in the
amount of $66,655,000, the difference between our deferred tax assets and
liabilities, has been recorded as of October 31, 2004 as a result of
uncertainties regarding the ultimate realizability of the net deferred tax
asset balance.
Dividends
Related to Series A and Series A-1 Convertible Preferred Stock
In October 2003, we issued 50,000 shares of our Series A
Convertible Preferred Stock for $1,000 per share. In connection with completing the February 5,
2004 exchange of shares of Series A-1 Convertible Preferred Stock for
outstanding Series A shares, we removed the carrying value of the Series A
shares and related derivative and recorded the fair value of the Series A-1
shares issued in the exchange transaction.
The difference between these two amounts was $6,305,000 and was recorded
as a non-cash dividend in fiscal year 2004.
With the completion of the repurchase transaction with BayStar Capital II,
L.P. (“BayStar”) during fiscal year 2004, as a result of which no Series A-1
shares remain outstanding, we will not be required to continue to accrue or pay
any dividends on the Series A-1 shares.
As a result of completing the repurchase transaction with BayStar, we
recorded a capital contribution in the amount of $15,475,000, which represented
the difference in the carrying value of the Series A-1 shares and accrued
dividends less the fair value of the 2,105,263 shares of common stock and the
$13,000,000 in cash.
33
If the repurchase had
not occurred, dividends on the Series A-1 shares would have been paid
after October 16, 2004, the first anniversary of the original Series A
private placement, quarterly at a rate of 8 percent per annum, subject to
annual increases of 2 percent per annum, not to exceed 12 percent per
annum. We will no longer accrue
dividends on preferred stock because the Series A-1 shares were
repurchased. No dividends were paid on
the Series A or Series A-1 shares.
The following table
details the components of the dividends for fiscal years 2004, 2003 and 2002
(in thousands):
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
Accrual of dividends on preferred stock
|
|
$
|
(2,047
|
)
|
$
|
(123
|
)
|
$
|
—
|
|
|
Exchange of Series A shares for
Series A-1 shares
|
|
(6,305
|
)
|
—
|
|
—
|
|
|
Repurchase of Series A-1 shares from
BayStar
|
|
15,475
|
|
—
|
|
—
|
|
|
Total
|
|
$
|
7,123
|
|
$
|
(123
|
)
|
$
|
—
|
|
Quarterly Results of Operations
The
following table sets forth certain unaudited quarterly statement of operations
data for the last eight quarters. This
information has been derived from our unaudited consolidated financial
statements, which, in management’s opinion, have been prepared on the same
basis as the audited financial statements and include all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the information for the quarters presented. This information should be read in conjunction
with the audited consolidated financial statements and related notes included
elsewhere in this Form 10-K. The
operating results for any quarter are not necessarily indicative of the
operating results for any future period.
|
|
|
Quarter Ended
|
|
|
|
|
January 31,
2004
|
|
April 30,
2004
|
|
July 31,
2004
|
|
October 31,
2004
|
|
|
|
|
(unaudited)
(In thousands, except per share data)
|
|
|
Fiscal Year 2004
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
11,392
|
|
$
|
10,137
|
|
$
|
11,205
|
|
$
|
10,075
|
|
|
Gross margin
|
|
5,742
|
|
3,679
|
|
2,190
|
|
4,100
|
|
|
Loss from operations
|
|
(5,402
|
)
|
(9,174
|
)
|
(7,387
|
)
|
(6,610
|
)
|
|
Net income available (loss applicable) to
common stockholders
|
|
(2,486
|
)
|
(14,726
|
)
|
7,501
|
|
(6,516
|
)
|
|
Net income (loss) per common share
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.18
|
)
|
$
|
(1.04
|
)
|
$
|
0.49
|
|
$
|
(0.37
|
)
|
|
Diluted
|
|
$
|
(0.18
|
)
|
$
|
(1.04
|
)
|
$
|
0.38
|
|
$
|
(0.37
|
)
|
|
Weighted average basic common shares
|
|
13,824
|
|
14,100
|
|
15,242
|
|
17,436
|
|
|
Weighted average diluted common shares
|
|
13,824
|
|
14,100
|
|
19,912
|
|
17,436
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter
Ended
|
|
|
|
|
January 31,
2003
|
|
April 30,
2003
|
|
July 31,
2003
|
|
October 31,
2003
|
|
|
|
|
(unaudited)
(In thousands, except per share data)
|
|
|
Fiscal Year 2003
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
13,540
|
|
$
|
21,369
|
|
$
|
20,055
|
|
$
|
24,290
|
|
|
Gross margin
|
|
10,662
|
|
16,222
|
|
15,521
|
|
16,927
|
|
|
Income (loss) from operations
|
|
(738
|
)
|
4,925
|
|
3,410
|
|
(4,161
|
)
|
|
Net income available (loss applicable) to
common stockholders
|
|
(724
|
)
|
4,500
|
|
3,096
|
|
(1,568
|
)
|
|
Net income (loss) per common share:
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.06
|
)
|
$
|
0.39
|
|
$
|
0.25
|
|
$
|
(0.12
|
)
|
|
Diluted
|
|
$
|
(0.06
|
)
|
$
|
0.33
|
|
$
|
0.19
|
|
$
|
(0.12
|
)
|
|
Weighted average basic common shares
|
|
11,244
|
|
11,561
|
|
12,469
|
|
13,371
|
|
|
Weighted average diluted common shares
|
|
11,244
|
|
13,663
|
|
16,180
|
|
13,371
|
|
34
Fluctuations in
Quarterly Results
Factors that may affect quarterly results
include:
• the interest level of solution providers in
recommending UNIX business solutions to end users;
• the contingency fees we may pay to the Law
Firms representing us in the SCO Litigation;
• the level, magnitude and timing of SCOsource
license revenue;
• the amount of legal fees incurred in
connection with the SCO Litigation;
• the introduction, development, timing,
competitive pricing and market acceptance of our products and services and
those of our competitors;
• changes in general economic conditions that
could affect capital expenditures in the UNIX market; and
• changing business attitudes toward UNIX as a
viable operating system alternative to other competing systems, especially
Linux.
As a result of the factors listed above and
elsewhere in the “Forward-Looking Statements and Factors That May Affect
Future Results and Financial Condition” and “Risk Factors” section of this
Form 10-K, it is possible that in some future periods our results of operations
may fall below management’s expectations as well as the expectations of public
market analysts and investors. If
revenue falls below management’s expectations in any quarter and we are unable
to reduce expenses, our operating results will be lower than expected.
Liquidity and Capital
Resources
Our
cash and equivalents balance decreased from $64,428,000 as of October 31,
2003 to $12,693,000 as of October 31, 2004. During this same time period, our investment
in available-for-sale securities increased from $4,095,000 to $18,756,000. Total cash and equivalents and available-for
sale securities were $31,449,000 as of October 31, 2004. We also have $5,000,000 classified as a
component of restricted cash set aside to cover expert and other costs related
to our SCO Litigation. During fiscal
year 2004, we expended a significant amount of cash for our intellectual
property litigation and for our UNIX business.
During
fiscal year 2003, we generated positive cash flow for the first time in our
operating history. This was primarily
achieved through significant license revenue generated from our SCOsource
business. We also received cash in
fiscal year 2003 from the sale of 50,000 shares of our now retired Series A
Convertible Preferred Stock.
We
intend to use the cash and equivalents and available-for-sale securities as of October 31,
2004 to maintain our UNIX business and pursue our SCO Litigation. We believe that we will have sufficient cash
resources to fund our current operations for the next 12 months.
Our
net cash used in operations during fiscal year 2004 was $22,604,000 and was
attributable to a net loss of $23,350,000, non-cash items of $922,000 and
changes in operating assets and liabilities of $176,000. Our working capital decreased from $37,168,000
as of October 31, 2003 to $15,413,000 as of October 31, 2004.
Our
net cash provided by operations during fiscal year 2003 was $12,087,000. Cash provided by operations was attributable
to net income of $5,427,000, non-cash items totaled $11,610,000 and changes in
operating assets and liabilities of $4,950,000.
Our long-term liabilities decreased from $1,625,000 to $508,000 during
fiscal year 2003.
35
Cash used in operations during fiscal year 2002
was $10,592,000 and was primarily attributable to the net loss of $24,877,000,
partially offset by non-cash items of $10,101,000 and cash provided by changes
in operating assets and liabilities of $4,184,000.
Our investing activities have historically consisted
of equipment purchases, investing in strategic partners and the purchase and
sale of available-for-sale securities.
During fiscal year 2004, cash used in investing activities was
$15,443,000, which was primarily a result of purchases, net of sales, of
available-for-sale securities of $14,728,000, purchases of equipment of
$506,000 and the purchase of the remaining minority interest in our Japanese
subsidiary of $209,000.
During fiscal year 2003, cash used in investing
activities was $5,512,000, which was primarily a result of our purchase of
available-for-sale securities of $4,095,000, equipment purchases of $467,000
and our investment in non-marketable securities of $950,000.
During fiscal year 2002, cash provided by
investing activities was $5,287,000, which was primarily generated from the
sale of $5,943,000 of available-for-sale securities, offset by an investment in
a non-marketable security of $350,000, cash paid for the purchase of equipment
of $206,000 and payment of $100,000 to The Santa Cruz Operation.
Our financing activities used $13,864,000 of
cash in fiscal year 2004. The primary
uses of cash were $13,000,000 used for the repurchase and retirement of shares
of our Series A-1 Convertible Preferred Stock, $2,414,000 for the purchase
of shares of our common stock on the open market and $211,000 paid in
connection with the issuance of the Series A-1 in exchange for outstanding
Series A shares. These uses of cash
were offset by proceeds generated from the exercise of options to acquire common
stock of $951,000 and proceeds of $810,000 received from the sale of common
stock through the ESPP.
Our financing activities provided $50,888,000
of cash during the fiscal year 2003 and consisted primarily of net proceeds of
$47,740,000 generated from our issuance of 50,000 now retired Series A
shares. Additional financing activities
included proceeds received from the exercise of stock options of $2,056,000,
proceeds from the purchase of shares of common stock by our employees through
our ESPP of $236,000 and proceeds from the issuance of warrants of $856,000.
Our financing activities used $8,998,000 of
cash during fiscal year 2002 and consisted primarily of a $5,000,000 payment to
retire the note payable to The Santa Cruz Operation and $4,584,000 for the
purchase of shares of our common stock held by two investors. These payments were offset by $291,000 of
proceeds received from the exercise of stock options and $295,000 received from
employees who purchased shares of our common stock through our employee stock
purchase program.
Our net accounts
receivable balance decreased from $9,282,000 as of October 31, 2003 to
$6,638,000 as of October 31, 2004, primarily as a result of lower
invoicing and revenue in the fourth quarter of fiscal year 2004 as compared to
the fourth quarter of fiscal year 2003.
The majority of our accounts receivable are current and our allowance
for doubtful accounts was $136,000 as of October 31, 2004, which
represented approximately 2 percent of our gross accounts receivable
balance. This percentage of gross
accounts receivable is consistent with our experience in prior periods, and we
expect this trend to continue. Our
write-offs of uncollectible accounts during fiscal years 2004 and 2003 were not
significant.
On
October 31, 2004, we entered into the Engagement Agreement the Law
Firms. The Engagement Agreement
supercedes and replaces the original engagement agreement that was entered into
in February 2003. The Engagement
Agreement governs the relationship between us and the Law Firms in connection
with their representation of us in the SCO Litigation, through the end of the
current litigation between us and IBM.
This litigation is described in more detail under Part I, Item 3 of
this Form 10-K. Our purpose in
entering into this Engagement Agreement was to limit the cash expenditures
needed to pursue the SCO Litigation. The
Engagement Agreement provides for the payment of
36
approximately $26,000,000 for certain previously
accrued expenses, totaling $13,906,000 as of October 31, 2004, and all
future attorney fees in connection with the SCO Litigation through the end of
the current litigation between us and IBM and the escrow of at least $5,000,000
for the payment of any expert, consulting and other expenses. As of October 31, 2004, this $5,000,000
was classified as a component of restricted cash. We paid the $13,906,000 subsequent to October 31,
2004.
Future legal fees
covered under the Engagement Agreement will require us to pay to the Law Firms
$2,000,000 per quarter for each successive quarter beginning September 1,
2004 and ending December 1, 2005 for a total amount of $12,000,000, of
which $10,000,000 will be paid in fiscal year 2005. In the first quarter of fiscal year 2005, we
made the quarterly payments for September 2004 as well as December 2004
for a total of $4,000,000. The payment
of these fees has had and will continue to have a material impact on our cash
position.
In
addition to the cash expenditures mentioned above, we must also pay one or more
contingency fees upon any amount we or our stockholders may receive as a
recovery from our litigation, our intellectual property licensing or a sale of
our company. The contingency fee amounts
payable to the Law Firms will be, subject to certain credits and adjustments,
as follows:
• 33 percent of any aggregate recovery amounts
received up to $350,000,000;
• plus 25 percent of any aggregate recovery
amounts above $350,000,000 but less than or equal to $700,000,000;
• plus 20 percent of any aggregate recovery
amounts in excess of $700,000,000.
The
Engagement Agreement specifically provides that, except for the compensation
obligations specifically described above, we will not be obligated to pay any
legal fees, whether hourly, contingent or otherwise, to the Law Firms, or any
other law firms that may be engaged by the Law Firms, in connection with the
SCO Litigation through the end of the current litigation between us and IBM,
including any appeals.
We
have entered into operating leases for our corporate offices located in the
United States and our international sales offices. We have commitments under these leases that
extend through fiscal year 2010.
The
following table summarizes our contractual operating lease obligations and our
required payments to the Law Firms as of October 31, 2004:
|
|
|
Total
|
|
Less than
1 year
|
|
1 – 3 years
|
|
More than
3 years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating lease obligations
|
|
$
|
4,770,000
|
|
$
|
1,714,000
|
|
$
|
2,938,000
|
|
$
|
118,000
|
|
|
Payments to Law Firms
|
|
24,573,000
|
|
22,573,000
|
|
2,000,000
|
|
—
|
|
|
Total obligations
|
|
$
|
29,343,000
|
|
$
|
24,287,000
|
|
$
|
4,938,000
|
|
$
|
118,000
|
|
As of October 31,
2004, we did not have any long-term debt obligations, purchase obligations,
other long-term liabilities or material capital lease obligations.
Our ability to cut costs
to offset revenue declines in our UNIX business is limited because of
contractual commitments to maintain and support our existing UNIX
customers. This decline in our UNIX business may be accelerated
if industry partners withdraw their support as a result of our SCOsource
initiatives. Our SCOsource initiatives
may cause industry partners, developers and hardware and software vendors to
choose not to support or certify to our UNIX operating system products. This
37
would lead to an accelerated decline in our UNIX
products and services revenue. If
our UNIX products and services revenue is less than expected, our liquidity
will be adversely impacted.
As discussed elsewhere above in Part II, Item
7 of this Form 10-K and in the
section entitled “Recent Sales of Unregistered Securities” above in Part II,
Item 5 of this Form 10-K, we issued shares and granted options under our
Equity Compensation Plans without complying with registration or qualification
requirements under federal securities laws and the securities laws of certain
states. As a result, certain plan
participants have a right to rescind their purchases of shares under the Equity
Compensation Plans or recover damages if they no longer own the shares or hold
unexercised options, subject to applicable statutes of limitations, and we may
make a rescission offer to certain of such plan participants subject to
obtaining required regulatory approvals.
Additionally, regulatory authorities may require us to pay fines or they
may impose other sanctions on us, and we may face other claims by participants
other than rescission claims.
If our potential
rescission offer is made and accepted by plan participants holding shares
acquired under the Equity Compensation Plans or otherwise entitled to recover
damages from us in respect of such shares they have sold, or such plan participants
otherwise make rescission claims against us, we could be required to make
aggregate payments to these plan participants of up to $528,000 in the
aggregate, excluding interest and other possible fees, based upon shares
outstanding under the Equity Compensation Plans as of October 31, 2004.
We may also face
additional rescission liability to plan participants holding unexercised stock
options in California, Georgia and possibly other states. Regulatory authorities may require us to pay
fines or impose other sanctions on us.
Although we believe that it is reasonably possible that some plan
participants holding unexercised options may accept a rescission offer or
potentially attempt to enforce a rescission right, we are unable to estimate
the number of participants who might pursue rescission or the potential
rescission liability we may have to them.
Since any loss is considered reasonably possible but not estimable, we
have not recorded a liability for this contingency.
We may also be required
to pay interest and penalties up to statutory limits in connection with Plan
participants making rescission claims or in connection with any rescission
offer. We believe that it is reasonably
possible that we may be required to pay interest and penalties, but are not
able to estimate an amount.
In the event that cash
required to fund operations and strategic initiatives exceeds our current cash
resources and cash generated from operations, we will be required to reduce
costs and perhaps raise additional capital.
We may not be able to reduce costs in a manner that does not impair our
ability to maintain our UNIX business and pursue our SCOsource
initiatives. We may also not be able to
raise capital for any number of reasons including those listed under the section “Risk
Factors” below. If additional equity
financing is available, it may not be available to us on attractive terms and
may be dilutive to our existing stockholders.
In addition, if our stock price declines, we may not be able to access
the public equity markets on acceptable terms, if at all. Our ability to effect acquisitions for stock
would also be impaired.
Recent Accounting
Pronouncements
In December 2004,
the FASB issued SFAS No. 123R “Share-Based Payment” (“SFAS 123R”), a
revision to SFAS No. 123 “Accounting for Stock-Based Compensation” (“SFAS
123”), and superseding APB Opinion No. 25 “Accounting for Stock Issued to
Employees” and its related implementation guidance. SFAS 123R establishes standards for the
accounting for transactions in which an entity exchanges its equity instruments
for goods or services, including obtaining employee services in share-based
payment transactions. SFAS 123R applies
to all awards granted after the required effective date and to awards modified,
repurchased, or cancelled after that date.
Adoption of the provisions of SFAS 123R is effective as of the beginning
of the first interim or annual reporting period that begins after
38
June 15,
2005. We have not yet evaluated the
potential impact that the adoption of SFAS 123R will have on our consolidated
financial position and results of operations.
Forward-Looking
Statements and Factors That May Affect Future Results and Financial
Condition
With
the exception of historical facts, the statements contained in Management’s
Discussion and Analysis of Financial Condition and Results of Operations are “forward-looking
statements” within the meaning of the Private Securities Litigation Reform Act
of 1995, which reflect our current expectations and beliefs regarding our
future results of operations, performance and achievements. The section entitled “Business” above in
Part I, Item 1 of this Form 10-K also includes forward-looking
statements. These statements are subject
to risks and uncertainties and are based upon assumptions and beliefs that may
or may not materialize. These
forward-looking statements include, but are not limited to, statements
concerning:
• Our operating strategy to continue to
support our existing users of our UNIX operating system products and to pursue
SCOsource licensing opportunities and protect our intellectual property rights;
• Our intention to continue to maintain our
core UNIX business in fiscal year 2005 by continuing our research and
development efforts;
• Our belief that our OpenServer and
UnixWare products will continue to provide a revenue stream in fiscal year 2005
and our belief that revenue from such products will continue to decline;
• Our expectation that our sales channel
should continue to provide reliable UNIX operating systems for small-to-medium
sized business customers;
• Our intention to focus our development
resources on our next OpenServer product and maintaining our current UnixWare
products;
• Our intention to focus development
resources on augmenting our current UNIX products with other products that will
solve business problems for our existing installed base of customers;
• Our expectation that hardware and
software vendors, as well as software developments, will continue to turn their
certification and application development efforts toward Linux and elect not to
continue to support or certify to our UNIX operating system products;
• Our intention to release OpenServer in
the first half of calendar year 2005 and our expectation that our investment in
this effort will give customers confidence in our technology;
• Our expectation that developing a 64-bit
version of our operating system technology will give customers confidence in
their commitment to our technologies;
• Our intention to continue to pursue our
SCOsource initiatives in fiscal year 2005;
• Our belief that the future success of our
SCOsource initiatives will depend on our ability to protect our intellectual
property;
• Our intention to vigorously defend legal
claims and counterclaims brought against us by others;
• Our intention to continue to pursue our
litigation against IBM, Novell, AutoZone, and DaimlerChrysler;
39
• Our belief that our cash balance will be
adequate for us to execute our business strategy as well as to continue to
pursue our intellectual property claims and that we have sufficient cash
reserves to fund our current operations for the next 12 months;
• Our expectation that maintaining our
strategic alliances with solution providers in fiscal year 2005 will be
critical to the success of our UNIX business and the success of our next
OpenServer product;
• Our intention to keep our relationships
with key partners in certain vertical markets;
• Our expectation of entering into future
vendor license agreements with developers, manufacturers, distributors and end
users of operating systems;
• Our expectation that product enhancements
to improve our UNIX technology will extend the life and improve the
functionality of our UNIX products and our belief that such improvements will
not result in significant revenue increases;
• Our belief that such product enhancements
to our UNIX technology will help prolong our OpenServer revenue stream for
future quarters;
• Our intention to continue to review the
status of our existing UNIX license agreements with UNIX vendors in fiscal year
2005;
• Our intention to continue to pursue our
IP licensing initiative against those that may be violating our UNIX
copyrights;
• Our expectation that our UNIX business
will generate positive cash flow during fiscal year 2005;
• Our belief that our allowance and bad
debts for accounts receivable will remain consistent with our prior experience;
• The strength of our intellectual property
rights and contractual claims regarding UNIX generally and specifically the
strength of our claim that unauthorized UNIX source code and derivatives of
UNIX source code are contained in Linux;
• Our expectation that total UNIX revenue
for fiscal year 2005 will decline from UNIX revenue generated in fiscal year
2004;
• Our belief that competition from Linux
will continue in fiscal year 2005 and future periods;
• Our expectation that we will continue to
be unable to predict the amount and timing of SCOsource licensing revenue, and
when generated, the revenue will be sporadic;
• Our expectation that future services
revenue will depend in part on our ability to generate UNIX products revenue
from new customers as well as the renewal of annual support and services
agreements from existing UNIX customers;
• Our expectation for fiscal year 2005 that
the dollar amount of our cost of products revenue will be lower than fiscal
year 2004;
• Our expectation for fiscal year 2005 that
the dollar amount of our cost of SCOsource licensing revenue will be lower than
fiscal year 2004;
• Our expectation for fiscal year 2005 that
the dollar amount of our cost of services revenue will be lower than fiscal
year 2004;
• Our expectation for fiscal year 2005 that
the dollar amount of our sales and marketing expenses will be lower than fiscal
year 2004;
40
• Our expectation for fiscal year 2005 that
the dollar amount of our research and development expenses will be lower than
fiscal year 2004;
• Our expectation for fiscal year 2005 that
the dollar amount of our general and administrative expenses will be lower than
fiscal year 2004;
• Our belief that our legal costs related
to our intellectual property litigation will decrease in fiscal year 2005
compared to fiscal year 2004, exclusive of any contingent payments;
• Our belief that our facilities are
adequate for our business; and
• Our belief that certain legal actions to
which we are a party will not have a material adverse effect on us.
We
wish to caution readers that our operating results are subject to various risks
and uncertainties that could cause our actual results and outcomes to differ
materially from those discussed or anticipated, including the success of our
SCOsource initiatives, competition from other operating systems, particularly
Linux, the amount and timing of SCOsource licensing revenue, our ability to
enhance our UNIX operating systems and maintain our UNIX business, and the
factors set forth in the subsection entitled “Risk Factors” below. We also wish to advise readers not to place
any undue reliance on the forward-looking statements contained in this report,
which reflect our beliefs and expectations only as of the date of this
report. We assume no obligation to update
or revise these forward-looking statements to reflect new events or
circumstances or any changes in our beliefs or expectations, other than as
required by law.
Risk
Factors
We do not have a history of profitable operations.
Our fiscal year ended October 31,
2003 was the first full year we were profitable in our operating history. Our profitability in fiscal year 2003
resulted primarily from our SCOsource licensing initiatives. For fiscal year 2004, we incurred a net loss
from operations of $28,573,000 and our accumulated deficit as of October 31,
2004 was $224,216,000. If we do not
receive SCOsource licensing revenue in future quarters and our revenue from the
sale of our UNIX products and services continues to decline, we will need to
further reduce operating expenses to generate positive cash flow. We may not be able to further reduce
operating expenses without damaging our ability to support our existing UNIX
business. Additionally, we may not be
able to achieve profitability through additional cost-cutting actions.
Our UNIX products and
services revenue has declined over the last several years primarily as a result
of increased competition from alternative operating systems, particularly
Linux. In our quarterly results of
operations, we recognize revenue from agreements for support and maintenance
contracts and other long-term contracts that have been previously invoiced and
are included in deferred revenue. Our
future UNIX revenue may be adversely impacted and may continue to decline if we
are unable to replenish these deferred revenue balances with long-term
maintenance and support contracts or replace them with other sustainable
revenue streams. If we are unable to
generate positive cash flow and profitable operations, our operations will be
adversely impacted.
We may not prevail in our SCO Litigation, which may
adversely affect our business.
We continue to pursue
our SCO Litigation as described in more detail in Item 3 of Part I of this
Form 10-K and believe very strongly in the merits of our cases. In our action against IBM, we seek damages
for claims generally relating to our allegation that IBM has inappropriately
used and distributed our UNIX source code and derivative works in connection
with its efforts to promote the Linux operating system. IBM has responded to our claims and brought
counterclaims against us asserting generally that we do not have the right to
assert claims based on our ownership of UNIX intellectual property against IBM
or others in the Linux market. Discovery
is continuing in the case, and several motions are currently
41
pending
before the court. If we do not prevail
in our action against IBM, or if IBM is successful in its counterclaims against
us, our business and results of operations would be materially harmed and we
may not be able to continue in business.
The litigation with IBM and others will be costly, and our costs for
legal fees have been and will continue to be substantial and may exceed our
capital resources. Additionally, the market price of our common stock may be
negatively affected as a result of developments in our legal action against IBM
that may be, or may be perceived to be, adverse to us.
As a result of our SCO
Litigation and our other SCOsource initiatives, several participants in the
Linux industry and others affiliated with IBM or sympathetic to the Linux
movement have taken actions attempting to negatively affect our business and
our SCOsource efforts. Linux proponents
have taken a broad range of actions against us, including, for example,
attempting to influence participants in the markets in which we sell our
products to reduce or eliminate the amount of our products and services they
purchase from us. We expect that similar
efforts likely will continue. There is a
risk that participants in our marketplace will negatively view our action
against IBM, Novell, DaimlerChrysler, and AutoZone and our other SCOsource
initiatives, and we may lose support from such participants. Any of the foregoing could adversely affect
our position in the marketplace, our results of operations and our stock price
and our ability to stay in business. We
have also experienced several denial-of-service attacks on our website, which
have prevented web users from accessing our website and doing business with us
for a period of time. If such attacks
continue or if our customers and strategic partners are also subjected to
similar attacks, our business and results of operations could be materially
harmed. In addition, some of the more
significant participants in the Linux industry have made efforts to ease Linux
end users’ concerns that their use of Linux may subject them to potential
copyright infringement claims from us.
As a further response to
our SCOsource initiatives and claim that our UNIX source code and derivative
works have inappropriately been included in Linux, Novell has publicly asserted
its belief that it owns certain copyrights in our UNIX source code, and it has
filed 15 copyright applications with the United States Copyright Office related
to UNIX. Novell also claims that it has
a license to UNIX from us and the right to authorize its customers to use UNIX
technology in their internal business operations. Specifically, Novell has also claimed to have
retained rights related to legacy UNIX SVRx licenses, including the license
with IBM. Novell asserts it has the
right to take action on behalf of SCO in connection with such licenses,
including termination and waiver rights.
Novell has purported to veto our termination of the IBM, Sequent and SGI
licenses. We have repeatedly asserted that we obtained the UNIX business,
source code, claims and copyrights when we acquired the assets and operations
of the server and professional services groups from The Santa Cruz Operation
(now Tarantella, Inc.) in May 2001, which had previously acquired all
such assets and rights from Novell in September 1995 pursuant to an asset
purchase agreement, as amended. In January 2004,
in response to Novell’s actions, we brought suit against Novell for slander of
title seeking relief for Novell’s alleged bad faith effort to interfere with
our copyrights and contract rights related to our UNIX source code and
derivative works and our UnixWare products.
Our lawsuit against Novell is also described in more detail in Item 3 of
Part I of this Form 10-K.
Notwithstanding our
assertions of full ownership of UNIX-related intellectual property rights, as
set forth above, including copyrights, and even if we are successful in our
legal action against Novell and end users such as AutoZone and DaimlerChrysler,
the efforts of Novell and the other Linux proponents described above may cause
Linux end users to be less willing to purchase from us our SCOsource IP
licenses authorizing their use of our intellectual property contained in the
Linux operating system, which has and may continue to adversely affect our
revenue from our SCOsource initiatives.
These efforts of Linux proponents also may increase the negative view
some participants in our marketplace have regarding our SCO Litigation and
regarding our SCOsource initiatives and may contribute to creating confusion in
the marketplace about the validity of our claim that the unauthorized use of
our UNIX source code and derivative works in Linux infringes on our copyrights. Increased negative perception
42
and
potential confusion about our claims in our marketplace could impede our
continued pursuit of our SCOsource initiatives and negatively impact our
business.
Our
failure to timely file this Form 10-K, and our quarterly report on Form 10-Q
for the quarter ended January 31, 2005 (as previously defined, the “Form 10-Q”),
could result in the delisting of our common stock on The Nasdaq SmallCap
Market.
We received notice on February 16,
2005 from The Nasdaq Stock Market that, due to the delay in filing this Form 10-K,
we were not, as of such date, in compliance with the filing requirements for
continued listing set forth in Marketplace Rule 4310(c)(14), and that our
common stock is, therefore, subject to delisting at the opening of business on February 25,
2004. We requested and participated in a
hearing with the Nasdaq Listing Qualifications Panel on March 17,
2005. At the hearing, we outlined
for the Panel our plan for filing this Form 10-K and the Form 10-Q,
which also was not filed in a timely fashion.
On March 18, 2005, we received a notice from The Nasdaq Stock
Market regarding our potential delisting as a result of our failure to file the
Form 10-Q in a timely fashion. The
notice informed us that the Panel will consider the filing delinquency of our Form 10-Q
in addition to the filing delinquency of this Form 10-K in rendering its
decision regarding our listing status.
We will continue to be listed on The Nasdaq SmallCap Market under the
symbol SCOXE pending the issuance of the Panel’s decision. Although
we have filed this Form 10-K, we have not yet filed the Form 10-Q,
and there can be no assurance that Nasdaq will not act to delist our common stock
from The Nasdaq SmallCap Stock Market.
Our Engagement Agreement with
the Law Firms will require us to spend a significant amount of cash during
fiscal year 2005 and could harm our liquidity position.
As of October 31,
2004, we had a total of $31,449,000 in cash and cash equivalents and
available-for-sale securities and an additional $5,000,000 as restricted cash
to be used in our operations and pursue the SCO Litigation. As a result of the Engagement Agreement
between us and the Law Firms, as described elsewhere in this filing, we
anticipate using cash of approximately $27,000,000 in the defense of our
intellectual property litigation during fiscal year 2005, which would leave us
approximately $9,449,000 in cash for our business operations. We expect that our UNIX business will
generate sufficient cash in fiscal year 2005 to cover our internal costs
related to our SCOsource initiatives and intellectual property litigation. However, if our UNIX business does not
generate cash or we spend additional cash on the SCO Litigation or additional
matters, our cash position would be negatively impacted, and our ability to
pursue our UNIX business objectives and our SCO Litigation would be harmed.
Our future SCOsource licensing revenue is uncertain.
We initiated the
SCOsource licensing effort in fiscal year 2003 to review the status of UNIX
licensing and sublicensing agreements.
This effort resulted in the execution of two significant vendor license
agreements during fiscal year 2003 and generated $25,846,000 in revenue. During fiscal year 2004, our SCOsource
licensing revenue declined significantly and was only $829,000. Due to a lack of historical experience and
the uncertainties related to SCOsource licensing revenue, we are unable to
estimate the amount and timing of future SCOsource licensing revenue, if
any. If we do receive revenue from this
source, it may be sporadic and fluctuate from quarter to quarter. Our SCOsource initiatives are unlikely to produce
stable, predictable revenue for the foreseeable future. Additionally, the success of these
initiatives may depend on the strength of our intellectual property rights and
contractual claims regarding UNIX, including the strength of our claim that
unauthorized UNIX source code and derivatives are prevalent in Linux.
We may lose the support of industry partners leading
to an accelerated decline in our UNIX products and services revenue.
The decline in our UNIX business and our SCOsource
initiatives may cause industry partners, developers and hardware and software
vendors to choose not to support or certify to our UNIX operating
43
system products. This would lead to an accelerated decline in
our UNIX products and services revenue and would adversely impact our results
of operations and liquidity.
Our claims relating to our UNIX intellectual property
may subject us to additional legal proceedings.
In August 2003, Red Hat brought a lawsuit
against us asserting that the Linux operating system does not infringe on our
UNIX intellectual property rights and seeking a declaratory judgment for
non-infringement of copyrights and no misappropriation of trade secrets. In addition, Red Hat claims we have engaged
in false advertising in violation of the Lanham Act, deceptive trade practices,
unfair competition, tortious interference with prospective business
opportunities, and trade libel and disparagement. Although this case is currently stayed
pending the resolution of our suit against IBM, we intend to vigorously defend
this action. However, if Red Hat is
successful in its claim against us, our business and results of operations
could be materially harmed.
In addition, regulators or others in the Linux
market and some foreign regulators have initiated or in the future may initiate
legal actions against us, all of which may negatively impact our operations and
future operating performance.
Fluctuations in our operating results or the failure
of our operating results to meet the expectations of public market analysts and
investors may negatively impact our stock price.
Fluctuations in our operating results or our failure
to meet the expectations of analysts or investors, even in the short-term,
could cause our stock price to decline significantly. Because of the potential
for significant fluctuations in our SCOsource licensing revenue in any
particular period, you should not rely on comparisons of our results of
operations as an indication of future performance.
Factors that may affect our results include:
• our ability to successfully negotiate and
complete licensing and other agreements related to our intellectual property;
• the interest level of resellers in
recommending our UNIX business solutions to end users;
• the introduction, development, timing,
competitive pricing and market acceptance of our products and services and
those of our competitors;
• changes in general economic conditions, such
as recessions, that could affect capital expenditures in the software industry;
• results of, or developments in our SCO
Litigation;
• changes in business attitudes toward UNIX as
a viable operating system compared to other competing systems, especially
Linux;
• the contingency and other legal fees we may
pay to the Law Firms representing us in our efforts to establish our
intellectual property rights; and
• changes in attitudes of customers and
partners due to the decline in our UNIX business and our aggressive position
against the inclusion of our UNIX code and derivative works in Linux.
We also experience fluctuations in operating results
in interim periods in Europe and the Asia Pacific regions due to seasonal
slowdowns and economic conditions in these areas. Seasonal slowdowns in these regions typically
occur during the summer months.
44
As a result of the factors
listed above and elsewhere, it is possible that our results of operations may
be below the expectations of public market analysts and investors in any
particular period. This could cause our stock price to decline. If revenue falls
below our expectations and we are unable to quickly reduce our spending in
response, our operating results will be lower than expected. Our stock price may fall in response to these
events.
We operate in a highly competitive market and face
significant competition from a variety of current and potential sources; many
of our current and potential competitors have greater financial and technical
resources than we do; thus, we may fail to compete effectively.
In the operating system market, our competitors
include IBM, Red Hat, Novell, Hewlett-Packard, Sun, Microsoft and other Linux
distributors. These and other
competitors are aggressively pursuing the current UNIX operating system
market. Many of these competitors have
access to substantially greater resources than we do. The major competitive alternative to our UNIX
products is Linux. The expansion of our
competitors’ offerings may restrict the overall market available for our UNIX
products, including some markets where we have been successful in the past.
Our future success may depend in part on our ability
to continue to meet the increasing needs of our customers by supporting
existing and emerging technologies. If
we do not enhance our products to meet these evolving needs, we may not remain
competitive and be able to grow our business.
Additionally, because technological advancement in the UNIX operating
system market and alternative operating system markets is progressing at an
advanced pace, we will have to develop and introduce enhancements to our
existing products and any new products on a timely basis to keep pace with
these developments, evolving industry standards and changing customer
requirements. Our failure to meet any of
these and other competitive pressures may render our existing products and
services obsolete, which would have an adverse impact on our revenue and
operations.
The success of our UNIX business will depend on the
level of commitment and certification we receive from industry partners and
developers. In recent years, we have
seen hardware and software vendors as well as software developers turn their
certification and application development efforts toward Linux and elect not to
continue to support or certify to our UNIX operating system products. If this trend continues, our competitive
position will be adversely impacted and our future revenue from our UNIX
business will decline. The decline in
our UNIX business may be accelerated if industry partners withdraw their
support from us for any reason, including our SCOsource
initiatives.
If the market for UNIX continues to contract, our
business will be harmed.
Our revenue from the sale of UNIX products has
declined over the last several years.
This decrease in revenue has been attributable primarily to increased competition
from other operating systems, particularly Linux. Our sales of UNIX products and services are
primarily to existing customers. If the
demand for UNIX products continues to decline, and we are unable to develop
UNIX products and services that successfully address a market demand, our UNIX
revenue will continue to decline, industry participants may not certify to our
operating system and products, we may not be able to attract new customers or
retain existing customers and our business and results of operations will be
adversely affected. Because of the long
adoption cycle for operating system purchases and the long sales cycle of our
operating system products, we may not be able to reverse these revenue declines
quickly.
We rely on our indirect sales channel for
distribution of our products, and any disruption of our channel at any level
could adversely affect the sales of our products.
We have a two-tiered distribution channel. The
relationships we have developed with resellers allow us to offer our products
and services to a much larger customer base than we would otherwise be able to
reach through our own direct sales and marketing efforts. Some solution providers also purchase
solutions through our resellers, and we anticipate they will continue to do
so. Because we usually sell
45
indirectly through resellers, we cannot
control the relationships through which resellers, solution providers or
equipment integrators purchase our products.
In turn, we do not control the presentation of our products to end
users. Therefore, our sales could be
affected by disruptions in the relationships between us and our resellers,
between our resellers and solution providers, or between solution providers and
end users. Also, resellers and solution
providers may choose not to emphasize our products to their customers. Any of these occurrences could diminish the
effectiveness of our distribution channel and lead to decreased sales.
Our Engagement Agreement with the Law Firms
representing us to enforce our intellectual property rights may reduce our
ability to raise additional financing.
Our Engagement Agreement with the Law Firms could
inhibit our ability to raise additional funding if needed. Although under the Engagement Agreement our
obligations to the Law Firms are limited to approximately $26,000,000 related
to certain previously accrued and all future attorney fees and the escrow of
$5,000,000 for the payment of any expert, consulting and other expenses to
pursue the SCO Litigation, the agreement provides
that the Law Firms will receive a contingency fee that may range from
20 to 33 percent of the proceeds from specified events related to the
protection of our intellectual property rights.
Events triggering a contingency fee may include settlements or judgments
related to the SCO Litigation, certain licensing
fees, subject to certain exceptions, and a sale of our company. Future payments payable to the Law Firms
under this arrangement will be significant.
The Law Firms’ right to receive such contingent payments could cause
prospective investors to choose not to invest in our company or limit the price
at which new investors would be willing to provide additional funds to our
company.
Our foreign-based operations and sales create special
problems, including the imposition of governmental controls and taxes and
fluctuations in currency exchange rates that could hurt our results.
We have foreign operations, including development
facilities, sales personnel and customer support operations in Europe, Latin
America and Asia. These foreign
operations are subject to certain inherent risks, including:
• potential loss of developed technology
through piracy, misappropriation, or more lenient laws regarding intellectual
property protection;
• imposition of governmental controls,
including trade restrictions and other tax requirements;
• fluctuations in currency exchange rates and
economic instability;
• longer payment cycles for sales in foreign
countries; and
• seasonal reductions in business activity.
In addition, certain of our operating expenses are
denominated in local currencies, creating risk of foreign currency translation
losses that could harm our financial results and cash flows. When we generate
profits in foreign countries, our effective income tax rate is increased.
In Latin America and Asia in particular, several
countries have suffered and may be especially susceptible to recessions and
economic instability, which may lead to increased governmental ownership or
regulation of the economy, higher interest rates, increased barriers to entry
such as higher tariffs and taxes, and reduced demand for goods manufactured in
the United States, resulting in lower revenue.
During the second quarter of fiscal year 2004, our
Indian office was given a withholding tax assessment from the Government of
India Income Tax Department. The Tax
Department assessed a 15 percent withholding tax on certain revenue transactions
in India that the Tax Department deemed royalty revenue under the Income Tax
Act. We have filed an appeal with the
Tax Department and believe that our
46
packaged software does not qualify for
treatment as royalties and therefore would not be subject to withholding
tax. However, we may be unsuccessful in
our appeal against the Tax Department and be obligated to pay the assessed
taxable amounts. If other countries in
which we have international operations, such as India, continue to develop and
begin enforcing their tax regimes, we may be subject to withholding or other
taxes.
If we are unable to retain key personnel in an
intensely competitive environment, our operations could be adversely affected.
We need to retain our management, technical, and
support personnel. Competition for
qualified professionals in the software industry is intense, and departures of
existing personnel could be disruptive to our business and might result in the
departure of other employees. The loss
or departure of any officers or key employees could harm our ability to
implement our business plan and could adversely affect our operations. Our future success depends to a significant
extent on the continued service and coordination of our management team,
particularly Darl C. McBride, our President and Chief
Executive Officer.
We
have issued shares and options under our Equity Compensation Plans that were
not exempt from registration or qualification under federal and state
securities laws, and, as a result, we may incur liability to repurchase such
shares and options and may face additional potential claims under federal and
state securities laws.
We have issued certain shares and granted
options under the Equity Compensation Plans without complying with registration
or qualification requirements under federal securities laws and the securities
laws of certain states. As a result,
certain plan participants that have acquired shares issued under the Equity
Compensation Plans have rescission rights against us, subject to applicable
statutes of limitations, and we may, subject to obtaining required regulatory
approvals, make a rescission offer to certain of such plan participants. Additionally, regulatory authorities may
require us to pay fines or they may impose other sanctions on us, and we may
face other claims by plan participants other than rescission claims.
If our potential rescission offer is made and
accepted by plan participants holding shares acquired under the Equity
Compensation Plans or otherwise entitled to recover damages from us in respect
of such shares they have sold, or such plan participants otherwise make
rescission claims against us, we could be liable to make aggregate payments to
these plan participants of up to $528,000 in the aggregate, excluding interest
and other possible fees, based upon shares outstanding under the Plans as of
October 31, 2004.
We may face additional rescission liability
to plan participants holding unexercised stock options in California, Georgia
and possibly other states. Additionally,
federal securities laws do not provide that a rescission offer will terminate a
plan participant’s right to rescind a sale of stock that was not registered as
required, and our possible rescission offer may not terminate a plan participant’s
right to rescind a sale of stock that was not registered as required under federal
law. If we do not make the planned
rescission offer to all plan participants, or any or all of the offerees reject the rescission offer, we may continue to be
subject to rescission risk under federal and state securities laws.
Our stock price is volatile.
The trading price for
our common stock has been volatile, ranging from a low closing sales price of
$1.09 in mid-February 2003, to a high closing sales price of $20.50 per
share in October 2003, to a current sales price of $3.52 on March 29, 2005. The share price has changed dramatically over
short periods. We believe that the
changes in our stock price are affected by changing public perceptions
concerning the strength of our intellectual property claims and other factors
beyond our control. Public perception
can change quickly and without any change or development in our underlying
business or litigation position. An
investment in our stock is subject to such volatility and, consequently, is
subject to significant risk.
47
There are risks associated with the potential
exercise of our outstanding options.
As of March 15, 2005, we have issued and outstanding
options to purchase up to approximately 3,481,000 shares of common stock with
an average exercise price of $4.18 per share.
The existence of such rights to acquire common stock at fixed prices may
prove a hindrance to our efforts to raise future equity and debt funding, and
the exercise of such rights will dilute the percentage ownership interest of
our stockholders and may dilute the value of their ownership. The possible future sale of shares issuable on the exercise of outstanding options could
adversely affect the prevailing market price for our common stock. Further, the holders of the outstanding
rights may exercise them at a time when we would otherwise be able to obtain
additional equity capital on terms more favorable to us.
The resale of common shares by BayStar
may have an adverse impact on the market value of our stock and the existing
holders of our common stock.
We previously had an effective registration
statement on Form S-3 relating to the sale or distribution by BayStar as a selling stockholder of the 2,105,263 shares of
common stock issued to BayStar in connection with our
repurchase completed in July 2004 of all Series A-1 shares previously held by BayStar. When we
failed to file this Form 10-K in a timely fashion, we became ineligible to use
Form S-3, our registration statement ceased to be effective and BayStar’s ability to resell shares pursuant to that
registration statement terminated. We
are currently in the process of preparing a new registration statement for the
resale of BayStar’s shares on Form S-1. Upon that registration statement being declared
effective by the SEC, BayStar will again be able to
resell its shares. We will not receive
any proceeds from the sales of the shares covered by such registration
statement. The shares that may be sold
or distributed pursuant to such registration statement, upon being declared
effective by the SEC, will represent approximately 8 percent of our issued and
outstanding common stock. The sale of
the block of stock to be covered by such registration statement, or even the
possibility of its sale, may adversely affect the trading market for our common
stock and reduce the price available in that market.
Our stock price could decline further because of the
activities of short sellers.
Our stock has attracted
the interest of short sellers. The
activities of short sellers could further reduce the price of our stock or
inhibit increases in our stock price.
The right of our board of directors to authorize
additional shares of preferred stock could adversely impact the rights of
holders of our common stock.
Our board of directors currently has the right, with
respect to the 5,000,000 shares of our preferred stock, to authorize the
issuance of one or more additional series of our preferred stock with such
voting, dividend and other rights as our directors determine. The board of directors can designate new
series of preferred stock without the approval of the holders of our common
stock. The rights of holders of our common stock may be adversely affected by
the rights of any holders of additional shares of preferred stock that may be
issued in the future, including without limitation, further dilution of the
equity ownership percentage of our holders of common stock and their voting
power if we issue preferred stock with voting rights. Additionally, the
issuance of preferred stock could make it more difficult for a third party to
acquire a majority of our outstanding voting stock.
Our Stockholder Rights Plan could make it more difficult for a hostile
bid for the Company or a change of control transaction to succeed at current
market prices for our stock.
We
have adopted a Stockholder Rights Plan (“Rights Plan”). The power given to the Board of Directors by
the Rights Plan may make it more difficult for a change of control of our
company to occur or for the Company to be acquired when the acquisition is
opposed by our Board of Directors.
48
Item 7A. Quantitative and
Qualitative Disclosures About Market Risk
Foreign
Currency Risk. We have
foreign offices and operations in Europe and Asia. As a result, a portion of our revenue is
derived from sales to customers outside the United States. Our international revenue is denominated in
U.S. dollars, Euros and United Kingdom Pounds.
Most of the operating expenses related to our foreign-based operations
are denominated in foreign currencies and therefore operating results are
affected by changes in the U.S. dollar exchange rate in relation to foreign
currencies such as the Euro, among others.
If the U.S. dollar further weakens compared to the Euro, our operating
expenses for foreign operations will be higher when translated back into U.S.
dollars. Our revenue can also be
affected by general economic conditions in the United States, Europe and other
international markets. Our results of
operations may be affected in the short term by fluctuations in foreign
currency exchange rates.
We have in the past
utilized foreign currency forward exchange contracts for market exposures of
underlying assets and liabilities. We do
not use forward exchange contracts for speculative or trading purposes. Our accounting policies for foreign exchange
contracts are based on our designation of each contract. The criteria we use for designating each
contract include such contract’s effectiveness in risk reduction and one-to-one
matching of forward exchange contracts to underlying assets and
liabilities. Gains and losses on
currency forward contracts that are firm commitments are deferred and
recognized in income in the same period that the underlying transactions are
settled. Gains and losses on currency
forward contracts that are designated and effective for existing transactions
are recognized in income in the same period as losses and gains on the
underlying transactions are recognized and generally offset. Gains and losses on any instruments not
meeting the above criteria are recognized in income in the current period. As of October 31, 2004, we had no outstanding
instruments classified as hedges.
Interest Rate Risk. The
primary objective of our cash management strategy is to invest available funds
in a manner that assures maximum safety and liquidity and maximizes yield
within such constraints. We believe that
a hypothetical movement in interest rates, either up or down, would not have a
material adverse impact on our cash and equivalent sand available-for-sale
securities. We do not borrow money for
short-term investment purposes.
Investment Risk. We
have invested in equity instruments of privately held and public companies in
the technology industry for business and strategic purposes. Investments are accounted for under the cost
method if our ownership is less than 20 percent and we are not able to exercise
influence over operations. Our
investment policy is to regularly review the assumptions and operating
performance of these companies and to record impairment losses when events and
circumstances indicate that these investments may be impaired. As of October 31, 2004, our investments
balance was approximately $561,000 and was related to our investment in a 30
percent owned Chinese company.
The stock market in general, and the market for
shares of technology companies in particular, has experienced price fluctuations. In addition, factors such as new product
introductions by our competitors or developments in the litigation related to
our SCOsource initiatives may have a significant
impact on the market price of our common stock.
Furthermore, quarter-to-quarter fluctuations in our results of
operations may have a significant impact on the market price of our common
stock. These conditions could cause the
price of our common stock to fluctuate substantially over short periods of
time.
49
Item 8. Financial Statements
and Supplementary Data
Index to Consolidated Financial
Statements and Financial Statement Schedule
50
Report of Independent Registered Public Accounting
Firm
The Board of
Directors and Stockholders of
The SCO Group, Inc.:
We
have audited the consolidated balance sheets of The SCO
Group, Inc. and subsidiaries as of October 31, 2004 and 2003, and the related
consolidated statements of operations and comprehensive income (loss),
stockholders’ equity and cash flows for each of the years in the three-year
period ended October 31, 2004. In
connection with our audits of the consolidated financial statements, we have
also audited the financial statement schedule.
These consolidated financial statements and financial statement schedule
are the responsibility of the Company’s management. Our responsibility is to express an opinion
on these consolidated financial statements and financial statement schedule
based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits
provide a reasonable basis for our opinion.
In
our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of The SCO Group, Inc. and subsidiaries as of October 31, 2004 and
2003, and the results of their operations and their cash flows for each of the
years in the three-year period ended October 31, 2004 in conformity with
accounting principles generally accepted in the United States of America. Also in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
|
/s/KPMG LLP
|
|
|
|
|
Salt Lake
City, Utah
|
|
February 18, 2005,
except as to Note 16,
which is as of March 11, 2005
|
51
THE SCO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in
thousands)
|
|
|
October 31,
|
|
|
|
|
2004
|
|
2003
|
|
|
|
|
|
|
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT ASSETS:
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
12,693
|
|
$
|
64,428
|
|
|
Restricted cash
|
|
8,283
|
|
2,025
|
|
|
Available-for-sale securities
|
|
18,756
|
|
4,095
|
|
|
Accounts receivable, net of allowance for
doubtful accounts of $136 and $230, respectively
|
|
6,638
|
|
9,282
|
|
|
Other current assets
|
|
1,870
|
|
2,450
|
|
|
Total current assets
|
|
48,240
|
|
82,280
|
|
|
|
|
|
|
|
|
|
PROPERTY AND EQUIPMENT:
|
|
|
|
|
|
|
Computer and office equipment
|
|
2,991
|
|
3,482
|
|
|
Leasehold improvements
|
|
406
|
|
608
|
|
|
Furniture and fixtures
|
|
103
|
|
189
|
|
|
|
|
3,500
|
|
4,279
|
|
|
Less accumulated depreciation and
amortization
|
|
(2,851
|
)
|
(3,131
|
)
|
|
Net property and equipment
|
|
649
|
|
1,148
|
|
|
|
|
|
|
|
|
|
OTHER ASSETS:
|
|
|
|
|
|
|
Goodwill, net
|
|
—
|
|
1,166
|
|
|
Intangibles, net
|
|
5,413
|
|
9,286
|
|
|
Other assets
|
|
1,098
|
|
1,072
|
|
|
Total other assets
|
|
6,511
|
|
11,524
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
55,400
|
|
$
|
94,952
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CURRENT LIABILITIES:
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
7,854
|
|
$
|
1,978
|
|
|
Payable to Novell, Inc.
|
|
3,283
|
|
2,025
|
|
|
Accrued compensation to law firms
|
|
7,956
|
|
10,556
|
|
|
Accrued payroll and benefits
|
|
3,369
|
|
4,752
|
|
|
Accrued liabilties
|
|
3,855
|
|
3,754
|
|
|
Derivative related to redeemable
convertible preferred stock
|
|
—
|
|
15,224
|
|
|
Deferred revenue
|
|
4,877
|
|
5,501
|
|
|
Other royalties payable
|
|
354
|
|
523
|
|
|
Taxes payable
|
|
1,279
|
|
799
|
|
|
Total current liabilities
|
|
32,827
|
|
45,112
|
|
|
|
|
|
|
|
|
|
LONG-TERM LIABILITIES
|
|
343
|
|
508
|
|
|
|
|
|
|
|
|
|
MINORITY INTEREST
|
|
—
|
|
145
|
|
|
|
|
|
|
|
|
|
COMMITMENTS AND CONTINGENCIES (Note 10)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SERIES A REDEEMABLE CONVERTIBLE PREFERRED
STOCK,
$0.001 par value; 5,000 shares authorized, 0 and 50 shares outstanding,
respectively (Note 6)
|
|
—
|
|
29,671
|
|
|
|
|
|
|
|
|
|
COMMON STOCK SUBJECT TO RESCISSION (Note 7)
|
|
528
|
|
—
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS’ EQUITY:
|
|
|
|
|
|
|
Common stock, $0.001 par value; 45,000
shares authorized, 17,956 and 13,824 shares outstanding, respectively
|
|
18
|
|
14
|
|
|
Additional paid-in capital
|
|
246,273
|
|
218,690
|
|
|
Common stock held in treasury
|
|
(2,414
|
)
|
—
|
|
|
Warrants outstanding
|
|
1,099
|
|
1,099
|
|
|
Deferred compensation
|
|
(22
|
)
|
(347
|
)
|
|
Accumulated other comprehensive income
|
|
964
|
|
926
|
|
|
Accumulated deficit
|
|
(224,216
|
)
|
(200,866
|
)
|
|
Total stockholders’ equity
|
|
21,702
|
|
19,516
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders’ equity
|
|
$
|
55,400
|
|
$
|
94,952
|
|
See accompanying notes to consolidated financial statements.
52
THE SCO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE
INCOME (LOSS)
(in
thousands, except per share data)
|
|
|
Year Ended October 31,
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
REVENUE:
|
|
|
|
|
|
|
|
|
Products
|
|
$
|
35,352
|
|
$
|
45,028
|
|
$
|
52,975
|
|
|
SCOsource
licensing
|
|
829
|
|
25,846
|
|
—
|
|
|
Services
|
|
6,628
|
|
8,380
|
|
11,266
|
|
|
Total revenue
|
|
42,809
|
|
79,254
|
|
64,241
|
|
|
|
|
|
|
|
|
|
|
|
COST OF REVENUE:
|
|
|
|
|
|
|
|
|
Products
|
|
3,221
|
|
4,068
|
|
7,558
|
|
|
SCOsource
licensing (inclusive of amortization of intangibles of $334, $337 and $0,
respectively)
|
|
19,743
|
|
9,500
|
|
—
|
|
|
Services
|
|
4,134
|
|
6,354
|
|
10,758
|
|
|
Total cost of revenue
|
|
27,098
|
|
19,922
|
|
18,316
|
|
|
|
|
|
|
|
|
|
|
|
GROSS MARGIN
|
|
15,711
|
|
59,332
|
|
45,925
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING EXPENSES:
|
|
|
|
|
|
|
|
|
Sales and marketing (exclusive of
stock-based compensation of $75, $129, and $89, respectively)
|
|
17,038
|
|
24,392
|
|
29,554
|
|
|
Research and development (exclusive of
stock-based compensation of $49, $112, and $45, respectively)
|
|
10,612
|
|
11,012
|
|
17,558
|
|
|
General and administrative (exclusive of
stock-based compensation of $795, $963, and $991, respectively)
|
|
7,626
|
|
6,230
|
|
9,307
|
|
|
Severance and exit costs
|
|
3,168
|
|
498
|
|
6,728
|
|
|
Amortization of intangibles
|
|
2,566
|
|
3,190
|
|
2,853
|
|
|
Loss on disposition and impairment of
long-lived assets
|
|
2,355
|
|
164
|
|
1,796
|
|
|
Write-off of investments
|
|
—
|
|
250
|
|
1,180
|
|
|
Stock-based compensation
|
|
919
|
|
1,204
|
|
1,125
|
|
|
Compensation to law firms
|
|
—
|
|
8,956
|
|
—
|
|
|
Total operating expenses
|
|
44,284
|
|
55,896
|
|
70,101
|
|
|
|
|
|
|
|
|
|
|
|
INCOME (LOSS) FROM OPERATIONS
|
|
(28,573
|
)
|
3,436
|
|
(24,176
|
)
|
|
|
|
|
|
|
|
|
|
|
EQUITY IN INCOME (LOSSES) OF AFFILIATES
|
|
111
|
|
(62
|
)
|
(50
|
)
|
|
|
|
|
|
|
|
|
|
|
OTHER INCOME (EXPENSE):
|
|
|
|
|
|
|
|
|
Interest income
|
|
905
|
|
188
|
|
377
|
|
|
Interest expense
|
|
—
|
|
(3
|
)
|
(206
|
)
|
|
Change in fair value of derivative (Note 6)
|
|
5,924
|
|
2,845
|
|
—
|
|
|
Other expense, net
|
|
(322
|
)
|
(203
|
)
|
(339
|
)
|
|
Total other income (expense), net
|
|
6,507
|
|
2,827
|
|
(168
|
)
|
|
|
|
|
|
|
|
|
|
|
INCOME (LOSS) BEFORE INCOME TAXES
|
|
(21,955
|
)
|
6,201
|
|
(24,394
|
)
|
|
|
|
|
|
|
|
|
|
|
PROVISION FOR INCOME TAXES
|
|
(1,395
|
)
|
(774
|
)
|
(483
|
)
|
|
|
|
|
|
|
|
|
|
|
NET INCOME (LOSS)
|
|
(23,350
|
)
|
5,427
|
|
(24,877
|
)
|
|
|
|
|
|
|
|
|
|
|
CONTRIBUTIONS FROM (DIVIDENDS ON)
REDEEMABLE CONVERTIBLE PREFERRED STOCK
|
|
7,123
|
|
(123
|
)
|
—
|
|
|
|
|
|
|
|
|
|
|
|
NET INCOME AVAILABLE (LOSS APPLICABLE) TO
COMMON STOCKHOLDERS
|
|
$
|
(16,227
|
)
|
$
|
5,304
|
|
$
|
(24,877
|
)
|
|
|
|
|
|
|
|
|
|
|
BASIC NET INCOME (LOSS) PER COMMON SHARE
|
|
$
|
(1.07
|
)
|
$
|
0.43
|
|
$
|
(1.93
|
)
|
|
DILUTED NET INCOME (LOSS) PER COMMON SHARE
|
|
$
|
(1.07
|
)
|
$
|
0.34
|
|
$
|
(1.93
|
)
|
|
|
|
|
|
|
|
|
|
|
WEIGHTED AVERAGE BASIC COMMON SHARES
OUTSTANDING
|
|
15,155
|
|
12,261
|
|
12,893
|
|
|
WEIGHTED AVERAGE DILUTED COMMON SHARES
OUTSTANDING
|
|
15,155
|
|
15,679
|
|
12,893
|
|
|
|
|
|
|
|
|
|
|
|
OTHER COMPREHENSIVE INCOME (LOSS)
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(23,350
|
)
|
$
|
5,427
|
|
$
|
(24,877
|
)
|
|
Unrealized gain (loss) on available-for-sale
securities
|
|
(67
|
)
|
23
|
|
—
|
|
|
Foreign currency translation adjustment
|
|
105
|
|
393
|
|
423
|
|
|
COMPREHENSIVE INCOME (LOSS)
|
|
$
|
(23,312
|
)
|
$
|
5,843
|
|
$
|
(24,454
|
)
|
See accompanying notes to consolidated financial statements.
53
THE SCO GROUP, INC. AND
SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in
thousands)
|
|
|
|
|
|
|
Additional
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
Common
Stock
|
|
Paid-in
|
|
Treasury
Stock
|
|
Warrants
|
|
Deferred
|
|
Comprehensive
|
|
Accumulated
|
|
|
|
|
|
|
Shares
|
|
Amount
|
|
Capital
|
|
Shares
|
|
Amount
|
|
Outstanding
|
|
Compensation
|
|
Income
(Loss)
|
|
Deficit
|
|
Total
|
|
|
Balance,
October 31, 2001
|
|
14,266
|
|
$
|
14
|
|
$
|
217,209
|
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
(1,290
|
)
|
$
|
87
|
|
$
|
(181,416
|
)
|
$
|
34,604
|
|
|
Issuance of
common shares for services
|
|
30
|
|
—
|
|
113
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
113
|
|
|
Compensation
expense for modifications made to certain option grants
|
|
—
|
|
—
|
|
73
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
73
|
|
|
Amortization of
deferred compensation
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
986
|
|
—
|
|
—
|
|
986
|
|
|
Removal of
deferred compensation related to termination of option holders
|
|
—
|
|
—
|
|
(155
|
)
|
—
|
|
—
|
|
—
|
|
155
|
|
—
|
|
—
|
|
—
|
|
|
Reversal of
compensation expense previously recorded related to termination of option
holders
|
|
—
|
|
—
|
|
(565
|
)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(565
|
)
|
|
Issuance of
common stock for services to officers and key employees
|
|
450
|
|
1
|
|
494
|
|
—
|
|
—
|
|
—
|
|
(495
|
)
|
—
|
|
—
|
|
—
|
|
|
Issuance of
common stock for prior services to former Chief Executive Officer
|
|
175
|
|
—
|
|
105
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
105
|
|
|
Issuance of common
stock for the cancellation of change in control agreements
|
|
105
|
|
—
|
|
119
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
119
|
|
|
Issuance of
common shares upon exercise of stock options
|
|
215
|
|
—
|
|
295
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
295
|
|
|
Issuance of
common shares under employee stock purchase program
|
|
175
|
|
—
|
|
291
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
291
|
|
|
Acquisition of
common shares from stockholders
|
|
(4,804
|
)
|
(5
|
)
|
(4,579
|
)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(4,584
|
)
|
|
Issuance of
common shares for a note receivable
|
|
800
|
|
1
|
|
899
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
900
|
|
|
Issuance of a
warrant
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
294
|
|
—
|
|
—
|
|
—
|
|
294
|
|
|
Cumulative
translation adjustment
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
423
|
|
—
|
|
423
|
|
|
Net loss
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(24,877
|
)
|
(24,877
|
)
|
|
Balance,
October 31, 2002
|
|
11,412
|
|
11
|
|
214,299
|
|
—
|
|
—
|
|
294
|
|
(644
|
)
|
510
|
|
(206,293
|
)
|
8,177
|
|
|
Issuance of
common shares to officers, key employees and directors for services, net of
cancellations
|
|
357
|
|
1
|
|
726
|
|
—
|
|
—
|
|
—
|
|
(569
|
)
|
—
|
|
—
|
|
158
|
|
|
Issuance of
common shares upon exercise of stock options
|
|
1,305
|
|
1
|
|
2,055
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
2,056
|
|
|
Issuance of
common shares under employee stock purchase program
|
|
345
|
|
—
|
|
236
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
236
|
|
|
Issuance of
common shares in connection with business combination
|
|
305
|
|
1
|
|
2,460
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
2,461
|
|
|
Compensation
expense for modifications made to certain option grants
|
|
—
|
|
—
|
|
42
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
42
|
|
|
Stock-based
compensation for services
|
|
—
|
|
—
|
|
296
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
296
|
|
|
Issuance of
warrants
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
1,099
|
|
—
|
|
—
|
|
—
|
|
1,099
|
|
|
Exercise of a
warrant
|
|
200
|
|
—
|
|
294
|
|
—
|
|
—
|
|
(294
|
)
|
—
|
|
—
|
|
—
|
|
—
|
|
|
Acquisition of
common shares from stockholder
|
|
(100
|
)
|
—
|
|
(1,718
|
)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(1,718
|
)
|
|
Amortization of
stock-based compensation
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
866
|
|
—
|
|
—
|
|
866
|
|
|
Cumulative
translation adjustment
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
393
|
|
—
|
|
393
|
|
|
Unrealized gain
on available-for-sale securities
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
23
|
|
—
|
|
23
|
|
|
Net income
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
5,427
|
|
5,427
|
|
|
Balance,
October 31, 2003
|
|
13,824
|
|
14
|
|
218,690
|
|
—
|
|
—
|
|
1,099
|
|
(347
|
)
|
926
|
|
(200,866
|
)
|
19,516
|
|
|
Amortization of
stock-based compensation
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
325
|
|
—
|
|
—
|
|
325
|
|
|
Compensation
expense for modifications made to certain option grants
|
|
—
|
|
—
|
|
92
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
92
|
|
|
Stock-based
compensation on options to non-employees
|
|
—
|
|
—
|
|
502
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
502
|
|
|
Unrealized gain
(loss) on available-for-sale securities
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(67
|
)
|
—
|
|
(67
|
)
|
|
Dividend recorded
on exchange of Series A-1 Preferred Stock for Series A Preferred
Stock
|
|
—
|
|
—
|
|
(6,305
|
)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(6,305
|
)
|
|
Capital
contribution recorded on repurchase of Series A-1 Convertible Preferred
Stock
|
|
—
|
|
—
|
|
15,475
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
15,475
|
|
|
Conversion of
Series A-1 Preferred Stock
|
|
2,846
|
|
3
|
|
18,757
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
18,760
|
|
|
Dividends on
Series A and Series A-1 Convertible Preferred Stock
|
|
—
|
|
—
|
|
(2,170
|
)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(2,170
|
)
|
|
Cumulative
translation adjustment
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
105
|
|
—
|
|
105
|
|
|
Acquisition of
common shares
|
|
—
|
|
—
|
|
—
|
|
(290
|
)
|
(2,414
|
)
|
—
|
|
—
|
|
—
|
|
—
|
|
(2,414
|
)
|
|
Cancellation of
restricted stock awards for terminated employees
|
|
(11
|
)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
|
Issuance of
common shares upon exercise of stock options
|
|
606
|
|
1
|
|
950
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
951
|
|
|
Issuance of
common shares under employee stock purchase program
|
|
691
|
|
—
|
|
810
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
810
|
|
|
Common stock
subject to rescission
|
|
—
|
|
—
|
|
(528
|
)
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(528
|
)
|
|
Net loss
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
—
|
|
(23,350
|
)
|
(23,350
|
)
|
|
Balance,
October 31, 2004
|
|
17,956
|
|
$
|
18
|
|
$
|
246,273
|
|
(290
|
)
|
$
|
(2,414
|
)
|
$
|
1,099
|
|
$
|
(22
|
)
|
$
|
964
|
|
$
|
(224,216
|
)
|
$
|
21,702
|
|
See accompanying notes to consolidated financial statements.
54
THE SCO GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in
thousands)
|
|
|
Year Ended October 31,
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
(23,350
|
)
|
$
|
5,427
|
|
$
|
(24,877
|
)
|
|
Adjustments to reconcile net income (loss)
to net cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
|
Issuance of common shares as compensation
to law firms
|
|
—
|
|
7,956
|
|
—
|
|
|
Amortization of intangibles
|
|
2,900
|
|
3,527
|
|
3,187
|
|
|
Stock-based compensation
|
|
919
|
|
1,204
|
|
1,125
|
|
|
Depreciation and amortization
|
|
783
|
|
1,049
|
|
2,555
|
|
|
Write-downs of investments
|
|
—
|
|
250
|
|
1,180
|
|
|
Issuance of a warrant (classified as cost
of SCOsource licensing revenue)
|
|
—
|
|
243
|
|
—
|
|
|
Loss on disposition and write-downs of
long-lived assets
|
|
2,355
|
|
164
|
|
1,796
|
|
|
Equity in (income) losses of affiliates
|
|
(111
|
)
|
62
|
|
50
|
|
|
Change in fair value of derivative
|
|
(5,924
|
)
|
(2,845
|
)
|
—
|
|
|
Amortization of debt discount
|
|
—
|
|
—
|
|
208
|
|
|
Changes in operating assets and
liabilities, net of effects of acquisitions:
|
|
|
|
|
|
|
|
|
Restricted cash
|
|
(5,000
|
)
|
—
|
|
—
|
|
|
Accounts receivable, net
|
|
2,644
|
|
(837
|
)
|
8,120
|
|
|
Other current assets
|
|
580
|
|
1,269
|
|
(145
|
)
|
|
Other assets
|
|
84
|
|
1,501
|
|
(1,387
|
)
|
|
Accounts payable
|
|
5,876
|
|
(217
|
)
|
(414
|
)
|
|
Payable to The Santa Cruz Operation
|
|
—
|
|
—
|
|
27
|
|
|
Accrued payroll and benefits
|
|
(1,383
|
)
|
1,115
|
|
(2,924
|
)
|
|
Compensation to law firms
|
|
(2,600
|
)
|
2,600
|
|
—
|
|
|
Accrued liabilities
|
|
101
|
|
(4,091
|
)
|
411
|
|
|
Deferred revenue
|
|
(624
|
)
|
(4,555
|
)
|
1,815
|
|
|
Other royalties payable
|
|
(169
|
)
|
(146
|
)
|
(503
|
)
|
|
Taxes payable
|
|
480
|
|
90
|
|
(240
|
)
|
|
Other long-term liabilities
|
|
(165
|
)
|
(1,679
|
)
|
(576
|
)
|
|
Net cash provided by (used in) operating
activities
|
|
(22,604
|
)
|
12,087
|
|
(10,592
|
)
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Purchase of property and equipment
|
|
(506
|
)
|
(467
|
)
|
(206
|
)
|
|
Acquisitions, net of acquisition costs and
cash received
|
|
—
|
|
—
|
|
(100
|
)
|
|
Purchase of available-for-sale securities
|
|
(59,224
|
)
|
(4,095
|
)
|
—
|
|
|
Proceeds from available-for-sale securities
|
|
44,496
|
|
—
|
|
5,943
|
|
|
Purchase of minority interest in Japanese
subsidiary
|
|
(209
|
)
|
—
|
|
—
|
|
|
Investment in non-marketable securities
|
|
—
|
|
(950
|
)
|
(350
|
)
|
|
Net cash provided by (used in) investing
activities
|
|
(15,443
|
)
|
(5,512
|
)
|
5,287
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Proceeds from sale of common stock through
employee stock purchase program
|
|
810
|
|
236
|
|
291
|
|
|
Proceeds from exercise of common stock
options
|
|
951
|
|
2,056
|
|
295
|
|
|
Repurchase of common stock
|
|
(2,414
|
)
|
—
|
|
(4,584
|
)
|
|
Net proceeds from the issuance of warrants
|
|
—
|
|
856
|
|
—
|
|
|
Repayments of long-term debt
|
|
—
|
|
—
|
|
(5,000
|
)
|
|
Costs incurred in connection with
Series A-1 Convertible Preferred Stock issuance
|
|
(211
|
)
|
—
|
|
—
|
|
|
Repurchase and retirement of Series A-1
Convertible Preferred Stock
|
|
(13,000
|
)
|
—
|
|
—
|
|
|
Net proceeds from issuance of Series A
Convertible Preferred Stock
|
|
—
|
|
47,740
|
|
—
|
|
|
Net cash provided by (used in) financing
activities
|
|
(13,864
|
)
|
50,888
|
|
(8,998
|
)
|
|
|
|
|
|
|
|
|
|
|
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS
|
|
(51,911
|
)
|
57,463
|
|
(14,303
|
)
|
|
EFFECT OF FOREIGN EXCHANGE RATES ON CASH
|
|
176
|
|
376
|
|
351
|
|
|
CASH AND CASH EQUIVALENTS, beginning of
year
|
|
64,428
|
|
6,589
|
|
20,541
|
|
|
CASH AND CASH EQUIVALENTS, end of year
|
|
$
|
12,693
|
|
$
|
64,428
|
|
$
|
6,589
|
|
See accompanying notes to consolidated financial statements.
55
|
|
|
Year Ended October 31,
|
|
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for taxes
|
|
$
|
957
|
|
$
|
413
|
|
$
|
877
|
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accretion of dividends
|
|
$
|
2,047
|
|
$
|
123
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
Capital contribution in connection with
repurchase and cancellation of Series A-1 shares
|
|
$
|
(15,475
|
)
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
Dividend in connection with exchange of
Series A-1 for Series A
|
|
$
|
6,305
|
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
Common stock subject to rescission
|
|
$
|
528
|
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
Deferred compensation for issuance of
common shares
|
|
$
|
—
|
|
$
|
569
|
|
$
|
495
|
|
|
|
|
|
|
|
|
|
|
|
Acquisition of Vultus, Inc.:
|
|
|
|
|
|
|
|
|
Intangible assets
|
|
$
|
—
|
|
$
|
1,555
|
|
$
|
—
|
|
|
Goodwill
|
|
$
|
—
|
|
$
|
1,166
|
|
$
|
—
|
|
|
Common stock issued
|
|
$
|
—
|
|
$
|
(2,461
|
)
|
$
|
—
|
|
|
Accrued liabilities assumed
|
|
$
|
—
|
|
$
|
(215
|
)
|
$
|
—
|
|
|
Acquisition costs
|
|
$
|
—
|
|
$
|
(45
|
)
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
Settlement of notes receivable from Vista
and NextEStage:
|
|
|
|
|
|
|
|
|
SCO shares
acquired
|
|
$
|
—
|
|
$
|
1,718
|
|
$
|
—
|
|
|
Investment write-off and other
|
|
$
|
—
|
|
$
|
500
|
|
$
|
—
|
|
|
Notes receivable, royalties and investment
|
|
$
|
—
|
|
$
|
(2,218
|
)
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
Settlement related to the acquisition of
the server and professional services groups of The Santa Cruz Operation
reflected as an adjustment to the purchase price
|
|
$
|
—
|
|
$
|
—
|
|
$
|
3,341
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common shares for a note
receivable
|
|
$
|
—
|
|
$
|
—
|
|
$
|
900
|
|
See accompanying notes to consolidated financial statements.
56
THE SCO GROUP, INC. AND
SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND DESCRIPTION OF BUSINESS AND LIQUIDITY
The Company was originally incorporated as Caldera Systems, Inc. (“Caldera
Systems”), a Utah corporation, on August 21, 1998, and reincorporated as a
Delaware corporation on March 6, 2000.
In March 2000, Caldera Systems completed an initial public offering of
its common stock. On March 6, 2000,
Caldera Systems reincorporated in Delaware.
On
May 7, 2001, Caldera International, Inc. (“Caldera”) was formed as a holding
company to own Caldera Systems and to acquire substantially all of the assets,
liabilities and operations of the server and professional services groups of
The Santa Cruz Operation, now known as Tarantella, Inc. The acquired operations from The Santa Cruz
Operation developed and marketed server software related to networked business
computing and were one of the leading providers of UNIX server operating
systems. In addition, these operations
provided professional services related to implementing and maintaining UNIX
system software products. The
acquisition provided Caldera with international offices and a distribution
channel with resellers throughout the world.
Subsequent to this acquisition, the Company has primarily sold UNIX
based products and services.
On
May 16, 2003, Caldera’s stockholders approved an amendment to Caldera’s
certificate of incorporation that changed Caldera’s name to The SCO Group, Inc. (the “Company”).
The
Company’s business focuses on marketing reliable, cost-effective UNIX software
products and related services for the small-to-medium sized business
market. In 2003 the Company established
its SCOsource division and launched its first of
several SCOsource initiatives to review and enforce
its intellectual property surrounding the UNIX operating system which it
acquired from The Santa Cruz Operation.
During the year ended
October 31, 2004, the Company used cash of $22,604,000 in its operations. A significant portion of this cash was used
to pursue the Company’s intellectual property litigation. As of October 31, 2004, the Company had a
total of $31,449,000 in cash and cash equivalents and available-for-sale
securities and an additional $5,000,000 as restricted cash to be used in its
operations and pursue its intellectual property litigation. As a result of the Engagement Agreement
between the Company and its Law Firms (see Note 10), the Company anticipates using
cash of approximately $27,000,000 in the defense of its intellectual property
litigation during the year ending October 31, 2005, which would leave the
Company approximately $9,449,000 in cash for its business operations. The Company expects that its UNIX business
will generate sufficient cash in the year ending October 31, 2005 to cover its
internal costs related to its SCOsource initiatives
and intellectual property litigation, and believes that it will have sufficient
cash resources to fund its operations for the next twelve months.
(2) SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates in the Preparation of
Financial Statements
The preparation of
financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from
these estimates. Key estimates in the
accompanying consolidated financial statements include, among others, revenue
recognition, allowances for doubtful accounts receivable, determination of fair
value of the derivative associated with the now retired
57
Convertible
Preferred Stock, impairment of long-lived assets, and valuation allowances
against deferred income tax assets.
Reclassifications
Certain reclassifications
have been made to the 2003 and 2002 fiscal year amounts to conform to the
current year presentation. The
reclassifications had no effect on net loss for the prior years.
Principles of Consolidation
The consolidated
financial statements include the accounts of the Company and its wholly-owned
and majority-owned operating subsidiaries after all intercompany
balances and transactions have been eliminated.
The following table
lists the Company’s subsidiaries, location and ownership interest:
|
Subsidiary
|
|
Location
|
|
Ownership Interest
|
|
|
|
|
|
|
|
SCO Operations,
Inc.
|
|
United States
|
|
Wholly-owned
|
|
SCO Global,
Inc.
|
|
United States
|
|
Wholly-owned
|
|
SCO Software
(Ireland) Ltd.
|
|
Ireland
|
|
Wholly-owned
|
|
SCO Software
(UK) Ltd.
|
|
United Kingdom
|
|
Wholly-owned
|
|
SCO Japan, Ltd.
|
|
Japan
|
|
Wholly-owned
|
|
The SCO Group Korea, Inc.
|
|
Korea
|
|
Wholly-owned
|
|
SCO Canada,
Inc.
|
|
Canada
|
|
Wholly-owned
|
|
The SCO Group (Deutschland) GmbH
|
|
Germany
|
|
Wholly-owned
|
|
The SCO Group (France) Sarl
|
|
France
|
|
Wholly-owned
|
|
The SCO Group (Italia) Srl
|
|
Italy
|
|
Wholly-owned
|
Fair Value of Financial Instruments
The carrying amounts reported in the accompanying consolidated financial
statements for cash and cash equivalents, accounts receivable and accounts
payable approximate fair values because of the immediate or short-term
maturities of these financial instruments.
The fair values of available-for-sale securities are determined using
quoted market prices for these securities.
The fair value of the Series A Convertible Preferred Stock derivative
and Series A Convertible Preferred Stock as of October 31, 2003 were determined
using a binomial pricing model (see Note 6).
Foreign Currency Translation
The functional currency
of the Company’s foreign subsidiaries is the local foreign currency. All assets and liabilities denominated in
foreign currencies are translated into U.S. dollars at the exchange rate
prevailing on the balance sheet date.
Revenue and expenses are translated at average exchange rates prevailing
during the period. Translation
adjustments resulting from translation of the subsidiaries’ accounts are
recorded in accumulated other comprehensive income. Gains and losses resulting from foreign
currency transactions are included as a component of other income in the
consolidated statements of operations.
Cash and Cash Equivalents
The Company considers
all investments purchased with original maturities of three or fewer months to
be cash equivalents. Cash equivalents
were $2,633,000 and $61,701,000 as of October 31, 2004 and 2003, respectively. Cash was $10,060,000 and $2,727,000 as of
October 31, 2004 and 2003, respectively.
58
Available-for-Sale Securities
The following table shows the cost, unrealized gain or loss and fair
market value of the Company’s cash equivalents and available-for-sale
securities as of October 31, 2004 and 2003 (in thousands):
|
|
|
October 31, 2004
|
|
|
|
Cost
|
|
Unrealized Gains
(Losses), net
|
|
Fair Market
Value
|
|
|
|
|
|
|
|
|
|
|
|
Corporate notes
|
|
$
|
2,000
|
|
$
|
—
|
|
$
|
2,000
|
|
|
U.S. Government agencies
|
|
16,800
|
|
(44
|
)
|
16,756
|
|
|
Total
|
|
$
|
18,800
|
|
$
|
(44
|
)
|
$
|
18,756
|
|
|
|
|
October 31, 2003
|
|
|
|
|
Cost
|
|
Unrealized Gains (Losses), net
|
|
Fair Market
Value
|
|
|
|
|
|
|
|
|
|
|
|
Corporate notes
|
|
$
|
1,874
|
|
$
|
16
|
|
$
|
1,890
|
|
|
U.S. Government agencies
|
|
2,198
|
|
7
|
|
2,205
|
|
|
Total
|
|
$
|
4,072
|
|
$
|
23
|
|
$
|
4,095
|
|
Available-for-sale
securities are recorded at fair market value, based on quoted market prices,
and unrealized gains and losses are recorded as a component of comprehensive
income (loss). Realized gains and losses,
which are calculated based on the specific-identification method, are recorded
in operations as incurred. As of October
31, 2004 and 2003, available-for-sale securities at amortized cost and fair
value consisted of the following (in thousands):
|
|
|
2004
|
|
2003
|
|
|
|
|
Amortized Cost
|
|
Fair Value
|
|
Amortized Cost
|
|
Fair Value
|
|
|
Maturity date
|
|
|
|
|
|
|
|
|
|
|
3 - 12 months
|
|
$
|
—
|
|
$
|
—
|
|
$
|
701
|
|
$
|
703
|
|
|
> 12 months
|
|
18,800
|
|
18,756
|
|
3,371
|
|
3,392
|
|
|
Total
|
|
$
|
18,800
|
|
$
|
18,756
|
|
$
|
4,072
|
|
$
|
4,095
|
|
All U.S. Government
agencies in an unrealized loss position as of October 31, 2004 were not
impaired at acquisition and the decline in fair value is primarily attributable
to interest rate fluctuations. A decline
in the market value of any available-for-sale security below cost that is
deemed other than temporary results in a charge to earnings and establishes a
new basis for the security.
Restricted Cash and Payable to
Novell, Inc.
Pursuant to the 1995 Asset Purchase Agreement and the Company’s
acquisition of assets and operations of The Santa Cruz Operation, the
Company acts as an administrative agent in the collection of payments from a
limited number of pre-existing Novell, Inc. (“Novell”) customers who continue
to deploy SVRx technology. Under the agency agreement, the Company
collects payments from such customers and receives 5 percent as an
administrative fee. The Company records
the 5 percent administrative fee as revenue in its consolidated statements of
operations. The accompanying
consolidated balance sheets as of October 31, 2004 and 2003 reflect amounts
collected related to this agency agreement but not yet remitted to Novell of
$3,283,000 and $2,025,000, respectively, as restricted cash and payable to
Novell. The Company’s obligation to act
as an administrative agent for Novell is unrelated to the Company’s SCOsource initiatives related to its intellectual property
rights or the
59
Company’s
lawsuit against Novell for slander of title alleging Novell’s bad faith effort
to interfere with the Company’s copyrights in its UNIX source code and
derivative works and its UnixWare product.
Allowance for Doubtful Accounts Receivable
The Company offers
credit terms on the sale of the Company’s products to a significant majority of
the Company’s customers and require no collateral from these customers. The Company performs ongoing credit
evaluations of the Company’s customers’ financial condition and maintains an
allowance for doubtful accounts receivable based upon the Company’s historical
experience and a specific review of accounts receivable at the end of each
period. As of October 31, 2004 and 2003,
the allowance for doubtful accounts was $136,000 and $230,000, respectively.
Inventories
Inventories consist primarily
of completed software products.
Inventories are stated at the lower of cost (using the first-in,
first-out method) or market value. As of
October 31, 2004 and 2003, inventories amounted to $248,000 and $298,000,
respectively. Inventories are included
in other current assets in the accompanying consolidated balance sheets.
Provisions, when
required, are made to reduce excess and obsolete inventories to their estimated
net realizable value. Due to competitive
pressures and technological innovation, it is possible that estimates of the
net realizable value could change in the near term.
Capitalized Software Costs
In accordance with
Financial Accounting Standards Board (“FASB”)
Statement of Financial Accounting Standards (“SFAS”)
No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed,” development costs incurred in the research and development of new
software products to be sold, leased or otherwise marketed are expensed as
incurred until technological feasibility in the form of a detail program
design. Software development costs
incurred after technological feasibility was established and prior to product
release were not material for fiscal years 2004, 2003 and 2002. The Company has charged its software
development costs to research and development expense in the accompanying
consolidated statements of operations.
Impairment of Long-Lived Assets
The Company reviews its
long-lived assets for impairment when events or changes in circumstances
indicate that the book value of an asset may not be recoverable. The Company evaluates, 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.
Property and Equipment
Property and equipment
are stated at cost, less accumulated depreciation and amortization. Computer equipment is depreciated using the
straight-line method over the estimated useful life of the asset, which is
typically three years. Furniture and
fixtures and office equipment are depreciated using the straight-line method
over the estimated useful life of the asset, typically three to five years. Leasehold improvements are amortized using
the straight-line method over the shorter of the estimated useful life of the
improvement or the remaining term of the applicable lease.
60
Expenditures for repairs
and maintenance are charged to expense when incurred. Expenditures for major renewals and
betterments that extend the useful lives of existing equipment are capitalized
and depreciated. Upon retirement or
disposition of property and equipment, the cost and related accumulated
depreciation are removed from the accounts and any resulting gain or loss is
recognized in the consolidated statements of operations.
Depreciation and
amortization expense was $783,000, $1,049,000 and $2,555,000 during the years
ended October 31, 2004, 2003 and 2002, respectively.
Revenue
Recognition
The Company recognizes
revenue in accordance with Statement of Position (“SOP”) 97-2, as modified by
SOP 98-9. The Company’s revenue is
primarily from three sources: (i) product license
revenue, primarily from product sales to distributors, end users and original
equipment manufacturers (“OEMs”); (ii) technical support service revenue,
primarily from providing technical support and consulting services to end
users; and (iii) licensing revenue from its SCOsource
intellectual property initiative.
The Company recognizes
product revenue upon shipment if a signed contract exists, the fee is fixed or
determinable, collection of the resulting receivable is probable and product
returns are reasonably estimable.
The majority of the
Company’s revenue transactions relate to product-only sales. On occasion, the Company has revenue
transactions that have multiple elements (such as software products,
maintenance, technical support services, and other services). For software agreements that have multiple
elements, the Company allocates revenue to each component of the contract based
on the relative fair value of the elements.
The fair value of each element is based on vendor specific objective
evidence (“VSOE”).
VSOE is established when such elements are sold
separately. The Company recognizes
revenue when the criteria for product revenue recognition set forth above have
been met. If VSOE
of all undelivered elements exists, but VSOE does not
exist for one or more delivered elements, then revenue is recognized using the
residual method. Under the residual
method, the fair value of the undelivered elements is deferred and the
remaining portion of the license fee is recognized as revenue in the period
when persuasive evidence of an arrangement is obtained assuming all other
revenue recognition criteria are met.
The Company recognizes
product revenue from OEMs when the software is sold by the OEM to an end-user
customer. Payments for fees are
generally made in advance and are non-refundable. Revenue from technical support services and
consulting services is recognized as the related services are performed. Revenue for maintenance is recognized ratably
over the maintenance period.
The Company considers an
arrangement with payment terms longer than the Company’s normal business
practice, which do not extend beyond 12 months, not to be fixed and
determinable and revenue is recognized when the fee becomes due. The Company typically provides stock rotation
rights for sales made through its distribution channel and sales to
distributors are recognized upon shipment by the distributor to end users. For direct sales not through the Company’s
distribution channel, sales are typically non-refundable and
non-cancelable. The Company estimates
its product returns based on historical experience and maintains an allowance
for estimated returns, which is recorded as a reduction to accounts receivable.
The Company’s SCOsource licensing revenue to date has been primarily
generated from license agreements to utilize the Company’s UNIX source code as
well as from intellectual property compliance licenses. The Company recognizes revenue from SCOsource licensing agreements when a signed contract
exists, the fee is fixed and determinable, collection of the receivable is
probable and delivery has
61
occurred. If the payment terms extend beyond the
Company’s normal payment terms, revenue is recognized as the payments become
due.
Royalty Costs
Royalties paid by the
Company on applications licensed from third parties that are incorporated into
the software products sold by the Company are expensed as cost of revenue on a
per unit basis as software products are sold.
Royalties paid in advance of product sales are included in other current
assets and recorded as cost of revenue when the related products are sold. During fiscal years 2004, 2003 and 2002, the
Company incurred $1,262,000, $1,464,000 and $1,552,000, respectively, in
royalty expense.
Advertising
The Company expenses the
cost of advertising as incurred.
Advertising expenses totaled $350,000, $665,000 and $1,698,000,
respectively, for fiscal years 2004, 2003 and 2002, respectively.
Stock-based Compensation
The Company accounts for
stock options issued to directors, officers and employees under Accounting
Principles Board (“APB”) No. 25, “Accounting for Stock Issued to Employees, and
Related Interpretations.” Under APB No.
25, compensation expense is recognized if an option’s exercise price on the
measurement date is below the fair market value of the Company’s common
stock. The Compensation expense, if any,
is amortized to expense over the vesting period.
SFAS
No. 148, “Accounting for Stock-Based Compensation,” requires pro forma
information regarding net
income (loss) as if the Company had accounted for its stock options granted
under the fair value method prescribed by SFAS No.
123, “Accounting for Stock-Based Compensation.”
The fair value for the Company’s stock options is estimated on the date
of grant using the Black-Scholes option-pricing
model.
With
respect to stock options and restricted stock awards granted and employee stock
purchase program (“ESPP”) shares purchased during the
years ended October 31, 2004, 2003 and 2002, the assumptions used in the Black-Scholes option-pricing model are as follows:
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
Risk-free interest rate
|
|
2.8
|
%
|
2.9
|
%
|
3.0
|
%
|
|
Expected dividend yield
|
|
0.0
|
%
|
0.0
|
%
|
0.0
|
%
|
|
Volatility
|
|
79.5
|
%
|
126.0
|
%
|
161.0
|
%
|
|
Expected exercise life (in years)
|
|
3.0
|
|
2.7
|
|
2.5
|
|
For
purposes of the pro forma disclosure, the estimated fair value of stock
options, restricted stock awards and ESPP shares are
amortized over the vesting period of the award.
The following is the pro forma disclosure and the related impact on net
income (loss) to common stockholders and the net income (loss) to common
stockholders per diluted common share for the years ended October 31, 2004,
2003 and 2002 (in thousands, except per share amounts):
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
Net income available (loss applicable) to
common stockholders:
|
|
|
|
|
|
|
|
|
As reported
|
|
$
|
(16,227
|
)
|
$
|
5,304
|
|
$
|
(24,877
|
)
|
|
Stock-based compensation included in
reported net income (loss)
|
|
919
|
|
1,204
|
|
1,125
|
|
|
Stock-based compensation under fair value
method
|
|
(2,082
|
)
|
(1,855
|
)
|
(6,814
|
)
|
|
Pro forma net income available (loss
applicable) to common stockholders
|
|
$
|
(17,390
|
)
|
$
|
4,653
|
|
$
|
(30,566
|
)
|
|
Net income available (loss applicable) to
common stockholders per basic common share:
|
|
|
|
|
|
|
|
|
As reported
|
|
$
|
(1.07
|
)
|
$
|
0.43
|
|
$
|
(1.93
|
)
|
|
Pro forma
|
|
$
|
(1.15
|
)
|
$
|
0.38
|
|
$
|
(2.37
|
)
|
|
Net income available (loss applicable) to
common stockholders per diluted common share:
|
|
|
|
|
|
|
|
|
As reported
|
|
$
|
(1.07
|
)
|
$
|
0.34
|
|
$
|
(1.93
|
)
|
|
Pro forma
|
|
$
|
(1.15
|
)
|
$
|
0.30
|
|
$
|
(2.37
|
)
|
62
Income Taxes
The Company recognizes a
liability or asset for the deferred tax consequences of all temporary
differences between the tax bases of assets and liabilities and their reported
amounts in the consolidated financial statements that will result in taxable or
deductible amounts in future years when the reported amounts of the assets and
liabilities are recovered or settled.
These deferred tax assets or liabilities are measured using the enacted
tax rates that will be in effect when the differences are expected to
reverse. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
Deferred tax assets are reviewed periodically for recoverability, and
valuation allowances are provided when it is more likely than not that some or
all of the deferred tax assets may not be realized. The Company has provided a valuation
allowance against the entire net deferred tax asset because of its history of
net operating losses and the uncertainties regarding future operating
profitability and taxable income.
Comprehensive Income (Loss)
Comprehensive income
(loss) consists of net income (loss), foreign currency translation adjustments
and unrealized gain (loss) on available-for-sale securities and is presented in
the accompanying consolidated statements of operations and comprehensive income
(loss).
Hedging of Foreign Currency
Transactions
The Company has in the
past utilized foreign currency forward exchange contracts for market exposures
of underlying assets and liabilities.
The Company has not used forward exchange contracts for speculative or
trading purposes. The Company’s
accounting policies for foreign exchange contracts are based on the Company’s
designation of each contract. The
criteria used for designating each contract include such contract’s
effectiveness in risk reduction and one-to-one matching of forward exchange
contracts to underlying assets and liabilities.
Gains and losses on currency forward contracts that are firm commitments
are deferred and recognized in income in the same period that the underlying
transactions are settled. Gains and
losses on currency forward contracts that are designated and effective for existing
transactions are recognized in income in the same period as gains and losses on
the underlying transactions are recognized and generally offset. Gains and losses on any instruments not
meeting the above criteria are recognized in income in the current period. As of October 31, 2004, the Company had no
outstanding instruments classified as hedges.
Net Income (Loss) per Common Share
Basic net income (loss) per common share (“Basic
EPS”) is computed by dividing net income (loss) by the weighted average number
of common shares outstanding. Diluted
net income (loss) per common share (“Diluted EPS”) is computed by dividing net
income by the sum of the weighted average number of common shares outstanding
and the dilutive potential common share equivalents then outstanding. Potential common share equivalents consist of
the weighted average of shares issuable upon the
exercise of outstanding stock options, restricted stock awards, warrants to
acquire common stock and preferred stock convertible into common shares. If dilutive, the Company computes Diluted EPS
using the treasury stock method.
63
The following table is a
reconciliation of the numerator and denominator of Basic EPS to the numerator
and denominator of Diluted EPS (in thousands, except per share amounts):
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
Net income available (loss applicable) to
common stockholders
|
|
$
|
(16,227
|
)
|
$
|
5,304
|
|
$
|
(24,877
|
)
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
15,155
|
|
12,256
|
|
12,893
|
|
|
Series A Convertible Preferred Stock
|
|
—
|
|
5
|
|
—
|
|
|
Weighted average basic common shares
outstanding
|
|
15,155
|
|
12,261
|
|
12,893
|
|
|
Stock options
|
|
—
|
|
2,833
|
|
—
|
|
|
Restricted stock
|
|
—
|
|
471
|
|
—
|
|
|
Warrants
|
|
—
|
|
114
|
|
—
|
|
|
Weighted average diluted common shares
outstanding
|
|
15,155
|
|
15,679
|
|
12,893
|
|
|
Basic EPS
|
|
$
|
(1.07
|
)
|
$
|
0.43
|
|
$
|
(1.93
|
)
|
|
Diluted EPS
|
|
(1.07
|
)
|
0.34
|
|
(1.93
|
)
|
|
|
|
|
|
|
|
|
|
|
Excluded anti-dilutive common share
equivalents
|
|
3,161
|
|
387
|
|
4,374
|
|
The excluded
anti-dilutive common share equivalents are not included in the computation of
Diluted EPS as their effect would have decreased Diluted EPS.
(3) ACQUISITIONS
Vultus
Under the terms of an Asset Acquisition Agreement (the “Vultus Agreement”) dated June 6, 2003, the Company acquired
substantially all of the assets of Vultus, Inc. (“Vultus”), a corporation engaged in the web services
interface business. As consideration for
the assets acquired, the Company issued approximately 167,000 shares of the
Company’s common stock, of which The Canopy Group, Inc. (“Canopy”), the Company’s
principal stockholder as of October 31, 2004, received approximately 37,000
shares. The Company also assumed
approximately $215,000 in accrued liabilities of Vultus. In addition, the Company assumed the
obligations of Vultus under two secured notes payable
to Canopy totaling $1,073,000. In
connection with the assumption of the notes payable to Canopy, Canopy agreed to
accept the issuance of approximately 138,000 shares of the Company’s common
stock in full satisfaction of the obligations.
Canopy was a stockholder and significant debt holder of Vultus. Neither
Canopy nor any of its officers or directors participated in the Company’s
approval of this transaction.
The following table summarizes the components of the consideration paid
to Vultus (in thousands, except per share data):
|
Consideration paid:
|
|
|
|
|
Fair value of common stock issued (305,000
shares at $8.06 per share)
|
|
$
|
2,461
|
|
|
Assumed liabilities
|
|
215
|
|
|
Direct expenses
|
|
45
|
|
|
Total consideration
|
|
$
|
2,721
|
|
The $8.06 per share
value of the common stock issued was determined based on the average market
price of the Company’s common stock for the two days before and the day of
signing the Vultus Agreement.
64
The Company accounted for the acquisition of
Vultus as a business combination in accordance with SFAS No. 141. SFAS No. 141 requires that the total
purchase price, including direct fees and expenses, be allocated to the assets
acquired based upon their respective fair values. No current assets or tangible assets of
significant value were acquired. Based
on the nature and status of the research and development projects at the date
of acquisition, none of the purchase price has been allocated to in-process
research and development. The purchase
price has been allocated to the intangible assets acquired as follows (in
thousands):
|
Purchase price allocation:
|
|
|
|
|
Acquired technology (estimated useful life
of two years)
|
|
$
|
1,555
|
|
|
Goodwill
|
|
1,166
|
|
|
Total
|
|
$
|
2,721
|
|
Pro Forma Financial Information
The following table sets
forth certain pro forma financial information had the Vultus acquisition been
completed as of November 1, 2002 (unaudited, in thousands, except per
share amounts):
|
|
|
Year Ended October 31,
|
|
|
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
79,254
|
|
$
|
64,296
|
|
|
Net income (loss) from operations
|
|
2,133
|
|
(26,142
|
)
|
|
Net income available (loss) applicable to
common stockholders
|
|
3,998
|
|
(26,877
|
)
|
|
Basic net income (loss) per common share
|
|
$
|
0.32
|
|
$
|
(2.04
|
)
|
|
Diluted net income (loss) per common share
|
|
$
|
0.25
|
|
$
|
(2.04
|
)
|
As discussed in more detail in Note 4, the
Company recorded an asset impairment related to Vultus during the year ended October 31,
2004.
(4) GOODWILL AND
INTANGIBLE ASSETS
The following table
shows the activity related to amortized intangible assets for the years ended October 31,
2003 and 2004 as well as the remaining unamortized balances as of October 31,
2004 (in thousands):
|
|
|
As of
October 31, 2002
|
|
Year Ended
October 31, 2003
|
|
As of
October 31, 2003
|
|
|
|
|
Net Book Value
|
|
Amortization
Expense
|
|
Additions
|
|
Net Book Value
|
|
|
Amortizable intangible assets:
|
|
|
|
|
|
|
|
|
|
|
Distribution/reseller channel
|
|
$
|
9,273
|
|
$
|
(2,319
|
)
|
$
|
—
|
|
$
|
6,954
|
|
|
Acquired technology
|
|
1,777
|
|
(1,157
|
)
|
1,555
|
|
2,175
|
|
|
Trade name
|
|
208
|
|
(51
|
)
|
—
|
|
157
|
|
|
Total intangible assets
|
|
$
|
11,258
|
|
$
|
(3,527
|
)
|
$
|
1,555
|
|
$
|
9,286
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of
October 31, 2003
|
|
Year
Ended
October 31, 2004
|
|
As of
October 31, 2004
|
|
|
|
|
Net Book
Value
|
|
Amortization
Expense
|
|
Impairment
Loss
|
|
Net Book
Value
|
|
|
Amortizable intangible assets:
|
|
|
|
|
|
|
|
|
|
|
Distribution/reseller channel
|
|
$
|
6,954
|
|
$
|
(2,318
|
)
|
$
|
—
|
|
$
|
4,636
|
|
|
Acquired technology
|
|
2,175
|
|
(529
|
)
|
(973
|
)
|
673
|
|
|
Trade name
|
|
157
|
|
(53
|
)
|
—
|
|
104
|
|
|
Total intangible assets
|
|
$
|
9,286
|
|
$
|
(2,900
|
)
|
$
|
(973
|
)
|
$
|
5,413
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
65
Of the $2,900,000 in
amortization expense for the year ended October 31, 2004, $334,000 was
classified as cost of SCOsource licensing revenue and the remaining $2,566,000
was classified as amortization of intangible assets in operating expenses. Of the $3,527,000 in amortization expense for
the year ended October 31, 2003, $337,000 was classified as cost of
SCOsource licensing revenue and the remaining $3,190,000 was classified as
amortization of intangible assets in operating expenses. Amortization expense was $3,187,000 for the
year ended October 31, 2002 and $2,853,000 was classified as an operating
expense.
During the year ended October 31,
2004, the Company recorded a loss on impairment of long-lived assets totaling
$2,139,000, which related to an impairment loss on intangible assets of
$973,000 and an impairment of goodwill of $1,166,000. The intangible assets and goodwill were
included as part of the UNIX segment.
The impairment loss
related to goodwill and intangible assets acquired in connection with the
acquisition of Vultus in June 2003.
The Company concluded that an impairment-triggering event occurred
during the three months ended April 30, 2004 as the Company had a reduction
in force that impacted the Company’s ability to move the Vultus initiative
forward on a stand-alone basis and because an impending partnership that would
have solidified the Vultus revenue and cash flow opportunities did not
materialize. Consequently, the Company
concluded that no significant future cash flows related to its Vultus assets
would be realized. The Company performed
an impairment analysis of its recorded goodwill related to the Vultus reporting
unit using a present value of future cash flows model. Additionally, an impairment analysis of the
intangible assets was performed in accordance with SFAS No. 144. As a result of these analyses, the Company
wrote-down the carrying value of its goodwill related to the Vultus acquisition
from $1,166,000 to $0 and wrote-down intangible assets related to its Vultus
acquisition from $973,000 to $0.
Future amortization
expense for the above intangible assets as of October 31, 2004, is as
follows (in thousands):
|
|
|
Amortization
|
|
|
|
|
Expense
|
|
|
Year ending October 31,
|
|
|
|
|
2005
|
|
$
|
2,706
|
|
|
2006
|
|
2,707
|
|
|
Total
|
|
$
|
5,413
|
|
Pursuant to SFAS No. 142,
the Company is required to test its intangible assets for impairment at least
annually. The Company performed a test
as of October 31, 2004 and concluded that no impairment had occurred.
(5) INVESTMENTS IN NON-MARKETABLE SECURITIES
The Company accounts for each of its investments in non-marketable
securities under the cost method, if the Company owns less than 20 percent of
the outstanding voting securities or under the equity method if the Company
owns more than 20 percent but less than 50 percent of the outstanding voting
securities.
In connection with the Company’s acquisition of the server and
professional services groups from The Santa Cruz Operation, it acquired a 30
percent ownership interest in SCO Software, China; a
66
joint venture in China. This investment is being accounted for using
the equity method. As of October 31,
2004, the Company had a balance of $561,000 for its China investment, which is
included as a component of other assets.
The Company’s other investments in non-marketable securities have been
fully impaired in prior fiscal years and did not have a book value as of October 31,
2004.
Income or loss recorded on the Company’s investments is recorded as
equity in income (losses) of affiliates in the consolidated statements of
operations and amounted to $111,000, ($62,000) and ($50,000) for the fiscal
years ended October 31, 2004, 2003 and 2002, respectively.
Investment Impairments and Write-offs
Management routinely assesses the Company’s investments for impairment
and adjusts the carrying amount to estimated realizable values when impairment
has occurred. During the years ended October 31,
2003 and 2002, management determined that the carrying value of certain of its
investments would most likely not be recoverable and incurred write-offs of
$250,000 and $1,180,000, respectively.
The necessary write-offs were due to declines in general economic
conditions and the impact of such declines in the operations of these companies
as well as a decline in overall market valuations.
(6) REDEEMABLE CONVERTIBLE PREFERRED STOCK
On October 16,
2003, the Company issued 50,000 shares of its redeemable Series A
Convertible Preferred Stock (the “Series A”) for $1,000 per share. The net proceeds from the sale of the Series A
were $47,740,000. The value of the Series A
was classified outside of permanent equity because of certain redemption
features that were outside the control of the Company.
The terms of the Series A
included a number of conversion provisions that represented a derivative
financial instrument under SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities.” The
Company determined that the conversion feature allowing Series A holders
to acquire common shares was an embedded derivative requiring separate
accounting. This required the Company to
record the derivative at fair value and mark to fair value at each reporting
period. Changes in the fair value of the
derivative were recorded in the Company’s statement of operations. As of October 16, 2003, the Company,
through the assistance of an independent valuation firm, determined the initial
fair value of the derivative was $18,069,000.
As of October 31, 2003, the fair value of the derivative was
$15,224,000 and the decrease in fair value of $2,845,000 was recorded as a gain
as a change in fair value of derivative in other income in the statement of
operations for fiscal year 2003.
As of January 31,
2004, the fair value of the derivative was $11,600,000, and the decrease in
fair value of $3,624,000 was recorded as a gain as a change in fair value of
derivative in other income in the statement of operations for three months
ended January 31, 2004. On February 5,
2004, all outstanding Series A shares were exchanged for shares of the
Company’s Series A-1 Convertible Preferred Stock (the “Series A-1”),
and, as a result, no Series A shares remained outstanding as of February 5,
2004. The exchange did not result in the
Company receiving any additional proceeds.
As of February 5, 2004, the fair value of the derivative was
$9,300,000 and the decrease in fair value of $2,300,000 from January 31,
2004 was recorded as a gain as a change in fair value of derivative in other
income in the statement of operations.
As of February 5,
2004, the Company, through the assistance of an independent valuation firm,
determined the fair value of the Series A-1 was $45,276,000. The Company incurred $211,000 in offering
costs in connection with the issuance of the Series A-1 in the exchange
for Series A, resulting in a net fair value of $45,065,000. The difference of $6,305,000 in the fair
value of the Series A-1 and the combined carrying value of the Series A
and the related derivative was recorded as a non-cash dividend in the
statements of operations for the three months ended April 30, 2004.
67
Conversion
of Series A-1 Shares and Transfer of Series A-1 Shares to BayStar
On
May 5, 2004, the Company received a notice from Royal Bank of Canada (“RBC”),
one of the holders of the Series A-1 shares that RBC had elected to
convert 10,000 Series A-1 shares into a total of 740,740 shares of the Company’s
common stock. The converted Series A-1
shares were purchased at a price of $1,000 per share and were converted into
shares of common stock based on a conversion price of $13.50 per share. A total of $9,013,000 was recorded as
permanent equity as a result of this conversion. Additionally, RBC informed the Company that
it had sold its remaining 20,000 Series A-1 shares to BayStar Capital II,
L.P. (“BayStar”), which following such transfer held a total of 40,000 Series A-1
shares.
Agreement
to Repurchase BayStar Capital Series A-1 Shares
On May 31, 2004,
the Company entered into an agreement with BayStar to repurchase and retire
BayStar’s 40,000 Series A-1 shares, including accrued dividends. Terms of the agreement required the Company
to pay to BayStar $13,000,000 in cash and issue 2,105,263 shares of the Company’s
common stock. The repurchase price was
payable and issuable upon the effectiveness of a shelf registration statement
covering the resale of the shares of common stock that would be issued to
BayStar upon the closing of the repurchase.
On July 21, 2004, the SEC declared the Company’s registration
statement on Form S-3 effective, and, in accordance with the terms of the
repurchase agreement, the closing of the repurchase with BayStar closed on that
date. The fair value of the cash and
common shares delivered to BayStar was less than the carrying value of the
remaining value of the Series A-1 shares and the Company recorded a
capital contribution as a dividend for this difference as outlined in the
following table (in thousands):
|
Fair value of 2,105,263 common shares
|
|
$
|
9,747
|
|
|
Cash consideration
|
|
13,000
|
|
|
Total value to BayStar
|
|
22,747
|
|
|
Carrying value of Series A-1 including
dividends
|
|
38,222
|
|
|
Capital contribution
|
|
$
|
(15,475
|
)
|
Dividends
If the repurchase had
not occurred, dividends on the Series A-1 shares would have been paid
after October 16, 2004, the first anniversary of the original Series A
private placement, quarterly at a rate of 8 percent per annum, subject to
annual increases of 2 percent per annum, not to exceed 12 percent per
annum. Although the Company accrued
dividends of $2,047,000 and $123,000 for the years ended October 31, 2004
and 2003, respectively, which reduced earnings to common stockholders, the
Company will no longer accrue dividends on preferred stock because the
repurchase transaction with BayStar closed.
The Company never paid any dividends on the Series A or Series A-1
shares.
(7) COMMON STOCK SUBJECT TO RESCISSION
The Company believes
certain shares and options granted under the Equity Compensation Plans were
issued without complying with registration or qualification requirements under
federal securities laws and the securities laws of certain states. As a result, certain Plan participants have a
right to rescind their purchases of shares under the Plans or recover damages
if they no longer own the shares or hold unexercised options, subject to
applicable statutes of limitations.
Additionally, regulatory authorities may require the Company to pay fines
or impose other sanctions. Although the
Company continues to evaluate the possible actions it may take, the Company may
make a rescission offer to certain Plan participants entitled to rescission
rights subject to obtaining required regulatory approvals.
68
Accounting Series Release
(“ASR”) No. 268 and Emerging Issues Task Force (“EITF”) Topic D-98 require
that stock subject to rescission or redemption requirements outside the control
of the Company to be classified outside of permanent equity. The
exercise of the rescission right is at the holders’ discretion, but exercise of
that right may depend in part on the fair value of the Company’s common stock
which is outside of the Company’s and the holders’ control. Consequently, common stock subject to
rescission is classified as temporary equity.
If the Company’s possible rescission offer is made and accepted by plan
participants holding shares acquired under the Equity Compensation Plans or
otherwise entitled to recover damages from the Company in respect of such
shares they have sold, or such plan participants otherwise make rescission
claims against the Company, the Company could be required to make aggregate
payments to these plan participants of up to $528,000 in the aggregate,
excluding interest and other possible fees, based upon approximately 499,000 shares
outstanding under the Plans as of October 31, 2004.
In the event the Company
completes a rescission offer or plan participants otherwise exercise rescission
rights, any amounts the Company may pay to plan participants, excluding
interest and other possible charges, will be deducted from common stock subject
to rescission, and, in the event a plan participant declines a rescission offer
or otherwise is determined to no longer have a rescission right, any remaining
amounts recorded to common stock subject to rescission will be recorded as
permanent equity.
(8) STOCKHOLDERS’ EQUITY
Reverse Stock Split
On December 17,
2001, the Company’s board of directors approved a one-for-four reverse stock
split for holders of common stock. On March 4,
2002, the stockholders approved this reverse stock split and the Company’s
authorized shares were reduced from 200,000,000 shares to 50,000,000 shares
consisting of 5,000,000 shares of preferred stock and 45,000,000 shares of
common stock. The outstanding common
shares were reduced from 57,715,000 shares to 14,428,750 shares. The reverse stock split of common shares has
been retroactively reflected in the accompanying consolidated financial
statements and notes for all periods presented, unless otherwise indicated.
Stock Options
During the year ended October 31, 1998,
the Company adopted the 1998 Stock Option Plan (the “1998 Plan”) that provided
for the granting of nonqualified stock options to purchase shares of common
stock. On December 1, 1999, the
Company’s board of directors approved the 1999 Omnibus Stock Incentive Plan
(the “1999 Plan”), which was intended to serve as the successor equity
incentive program to the 1998 Plan. The
1999 Plan allows for the grant of awards in the form of incentive and
non-qualified stock options, stock appreciation rights, restricted shares,
phantom stock and stock bonuses. Awards
may be granted to individuals in the Company’s employ or service.
On
May 16, 2003, the Company’s stockholders approved the 2002 Omnibus Stock
Incentive Plan (the “2002 Plan”) upon the recommendation of the board of
directors. The 2002 Plan permits the
award of stock options, stock appreciation rights, restricted stock, phantom
stock rights, and stock bonuses. Stock
options may have an exercise price equal to, less than, or greater than the
fair market value of the common stock on the date of grant, except that the
exercise price of incentive stock options must be equal to or greater than the
fair market value of the common stock as of the date of grant.
On
April 20, 2004, the Company’s stockholders approved the 2004 Omnibus Stock
Incentive Plan (the “2004 Plan”) upon the recommendation of the board of
directors. The 2004 Plan allows for the
award of up to 1,500,000 shares of the Company’s common stock and permits the
award of stock options, stock appreciation rights, restricted stock, phantom
stock rights, and stock bonuses. The
2004 Plan is administered by the Compensation Committee of the Company’s board
of directors. The Compensation Committee
has the ability to determine the terms of the option, the exercise price, the
number of shares
69
subject to each option, and the
exercisability of the options. Stock
options may have an exercise price equal to, less than, or greater than the
fair market value of the common stock on the date of grant, except that the
exercise price of incentive stock options must be equal to or greater than the
fair market value of the common stock as of the date of grant. Shares issued pursuant to the 2004 Plan may
be authorized and unissued shares, treasury shares or shares acquired by the
Company for purposes of the 2004 Plan.
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 at 25 percent after the completion of one year of service and then 1/36
per month for the remaining three years and would be fully vested at the end of
four years.
The
board may suspend, revise, terminate or amend any of the option plans at any
time; provided, however, that stockholder approval must be obtained if and to
the extent that the board deems it appropriate to satisfy Section 162(m)
of the Code, Section 422 of the Code or the rules of any stock
exchange on which the common stock is listed.
No action under the option plans may, without the consent of the
participant, reduce the participant’s rights under any outstanding award.
As
of October 31, 2004, 232,000 shares were available for issuance under the
1999 Plan, 452,000 shares were available for issuance under the 2000 Plan, and
1,145,000 shares were available for issuance under the 2004 Plan. A summary of stock option activity under the
1998, 1999, 2002 and 2004 Plans for the
years ended October 31, 2004, 2003 and 2002 is as follows (in thousands,
except per share amounts):
|
|
|
|
|
Weighted Average
|
|
|
|
|
Options
|
|
Exercise Price
|
|
|
|
|
|
|
|
|
|
Balance, October 31, 2001
|
|
3,108
|
|
$
|
10.12
|
|
|
Granted
|
|
3,910
|
|
0.98
|
|
|
Exercised
|
|
(215
|
)
|
1.37
|
|
|
Cancelled
|
|
(2,537
|
)
|
7.54
|
|
|
Balance, October 31, 2002
|
|
4,266
|
|
3.78
|
|
|
Granted
|
|
1,755
|
|
5.56
|
|
|
Exercised
|
|
(1,305
|
)
|
1.57
|
|
|
Cancelled
|
|
(1,055
|
)
|
9.34
|
|
|
Balance, October 31, 2003
|
|
3,661
|
|
3.74
|
|
|
Granted
|
|
939
|
|
7.31
|
|
|
Exercised
|
|
(606
|
)
|
1.57
|
|
|
Cancelled
|
|
(833
|
)
|
7.62
|
|
|
Balance, October 31, 2004
|
|
3,161
|
|
$
|
4.18
|
|
The weighted average fair value of options granted for the years ended October 31,
2004 2003 and 2002 was $7.31, $5.56 and $0.98, respectively.
During the years ended October 31, 2004, 2003 and 2002, the Company
did not grant any stock options with exercise prices that were less than the
quoted market price of the Company’s common stock. A summary of stock options outstanding and
exercisable under the Company’s 1998, 1999, 2002 and 2004 Plans as of October 31,
2004 is as follows (in thousands, except per share amounts):
70
|
|
|
Options Outstanding
|
|
Options Exercisable
|
|
|
|
|
|
|
Weighted
|
|
Weighted
|
|
|
|
Weighted
|
|
|
|
|
|
|
Average
|
|
Average
|
|
|
|
Average
|
|
|
|
|
Options
|
|
Contractual
|
|
Exercise
|
|
Options
|
|
Exercise
|
|
|
Exercise Prices
|
|
Outstanding
|
|
Life
|
|
Price
|
|
Exercisable
|
|
Price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ 0.66 – $0.76
|
|
600
|
|
7.66
|
years
|
|
$
|
0.76
|
|
283
|
|
$
|
0.76
|
|
|
$ 0.77 – $1.10
|
|
397
|
|
7.68
|
|
|
0.90
|
|
322
|
|
0.87
|
|
|
$ 1.12 – $2.00
|
|
407
|
|
7.21
|
|
|
1.21
|
|
282
|
|
1.15
|
|
|
$ 2.07 – $4.05
|
|
770
|
|
8.30
|
|
|
2.59
|
|
365
|
|
2.34
|
|
|
$ 4.50 – $9.12
|
|
658
|
|
9.13
|
|
|
6.57
|
|
99
|
|
7.37
|
|
|
$ 9.12 and above
|
|
329
|
|
8.21
|
|
|
16.99
|
|
131
|
|
18.90
|
|
|
|
|
3,161
|
|
8.12
|
years
|
|
$
|
4.18
|
|
1,482
|
|
$
|
3.29
|
|
2000 Employee Stock Purchase Plan
The 2000 Employee Stock
Purchase Plan, as amended, 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. A participant may contribute
up to 10 percent of his or her cash earnings through payroll deductions and the
accumulated payroll deductions will be applied to the purchase of shares on the
participant’s behalf on each semi-annual purchase date (the last business day
in May and November). The purchase
price per share will be 85 percent of the lower of the fair market value of the
Company’s common stock on the participant’s entry date into the offering period
or the fair market value on the semi-annual purchase date.
The board may at any
time amend or modify the plan. The plan
will terminate no later than the last business day in April 2010.
During the year ended October 31,
2004, 691,000 shares were purchased at prices ranging from $0.66 to $5.21 per
share. During the year ended October 31,
2003, 345,000 shares were purchased at prices ranging from $0.66 to $1.38 per
share and during the year ended October 31, 2002, 175,000 shares were
purchased at prices ranging from $0.71 to $2.62 per share.
Stock-based Compensation
Stock-based compensation was $919,000,
$1,204,000 and $1,125,000 during the years ended October 2004, 2003 and
2002, respectively. The following table
summarizes the components of stock-based compensation (in thousands):
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of stock-based compensation
|
|
$
|
325
|
|
$
|
866
|
|
$
|
986
|
|
|
Options, warrants and shares for services
|
|
502
|
|
296
|
|
631
|
|
|
Option modifications
|
|
92
|
|
42
|
|
73
|
|
|
Reversal of previously recorded expense
related to terminated employees
|
|
—
|
|
—
|
|
(565
|
)
|
|
Total
|
|
$
|
919
|
|
$
|
1,204
|
|
$
|
1,125
|
|
Restricted Stock Awards
During the year ended October 31,
2004, the Company did not grant any shares of restricted stock. During the year ended October 31, 2003,
the Company issued 180,000 shares of restricted stock to certain key
employees. The restrictions on the
restricted stock awards granted to key employees lapse over a period of 24
months. The fair value of the restricted
stock awards granted was approximately $374,000. The fair value of the restricted stock awards
was recorded as a component of deferred compensation and is amortized to
stock-based compensation as the restrictions lapse. Additionally in 2003, the Company’s board of
directors approved a resolution to receive remaining amounts owed to them for
services provided during the year ended October 31, 2002 fiscal year in
the form of restricted stock awards. The
Company issued 27,500 shares of common stock with a fair value of $36,000 that
was expensed as a component of options and shares for services in the above
table. Finally, the Company
71
granted
150,000 shares of restricted common stock to members of the Company’s board of
directors with a fair value of $195,000 and was recorded as a component of
deferred compensation. The restricted
common stock issued to the board of directors was in lieu of cash compensation
for their services to the Company during fiscal year 2003 and the restrictions
lapsed on October 31, 2003.
During the year ended October 31,
2002, the Company issued 450,000 shares of restricted stock to certain key
employees. The restrictions related to
the restricted stock awards lapse over a period of 24 months. The fair value of the restricted stock awards
granted of $495,000 was recorded as a component of deferred compensation and is
amortized to stock-based compensation as the restrictions lapse.
Warrants
In August 2002, the Company entered into an agreement with Morgan
Keegan & Company (“Morgan Keegan”) to act as an exclusive financial
advisor to assist the Company in its analysis, consideration and if appropriate,
execution of various financial and strategic alternatives including, but not
limited to, securing additional equity and/or debt capital and potential
strategic transactions including mergers, acquisitions and joint ventures. During the year ended October 31, 2003,
the Company paid a fee to Morgan Keegan of $2,000,000 in connection with the
Company’s Series A private placement.
In consideration for the services provided, in August 2002, the
Company issued to Morgan Keegan a warrant to purchase 200,000 shares of the
Company’s common stock at an exercise price of $0.01 per share. Morgan Keegan was granted demand registration
rights to have the Company use its best efforts to register the shares upon
exercise of the warrant. The Company
expensed the fair value of the
warrant of $294,000, determined using the Black-Scholes option-pricing model.
In January 2003, Morgan Keegan exercised the warrant.
During the year ended October 31,
2003, the Company issued three warrants to Sun Microsystems, Inc. (“Sun”). The warrants allow Sun to acquire a total of
235,000 shares of the Company’s common stock at an exercise price of $1.83 per
share for a term of five years from the date of grant. The warrants were issued in connection with a
SCOsource revenue transaction with Sun, and the Company has recorded the fair
value of the warrants of $856,000, as determined using the Black-Scholes
option-pricing model, as a warrant outstanding and reduced SCOsource license
revenue. The Company received the
$856,000 in cash from Sun in connection with payments received under the terms
of the revenue transaction. As of October 31,
2004, all warrants to Sun remained outstanding and unexercised.
During the year ended October 31,
2003, the Company issued a warrant to a consultant, as part of an agreement to
assist the Company with its SCOsource licensing initiative. The warrant allows the consultant to acquire
25,000 shares of the Company’s common stock at an exercise price of $8.50 per
share for a term of two years from the date of the agreement. The Company has recorded the fair value of
the warrant of $243,000, as determined using the Black-Scholes option-pricing
model, as a warrant outstanding and included this cost as a cost of SCOsource
licensing revenue. As of October 31,
2004, the warrant remains outstanding and unexercised.
Repurchase of Common Stock
On March 10, 2004,
the Company’s board of directors authorized management, in its discretion, to
purchase up to 1,500,000 shares of the Company’s common stock over the 24-month
period following March 10, 2004, the time at which the repurchase program
was effective. Any repurchased shares
will be held in treasury and will be available for general corporate
purposes. The repurchase program will
allow the Company to repurchase its shares from time to time in accordance with
the requirements of the Securities and Exchange Commission on the open market,
in block trades and in privately negotiated transactions, depending on market
conditions and other factors. During the
year ended October 31, 2004,
72
the
Company purchased approximately 290,000 shares of its common stock at a total
cost of approximately $2,414,000.
Stockholder Rights Plan
On August 10, 2004, the Company’s Board of Directors adopted a
Stockholder Rights Plan (the “Rights Plan”) designed to deter coercive takeover
tactics, including accumulation of shares in the open market or through private
transactions and to prevent an acquirer from gaining control of the Company
without offering a fair price to all of the Company’s stockholders.
Under the terms of the Rights Plan, Series A Junior Participating
Preferred Stock purchase rights will be distributed as a dividend at the rate
of one right for each share of common stock of the Company held by stockholders
of record as of the close of business on August 30, 2004. The Rights Plan would be triggered if a
person or group acquired beneficial ownership of 15 percent or more of the
Company’s common stock other than pursuant to a board-approved tender or
exchange offer or commences, or publicly announces an intention to commence, a
tender or exchange offer upon consummation of which such person or group would
beneficially own 15 percent or more of the Company’s common stock. The value of the purchase rights is immaterial
as of October 31, 2004.
Stock Buyback from The Santa
Cruz Operation and MTI Technology Corp. (“MTI”)
During the year ended October 31,
2002, the Company bought back an aggregate of 3,615,000 shares of its
outstanding common stock from The Santa Cruz Operation in two
transactions. The Company paid an
aggregate of $3,514,000 for these shares, or an average of $0.97 per
share. In connection with the
repurchase, the Company received and accepted a resignation letter from one of
the directors representing The Santa Cruz Operation on the Company’s board of
directors.
During the year ended October 31,
2002, the Company purchased 1,189,000 shares of its outstanding common stock
from MTI for $1,070,000, or $0.90 per share, which represented a premium from
the quoted market price.
The Company has elected
to retire the acquired shares and has accordingly reflected the amounts paid as
a reduction to stockholders’ equity.
(9) INCOME
TAXES
The net income (loss)
before income taxes consisted of the following components for the years ended October 31,
2004, 2003 and 2002 (in thousands):
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
Domestic U.S. operations
|
|
$
|
(21,875
|
)
|
$
|
8,546
|
|
$
|
(25,371
|
)
|
|
Foreign operations
|
|
(80
|
)
|
(2,345
|
)
|
977
|
|
|
Total
|
|
$
|
(21,955
|
)
|
$
|
6,201
|
|
$
|
(24,394
|
)
|
The components of the
provision for income taxes for the years ended October 31, 2004, 2003 and
2002 are as follows (in thousands):
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
Current:
|
|
|
|
|
|
|
|
|
U.S. State
|
|
$
|
27
|
|
$
|
16
|
|
$
|
—
|
|
|
Non – U.S.
|
|
1,368
|
|
758
|
|
483
|
|
|
|
|
1,395
|
|
774
|
|
483
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
U.S. Federal
|
|
(13,248
|
)
|
1,114
|
|
(8,894
|
)
|
|
U.S. State
|
|
(499
|
)
|
42
|
|
(335
|
)
|
|
Change in valuation allowance
|
|
13,747
|
|
(1,156
|
)
|
9,229
|
|
|
|
|
|
|
|
|
|
|
|
Total provision for income taxes
|
|
$
|
1,395
|
|
$
|
774
|
|
$
|
483
|
|
73
Deferred tax assets and
liabilities are determined based on the differences between the financial
reporting and tax bases of assets and liabilities. They are measured by applying the enacted tax
rates and laws in effect for the years in which such differences are expected
to reverse.
The significant
components of the Company’s deferred income tax assets and liabilities at October 31,
2004 and 2003 are as follows (in thousands):
|
|
|
2004
|
|
2003
|
|
|
Deferred income tax assets:
|
|
|
|
|
|
|
Net operating loss carry-forwards
|
|
$
|
45,580
|
|
$
|
33,534
|
|
|
Intangible assets
|
|
7,299
|
|
7,326
|
|
|
Tax basis in excess of book basis related
to acquired assets
|
|
4,491
|
|
4,313
|
|
|
Reserves and accrued expenses
|
|
4,862
|
|
2,129
|
|
|
Book depreciation in excess of tax
|
|
425
|
|
1,356
|
|
|
Deferred revenue
|
|
270
|
|
514
|
|
|
Basis difference in investments
|
|
151
|
|
451
|
|
|
Capital loss carry-forward
|
|
4,009
|
|
3,851
|
|
|
Total deferred income tax assets
|
|
67,087
|
|
53,474
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
Tax on foreign earnings
|
|
(432
|
)
|
(566
|
)
|
|
Total deferred income tax liabilities
|
|
(432
|
)
|
(566
|
)
|
|
Valuation allowance
|
|
(66,655
|
)
|
(52,908
|
)
|
|
Net deferred income tax assets
|
|
$
|
—
|
|
$
|
—
|
|
The amount, and ultimate
realization, of the deferred income tax assets is dependent, in part, upon the
tax laws in effect, the Company’s future earnings, and other future events, the
effects of which cannot be determined.
The Company has established a full valuation allowance against its net
deferred income tax assets. Management
believes that as of October 31, 2004, based on a number of factors, the
available objective evidence creates sufficient uncertainty regarding the
ultimate realizability of these deferred income tax assets, that it is more
likely than not that those assets will not be realized.
As of October 31,
2004, the Company had net operating loss carry-forwards for federal income tax
reporting purposes totaling approximately $121,448,000 that expire between 2019
and 2024. Approximately $18,848,000 of
this amount is a result of the exercise of employee stock options. When recognized the tax benefit of these
exercises will be accounted for as a credit to stockholders’ equity.
The Internal Revenue
Code contains provisions that likely could reduce or limit the availability and
utilization of net operating loss carry-forwards if certain changes in
ownership have taken place or will take place.
Ownership changes have occurred and utilization of the Company’s net
operating loss carry-forwards may be limited pursuant to Internal Revenue Code Section 382
as a result of these ownership changes.
The differences between
the provision for income taxes at the U.S. statutory rate and the Company’s
effective tax rate are as follows:
74
|
|
|
2004
|
|
2003
|
|
2002
|
|
|
|
|
|
|
|
|
|
|
|
Provision (benefit) at statutory rate
|
|
(34.0
|
)%
|
34.0
|
%
|
(34.0
|
)%
|
|
Other permanent book to tax differences
|
|
1.9
|
%
|
0.2
|
%
|
0.2
|
%
|
|
State income taxes, net of federal effect
|
|
0.0
|
%
|
0.3
|
%
|
(3.9
|
)%
|
|
Foreign income taxes
|
|
6.4
|
%
|
12.3
|
%
|
2.0
|
%
|
|
Change in fair value of derivative
|
|
(9.1
|
)%
|
(15.6
|
)%
|
—
|
|
|
Other
|
|
—
|
|
—
|
|
(0.1
|
)%
|
|
Change in valuation allowance
|
|
41.2
|
%
|
(18.7
|
)%
|
37.8
|
%
|
|
Total provision for income taxes
|
|
6.4
|
%
|
12.5
|
%
|
2.0
|
%
|
(10) COMMITMENTS
AND CONTINGENCIES
Litigation
IBM
Corporation
On or about March 6,
2003, the Company filed a complaint against IBM Corporation (“IBM”). This action is pending in the United States
District Court for the District of Utah, under the title The SCO Group, Inc.
v. International Business Machines Corporation, Civil No. 2:03CV0294. The initial complaint included claims for
breach of contract, misappropriation of trade secrets, tortious interference,
and unfair competition. The initial
complaint also alleged that IBM had used and distributed information concerning
the UNIX source code and derivative works in connection with its efforts to
promote the Linux operating system. As a
result of IBM’s actions, the Company is requesting damages in an amount to be
proven at trial, together with additional damages through and after the time of
trial. On or about June 13, 2003,
the Company delivered to IBM a notice of termination of IBM’s UNIX license
agreement with the Company, which license underlies IBM’s AIX software.
On or about June 16, 2003, the Company filed an amended complaint
in the IBM case. The amended complaint
essentially restated and re-alleged the allegations of the initial complaint
and expanded on those claims. Among
other things, the amended complaint raised new allegations regarding IBM’s
breaches (in ways similar to those set forth above) of a UNIX license agreement
involving Sequent Computer Systems, Inc. (“Sequent”), which IBM had
acquired. The Company has sought damages
for breaches of the Sequent license agreement.
The Company is also seeking injunctive relief on several claims.
IBM has filed a response and counterclaims to the complaint,
including a demand for a jury trial. The
Company has filed an answer to the IBM counterclaims denying the claims and
asserting affirmative defenses. On February 4,
2004, the Company filed a motion for leave to file amended pleadings in the
case proposing to amend its complaint against IBM and to modify its affirmative
defenses to IBM’s counterclaims. On February 25,
2004, the court granted the Company’s motion for leave to amend.
The second amended complaint, which was filed on February 27,
2004, 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 fourteen 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 for a declaratory judgment claim for non-infringement of
copyrights.
On March 3, 2004, the U.S. Magistrate Judge issued an
order addressing certain discovery matters relating to both the Company and
IBM.
The Company thereafter filed motions to amend the scheduling
order and to bifurcate IBM’s patent counterclaims into a separate action. A hearing on those latter two motions was
held on June 8,
75
2004. The court issued its ruling on June 10,
2004, granting the Company’s motion to amend the scheduling order, with certain
changes. The court also denied the
Company’s motion to bifurcate IBM’s patent counterclaims without prejudice to
the Company’s right to request a bifurcation again at a later date.
Following a hearing on October 19, 2004, on January 19,
2005, the Magistrate Judge issued a further order granting in part and denying
in part discovery applications that the Company had made. In that order, the court ordered IBM to
produce much of the information, including source code and revision information
the Company had previously requested.
The court also struck the Amended Scheduling Order and directed the
parties to submit a proposed amended scheduling order which both parties have
done.
On February 9, 2005, the U.S. District Judge ruled on
several pending dispositive motions. The
Court denied the three motions for partial summary judgment that IBM had filed
– on the Company’s contract claims, on IBM’s eighth counterclaim for copyright
infringement and on IBM’s tenth counterclaim for a declaration of
non-infringement of the Company’s copyrights.
The Court denied each of those motions without prejudice to IBM’s renewing
or refiling the motions after discovery is complete. The Court also denied the Company’s motion to
stay or dismiss IBM’s tenth counterclaim.
The Court ordered that no further dispositive motions could be filed
until the close of discovery, except by stipulation of the parties, and vacated
its prior order, dated September 30, 2004, to the extent that order had
granted permission to file dispositive motions before the close of discovery.
In addition to the materials that have been publicly filed
with the court, certain information has been filed under seal in accordance
with the protective order entered in the case.
On November 30, 2004, a third party filed a motion to intervene in
the case for the purpose of challenging the sealing of certain documents with
the court. Additional groups have joined
in that motion. That motion has been
scheduled for a hearing on April 26, 2005.
The Company has also filed a motion for leave to file a
third amended complaint to allege an additional copyright violation against IBM
in the case. The Company expects that
matter to be heard by the court in the next few months. Discovery is continuing in the case.
Red Hat, Inc.
On August 4, 2003,
Red Hat, Inc. (“Red Hat”) filed a complaint against the Company. The action is pending in the United States
District Court for the District of Delaware under the case caption Red Hat, Inc.
v. The SCO Group, Inc., Civil No. 03-772. Red Hat asserts that the Linux operating
system does not infringe on the Company’s UNIX intellectual property rights and
seeks a declaratory judgment for non-infringement of copyrights and no
misappropriation of trade secrets. In
addition, Red Hat claims the Company has engaged in false advertising in
violation of the Lanham Act, deceptive trade practices, unfair competition,
tortious interference with prospective business opportunities, trade libel and
disparagement.
On or about September 15,
2003, the Company filed a motion to dismiss the Red Hat complaint. The motion to dismiss asserted that Red Hat
lacks standing and that no case or controversy exists with respect to the
claims seeking a declaratory judgment of non-infringement. The motion to dismiss further asserted that
Red Hat’s claims under the Lanham Act and related state laws are barred by the
First Amendment to the U.S. Constitution and the common law privilege of
judicial immunity. On April 6,
2004, the court issued an order denying the Company’s motion to dismiss;
however, the court stayed the case and requested status reports every 90 days
regarding the case against IBM. Red Hat
has filed a motion for reconsideration.
No ruling has been issued on that motion. The Company intends to vigorously defend this
action.
76
Novell, Inc.
On January 20, 2004,
the Company filed suit in Utah state court against Novell, Inc. (“Novell”)
for slander of title seeking relief for its alleged bad faith effort to
interfere with the Company’s ownership of copyrights related to its UNIX source
code and derivative works and its UnixWare product. The case, after removal to federal court, is
pending in the United States District Court for the District of Utah, under the
caption The SCO Group, Inc. v. Novell, Inc., Civil No. 2:04CV00139. In the lawsuit, the Company requested
preliminary and permanent injunctive relief as well as damages. Through these claims, the Company seeks to
require Novell to assign to the Company all copyrights that it believes Novell
has wrongfully registered, prevent Novell from representing any ownership
interest in those copyrights and require Novell to retract or withdraw all
representations it has made regarding its purported ownership of those
copyrights.
Novell removed the case
to federal court and also filed a motion to dismiss the Company’s complaint
claiming that it had never transferred the copyrights to The Santa Cruz
Operation (now Tarantella, Inc.).
The Company filed a response to Novell’s motion to dismiss and has also
filed a motion to remand the case back to the state court. On June 10, 2004, the court issued a
memorandum decision and order which denied the Company’s motion to remand the
case to state court. The memorandum
decision also denied in part and granted in part Novell’s motion to
dismiss. The court granted Novell’s
motion to dismiss regarding the Company’s allegations of special damages, but
granted the Company 30 days leave to amend its complaint to plead special
damages with greater specificity. The
Company has filed its amended complaint and Novell has responded with another
motion to dismiss claiming, among other things, that Novell’s false statements
were not made with malice and are privileged under the law. That motion has been briefed by the parties
and is scheduled to be argued to the court on May 25, 2005. The Company intends to continue to vigorously
pursue its claims against Novell.
DaimlerChrysler Corporation
On or about March 3,
2004, the Company brought suit against DaimlerChrysler Corporation (“DaimlerChrysler”)
for its alleged violations of its UNIX license agreement with the Company. The lawsuit alleges that DaimlerChrysler
breached its UNIX software agreement by failing to provide an adequate or
timely certification of its compliance with that agreement as the Company
requested. The lawsuit, filed in Oakland
County Circuit Court in the State of Michigan, requests the court to declare
that DaimlerChrysler has violated the certification requirements of its UNIX
software agreement, permanently enjoin DaimlerChrysler from further violations
of the UNIX software agreement, issue a mandatory injunction requiring
DaimlerChrysler to remedy the effects of its past violations of the UNIX
software agreement and award the Company damages in an amount to be determined
at trial together with costs, attorneys’ fees and any such other or different
relief that the Court may deem to be equitable and just.
On April 15, 2004,
DaimlerChrysler filed a motion to dismiss the Company’s claims. DaimlerChrysler’s motion was heard on July 21,
2004, and the court granted DaimlerChrysler’s motion as to the substance of
DaimlerChrysler’s certification, but denied the motion as to whether the
certification was timely. Based on this
ruling, the Company filed a motion to stay the case pending the clarification
of certain issues in the IBM litigation.
The court denied the motion to stay.
Based on a stipulation of the parties, however, the court signed an
order of dismissal without prejudice.
The appellate court has dismissed the Company’s appeal of the July 21,
2004 ruling finding that the order was not a final, appealable order; the
Company is evaluating its options regarding the appellate court’s ruling.
AutoZone, Inc.
On or about March 2,
2004, the Company brought suit against AutoZone, Inc. (“AutoZone”) for its
alleged violations of the Company’s UNIX copyrights through its use of
Linux. The lawsuit alleges copyright
infringement by AutoZone by, among other things, running versions of the Linux
operating
77
system
that contain proprietary material from UNIX System V. The lawsuit, filed in United States District
Court in Nevada, requests injunctive relief against AutoZone’s further use or
copying of any part of the Company’s copyrighted materials and also requests damages
as a result of AutoZone’s infringement in an amount to be proven at trial. On April 23, 2004, AutoZone filed a
motion to transfer the case to Tennessee or to stay the case. On August 6, 2004, the federal court in
Nevada entered an order granting AutoZone’s motion to stay the case with 90-day
status reports to the court. The court
denied without prejudice AutoZone’s motion for a more definite statement and
its motion to transfer the case to Tennessee.
The court is allowing the parties to take limited expedited discovery
relating to the issue of preliminary injunctive relief. The Company is currently pursuing that
discovery and continuing to evaluate its claims in that regard.
IPO Class Action Matter
The Company is
an issuer defendant in a series of class action lawsuits involving over 300
issuers that have been consolidated under In re Initial Public Offering
Securities Litigation, 21 MC 92 (SAS).
The consolidated complaint alleges, among other things, certain
improprieties regarding the underwriters’ conduct during the Company’s initial
public offering and the failure to disclose such conduct in the registration
statement in violation of the Securities Act of 1933, as amended.
The
plaintiffs, the issuers and the insurance companies have negotiated an
agreement to settle the dispute between the plaintiffs and the issuers. All parties, including the plaintiffs,
issuers and insurance companies, have executed this settlement agreement and
the settlement agreement has been submitted to the court for approval. If the settlement agreement is approved by
the court, and if no cross-claims, counterclaims or third-party claims are
later asserted, this action will be dismissed with respect to the Company and
its directors.
The Company
has notified its underwriters and insurance companies of the existence of the
claims. Management believes, after
consultation with legal counsel, that the ultimate outcome of this matter will
not have a material adverse effect on the Company’s results of operations or
financial position and will not exceed the $200,000 self-insured retention
already paid or accrued by the Company.
Other
Matters
In April 2003,
a former Indian distributor of the Company filed a claim in India, requesting
summary judgment for payment of $1,428,000, and an order that the Company trade
in India only through the distributor and/or give a security deposit until the
claim is paid. The distributor claims
that the Company is responsible to repurchase certain software products and to
reimburse the distributor for certain other operating costs. The distributor additionally requested that
the Indian courts grant interim relief in the form of attachment of local
assets. Management does not believe that
the Company is responsible to reimburse the distributor for any operating costs
and also believes that the return rights related to any remaining inventory
have lapsed. Discovery has commenced and
hearings on the requests for interim relief have been held and are ongoing. The Company intends to vigorously defend this
action.
Pursuit and
defense of the above-mentioned matters will be costly, and management expects
the costs for legal fees and related expenses will be substantial. The ultimate outcome or potential effect on
the Company’s results of operations or financial position of the
above-mentioned matters is not currently known or determinable.
The Company is
a party to certain other legal proceedings arising in the ordinary course of
business including legal proceedings arising from its SCOsource initiatives. Management believes, after consultation with
legal counsel, that the ultimate outcome of such legal proceedings will not
have a material adverse effect on the Company’s results of operations or
financial position.
78
Operating Lease Agreements
The
Company has entered into operating leases for its offices located in the United
States and for international sales offices.
The Company has commitments under these leases that extend through
fiscal year 2010. Future minimum lease payments under
non-cancelable operating leases as of October 31, 2004 were as follows (in
thousands):
|
|
|
Operating
|
|
|
|
|
Leases
|
|
|
Year ending October 31,
|
|
|
|
|
2005
|
|
$
|
1,714
|
|
|
2006
|
|
1,578
|
|
|
2007
|
|
1,066
|
|
|
2008
|
|
294
|
|
|
2009
|
|
102
|
|
|
Thereafter
|
|
16
|
|
|
Total minimum payments
|
|
$
|
4,770
|
|
Total rent expense for
all of the Company’s operating leases were $3,097,000, $3,170,000 and
$3,799,000 for the years ended October 31, 2004, 2003 and 2002,
respectively.
Arrangement
with Law Firms
On
October 31, 2004, the Company entered into an engagement agreement (the “Engagement
Agreement”) with Boies, Schiller & Flexner LLP, Kevin McBride and
Berger Singerman (the “Law Firms”). This
Engagement Agreement supercedes and replaces the original engagement agreement
that was entered into in February 2003.
The Engagement Agreement governs the relationship between the Company
and the Law Firms in connection with their representation of the Company in the
Company’s current litigation between it and IBM, Novell, Red Hat, AutoZone and
DaimlerChrysler (the “SCO Litigation”).
The Company’s purpose in entering into the Engagement Agreement was to
limit the cash expenditures needed to pursue the above litigation. The Engagement Agreement provides for the
payment of approximately $26,000,000 for certain previously accrued expenses
totaling $13,906,000 as of October 31, 2004, and all future attorney fees
in connection with the SCO Litigation through the end of the current litigation
between the Company and IBM and the escrow of at least $5,000,000 for the
payment of any expert, consulting and other expenses. As of October 31, 2004, the $5,000,000
was classified as a component of restricted cash. The Company paid the $13,906,000 subsequent
to October 31, 2004.
Future legal fees
covered under the Engagement Agreement will require the Company to pay to the
Law Firms $2,000,000 per quarter for each successive quarter beginning September 1,
2004 and ending December 1, 2005 for a total amount of $12,000,000, of which
$10,000,000 will be paid in the year ending October 31, 2005. In the three months ending January 31,
2005, the Company made the quarterly payments for September 2004 as well
as December 2004 for a total of $4,000,000. The payment of these fees has had and will
continue to have a material impact on the Company’s cash position.
In
addition, the Company must also pay one or more contingency fees upon any
amount the Company or its stockholders may receive as a recovery from the
litigation, the Company’s intellectual property licensing or a sale of the
company. The contingency fee amounts
payable to the Law Firms will be, subject to certain credits and adjustments,
as follows:
• 33 percent of any aggregate recovery
amounts received up to $350,000,000;
79
• plus 25 percent of any aggregate recovery
amounts above $350,000,000 but less than or equal to $700,000,000;
• plus 20 percent of any aggregate recover
amounts in excess of $700,000,000.
The
Engagement Agreement specifically provides that, except for the compensation
obligations specifically described above, the Company will not be obligated to
pay any legal fees, whether hourly, contingent or otherwise, to the Law Firms,
or any other law firms that may be engaged by the Law Firms, in connection with
the Company’s SCO Litigation through the end of the current litigation between
it and IBM, including any appeals.
During the year ended October 31,
2003, the Company incurred $8,956,000 related to the prior arrangement as
contingency fees in connection with the issuance of shares of the Company’s Series A
Convertible Preferred Stock. This charge
consisted of a non-cash charge of $7,956,000 related to the issuance of 400,000
shares of the Company’s common stock and a $1,000,000 cash payment. As part of the consideration to be paid to
the Law Firms in connection with the Engagement Agreement, the Company agreed
to pay to the Law Firms $7,956,000 in lieu of issuing the 400,000 shares of
common stock. This payment was made
subsequent to October 31, 2004 and is included as accrued compensation to
law firms as of October 31, 2004.
Grants of Unregistered Stock Options; Potential
Interest and Penalties Related to Rescission Rights
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 have a
right to rescind their purchases of shares under the Equity Compensation Plans
or recover damages if they no longer own the shares or hold unexercised
options, subject to applicable statutes of limitations. Additionally, regulatory authorities may require
the Company to pay fines or impose other sanctions. Although the Company continues to evaluate
the possible actions it may take, the Company may make a rescission offer to
certain plan participants entitled to rescission rights subject to obtaining required
regulatory approvals.
The Company believes
certain of its stock option grants made since February 2003 may have also
violated applicable securities laws in California, Georgia and possibly other
states even though holders have not exercised such options. Although the Company is continuing to
evaluate its potential rescission risk to option holders, the Company is
considering making a rescission offer to certain option holders. Because the options in question have not been
exercised, no amounts are recorded in permanent equity. There are a number of factors that must be
considered in determining what a rescission offer to option holders may
involve. At the current time, the
Company is unable to determine and quantify all of the key factors for a potential
rescission offer.
The Company believes
that it is reasonably possible that some option holders may accept a rescission
offer, but the Company is unable to estimate the number of participants who
might accept a rescission offer and the amount of potential damages that it would
be required to pay under a rescission offer.
Since any loss is considered reasonably possible but not estimable, the
Company has not recorded a liability for this contingency.
The Company may also be
required to pay interest and penalties up to statutory limits in connection
with Plan participants making rescission claims or in connection with any
rescission offer. The Company believes
that it is reasonably possible that it may be required to pay interest and
penalties, but it is not able to estimate an amount.
80
(11)
SEVERANCE AND EXIT COSTS
Since fiscal year 2001,
the Company has undertaken significant restructuring activities to reduce its
ongoing cost of operations. All
restructurings that occurred prior to fiscal year 2003 were accounted for in
accordance with Emerging Issues Task Force (“EITF”) No. 94-3 “Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity.” For restructuring
activities initiated beginning with fiscal year 2003, the Company has accounted
for one-time termination benefits, contract termination costs and other
associated costs in accordance with SFAS No. 146 “Accounting for Costs
Associated with Exit or Disposal Activities.”
Other severance benefits under ongoing severance plans have been
accounted for in accordance with SFAS No. 112 “Employers’ Accounting for
Postemployment Benefits.” and SFAS No. 88 “Employers’ Accounting for
Settlements and Curtailments of Defined Benefit Plans and for Termination
Benefits.”
During the three months
ended April 30, 2004, the Company entered into a plan to reduce operating
expenses in its UNIX business and eliminated a total of 48 positions and closed
one facility. The total cost associated
with this activity was $682,000. During
the three months ended October 31, 2004, the Company entered into another
plan to reduce consolidated operating expenses.
Actions in this plan included eliminating a total of 50 positions and closing
certain international offices. The total
cost associated with this activity was $2,486,000.
Each of the Company’s
restructurings have required it to make estimates and assumptions related to
losses on vacated facilities, provisions for termination benefits, outplacement
costs, and other costs. The Company
records an accrual for any amounts associated with a restructuring that are not
paid in the current period and regularly evaluates the adequacy of the accruals
based on changes in estimates.
In connection with the
Company’s restructuring activities, the Company incurred the following (in
thousands):
|
Fiscal 2004
|
|
Balance at
November 1, 2003
|
|
Additions
|
|
Adjustments
|
|
Utilization
|
|
Balance at
October 31, 2004
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-time severance
|
|
$
|
—
|
|
$
|
309
|
|
$
|
—
|
|
$
|
(309
|
)
|
$
|
—
|
|
|
Ongoing severance and other
|
|
—
|
|
2,071
|
|
—
|
|
(1,670
|
)
|
401
|
|
|
Facilities
|
|
348
|
|
788
|
|
—
|
|
(1,136
|
)
|
—
|
|
|
Total
|
|
$
|
348
|
|
$
|
3,168
|
|
$
|
—
|
|
$
|
(3,115
|
)
|
$
|
401
|
|
|
Fiscal
2003
|
|
Balance
at
November 1, 2002
|
|
Additions
|
|
Adjustments
|
|
Utilization
|
|
Balance
at
October 31, 2003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-time severance
|
|
$
|
—
|
|
$
|
198
|
|
$
|
—
|
|
$
|
(198
|
)
|
$
|
—
|
|
|
Ongoing severance and other
|
|
560
|
|
1,388
|
|
(273
|
)
|
(1,675
|
)
|
—
|
|
|
Facilities
|
|
2,117
|
|
—
|
|
(815
|
)*
|
(954
|
)
|
348
|
|
|
Total
|
|
$
|
2,677
|
|
$
|
1,586
|
|
$
|
(1,088
|
)
|
$
|
(2,827
|
)
|
$
|
348
|
|
* The facilities adjustment of $815,000 was the
result of successfully negotiating out of lease commitments in connection with
the Company’s winding down of SCO Group, Ltd.
|
Fiscal 2002
|
|
Balance at
November 1, 2001
|
|
Additions
|
|
Adjustments
|
|
Utilization
|
|
Balance at
October 31, 2002
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Severance and other
|
|
$
|
692
|
|
$
|
4,053
|
|
$
|
—
|
|
$
|
(4,185
|
)
|
$
|
560
|
|
|
Facilities
|
|
2,052
|
|
4,236
|
|
(1,561
|
)*
|
(2,610
|
)
|
2,117
|
|
|
Total
|
|
$
|
2,744
|
|
$
|
8,289
|
|
$
|
(1,561
|
)
|
$
|
(6,795
|
)
|
$
|
2,677
|
|
81
*The facilities
adjustment of $1,561,000 was the result of successfully re-negotiating an
existing lease commitment.
Amounts to be paid for restructurings are recorded as accrued
liabilities. The $401,000 accrued as of October 31,
2004 is anticipated to be paid in the quarter ended January 31, 2005.
(12)
RELATED PARTY TRANSACTIONS
Canopy
As of October 31,
2004, the chairman of the Company’s board of directors was the president and
chief executive officer and a director of Canopy. Additionally, another director of the Company
was the chief financial officer of Canopy. As of October 31,
2004, Canopy owned approximately 31 percent of the Company’s issued and
outstanding common stock. As described in
more detail in Note 16, Canopy transferred all of its shares of common stock
effective March 11, 2005.
In connection with the
Company’s acquisition of Vultus (see Note 3), the Company assumed the
obligations of Vultus under two secured notes payable to Canopy totaling
$1,073,000. In connection with the
assumption of the notes payable to Canopy, Canopy agreed to accept the issuance
of approximately 138,000 shares of the Company’s common stock in full
satisfaction of the obligations. The
Company also issued Canopy approximately 37,000 shares of its common stock as
part of the purchase price for the acquisition.
Canopy
was a stockholder and significant debt holder of Vultus.
On April 30, 2003,
the Company and Center 7, Inc. (“C7”) entered into a Marketing and
Distribution Master Agreement (the “Marketing Agreement”) and an Assignment
Agreement. On October 2, 2003, C7
assigned the Assignment Agreement to Vintela, Inc. (“Vintela”) and Vintela
and the Company entered into a new marketing agreement (the “Vintela Agreement”). Both C7 and Vintela are majority owned by
Canopy. Under the Vintela Agreement, the
Company was appointed as a worldwide distributor for Vintela products to
co-brand, market and distribute these products.
Under the Assignment
Agreement, the Company assigned the copyright applications, patents and
contracts related to Volution Manager, Volution Authentication, Volution Online
and Volution Manager Update Service (collectively, the “Assigned Software”). As consideration for this assignment, C7
issued and Vintela assumed, a $500,000 non-recourse promissory note payable to
the Company, secured by the Assigned Software.
This note was originally due on April 30, 2005 with interest
payable at a rate of one percent above the prime rate as reported in the Wall
Street Journal.
In November 2004,
the Company and Vintela began discussions to cancel the Vintela Agreement and
to pay the promissory note early. On December 1,
2004, the Company agreed with Vintela, the successor to C7, to forego any interest
charges on the promissory note in return for an immediate payment of the
$500,000 and the cancellation of the Vintela Agreement. On December 9, 2004, the Company
received the $500,000 payment from Vintela and will record the transaction
during the three months ending January 31, 2005.
During the time the
Company was developing the Assigned Software, it had expensed all amounts for
its research and development efforts. As
a result, at the time the promissory note was executed, the Company had no recorded
basis in the Assigned Software. Because
the transfer of the Assigned Software was to a related party in exchange for a
promissory note and there was substantial doubt as to the ability of C7 to pay
the note, no gain was recognized by the Company until payment was received on December 9,
2004.
During 2002, the Company
entered into an operating lease agreement with Canopy for office space for its
headquarters in Utah. The lease extends
through December 2007 and the Company pays Canopy for rent and related
expenses. During the years ended October 31,
2004, 2003 and 2002, the Company paid Canopy approximately $657,000, $639,000
and $348,000, respectively, for this space.
82
(13)
EMPLOYEE BENEFIT PLAN
The
Company maintains a 401(k) plan through which eligible participants may elect
to make contributions to the plan, subject to certain limitations under the
Internal Revenue Code. Under the terms
of the plan, the Company may make discretionary matching contributions up to
predetermined limits to partially match employee contributions to the
plan. During the years ended October 31,
2004, 2003 and 2002, the Company contributed $217,000, $206,000 and $597,000,
respectively, to the plan for matching contributions.
(14)
CONCENTRATION OF RISK
As
of October 31, 2004 and 2003, the Company had no customers who made up
more than 10 percent of the ending accounts receivable balance.
During
the year ended October 31, 2004, the Company did not have any single
customer that accounted for more than 10 percent of total revenue.
During
the year ended October 31, 2003, two significant customers, Microsoft and
Sun, accounted for approximately 21 percent and 12 percent of the Company’s
revenue. During fiscal year 2002, no
single customer accounted for more than ten percent of the Company’s total
revenue.
(15) SEGMENT INFORMATION AND GEOGRAPHIC REGIONS
Segments
The Company’s resources
are allocated and operating results managed to the operating income (loss)
level for each of the Company’s segments: UNIX and SCOsource. Both segments are based on the Company’s UNIX
intellectual property. The UNIX business
sells and distributes UNIX products and services through an extensive
distribution channel and to corporate end-users and the SCOsource business
enforces and protects the Company’s UNIX intellectual property.
During fiscal year 2004,
in an effort to maximize the assets and resources of the UNIX and SCOsource
business segments and to best represent management’s view of business
operations, the Company directed resources and reviewed financial information
for its UNIX and SCOsource segments. The
following table presents the results of the SCOsource segment had it existed
during the year ended October 31, 2003.
All costs associated with the SCOsource segment were classified as cost
of revenue for the year ended October 31, 2003 and there were no direct
sales or marketing efforts for that year.
The SCOsource segment did not exist during the year ended October 31,
2002. Segment disclosures for the
Company are as follows (in thousands):
|
|
|
Year Ended October 31, 2004
|
|
|
|
|
UNIX
|
|
SCOsource
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
41,980
|
|
$
|
829
|
|
$
|
42,809
|
|
|
Cost of revenue
|
|
7,355
|
|
19,743
|
|
27,098
|
|
|
Gross margin (deficit)
|
|
34,625
|
|
(18,914
|
)
|
15,711
|
|
|
Sales and marketing
|
|
15,806
|
|
1,232
|
|
17,038
|
|
|
Research and development
|
|
10,126
|
|
486
|
|
10,612
|
|
|
General and administrative
|
|
7,385
|
|
241
|
|
7,626
|
|
|
Other
|
|
9,008
|
|
—
|
|
9,008
|
|
|
Total operating expenses
|
|
42,325
|
|
1,959
|
|
44,284
|
|
|
Loss from operations
|
|
$
|
(7,700
|
)
|
$
|
(20,873
|
)
|
$
|
(28,573
|
)
|
83
|
|
|
Year Ended October 31, 2003
|
|
|
|
|
UNIX
|
|
SCOsource
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
53,408
|
|
$
|
25,846
|
|
$
|
79,254
|
|
|
Cost of revenue
|
|
10,422
|
|
9,500
|
|
19,922
|
|
|
Gross margin
|
|
42,986
|
|
16,346
|
|
59,332
|
|
|
Sales and marketing
|
|
24,392
|
|
—
|
|
24,392
|
|
|
Research and development
|
|
11,012
|
|
—
|
|
11,012
|
|
|
General and administrative
|
|
6,230
|
|
—
|
|
6,230
|
|
|
Other
|
|
5,306
|
|
8,956
|
|
14,262
|
|
|
Total operating expenses
|
|
46,940
|
|
8,956
|
|
55,896
|
|
|
Income (loss) from operations
|
|
$
|
(3,954
|
)
|
$
|
7,390
|
|
$
|
3,436
|
|
|
|
|
Year
Ended October 31, 2002
|
|
|
|
|
UNIX
|
|
SCOsource
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
64,241
|
|
$
|
—
|
|
$
|
64,241
|
|
|
Cost of revenue
|
|
18,316
|
|
—
|
|
18,316
|
|
|
Gross margin
|
|
45,925
|
|
—
|
|
45,925
|
|
|
Sales and marketing
|
|
29,554
|
|
—
|
|
29,554
|
|
|
Research and development
|
|
17,558
|
|
—
|
|
17,558
|
|
|
General and administrative
|
|
9,307
|
|
—
|
|
9,307
|
|
|
Other
|
|
13,682
|
|
—
|
|
13,682
|
|
|
Total operating expenses
|
|
70,101
|
|
—
|
|
70,101
|
|
|
Loss from operations
|
|
$
|
(24,176
|
)
|
$
|
—
|
|
$
|
(24,176
|
)
|
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 October 31, 2004 (in thousands):
|
|
|
October 31,
2004
|
|
October 31,
2003
|
|
|
Intangible assets and goodwill:
|
|
|
|
|
|
|
UNIX (reseller channel, trade name and
Vultus technology)
|
|
$
|
4,740
|
|
$
|
8,276
|
|
|
SCOsource (UNIX technology)
|
|
673
|
|
1,010
|
|
|
Goodwill
|
|
—
|
|
1,166
|
|
|
Total intangible assets and goodwill
|
|
$
|
5,413
|
|
$
|
10,452
|
|
Geographic Regions
The Company’s two
geographic regions consist of the Americas and International. The International division consists of
operations in Europe and Asia. Any
financial amounts not directly attributable to either the Americas or
International geographic region are included in the corporate column. The following tables present the Company’s
results of operations by geographic region (in thousands):
84
|
|
|
Year
Ended October 31, 2004
|
|
|
|
|
Americas
|
|
International
|
|
Corporate
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
24,531
|
|
$
|
18,278
|
|
$
|
—
|
|
$
|
42,809
|
|
|
Cost of revenue
|
|
24,031
|
|
3,067
|
|
—
|
|
27,098
|
|
|
Gross margin
|
|
500
|
|
15,211
|
|
—
|
|
15,711
|
|
|
Sales and marketing
|
|
8,072
|
|
8,966
|
|
—
|
|
17,038
|
|
|
Research and development
|
|
6,215
|
|
4,397
|
|
—
|
|
10,612
|
|
|
General and administrative
|
|
4,077
|
|
3,549
|
|
—
|
|
7,626
|
|
|
Other
|
|
—
|
|
—
|
|
9,008
|
|
9,008
|
|
|
Total operating expenses
|
|
18,364
|
|
16,912
|
|
9,008
|
|
44,284
|
|
|
Loss from operations
|
|
$
|
(17,864
|
)
|
$
|
(1,701
|
)
|
$
|
(9,008
|
)
|
$
|
(28,573
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended October 31, 2003
|
|
|
|
|
Americas
|
|
International
|
|
Corporate
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
55,130
|
|
$
|
24,124
|
|
$
|
—
|
|
$
|
79,254
|
|
|
Cost of revenue
|
|
15,435
|
|
4,487
|
|
—
|
|
19,922
|
|
|
Gross margin
|
|
39,695
|
|
19,637
|
|
—
|
|
59,332
|
|
|
Sales and marketing
|
|
9,724
|
|
14,668
|
|
—
|
|
24,392
|
|
|
Research and development
|
|
6,200
|
|
4,812
|
|
—
|
|
11,012
|
|
|
General and administrative
|
|
3,513
|
|
2,717
|
|
—
|
|
6,230
|
|
|
Other
|
|
8,956
|
|
—
|
|
5,306
|
|
14,262
|
|
|
Total operating expenses
|
|
28,393
|
|
22,197
|
|
5,306
|
|
55,896
|
|
|
Income (loss) from operations
|
|
$
|
11,302
|
|
$
|
(2,560
|
)
|
$
|
(5,306
|
)
|
$
|
3,436
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year
Ended October 31, 2002
|
|
|
|
|
Americas
|
|
International
|
|
Corporate
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
32,973
|
|
$
|
31,268
|
|
$
|
—
|
|
$
|
64,241
|
|
|
Cost of revenue
|
|
11,160
|
|
7,156
|
|
—
|
|
18,316
|
|
|
Gross margin
|
|
21,813
|
|
24,112
|
|
—
|
|
45,925
|
|
|
Sales and marketing
|
|
12,837
|
|
16,717
|
|
—
|
|
29,554
|
|
|
Research and development
|
|
9,001
|
|
8,557
|
|
—
|
|
17,558
|
|
|
General and administrative
|
|
4,767
|
|
4,540
|
|
—
|
|
9,307
|
|
|
Other
|
|
—
|
|
—
|
|
13,682
|
|
13,682
|
|
|
Total operating expenses
|
|
26,605
|
|
29,814
|
|
13,682
|
|
70,101
|
|
|
Loss from operations
|
|
$
|
(4,792
|
)
|
$
|
(5,702
|
)
|
$
|
(13,682
|
)
|
$
|
(24,176
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-lived assets, which
include property and equipment, intangible assets and goodwill, by geographic
region consist of the following as of October 31, 2004 and October 31,
2003 (in thousands):
|
|
|
October 31,
2004
|
|
October 31,
2003
|
|
|
Long-lived assets:
|
|
|
|
|
|
|
Americas
|
|
$
|
5,953
|
|
$
|
11,234
|
|
|
International
|
|
109
|
|
366
|
|
|
Total long-lived assets
|
|
$
|
6,062
|
|
$
|
11,600
|
|
85
(16) SUBSEQUENT EVENTS
Change in Control Agreements
On
December 10, 2004, the
Company entered in Change in
Control Agreements with the following officers:
Darl C. McBride;
Bert B. Young; Christopher Sontag;
Jeff F. Hunsaker; and Ryan E. Tibbitts (each, an “Officer”). Each agreement is effective as of December 10,
2004.
Pursuant to the terms of
each Agreement, the Officer agrees that he or she will not voluntarily leave the
employ of the Company in the event any individual, corporation, partnership,
company or other entity takes certain steps to effect a Change in Control (as
defined in the Agreement) of the Company, until the attempt to effect a Change
in Control has terminated, or until a Change in Control occurs.
If the Officer is still
employed by the Company when a Change in Control occurs, any stock, stock
option or restricted stock granted to the Officer by the Company that would
have become vested upon continued employment by the Officer shall immediately
vest in full and become exercisable notwithstanding any provision to the
contrary of such grant and shall remain exercisable until it expires or
terminates in accordance with its terms.
Each Officer shall be
solely responsible for any taxes that arise or become due pursuant to the
acceleration of vesting that occurs pursuant to the Agreement.
Transfer of Stock Ownership by
Canopy to Ralph Yarro
Effective March 11,
2005, Canopy transferred all of its shares of the Company’s common stock to
Ralph Yarro, the Chairman of the Company’s Board of Directors.
86
THE SCO
GROUP, INC.
AND
SUBSIDIARIES
SCHEDULE II – VALUATION AND QUALIFYING ACCOUNTS
(in
thousands)
|
Description
|
|
Balance at
Beginning of
Period
|
|
Charged to
Costs and
Expenses
|
|
Deductions
|
|
Balance at End of
Period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts:
|
|
|
|
|
|
|
|
|
|
|
Year ended October 31, 2004
|
|
$
|
230
|
|
$
|
11
|
|
$
|
(105
|
)(a)
|
$
|
136
|
|
|
Year ended October 31, 2003
|
|
348
|
|
296
|
|
(414
|
)(a)
|
230
|
|
|
Year ended October 31, 2002
|
|
362
|
|
198
|
|
(212
|
)(a)
|
348
|
|
|
Inventory reserves:
|
|
|
|
|
|
|
|
|
|
|
Year ended October 31, 2004
|
|
19
|
|
59
|
|
(22
|
)(b)
|
56
|
|
|
Year ended October 31, 2003
|
|
115
|
|
—
|
|
(96
|
)(b)
|
19
|
|
|
Year ended October 31, 2002
|
|
269
|
|
18
|
|
(172
|
)(b)
|
115
|
|
|
Allowance for sales returns:
|
|
|
|
|
|
|
|
|
|
|
Year ended October 31, 2004
|
|
819
|
|
489
|
|
(1,050
|
)(c)
|
258
|
|
|
Year ended October 31, 2003
|
|
1,055
|
|
1,958
|
|
(2,194
|
)(c)
|
819
|
|
|
Year ended October 31, 2002
|
|
2,199
|
|
2,602
|
|
(3,746
|
)(c)
|
1,055
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) Represents
write-offs of uncollectible accounts receivable
(b) Represents
inventory destroyed or scrapped
(c) Represents
product returns
87
Item 9. Changes in and
Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and
Procedures
Under the supervision
and with the participation of our management, including our Chief Executive
Officer and Chief Financial Officer, we evaluated the effectiveness of the
design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based upon that evaluation, and subsequent
evaluations, the Chief Executive Officer and Chief Financial Officer concluded
that, as of the end of the period covered by this report and as a result of the
material weakness in our internal controls described below, our disclosure
controls and procedures were not
effective to ensure that information required to be disclosed by us in the
reports we file or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in applicable rules and
forms.
We have a material
weakness with respect to accounting for capital stock and stock option
transactions. We have issued certain
shares of our common stock under our equity compensation plans without
complying with the registration requirements of federal and applicable state
securities laws. As a result, the
holders of such shares may have a rescission right, and, consequently, certain
amounts the Company received upon purchase of such shares must be reclassified
from permanent equity to temporary equity.
As of October 31, 2004 we recorded temporary equity of $528,000 related
to certain shares of common stock issued under the Company’s equity
compensation plans that are subject to rescission. We determined that we lacked procedures to
reconcile shares issued with shares available under registration statements in
a timely manner.
In addition, we
incorrectly accounted for dividends on Series A Convertible Preferred
Stock by not recording dividends payable as of January 31, 2004 and April 30,
2004. We also incorrectly accounted for
compensation expense by not properly accounting for a non-routine stock option
grant to a non-employee. Neither of the
above mentioned matters impacted the financial statements as of and for the
year ended October 31, 2004. We
determined that we lacked resources with proper experience to review the
Company’s accounting for capital stock and stock option transactions.
Our internal controls
over financial reporting did not identify the preceding error prior to the
completion of the financial statements.
We have discussed these matters with the Audit Committee of the Board of
Directors and with KPMG LLP, our independent auditors. In response, we have implemented in our
internal control procedures additional detail transactional controls, an equity
compliance checklist and additional review and approval procedures.
During the most recent quarter ended October 31,
2004, there has been no change in our internal control over financial reporting
(as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange
Act) that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting. However, as discussed above, changes have
been implemented subsequent to the period covered by this Form 10-K to add
additional controls to correct the material weakness in internal control over
financial reporting.
Item 9B. Other
Information
None.
PART III
Item 10. Directors and
Executive Officers of the Registrant
Directors
88
Our Board of Directors currently consists of seven directors and has
one vacancy. Directors are elected at
each annual meeting of stockholders to serve until the next annual meeting of
stockholders or until their successors are duly elected and qualified. There are no family relationships among any
of our directors, officers or key employees.
The names of our directors, their ages and their respective business
backgrounds are set forth below.
|
Name
|
|
Position(s) With the Company
|
|
Age
|
|
Director
Since
|
|
Ralph
J. Yarro III
|
|
Chairman
of the Board of Directors and Director
|
|
40
|
|
1998
|
|
Edward
E. Iacobucci
|
|
Director
|
|
51
|
|
2000
|
|
R.
Duff Thompson
|
|
Director
|
|
54
|
|
2001
|
|
Darcy
G. Mott
|
|
Director
|
|
52
|
|
2002
|
|
Darl
C. McBride
|
|
Chief
Executive Officer, Director
|
|
45
|
|
2002
|
|
K.
Fred Skousen
|
|
Director
|
|
62
|
|
2003
|
|
Daniel
W. Campbell
|
|
Director
|
|
50
|
|
2003
|
Ralph J. Yarro III has served as the Chairman of the Board of Directors
of the Company since August 1998. Mr. Yarro
has served as an independent investor and business consultant since December 2004. Mr. Yarro previously served as the
President and Chief Executive Officer of The Canopy Group, Inc., a
management and resource company (“Canopy”), from August 1998 to December 2004. Mr. Yarro also served as a director of
Canopy from August 1998 to March 2005. Mr. Yarro holds a B.A. degree in
Political Science from Brigham Young University.
Edward E. Iacobucci has served as a member of the Board of Directors
since January 2000. In 1989, Mr. Iacobucci
co-founded Citrix Systems, Inc., a supplier of products and technologies
that enable enterprise-wide deployment of software applications, and held the
positions of Chief Technical Officer and Vice President of Strategy and
Technology. Mr. Iacobucci also
served as Chairman of the Board of Citrix from September 1991 to June 2000. Mr. Iacobucci holds a B.S. degree in
Systems Engineering from the Georgia Institute of Technology.
R. Duff Thompson has served as a member of the Board of Directors since
May 2001. Mr. Thompson has
served as a Managing General Partner of EsNet, Ltd., an investment group that
is active in both technology and real estate ventures, from 1996 to the
present. From June 1994 to January 1996,
Mr. Thompson served as Senior Vice President of the Corporate Development
Group of Novell, Inc. Prior to that
time, he served as Executive Vice President and General Counsel for WordPerfect
Corporation, and before joining WordPerfect Corporation in 1986, he was a
partner with the Salt Lake City law firm of Callister Duncan &
Nebeker. Mr. Thompson holds a B.S.
degree in Economics, a masters degree in Business Administration and a J.D.
degree, all from Brigham Young University.
Darcy G. Mott has served as a member of the Board of Directors since March of
2002. Mr. Mott has served as an
independent investor and business consultant since December 2004. Mr. Mott previously served as Vice
President, Treasurer and Chief Financial Officer of Canopy from May 1999
to December 2004. Mr. Mott is
a certified public accountant and holds a B.S. degree in Accounting from
Brigham Young University.
Darl C. McBride has served as the Company’s President and Chief
Executive Officer and as a member of the Board of Directors since June 2002. Before joining the Company, Mr. McBride
was the president of Franklin Covey Co.’s online planning business from May 2000
to May 2002. From April 1999
to July 2000, Mr. McBride was the CEO of Pointserve. From November 1997 to August 1998, Mr. McBride
was the Chairman, President and CEO of SBI.
From February 1996 to October 1997, Mr. McBride served
89
as the Senior Vice President of IKON Office Solutions. From 1988 to 1996, Mr. McBride held
several positions at Novell, Inc. and concluded his service as Vice
President and General Manager of Novell’s Embedded Systems Division
(NEST). Mr. McBride holds a B.S.
degree from Brigham Young University and received a masters degree in Labor &
Industrial Relations from the University of Illinois at Urbana-Champaign.
K. Fred Skousen has served as a
member of the Company’s Board of Directors since June 2003. He has served as Advancement Vice President
at Brigham Young University since May 1998. From September 1989 until May 1998,
he was Dean of the Marriott School of Management and, prior to that, Director
of the School of Accountancy at Brigham Young University. Mr. Skousen has been a consultant to the
Financial Executive Research Foundation, the Controller General of the United
States, the Federal Trade Commission and to several large companies. Mr. Skousen has been a visiting
professor at the University of California, Berkeley, and University of
Missouri, as well as a faculty resident on the staff of the Securities and
Exchange Commission and a faculty fellow at Price Waterhouse &
Co. Mr. Skousen is a certified
public accountant and has a B.S. degree in Accounting from Brigham Young
University and has M.A.S. and Ph.D. degrees in Accounting from the University
of Illinois.
Daniel W. Campbell has served as a member of the Company’s Board of
Directors since November 2003. Mr. Campbell
has served as a Managing General Partner of EsNet, Ltd., an investment group
that is active in both technology and real estate ventures, from July 1994
to the present. From 1992 to July 1994,
Mr. Campbell worked at WordPerfect Corporation as Senior Vice President
and Chief Financial Officer. Prior to
that, Mr. Campbell was a partner with Price Waterhouse, an international
accounting firm. Mr. Campbell also
serves as a director of Nu Skin Enterprises, Inc., where he is the
Chairman of the Audit Committee. Mr. Campbell
received an Accounting degree from Brigham Young University in 1979.
Affirmative Determinations Regarding Director
Independence
The Board of Directors has determined each of the following directors
to be an “independent director” as such term is defined in Marketplace Rule 4200(a)(15)
of the National Association of Securities Dealers (the “NASD”): Edward E. Iacobucci, R. Duff Thompson, K.
Fred Skousen and Daniel W. Campbell.
Audit Committee
We have an Audit Committee which assists the Board in the oversight of
our financial statements, legal compliance, qualifications of independent
auditors, and engagement and oversight of our independent auditors. The Audit Committee acts pursuant to a
written charter adopted by the Board.
The members of the Audit Committee are Messrs. Campbell (Committee
Chair), Thompson and Skousen. The Audit Committee has determined that Mr. Campbell
and Mr. Skousen are audit committee financial experts, as such term is
defined in Item 401(h) of Regulation S-K promulgated by the Securities and
Exchange Commission. All members of the
Audit Committee are independent directors.
Executive Officers
The
following table presents information regarding the current executive officers
of the Company:
|
Name
|
|
Age
|
|
Position
|
|
|
|
|
|
|
|
Darl
C. McBride
|
|
45
|
|
Chief
Executive Officer, Director
|
|
Bert B. Young
|
|
50
|
|
Chief
Financial Officer
|
|
Christopher
Sontag
|
|
41
|
|
Sr.
Vice President Business Development
|
|
Jeff
F. Hunsaker
|
|
39
|
|
Sr.
Vice President and General Manager, UNIX Division
|
|
Ryan
E. Tibbitts
|
|
49
|
|
General
Counsel and Corporate Secretary
|
90
Set forth below is the business background of each of our executive
officers. Information on the business
background of Darl C. McBride is set forth above under the caption “Directors.”
Bert B. Young has served as Chief Financial Officer since April 2004. Mr. Young is responsible for all
finance, accounting, and administration of our worldwide operations. From November 2002 to April 2004, Mr. Young
worked as Chief Financial Officer at LANDesk Software Inc. and from September 2000
to November 2002 was the Chief Financial Officer of Talk2 Technology
Inc. Prior to that, Mr. Young was
the Chief Financial Officer at marchFIRST Inc.
Mr. Young holds a B.S. degree in Accounting from Utah State
University.
Christopher Sontag has served as Senior Vice President, Business
Development, since January 2005 and prior to that was the Senior Vice
President of our SCOsource Division since September 2002. From April 2000 to October 2002, Mr. Sontag
was the President of Sontag Consulting.
From January 1996 to April 2000, Mr. Sontag was the
co-founder, President and Chief Technology Officer of emWare, Inc. Before his service at emWare, Mr. Sontag
developed marketing and engineering strategies for Novell, Inc., where he
worked as the Director of Marketing and Product Development. Mr. Sontag earned a B.S. degree in
Information Management from Brigham Young University.
Jeff F. Hunsaker has served as Senior Vice President and General
Manager, UNIX Division, since January 2004. From February 2003 to December 2003,
Mr. Hunsaker served as Senior Vice President of Worldwide Sales and Marketing
for the Company and prior to that Mr. Hunsaker served as Vice President
and General Manager, Americas Division, from January 2000 to January 2003. Upon joining the Company, Mr. Hunsaker
was the Sales Director for North America from January 2000 to January 2001. From January 1998 to December 1999,
Mr. Hunsaker was Director of Channel Sales for the Baan Company. Prior to that, Mr. Hunsaker spent eight
years working in a senior sales and marketing capacity for the WordPerfect
suite of products for WordPerfect Corporation, Novell, Inc. and Corel
Corporation. Mr. Hunsaker holds a
B.S. degree in Business Finance from Utah State University.
Ryan E. Tibbitts joined the Company in June 2003 as General
Counsel and became the Corporate Secretary in September 2003. Mr. Tibbitts is responsible for all
legal aspects of the Company’s worldwide operations. Prior to joining the Company, Mr. Tibbitts
worked as General Counsel at Center 7, Inc. from October 2001 to June 2003
and Lineo, Inc. from January 2001 to September 2001. Mr. Tibbitts worked in private practice
with a law firm in Utah from 1985 until 2001.
Mr. Tibbitts is a member of the Utah State Bar and American Bar
Association and received his J.D. and B.S. degrees from Brigham Young
University.
Section 16(a) Beneficial
Ownership Reporting and Compliance
Section 16(a) of the Securities Exchange Act of 1934, as
amended, requires our directors and officers, and persons who own more than ten
percent of a registered class of our equity securities, to file with the
Securities and Exchange Commission initial reports of ownership and reports of
changes in ownership of our equity securities.
Officers, directors, and greater than ten percent stockholders are
required to furnish us with copies of all Section 16(a) forms they
file. We believe that during the year
ended October 31, 2004, all reporting persons complied with all applicable
filing requirements, with the exception that each of the following reporting
persons filed one Form 4 after the required filing date with respect to
one transaction for each: Steven M.
Cakebread, Ryan E. Tibbitts, Edward E. Iacobucci, Darcy G. Mott, Thomas P.
Raimondi, R. Duff Thompson and Ralph J. Yarro III.
91
Code of Ethics
We have adopted a code of ethics that applies to all employees,
including employees of our subsidiaries, as well as each member of the
Board. The code of ethics is available at
our website at:
http://www.sco.com/images/company/SCO_Code_of_Conduct_and_Ethics_Policy-Final.pdf.
Item 11.
Executive Compensation
The following table presents compensation information for our last
three fiscal years for our Chief Executive Officer and our four most highly
compensated executive officers other than our Chief Executive Officer.
Summary Compensation Table
|
|
|
|
|
|
|
|
|
Long-Term Compensation
|
|
|
|
|
|
|
Annual
|
|
Awards
|
|
|
|
Payouts
|
|
|
|
|
|
|
|
|
Compensation(1)
|
|
|
|
Securities
|
|
|
|
|
|
|
|
|
Year
|
|
Salary
|
|
Bonus /
Commission
|
|
Restricted
Stock awards
|
|
Underlying
Options
|
|
LTIP
Payouts
|
|
All Other
Compensation
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Darl C. McBride(2)
|
|
2004
|
|
$
|
257,498
|
|
$
|
35,000
|
|
$
|
—
|
|
—
|
|
$
|
—
|
|
$
|
—
|
|
|
Chief Executive Officer
|
|
2003
|
|
230,769
|
|
755,278
|
|
78,511
|
|
200,000
|
|
—
|
|
—
|
|
|
|
|
2002
|
|
80,525
|
|
—
|
|
—
|
|
600,000
|
|
—
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bert B. Young(3)
|
|
2004
|
|
$
|
84,346
|
|
$
|
30,000
|
|
$
|
—
|
|
150,000
|
|
—
|
|
—
|
|
|
Chief Financial Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Christopher Sontag(4)
|
|
2004
|
|
$
|
160,000
|
|
$
|
20,000
|
|
$
|
—
|
|
—
|
|
—
|
|
—
|
|
|
Sr. Vice President,
|
|
2003
|
|
153,000
|
|
281,746
|
|
64,340
|
|
100,000
|
|
|
|
|
|
|
Business Development
|
|
2002
|
|
6,231
|
|
—
|
|
—
|
|
110,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Jeff F. Hunsaker(5)
|
|
2004
|
|
$
|
160,000
|
|
$
|
133,981
|
|
$
|
—
|
|
—
|
|
—
|
|
—
|
|
|
Sr. Vice President,
|
|
2003
|
|
142,889
|
|
95,932
|
|
—
|
|
100,000
|
|
|
|
|
|
|
UNIX Division
|
|
2002
|
|
147,922
|
|
88,084
|
|
21,980
|
|
38,750
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ryan E. Tibbitts(6)
|
|
2004
|
|
$
|
130,384
|
|
$
|
50,000
|
|
$
|
—
|
|
110,000
|
|
—
|
|
—
|
|
|
General Counsel and
|
|
2003
|
|
45,153
|
|
13,500
|
|
2,500
|
|
65,000
|
|
|
|
|
|
|
Corporate Secretary
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) The
column for “Other Annual Compensation” has been omitted because there is no
compensation required to be reported in that column. The aggregate amount of perquisites and other
personal benefits provided to each executive officer listed above is less than
the lesser of $50,000 and ten percent of the named executive officer’s total
annual salary and bonus.
(2) Mr. McBride
was hired as our President and Chief Executive Officer in June 2002. With respect to 200,000 options issued to Mr. McBride
during fiscal year 2002, vesting commences five years after the date of grant,
subject to acceleration of vesting if certain performance objectives are
achieved. One such objective was our
becoming profitable before the fourth quarter of fiscal year 2003, which in
fact occurred. Accordingly, Mr. McBride
is now vested as to 50,000 shares related to such grant. The bonus of $35,000 earned by Mr. McBride
in fiscal year 2004 was paid during fiscal year 2005. Of the $755,278 bonus earned by Mr. McBride
in fiscal year 2003, $480,134 was paid during fiscal year 2003 and the
remaining $275,144 was paid during fiscal year 2004.
(3) Mr. Young
was hired as the Company’s Chief Financial Officer in April 2004. The bonus of $30,000 earned by Mr. Young
in fiscal year 2004 was paid during fiscal year 2005.
92
(4) Mr. Sontag
was hired as the Company’s Senior Vice President and General Manager,
SCOsource, in September 2002. The bonus of $20,000 earned by Mr. Sontag
in fiscal year 2004 was paid during fiscal year 2005. Of the $281,746 bonus earned by Mr. Sontag
in fiscal year 2003, $181,590 was paid during fiscal year 2003 and the
remaining $100,156 was paid during fiscal year 2004.
(5) Of
the $133,981 in commission earned by Mr. Hunsaker in fiscal year 2004,
$82,177 was paid during fiscal year 2004 and the remaining $51,804 was paid
during fiscal year 2005. Of the $95,932
commission earned by Mr. Hunsaker in fiscal year 2003, $76,820 was paid
during fiscal year 2003 and the remaining $19,112 was paid during fiscal year
2004.
(6) Mr. Tibbitts
was hired as our General Counsel in June 2003 and became the Corporate Secretary
in September 2003. The bonus of
$50,000 earned by Mr. Tibbitts in fiscal year 2004 was paid during fiscal
year 2005. Of the $13,500 bonus earned
by Mr. Tibbitts in fiscal year 2003, $7,500 was paid during fiscal year
2003. The remaining $6,000 was paid
during fiscal year 2004.
Option Grants in Last Fiscal Year
The following table presents the grants of stock options, under our
option plans during fiscal year 2004, to each of the executive officers named
in the Summary Compensation Table.
All option grants under each of the plans are nonqualified stock
options. Options expire ten years from
the date of grant.
The exercise price of each option granted is equal to the fair market
value of our common stock as determined by the Board of Directors on the date
of grant. In fiscal year 2004, we
granted to our employees options to purchase a total of 939,000 shares of our
common stock.
Potential realizable values are computed by:
• Multiplying
the number of shares of common stock subject to a given option by the exercise
price per share;
• Assuming
that the aggregate option exercise price derived from that calculation
compounds at the annual five percent or ten percent rates shown in the table
for the entire 10-year term of the option; and
• Subtracting
the aggregate option exercise price from that result.
The five percent and ten percent assumed annual rates of
stock price appreciation are required by the rules of the Securities and
Exchange Commission and do not represent our estimate or projection of future
common stock prices.
|
|
|
Number of
Securities
Underlying
|
|
Percent
of Total
Options
Granted to
|
|
Exercise
Price Per
|
|
|
|
Potential Realizable Value at Assumed
Annual Rates of Stock Price
Appreciation for Option Term
|
|
|
|
|
Options
Granted(1)
|
|
Employees in
Fiscal Year
|
|
Share
($/Share)
|
|
Expiration
Date
|
|
|
|
|
|
|
|
|
|
0%
|
|
5%
|
|
10%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Darl C. McBride
|
|
—
|
|
0
|
%
|
—
|
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bert B. Young
|
|
150,000
|
|
19.0
|
%
|
$
|
7.18
|
|
4/19/2014
|
|
$
|
—
|
|
$
|
677,320
|
|
$
|
1,760,461
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Christopher Sontag
|
|
—
|
|
0
|
%
|
—
|
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Jeff F. Hunsaker
|
|
—
|
|
0
|
%
|
—
|
|
—
|
|
$
|
—
|
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ryan E. Tibbitts
|
|
100,000
|
|
12.7
|
%
|
$
|
4.05
|
|
7/26/2014
|
|
$
|
—
|
|
$
|
254,702
|
|
$
|
645,466
|
|
|
|
|
10,000
|
|
1.3
|
%
|
5.05
|
|
5/25/2014
|
|
$
|
—
|
|
$
|
31,759
|
|
$
|
80,483
|
|
93
(1) Unless
otherwise provided in an award agreement, all options granted become exercisable with respect to 25 percent
of the shares covered thereby on the first anniversary of the date of grant and
vest 1/36th per month thereafter. Options are granted for a term
of ten years, subject to earlier termination in certain events, and are not
transferable. The Compensation Committee
retains discretion, subject to certain restrictions, to modify the terms of
outstanding options.
On December 8, 2004, each of the above
named executive officers received an option grant to acquire common shares at
an exercise price of $4.85 per share. Mr. McBride
received a grant of 100,000 shares; Mr. Young received a grant of 150,000
shares; Mr. Sontag received a grant of 25,000 shares; Mr. Hunsaker
received a grant of 25,000 shares; and Mr. Tibbitts received a grant of
150,000 shares.
Aggregated Option Exercises in
Fiscal Year 2004 and Year-end Option Values
|
|
|
Shares Acquired
on Exercise
|
|
Value
Realized
|
|
Number of Shares
Underlying
Unexercised Options at
October 31, 2004
|
|
Value of Unexercised
In-the-Money Options at
October 31, 2004
|
|
|
|
|
|
Exercisable
|
|
Unexercisable
|
|
Exercisable
|
|
Unexercisable
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Darl C. McBride
|
|
—
|
|
$
|
—
|
|
362,499
|
|
437,501
|
|
$
|
701,040
|
|
$
|
812,960
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bert B. Young
|
|
—
|
|
$
|
—
|
|
—
|
|
150,000
|
|
$
|
—
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Christopher Sontag
|
|
—
|
|
$
|
—
|
|
94,583
|
|
115,417
|
|
$
|
139,421
|
|
$
|
158,379
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Jeff F. Hunsaker
|
|
—
|
|
$
|
—
|
|
108,969
|
|
24,781
|
|
$
|
121,254
|
|
$
|
32,521
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ryan E. Tibbitts
|
|
—
|
|
$
|
—
|
|
20,104
|
|
154,896
|
|
$
|
—
|
|
$
|
—
|
|
Director
Compensation
The
compensation and benefits for service as a member of the Board of Directors is
determined by the Nominations Committee.
Directors employed by us or one of our subsidiaries are not compensated
for service on the Board or on any Committee of the Board. Our non-employee directors currently receive
$25,000 for each year of service as a director plus an additional $5,000 per
year for each committee of the Board on which such non-employee directors
serve. Additionally, the chairpersons of
each of the Compensation Committee and the Nominations Committee receive an
additional $5,000 per year and the chairpersons of each of the Audit Committee
and the Litigation Oversight Committee receive an additional $10,000 per
year. In addition, Board members are
reimbursed for expenses incurred in connection with attendance at Board and
committee meetings. Non-employee
directors also receive stock option awards under the our stock option plans,
which awards currently include an initial option to purchase 45,000 shares of
common stock upon joining the Board as a director and thereafter each
non-employee director who continues to serve on the Board automatically
receives an annual grant of an option to acquire 15,000 shares upon his or her
election at the annual meeting.
Employment
Agreements
The Company has not entered into any employment
agreements with its executive officers or any other employees.
94
Change in Control Agreements
On December 10,
2004, we entered into Change in Control Agreements with the following
officers: Darl C. McBride; Bert B. Young;
Christopher Sontag; Jeff F. Hunsaker; and Ryan E. Tibbitts (each, an “Officer”). Each agreement is effective as of December 10,
2004.
Pursuant to the terms of
these agreements, each Officer agrees that he or she will not voluntarily leave
the employ of our company in the event any individual, corporation,
partnership, company or other entity takes certain steps to effect a change in
control of our company, until the attempt to effect a change in control has
terminated, or until a change in control occurs.
If the Officer is still
employed by us when a change in control occurs, any stock, stock option or
restricted stock granted to the Officer by us that would have become vested
upon continued employment by the Officer shall immediately vest in full and
become exercisable notwithstanding any provision to the contrary of such grant
and shall remain exercisable until it expires or terminates in accordance with
its terms.
Each Officer shall be
solely responsible for any taxes that arise or become due pursuant to the
acceleration of vesting that occurs pursuant to the Change in Control
Agreement.
Compensation
Committee Interlocks and Insider Participation
The
members of the Compensation Committee for our last fiscal year were Messrs. Mott,
Iacobucci, and Thompson. None of the
members of our Compensation Committee has at any time been an officer or
employee of us or any of our subsidiaries or parent. None of our executive officers currently
serves or in the past year has served as a member of the board of directors or
compensation committee of any entity that has one or more executive officers
serving on our Board or Compensation Committee.
Compensation Committee Report on Executive Compensation
It
is the duty of the Compensation Committee to review and determine the salaries,
bonuses and equity compensation of executive officers of the Company, including
the Chief Executive Officer, and to establish the general compensation policies
for such individuals. The Compensation
Committee also has the authority to make discretionary option grants to the
Company’s executive officers under the 1999, 2002 and 2004 Omnibus Stock
Incentive Plans. In November 2004,
Thomas P. Raimondi, Jr. resigned as a director and a member of the
Compensation Committee. In February 2005,
R. Duff Thompson, a director, replaced Mr. Raimondi as a member of the
Compensation Committee.
The
Compensation Committee believes that the compensation programs for the Company’s
executive officers should reflect the Company’s performance and the value
created for its stockholders. In
addition, the compensation programs should support the short-term and long-term
strategic goals and values of the Company and should reward individual contribution
to the Company’s success. The Company is
engaged in a very competitive industry, and the Company’s success depends upon
its ability to attract and retain qualified executives through competitive
compensation packages.
General Compensation Policy. The Compensation Committee’s
policy is to provide the Company’s executives with compensation opportunities
that are based upon their personal performance, the financial performance of
the Company and their contribution to that performance and that are competitive
enough to attract and retain highly skilled individuals. Each executive’s compensation package is
comprised of three elements: (i) base
salary that is competitive with the market and reflects individual performance;
(ii) quarterly and annual performance awards tied to the Company’s
attainment of financial performance objectives; and (iii) long-term
stock-based incentive awards designed to strengthen the mutuality of interests
between the executives and it’s the Company’s stockholders. As an executive’s level of responsibility
increases, a greater proportion of his or her total compensation is tied to the
Company’s financial performance and stock price appreciation rather than base
salary.
95
Factors. The principal factors that were taken into
account in establishing each executive officer’s compensation package for the
2004 fiscal year are described below.
However, the Compensation Committee has reserved the ability to exercise
its discretion in applying entirely different factors, such as different
measures of financial performance, for future fiscal years.
Base Salary. The base salary levels for the executive
officers were established for the 2004 fiscal year on the basis of the
following factors: personal performance
and experience and the estimated salary levels in effect for similar positions
within and outside the Company’s industry with which the Company competes for
executive talent and internal comparability considerations. The Compensation Committee made its decision
as to the appropriate market level of base salary for each executive officer on
the basis of its understanding of the salary levels in effect for similar
positions at those companies with which the Company competes for executive talent. In completing this analysis, the Compensation
Committee reviewed national and regional independent executive compensation
surveys for technology companies. The
Compensation Committee reviews executive base salaries at least annually and
makes adjustments in accordance with the factors indicated above.
Quarterly and Annual Performance Awards.
Certain executives (other than the Chief Executive Officer, whose
quarterly and annual performance awards are described below under “CEO
compensation”) were eligible to earn quarterly and annual performance awards
based on (i) operating results for the Company’s UNIX division, (ii) management
of the Company’s intellectual property litigation and (iii) objectives
related to simplifying the Company’s capital structure. During the 2004 fiscal year, the Company’s
executives (other than the Chief Executive Officer) received quarterly and
annual performance awards of approximately $234,000, based on the attainment of
the corporate objectives specified for each executive.
Equity Incentives. Executives have received equity incentives from stock option grants
and restricted stock awards under the 1999, 2002 and 2004 Omnibus Stock
Incentive Plans. The grants and awards
have been designed to align the interests of each executive officer with those
of the stockholders and provide each executive with a significant incentive to
manage the Company from the perspective of an owner with an equity stake in the
business. Each grant allows the executive
to acquire shares of the Company’s common stock at a fixed price per share (the
market price of the grant date) over a specified period of time (up to ten
years). The shares subject to each
option vest in installments, contingent upon the executive officer’s continued
employment with the Company.
Accordingly, each award provides a return to the executive only if the
executive remains employed by the Company during the applicable vesting period,
and then only if the market price of the underlying shares appreciates over the
option term.
The
Compensation Committee sets the number of shares subject to each option grant
or restricted stock award at a level intended to create a meaningful
opportunity for stock ownership based on (i) the executive’s current
position with the Company, (ii) the base salary associated with the
position, (iii) the size of comparable awards made to individuals in
similar positions within the industry, and (iv) the executive’s personal
performance in recent periods. The
Compensation Committee also takes into account the executive’s existing
holdings of the Company’s common stock and the number of vested and unvested
option shares exercisable by the executive in order to maintain an appropriate
level of equity incentive to keep the executives’ interests aligned with the
Company’s stockholders.
During
fiscal year 2004, the Compensation Committee did not grant equity awards to
executives except for (i) a stock option grant to an executive who was
hired during such fiscal year and (ii) a stock option grant to another
executive in response to such executive’s increased responsibilities assumed
during such fiscal year. However, in the
first quarter of fiscal year 2005, the Compensation Committee granted stock
options for a total of 350,000 shares of the Company’s common stock to
executives (other than the Chief Executive Officer) upon an analysis of the
executives’ current equity holdings in the
96
Company
and the vesting status of their equity awards to maintain alignment of
interests with the Company’s stockholders.
CEO Compensation. In reviewing and setting the total
compensation of the Company’s Chief Executive Officer for the 2004 fiscal year,
the Compensation Committee sought to make that compensation competitive, while
at the same time assuring that a significant percentage of compensation was
tied to the Company’s performance. The
Compensation Committee reviewed the national and regional compensation surveys
described above for chief executive officers of comparable software companies
to determine an appropriate compensation level.
During fiscal year 2004, the base salary for Darl McBride, the Company’s
Chief Executive Officer, was $257,498. Mr. McBride
received an annual performance bonus of $35,000 for fiscal year 2004 that was
paid in the first quarter of fiscal year 2005.
Mr. McBride earned this bonus as a result of attaining specific
objectives focused on the Company’s intellectual property litigation being
managed effectively, resolving and simplifying the Company’s capital structure
and restoring the Company’s UNIX division to operating profitability.
Mr. McBride
did not receive an option grant in fiscal year 2004. However, in the first quarter of fiscal year
2005, he was awarded an option to purchase 100,000 shares of the Company’s
common stock at an exercise price of $4.85 per share. This option vests over
four years, although vesting accelerates upon a change in control of the
Company. As was the case for the other
executives, this award was determined based upon Mr. McBride’s current
equity holdings in the Company and related vesting to maintain alignment of his
interests with the stockholders generally.
Change in Control Agreements. As described in more detail
under the section above of Part III, Item 11, entitled “Change in
Control Agreements,” the Company entered into Change in Control Agreements with
its executives including Mr. McBride.
The Change in Control Agreements provide that if an executive remains
employed by the Company when a change in control of the Company occurs, the
vesting will accelerate of any unvested tock, stock option or any restricted
stock granted to the executive. The
Company’s purpose in entering into the Change in Control Agreements was to
attempt to increase the alignment of the interests of the executives with the
interests of the Company’s stockholders in connection with any potential change
in control of the Company.
Compliance with Internal Revenue Code Section 162(m). Section 162(m)
of the Internal Revenue Code disallows a tax deduction to publicly held
companies for compensation paid to certain of their executive officers, to the
extent that compensation exceeds $1 million per covered officer in any fiscal
year. The limitation applies only to
compensation which is not considered to be performance-based. Non-performance based compensation paid to
the Company’s executive officers for the 2004 fiscal year did not exceed the $1
million limit per officer, and the Compensation Committee does not anticipate
that the non-performance based compensation to be paid to the Company’s
executive officers for fiscal year 2005 will exceed that limit. The Company’s 1999, 2002 and 2004 Omnibus
Stock Incentive Plans have been structured so that any compensation deemed paid
in connection with the exercise of option grants made under that plan with an
exercise price equal to the fair market value of the options shares on the
grant date will qualify as performance-based compensation which will not be
subject to the $1 million limitation.
Because it is unlikely that the cash compensation payable to any of the
Company’s executive officers in the foreseeable future will approach the $1
million limit, the Compensation Committee has decided at this time not to take
any action to limit or restructure the elements of cash compensation payable to
the Company’s executive officers. The
Compensation Committee will reconsider this decision should the individual
non-performance based cash compensation of any executive officer ever approach
the $1 million level.
It
is the opinion of the Compensation Committee that the executive compensation
policies and plans provide the necessary total remuneration program to properly
align the Company’s performance and the interest of its stockholders through the
use of competitive and equitable executive compensation in a balanced and
reasonable manner, for both the short- and long-term.
97
|
|
Submitted
by:
|
|
|
Darcy
Mott (chair)
|
|
|
Edward
E. Iacobucci
|
|
|
R.
Duff Thompson
|
|
|
Members
of the Compensation Committee
|
Stock Performance
The
following graph shows a comparison of cumulative total stockholder return on
the Company’s common stock, based on the market price of our common stock,
assuming reinvestment of dividends, with the cumulative total return on The
Nasdaq Stock Market (U.S.) Index as reported by Media General Financial
Services and the MG Group Index for internet software and services as reported
by Media General Financial Services for the period beginning March 21,
2000 (the date of the Company’s initial public offering) through October 31,
2004.
Assumes $100 Invested on March 21, 2000
Assumes Dividend Reinvested
Fiscal Year Ending October 31, 2004
|
|
|
3/21/00
|
|
10/31/00
|
|
10/31/01
|
|
10/31/02
|
|
10/31/03
|
|
10/31/04
|
|
|
The SCO Group, Inc.
|
|
100.00
|
|
11.89
|
|
1.02
|
|
1.11
|
|
14.35
|
|
2.53
|
|
|
MG Group Index
|
|
100.00
|
|
44.01
|
|
11.80
|
|
9.42
|
|
19.63
|
|
21.49
|
|
|
NASDAQ Market Index
|
|
100.00
|
|
73.50
|
|
36.86
|
|
29.66
|
|
43.07
|
|
44.02
|
|
Item 12.
Security Ownership of Certain Beneficial Owners and Management
The following table sets
forth, as of March 15, 2005, the number of shares of common stock held of
record or beneficially by each person who held of record, or who had the right
to acquire shares of common stock within 60 days, or was known by us to own
beneficially, more than five percent of our common stock, and the name and
holdings of each director and named executive officer and of all executive
officers and directors as a group.
98
|
Name of Person or Group
|
|
Number of Shares
Beneficially Owned
|
|
Percent of
Class
|
|
|
|
|
|
|
|
|
|
Principal Stockholders:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ralph J.
Yarro III
355 South 520 West
Suite 100
Lindon, Utah 84042
|
|
5,629,355
|
(1)
|
31.4
|
%
|
|
|
|
|
|
|
|
|
BayStar
Capital II, LLP
80 East Sir Francis Drake Blvd.
Suite 2B
Larkspur, California 94939
|
|
1,746,453
|
|
9.7
|
%
|
|
|
|
|
|
|
|
|
Royce &
Associates, LLC
1414 Avenue of the Americas
New York, NY 10019
|
|
1,299,700
|
|
7.3
|
%
|
|
|
|
|
|
|
|
|
Capital
Guardian Trust Company
11100 Santa Monica Boulevard
Los Angeles, CA 90025
|
|
1,459,900
|
|
8.1
|
%
|
|
|
|
|
|
|
|
|
Named Executive Officers And Directors:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ralph J. Yarro III
|
|
5,629,355
|
(1)
|
31.4
|
%
|
|
|
|
|
|
|
|
|
Edward E. Iacobucci
|
|
121,923
|
(2)
|
*
|
|
|
|
|
|
|
|
|
|
Darcy G. Mott
|
|
93,799
|
(3)
|
*
|
|
|
|
|
|
|
|
|
|
R. Duff Thompson
|
|
76,923
|
(4)
|
*
|
|
|
|
|
|
|
|
|
|
K. Fred Skousen
|
|
30,000
|
(5)
|
*
|
|
|
|
|
|
|
|
|
|
Daniel W. Campbell
|
|
30,000
|
(6)
|
*
|
|
|
|
|
|
|
|
|
|
Darl C. McBride
|
|
456,217
|
(7)
|
2.4
|
%
|
|
|
|
|
|
|
|
|
Bert B. Young
|
|
0
|
(8)
|
*
|
|
|
|
|
|
|
|
|
|
Christopher Sontag
|
|
128,863
|
(9)
|
*
|
|
|
|
|
|
|
|
|
|
Jeff F. Hunsaker
|
|
147,094
|
(10)
|
*
|
|
|
|
|
|
|
|
|
|
Ryan E. Tibbitts
|
|
32,666
|
(11)
|
*
|
|
|
|
|
|
|
|
|
|
All Officers and Directors as a Group (11
Persons)
|
|
6,746,840
|
(12)
|
37.7
|
%
|
* Does not exceed one percent.
(1) Consists
of options to purchase 97,500 shares of common stock, 10,000 shares of common
stock acquired through an open-market purchase, 175 shares of common stock, 28,846
shares of common stock received for service on the Board, and 5,492,834 shares
of common stock previously held by The Canopy Group, Inc. (“Canopy”). On March 11, 2005, Canopy transferred
all of its shares of our common stock to Mr. Yarro.
(2) Consists
of options to purchase 85,000 shares of common stock, 10,000 shares of common
stock acquired through an open-market purchase and 26,923 shares of common
stock received for service on the Board.
(3) Consists
of 337 shares of common stock, options to purchase 60,000 shares of common
stock and 33,462 shares of common stock received for service on the Board.
(4) Consists
of options to purchase 60,000 shares of common stock and 16,923 shares of
common stock received for service on the Board.
99
(5) Consists
of options to purchase 30,000 shares of common stock.
(6) Consists
of options to purchase 30,000 shares of common stock.
(7) Consists
of 7,003 shares of restricted common stock, 8,000 shares of common stock
acquired in an open-market purchase, 3,615 shares of common stock acquired
through our Employee Stock Purchase Plan, 100 shares of common stock, and
options to purchase 437,499 shares of common stock.
(8) Mr. Young
received an option to acquire 150,000 shares on April 20, 2004 at an
exercise price of $7.18 per share.
(9) Consists
of 5,739 shares of restricted common stock and options to purchase 123,124
shares of common stock.
(10) Consists
of 15,000 shares of restricted common stock, 3,189 shares of common stock
acquired through our Employee Stock Purchase Plan, and options to purchase 128,905
shares of common stock.
(11) Consists
of 223 shares of restricted common stock, 2,485 shares of common stock acquired
through our Employee Stock Purchase Plan, 1,000 shares of common stock acquired
in open market purchases prior to joining the Company, and options to purchase 28,958
shares of common stock.
(12) See
notes (1) through (11) as applicable.
Item 13. Certain Relationships
and Related Transactions
Other than the transactions described below, during fiscal year 2004
there has not been, nor is there currently proposed, any transaction or series
of similar transactions to which we were or will be a party:
• in
which the amount exceeds $60,000; and
• in
which any director, executive officer, holder of more than five percent of our
common stock or any member of their immediate family had or will have a direct
or indirect material interest.
The Canopy Group, Inc.
As of October 31,
2004, Ralph J. Yarro III, the Chairman of our Board, was the President and
Chief Executive Officer and a director of Canopy. Additionally, another of our directors, Darcy
G. Mott, was the Chief Financial Officer of Canopy. As of October 31,
2004, Canopy owned approximately 31 percent of our issued and outstanding
common stock. As described elsewhere in
this Form 10-K, on March 11, 2005 Canopy transferred all of its
shares of our common stock to Mr. Yarro.
Additionally, in December 2004, Mr. Yarro’s and Mr. Mott’s
employment at Canopy terminated.
In connection with our
acquisition of Vultus, we assumed the obligations of Vultus under two secured
notes payable to Canopy totaling $1,073,000.
In connection with the assumption of the notes payable to Canopy, Canopy
agreed to accept the issuance of approximately 138,000 shares of our common
stock in full satisfaction of the obligations.
We also issued Canopy approximately 37,000 shares of its common stock as
part of the purchase price for the acquisition.
Canopy
was a stockholder and significant debt holder of Vultus.
On April 30, 2003,
we entered into a Marketing and Distribution Master Agreement (the “Marketing
Agreement”) and an Assignment Agreement with Center 7, Inc. (“C7”). On October 2, 2003, C7 assigned the
Assignment Agreement to Vintela, Inc. (“Vintela”) and we entered into a
new marketing agreement with Vintela (the “Vintela Agreement”). Both C7 and Vintela are majority owned by
Canopy.
100
Under the Vintela Agreement, we were appointed
as a worldwide distributor for Vintela products to co-brand, market and
distribute these products.
Under the Assignment
Agreement, we assigned the copyright applications, patents and contracts
related to Volution Manager, Volution Authentication, Volution Online and
Volution Manager Update Service (collectively, the “Assigned Software”). As consideration for this assignment, C7
issued and Vintela assumed, a $500,000 non-recourse promissory note payable to
us, secured by the Assigned Software.
This note was originally due on April 30, 2005 with interest
payable at a rate of one percent above the prime rate as reported in the Wall
Street Journal.
In November 2004,
we began discussions with Vintela to cancel the Vintela Agreement and to pay
the promissory note early. On December 1,
2004, we agreed with Vintela, the successor to C7, to forego any interest
charges on the promissory note in return for an immediate payment of the
$500,000 and the cancellation of the Vintela Agreement. On December 9, 2004, we received the
$500,000 payment from Vintela and will record the transaction during the three
months ending January 31, 2005.
During the time we were
developing the Assigned Software, it had expensed all amounts for its research
and development efforts. As a result, at
the time the promissory note was executed, we had no recorded basis in the
Assigned Software. Because the transfer
of the Assigned Software was to a related party in exchange for a promissory
note and there was substantial doubt as to the ability of C7 to pay the note,
no gain was recognized by us until payment was received on December 9,
2004.
During
2002, we entered into an operating lease agreement with Canopy for office space
for its headquarters in Utah. The lease
extends through December 2007 and we pay Canopy for rent and related
expenses. During the years ended October 31,
2004, 2003 and 2002, we paid Canopy approximately $657,000, $639,000 and
$348,000, respectively, for this space.
Item 14. Principal Accounting Fees and Services
The
following table presents fees for professional audit services rendered by KPMG
LLP for the audit of our annual financial statements for the fiscal years
ending October 31, 2004 and October 31, 2003 and fees billed for
other services rendered by KPMG LLP during those periods (in thousands):
|
|
|
2004
|
|
2003
|
|
|
Audit fees(1)
|
|
$
|
393
|
|
$
|
185
|
|
|
Audit-related fees(2)
|
|
94
|
|
69
|
|
|
Tax fees(3)
|
|
101
|
|
52
|
|
|
All other fees(4)
|
|
95
|
|
—
|
|
|
Total
|
|
$
|
683
|
|
$
|
306
|
|
(1) Audit Fees consist of fees billed for the annual
audits and quarterly reviews.
(2) Audit-Related Fees consist of fees billed for
various SEC filings and accounting research.
(3) Tax
Fees consist of fees billed for tax consultation and assistance in the
preparation of tax returns.
(4) All other fees principally include fees for the
preparation of statutory accounts for the Company’s international subsidiaries.
The
Audit Committee pre-approved all audit, audit-related and non-audit services
performed by our independent auditors and subsequently reviewed the actual fees
and expenses paid to KPMG. The Audit
Committee has determined that the fees paid to KPMG for non-audit services are
compatible with maintaining KPMG’s independence as our auditors.
101
PART IV.
(a) The following documents are filed as part of
this report:
(1) Consolidated Financial Statements: See Index to Consolidated Financial
Statements at Item 8 on page 50 of this report.
(2) Financial Statement Schedule: See Index to Consolidated Financial
Statements at Item 8 on page 50 of this report.
(3) Exhibits are incorporated herein by reference or
are filed with this report as indicated below:
|
Exhibit Number
|
|
Description
|
|
|
|
|
|
2.1
|
|
Agreement and Plan of Reorganization by and
among Caldera Systems, Inc., Caldera International, Inc., now known
as The SCO Group, Inc. (the “Registrant”), and The Santa Cruz
Operation, Inc., and related amendments (incorporated by reference to
Exhibit 2.1 to the Registrant’s Registration Statement on Form S-4
(File No. 333-45936)).
|
|
3.1
|
|
Amended and Restated Certificate of
Incorporation of Caldera International, Inc. (incorporated by reference
to Exhibit 3.1 to the Registrant’s Registration Statement on Form 8-A12G/A
(File No. 000-29911)).
|
|
3.2
|
|
Certificate of Amendment to Amended and
Restated Certificate of Incorporation regarding consolidation of outstanding
shares (incorporated by reference to Exhibit 3.2 to the Registrant’s
Registration Statement on Form 8-A12G/A (File No. 000-29911)).
|
|
3.3
|
|
Certificate of Amendment to Amended and
Restated Certificate of Incorporation regarding change of name to The SCO
Group, Inc. (incorporated by reference to Exhibit 3.3 to the
Registrant’s Registration Statement on Form 8-A12G/A (File No. 000-29911)).
|
|
3.4
|
|
Amended and Restated Bylaws (incorporated by
reference to Exhibit 3.4 to the Registrant’s Registration Statement on
Form 8-A12G/A (File No. 000-29911)).
|
|
3.5
|
|
Certificate of Designation of Series A
Junior Participating Preferred Stock (incorporated by reference to
Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on
September 1, 2004 (File No. 000-29911)).
|
|
3.6
|
|
Certificate of Correction correcting the
Certificate of Designation of Series A Junior Participating Preferred
Stock (incorporated by reference to Exhibit 4.2 to the Registrant’s
Current Report on Form 8-K filed on September 1, 2004 (File
No. 000-29911)).
|
|
4.1
|
|
Specimen Common Stock Certificate
(incorporated by reference to Exhibit 4.1 to the Registrant’s
Registration Statement on Form 8-A12G/A (File No. 000-29911)).
|
|
4.2
|
|
Rights Agreement dated as of August 10,
2004 by and between the Company and Computershare Trust Company, Inc.
(incorporated by reference to Exhibit 4.3 to the Registrant’s Current
Report on Form 8-K filed on September 1, 2004 (File No. 000-29911)).
|
|
10.1
|
|
1998 Stock Option Plan (incorporated by
reference to Exhibit 10.3 to the Registrant’s Registration Statement on
Form S-1 (File No. 333-94351)).
|
|
10.2
|
|
Amendment No. 1 to 1998 Stock Option
Plan.
|
|
10.3
|
|
Form Notice of Grant of Stock Options for
1998 Stock Option Plan.
|
|
10.4
|
|
1999 Omnibus Stock Incentive Plan, as amended
(incorporated by reference
|
102
|
|
|
to Exhibits 10.4 through 10.8 of the
Registrant’s Registration Statement on Form S-4 (File No. 333-45936)).
|
|
10.5
|
|
Amendment No. 5 to 1999 Omnibus Stock
Incentive Plan.
|
|
10.6
|
|
Amendment No. 6 to 1999 Omnibus Stock
Incentive Plan.
|
|
10.7
|
|
Form Notice of Grant of Stock Options for
1999 Omnibus Stock Incentive Plan.
|
|
10.8
|
|
2000 Employee Stock Purchase Plan, as amended
(incorporated by reference to Exhibit 10.9 to the Registrant’s Registration
Statement on Form S-4 (File No. 333-45936)).
|
|
10.9
|
|
Amendment No. 2 to 2000 Employee Stock
Purchase Plan.
|
|
10.10
|
|
Amendment No. 3 to 2000 Employee Stock
Purchase Plan.
|
|
10.11
|
|
Amendment No. 4 to 2000 Employee Stock
Purchase Plan (incorporated by reference to Exhibit 10.2 to the
Registrant’s Quarterly Report on Form 10-Q for the fiscal quarter ended
July 31, 2003 (File No. 000-29911)).
|
|
10.12
|
|
2002 Omnibus Stock Incentive Plan
(incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly
Report on Form 10-Q for the fiscal quarter ended July 31, 2003
(File No. 000-29911)).
|
|
10.13
|
|
Form Notice of Grant of Stock Options for
2002 Omnibus Stock Incentive Plan.
|
|
10.14
|
|
Office Sublease Agreement by and among the
Registrant, Canopy Properties, Inc. and Gateway Technology Center, LLC,
dated January 10, 2002 (incorporated by reference to Exhibit 10.6
to the Registrant’s Annual Report on Form 10-K for the fiscal year ended
October 31, 2003 (File No. 000-29911)).
|
|
10.15
|
|
First Amendment to Office Sublease Agreement
by and among the Registrant and Canopy Properties, Inc., dated
September 15, 2003 (incorporated by reference to Exhibit 10.7 to
the Registrant’s Annual Report on Form 10-K for the fiscal year ended
October 31, 2003 (File No. 000-29911)).
|
|
10.16
|
|
Engagement Letter by and among the Registrant
and Morgan Keegan & Company, Inc., dated August 16, 2002
(incorporated by reference to Exhibit 10.8 to the Registrant’s Annual
Report on Form 10-K for the fiscal year ended October 31, 2003
(File No. 000-29911)).
|
|
10.17
|
|
First Amendment to Engagement Letter by and
among the Registrant and Morgan Keegan & Company, Inc., dated
February 13, 2003 (incorporated by reference to Exhibit 10.9 to the
Registrant’s Annual Report on Form 10-K for the fiscal year ended
October 31, 2003 (File No. 000-29911)).
|
|
10.18
|
|
Second Amendment to Engagement Letter by and
among the Registrant and Morgan Keegan & Company, Inc., dated
August 16, 2003 (incorporated by reference to Exhibit 10.10 to the
Registrant’s Annual Report on Form 10-K for the fiscal year ended
October 31, 2003 (File No. 000-29911)).
|
|
10.19
|
|
Warrant to Purchase Shares of Common Stock
issued by the Registrant to Morgan Keegan & Company, Inc.,
dated August 16, 2002 (incorporated by reference to Exhibit 10.11
to the Registrant’s Annual Report on Form 10-K for the fiscal year ended
October 31, 2003 (File No. 000-29911)).
|
|
10.20
|
|
Common Stock Warrant issued by the Registrant
to, and accepted and agreed to by, Sun Microsystems, Inc., dated
March 11, 2003 (incorporated by reference to Exhibit 10.12 to the
Registrant’s Annual Report on Form 10-K for the fiscal year ended
October 31, 2003 (File No. 000-29911)).
|
|
10.21
|
|
Common Stock Warrant issued by the Registrant
to, and accepted and agreed to by, Sun Microsystems, Inc., dated
July 31, 2003 (incorporated by reference to Exhibit 10.13 to the
Registrant’s Annual Report on Form 10-K
|
103
|
|
|
for the fiscal year ended October 31,
2003 (File No. 000-29911)).
|
|
10.22
|
|
Common Stock Warrant issued by the Registrant
to, and accepted and agreed to by, Sun Microsystems, Inc., dated
October 31, 2003 (incorporated by reference to Exhibit 10.14 to the
Registrant’s Annual Report on Form 10-K for the fiscal year ended
October 31, 2003 (File No. 000-29911)).
|
|
10.23
|
|
Independent Contractor Agreement by and among
the Registrant and S2 Strategic Consulting, LLC, dated July 1, 2003
(incorporated by reference to Exhibit 10.15 to the Registrant’s Annual
Report on Form 10-K for the fiscal year ended October 31, 2003
(File No. 000-29911)).
|
|
10.24
|
|
Common Stock Warrant issued by the Registrant
to, and accepted and agreed to by, S2 Strategic Consulting, LLC, dated
July 1, 2003 (incorporated by reference to Exhibit 10.16 to the
Registrant’s Annual Report on Form 10-K for the fiscal year ended
October 31, 2003 (File No. 000-29911)).
|
|
10.25
|
|
Severance Agreement between Ransom H. Love and
Caldera International, Inc. (incorporated by reference to
Exhibit 10.16 to the Registrant’s Annual Report on Form 10-K for the
fiscal year ended October 31, 2002 (File No. 000-29911)).
|
|
10.26
|
|
Securities Purchase Agreement dated as of
October 16, 2003 between the Registrant and the persons listed therein
as Purchasers (incorporated by reference to Exhibit 10.1 to the
Registrant’s Current Report on Form 8-K filed on October 17, 2003
(File No. 000-29911)).
|
|
10.27
|
|
Registration Rights Agreement dated as of
October 16, 2003 between the Registrant and the persons listed therein
as Purchasers (incorporated by reference to Exhibit 10.2 to the
Registrant’s Current Report on Form 8-K filed on October 17, 2003
(File No. 000-29911)).
|
|
10.28
|
|
Letter Agreement dated December 8, 2003
among the Registrant, BayStar Capital II, L.P., Royal Bank of Canada and
Acknowledged by Boies, Schiller & Flexner LLP (incorporated by
reference to Exhibit 99.3 to the Registrant’s Current Report on
Form 8-K filed on December 9, 2003 (File No. 000-29911)).
|
|
10.29
|
|
Asset Purchase Agreement dated June 6,
2003 between the Registrant and Vultus, Inc. (incorporated by reference
to Exhibit 2.1 to Amendment No. 1 to the Registrant’s Registration
Statement on Form S-3 (File No. 333-106885)).
|
|
10.30
|
|
Exchange Agreement dated as of
February 5, 2004 among SCO, BayStar Capital II, L.P. and Royal Bank of
Canada (incorporated by reference to Exhibit 99.1 to SCO’s Current
Report on Form 8-K filed on February 9, 2004 (File No. 000-29911)).
|
|
10.31
|
|
Stock Repurchase Agreement dated as of
May 31, 2004 between the Registrant and BayStar (incorporated by
reference to Exhibit 99.1 to the Registrant’s Current Report on
Form 8-K filed on June 2, 2004 (File No. 000-29911)).
|
|
10.32
|
|
Letter Agreement dated October 31, 2004
among Boies, Schiller & Flexner LLP, Kevin McBride, Berger Singerman
and SCO (incorporated by reference to Exhibit 99.1 to the Registrant’s
Current Report on Form 8-K filed on November 4, 2004 (File
No. 000-29911)).
|
|
10.33
|
|
Summary of Director Compensation.
|
|
10.34
|
|
2004 Omnibus Stock Incentive Plan.
|
|
10.35
|
|
Form Notice of Grant of Stock Options for
2004 Omnibus Stock Incentive Plan.
|
|
21.1
|
|
Subsidiaries of the Registrant.
|
104
|
23.1
|
|
Consent of KPMG LLP, Independent Registered
Public Accounting Firm.
|
|
31.1
|
|
Certification of Darl C. McBride, President
and Chief Executive Officer, pursuant to Rule 13a-14(a) of the
Securities Exchange Act, as adopted pursuant Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
31.2
|
|
Certification of Bert B. Young, Chief
Financial Officer, pursuant to Rule 13a-14(a) of the Securities
Exchange Act, as adopted pursuant Section 302 of the Sarbanes-Oxley Act
of 2002.
|
|
32.1
|
|
Certification of Darl C. McBride, President
and Chief Executive Officer, pursuant to Section 1350, Chapter 63 of
Title 18, United States Code, as adopted pursuant Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
32.2
|
|
Certification of Bert B. Young, Chief
Financial Officer, pursuant to Section 1350, Chapter 63 of Title 18,
United States Code, as adopted pursuant Section 906 of the
Sarbanes-Oxley Act of 2002.
|
105
Signatures
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused the report to be signed on its
behalf by the undersigned, thereunto duly authorized, on April 1, 2005.
|
|
THE SCO GROUP, INC.
|
|
|
|
|
|
|
By:
|
/s/ Bert B. Young
|
|
|
|
|
Bert B. Young
|
|
|
|
Chief Financial
Officer
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant and in
the capacities and on the dates indicated.
|
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
|
|
Principal Executive Officer:
|
|
|
|
|
|
|
|
|
|
|
|
/s/ Darl C. McBride
|
|
President, Chief Executive
|
|
April 1, 2005
|
|
Darl C. McBride
|
|
Officer and Director
|
|
|
|
|
|
|
|
|
|
Principal Financial
and
Accounting Officer:
|
|
|
|
|
|
|
|
|
|
|
|
/s/ Bert B. Young
|
|
Chief Financial Officer
|
|
April 1, 2005
|
|
Bert B. Young
|
|
|
|
|
|
|
|
|
|
|
|
Additional
Directors:
|
|
|
|
|
|
|
|
|
|
|
|
/s/ Ralph J. Yarro III
|
|
Chairman of the Board
|
|
April 1, 2005
|
|
Ralph J. Yarro III
|
|
|
|
|
|
|
|
|
|
|
|
/s/ Darcy G. Mott
|
|
Director
|
|
April 1, 2005
|
|
Darcy G. Mott
|
|
|
|
|
|
|
|
|
|
|
|
/s/ Edward E. Iacobucci
|
|
Director
|
|
April 1, 2005
|
|
Edward E. Iacobucci
|
|
|
|
|
|
|
|
|
|
|
|
/s/ R. Duff Thompson
|
|
Director
|
|
April 1, 2005
|
|
R. Duff Thompson
|
|
|
|
|
|
|
|
|
|
|
|
/s/ K. Fred Skousen
|
|
Director
|
|
April 1, 2005
|
|
K. Fred Skousen
|
|
|
|
|
|
|
|
|
|
|
|
/s/ Daniel W. Campbell
|
|
Director
|
|
April 1, 2005
|
|
Daniel W. Campbell
|
|
|
|
|
106