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More Changes in the New SEC Filing
Saturday, January 17 2004 @ 07:06 AM EST

In addition to the new risk factors already pointed out, here are some other changes in Amendment 1 to SCO's November S3, which it just filed.

On the left, you find the new version, with red text representing new or altered material. On the right, you find the November filing, with blue text representing deleted or altered material.

As a general rule, lawyers don't change a legal document unless it has some significance. To a lawyer, words are weapons. They aim for precision, not beauty, or at least if they aim for beauty, it's definitely second. This isn't a criticism. Precision in your words in a document can make the difference between a solid contract that doesn't need to be decided by a judge because there is no dispute about what it means and one that ends up a lawsuit because nobody is sure what it is saying. I won't characterize the changes here, because you can do that for yourself. The purpose of the chart is to help you note what is new. Enjoy the fine points. If you see anything I missed, which is certainly possible, or any mistakes, do let me know, so I can perfect the chart. The numbers on the left have no significance, except to keep me from going blind in a thick forest of HTML.

# SCO's January Amendment 1 to S3 SCO's November S3
1 In addition to SCOx, we implemented our first SCOsource initiative in January 2003 to review and establish our intellectual property rights in the UNIX operating system. In March 2003, we filed a lawsuit against IBM as part of this and other SCOsource initiatives. In addition to SCOx, we implemented our first SCOsource initiative in January 2003 to review and enforce our intellectual property rights in the UNIX operating system. In March 2003, we filed a lawsuit against IBM as part of this initiative.
2 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. 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 deferred revenue balance has declined from $10.1 million as of October 31, 2002 to $6.8 million as of July 31, 2003.
3 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. [Nothing equivalent.]
4 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. We initiated the SCOsource licensing effort in January 2003 to review the status of UNIX licensing and sublicensing agreements and to identify others in the industry that may be currently using our intellectual property without obtaining the necessary licenses. This effort resulted in the execution of two license agreements during the quarter ended April 30, 2003, and the receipt of additional license fees from these two contracts during the July 31, 2003 and October 31, 2003 quarters.
5 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.Given the unauthorized use of our UNIX code and derivatives and the resultant litigation, it is difficult to predict if our SCOsource initiative will produce stable, predictable revenue for the foreseeable future, and to what degree. The success of this initiative in part may depend on the 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.
6 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. IBM has filed a response and counter claim to the complaint, including a demand for jury trial. The discovery process of the action has commenced. The action has been removed from Utah Third District State Court and is currently pending in the Federal District Court for the District of Utah. We have filed an answer to the IBM counterclaim.
7 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. If we do not prevail in our action against IBM, or if IBM is successful in its counter claim against us, our business and results of operations could be materially harmed. The litigation with IBM and others could be costly, and our costs for legal fees may be substantial and in excess of amounts for which we have budgeted. In addition, we may experience a decrease in revenue as a result of the loss of sales of Linux products and initiatives previously undertaken jointly with IBM and others affiliated with IBM or sympathetic to the Linux movement. We are informed that participants in the Linux industry have attempted to influence participants in the markets in which we sell our products to reduce or eliminate the amount of our products and services that they purchase. They have been somewhat successful in those efforts and similar efforts and success will likely continue. There is also a risk that the assertion of our intellectual property rights will be negatively viewed by participants in our marketplace and we may lose support from such participants. Any of the foregoing could adversely affect our position in the marketplace and our results of operations.
8 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. [Nothing equivalent.]
9 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.

As a result of our assertion of our intellectual property rights, we have been subjected to several denial of service attacks on our website which 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.
10 We have filed a motion to dismiss the Red Hat complaint, asserting that Red Hat lacks standing and that no case or controversy exists on which to base a declaratory judgment. If Red Hat is successful in its claim against us, our business and results of operations could be materially harmed. Red Hat has filed an opposition to the Company's motion to dismiss, but the court has not ruled on the motion. Red Hat also announced it was contributing $1 million to establish the Open Source Now fund to help pay the costs of Linux companies involved in legal action with us, and encouraged other participants in the Linux community to make contributions. We have filed a motion to dismiss the Red Hat complaint, asserting that Red Hat lacks standing and that no case or controversy exists on which to base a declaratory judgment. If Red Hat is successful in its claim against us, our business and results of operations could be materially harmed.
11 We have not heard from the ACCC since that time. It is unknown if any future action will be taken. [re Australia] [Nothing equivalent]
12 [Deleted] We are negotiating with the various claimants in Germany over the temporary restraining orders.
13 [Deleted] If our SCO branding effort is not accepted or causes market confusion, our business may be adversely affected.

We recently launched a rebranding effort for our products and services as well as our corporate image. On May 16, 2003, our stockholders approved the change of our corporate name to The SCO Group, Inc. Prior to our name change, we renamed our UNIX products and services using the SCO trademark to draw on this strong brand recognition. We acquired the rights to use this trademark in May 2001 from Tarantella in connection with our acquisition of certain Tarantella assets and operations. If the rebranding effort is not accepted by our resellers or customers of our products and services, if the rebranding efforts cause confusion, or if there are negative connotations associated with the trademark that we cannot successfully address, our business may be adversely affected.

If our recently launched products and services are not accepted in the marketplace, our business may be adversely affected.

In January 2003, we announced SCOsource, our intellectual property licensing initiative, and in April 2003, we announced SCOx, our web services strategy. In addition, we have recently released new versions of our SCO OpenServer and SCO UnixWare operating systems. If our resellers or customers do not accept these initiatives or product enhancements, if the products fail to perform as expected, or if revenue from these initiatives is below our expectations, our business will be adversely affected.

14 --the contingency fees we may pay to the law firms representing us in our efforts to establish our intellectual property rights [in list of "Factors that may affect our results".] [Nothing equivalent]
15Deleted -- the unauthorized use of our UNIX code and derivatives by others to compete with us [dropped from list of Factors that may affect our results".]
16 changes in business attitudes toward UNIX as a viable operating system compared to other competing systems, especially Linuxchanges in business attitudes toward UNIX as a viable operating system compared to other competing systems
17 Our revenue from the sale of UNIX-based products has declined over the last several quarters. This decrease in revenue has been attributable to the worldwide economic slowdown, lower information technology spending, and increased competitive pressures from alternative operating systems. If the demand for UNIX-based products continues to decline, and we are unable to develop new products and services that successfully address a market demand, our business will be adversely affected. Our revenue from the sale of UNIX-based products has declined over the last eight quarters. This decrease in revenue has been attributable to the worldwide economic slowdown, lower information technology spending, and increased competitive pressures from alternative operating systems. As explained elsewhere in this filing, we claim that much of this competition is in violation of our contractual and intellectual property rights. If the demand for UNIX-based products continues to decline, and we are unable to develop new products and services that successfully address a market demand, our business will be adversely affected.
18 Many of these competitors have access to greater resources than we do. The major competitive alternatives to our UNIX products are Microsoft's NT and Linux. The expansion of Microsoft's and our other competitors' offerings may restrict the overall market available for our server products, including some markets where we have been successful in the past. While we believe that our server products retain a competitive advantage in a number of targeted application areas, the expansion of Microsoft's and our other competitors' offerings may restrict the overall market available for our server products, including some markets where we have been successful in the past.
19 Our compensation arrangement with the law firms representing us in our efforts to establish our intellectual property rights may harm our ability to raise additional financing.

Our compensation arrangement with the law firms representing us in our efforts to establish our intellectual property rights could harm our ability to raise additional funding if needed. We may be obligated to pay our law firms, subject to certain limitations, contingency fees of up to 20 percent of the proceeds we receive from litigation, settlements, certain licenses and other transactions related to our intellectual property and from a sale of our company, and this arrangement may be construed to include contingency fee payments in connection with issuances of our equity securities. Our 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.

[Nothing equivalent]
20 [Deleted]Our competitive position could decline if we are unable to obtain additional financing.

We recently completed the private placement of $50 million of our Series A Convertible Preferred Stock, for which we received approximately $47.8 million in net proceeds. However, if this additional capital is not sufficient to fund the expansion of our business, support operations, fund litigation expenses, respond to competitive pressures, acquire complementary businesses or technologies or respond to unanticipated requirements, we may need to raise additional capital. We cannot assure you that additional funding will be available to us in amounts or on terms acceptable to us.

21 When we generate profits in foreign countries, our effective income tax rate is increased. When we generate profits in foreign countries, our effective income tax rate is increased, even though we generate consolidated net losses.
22 If the current slowdown continues, our revenue and results of operations may continue to be lower than expected. If the economic slowdown and the unauthorized use of our UNIX code continue
23 The trading price for our common stock has been volatile, ranging from a sales price of $1.09 in mid-February 2003, to a sales price of over $22.00 per share in October 2003, to a sales price of $15.65 in January 2004. The trading price for our common stock has been volatile, ranging from a sales price of $1.09 in mid-February 2003, to a sales price of over $22.00 per share in October 2003, to a sales price of $14.73 in November 2003.
24 The shares subject to this prospectus represent approximately 27 percent of our issued and outstanding common stock as of January 16, 2004, although, as described more fully below, no selling stockholder and its affiliates may beneficially own more than 4.99 percent of our common stock at any time. The shares subject to this prospectus represent approximately 28 percent of our issued and outstanding common stock as of October 31, 2003.
25 As of December 31, 2003, we have issued and outstanding options to purchase up to 3,620,168 shares of common stock with exercise prices ranging from $0.66 to $28.00 per share. As of October 31, 2003, we have issued and outstanding options to purchase up to 3,629,568 shares of common stock with exercise prices ranging from $0.66 to $28.00 per share.
26 If the selling stockholders choose not to convert shares of Series A Convertible Preferred Stock, then, as holders of shares of Series A Convertible Preferred Stock, among other rights, they will be entitled to require us to repurchase for cash all the shares of Series A Convertible Preferred Stock held by them at a premium price if any of several redemption trigger events occurs. Our redemption obligation may be triggered by events that are beyond our control. These redemption provisions, if triggered, would require us to redeem the then-issued and outstanding shares of our Series A Convertible Preferred Stock for cash. If we were required to pay cash to the holders of shares of our Series A Convertible Preferred Stock, it could have a material impact on our liquidity, which may require us to obtain additional sources of cash to sustain operations and may negatively impact the holders of our common stock.

Additionally, the holders of shares of our Series A Convertible Preferred Stock will be entitled to receive a preferential distribution of our assets prior to any distribution to our holders of common stock upon a liquidation, dissolution, winding up or other change in control transaction in which we sell all or substantially all our assets or merge or consolidate or otherwise combine with another company or entity.

If the selling stockholders choose not to convert shares of Series A Convertible Preferred Stock, then, as holders of shares of Series A Convertible Preferred Stock, among other rights, they will be entitled to receive a preferential distribution of our assets prior to any distribution to our holders of common stock upon a liquidation, dissolution, winding up or other change in control transaction in which we sell all or substantially all our assets or merge or consolidate or otherwise combine with another company or entity.
27 Depending on the amount of assets we have available for distribution to stockholders upon a liquidation event when shares of Series A Convertible Preferred Stock remain outstanding, we may be required to distribute all such assets or a portion of such assets that exceeds the preferred stockholders' pro rata ownership of our common stock assuming full conversion of their preferred shares into common stock, which could eliminate or limit the assets available for distribution to our common stockholders. Our potential obligation to pay to the law firms representing us in our efforts to establish our intellectual property rights a contingent fee of 20 percent of the proceeds we receive from a sale of our company, subject to certain limitations, could also contribute to eliminating or limiting the assets available for distribution to our common stockholders. Depending on the amount of assets we have available for distribution to stockholders upon a liquidation event when shares of Series A Convertible Preferred Stock remain outstanding, we may be required to distribute all such assets or a portion of such assets that exceeds the preferred stockholders' pro rata ownership of our common stock assuming full conversion of their preferred shares into common stock, which could eliminate or limit the assets available for distribution to our common stockholders.
28 The Certificate of Designation also provides that the holders of our Series A Convertible Preferred Stock have a participation right entitling them to purchase their pro rata share of any future equity securities, or debt that is convertible into equity, on the same terms offered by us to other purchasers of such securities. Additionally, we have agreed with the holders of our Series A Convertible Preferred Stock that we will not complete a transaction or take any action that could result in a claim for a contingency payment by the law firms representing us in our efforts to establish our intellectual property rights, other than contingency payments related to certain license transactions, without first obtaining the consent of the investors holding at least two thirds of the shares of our Series A Convertible Preferred Stock. This right of consent, and the participation right and other approval rights described above, may make it more difficult for management, our board of directors or our stockholders to reach a settlement in our litigation with IBM, raise capital in the future in either equity or debt financing transactions or to take other significant company actions. These provisions could also limit the price that some investors might be willing to pay for shares of our common stock in the future. Additionally, the Certificate of Designation provides that the holders of our Series A Convertible Preferred Stock have a participation right entitling them to purchase their pro rata share of any future equity securities, or debt that is convertible into equity, on the same terms offered by us to other purchasers of such securities. This participation right, and the right to approve the company actions described above, may make it more difficult for management, our board of directors or our stockholders to raise capital in the future in either equity or debt financing transactions or to take other significant company actions. These provisions could also limit the price that some investors might be willing to pay for shares of our common stock in the future.
29 These measures, combined with aggregate revenue of $25.8 million from our SCOsource intellectual property rights licensing initiatives, resulted in fiscal 2003 being the first profitable year in our operating history. These measures, combined with aggregate revenue of $15.53 million from our intellectual property rights licensing initiative, SCOsource, resulted in the first two profitable quarters in our history during the six months ended July 31, 2003. In addition, subsequent to July 31, 2003, Microsoft exercised an option it held to acquire a broader license to our UNIX source code resulting in a payment to us of $8 million.
30 [Deleted] Additionally, the dividends on the Series A Convertible Preferred Stock will be accrued for the difference in the stated dividend rate and 12% per annum. These additional dividends will reduce earnings available to common stockholders as incurred from this:
31 On October 16, 2003, we completed a $50 million private placement of 50,000 shares of our nonvoting Series A Convertible Preferred Stock and received net proceeds of approximately $47.7 million. The Series A Convertible Preferred Stock is convertible into shares of our common stock at an initial conversion price of $16.93 per common share. Additionally, among other rights and preferences, the Series A Convertible Preferred Stock will accrue cumulative dividends after the first anniversary of the closing of the private placement. The dividends, which must be paid quarterly, will accrue at a rate of 8 percent per annum, with annual increases of 2 percent per annum not to exceed a maximum annual rate of 12 percent. We have the flexibility to pay the dividends in cash or additional shares of Series A Convertible Preferred Stock, subject to certain limitations. We have filed this registration statement as part of our agreement to register the resale of the approximately 3,850,000 shares of common stock issuable on conversion of the Series A Convertible Preferred Stock issued in the private placement and that may be issued in paying accrued dividends. On October 16, 2003, we completed a $50 million private placement of 50,000 shares of our nonvoting Series A Convertible Preferred Stock and received net proceeds of approximately $47.8 million. The Series A Convertible Preferred Stock is convertible into shares of our common stock at an initial conversion price of $16.93 per common share. Additionally, among other rights and preferences, the Series A Convertible Preferred Stock will accrue cumulative dividends after the first anniversary of the closing of the private placement. The dividends, which must be paid quarterly, will accrue at a rate of 8 percent per annum, with annual increases of 2 percent per annum not to exceed a maximum annual rate of 12 percent. We have the flexibility to pay the dividends in cash or additional shares of Series A Convertible Preferred Stock, subject to certain limitations. Additionally, the dividends on the Series A Convertible Preferred Stock will be accrued for the difference in the stated dividend rate and 12% per annum. These additional dividends will reduce earnings available to common stockholders as incurred. We have filed this registration statement as part of our agreement to register the resale of the approximately 3,850,000 shares of common stock issuable on conversion of the Series A Convertible Preferred Stock issued in the private placement or that may be issued in paying accrued dividends.
32 [Deleted]We anticipate recording a beneficial conversion feature related to the issuance of the Series A Convertible Preferred Stock in our private placement of approximately $8,741,000. The beneficial conversion feature represents the intrinsic value of the difference in the Series A conversion price and the closing market price of our common stock on October 16, 2003.
33 We anticipate using the funds available to us from our private placement to target vertical markets for our existing UNIX-based offerings, to expand our UNIX licensing program and provide migration options for Linux end users, to roll-out major upgrades for our UNIX-based operating systems and to further establish our intellectual property rights. We anticipate using the funds available to us from the foregoing transactions for our internet-based offerings under our SCOx initiative, to target vertical markets for our existing UNIX-based offerings, to expand our UNIX licensing program and provide migration options for Linux end users, to roll-out major upgrades for our UNIX-based operating systems and to protect our intellectual property rights.
34 To properly account for our private placement, we have bifurcated the value of the Series A Convertible Preferred Stock issued in the transaction into two components, the preferred stock instrument and a derivative instrument. The conversion and redemption features of the Series A Convertible Preferred Stock require the bifurcation of the instruments. We assigned $29.7 million of the value of the Series A Convertible Preferred Stock to the preferred stock instrument. In valuing the derivative component, we engaged an independent appraisal firm to assist us. As of October 31, 2003, we recorded a liability of $15.2 million as the fair value of the derivative component. Also, for our fourth quarter and fiscal year ended October 31, 2003, we recorded $2.8 million as other income representing the decrease in the fair value of the derivative component from October 16, 2003, the closing date of our private placement, to October 31, 2003. The accounting for the derivative component will require us to mark-to-market its value at the end of each quarter, and we will include in our statement of operations other income or expense for any change in the fair value of the derivative. [Nothing equivalent]
35 In March 2003, we filed a complaint against IBM alleging breach of contract, misappropriation of trade secrets, tortuous 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. Based on these claims, we delivered to IBM a notice of termination of the license agreement we have with IBM that permitted the use of our UNIX source code in the development of IBM's AIX operating systems.

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 a jury trial. The discovery process of the action has commenced. We filed an answer to IBM's 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, they assert that we have breached the GNU General Public License and have infringed on certain patents held by IBM. Their 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 and seeks a declaratory judgment against us. Discovery is ongoing in the case. We intend to vigorously defend against these counterclaims.

In August 2003, we delivered notice of termination of the UNIX license agreement we had with Sequent Computer Systems, Inc., which was previously acquired by IBM, based on similar breaches we had claimed against IBM. This license was the basis for Sequent's UNIX-based offering, the DYNIX/Ptx operating system.

In March 2003, we filed a complaint against IBM alleging, in part, that it had breached its license agreement with us by, among other things, inappropriately contributing UNIX source code and derivative works to the open source community and seeking to use its knowledge and methods with respect to UNIX source code and derivative works and modifications licensed to it to destroy the value of the UNIX operating system in favor of promoting the adoption by businesses of the Linux operating system, of which it has been a major backer. Based on these breaches, we terminated the license agreement we have with IBM that permitted the use of our UNIX source code in the development of IBM's AIX operating system. In May 2003, we sent letters to approximately 1,500 large corporations notifying them that the use of the Linux operating system may be a violation of our intellectual property rights.

IBM has filed a response and counter claim to the complaint, including a demand for a jury trial. The discovery process of the action has commenced. The action has been removed from Utah Third District State Court and is currently pending in the Federal District Court for the District of Utah. We filed an answer to IBM's counterclaim.

In its counter claim, as amended 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, they assert that we have breached the GNU General Public License and have infringed on certain patents held by IBM. Their counter claims 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 and seeks a declaratory judgment against us. We intend to vigorously defend against these counter claims.

Subsequent to July 31, 2003, we terminated the UNIX license agreement we had with Sequent Computer Systems, Inc. ("Sequent") (which was previously acquired by IBM) based on similar breaches we had claimed against IBM. This license was the basis for Sequent's UNIX-based offering, the DYNIX/Ptx operating system.

36 In May 2003, we sent letters to approximately 1,500 large corporations notifying them that the use of the Linux operating system may violate our asserted intellectual property rights. In December 2003, we also began 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 began notifying selected Linux end users in writing of violations under the Digital Millennium Copyright Act related to SCO's copyrights contained in Linux.

As another SCOsource initiative, in August 2003, we first offered to Linux end users the SCO Intellectual Property License for Linux in the United States. We recently announced that we will begin offering the license worldwide by February 1, 2004. The license permits the use of our intellectual property, in binary form only, as contained in Linux distributions. By purchasing the license, customers are properly compensating us for our UNIX source code, derivative UNIX code and other UNIX-related intellectual property and copyrights owned by us as we allege they are currently found in Linux. We additionally have announced that we expect to commence by mid-February 2004 our first legal action against a Linux end user for copyright infringement claims.

[Nothing equivalent]
37 The success of our licensing and other SCOsource initiatives will depend to a great extent on the perceived strength of our intellectual property and contractual claims and our ability to establish our rights. Many, particularly those in the open source community, dispute the allegations of infringement that we have made. Our SCOsource initiatives resulted in revenue of $25.8 million in fiscal 2003 from two license agreements obtained from Sun Microsystems and Microsoft. We continue negotiations with other industry participants that we believe may lead to additional SCOsource license agreements, but we are currently unable to predict the amount or timing of future revenue from this source, if any. The success of our SCOsource licensing initiative, at least initially, will depend to a great extent on the perceived strength of our intellectual property and contractual claims and our willingness to enforce our rights. Many, particularly those in the open source community, dispute the allegations of infringement that we have made. While this SCOsource initiative has resulted in revenue of $15.53 million through July 31, 2003, and we continue negotiations with other industry participants that we believe may lead to additional SCOsource license agreements, we are currently unable to predict the amount or timing of future revenue from this source, if any.
38 In connection with our $50 million private placement, we have agreed to pay to Boies, Schiller & Flexner LLP and other firms representing us in establishing our intellectual property rights $1 million and register the issuance of 400,000 shares of our common stock by March 1, 2004. Subject to the registration statement covering such shares being declared effective by the Securities and Exchange Commission, we would issue such shares under our current equity incentive plans. As a result of the issuance of this consideration to Boies, Schiller & Flexner LLP and other firms, we recorded an additional charge to earnings of approximately $9.0 million in our fourth quarter that ended October 31, 2003. This $9.0 million charge to earnings is comprised of non-cash expense of $8.0 million related to the issuance of the 400,000 shares of common stock and $1.0 million in cash expense.

Our agreement with the law firms provides that the law firms will receive a contingency fee of 20 percent of the proceeds from specified events related to establishing our intellectual property rights. These events include settlements, judgments, licensing fees, subject to certain exceptions, or a sale of our company during the pendency of litigation or through settlement, subject to agreed upon credits for amounts received as discounted hourly fees and unused retainer fees and may be construed to include issuances of our equity securities.

We also have agreed with the investors in our private placement that we will not complete a transaction or take any action that could result in a claim for a contingency payment by our law firms, other than contingency payments related to licenses other than licenses entered into as part of any settlement of litigation or sale of our company, without first obtaining the consent of the investors holding at least two thirds of the shares of our Series A Convertible Preferred Stock issued in our private placement. Our obligation to obtain the consent of our private placement investors will terminate automatically if and when the aggregate number of shares of our common stock issuable upon conversion of all outstanding shares of Series A Convertible Preferred Stock held by the investors fails to equal or exceed five percent of our outstanding shares of common stock as of December 8, 2003.

We have agreed to pay to Boies, Schiller & Flexner LLP and other firms representing us in the protection of our intellectual property rights $1 million and register the issuance, pursuant to an effective registration statement, to Boies, Schiller & Flexner by March 1, 2004 of 400,000 shares of our common stock. Subject to the registration statement covering such shares being declared effective by the Securities and Exchange Commission, we would issue such shares under our current equity incentive plans. As a result of the issuance of this consideration to Boies, Schiller & Flexner LLP and other firms, SCO anticipates recording an additional charge to earnings of approximately $8,956,000 in its fourth quarter that ended October 31, 2003. This $8,956,000 charge to earnings is comprised of non-cash expense of $7,956,000 related to the issuance of the 400,000 shares of common stock and $1,000,000 in cash expense.
39 New footnote 5: BayStar Capital Management, LLC, a Delaware limited liability company, is the general partner of BayStar Capital II, LP. Steven Derby, a managing member of BayStar Capital Management, LLC, has voting and dispositive power over the shares of our common stock held by BayStar Capital II, LP. Neither BayStar Capital Management, LLC nor BayStar Capital II, LP is an affiliate of a registered broker-dealer. [Nothing equivalent]
40In the UNIX operating system market, our competitors include IBM, Hewlett-Packard and Sun. These and other competitors are aggressively pursuing the current UNIX operating system market. Many of these competitors have access to greater resources than we do. The major competitive alternatives to our UNIX products are Microsoft's NT and Linux. The expansion of Microsoft's and our other competitors' offerings may restrict the overall market available for our server products, including some markets where we have been successful in the past. In the UNIX operating system market, our competitors include IBM, Microsoft, Hewlett Packard and Sun. These and other competitors are aggressively pursuing the current UNIX operating system market. These competitors have access to greater resources than we do. The major competitive alternatives to our UNIX products are Microsoft's NT and Linux. While we believe that our server products retain a competitive advantage in a number of targeted application areas, the expansion of Microsoft's and our other competitors' offerings may restrict the overall market available for our server products, including some markets where we have been successful in the past.


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