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SCO March 3, 2004 First Quarter Teleconference - Transcript
Wednesday, March 10 2004 @ 08:18 AM EST

Here is our transcript of SCO's March 3, 2004 teleconference with Darl McBride, Robert Bench and Mark Heise.

There are a number of hints about "third-party websites" allegedly presenting IBM's side. I believe they mean Groklaw, because yesterday SCO again tried to make a connection between IBM and Groklaw, telling Bob Mims of The Salt Lake Tribune that IBM had "leaked" a letter which allegedly was posted "anonymously" to Groklaw. Today, Mims has corrected that false information.

I can tell you truthfully that IBM has never leaked any information to Groklaw.

SCO may prefer secrecy, but I believe the public has a proper interest in this case, because the outcome will affect more than just the parties. For one thing, authors of the kernel code, which can be distributed only under the GPL, have a need and, I think, a right to know who takes a potentially conflicting SCO "IP" license. I fail to see how anyone can properly assert a "right" to "confidentiality" if the goal or the result is to hide violations of the license rights of others.

I suspect that SCO may be working up to asking the judge to make Groklaw stop covering the case or to restrict our coverage. That may be why they keep insisting, falsely, that Groklaw is sponsored by IBM.

Their overzealous supporter, who calls himself "ledite" on the Yahoo Finance board, wrote in his recent message threatening my person that it was "just a matter of time" before the judge shut Groklaw down. If he is a SCO insider, as some on the Yahoo board have conjectured based on his past record of predictions, then SCO may attempt this. Time will tell.

I have marked the transcript in blue, wherever there seemed to be particularly significant information. This is not an official transcript. While we try to be as accurate as we can be, for anything that matters to you, go by the video SCO makes available on its website. As always, if you note any errors, kindly let us know, so we can correct.

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

Darl McBride: Thank you for joining us on our call here today. As we begin our 2004 fiscal year, I'd like to start off by taking a look at how the SCO Group has evolved since I became CEO a little over 18 months ago. Upon joining the company, one of my first decisions was to identify the strengths and the core assets of the company. This quickly resulted in a renewed focus on our UNIX intellectual property and a return to the recognized SCO UNIX brand.

Since that time we've been successful in re-establishing SCO in the marketplace as the owner of the UNIX operating system and as a leading provider of UNIX-based technology and solutions.

During 2003 we worked to improve and to strengthen SCO's financial foundation. As a result of our efforts, the company's cash position has increased from $6.6 million to $68.5 million during the past year. We've remained debt-free, and the Company reported net income and generated positive cash from operations for the first time in SCO's history last fiscal year.

Looking at 2004, we're committed to building on our stable foundation, taking advantage of the strength of our intellectual property assets, loyal UNIX customer installed base, and longtime partners and customers, delivering a powerful business model for the future. As we implement our longer-term strategic plan for 2004 and beyond, the management team at SCO continues to place emphasis on meeting near-term quarterly objectives. Accordingly, for the first quarter of fiscal year 2004 our revenue and operating results came in as we had expected, and are in line with the guidance we had previously provided.

During this call I will ask Bob, our CFO, to review our first-quarter results in more detail. Following his comments, I will highlight recent activities and review the progress we're making in connection with achieving our longer-term objectives. Bob?

Robert Bench: Thanks Darl. Our first-quarter revenue was $11.4 million, primarily attributed to our UNIX products and services. Revenue from our SCOsource division relating to compliance licenses was $20,000. Our SCOsource initiatives are continuing as planned, and we expect SCOsource related revenue will gain traction this quarter and continue to increase momentum in future quarters.

As we've indicated in prior calls, the nature of the SCOsource revenue makes it difficult to predict the timing and level of revenue in the near term or in any given quarter.

The breakdown by geography of our UNIX products and services revenue for the first quarter was 59% from the Americas, 32% from EMEA, and 9% from Asia. It appears to us, based on our customer orders and economic reports, that IT spending is beginning to increase in the Americas and stabilizing in Europe and Asia.

As in previous quarters, we're continuing to classify legal and professional fees and other costs and expenses that relate directly to the enforcement of our intellectual property rights as a cost of revenue.

Even though cost and expenses may exceed associated revenue in any given quarter, we anticipate these efforts will result in license fees during our 2004 fiscal year, and that this presentation will reflect the economic effectiveness of our IP revenue initiatives.

For the first quarter of 2004 these costs were $3.4 million and were in line with our expectations. We expect that these costs and expenses relating to the enforcement of our intellectual property rights will remain at similar levels for the next several quarters. The gross margin for the products and services in our UNIX division was $9.2 million or 81%, consistent with the gross margin generated from these product lines in prior quarters. We expect these percentage trends to continue and be consistent in future quarters.

Operating costs and expenses for our UNIX division for the first quarter of fiscal 2004 were $10.9 million and continued to trend down as expected and were 10 percent lower than the operating expenses of $12.1 million incurred in the prior quarter.

Our general and administrative expense costs of $2.2 million for this first quarter of fiscal 2004 were higher than those costs of $1.7 million last quarter. This is comparable to the prior period, and primarily related to the increase in legal and professional fees as a result of increased compliance and corporate governance this past quarter.

We expect to continue to gain efficiencies in our worldwide operations, and therefore project our ongoing operating expenses for the UNIX division will continue to decrease in future quarters.

As the company had previously announced, we're accounting for the conversion feature included in our Series A convertible preferred stock financing as a derivative financial instrument, which requires us to determine its fair value at the end of each quarter. The decrease in the derivative valuation for the first quarter of 2004 was $3.6 million and is included as other income.

On February 5, 2004 we exchanged our Series A preferred stock for Series A-1 preferred stock. As a result of the exchange, we eliminated the derivative financial instrument. Subsequent to February 5th we will no longer report a charge with a change in fair value of the derivative. Any difference between the fair value of the new Series A-1 preferred stock and the carrying value of the Series A preferred stock and related derivative will be recorded as a dividend in our income statement for the second quarter ending April 30, 2004. This dividend may be material and increase loss (ph) to net common shareholders for our April 30th quarter. This dividend will not affect our cash balance or our operating margins, and will decrease our current liabilities.

Looking forward to our second quarter, consolidated revenue is expected to be in the range of $10 to $14 million. Revenue from our SCOsource initiatives is expected to increase in the next several quarters. However, the nature and predictability of SCOsource revenue is continuing to prove difficult. The company's cash and working capital position, coupled with the fact that we have no longterm debt, places the company in a very strong financial position to pursue our strategic goals for fiscal 2004. With that, I will turn it back to you, Darl.

McBride: I'd like to spend the remainder of the call before we go to Q & A and focus on several major initiatives that are designed to really drive revenue and build shareholder value during 2004 and beyond. Although many people's perception of SCO is dominated by our SCOsource-related activities, I want to take a moment or two here to underscore the value and importance of our UNIX operating business, its people, its products, and its services.

Not only does SCO own Unix System V, I'm proud to say we have the best UNIX on Intel engineering talent in the industry. A number of our senior engineers have well over 25 years' experience in the software industry, and in many cases their careers go back to include time at AT&T Bell Labs. We are proud of our vibrant, engaged ISV and retailer channels. These relationships represent many years of working together to serve the needs of corporate customers who want reliable software at affordable prices.

We're also proud of SCO's technological support teams who year in and year out continue to garner best in class accolades from industry organizations. And we're proud of our loyal customer base, end users who span numerous industry verticals who have come to rely on SCO software to run their businesses.

The foundation of our business is built upon UNIX-related intellectual property, people, products, and services. During our first quarter, we continued to see the value of these UNIX operating assets with UNIX product wins with notable customers such as Kroger, McDonald's, Rent-a-Center, CitiFinancial, Telecom Italia, and Japan Family Mart [inaudible] value from these UNIX-based assets. We're committed to addressing the ongoing customer demands for interoperability in heterogeneous environments and access to Web-enabled application servers. We reiterate our commitment to the future development of our UNIX OS products and are anticipating the release of SCO Legend and our 64-bit product during 2004 or early 2005, as we have discussed on prior calls. And we will continue to make the changes necessary to increase operating efficiencies designed to create positive cash flow in this division for the remainder of 2004.

Now, turning our attention to SCOsource, for over a year we've maintained that SCO has strong and deep intellectual property rights in UNIX. We have been engaged in an ongoing effort to educate and inform end users of the rights we hold, which include broad contract rights as well as extensive rights under US and international copyright laws.

Beginning today, with our actions over the last few hours, we're now moving to enforce these contract rights and copyrights through legal action against end users who have chosen to ignore SCO's position. SCO will be enforcing its legal rights in the US and around the globe.

First, regarding SCO's contract rights, early today, in fact, as we speak here, SCO is in the process of filing a lawsuit in Oakland County Circuit Court in the state of Michigan against DaimlerChrysler Corporation.

DaimlerChrysler is one of several thousand companies that have a source code and/or source reference license agreement with SCO. These agreements, such as the one with DaimlerChrysler, describe the terms under which the licensee may use UNIX System V, as well as the derivative works of UNIX System V, which include certain other flavors of UNIX, as well as Linux.

Beginning in December of last year, SCO notified thousands of these licensees of their obligations under these agreements. Some companies responded appropriately and certified their compliance with the terms of the agreement. Some companies, including DaimlerChrysler, have failed to respond appropriately. As we've previously noted, SCO's Unix System V source code license agreements serve as the legal foundation upon which much of the industry's enterprise UNIX operating systems are licensed. These UNIX licensees include some of the largest companies in the pharmaceutical, financial services, transportation, energy, automotive, computer hardware and software industries. These UNIX licensees include approximately one-third of the Fortune 100.

Second, regarding SCO's copyrights, yesterday afternoon SCO filed suit in Federal District Court in Las Vegas, Nevada against AutoZone. I invite you to read a copy of the complaint for full details, but in essence our complaint alleges that AutoZone as a business enterprise running Linux is infringing SCO's copyright. Our copyright claims relate to core operating system functionality of essential root structure and sequence of UNIX System V that was used in the design of Linux in the categories defined in our complaint.

Use of copyrighted material without permission is prohibited under copyright law and can carry significant monetary damages. I reference these actions as elements of SCO's enforcement initiatives and to underscore SCO's commitment to vigorously protect and enforce our intellectual property, our System V code, our contract rights, and our copyrights. With representation of Boies, Schiller & Flexner and their associated firms, we have now taken the significant next step in the process of enforcing our contract rights and copyrights through legal action against end users. We believe that there are important similarities between our recently legal actions against end users and those actions that have taken place in the recording industry. It wasn't until RIAA ultimately launched a series of lawsuits against end user copyright violators that the community-at-large became fully educated regarding the liabilities associated with using copyrighted materials without providing remuneration to the copyright owner. We believe that the legal actions we have taken and will continue to take will have a similar impact on end users of UNIX and Linux. We anticipate that there are many end users who have not considered the ramifications of the unlicensed use of SCO copyrighted technology and that an increasing number of companies will now take appropriate action to license SCO's intellectual property.

On Monday of this week, we announced a SCO Intellectual Property IP Licensing Agreement with EV1servers.net, one of the largest dedicated hosting firms and independent Internet service providers in the United States.

EV1servers.net is one of several companies so far that has made the business decision to eliminate the SCO intellectual property violation risks for its own business and that of its customers. As more companies work with SCO to understand our claims and complete their risk-analysis assessments, we anticipate that others will choose to take advantage of the SCO IP license, and that consequently SCO will begin to see increasing revenue from this initiative over the next several quarters.

Finally, as a quick update to our existing case against IBM, we continue to look forward to having our case heard in a Utah courtroom. That is currently scheduled for April 11, 2005. We believe that a jury will come to the same conclusion we have, namely that the rule of law provides protection to SCO's intellectual property. We are currently continuing the discovery phase of that case and look forward to this case going to a jury trial.

To summarize then, with another quarter behind us, SCO continues to make notable progress on our effort to build significant longterm value for our shareholders. As we move into 2004, we will continue to focus on harvesting and building new value from our UNIX operating assets, continuing the enforcement of SCO's intellectual property rights, and generating increased traction and revenue from our SCO IP licensing initiatives. Our work last year produced a firm and stable financial and legal foundation from which we can enforce our rights and build our business. Our actions this year should indicate to our shareholders that we are aggressively moving forward to enforce our rights to generate value from the assets that we own.

So at this point we would like to switch gears and go to Q & A. Bob and I will be available to take your questions. We've also invited Mark Heise, who is partnered with Boies, Schiller & Flexner Law Firm, to be on the call and entertain whatever questions you may have from a legal front. So with that, why don't we turn it back over to the operator to build the Q & A list?

Operator: . . . Dion Cornett, Decatur Jones.

Cornett: Good morning. I have to admit here just when I give up on you guys bringing in some SCOsource revenue and filing end-user lawsuits, you guys prove me wrong. So I guess congrats on the steps forward there.

Real quick on the AutoZone case. Looking at your Supplemental Response Interrogatory Numbers one and two, you state there that you believe AutoZone is using your shared libraries because of their speed in porting to Linux. Do you have any other evidence that they're using those, particularly given that AutoZone employees, including Jim Greer, that once served on your Advisory Board, said that those were not used? Earlier in the comments you talked about it being core to their use in the copyright. I assume this goes to their use of Red Hat, and this is the general part that would apply to all end users as opposed to the shared libraries which would only apply to your customers.

McBride: Let me start off by making a general statement as we get into these legal questions and then I am going to turn some time over to Mark on these as well. From a company standpoint, as a public company we have a very strong need to get as much information as we can to our shareholders, and we've been trying to do that over here the last year and be as open as we can down to as much detail level as we could. Our counterparts that we're in battle against here have convenient third-party websites that promote their cause, whereas we've basically had the responsibility to tell our story ourselves.

In the Utah case, Magistrate Wells has asked both parties to show restraint in what we say publicly, especially as it relates to the details of the case and beyond some the questions we're getting to here, you are starting to get into the details.

So the judicial process is most important to SCO. Obviously we're going to get as much information as we can out publicly, but in deference to Judge Wells and her request, we will be answering things in a general as opposed to a specific nature.

I will give one response to your questions there, and then if Mark has anything else to add. What I would say in the case that we filed today: this is a general set of claims that we have [inaudible] . . .

Cornett: I'm losing you. Could you speak up a little bit?

McBride: . . . Did that not come through? [inaudible] Hello?

Cornett: I didn't hear anything that you said, Darl.

McBride: Guys, I think we've got a problem with the phone in there. Can you get something else? Take it off speaker or something. Apparently they're not even hearing what we are saying.

Operator: Mr. McBride, you are coming through again.

McBride: Was it a problem on your end?

Cornett: You faded out. I didn't hear your response.

McBride: I want to make sure [inaudible] faded back in before I start talking again. Can you hear me now?

Cornett: Yes sir.

McBride: Let me restate that as a public company we have a very strong desire and need to get information out to our shareholders. Our counterparts on the IBM front have convenient third-party websites that promote their cause. We've been in a position of having to basically go out with detailed information. In the IBM case, Magistrate Wells has asked both parties to show restraint in talking about this case in a public forum such as it relates to the details. The judicial process is very important to SCO, and in deference to Judge Wells' request from a going-forward standpoint, we will be speaking at a general level as opposed to specifics.

What I would say about your question, Dion, the case we filed today was not specific to the SCO shared libraries that you mentioned. This was a case that is very general to anybody who would be using the Linux operating system. Mark, do you have anything to add to that?

Heise: No. I would repeat what you said. First, we all are very much concerned and don't want to do anything in opposition to the Magistrate Judge's request. And I agree that, as a result, we really don't want to get into specifics. But I think it is important to emphasize at this time that with the actions that have been taken this week, including the case that we filed later today, make it very clear while copyright is certainly an issue, SCO is a company that has literally thousands of software agreements and licenses that have very clear restrictions on them, and SCO is committed to [inaudible] and will do everything in its power to do so. It has tried voluntarily to get people to certify their compliance with these Unix System V licenses, and where it meets resistance it is going to, unfortunately, have to resort to the legal process and spend the time and money to do so. But SCO is committed to doing so. And when a company has this many valuable contracts it certainly is not just appropriate but is important for the company to vindicate its rights.

Cornett: In recognition of deference to the judge, I certainly understand that, but there's an assumption that you would have filed your best end-user lawsuit first, and that AutoZone must be the best case you have and if filed in a different venue certainly I would expect you to put out details to bolster that case, particularly given the fact that there are tremendous amounts of details coming out of the other side that make your case there appear weak. Furthermore, it's sort of surprising that if you are going to file an end-user lawsuit you would pick a past customer, which has all kinds of other agreements tied to that that a general end-user that was not once a SCOsource -- a SCO user would not have.

Heise: I don't really want to get into the detail of how a particular end user is selected or not. But with respect to your comment that there are folks on the other side or out on the Internet that are claiming X, Y, and Z, that's the kind of detail that is best left to the courtroom. And that's exactly where the company is going to present all of its detail.

Operator: Brian Skiba, Deutsche Bank.

Skiba: First one, perhaps, maybe for clarification. You mentioned $3.4 million in costs in the quarter for IP enforcement. Does that figure included contractual enforcement, i.e. IBM and the preparation for the Daimler suit or is that simply on the copyright and IP side?

Bench: That's all of the legal and cost and fees associated with the full SCOsource initiative. We've chosen to leave those in one bucket so our readers of our financials could follow the cost and expenses associated with the full SCOsource initiative. And that would include all of our litigation, IBM, discovery, and also these claims that are being filed now with the end users.

Skiba: And perhaps for Mark here, and I know you don't want to comment extensively on this, but it would be fair to say that it's been a long time since Judge Wells has responded back from post-SCO providing materials to IBM to, in effect mandate that IBM return the favor, if you will, and put the AIX source code up and basically make it available for you guys? I think it's something that the world anticipated being measured in days, and now it's already been weeks. I'm just wondering whether it's possible to get any kind of read on why that time frame has been so long? And just as a followup to that, if we can get any color on why the end-user lawsuit against AutoZone basically was 3.5 months in the making? And should we anticipate that each, there will be subsequent suits faster, or whether . . .How we should take a read on that?

Heise: With respect to Magistrate Judge Wells, I cannot speculate as to what it is that's causing her delay, although I can tell you when we did meet in the hearing in Utah, she was very clear that she, like many federal judges, has a very busy calendar. So beyond that, I don't have any other information. With respect to future suits, I think there's not going to be this concern of having to wait three months or six months between litigation. Suits will be filed to the extent they are appropriate as done. But these are not cases that the company takes lightly, and they want to fully investigate before filing any claims.

Operator: Hiawatha Bray, Boston Globe.

Bray: Kind of an obvious question: this thing about DaimlerChrysler is all news to me, and I'm not really clear what it means. It sounds similar to the IBM case, if I have understood it correctly, some kind of a contract case. I'm wondering what exactly is the connection, if any, with the dispute over Linux?

McBride: In the IBM case, clearly that is a contract case. There are some similarities that way. But these are very different in terms of being end users of the UNIX license as opposed to IBM, which is a vendor. So the two cases we filed today are separate from the litigation that is going on in Salt Lake. The requirement that we have in our agreements with DaimlerChrysler and with thousands of others that we have mailed out here over the last couple of months is a performance requirement that they come back and certify to us that they're in fact living up to the obligations that are found inside of the agreement itself.

We've had many that have fulfilled that certification requirement. We have many others who have not. So that has put us in this position where we have an absolute demand requirement that we can put out on them. They have a requirement to respond back to us, and when they don't respond, the only way to follow up on that is with the litigation enforcement steps we took today. So as you read through the suit, you'll be able to see what we're looking at there that mainly is a breach of a UNIX software agreement by failing to voluntary certify its compliance with our software agreements.

Bray: It has nothing to do, then, with any assertion that they are, for example, misappropriating your intellectual property by using Linux or adding code to the Linux operating system? Does Linux have anything to do with this one at all?

McBride: It does relate to it in that to the extent that they have taken . . .they have had access to our source code, and then they have in fact imported that knowledge or that code or in other ways broken their contract rights on the UNIX source code license as they have developed or grown or contributed to Linux, then that would absolutely create a violation. That is why we sent out the certification demands. And to the extent that people have not broken those agreements, then that's fine. To the extent they have not had a clean-room implementation or a clean-room environment as they have been working on Linux, then that absolutely creates the problem with the requirements they have under their UNIX source code . . .

Bray: But are you saying that they actually have done this with Linux? Or are you just saying we don't know, and we insist that you confirm one way or the other?

McBride: That's all this suit is about is: you need to confirm one way or another.

Operator: Bill Claybrook, The Harvard Research Group.

Claybrook: You may have answered this question that I have before about why Daimler and AutoZone were the two companies you picked. If you've answered that, then I have another question.

McBride: In the case of Daimler, they were one of a number of companies that didn't respond to the request we sent out. If you remember, in December we sent out requests to UNIX licensees, asking them to certify their compliance with the software agreement. Back to one of the questions that came up earlier from Brian, why is it taking a longer period of time . . . why did it take three months? We went in December, we sent out letters to large users of Linux, and to UNIX licensees. We gave them a time frame to respond. January 31st was the first deadline that came . . . after that deadline came, we looked at the companies that had violated the agreements just in terms of not responding, so that in itself creates a contractual violation. And based on a variety of other factors I'm not going to get into, that put Daimler at the head of the class.

With respect to AutoZone, a similar type of situation where we have been in communication with them, we have had various talks with them over the last several months. And then back to the situation again of sending out a letter to them regarding the use of Linux, and that put them into the camp.

One thing to think about here is that these are not just two users that we randomly picked. They're basically at the head of two different classes of end users that we feel are violating our agreements or our copyrights. And that's the two groups: one is source code licensees and then the other group is Linux end users that we feel are violating our copyrights.

Claybrook: As you know, I've been following this for a long time. And recently, after talking to SCO in another briefing, I went back and looked at the history of development of UNIX. Just about everything [inaudible] BSD jumpstarted from AT&T's efforts with Richie and Thompson. And BSD code went into their version and some code from their version went into the BSD, back and forth. Why is it that . . . I don't think you're saying that you own copyright to Linux, but why aren't you?

McBride: We're not claiming rights on all of Linux. What we're claiming is rights to our UNIX System V that we own. And if you look at . . . if you take a hard look at the AutoZone suit, what you'll see in there are claims we have on structural copyright components that tie to pieces inside of Linux that we feel are violating those copyrights. It's not the entire code base of Linux. It is structural components that we feel are significant, by the way, that map over to Linux. Mark, do you have anything else to add on that?

Heise: No. I think that, as we discussed earlier, in keeping with the court's request, that there's not much else that can be said or should be said at this time.

Operator: Stephen Vaughan-Nichols, Eweek.com.

Vaughan-Nichols: My question is a clarification of the situation of AutoZone. Am I correct in assuming that the real problem with AutoZone is not so much that they're using Linux, it's that they're in violation of their OpenServer license agreement concerning shared libraries and that that is the core of your complaint with AutoZone, that they're using these OpenServer shared licenses in Linux, which is of course not according to the license for those libraries?

Heise: With respect to that issue, the fact that they've got the OpenServer shared libraries is an issue, but that is not the core of the copyright claim that's been asserted. As set forth in the complaint, it lays out the various structure sequences and functionalities of UNIX System V that appear in Linux which is being used by AutoZone.

Vaughan-Nichols: So, it's both the issue that they are using Linux, which SCO maintains contains copyrighted SCO System V, and the OpenServer shared libraries?

Heise: I think the two. The OpenServer shared libraries just adds an additional layer, but at its core, it is a copyright claim for the use of the UNIX System V as is shown in the complaint.

McBride: Maybe the simple way to think about it is that if you took a near replica of this current complaint and filed it against someone we've never had an agreement with, it would look just about the same.

Vaughan-Nichols: One further clarification. And the difference between this and DaimlerChrysler is that in DaimlerChrysler's case, the core of that case is that they had access to UNIX source code? They have not complied with your request to assert that they have not in any way, shape or form allowed any of that source code to go into Linux?

McBride: Correct. That's one of the things we're asking for certification on.

Heise: Among other items.

Operator: Todd Weiss, Computer World.

Weiss: Two quick questions. Again, I wonder, what if the companies don't want to line up for these licenses and want to wait for the court to decide? What's SCO going to do if they don't all line up like you're hoping they do?

McBride: Let's take that one on first. I believe our story right now is pretty simple. We feel very strongly that we have these end-user problems relating to contracts and to copyrights, and if people would prefer to work through the court system, then we will file complaints and we'll work through the court system. That's what we have announced here today. Earlier this week we had another end user that chose to take the licensing path, and a substantial, material sites deal that we signed on Monday where EV1servers.net is going to be going out to their customers and having a safe environment to operate in. So depending on which way customers want to go, we will accommodate their desires.

Weiss: One other question, and that is . . .and I've asked you this before, Darl . . . but now, as we get into these lawsuits, it really makes me wonder: What if, at the end of all this, say this goes to trial, and the trial's completed and SCO loses. Are you guys going to . . . you're going to have a bunch of companies, whoever signed up for this, angry. Are you going to refund these fees, if in fact it is found at the end of this trial, however long it takes, you're wrong?

McBride: I think as a simple answer on that one, we wrote some code out, we sent some out last summer. Community members in the Linux program environment came out and admitted that the code was in Linux in error, that our System V code was in there in error. And we feel very comfortable at various levels that we have infringement problems going on today. We're not saying take a license for Linux, the whole thing. We're saying when you take the license for Linux, you can use out IP, wherever it may be showing, in this case inside of Linux. And there's already admitted violations going on inside of Linux. So we feel very comfortable on that front that we're giving people coverage. In that environment, people don't have to go start ripping code out. They have the mechanism to be safe while they're running Linux.

Operator: Larry Greenmeier, Information Week Magazine.

Greenmeier: Most of my questions have been asked already, but I wanted to get back to the UNIX license question with DaimlerChrysler. Could you explain to me, just quickly, what the certification means? What you were looking for them to prove when you sent that letter out a few months ago?

Heise: Just in terms of, as laid out in the complaint, there are various obligations of licensees like Daimler and many others have agreed . . . in exchange for their access to the UNIX operating system, they've agreed to certain restrictions. For example, confidentiality, not disposing of it in whole or in part. And the company in December sent out a letter very clearly specifying that they wanted certification that the UNIX System V was being used in pursuant to the terms of the agreement and wanted to make sure that it was being maintained in confidence, was not being disposed of in whole or in part, that anybody that had access to it was keeping it confidential, that employees were being told and required to keep it confidential and issues like that. That is all very clearly laid out in the suit that will be filed.

Greenmeier: So them not returning that certification sent up a red flag to SCO, is that what we are talking about here?

Heise: Yes.

McBride: More than a red flag. It created a contract violation in and of itself. They have a contract requirement to, in fact, certify, and so at a first pass it's a pretty simple contract violation. Then as we go through discovery and we go through the process of finding out what is going on over there, we will see if there are further violations.

Operator: Herbert Jackson, Renaissance Ventures.

Jackson: I have got one question with respect to discovery on Novell and then a follow. Where are you? I'm not sure who is due to reply to the last set of a interrogatories.

Heise: In the Novell case?

Jackson: In the Novell case, yes.

Heise: The Novell case was originally filed in the state court and was removed to federal court, and, as a result, discovery does not take place until there's been a scheduling conference, which usually does not take place until down the road. So there's been no discovery back and forth in the Novell case at all.

Jackson: The end-users suits that you're filing now, they seem to be non-dependent upon the allegations that you made against Novell. Could you comment?

Heise: I think that's an accurate statement. These cases don't implicate the issues in Novell. And SCO is the owner of UNIX System V, both the software sub-licensing agreements, the copyrights and everything related thereto, and it also is the holder of claims arising out of any breach of the agreements. That's where SCO finds itself. And the Novell case really has little to do with that.

Jackson: Thanks. That is great.

Operator: Phil Keys, Nikkei Electronics.

Keys: I just wanted to ask if there was any reason why you chose a couple of companies resident here in the United States? And if there's also any plans to look at companies residing outside the United States for possible lawsuits?

McBride: We started here in the US. That's where we have the cornerstone of our legal team based right now. We do have other initiatives we're looking at in Europe, as well as in Asia. But clearly for us the important starting point was here in the United States. Just as importantly, if you look at these thousands of UNIX license agreements we have, it clearly is not a US-only situation. And just as obviously, Linux is not a US-only situation. So we will be enforcing our legal rights not just here in the US, but around the world. But the starting point is definitely here.

Operator: Ken Brown, Investors Business Daily.

Brown: In the customers that are the subjects you chose to file the first lawsuits against, are you afraid of sending the message that you're going to go after your own customers, your own licensees first? And when do you expect to file some against Linux users who are not UNIX licensees?

McBride: I think if you look at the people we have filed suit against today, they're not currently customers of SCO. We sat down with 25 of our largest customers here several months ago at our national advisory board meeting, and we have very good relationships with our current customer set. The current customers we have are paying us licensing fees, and that is not where we have the problem. It's been years since we have had a relationship with AutoZone and a similar situation with Daimler. What we're looking at that with these UNIX license contracts, basically even though we don't have revenue coming in from those right now, what we do have, like in the case of Daimler, is a requirement that they keep those source code licenses upheld in terms of the restrictions on confidentiality. And so that's what we're doing in that case.

Operator: Matthew Mark, Jet Capital.

Mark: Can you walk through the timeline on the user litigation and how it is going to be affected most likely by the timeline on the IBM suit, as well as the timeline on any of the other litigations the company has pending against it?

Heise: With respect to predicting the future, I'm not particularly adept. I can tell you that the copyright claims are all going to be in federal court, and so just depending upon the district in which they're filed, they will proceed accordingly. There should be no impact one way or the other to the IBM case.

McBride: With respect to the Daimler case, that is filed in state court, so I don't know if that created a different timeline or not. But there is a subtle difference there between state and federal courts, I suppose.

Heise: It would be expected that the case outside Detroit will proceed a little bit more rapidly.

Operator: Peter Williams, VNU Business Publications.

Williams: Can you tell me whether there's any company in the UK that's likely to be assessed for a lawsuit in the next couple of months?

McBride: We're not here to talk about future litigation or other [inaudible] but I can absolutely tell you that we have enforcement activities going on in Europe that would include the UK and other various countries over there, as well as we do over in Japan. So they will be lagging a bit behind us from where we are right now, but absolutely we would expect at some point in time we would end up in that situation.

Williams: Can you comment on the fact that an Australian company is actually suing you at the moment?

McBride: We don't have any outstanding lawsuits against us in Australia right now.

Williams: Just a moment. A company called CyberKnights . . .

McBride: If it's happened in the last 12 hours, I wouldn't know -- I'm not familiar with one over there . . . Williams: Not actually familiar with it?

McBride: Right.

Heise: [inaudible] . . . I don't believe a lawsuit has been filed.

McBride: Right.

Operator: Terry Tillman, Schwab Soundview.

Tillman: In terms of the SCOsource licensing, you said you had one customer that signed up for that earlier in the week, and you put out an announcement. How does the revenue recognition work for that?

Bench: As with some of the other licenses, that revenue will be recognized as the cash comes in. Some of these are structured over time rather then up-front payments. And since we don't have any trends right now established, we will recognize that as the cash comes in.

Tillman: This seems like it was a bigger contract. Are they paying monthly, or are they paying once a year, or . . . ?

Bench: They are paying on a periodic basis, and right now that contract requires that we not disclose the terms of that. But it will be over . . . as we announced, we will recognize that income over the next several quarters.

Tillman: Thank you.

McBride: It is material and sizable compared to deals that we have had up to this point.

Tillman: Got it. Thanks.

Operator: Stephen Shankland, CNET.

Shankland: I had two questions. First of all, Mark, you said, I believe, that the case with Novell does not have any bearing on this. It seems to me that establishing ownership of the copyright to UNIX System V would have a great deal of bearing on this case.

Heise: SCO has consistently maintained its ownership of the copyrights. And Novell has come out and said that they owned it, then realized that they didn't, retracted from that, and then they went ahead and started on. But SCO has always maintained the unequivocal position of ownership of the copyrights, and as a result is the precise reason why it filed a slander of title action against Novell for its actions in the marketplace claiming ownership to the copyrights that SCO owns.

Shankland: With Novell also having registered UNIX copyrights, isn't the first thing a court is going to do is say, "OK, we have to wait and see who has actually established rights to these, since this is under litigation"? Or do they just go ahead and do it since you have established some copyrights?

Heise: As you noted, both of us have registered copyrights. How a court would react to that will remain to be seen.

Shankland: Another question on the business. Actually a legal question. Why Nevada for AutoZone?

Heise: Nevada is where AutoZone is incorporated, and so it's taking advantage of the corporate benefits of being a resident of Nevada and has been sued where it is a resident.

Shankland: For Darl, more on the business side, I wonder if you fear the fact that you're suing licensees? And granted it's a former customer, but if that sends a message to potential future customers, do you think that people are going to be excited at the opportunity of buying or licensing your technology given your litigious nature right now?

McBride: Again, back to our current customer set, that is not where we have the problem. In fact, many of our current customers have come in and said, "Go, fight, win. We're glad that you're fighting for your rights and we hope that you win."

Shankland: I'm talking future customers, not current customers.

McBride: Right, and so to the point, we didn't have a lot of future customers to talk about in the world where we had a thing out there called a Linux operating system that was replicating our UNIX, and whenever you put something out there for a zero price versus what we were charging, the future was not very bright in that environment. What I can say is that this quarter alone, we have signed new customers. We've actually seen some rebound effect starting to come in to the core business on the UNIX side. And our expectation as we go forward is that people are going to appreciate it. I think a lot of this comes down, as Bob said earlier, from an education standpoint people need to understand what's going on here and once they get educated and they get a better understanding of what our rights are, then for the most part 90 some odd percent of the marketplace actually agrees very strongly with the copyright and contract protection. So we think that as we go forward and we educate people on our rights that it's going to be favorable for us.

If you go to the music industry as an example, think about when Napster was in its heyday. There were 40 million people downloading songs, and the initial response when the word came out that this might be illegal was, "Oh, I didn't know about it." Then there was a period where people kept downloading, but then once things started to really tighten down on the legal front, then the RIAA actually saw a decrease of over half the people who were doing music downloads illegally quit doing them. So we think that for the most part we're going to see some similar trends here.

Operator: Mike [inaudible]

Mike: Just wondering if you could give us an idea on what you're going be seeking in terms of damages.

McBride: That's going to be stated at trial. Mark, I don't know. Do you want to just . . .? We're not talking specifically on this, but Mark maybe you can give . . .?

Mike: A ballpark figure maybe.

McBride: Mark, maybe you can give a tutorial on how copyright damages work in the willful or nonwillful categories.

Heise: At this juncture a dollar figure has not been presented and is not required to be presented, so I would rather really not comment on what is we're seeking from any individual user.

Mike: Could you clarify again your relationship with DaimlerChrysler? Are they a past customer or a current customer?

Heise: DaimlerChrysler has a software agreement with SCO, actually its predecessor. That's the agreement that's the operative agreement in the litigation.

Operator: Paula Rooney, CRN.

Rooney: I'm trying to narrow down the case against AutoZone. So, the copyright claim has nothing to do with the Linux kernel per se, correct?

McBride: No, this does have to do with the Linux kernel.

Rooney: You said that the case is not specific to SCO shared libraries, that it's a very general . . . to anyone using the operating system . . .

McBride: I'm saying anybody using Linux. I guess what I'm trying to say here is a lot of people . . . I think we are trying to say. . . because there is the fact that AutoZone has been a SCO UNIX user in the past, a OpenServer user until a couple of years ago, that in the migration to Linux there could have been some problems with the SCO shared libraries that would have been unique to a customer using SCO moving to Linux. The case that was filed today was much broader than that, and basically impacts anywhere the Linux kernel would be showing up in an end-user environment.

Rooney: But you said it has to do with structural components that is tied to pieces inside Linux.

McBride: And those would be kernel-related.

Rooney: But the components are those developed by AutoZone the customer?

McBride: No. Again, I guess the simple way to think of it is if you took the case we filed against AutoZone yesterday and did a search and replace on the name of an end user who we never had a relationship with but is running Linux, that suit would pretty much hold up. It's going to be a little bit different obviously, but in general the claims that we're making there are pervasive throughout the end-user Linux community.

Rooney: But you are saying it's not the shared libraries, so what is the code in question here?

McBride: It's all spelled out in the complaint, and it's pretty detailed to go through right now. But there are a number of structural components as you read through the complaint that you will see where those are.

Heise: Let me just interject for one moment. This is the precise type of information that was specifically requested by the court to not go into. So it's really just something that I want to caution Darl on that we just really don't want to be getting into that kind of detail.

Rooney: It's the heart of the case, I think it's fair to ask the question on what the code is.

McBride: Again, it's in the filing.

Rooney: Then you mentioned that there were specific programmers who acknowledge violation. Who are these programmers?

Heise: Again, we're not getting into the witnesses in the case, the underlying information of the case. It's not where we're going.

Operator: Rebecca Reid, ITWorld Canada.

Reid: I actually just have a couple of questions. How many SCO IP licenses have the Company sold so far?

McBride: We haven't published the exact number right now, but it is still measured in the handfuls. The significance of this week is the level and materiality of those in this last case has definitely increased significantly.

Reid: When you say a handful, is that less than 10 or less than 50?

McBride: Less than 50.

Reid: I'm also interested in -- I know you sent out, you have about 3,000 UNIX licenses. How many of those did respond to the December letter?

McBrideL I don't have those exact numbers in front of me. I can tell you that we had a number of responses that did come back to us. I can tell you there was a substantial number that did not respond.

Reid: So, more than half?

McBride: I would say more than half did not respond.

Reid: Great. Thank you very much.

Operator: Ladies and gentlemen, due to time constraints, we will conclude today's question-and-answer session. At this time, for any closing or additional remarks, I will turn the conference back to Mr. Darl McBride. Please go ahead, sir.

McBride: Thanks for joining us here on our call today. As we said earlier, 2003 fiscal year was really about shoring up the balance sheet. Our cash position did get significantly stronger. We built a war chest to be able to go out and defend our intellectual property rights, which we think are substantial, and we're doing that, as we did last year in the IBM case and as we're doing today, as we have broadened the enforcement down to the end-user playing field.

As we go through this year, we're very focused on building this company from a shareholder-value standpoint, not just around big [inaudible] revenue that show up and then don't continue. We had actually some opportunities at the end of last year to do some other major tens of millions of dollars-type of licensing deals that would have given a substantial amount of absolution to the Linux marketplace, but it would have had a very dampening effects on our company's longer-term future. What we're focused on is not something that is going to be measured in tens of millions, but something that has another zero or two behind that over the coming years. So with today's announcement, even though the actual numbers were down for the quarter, we're very encouraged about the progress we're making on the legal front. We're encouraged about the foundation we have on the balance sheet-side, and we're encouraged that we now have end users that are starting to step up in a substantial way. So we believe that we're going to have a good year this year rebuilding the operating statement like we had rebuilding the balance sheet last year.

The final thing I would say is it is a tough position we're in [inaudible] a number of the questions today. Gosh, it's hard to go out and sue somebody. Yes, we're not particularly thrilled with it ourselves, but we do believe that this is an education process and that as we work through these issues with the end-user environment, both on the UNIX and the Linux side, that we will come to some positive resolutions as we move forward. And the same [inaudible] hope too on the copyright front as well. I appreciate you joining our call today, and we look forward to talking to you again.

Operator: Ladies and gentlemen, this will conclude today's teleconference. We do thank you for your participation and you may disconnect at this time.


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