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SCO's S-1: Naming Names - Where the $10M Came From & Yarro's Law

Thursday, March 09 2006 @ 12:06 PM EST

Listening to yesterday's financial teleconference, I noted that Darl McBride mentioned the private placement in November was to previous shareholders, and indeed the press release in November of 2005 told us the same thing, that it was previous institutional investors plus one member of the board, but no specifics were provided. However, the new S-1 SCO filed recently fills in the blanks.

Here's the list:

On November 30, 2005, the Company issued 2,852,449 shares of its common stock to the following institutional investors or their affiliates: AmTrust Financial, C P Management, L.L.C., Eton Park Capital Management, Glenhill Capital, Jet Capital Management, and Scoggin Capital Management (the “Institutional Investors”). The Institutional Investors were all stockholders of the Company prior to issuance of such shares. In addition, Darcy G. Mott, one of the directors and a stockholder of the Company, also purchased shares of the Company’s common stock in connection with this offering. Shares were sold to the Institutional Investors for $3.50 per share and to Mr. Mott for $3.92 per share. Gross proceeds from the sale of such shares were $10,005,000.

So, now we know. $3.50 per share, eh? When was the last time the stock was that low? Here's a 3-month chart. How about a 6-month chart? I wondered why anyone would give SCO money for its stock. The S-1 opens like this:

This prospectus relates to the sale, transfer or distribution of up to 2,852,449 shares of the common stock, par value $0.001 per share, of The SCO Group, Inc. by the selling stockholders described herein. The price at which the selling stockholders may sell the shares will be determined by the prevailing market price for the shares or in negotiated transactions. We will not receive any proceeds from the sale or distribution of the common stock by the selling stockholders.
Our common stock is quoted on The Nasdaq Capital Market under the trading symbol “SCOX.” On February 27, 2006, the last price for our common stock, as reported by The Nasdaq Capital Market, was $4.33.

And here I thought they were just true believers. The document states: "The information in this prospectus is not complete and may be changed. The selling stockholders may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective."

Unfortunately for SCO, despite the new $10M, the S-1 also lists unpaid royalties due to Novell, also in the millions. Here's what the S-1 says they have yet to pay Novell:

Restricted Cash and Payable to Novell, Inc.
Pursuant to the 1995 Asset Purchase Agreement and the Company’s acquisition of assets and operations of The Santa Cruz Operation, the Company acts as an administrative agent in the collection of royalty payments from a limited number of pre-existing Novell customers who continue to deploy SVRx technology. Under the agency agreement, the Company collects payments from such customers and receives 5% as an administrative fee and remits the remaining 95% to Novell on a routine basis. The Company records the 5% administrative fee as revenue in its consolidated statements of operations. The accompanying consolidated balance sheets as of October 31, 2005 and 2004 reflect amounts collected related to this agency agreement as of each balance sheet date, but not yet remitted to Novell of $2,815,000 and $3,283,000, respectively, as restricted cash and payable to Novell.

Look what the IBM case is about now, in the world according to SCO, version 2006:

On or about March 6, 2003, we filed a civil complaint against IBM in the United States District Court for the District of Utah, under the title The SCO Group, Inc. v. International Business Machines Corporation, Civil No. 2:03CV0294. In this action we claim, among other things, that IBM breached its UNIX source code licenses (both the IBM and Sequent Computer Systems, Inc. (“Sequent”) licenses) by disclosing restricted information concerning the UNIX source code and derivative works and related information in connection with its efforts to promote the Linux operating system. Our complaint includes, among other things, claims for breach of contract, unfair competition, tortious interference and copyright infringement.

Can you imagine if back in March of 2003, SCO had simply announced that it was suing IBM for breaching a license by disclosing restricted information about UNIX source code and derivative works in connection with its efforts to promote Linux? I daresay there would have been barely a ripple in the media, and probably Groklaw would have picked a different case to follow closely as a result.

Here's a sentence I don't remember seeing in SCO's SEC filings before: "To protect our proprietary rights, we rely primarily on a combination of copyright laws, contractual rights and an aggressive legal strategy." Certainly that last is the truth.

Here's why they needed the PIPE Fairy to step up to the plate:

Our cash and cash equivalents balance decreased from $12,693,000 as of October 31, 2004 to $4,272,000 as of October 31, 2005. During this same time period, our investment in available-for-sale securities decreased from $18,756,000 to $6,165,000. Total cash and cash equivalents and available-for-sale securities were $10,437,000 as of October 31, 2005. As of October 31, 2005, we also have $5,690,000 classified as restricted cash, of which $2,875,000 is set aside to cover expert and other costs related to our SCO Litigation and $2,815,000 is set aside for royalties payable to Novell. During the year ended October 31, 2005, we expended a significant amount of cash in pursuit of our SCO Litigation.

I don't even know what this next means, but it doesn't sound so good:

As of October 31, 2005, we had net operating loss carry-forwards for U.S. federal and state income tax reporting purposes of approximately $144,980,000 that expire at various dates between 2019 and 2025. We had net deferred tax assets, including net operating loss carry-forwards and other temporary differences between book and tax deductions, totaling approximately $69,292,000 as of October 31, 2005. We also had net deferred tax liabilities of approximately $53,000 related to taxes on foreign earnings. A valuation allowance in the amount of $69,239,000, the difference between our deferred tax assets and liabilities, has been recorded as of October 31, 2005 as a result of uncertainties regarding the ultimate realizability of the net deferred tax assets.

And more gloom:

Revenue from our UNIX business decreased by $6,142,000, or 15%, for the year ended October 31, 2005 compared to the year ended October 31, 2004 and decreased by $11,428,000, or 21%, for the year ended October 31, 2004 compared to the year ended October 31, 2003. ...
In our UNIX business, we have reduced the number of full-time equivalent employees from 295 as of October 31, 2003, to 193 as of October 31, 2004, and to 163 as of October 31, 2005. ...
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.

Darl isn't making a million a year any more, either. In 2005, he was paid a salary of $265,000 and bonus/commissions of $213,823 and underlying options 100,000. In 2003, his salary was $230,769 and bonus/commissions were $755,278, restricted stock awards of 78,511 and underlying options 200,000. I thought that was worth noting, since I saw a comment the other day that it was all worth it to Darl, because he was making a million a year while the Good Ship SCO was sinking. That's not true. Well, the sinking part is true, judging from the S-1 and the teleconference.

The final thing I noticed about the S-1 is something I've never noted before. Pretty much everyone in this company or on the board are relative newcomers. I know Caldera is a relatively young company, but SCO claims to be Santa Cruz (when it helps their arguments, anyway), and yet look at the longevity chart I drew up from the info in the S-1:

Execs:
Bert Young April 2004
Tim Negris joined Aug 05
Sandeep Gupta "joined the company in 1996". But CTO since Aug 05
Ryan Tibbits joined in June 2003
Chris Sontag joined in Sept. 2002
Jeff Hunsaker joined in 2000
Board:
Ralph Yarro since 1998
Ed Iacobucci since 2000
R. Duff Thompson since May 2001
Darcy Mott since March 2002
Darl McBride since June 2002
Daniel W. Campbell since Nov. 2003
Omar Leeman since 2005
J. Kent Millington since 2005

Their oldest executive is 51, by the way. The S-1 states, "The Company was originally incorporated as Caldera Systems, Inc. (“Caldera Systems”), a Utah corporation, on August 21, 1998, and reincorporated as a Delaware corporation on March 6, 2000." So Mr. Gupta was a Santa Cruz employee. And if you read his 2004 Supplemental Declaration in the IBM litigation, sure enough, you will see that is the explanation. So he and Ralph Yarro are the two longtimers, followed by Thompson, Hunsaker and Iacobucci. The rest hopped on from 2002 onward.

Some employees have just hopped off, according to yesterday's teleconference. Bert Young explained the approximately half million reduction in compensation to employees in the following way: it seems they were not laid off. They were redeployed, from California to New Jersey. And some chose not to accept the offer to relocate from sunny California to the Garden State. So costs are down, but Mr. Young said they'll be filling those positions.

And finally, to be fair, I should tell you that Darl mentioned in the conference call that Me Inc. had won an award and the announcement was coming out soon. Here it is. It won the best consumer technology award for 2006 by the Utah Information Technology Association (UITA) at Utah's Big Business & Technology Expo. What can I say? This is the same group that has invited Ralph Yarro to be the speaker at an upcoming event and has as its mission, "Building Utah's Technology Community". UITA describes Mr. Yarro like this:

Mr. Yarro is Founder, President and Chief Executive Officer of ThinkAtomic, Inc. a high tech incubator, think tank and venture accelerator. ThinkAtomic, www.thinkatomic.com, is developing technologies and concepts that serve mankind as in the CP80 Internet Channel Initiative, which is dedicated to solving the internet porn problem through existing technologies to offer families and businesses choice of content while preserving free speech.
The breakfast will include a presentation by Mr. Yarro entitled "Fight Change You Die – Affect Change You Thrive" followed by a question and answer session.

Well, perhaps we'd need to define our terms. Fighting Linux is fighting change, isn't it? Maybe that is why SCO is having a bad few years. What a dumb thing it did when it dropped its Linux offering. Now Linux is eating its lunch, to hear them tell it in the S-1, but if they'd just kept going, they could have had all that Linux business they claim is undermining their Unix business for themselves. They could have had both a Linux and a Unix business.

If you go to the full bio for Mr. Yarro, you find this tantalizing info:

Mr. Yarro has been an avid developer, acquirer, and defender of intellectual property, which he believes must be fostered and protected to create a fertile, and stable high tech environment. In 2003, he sponsored a bill (S.B. 239), which passed in 2004, to improve the IP laws in the state of Utah.
Mr. Yarro has served on the Board of Trustees of UITA.

Perhaps you'd like to read the bill he "sponsored", although how a private citizen can sponsor a bill is unknown to me. Must be a Utah thing. Utah lists the bill, called The Unfair Competition Act," as sponsored by Mike Dmitrich, with co-sponsors R. Allen and C. Bramble. Perhaps he wasn't so much its sponsor as its inspiration. The first version introduced read like this, and I've made it colored text so you can easily see where it begins and ends:

13-5a-101. Title.
This chapter is known as the "Unfair Competition Act."
Section 2. Section 13-5a-102 is enacted to read:
13-5a-102. Definitions.
As used in this chapter, "unfair competition" includes:
(1) any unlawful, unfair, or fraudulent business act or practice;
(2) unfair, deceptive, untrue, or misleading advertising; and
(3) any act leading to a diminution in value of intangible property.
Section 3. Section 13-5a-103 is enacted to read:
13-5a-103. Action by attorney general.
(1) The attorney general may bring an action against any person who engages, has engaged, or proposes to engage in unfair competition.
(2) In an action under Subsection (1), the court may:
(a) make any order or judgment necessary to:
(i) prevent a person from engaging in unfair competition; and
(ii) provide a person actual damages incurred through unfair competition; and
(b) impose a civil penalty not to exceed $5,000 for each act of unfair competition.
(3) All civil penalties paid pursuant to this section shall be deposited in the Consumer Protection Education and Training Fund created in Section 13-2-8 .
Section 4. Section 13-5a-104 is enacted to read:
13-5a-104. Private action.
(1) A person injured by an act of unfair competition may bring an action against a person who engages in an act of unfair competition.
(2) In an action under Subsection (1), a person injured by an act of unfair competition may recover:
(a) actual damages;
(b) costs and attorney fees; and
(c) if the court determines that the circumstances are appropriate, punitive damages.

Good thing for SCO it wasn't passed in 2003, or I dare say IBM and Novell would have used it against SCO. And you thought SCO had no sense of irony. The governor vetoed it, but the House and Senate overrode the veto. Well, the bill got substituted several times, and the final bill as actually passed goes like this:

CHAPTER 5a. UNFAIR COMPETITION ACT
13-5a-101. Title.
This chapter is known as the "Unfair Competition Act."
Section 2. Section 13-5a-102 is enacted to read:
13-5a-102. Definitions.
As used in this chapter:
(1) "Control" means:
(a) ownership of more than 5% of the voting shares or ownership interests of an entity;
(b) the power to vote more than 5% of the voting shares of an entity; or
(c) the ability to influence the management of an entity.

(2) "Cyber-terrorism" means:
(a) the unlawful use of computing resources to intimidate or coerce others;
(b) accessing a computer without authorization or exceeding authorized access;
(c) willfully communicating, delivering, or causing the transmission of a program, information, code, or command without authorization or exceeding authorized access;
(d) intentionally or recklessly:
(i) intends to defraud or materially cause damage or disruption to any computing resources or to the owner of any computing resources; or
(ii) intends to materially cause damage or disruption to any computing resources indirectly through another party's computing resources.

(3) "Depository institution" is as defined in Section 7-1-103 .
(4) (a) Except as provided in Subsection (4)(b), "unfair competition" means an intentional business act or practice that:
(i) (A) is unlawful, unfair, or fraudulent; and
(B) leads to a material diminution in value of intellectual property; and
(ii) is one of the following:
(A) cyber-terrorism;
(B) infringement of a patent, trademark, or trade name;
(C) a software license violation; or
(D) predatory hiring practices.

(b) Notwithstanding Subsection (4)(a), "unfair competition" does not include the departure and hiring of an employee by a competitor.
Section 3. Section 13-5a-103 is enacted to read:
13-5a-103. Private action for unfair competition.
(1) (a) Except as provided in Subsection (2), a person injured by unfair competition may bring a private cause of action against a person who engages in unfair competition.
(b) In an action under this Subsection (1), a person injured by unfair competition may recover:
(i) actual damages;
(ii) costs and attorney fees; and
(iii) if the court determines that the circumstances are appropriate, punitive damages.

(2) A person may not bring an action described in Subsection (1) against:
(a) a depository institution; or
(b) an entity that:
(i) controls a depository institution;
(ii) is controlled by an entity that controls a depository institution; or
(iii) is controlled by a depository institution.

Yes, sir. A bill after SCO's own heart. Opportunities for mischief galore. Now if *that* doesn't make you want to move to Utah, nothing will.

And now you know what the US Supreme Court is for.

SCO's S-1: Naming Names - Where the $10M Came From & Yarro's Law | 197 comments | Create New Account

Comments belong to whoever posts them. Please notify us of inappropriate comments.

Off-Topic here, please

Authored by: overshoot on Thursday, March 09 2006 @ 12:10 PM EST

Licky Clinks, HTML, preview, instructions in red.

Thanks in advance.