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SCO's Financial Spin & Dec. 22, 2003 earnings call transcript
Monday, December 22 2003 @ 08:21 AM EST

SCO's press release blowing their own horn is here. I see no Linux license sales except the usual suspects, Sun and Microsoft:
Fourth quarter revenue from UNIX products and services was $14.0 million. In addition, revenue generated from the Company's SCOsource licensing initiative was $10.3 million, which was derived from licensing agreements reached with Microsoft Corporation and Sun Microsystems, Inc. earlier in fiscal 2003.
They spin it by comparing it to last year's fourth quarter, and I'm guessing they had no place to go but up from last year:
The SCO Group, Inc. (Nasdaq: SCOX -News ), owner of the UNIX operating system and a leading provider of UNIX-based solutions, today reported revenue of $24.3 million for the fourth quarter of its fiscal year ended October 31, 2003, a 57% increase over revenue of $15.5 million for the comparable quarter a year ago.
So, I see they are marking on a curve.

But take a look at this paragraph:
For the fourth quarter of 2003, the Company reported a net loss to common stockholders of $1.6 million, or $0.12 per diluted common share. Excluding the previously reported charge of approximately $9.0 million incurred in connection with its October 2003 private placement for compensation paid to law firms engaged to enforce its intellectual property rights, the Company would have reported net income for the fourth quarter of $7.4 million, or $0.44 per diluted common share. The Company reported a net loss to common stockholders of $2.7 million, or $0.26 per diluted common share, in the comparable quarter a year ago. A GAAP reconciliation of net income (loss) and earnings per share for the fourth quarter and fiscal 2003 excluding the above charge is included in the financial tables at the end of this release.
Sun and Microsoft gave them a lot of money this year. And they paid their lawyers a lot of money. And they report a net loss to common stockholders. Am I missing something here? This is their best year ever?

Here's the transcript of SCO's 4th quarter earnings call, dated December 22, 2003, prepared by Groklaw members kelledin, elrond_2003, rcrook, rc, Cableguy, Frank Jaffe, Screenwriter, be2weenthelines, peterwn, Jude.

**********************************

Operator: Good day everyone and welcome to the SCO Group's fourth quarter 2003 conference call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer session. At that time if you have a question you will need to press star-one on your touch tone telephone. Any reproduction of this call, in whole or in part, is not permitted without prior written authorization from the SCO Group.

As a reminder, this call is being recorded today, Monday, December the 22nd, year 2003. Participating in today's call are Darl McBride, President and CEO, and Robert Bench, Chief Financial Officer.

Before we begin today's call, I would like to inform you that our discussion may contain forward-looking statements, including without limitation statements relating to our future operation and financial performance. Such forward-looking statements reflect management's current expectations and beliefs, but they are not guarantees and are subject to risks and uncertainties that cause our results to differ materially from those contained in the forward-looking statements. These risks and uncertainties include, but are not limited to, those set forth in our earnings press release issued earlier today and in our filings with the SEC.

Now ladies and gentlemen, I'll turn the call over to Darl McBride, President and CEO of the SCO Group. Please go ahead sir.

McBride: OK, thank you and thank you all for joining us today. Fiscal 2003 was a year of tremendous progress for SCO on many fronts. First, we achieved record financial results in the fourth quarter. Our revenue of 24.3 million dollars represents an increase of 57% over the fourth quarter of last year. These results are in line with our expectations.

Second, we achieved record financial results for our full fiscal year. We posted net income of 5.3 million dollars or 34 cents per diluted common share, reversing a net loss of 24.9 million or a $1.93 per diluted common share in fiscal 2002.

This marks the first time that SCO has generated cash and been profitable on a full-year basis.

Third, we ended up the year in a position of financial strength that represents a substantial turnaround from this time last year. Our positive financial results along with the $50 million equity financing completed in October have given us the resources and flexibility we need to pursue our strategies. At the close of the fiscal year we have 64.4 million of cash on the balance sheet.

Overall, I would characterize 2003 as a year in which we created a strong platform for SCO. A platform upon which we expect to generate long term growth in 2004 and beyond. We have taken important first steps over the last twelve months, strengthening our management team, our financial footing, our core Unix product offerings, and our intellectual property positioning. We're excited about our future at SCO, and in fact today we're announcing two important new initiatives. But before we get into those announcements, I would like to turn the call over to Bob to review last year's financial results.

Bench: Thanks, Darl. The fourth quarter ended October 31, 2003 was our third consecutive quarter of strong revenue and cash contribution. Of the 24.3 million in fourth quarter revenue, 58% was related to our Unix product and services business line and 42% was generated from our SCOsource licensing initiatives.

The fourth quarter revenue performance for our Unix product line was the strongest quarterly performance this year. The breakdown of revenue for the fourth quarter by geography was as follows: 58% in the Americas, 31% in EMEA, and 11% in AsiaPac.

Our gross margin of 16.9 million, or 70%, was lower than prior quarters, primarily as a result of increased legal fees incurred with the connection with our SCOsource initiatives. Operating costs and expenses for the fourth quarter of fiscal 2003, exclusive of the compensation charge to law firms, were 12.1 million, which is trending as expected and was consistent with our prior quarter. Operating expenses in the fourth quarter of fiscal 2003 were 2.8 million lower than operating expenses of 14.9 million in the fourth quarter of the prior year.

Our full year revenue for fiscal 2003 increased 23% to 79.3 million from 64.2 million for 2002. And on a fiscal year basis, operating expenses declined 20% from 70.1 million to 55.9 million. Additionally, our gross margin percentage increased from 71 percent to 75 percent compared to the prior year. These operating improvements were expected, as we delivered and met our fiscal 2003 operating objectives. For fiscal year 2003 net income to common shareholders was 5.3 million, or 34 cents per common, diluted share. That's compared to a net loss to common shareholders of 24.9 million or $1.93 per share the prior year. Fiscal 2003 results include revenue from our SCOsource initiative of 25.8 million, and as Darl noted earlier, the company's 2003 net income of 5.3 million represents the first profitable year for the SCO Group.

[6:06]

As the company had previously announced, we raised net proceeds of 47.7 million in October. The accounting treatment for this transaction was complex although not uncommon for financial transactions such as this. The financing was required to be split into two pieces: temporary equity and a derivative financial instrument. The temporary equity was assigned 29.7 million of the value of series A preferred stock. The company engaged an outside firm to assist in the valuation of the derivative, which was the reason for our delay in this earnings call. As of October 31, 2003, the company recorded the fair value of the derivative of 15.2 million as a current liability. And the change in that fair value of the derivative from October 16 to October 31 of 2.8 million has been recorded in the company's fourth quarter and fiscal year 2003 income statement as "other income". The accounting for the derivative will require the company to mark to market its value at the end of each quarter, and any difference in the carrying value will be included in the income statement as other income or expense. As was the case for the fourth quarter, this charge could be material.

Our positive financial results for fiscal 2003, and the 50 million funding completed in October have increased our cash balance to 64.4 million and our working capital to 37.2 million. The significant increase in cash, and working capital coupled with the fact that we have no long term debt puts the company in a very strong financial position to pursue our strategic goals in fiscal 2004. We believe our revenue outlook for 2004 will be enhanced by the strength of our financial position. Furthermore, management's attention can be directed towards growth initiatives and revenue generating activities. For fiscal 2004, the company has three major business initiatives to drive increasing revenue. Our Unix operating systems and services business. Two, Our SCOsource vendor licensing program that was successfully rolled out in fiscal 2003. And three, our recently introduced SCOsource intellectual property licensing program.

Revenues for the two SCOsource initiatives is expected to be minimal for this first quarter of 2004, as the company finalizes license agreements with its vendors, and begins the implementation of its intellectual property licensing programs. Our future revenue pipeline has strengthened this year, along with our increased confidence in our intellectual property claims. We therefore anticipate significant revenue in subsequent quarters from both SCOsource licensing initiatives. However, the nature and predictability of these lines of revenue and the variability of revenue recognition does not allow for accurate near-term guidelines.

In its first quarter, ending January 31 2004, the company expects total revenue to be in the range of 10 to 15 million, which is in line with first quarter revenue of last year. The company's Unix line of products and services are expected to represent the majority of the consolidated revenue for this quarter. Operating expenses relating to our core business lines should remain consistent with recent quarters. Expenses related to SCOSouce are expected to increase in fiscal 2004 as the company expands and pursues its legal strategy.

[10:00]

With focused attention on our Unix product development, our strong financial position and the increased size of our pipeline of licensing opportunities, we look forward to strong results from both our divisions in 2004.

With that, I'll turn it back to Darl.

McBride: OK. Thanks Bob.

As Bob mentioned in his financial review our results demonstrated SCO's business in 2003 not only stabilized but thrived as we developed and emphasized new areas of our business, created and strengthened relationships with key partners, and worked to enforce and protect our intellectual property. We've put together a strong foundation from which we will build our business in the new year.

We have also introduced and built our SCOsource business unit to enforce our intellectual property rights. As we move into the digital age, intellectual property enforcement is a necessary and proper area of focus for companies around the world. Profitability will be sustained only to the extant intellectual property is identified, cataloged, and protected. We at SCO are pleased to be a leader in this important new area.

Before we move on to today's SCOsource announcements, I'd like to make a few comments on our core Unix operating business. In our OpenServer and UnixWare product lines, we continue to see good uptake from existing customers while attracting new customers in our key vertical markets, which encompass large as well as small to medium businesses. Let me just rattle off a few of the customer deals that we completed transactions with during the previous quarter.

In North America the list would include organizations such as: the Department of Justice, Lockheed Martin, US Air Force, Accent Oil, Goodyear, AT&T, Avaya, CSK Auto, Pinkertons, 84 Lumber, Cracker Barrel restaurants. McDonald's, GE aircraft engines, Daimler-Chrysler, and NASDAQ. To move on to Europe, we are looking at organizations like Barcrest, Marconi, Dolond and Atchison, Fleet Air Army, and Argos; in Germany BMW; out of Italy, ministry of Finance. Moving on to AsiaPac area: out of Japan, we have companies like Toshiba, Matsushita Electronics, and Image Partner. Out of Taiwan: LCC, Taiwan educational training group. In China: China Central Bank, Peoples Bank of China, Highway Administration, and Shandong Province. In India: India Overseas Bank, Bank of Pakistan, and Bank of India.

As you can see, we have a global business. We have large and medium sized customers that work with us and we are very pleased with the continued progress of our core business.

For the future of OpenServer and UnixWare, SCO is focused on developing products and services that build on our historical strength in vertical markets, which is a key part of our strategy. There are a lot of high tech companies out there trying to align their offerings to vertical markets. SCO is already there today with a partner base of more than 4300 application providers selling in to markets such as retail, health care, and financial services. At SCO Forum last August, our annual reseller and customer conference, we announced that we had begun work on new versions of the company's flagship UnixWare and OpenServer Unix operating systems. We also added to the company's road map plans for a 64 bit Unix product. We expect to deliver the upgrade to UnixWare and introduce the beta for OpenServer, currently code named "Legend", during 2004.

So let's now move on to our SCOsource initiatives. As most of you are probably aware by now, throughout the course of 2003, SCO has been actively engaged in protecting and enforcing our valuable intellectual property under our SCOsource business unit. We believe this is a model that many companies will adopt in one form or another as intellectual property protection becomes a key area of focus in our digital age. This coming year SCOsource will continue to focus on winning the IBM lawsuit, and we will expand our focus to enforce our Unix intellectual property rights against other companies.

Let's talk for a moment about the IBM litigation then. Our lawsuit with IBM is progressing to our satisfaction as we have been building our case through the discovery process. The case is scheduled to come to trial on April 11, 2005. We are encouraged by the strength of our case there, as reflected by the evidence that we have been able to discover thus far. And we are absolutely prepared to see this case to its full conclusion.

Based on our claim that IBM's breached its software agreement with us, we have terminated its ability to license any product based on Unix System V. IBM's ongoing business related to AIX licensing is therefore operating outside its license grant in Unix technology. IBM does not have the right to currently license Unix technology and customers do not have the right to license Unix technology from IBM. This is a significant legal right that we will enforce in the coming year.

[15:15]

In addition, we will enforce and protect the company's intellectual property rights against unauthorized use and distribution under the Digital Millennium Copyright Act. We are beginning with enforcement of certain copyrighted Unix header files that are found in Linux which have been used improperly in Linux with copyright attributions removed. We've identified specific code that must be removed from Linux prior to any further use or distribution. Failure to remove this copyrighted code from any new distribution under the GPL may subject the distributing company to liability under the Digital Millennium Copyright Act, section 1202, for knowing distribution of copyrighted material with copyright management information improperly removed.

From today's press release I'd like to call particular attention to the written notices we're sending to our Unix source code licensees. And I'd really like to emphasize a couple of points here. First, these source code agreements are the legal foundation upon which much of the industry's enterprise Unix operating systems are licensed. Second, the list of Unix source code licensees is substantial, both in number and in scope. These source code licensees include 41 companies in the Fortune 100. They include leaders in numerous industries, including pharmaceutical, financial services, transportation, energy, automotive, computer hardware, and computer software. And there are thousands of them. Third, under the terms of these agreements, SCO is requiring each of these licensees to certify in writing that they are utilizing the code in compliance with the terms of the agreement.

This means that each company must certify to SCO that each of the following three points. First, the company is not running Linux binary code that was compiled from any version of Linux including code that contains SCO's copyrighted application binary interface code. Second, the company, its employees' and contractors, have held, at all times, all parts of the Unix products in confidence for SCO. And third, no employees or contractors who have had access to Unix have contributed any software code based on that product to Linux or any other Unix based product. SCO has requested that such certification be provided by the end of January. Failure to respond or failure to certify full compliance gives SCO the right to terminate the agreement and require the licensee to discontinue use of the Unix software. I might add here it's important to understand also that we're not talking about the previous products group. When we talk about SCO Unix, UnixWare, OpenServer that was sold in as a product. These are the underlying source code agreements that emanated from AT&T that have been passed on and are still valid today.

The Unix source code license agreements were put in place years ago to allow companies themselves to make source code changes to their versions of Unix. That activity alone is fine if exercised within the terms and conditions of the agreement. However, some of these same companies are using, modifying and redistributing Linux. To the extent any Unix information, methods, or concepts have been used by a company ... by such a company in making its Linux modifications, our source code agreement has been violated. We therefore will require that every SCO source code licensee verify its compliance with its Unix software agreement with us as a condition of continued use of its Unix technology. If verification is not complete or if violations are found inside any company, we will terminate that company's right to use Unix consistent with the terms of our source code agreement. We will not allow any Unix licensee to use Unix technology to build Linux. Unix source code licensees who are doing this will lose the right to use any version of Unix. We expect that this will also become an area of focus for our enforcement initiatives in the near term.

So to put a summary on all of this, fiscal 2003 was a pivotal and successful year for SCO. This was the first profitable year in more than 7 years for this company. We have no long term debt, we have more than 64.4 million in cash on our balance sheet, and this strong financial basis will provide SCO with the resources and flexibility to focus on its strategies for the new year.

[20:14]

So the key things going forward for us will be: delivering new Unix products and services which address customer demands for greater flexibility and interoperability; pursuing our claims against IBM; building awareness with Linux users and providing them with a path for continued Linux use which will build recurring revenue for SCO through a flexible licensing program, and also building industry relationships which support our Unix business and our SCOsource initiatives.

We're encouraged by the positive momentum we have in these areas as we head into FY2004, and we are looking forward to an outstanding year. With that, why don't we turn it over to the operator to build the Q&A list.

Operator: Thank you, sir. If you would like to ask a question on today's call, you may do so by pressing star-one on your touch tone telephone. Again, to ask a question, you may do so by pressing star-one on your touch tone telephone. If you are on a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that is star-one to ask a question. We'll pause a moment to assemble our roster.

We'll take our first question from Brian Skiba with Deutsche Bank.

Skiba: Yeah. Yes, hi, good morning. And congratulations on that quarter. A question around the notices you're sending out of the letters to the Fortune 1000 Linux end-users .... Darl, can you give us any kind of range about how many of those sort of letters have been sent out, and whether this is, you know, more-or-less a first set of letters and there's more to follow, and then what kind of legal options, as it mentions in the press release, are available to them at that point?

McBride: OK, so let's talk about the numbers first, then we'll go to the options. On the numbers side, really the two letters that we started last week, we've got a few days we're down for Christmas this week, and then after the Christmas break we'll jump back in, and by the first of the year, we expect we will have several thousand letters in the hands of the Unix licensees who have a requirement to certify back to us that they are not using Linux in contradiction of our Unix license agreements. With respect to the Linux end users, basically we're starting with a list we have of fifteen hundred. We have a lot of intelligence there now. We know a number of those organizations that are not using Linux, but we also know of a number that are, so I would say that list is going to be in the hundreds, but it probably won't get to a thousand, but it will be substantial in terms of those that receive the DMCA notice. Those who receive the Unix letters will also receive a copy of the DMCA letter stating that use of Linux in their environment, on top of the Unix violations that they may face would be relevant to them as well from a copyright perspective.

Let's talk then about the options organizations have. You know, I think it's ... there's really three ... you know, the first one is to cease and desist use of Linux. We absolutely see our copyrighted code inside of there; we've said that continually. This is a very clear-cut set of violations. We have spelled those violations out in the letters. People have been asking for discreet disclosure of where these files are. We have over forty files that are disclosed here. And so, you know, basically discontinued use of Linux would be the option number one. Or removing those header files out of Linux I suppose would be a subset of that option. The one challenge of trying to remove the header files is that when you get into the middle of this, you're going to see that the header files touch virtually every application that's been written in Linux. So removal of the files themselves would tend to create an incompatibility of the application that's running inside of your organization on Linux. So option one then, summarized, is essentially stop using. Option two would be I want to keep using Linux, but I want to be straight with the legal side of things, and we have provided the mechanism for licensing there, and in our price by there is 399 per CPU. We have extended for some period of time the 699 price yet going on that, and so that would be the option two. And then the final one would be to continue using Linux, and then at that point, we would be pursuing whatever ... all the legal options that we have at our ... within our hands at that point in time. So I think those are the three remedies that I see, the three options.

Skiba: OK, and the 699 is a one-time fee, and they have the source code rights to use Linux and everything at that point?

McBride: They basically would have a right to use a binary version and continue to run Linux, is the way that program works.

Skiba: OK. Very good, thank you.

McBride: Yup.

Operator: We'll take our next question from Nicholas Donovan with J.P. Morgan.

Donovan: Yes, Darl, how you doing this morning. Congratulations on your quarter.

McBride: Thanks, Nicholas.

Donovan: My question to you is ... as it relates to the source-code licensing, how will ... if you process on a per-CPU on a multiple-processor machine ... and what about distributed application programming?

McBride: Well, I think the ... the per-CPU, the reason we license by CPU, it's important to recognize that the world is moving to larger and larger machine types and expanded environments here, and our licensing program on the source code side has always been listed as a CPU count. If you go back to the Unix license agreements that were signed 20 years ago, from 20 years ago going forward, what you'll see is these thousands of companies that are out there today that have these agreements have an obligation to report to us by CPU. And if the source code that is licensed to us is exceeding the CPU count that they have licenses for, then they're out of bounds. So, you know, I think it is an important distinction to make that we're focused on CPU count here, not on the the server count. When you get into these large, expanded server farms, you know, this is a key point to understand from a distributed application standpoint, that there is a focus on the CPU side of things.

Does that address your question? Nicholas?

Donovan: Yeah, it sure does, thank you.

McBride: OK, great.

Operator: Once again, that is star-one if you would like to ask a question. And if you're on a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment. Once again, that is star-one to ask a question. We'll take our next question from Herbert Jackson with Renaissance.

Jackson: Hey, good morning, good quarter. Congrats.

McBride: Thanks, Herb.

Jackson: Couple of questions. One's been answered, but the Fortune 1000 Unix IP licensees that you referenced in some prior press interviews, do those begin to book in subsequent quarters? Have those been finalized?

McBride: Yeah, you're talking about the Unix side of things.

Jackson: Yes.

McBride: Yes, we see a very healthy pipeline right now, Herb, in a handful of different areas. As we move forward here, we have basically very strong contractual rights going down to the end use customers that hold Unix source licenses that came down through the AT&T side. As we go out and go through this process that was just initiated last week, you know, we think that as we move primarily into Q2 and beyond, that that is going to be a very healthy pipeline. I mean, the point is, someone who's out there and has Linux source licenses is either going to have to -- and they have a lot of Linux inside their shop, and that's ... there's going to be a lot of companies that fit that bill that are really going to be forced into a situation of discontinuing use of Linux or paying a fee here. And you know, it's going to be one or the other. There's no doubt that Linux is popular out there. It's popular in large part because it's free. But we do see a healthy pipeline coming from that side. The second pipeline that we see that's healthy heading into the new fiscal year is that on the vendor side, we see our vendor pipeline healthy. You know, obviously we did some deals last year. As we head into this new year, quite frankly one of the biggest issues that is basically between us and some deals here has been our coming out and putting on the table some things on the legal side that relate not to IBM. You know, the ... a lot of folks have become a little bit conditioned to saying "Well, let's wait until the IBM thing turns out, and we'll go from there." Let's be 100% crystal clear on what we announced this morning. The DMCA copyright violations that were announced this morning are independent of the IBM legal case. You know, the contract case has been moving since March with IBM, and we like where that's going. The case that came out this morning is the first time we've come out definitively saying, "Here is our set of issues, here are our problems that we have, here are the set of files." And we're going to go out and pursue that. It's not the only set of files. Think of this again as the tip of the iceberg. We rolled out a small set of code in the summer timeframe -- 80 lines or so -- the Linux community came out and said, "We've removed that." Well, by removing it, essentially there are a few million servers out there today that don't have it removed on. So on that basis alone, Linux is tainted. But what we're talking about here is much more than 80 lines of code. We're talking about 43 or so header file that touch virtually all of the applications that have been written in Linux. So as those come together now, that's where a lot of the vendors, as well as the end users quite honestly have been looking for before they move forward on the licensing program.

Jackson: Great, Thanks. If you'll take one more question, totally unrelated, but any visibility for your web services platform sell through in subsequent quarters?

McBride: Yeah, on the web services sell through, we had it set in the summer time frame that we thought in 2004 we would see some traction there, and we're starting 2004 right now. We are basically putting together this program to go the 4300 applications in a vertical environment and we have some interesting partnerships that we're in the middle of right now that we think we will really drive that in a positive way. We're well positioned there. I don't see the uptake on that hitting in Q1, but I see some positive momentum that comes out of that in this fiscal year.

Jackson: Great. Thanks.

McBride: Yeah.

Operator: We'll take our question from Dion Cornett with Decatur Jones.

Cornett: Good morning all and congrats on a strong quarter.

McBride: Thanks, Dion.

Cornett: A couple quick questions about the guidance coming forward and trying to model that out. Now obviously it's a ... you know, it's complicated and unusual for a software company to migrate to some things you're having to with these end user agreements. But, you know I had a number of two and a half million for January. Looks like if I'm reading the guidance right, it's now zero, and I'm trying to figure out how I get a handle on what the April numbers should look like. Could you ... the easiest way to do this is if you look at the last initiative where you sent out the 1500 letters and you talked about this a little bit with Brian's question. Can you break down, the best you can to the nearest 100, nearest 10 percent of those 1500 letters, what percentage of folks responded to you, and of those people that responded, how many did you meet with, and in the general ballpark, how many said, "Yes" and it was just a matter of some administrative stuff to get the licensing fees in, how many "No"?

McBride: Yes, all good questions Dion. When we rolled this thing out initially last summer, there was a lot of stuff flying around out there. We were going to send out invoices, we were going to do this, we were going to do that, it sounded like a direct mail campaign. That wasn't obviously what we were trying to do. What we did do during the last quarter was spend a lot of one-on-one time meeting with large end-users of Linux. Probably had twelve to fifteen or so direct, one-on-one meetings.

Cornett: Right.

McBride: And we learned a lot through that process. I would really look Q4 as more of a modeling, as almost like a testing time that we went through here, to tell everybody where we were and we listened to where everybody else was, and essentially what comes out of that then is ... you know, we had several people sign up for the license, and these are people we don't have other deals going with in the technology industry. These are Fortune 500/Fortune 1000 level accounts that signed up. We have another group of those people we met with that have basically said "Fine, I'm not going to use Linux." You know, CIO's were in meetings, and they said, "Fine, we're not going to do it." And then we have another group that essentially has said that "We're looking for something. We're either going to wait until the IBM litigation is done, or we're looking for something on your copyright claims, and if you show us something there, then we'll step up and move."

So, if you take those, and you say, you know, the greatest group of those -- you know, again there were some of them that said that they're not going to use any -- but the greatest group either licensed or said they would upon seeing something that legally they felt like they should moving on now as opposed to waiting for the IBM case. The other thing to recognize is in Q4 we only had two people involved in this. One coming from more of a legal side, and one more from a market place presence perspective/accounts perspective. We intentionally kept this thing very tight, very controlled because we wanted to not let this thing get out ahead of us.

[35:30]

We feel now from where we sit that we are in a mode to move this out. We announced this today, and we are now and we are going to be moving very aggressively. Whereas, last quarter we had two people working on this, starting next week when we come back from the holidays we're going to be moving essentially dozens of resources on to this project. And as we move forward with those resources internally backed by the Boies team externally, we think that -- again, we might see some uptake here in Q1 as it relates to this, but as we get into Q2 and beyond, you know, it's hard to give guidance exactly, Dion.

What I can tell you is that the people we're meeting with have thousands and thousands of units of Linux inside the shop. You take, some of these that have anywhere from five to ten thousand units going. You can model out, you know, the 699, the 1399 price point. That [unclear] I'd stick on the lower end of that right now, because we still have that as an option. As we move into the legal side of this it's important for people to understand that under copyright law, people who are violating copyright law can face statutory damages as high as 30,000 dollars for not willful infringement on a per instance basis, so per server per CPU basis, and as high as 150,000 per instance for willful violations. So people are going to be staring at these letters that say, you know, we're going to be considering you a willful violator if you continue to copy our IP going forward. So you know, I think that the options are really clear. You go down a legal path and it's going to be, you know, where it is with the legal remedies. The licensing path is another. The third would be to just not use it at all. But I think the realistic path probably is going to be the licensing path for many companies.

Cornett: OK, and then so ... just, you know, one of the other points you made ... you have signed up several, and I can understand why these customers would want anonymity, but how ... for the three, four you have signed up, in rough ballpark what are the dollars associated with those deals.

McBride: Yeah, we haven't signed up any yet that are in the thousands of users so you know we've ... I haven't seen the exact number on that, but I would say that we've not signed any of the large users yet. I can say that we have large users that are north of five thousand boxes in their enterprise that are on the bubble waiting to see where they go on this.

Cornett: OK, and then just one final thing on this morning's initiative. If the Linux community were to come back and say, that's fine, we've got to take the header files out which are, you know, largely definition files. Then you guys take Samba and some of our stuff out of your software, what would be your response. Would you remove those open source components or do you believe there is a valid licence out there that allows you to ship them.

McBride: Well, again, we're not taking a shot at the whole open source community. We're saying we see that there is a flaw in the process out there where our stuff is seeping in there. So you know we're not ... you know, this is not a case of SCO versus Open Source. This is a case very clearly where our IP has been misappropriated. The fact that, you know, we're seeing these violations there is what has given us the basis to step up and make those claims.

Cornett: All right, thanks very much.

Operator: We'll take our next question from Gary Dean with Jetstream Capital.

Dean: Hi, good morning. A couple questions. I'm newer to the story. What was the revenue from last year's fourth quarter from the Unix product segment?

McBride: Bob, do you have that on the tip of your tongue? I don't have the exact on the units from a year ago.

Bench: Yeah, that was about 15 million, Gary, just a little over about 15.5 million. Almost all of last year, since we did not have the SCOsource initiative at that time, all of the revenues we reported were really from the Unix related business line.

[39:55]

Gary: OK, and .... thank you. My second question was related to Darl's comment earlier about the action ... the notices being sent out to Linux customers being an independent action. Assuming ... if the customers who receive the notices ... I think Darl let out two choices. They could either stop using Linux, or they can remove the code. If they decide to wait and say, "Wait, we want to wait to see what the outcome of the IBM action is, we can see if the base argument being made here is valid", and you decide to pursue them, would you pursue customers individually, collectively, what is the strategy for pursuit if they decide to do nothing and not move on your letter?

McBride: Yeah, that's going to be a decision for David Boies. In terms of the ultimate strategy, on our call a month ago he did say within 90 days, you know, that you should expect to see an end user facing a lawsuit showing up during that period of time that would basically give us the basis to go in and establish the claims that we have here on the copyright side.

What we're announcing here today with these violation notices will eventually tie in to that litigation. So now, do you go after one, do you go after a set? You know, those are going to be calls for David.

With respect to some of the concerns that have come up from various folks saying it's crazy to be going after end users, I know that some folks in the industry have been on record coming out of the Free Software environment saying, "You know, this is as crazy as going out and finding someone who bought a book at Barnes and Noble and chasing them down at home and while they're in their living room, suing them for reading the book." But I would point out two major differences with the free software example that they're floating around out there. The first one is that when you look at the GPL, you realize that you don't actually buy this. So in other words this would be like going into Barnes and Noble and not buying a book, but Barnes and Noble bookseller gives you a book for free. And then they point you to the GPL language that says "by the way Since this is free, there's no warranty, and essentially this is as is. If somebody comes after you, you're on you're own." So that's one significant difference.

The second difference that I'd say is even bigger is, the bookreader that went home and sitting by his fireplace reading the book, when he got through with it, he didn't intend to get up and make 500 copies and give it to his closest friends and neighbors. That's what's happening with Linux. There's huge amounts of copying. So this would be like getting the book, you read the book, and then you make 500 copies and you send it around the neighborhood.

That is the whole point here. Copyrights are to protect people from making copies. At the end user level is where the substantial amount of copying is going on. And that is thus the target area for the litigation that will be coming up with respect to Linux-related lawsuits.

[43:26]

Dean: OK. Thank you.

McBride: Yes. I'll just mention on that, the GPL forces that issue. It pushes everything down to the level. When I met with IBM earlier this year, they said you can't sue us, we don't do distributions. If you look at Linux distributors, everybody can point to some out clause where they don't have liability. And technically, whether they have contributory infringement, that's for lawyers to decide. But clearly what's happening here is they are pushing the liability down to the users. OK, go ahead.

Operator: We'll take our next question from Andy Schopick with Nutmeg Securities.

McBride: Hey Andy.

Schopick: Hi. A couple of questions, I hope you can clarify.

McBride: Sure.

Schopick: In connection with the IBM litigation, can you give us any sense of what the general expected litigation costs will be in this upcoming fiscal year, and what they actually were in the fiscal year you've just reported?

McBride: Um, yeah. Bob, do you want to take that?

Bench: Yeah, Andy. This past year we spent about nine million dollars in total costs. That's including the cost for internal expenses. And probably spent about seven million dollars on legal fees, uh, last year. So about two and a half to three million per quarter. We are expecting that will increase. Our activity has increased dramatically, and we would expect an additional million to two million dollars per quarter as we move forward in this year compared to last year's costs.

Schopick: Of just the legal costs?

Bench: Legal, expert advice, all the relevant costs associated with pursuing these claims, Gary.

Schopick: OK, so it's an extra one to two million per quarter above the rate of spending that we have seen this past year.

Bench: Right. That's right.

McBride: And what you should factor in there also is that we are stepping up our enforcement activities, and there's a level of almost variability here, that when you talk about going after this end user campaign, very clearly we fully expect to see some pretty big returns coming back to us either through the licensing or through the litigation program.

And so it's not just a dial up against the IBM related expenses. It's also against things we expect are going to generate revenues during this fiscal year.

Schopick: On the revenue side, secondarily, in connection with having terminated IBM's rights to Unix 5.0 ...

McBride: Right.

Schopick: ... what were the, you know, license revenues associated with that in the most resent fiscal year? I assume those will go to zero now.

McBride: Yes, it's a little bit quirky. The thing that ... if you go back and have a look at the IBM agreement, IBM had bought out the royalty suit, so they actually didn't have an obligation to pay ongoing royalties, and I think that is a little bit of the confusion of how we got to where we were.

You know, on their side, they sort of probably felt like, "Hey we've already bought this thing out". What we own though is the underlying intellectual property rights that essentially said, you know, you can go ahead and sell your product, but what you can't do is disclose this source code in an unconfidential manner. And certainly you can't give the source code away, in violation of our contract rights.

So what it is ... what we have been in the middle of here is a ... you think of it as a dumping case. What happens when you have a dumping case, you basically take the value of the market and you take it down.

Well, Linux is the ultimate dumping case. The price is zero. You can't destroy a market any more than that. And so our claims are against the destruction of our marketplace as the owners of the Unix operating system. And they taking that and destroying the value, and trying to take the value down to zero. You know, we are losing a lot of ability to monetize our assets along the way.

Schopick: So there is no real additional revenue impact from having outright terminated IBM's rights.

McBride: That's correct. Again, even when you go to the ... when we talk about thousands of Unix licensees, you know, the people we are out meeting with on this, are not really our customers per say, on the OpenServer and Unixware side. Those guys are already buying products from us, most of those are not using Linux, so they're independent ... they're really separate from this.

We are talking about a lot of folks out there, who have the requirement to keep Unix safeguarded and protected. And they may fall under an HP camp, they may fall under an IBM camp, or, you know, one of the other big vendors out there.

Schopick: OK, thank you very much.

McBride: Sure.

Operator: Let's take our next question from Peter Richards with Empire Capital.

Richards: Thank you, my question's been answered already.

McBride: OK.

Operator: We'll go to Robert Phillips with RLP Capital.

Phillips: Hello?

McBride: Hello Robert.

Phillips: Hello. I think I may have missed it earlier. Is there a web site I could go to with a list of the 65 files in question, so I can kind of get an idea of how good this is going to work out?

McBride: We already have that out there. There is going to be a posting ... I think there was a lot of requests coming in from the press earlier today, so we will probably put that up on the web site here today.

So either go to ...

Could you get Blake, and just ask what time and where that's going to be ...

We will have it up on the web site and you should be able to take a look at that. Either go to sco.com/scosource and they should have out there somewhere.

Phillips: On later today?

Mcbride: OK, he's just given me the high sign. He said it'll be out there in about two hours.

Phillips: About two hours. OK. Thank you very much.

McBride: OK.

Operator: This concludes the portion of our question and answer session. At this time I would like to turn the call back over to Mr. Darl McBride.

McBride: OK. I would like to ask one more question that is on the mind of some people out there. I know because they have called in separately, and it didn't come up here now, so I take that one head on.

That is the question about Novell and a recent action that they have taken. We found out over the last couple of weeks that Novell snuck into the copyright office and tried to file some copyrights that would be basically on top of the claims ... the copyright registrations that we have made.

You know, the acts that Novell is going through here seem to be desperate. I know they are tied in very closely with IBM, and I know IBM and those guys are working very closely to try and win this battle against us.

As we found out two quarters ago on the day of our earnings release, when Novell came out and said, "We own the copyrights", and then we had produced amendment 2, that basically said, "Well no actually those copyrights have now been transferred over to us". We find it very interesting behavior on their part, that they are still trying to play some games here.

Let me be real clear with anybody who has any questions about some of the legal rights, that SCO acquired in its transaction with Novell. In the contract that we received from them, on the included assets it says "We have all rights and ownership of Unix and UnixWare". That was later amended with Amendment 2 to include all copyrights for Unix and UnixWare.

Turn the page, we have the right to all claims that arise after the closing date. So if there is any claim with respect to copyright violation, it says in our contract that those claims are all owned by SCO.

So that's another key point there to understand.

If you go look at the press release that was issued the day that SCO and Novell did their deal, very clearly said that the intellectual property rights to Unix were transferring over to SCO.

I found that ... I've heard that Novell had actually pulled that press release off from their web site. I guess that they don't like that floating around out there.

I think in Novell's case, very clearly they're getting money funded to them from IBM right now. We get a lot of communications that come from Novell where they cc IBM, and these guys are obviously working closely together.

If you turn the clock back exactly a year ago when I first brought the issues up around our intellectual property rights being violated with IBM, they came back and said, "Well, you know, we've looked at the asset purchase agreement, and you didn't appear to get any of the intellectual property rights." So that's been the defense they used all the way up to May 28, when we produced amendment 2.

When that happened, it was a bad day on that side. We see them taking desperate steps at this point to try and grasp for something that doesn't appear to be there.

So, they're trying to force some kind of issue here. We'll be glad to take the necessary legal steps to remedy that. We see this as a fraudulent filing of copyright notices on their side, and we'll take the appropriate measures as necessary with our legal team.

In summary, I see the Novell case as being one of tall hat and no cattle.

With that, we'd like to thank you all for joining call here today, and have a good holiday season. We'll look forward to talking to you in the new year.

Operator: And this does conclude todays conference call, at this time you may disconnect.


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