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SCO's Amendment to S3 Lists Novell in Risks Section At Last
Friday, January 16 2004 @ 05:58 PM EST

Is SCO reading Groklaw?

Immediately after I wrote about the singular lack of any mention that Novell was disputing SCO's copyright claims as a risk factor in their SEC filings, SCO has filed an amendment to their November S3 with the SEC, listing Novell in their risks section.

It's here, part of their January 16 Amendment 1 to their S3 prospectus. There is a notice that "the information in this prospectus is not complete" and is subject to further change.

Here is their amended risks section, and because it's so long, I've highlighted the new Novell information:

"Risks Related to the Business

"We do not have a history of profitable operations.

"Our fiscal year ended October 31, 2003 was the first full year our company was profitable in its operating history. Our profitability in fiscal 2003 resulted primarily from revenue we received from our SCOsource licensing initiative. If we do not receive SCOsource licensing revenue in future quarters and our revenue from the sale of our operating system platform products and services declines, we will need to further reduce operating expenses to maintain profitability or generate positive cash flow.

"In our 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 deferred revenue balance has declined from $10.1 million as of October 31, 2002 to $5.5 million as of October 31, 2003, and this decline in deferred revenue may continue into future quarters, which may have a negative impact on our operating system platform products revenue. Our future operating system platform 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 continue to generate positive cash flow and profitable operations, our operations may be adversely impacted.

"Additionally, as explained in more detail below in the section entitled "Recent Developments," we must account for the issuance of shares of our Series A Convertible Preferred Stock from our October 2003 private placement by bifurcating the value of the Series A Convertible Preferred Stock into a preferred stock component and a derivative component. As of October 31, 2003, we recorded a liability of $15.2 million as the fair value of the derivative component. To account for the derivative component in subsequent periods, we will mark-to-market its value at each balance sheet date and will include in our consolidated statement of operations any changes in value as a component of other income or expense. Changes in the value of the derivative component may be significant because the value of our common stock at each balance sheet date will have a significant impact on the derivative's value. For example, an increase in the value of our common stock by $1.00 may require us to record an expense of approximately $1,000,000, and, conversely, a decrease in our common stock by $1.00 may require us to record income of approximately $1,000,000. If this accounting treatment requires us to record significant expenses in future periods, our profitability in those periods may be adversely impacted.

"Our future SCOsource licensing revenue is uncertain.

"We initiated the SCOsource licensing effort in January 2003 to review the status of UNIX licensing and sublicensing agreements and to identify those in the industry that may be currently using our intellectual property without obtaining the necessary licenses. This effort resulted in the execution of two significant license agreements during fiscal year 2003 and generated $25.8 million in revenue. 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 initiative is unlikely to produce a stable or predictable revenue stream for the foreseeable future. Additionally, the success of this initiative may depend on the perceived strength of our intellectual property rights and contractual claims regarding UNIX, including, the strength of our claim that unauthorized UNIX System V source code and derivatives are prevalent in Linux.

"We may not prevail in our legal action against IBM, and unintended consequences of our action against IBM and initiatives to assert our intellectual property rights may adversely affect our business.

"On or about March 6, 2003, we filed a complaint against IBM alleging breach of contract, misappropriation of trade secrets, tortious interference, and unfair competition. The matter is currently pending in the United States District Court for the District of Utah. The complaint centers on IBM's activities regarding the UNIX operating system that underlies our UNIX-based operating systems and IBM's AIX UNIX-based operating system. The complaint alleges that IBM obtained information concerning the UNIX source code from us and inappropriately used and distributed that information in connection with its efforts to promote the Linux operating system.

"On or about June 16, 2003, we filed an amended complaint in the IBM case. The amended complaint essentially restates and realleges the allegations of the original complaint and expands on those claims in several ways. Most importantly, the amended complaint raises new allegations regarding IBM's actions and breaches through the products and services of Sequent, which IBM acquired. We allege that IBM breached the Sequent agreement in several ways similar to those set forth above and we are seeking damages flowing from those breaches. We are also seeking injunctive relief on several of our claims.

"IBM has filed a response and counterclaim to the complaint, including a demand for jury trial. We have filed an answer to the IBM counterclaim denying the claims and asserting affirmative defenses.

"In its counterclaim, as amended on September 25, 2003, IBM asserts that we do not have the right to terminate its UNIX license or assert claims based on our ownership of UNIX intellectual property against them or others in the Linux community. In addition, IBM asserts that we have breached the GNU General Public License and have infringed on certain patents held by IBM. IBM's counterclaims include claims for breach of contract, violation of the Lanham Act, unfair competition, intentional interference with prospective economic relations, unfair and deceptive trade practices, promissory estoppel, copyright infringement and patent infringement. Discovery is ongoing in the case. We intend to vigorously defend against these counterclaims.

"If we do not prevail in our action against IBM, or if IBM is successful in its counterclaim against us, our business and results of operations could be materially harmed. The litigation with IBM and potentially others could be costly, and our costs for legal fees may be substantial and in excess of amounts for which we have budgeted. 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.

"In addition, we have publicly, and in individual letters to 1,500 of the world's largest corporations, cautioned users of Linux that there are unresolved intellectual property issues surrounding Linux that may expose them to unanticipated liability. As a result of these concerns, we have suspended our sales of Linux products. We also have begun delivering written notice to a large number of licensees under our System V UNIX contracts requiring them to, among other things, provide written certification that they are in full compliance with their agreements, including certification that they are not using our proprietary UNIX code in Linux, have not allowed unauthorized use of licensed UNIX code by their employees or contractors and have not breached confidentiality provisions relating licensed UNIX code. Additionally, we have begun notifying selected Linux end users in writing of violations we allege under the Digital Millennium Copyright Act related to SCO's copyrights contained in Linux.

"As a result of our action against IBM and our SCOsource initiatives to protect our intellectual property rights, 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. These actions have been somewhat successful in negatively impacting our business, and we expect that similar efforts likely will continue. There is a risk that participants in our marketplace will negatively view our legal action against IBM and our 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.

"Another recent Linux proponent action has been to initiate several denial of service attacks on our website, which have prevented web users from accessing our website and doing business with us for a period of time. If such attacks continue or if our customers and strategic partners are also subjected to similar attacks, our business and results of operations could be materially harmed.

"Also, some of the more significant participants in the Linux industry have made efforts to ease Linux end users' concerns that their use of Linux may subject them to potential copyright infringement claims from us. For example, Hewlett-Packard and Novell have each established indemnification programs for qualified customers purchasing Linux-based products and services that may potentially become subject to a copyright infringement claims from us. Additionally, Open Source Development Labs, a non-profit organization (OSDL), has established a legal defense fund that will be used to defend Linux users against copyright infringement lawsuits brought by us. It has been reported that OSDL so far has attracted at least $3 million in pledges from contributors including IBM and Intel, among others. Similarly, Red Hat, Inc. has announced it has committed $1 million for a separate fund it created to cover the legal expenses of other companies developing Linux.

"As a further response to our SCOsource initiatives and claim that our UNIX source code has inappropriately been included in Linux, Novell has publicly asserted its belief that it owns certain copyrights in our UNIX System V source code, and it has filed 15 copyright applications with the United States Copyright Office related to UNIX System V. 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. We have repeatedly asserted that we obtained the UNIX business, source code, claims and copyrights when we acquired the operations of Tarantella (formerly, The Santa Cruz Operation, 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.

"Notwithstanding our assertions of full ownership of UNIX-related intellectual property rights, as set forth above, including copyrights, the efforts of Novell and the other Linux proponents described above may cause Linux end users to be less willing to purchase from us our SCO Intellectual Property Licenses authorizing their use of our intellectual property contained in the Linux operating system, which may adversely affect our revenue from our SCOsource initiatives. In addition, these efforts may increase the negative view some participants in our market place have regarding our legal action against IBM and 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 System V source code and derivatives 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.
" [emphasis added]


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