SCO GROUP INC - 10-Q Quarterly Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)

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

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended April 30, 2005

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)

Delaware		87-0662823
(State or other jurisdiction of		(I.R.S. Employer Identification Number)
incorporation or organization)

355 South 520 West

Suite 100

Lindon, Utah 84042

(Address of principal executive offices and zip code)

(801) 765-4999

(Registrant’s telephone number, including area code)

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

YES ý NO o

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

YES o NO ý

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

The SCO Group, Inc.

Table of Contents

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

THE SCO GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands)

	April 30,			October 31,
	2005			2004
	(unaudited)
ASSETS

CURRENT ASSETS:
Cash and cash equivalents	$	8,145		$	12,693
Restricted cash	7,974			8,283
Available-for-sale securities	6,047			18,756
Accounts receivable, net of allowance for doubtful accounts of $149 and $136, respectively	6,325			6,638
Other current assets	2,288			1,870
Total current assets	30,779			48,240

PROPERTY AND EQUIPMENT:
Computer and office equipment	2,025			2,991
Leasehold improvements	390			406
Furniture and fixtures	29			103
	2,444			3,500
Less accumulated depreciation and amortization	(1,865		)	(2,851		)
Net property and equipment	579			649

OTHER ASSETS:
Intangibles, net	4,060			5,413
Other assets	1,134			1,098
Total other assets	5,194			6,511

Total assets	$	36,552		$	55,400

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Accounts payable	$	1,424		$	7,854
Payable to Novell, Inc.	4,007			3,283
Accrued compensation to law firms	—			7,956
Accrued payroll and benefits	2,761			3,369
Accrued liabilties	3,606			3,855
Deferred revenue	4,896			4,877
Other royalties payable	309			354
Taxes payable	1,287			1,279
Total current liabilities	18,290			32,827

LONG-TERM LIABILITIES	342			343

COMMITMENTS AND CONTINGENCIES (Note 5)

COMMON STOCK SUBJECT TO RESCISSION (Note 6)	851			528

STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value; 45,000 shares authorized, 18,208 and 17,956 shares outstanding, respectively	18			18
Additional paid-in capital	246,528			246,273
Common stock held in treasury; 290 shares, respectively	(2,414		)	(2,414		)
Warrants outstanding	1,099			1,099
Deferred compensation	—			(22		)
Accumulated other comprehensive income	977			964
Accumulated deficit	(229,139		)	(224,216		)
Total stockholders' equity	17,069			21,702

Total liabilities and stockholders' equity	$	36,552		$	55,400

See accompanying notes to consolidated financial statements.

THE SCO GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(in thousands, except per share data)

	Three Months Ended April 30,						Six Months Ended April 30,
	2005			2004			2005			2004
	(unaudited)						(unaudited)
REVENUE:
Products	$	7,838		$	8,415		$	15,142		$	18,127
SCOsource licensing	30			11			100			31
Services	1,390			1,711			2,881			3,371
Total revenue	9,258			10,137			18,123			21,529

COST OF REVENUE:
Products	563			818			1,207			1,623
SCOsource licensing (inclusive of amortization of intangibles of $84, $83, $167, and $166, respectively)	2,889			4,567			6,382			8,090
Services	746			1,073			1,495			2,395
Total cost of revenue	4,198			6,458			9,084			12,108

GROSS MARGIN	5,060			3,679			9,039			9,421

OPERATING EXPENSES:
Sales and marketing (exclusive of stock-based compensation of $7, $29, $14, and $47, respectively)	2,963			4,698			5,900			9,719
Research and development (exclusive of stock-based compensation of $0, $12, $8, and $23, respectively)	2,117			2,868			4,197			5,575
General and administrative (exclusive of stock-based compensation of $0, $122, $0, and $528, respectively)	2,036			1,710			3,799			3,904
Loss on impairment of long-lived assets	—			2,139			—			2,139
Severance and exit costs	—			682			—			682
Amortization of intangibles	593			593			1,186			1,380
Stock-based compensation	7			163			22			598
Total operating expenses	7,716			12,853			15,104			23,997

LOSS FROM OPERATIONS	(2,656		)	(9,174		)	(6,065		)	(14,576		)

EQUITY IN INCOME OF AFFILIATE	17			37			70			74

OTHER INCOME (EXPENSE):
Interest income	98			242			135			512
Change in fair value of derivative	—			2,300			—			5,924
Other income (expense), net	702			(120		)	1,174			(251		)
Total other income (expense), net	800			2,422			1,309			6,185

LOSS BEFORE INCOME TAXES	(1,839		)	(6,715		)	(4,686		)	(8,317		)

PROVISION FOR INCOME TAXES	(123		)	(966		)	(237		)	(1,094		)

NET LOSS	(1,962		)	(7,681		)	(4,923		)	(9,411		)

DIVIDENDS ON REDEEMABLE CONVERTIBLE PREFERRED STOCK	—			(7,045		)	—			(7,801		)

NET LOSS APPLICABLE TO COMMON STOCKHOLDERS	$	(1,962	)	$	(14,726	)	$	(4,923	)	$	(17,212	)

BASIC AND DILUTED NET LOSS PER COMMON SHARE	$	(0.11	)	$	(1.04	)	$	(0.28	)	$	(1.23	)

WEIGHTED AVERAGE BASIC AND DILUTED COMMON SHARES OUTSTANDING	17,913			14,100			17,831			13,960

OTHER COMPREHENSIVE LOSS
Net loss	$	(1,962	)	$	(7,681	)	$	(4,923	)	$	(9,411	)
Unrealized gain (loss) on available-for-sale securities	12			(99		)	9			(118		)
Foreign currency translation adjustment	(58		)	138			4			148
COMPREHENSIVE LOSS	$	(2,008	)	$	(7,642	)	$	(4,910	)	$	(9,381	)

See accompanying notes to consolidated financial statements.

THE SCO GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Six Months Ended April 30,
	2005			2004
	(unaudited)

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(4,923	)	$	(9,411	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of intangibles	1,353			1,546
Depreciation and amortization	184			435
Stock-based compensation	22			598
Loss on impairment of long-lived assets	32			2,139
Equity in income of affiliates	(70		)	(74		)
Change in fair value of derivative	—			(5,924		)
Changes in operating assets and liabilities:
Restricted cash	1,033			—
Accounts receivable, net	313			2,471
Other current assets	(418		)	(81		)
Other assets	34			(201		)
Accounts payable	(6,430		)	853
Accrued payroll and benefits	(608		)	(884		)
Compensation to law firms	(7,956		)	(2,600		)
Accrued liabilities	(249		)	3,371
Deferred revenue	19			2,053
Other royalties payable	(45		)	(214		)
Taxes payable	8			690
Other long-term liabilities	(1		)	27
Net cash used in operating activities	(17,702		)	(5,206		)

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment	(145		)	(186		)
Purchase of available-for-sale securities	(8,200		)	(41,234		)
Proceeds from available-for-sale securities	20,909			5,025
Purchase of minority interest in Japanese subsidiary	—			(209		)
Net cash provided by (used in) investing activities	12,564			(36,604		)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock through employee stock purchase program	373			370
Proceeds from exercise of common stock options	205			559
Offering costs incurred in connection with Series A-1 issuance	—			(212		)
Purchase of common stock	—			(2,414		)
Net cash provided by financing activities	578			(1,697		)

EFFECT OF FOREIGN EXCHANGE RATES ON CASH	12			121
NET DECREASE IN CASH AND CASH EQUIVALENTS	(4,560		)	(43,507		)
CASH AND CASH EQUIVALENTS, beginning of period	12,693			64,428
CASH AND CASH EQUIVALENTS, end of period	$	8,145		$	21,042

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

Cash paid for taxes	$	248		$	274

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:

Dividend in connection with exchange of Series A-1 for Series A shares	$	—		$	6,305

Accretion of dividends	$	—		$	1,496

Common stock subject to rescission	$	323		$	188

See accompanying notes to consolidated financial statements.

THE SCO GROUP, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) ORGANIZATION AND DESCRIPTION OF BUSINESS

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

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

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

(2) SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

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

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

Use of Estimates in the Preparation of Financial Statements

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

Revenue Recognition

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

The Company recognizes product revenue upon shipment if a signed contract exists, the fee is fixed or determinable, collection of the resulting receivable is probable and product returns are reasonably estimable.

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

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

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

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

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

Pro Forma Fair Value of Stock-based Compensation

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

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

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

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

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

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

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

Cash and Cash Equivalents

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

Available-for-Sale Securities

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

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

Earnings per Share

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

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

	Three Months Ended April 30,						Six Months Ended April 30,
	2005			2004			2005			2004

Numerator:
Net loss applicable to common stockholders	$	(1,962	)	$	(14,726	)	$	(4,923	)	$	(17,212	)
Denominator:
Weighted average common shares outstanding	17,913			14,100			17,831			13,960
Stock options	—			—			—			—
Restricted stock	—			—			—			—
Warrants	—			—			—			—
Weighted average diluted common shares outstanding	17,913			14,100			17,831			13,960
Basic and diluted EPS	$	(0.11	)	$	(1.04	)	$	(0.28	)	$	(1.23	)

Excluded anti-dilutive common share equivalents	3,696			6,665			3,696			6,665

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

Income Taxes

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

Reclassifications

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

(3) INTANGIBLE ASSETS

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

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

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

(4) INVESTMENTS

Sale of Troll Tech Shares

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

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

(5) COMMITMENTS AND CONTINGENCIES

Litigation

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

IBM Corporation

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

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

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

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

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

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

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

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

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

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

Red Hat, Inc.

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

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

Novell, Inc.

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

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

DaimlerChrysler Corporation

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

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

AutoZone, Inc.

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

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

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

IPO Class Action Matter

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

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

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

Other Matters

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

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

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

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

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

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

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

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

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

(6) COMMON STOCK SUBJECT TO RESCISSION

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

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

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

(7) STOCKHOLDERS’ EQUITY

Stock Options

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

Change in Control Agreements

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

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

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

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

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

Stockholder Rights Plan

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

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

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

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

(8) CONCENTRATION OF RISK

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

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

(9) RELATED PARTY TRANSACTIONS

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

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

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

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

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

(10) SEGMENT INFORMATION

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

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

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

	Three Months Ended April 30, 2005

	UNIX		SCOsource			Total

Revenue	$	9,228	$	30		$	9,258
Cost of revenue	1,309		2,889			4,198
Gross margin (deficit)	7,919		(2,859		)	5,060
Sales and marketing	2,956		7			2,963
Research and development	2,027		90			2,117
General and administrative	1,866		170			2,036
Other	600		—			600
Total operating expenses	7,449		267			7,716
Income (loss) from operations	$	470	$	(3,126	)	$	(2,656	)

	Three Months Ended April 30, 2004

	UNIX			SCOsource			Total

Revenue	$	10,126		$	11		$	10,137
Cost of revenue	1,891			4,567			6,458
Gross margin (deficit)	8,235			(4,556		)	3,679
Sales and marketing	4,117			581			4,698
Research and development	2,797			71			2,868
General and administrative	1,710			—			1,710
Other	3,577			—			3,577
Total operating expenses	12,201			652			12,853
Loss from operations	$	(3,966	)	$	(5,208	)	$	(9,174	)

	Six Months Ended April 30, 2005

	UNIX		SCOsource			Total

Revenue	$	18,023	$	100		$	18,123
Cost of revenue	2,702		6,382			9,084
Gross margin (deficit)	15,321		(6,282		)	9,039
Sales and marketing	5,746		154			5,900
Research and development	3,995		202			4,197
General and administrative	3,538		261			3,799
Other	1,208		—			1,208
Total operating expenses	14,487		617			15,104
Income (loss) from operations	$	834	$	(6,899	)	$	(6,065	)

	Six Months Ended April 30, 2004

	UNIX			SCOsource			Total

Revenue	$	21,498		$	31		$	21,529
Cost of revenue	4,018			8,090			12,108
Gross margin (deficit)	17,480			(8,059		)	9,421
Sales and marketing	9,128			591			9,719
Research and development	5,477			98			5,575
General and administrative	3,882			22			3,904
Other	4,799			—			4,799
Total operating expenses	23,286			711			23,997
Loss from operations	$	(5,806	)	$	(8,770	)	$	(14,576	)

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

	April 30, 2005		October 31, 2004
Intangible assets:
UNIX (reseller channel and trade name)	$	3,554	$	4,740
SCOsource (UNIX technology)	506		673
Total intangible assets and goodwill	$	4,060	$	5,413

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

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

Overview

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

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

On February 16, 2005, we received a notice from the staff of The Nasdaq Stock Market indicating that we were subject to potential delisting from The Nasdaq SmallCap Market for failure to comply with Nasdaq’s requirement to file our annual report on 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 our Form 10-K and our Form 10-Q for the quarter ended January 31, 2005, 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 this Form 10-Q in a timely fashion. The notice informed us that the Panel would consider the filing delinquency of our Form 10-Q for the quarter ended January 31, 2005 in addition to the filing delinquency of the Form 10-K in rendering its decision regarding our listing status. On April 1, 2005, we filed our Form 10-K, and we filed the Form 10-Q for the quarter ended January 31, 2005 on April 14, 2005. On April 20, 2005, we received written confirmation from the Nasdaq Listing Qualifications Panel that we were in full compliance with the Nasdaq filing requirement and all other requirements for continued listing.

In connection with our determination that 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, we determined we needed to classify our common stock that is subject to rescission as temporary equity. As a result, on April 1, 2005, we filed amended quarterly reports on Form 10-Q for the quarters ended January 31, 2004, April 30, 2004 and July 31, 2004 with restated condensed consolidated financial statements. In the restated financial statements for each of the periods covered by the amended Form 10-Qs, we reclassified our common stock subject to rescission from permanent equity to temporary equity and made certain other changes as described in Note 2 to the financial statements in each of the amended Form 10-Qs. The restatement of these financial statements did not impact our revenue, net loss or its earnings per share for the fiscal year ended October 31, 2004 or our aggregate cash and available for sale securities balances as of October 31, 2004.

Business Focus

We generate revenue from sales of product and services from our UNIX business and from sales of SCOsource intellectual property (“IP”) licenses and vendor licenses from our SCOsource business.

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

We access these corporations through their information technology or purchasing departments with our Area Sales Managers (“ASMs”) in the United States and through our reseller channel in countries outside the United States. In addition, we also sell our operating

system products to original equipment manufacturers (“OEMs”). Our sales of UNIX products and services during the last several periods have been primarily to pre-existing UNIX customers and not newly acquired customers. Our UNIX business revenue depends significantly on our ability to market and sell our products to existing customers and to generate upgrades from existing customers.

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

	Three Months Ended April 30,					Six Months Ended April 30,
	2005		2004			2005		2004

Revenue	$	9,228	$	10,126		$	18,023	$	21,498
Cost of revenue	1,309		1,891			2,702		4,018
Gross margin	7,919		8,235			15,321		17,480
Sales and marketing	2,956		4,117			5,746		9,128
Research and development	2,027		2,797			3,995		5,477
General and administrative	1,866		1,710			3,538		3,882
Other	600		3,577			1,208		4,799
Total operating expenses	7,449		12,201			14,487		23,286
Income (loss) from operations	$	470	$	(3,966	)	$	834	$	(5,806	)

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

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

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

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

An important initiative for our UNIX business for the 2005 fiscal year will be the release of the next major upgrade to our OpenServer product, OpenServer 6 in June 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. We anticipate that these enhancements will not have a direct impact on our short-term OpenServer revenue because of the long adoption cycle for new operating system purchases and our long operating system product sales cycle, but we believe that they will help prolong our OpenServer revenue stream for future quarters.

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

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

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

	Three Months Ended April 30,						Six Months Ended April 30,
	2005			2004			2005			2004

Revenue	$	30		$	11		$	100		$	31
Cost of revenue	2,889			4,567			6,382			8,090
Gross deficit	(2,859		)	(4,556		)	(6,282		)	(8,059		)
Sales and marketing	7			581			154			591
Research and development	90			71			202			98
General and administrative	170			—			261			22
Other	—			—			—			—
Total operating expenses	267			652			617			711
Loss from operations	$	(3,126	)	$	(5,208	)	$	(6,899	)	$	(8,770	)

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

This uncertainty represents a significant risk and challenge for us, both in the short and long term. If we do receive revenue from this source, it may be sporadic and fluctuate from quarter to quarter. Our SCOsource initiatives are unlikely to produce a stable or predictable

revenue stream for the foreseeable future. We are unlikely to generate significant revenue from our SCOsource business unless and until we prevail in our litigation against IBM, Red Hat, Novell, Daimler Chrysler and AutoZone (the “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 prevalent in Linux.

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

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

Critical Accounting Policies

Our critical accounting policies and estimates include the following:

• Revenue recognition;

• Deferred income taxes and related valuation allowances;

• Severance and exit costs;

• Impairment of long-lived assets; and

• 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.

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

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

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

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

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

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

Allowance for Doubtful Accounts. We offer credit terms on the sale of our products to a majority of our customers and require no collateral from these customers. We perform ongoing credit evaluations of our customers’ financial condition and maintain an allowance for doubtful accounts based upon our historical collection experience and expected collectibility of all accounts receivable and have applied these policies consistently throughout the last three fiscal years. Our

allowance for doubtful accounts, which is determined based on our historical experience and a specific review of customer balances, was $149,000 as of April 30, 2005. Our past experience has resulted in minimal differences from the actual amounts provided for bad debts and our recorded estimates. However, our actual bad debts in future periods may differ from our current estimates and the differences may be material, which may have an adverse impact on our future accounts receivable and cash position.

Results of Operations

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

	Three Months Ended April 30,						Six Months Ended April 30,
Statement of Operations Data:	2005			2004			2005			2004

Revenue:
Products	$	7,838		$	8,415		$	15,142		$	18,127
SCOsource licensing	30			11			100			31
Services	1,390			1,711			2,881			3,371
Total revenue	9,258			10,137			18,123			21,529
Cost of revenue:
Products	563			818			1,207			1,623
SCOsource licensing	2,889			4,567			6,382			8,090
Services	746			1,073			1,495			2,395
Total cost of revenue	4,198			6,458			9,084			12,108
Gross margin	5,060			3,679			9,039			9,421
Operating expenses:
Sales and marketing	2,963			4,698			5,900			9,719
Research and development	2,117			2,868			4,197			5,575
General and administrative	2,036			1,710			3,799			3,904
Loss on disposition of long-lived assets	—			2,139			—			2,139
Severance and exit costs	—			682			—			682
Amortization of intangibles	593			593			1,186			1,380
Stock-based compensation	7			163			22			598
Total operating expenses	7,716			12,853			15,104			23,997
Loss from operations	(2,656		)	(9,174		)	(6,065		)	(14,576		)
Equity in income of affiliate	17			37			70			74
Other income, net	800			2,422			1,309			6,185
Provision for income taxes	(123		)	(966		)	(237		)	(1,094		)
Net loss	(1,962		)	(7,681		)	(4,923		)	(9,411		)
Dividends on redeemable convertible preferred stock	—			(7,045		)	—			(7,801		)
Net loss applicable to common stockholders	$	(1,962	)	$	(14,726	)	$	(4,923	)	$	(17,212	)

THREE AND SIX MONTHS ENDED APRIL 30, 2005 AND 2004

Revenue

	Three Months Ended April 30,
	2005		Change		2004

Revenue	$	9,258,000	(9	)%	$	10,137,000

	Six Months Ended April 30,
	2005		Change		2004

Revenue	$	18,123,000	(16	)%	$	21,529,000

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

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

	Three Months Ended April 30,
	2005			Change		2004

UNIX revenue	$	9,228,000		(9	)%	$	10,126,000
Percent of total revenue	100		%			100		%
SCOsource revenue	30,000			173	%	11,000
Percent of total revenue	0		%			0		%

	Six Months Ended April 30,
	2005			Change		2004

UNIX revenue	$	18,023,000		(16	)%	$	21,498,000
Percent of total revenue	99		%			100		%
SCOsource revenue	100,000			223	%	31,000
Percent of total revenue	1		%			0		%

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

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

certification support or direct their support to our competitors. This may occur as a result of the decline of our UNIX business and our SCOsource initiatives.

Products Revenue

	Three Months Ended April 30,
	2005			Change		2004

Products revenue	$	7,838,000		(7	)%	$	8,415,000
Percent of total revenue	85		%			83		%

	Six Months Ended April 30,
	2005			Change		2004

Products revenue	$	15,142,000		(16	)%	$	18,127,000
Percent of total revenue	84		%			84		%

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

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

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

	Three Months Ended April 30,
	2005			Change		2004

OpenServer revenue	$	4,664,000		2	%	$	4,580,000
Percent of products revenue	60		%			54		%
UnixWare revenue	2,391,000			(1	)%	2,425,000
Percent of products revenue	30		%			29		%
Other products revenue	783,000			(44	)%	1,410,000
Percent of products revenue	10		%			17		%

	Six Months Ended April 30,
	2005			Change		2004

OpenServer revenue	$	8,677,000		(11	)%	$	9,782,000
Percent of products revenue	57		%			54		%
UnixWare revenue	4,527,000			(12	)%	5,163,000
Percent of products revenue	30		%			28		%
Other products revenue	1,938,000			(39	)%	3,182,000
Percent of products revenue	13		%			18		%

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

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

SCOsource Licensing Revenue

	Three Months Ended April 30,
	2005			Change		2004

SCOsource licensing revenue	$	30,000		173	%	$	11,000
Percent of total revenue	0		%			0		%

	Six Months Ended April 30,
	2005			Change		2004

SCOsource licensing revenue	$	100,000		223	%	$	31,000
Percent of total revenue	1		%			0		%

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

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

Services Revenue

	Three Months Ended April 30,
	2005			Change		2004

Services revenue	$	1,390,000		(19	)%	$	1,711,000
Percent of total revenue	15		%			17		%

	Six Months Ended April 30,
	2005			Change		2004

Services revenue	$	2,881,000		(15	)%	$	3,371,000
Percent of total revenue	16		%			16		%

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

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

Cost of Products Revenue

	Three Months Ended April 30,
	2005			Change		2004

Cost of products revenue	$	563,000		(31	)%	$	818,000
Percentage of products revenue	7		%			10		%

	Six Months Ended April 30,
	2005			Change		2004

Cost of products revenue	$	1,207,000		(26	)%	$	1,623,000
Percentage of products revenue	8		%			9		%

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

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

Cost of SCOsource Licensing Revenue

	Three Months Ended April 30,
	2005			Change		2004

Cost of SCOsource licensing revenue	$	2,889,000		(37	)%	$	4,567,000
Percentage of SCOsource licensing revenue	9630		%			41518		%

	Six Months Ended April 30,
	2005			Change		2004

Cost of SCOsource licensing revenue	$	6,382,000		(21	)%	$	8,090,000
Percentage of SCOsource licensing revenue	6382		%			26097		%

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

Cost of SCOsource licensing revenue decreased by $1,678,000, or 37 percent, during the second quarter of fiscal year 2005 as compared to the second quarter of fiscal year 2004 and decreased by $1,708,000, or 21 percent, during the first two quarters of fiscal year 2005 as compared to the first two quarters of fiscal year 2004. The decrease in costs in the second quarter of fiscal year 2005 compared to the second quarter of fiscal year 2004 was primarily attributable to

decreased legal costs incurred in connection with our SCO Litigation as a result of our Engagement Agreement.

According to the terms of our Engagement Agreement with the Law Firms described in more detail below in this Item 2 of Part I of this Form 10-Q, we anticipate that the dollar amount of our cost of SCOsource licensing for the remaining quarters of fiscal year 2005 will be generally consistent with the costs incurred in the first and second quarters of fiscal year 2005. However, future legal fees may include contingency payments made to the Law Firms as a result of a settlement, judgment, certain licensing fees or a sale of our company, which could cause cost of SCOsource licensing revenue to be higher than anticipated.

Cost of Services Revenue

	Three Months Ended April 30,
	2005			Change		2004

Cost of services revenue	$	746,000		(30	)%	$	1,073,000
Percentage of services revenue	54		%			63		%

	Six Months Ended April 30,
	2005			Change		2004

Cost of services revenue	$	1,495,000		(38	)%	$	2,395,000
Percentage of services revenue	52		%			71		%

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

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

Sales and Marketing

	Three Months Ended April 30,
	2005			Change		2004

Sales and marketing expense	$	2,963,000		(37	)%	$	4,698,000
Percentage of total revenue	32		%			46		%

	Six Months Ended April 30,
	2005			Change		2004

Sales and marketing expense	$	5,900,000		(39	)%	$	9,719,000
Percentage of total revenue	33		%			45		%

Sales and marketing expenses primarily consist of the salaries, commissions and other personnel costs of employees involved in the revenue generation process, as well as advertising and corporate allocations. The decrease in sales and marketing expense of $1,735,000, or 37 percent, from the second quarter of fiscal year 2004 compared to the second quarter of fiscal year

2005 and the decrease of $3,819,000, or 39 percent, from the first two quarters of fiscal year 2004 compared to the first two quarters of fiscal year 2005 was primarily attributable to reductions in sales and marketing employees, reduced travel expenses, less commissions and lower advertising costs. Our sales and marketing full-time equivalent employees decreased from 82 as of April 30, 2004 to 52 as of April 30, 2005.

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

Research and Development

	Three Months Ended April 30,
	2005			Change		2004

Research and development expense	$	2,117,000		(26	)%	$	2,868,000
Percentage of total revenue	23		%			28		%

	Six Months Ended April 30,
	2005			Change		2004

Research and development expense	$	4,197,000		(25	)%	$	5,575,000
Percentage of total revenue	23		%			26		%

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

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

General and Administrative

	Three Months Ended April 30,
	2005			Change		2004

General and administrative expense	$	2,036,000		19	%	$	1,710,000
Percentage of total revenue	22		%			17		%

	Six Months Ended April 30,
	2005			Change		2004

General and administrative expense	$	3,799,000		(3	)%	$	3,904,000
Percentage of total revenue	21		%			18		%

General and administrative expenses primarily consist of the salaries and benefits of finance, human resources, and executive management and expenses for professional services such as legal and accounting and corporate allocations. General and administrative expense increased by $326,000, or 19 percent, during the second quarter of fiscal year 2005 as compared to the second quarter of fiscal year 2004 and decreased by $105,000, or 3 percent, during the first two quarters of fiscal year 2005 as compared to the first two quarters of fiscal year 2004. The increase

in general and administrative expense during the second quarter of fiscal year 2005 compared to the second quarter of fiscal year 2004 was primarily attributable to legal and accounting costs incurred in connection with the restatement of our 2004 quarterly financial statements. The decrease in general and administrative expense for the first two quarters of fiscal year 2005 compared to the first two quarters of fiscal year 2004 was primarily attributable to lower personnel and related costs offset by the increased costs related to the restatement mentioned above. Our general and administrative full-time equivalent employees decreased from 54 as of April 30, 2004 to 29 as of April 30, 2005.

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

Loss on Impairment of Long-lived Assets

We recorded a loss on impairment of long-lived assets totaling $2,139,000 for the second quarter and first two quarters of fiscal year 2004. The impairment related to goodwill and intangible assets acquired in connection with our acquisition of Vultus, Inc. (“Vultus”) in June 2003. We concluded that an impairment triggering event occurred during the three months ended April 30, 2004 as an impending partnership that would solidify the Vultus revenue and cash flow opportunities did not materialize. Consequently, we concluded that no significant future cash flows related to our Vultus assets will be realized. We performed an impairment analysis of our recorded goodwill related to the Vultus reporting unit in accordance with SFAS No. 142. Additionally, an impairment analysis of the intangible assets was performed in accordance with SFAS No. 144. As a result of these analyses, we wrote-down the carrying value of our goodwill related to our Vultus acquisition from $1,166,000 to $0, and wrote-down the intangible assets related to our Vultus acquisition from $973,000 to $0.

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

Severance and Exit Costs

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

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

	Balance at November 1, 2004		Additions		Payments			Balance at April 30, 2005

Ongoing severance and other	$	401	$	—	$	(401	)	$	—

Amortization of Intangibles

	Three Months Ended April 30,
	2005			Change		2004

Amortization of intangibles	$	593,000		0	%	$	593,000
Percentage of total revenue	6		%			6		%

	Six Months Ended April 30,
	2005			Change		2004

Amortization of intangibles	$	1,186,000		(14	)%	$	1,380,000
Percentage of total revenue	7		%			6		%

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

Stock-based Compensation

	Three Months Ended April 30,
	2005			Change		2004

Stock-based compensation	$	7,000		(96	)%	$	163,000
Percentage of total revenue	0		%			2		%

	Six Months Ended April 30
	2005			Change		2004

Stock-based compensation	$	22,000		(96	)%	$	598,000
Percentage of total revenue	0		%			3		%

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

	Three Months Ended April 30,				Six Months Ended April 30,
	2005		2004		2005		2004

Amortization of stock-based compensation	$	7	$	113	$	22	$	223
Options, warrants and shares for services	—		50		—		283
Modifications to options	—		—		—		92
Total	$	7	$	163	$	22	$	598

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

Equity in Income (Losses) of Affiliate

We account for our ownership interests in companies in which we own at least 20 percent and less than 50 percent using the equity method of accounting. Under the equity method, we record our portion of the entities’ net income or net loss in our consolidated statements of

operations. As of April 30, 2005, the carrying value of our investments was related to our 30 percent ownership in a Chinese company.

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

Other Income (Expense), net

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

	Three Months Ended April 30,					Six Months Ended April 30,
	2005		2004			2005		2004

Interest income	$	98	$	242		$	135	$	512
Change in fair value of derivative	—		2,300			—		5,924
Other income (expense), net	702		(120		)	1,174		(251		)
Total	$	800	$	2,422		$	1,309	$	6,185

Interest income decreased by $144,000 from the second quarter of fiscal year 2004 to the second quarter of fiscal year 2005 and decreased by $377,000 from the first two quarters of fiscal year 2004 to the first two quarters of fiscal year 2005 and was primarily attributable to a decrease in our cash and available-for-sale securities balances.

The income recorded on the change in fair value of derivative for the second and first two quarters of fiscal year 2004 related to the decrease in fair value of this instrument and marking it to market at each balance sheet date. The derivative financial instrument was eliminated during the second quarter of fiscal year 2004.

The increase in other income (expense), net, for the first two quarters of fiscal year 2005 compared to the first two quarters of fiscal year 2004 was primarily attributable to two items: 1) the collection of a note receivable from Vintela, Inc. (“Vintela”) as described in more detail in Note 9 to our financial statements above in Part I, Item 1 of this Form 10-Q, which note receivable was originally received in April 2003, but because we received the note receivable in exchange for the transfer of certain software to a related party and there was substantial doubt concerning the ability of Vintela to repay the note, no gain was recognized until the first quarter of fiscal year 2005 when we received payment; and 2) the sale of shares we held in Troll Tech AS (“Troll Tech”) as described in more detail in Note 4 to our financial statements above in Part I, Item 1 of this Form 10-Q. The Troll Tech shares had been written off in fiscal year 2001, but because they were sold during the second quarter of fiscal year 2005, we recorded income on the proceeds received.

Provision for Income Taxes

The provision for income taxes was $123,000 in the second quarter of fiscal year 2005 and $966,000 in the second quarter of fiscal year 2004. The provision for income taxes was $237,000 in the first two quarters of fiscal year 2005 and $1,094,000 in the first two quarters of fiscal year 2004. Our provision for income taxes is primarily related to earnings in foreign subsidiaries and withholding taxes on revenue generated in certain locations. The decrease in the provision for income taxes for both the second quarter and first two quarters of fiscal year 2005 as compared to the second quarter and first two quarters of fiscal year 2004 is attributable to an accrual for withholding taxes of $710,000 that was made in the second quarter of fiscal year 2004 which taxes were estimated to be paid in connection with the operations of the Indian branch of our United Kingdom subsidiary, SCO Group, Ltd.

Dividends Related to Series A Convertible Preferred Stock

We had no dividends in either the second quarter or first two quarters of fiscal year 2005.

In connection with completing the February 5, 2004 exchange of all the then outstanding shares of Series A Convertible Preferred Stock for shares of our Series A-1 Convertible Preferred Stock, 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 for the second quarter and first two quarters of fiscal year 2004.

Additionally, with respect to the Series A-1 shares, we accrued dividends of $740,000 for the second quarter of fiscal year 2004 and $1,496,000 in dividends for the first two quarters of fiscal year 2004, we repurchased all outstanding Series A-1 shares in July 2004.

Liquidity and Capital Resources

During the six months ended April 30, 2005, we used cash of $17,702,000 in our operations. The majority of this cash was used to pay accounts payable, accrued liabilities and ongoing expenses related to our SCO Litigation. As of April 30, 2005, we have a total of $14,192,000 in cash and cash equivalents and available-for-sale securities and an additional $7,974,000 in restricted cash, of which $3,967,000 is designated to be used as payments for experts, consultants and other expenses in the SCO Litigation. As a result of the Engagement Agreement between us and the Law Firms, we anticipate using cash of approximately $7,000,000 in the defense of our SCO Litigation during the remainder of the year ending October 31, 2005, which would leave us approximately $11,159,000 in cash for our business operations as of October 31, 2005. We expect that our UNIX business will generate sufficient cash in the year ending October 31, 2005 to cover our internal costs for our SCOsource initiatives and the SCO Litigation, and we believe we will have sufficient cash resources to fund our operations through October 31, 2005.

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.

Our cash and equivalents balance decreased from $12,693,000 as of October 31, 2004 to $8,145,000 as of April 30, 2005. During this same time period, our investment in available-for-sale securities decreased from $18,756,000 to $6,047,000. Total cash and equivalents and available-for sale securities were $14,192,000 as of April 30, 2005. We also have $3,967,000 classified as a component of restricted cash set aside to cover expert, consulting and other expenses related to our SCO Litigation. During the first two quarters of fiscal year 2005, we expended a significant amount of cash to pay accounts payable, accrued liabilities and ongoing legal costs related to our intellectual property litigation. We intend to use the cash and equivalents and available-for-sale securities as of April 30, 2005 to maintain our UNIX business and pursue our SCO Litigation.

Our net cash used in operations during the first two quarters of fiscal year 2005 was $17,702,000 and was attributable to a net loss of $4,923,000, non-cash items of $1,521,000 and changes in operating assets and liabilities of $14,300,000. Our working capital decreased from

$15,413,000 as of October 31, 2004 to $12,489,000 as of April 30, 2005 and was primarily attributable to payments made to the Law Firms for the SCO Litigation.

Our net cash used in operations during the first two quarters of fiscal year 2004 was $5,206,000. Cash used in operations was attributable to a net loss of $9,411,000, non-cash expenses of $1,280,000 and from changes in operating assets and liabilities of $5,485,000.

Our investing activities have historically consisted of equipment purchases, investing in strategic partners and the purchase and sale of available-for-sale securities. During the first two quarters of fiscal year 2005, cash provided by investing activities was $12,564,000, which was primarily a result of sales, net of purchases, of available-for-sale securities of $12,709,000, which amount was offset by purchases of equipment of $145,000.

During the first two quarters of fiscal year 2004, cash used in investing activities was $36,604,000, which was primarily a result of our purchase of available-for-sale securities, net of sales, of $36,209,000, equipment purchases of $186,000, and the purchase of the remaining minority interest in our Japanese subsidiary of $209,000.

Our financing activities provided $578,000 of cash in the first two quarters of fiscal year 2005. The primary sources of cash were from the exercise of options to acquire common stock of $205,000 and proceeds of $373,000 received from the sale of common stock through our ESPP.

Our financing activities used $1,697,000 during the first two quarters of fiscal year 2004 and consisted primarily of cash used to purchase shares of our common stock on the open market of $2,414,000 and cash used to exchange Series A-1 for Series A shares of $212,000. These uses of cash were offset from proceeds received from the exercise of stock options of $559,000 and proceeds from the purchase of shares of common stock by our employees through our employee stock purchase program of $370,000.

Our net accounts receivable balance decreased from $6,638,000 as of October 31, 2004 to $6,325,000 as of April 30, 2005, primarily as a result of lower invoicing and revenue in the second quarter of fiscal year 2005 as compared to the fourth quarter of fiscal year 2004. The majority of our accounts receivable are current and our allowance for doubtful accounts was $149,000 as of April 30, 2005, 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 the first two quarters of fiscal year 2005 were not significant.

On October 31, 2004, we entered into the Engagement Agreement with the Law Firms. 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. 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 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 April 30, 2005, we had paid $1,033,000 of expenses and the remaining $3,967,000 was classified as a component of restricted cash.

For future legal fees, the Engagement Agreement requires us to pay to the Law Firms $2,000,000 per quarter for each successive quarter which began September 1, 2004 and will end December 1, 2005 for a total amount of $12,000,000. In the first two quarters of fiscal year 2005, we made the quarterly payments for September 2004, December 2004 and March 2005 for a total

of $6,000,000. 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 April 30, 2005:

	Total		Less than 1 year		1 — 3 years		More than 3 years

Operating lease obligations	$	3,506,000	$	1,521,000	$	1,917,000	$	68,000
Payments to Law Firms	6,000,000		4,000,000		2,000,000		—
Total obligations	$	9,506,000	$	5,521,000	$	3,917,000	$	68,000

As of April 30, 2005, 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 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.

We have 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 $851,000 in the aggregate, excluding interest and other possible fees, based upon shares outstanding under the Equity Compensation Plans as of April 30, 2005.

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.

ITEM 3. 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 April 30, 2005, 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 equivalents and 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 April 30, 2005, our investments balance was approximately $630,000 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 our SCO Litigation 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.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of disclosure 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) under the Securities Exchange Act of 1934 (the “Exchange Act”)). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.

Changes in internal control over financial reporting. During the most recent quarter ended April 30, 2005, we have implemented certain changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). We have implemented additional internal control procedures surrounding equity and equity issuances. These internal control procedures consist of additional detail transactional controls including the timely reconciliation and review of shares issued with shares available under registration statements, an equity compliance checklist and additional review and approval procedures by persons with appropriate experience. These additional controls were put in place as the result of an identified material weakness in our accounting for capital stock and stock option transactions as reported in our quarterly report on Form 10-Q for the fiscal quarter ended January 31, 2005 and prior periodic reports.

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. 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 belief that our UNIX business will continue to generate positive cash flow throughout fiscal year 2005;

• Our expectation that industry partners, developers, and hardware and software vendors, may elect not to continue to support or certify to our UNIX operating system products;

• Our intention to release SCO OpenServer 6 in June 2005;

• Our belief that SCO OpenServer 6 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, and our belief that these enhancements will not have a direct impact on our short-term SCO OpenServer revenue and that they will help prolong OpenServer revenue in future quarters;

• 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 continue to maintain our UNIX business and to pursue the SCO Litigation;

• Our belief that our allowance and bad debts for accounts receivable will remain consistent with our prior experience;

• 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 levels of 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 the remaining quarters of fiscal year 2005 that the dollar amount of our cost of products revenue will be generally consistent to that generated in the second quarter of fiscal year 2005 and that the cost of products revenue as a percentage of products revenue for the remaining quarters of fiscal year 2005 will be generally consistent to that incurred in the second quarter of fiscal year 2005;

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

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

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

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

• Our belief that we will use cash of approximately $7,000,000 in the defense of our SCO Litigation during the remainder of the year ending October 31, 2005;

• Our expectation that our UNIX business will generate sufficient cash in the year ending October 31, 2005 to cover our internal costs related to our SCOsource initiatives and the SCO Litigation, and our belief that we will have sufficient cash resources to fund our operations through October 31, 2005; and

• Our expectation that the dollar amount of our cost of SCOsource licensing for the remaining quarters of fiscal year 2005 will be generally consistent with the costs incurred in the first two quarters of fiscal year 2005.

We wish to caution readers that our operating results are subject to various risks and uncertainties that could cause our actual results and outcomes to differ materially from those discussed or anticipated, including the success of our SCOsource initiatives, competition from other operating systems, particularly Linux, the amount and timing of SCOsource licensing revenue, our ability to enhance our UNIX operating systems and maintain our UNIX business, and the factors set forth 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. For the first two quarters of fiscal year 2005 we incurred a net loss from operations of $6,065,000 and had an accumulated deficit of $229,139,000.

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

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

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

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

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

works in Linux infringes on our copyrights. Increased negative perception and potential confusion about our claims in our marketplace could impede our continued pursuit of our SCOsource initiatives and negatively impact our business.

Our Engagement Agreement with the Law Firms will require us to spend a significant amount of cash during fiscal year 2005 and could harm our liquidity position.

As of April 30, 2005, we had a total of $14,192,000 in cash and cash equivalents and available-for-sale securities and an additional $3,967,000 as restricted cash to be used in our operations and pursue the SCO Litigation. As a result of the Engagement Agreement between us and the Law Firms, for the remainder of fiscal year 2005 we anticipate spending approximately $7,000,000 in the defense of our SCO Litigation during fiscal year 2005, which would leave us approximately $11,159,000 in cash for our business operations as of October 31, 2005. 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 SCO Litigation. However, if our UNIX business does not generate cash or we spend additional cash on the SCO Litigation or additional matters, our cash position would be negatively impacted, and our ability to pursue our UNIX business objectives and our SCO Litigation could be harmed.

Our future SCOsource licensing revenue is uncertain.

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

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

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

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

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

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

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

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

Factors that may affect our results include:

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

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

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

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

• results of, or developments in our SCO Litigation;

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

• the contingency and other legal fees we may pay to the Law Firms representing us in our efforts to establish our intellectual property rights; and

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

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

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

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

In the operating system market, our competitors include IBM, Red Hat, Novell, Hewlett-Packard, Sun, 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 indirectly through resellers, we cannot control the relationships through which resellers, solution providers or equipment integrators purchase our products. In turn, we do not control the presentation of our products to end users. Therefore, our sales could be affected by disruptions in the relationships between us and our resellers, between our resellers and solution providers, or between solution providers and end users. Also, resellers and solution providers may choose not to emphasize our products to their customers. Any of these occurrences could diminish the effectiveness of our distribution channel and lead to decreased sales.

Our Engagement Agreement with the Law Firms representing us in our SCO Litigation may reduce our ability to raise additional financing.

Our Engagement Agreement with the Law Firms 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 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 without complying with registration or qualification requirements under federal and state securities laws, and, as a result, we may incur rescission liability for such shares and options and may face additional potential claims under federal and state securities laws.

We have issued shares and options granted 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 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 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 us in respect of such shares they have sold we could be liable to make aggregate payments to these plan participants of up to $851,000 in the aggregate, excluding interest and other possible fees, based upon shares outstanding under the Equity Compensation Plans as of April 30, 2005.

We may face additional rescission liability to plan participants holding unexercised stock options in California and possibly other states. Additionally, federal securities laws do not provide that a rescission offer will terminate a purchaser’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 liable 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 $4.12 on May 27, 2005. The share price has changed dramatically over short periods. We believe that the changes in our stock price are affected by changing public perceptions concerning the strength of our intellectual property claims and other factors beyond our control. Public perception can change quickly and without any change or development in our underlying business or litigation position. An investment in our stock is subject to such volatility and, consequently, is subject to significant risk.

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

As of May 27, 2005, we have issued and outstanding options to purchase up to approximately 3,430,000 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 issuance of common shares to 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 our annual report on Form 10-K for the fiscal year ended October 31, 2004 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 6 percent of our issued and outstanding common stock. The sale of the block of stock to be covered by such registration statement, or even the possibility of its sale, may adversely affect the trading market for our common stock and reduce the price available in that market.

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

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

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

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

Our Stockholder Rights Plan could make it more difficult for a hostile bid for 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.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

IBM Corporation

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

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

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

counterclaim. The Court ordered that no further dispositive motions could be filed until the close of discovery, except by stipulation of the parties, and vacated its prior order, dated September 30, 2004, to the extent that order had granted permission to file dispositive motions before the close of discovery.

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

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

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

Discovery is continuing in the case. We are reviewing that discovery and currently anticipate that we will seek to amend our complaint in the near future in order to assert additional claims against IBM.

AutoZone, Inc.

On or about March 2, 2004, we brought suit against AutoZone, Inc. (“AutoZone”) for its alleged violations of our UNIX copyrights through its use of Linux. The 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. In response to AutoZone’s motion to transfer the case to Tennessee or stay the case, the federal court in Nevada granted AutoZone’s motion to stay the case, with 90-day status reports to the court, and denied without prejudice AutoZone’s motion to transfer the case to Tennessee. The federal court allowed the parties to take limited expedited discovery relating to the issue of preliminary injunctive relief which discovery was concluded in May 2005.

We have concluded the initial discovery allowed by the court and filed our report with the court on May 27, 2005. Contrary to AutoZone’s own statements to the court, we found

through discovery, including depositions and other admissions of AutoZone, many instances of copying of programs containing SCO OpenServer code. AutoZone has represented that it has now removed all of the SCO code and proprietary information it copied or used in its migration to Red Hat Linux. Because AutoZone represents it has removed or otherwise is not using SCO code and proprietary information, we currently do not intend to move for a preliminary injunction. AutoZone does not admit that it violated our rights or caused us damage in that migration process, which are still points of dispute between the parties. Given the stay issued by the Court in the case, we reserve the right to pursue infringement and damages in the future based on these issues and other issues stayed by the Court.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Recent Sales of Unregistered Securities

As described elsewhere in this Form 10-Q, we have 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. 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.

ITEM 5. OTHER INFORMATION

One December 8, 2004, our board of directors adopted The SCO Group Employee Incentive Bonus Program for fiscal year 2005, which subsequently was ratified and approved by the compensation committee of our board of directors (the “Bonus Program”). Pursuant to the Bonus Program, all employees, including the executive officers identified in the table below, other than certain sales employees, may earn quarterly cash bonuses.

A bonus under the Bonus Program may only be paid for any quarter of fiscal year 2005 if our company meets specific revenue and operating performance objectives for such quarter. If these two performance objectives are satisfied, bonuses will be paid and additional bonuses may be earned if executive officers satisfy certain specified personal objectives. These personal objectives are established by the Compensation Committee for Mr. McBride, our President and Chief Executive Officer, and by Mr. McBride for the other executive officers.

The bonus payments made to our executive officers for the quarter ended January 31, 2005 were as follows:

Name	Bonus for Q1 2005
Darl C. McBride President and Chief Executive Officer	$	47,071
Bert B. Young Chief Financial Officer	$	17,255
Chris Sontag Senior Vice President, Business Development	$	16,240

Jeff Hunsaker Senior Vice President and General Manager, UNIX Division	$	16,240
Ryan E. Tibbitts General Counsel and Corporate Secretary	$	14,718
TOTALS	$	111,524

This description of the Bonus Program is subject to, and qualified in its entirety by, the The SCO Group Employee Incentive Bonus Program for fiscal year 2005 attached to the January 31, 2005 Form 10-Q as Exhibit 10.1.

ITEM 6. EXHIBITS

(a) Exhibits

3.1 Amended and Restated Certificate of Incorporation of Caldera International, Inc. (incorporated by reference to Exhibit 3.1 to SCO’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 SCO’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 SCO’s Registration Statement on Form 8A12G/A (File No. 000-29911)).

3.4 Amended and Restated Bylaws (incorporated by reference to Exhibit 3.4 to SCO’s Registration Statement on Form 8-A12G/A (File No. 000-29911)).

3.5 Certificate of Designation for Series A-1 Convertible Preferred Stock (incorporated by reference to Exhibit 4.1 to SCO’s Current Report on Form 8-K filed on February 9, 2004 (File No. 000-29911)).

3.6 Certificate of Correction correcting the Certificate of Designation for Series A-1 Convertible Preferred Stock (incorporated by reference to Exhibit 4.2 to SCO’s Current Report on Form 8-K filed on February 9, 2004 (File No. 000-29911)).

31.1 Certification of Darl C. McBride, President and Chief Executive Officer, pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to 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 Exchange Act, as adopted pursuant to 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 to 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 to Section 906 of the Sarbanes-Oxley Act of 2002.

ITEM 7. SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: June 2, 2005	THE SCO GROUP, INC.

		By:	/s/ Bert Young
			Bert Young
			Duly Authorized Officer and
			Chief Financial Officer
			(Principal Financial and
			Accounting Officer)

EXHIBIT INDEX

Exhibit Number		Exhibit Description

3.1		Amended and Restated Certificate of Incorporation of Caldera International, Inc. (incorporated by reference to Exhibit 3.1 to SCO’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 SCO’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 SCO’s Registration Statement on Form 8A12G/A (File No. 000-29911)).
3.4		Amended and Restated Bylaws (incorporated by reference to Exhibit 3.4 to SCO’s Registration Statement on Form 8-A12G/A (File No. 000-29911)).
3.5		Certificate of Designation for Series A-1 Convertible Preferred Stock (incorporated by reference to Exhibit 4.1 to SCO’s Current Report on Form 8-K filed on February 9, 2004 (File No. 000-29911)).
3.6		Certificate of Correction correcting the Certificate of Designation for Series A-1 Convertible Preferred Stock (incorporated by reference to Exhibit 4.2 to SCO’s Current Report on Form 8-K filed on February 9, 2004 (File No. 000-29911)).
31.1		Certification of Darl C. McBride, President and Chief Executive Officer, pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Bert Young, Chief Financial Officer, pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant to 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 to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Bert Young, Chief Financial Officer, pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.