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SCO Spent $2,414,000 Buying Back Its Own Shares Last Quarter --Sifting Through SCO's 10Q and S3
Monday, July 05 2004 @ 09:05 AM EDT

SCO has been buying back their own stock, to the tune of 290,000 shares just between March 10 and April 30, at a cost to them of nearly $2 1/2 million, according to the latest SCO SEC filings, both the 10Q and the S3. The S3 tells this part:

"On March 10, 2004, our board of directors authorized management, in its discretion, to purchase up to 1,500,000 shares of our common stock over a 24-month period. Shares may be purchased in open market transactions, block purchases or privately negotiated transactions. Any repurchased shares will be held as treasury stock and will be available for general corporate purposes. During the second quarter of fiscal year 2004, a total of 290,000 shares of our common stock were repurchased for a total of $2,414,000. If we continue to repurchase a substantial number of shares during this 24-month period, and we do not generate off-setting revenue form our UNIX and SCOsource businesses, our cash position could decrease significantly and our ability to fund future operations could be adversely impacted. Purchases under stock repurchase program are subject to the discretion of management based on market conditions and other factors including the trading price of our common stock, availability of stock, alternative uses of capital and our financial condition."

The 10Q says the shares were bought on the open market:

"During the quarter ended April 30, 2004, we purchased 290,000 shares of our common stock in open market purchases for a total cost of $2,414,000."

That might help to explain certain mysteries some have observed about the stock. You might wish to read Melanie Hollands' latest column on thinly traded stocks.

Of course, what's a couple of million to SCO? They are awash in money. No?

As I have been slogging through their recent filings, I found some other interesting details.

The Vultus Deal

A year ago this month, Groklaw covered a story about Vultus. In June of 2003, SCO acquired Vultus for some stock. SCO's latest quarterly filing tells us the rest of the story. First, to refresh our memories, here is what Groklaw wrote last July:

"SCO has filed, on July 8, a Registration Statement on Form S-3, relating to 'the public offering or distribution by selling stockholders of up to 305,274 shares of common stock, par value $0.001 per share, of The SCO Group, Inc.' The shares will be sold by Vultus, Inc., The Canopy Group, Inc., Angel Partners Inc., Michael Meservy, Bruce K. Grant Jr., Ty D. Mattingly and R. Kevin Bean. Only Canopy Group, in this list, will retain any SCO stock. SCO 'will not receive any proceeds from the sale or distribution of the common stock by the selling stockholders. ... On July 3, 2003, the last price for our common stock, as reported by the Nasdaq National Market, was $10.71.'"

Wait a sec. Isn't Vultus the company Frank Hayes wrote about in his article called "SCO's Shell Game"? Why, yes. Yes, it is:

"So, what do you do when you have no real business but your stock price keeps going up? We all learned that lesson during the dot-com bubble: You use that stock as currency. . . . It turns out SCO didn't simply use stock to buy another company. SCO printed up about $3 million in new stock. Then, in the complicated deal in which SCO acquired Vultus, the stock was cashed out, with most of the proceeds going to Canopy. Some went to Canopy as a Vultus shareholder; the rest went to Canopy as compensation for taking on Vultus' debt, some of which was presumably owed to Canopy.

"Got all that? If it sounds like a shell game, well, that's the way Canopy likes to move its companies around. But in effect, Canopy used SCO's stock price, boosted by SCO's Linux threats, to rake in a couple of million dollars in cash behind the scenes. And apparently it worked. Which means we can expect that as long as Canopy can find ways of cashing in on SCO's threats against Linux users, those threats will keep coming -- no matter how little sense they make."

Poor SCO. After buying the company, it seems it proved a poor investment. Who'd a thunk it? There is a tidbit about the Vultus writeoff in the latest 10Q for the quarter ending April 30, 2004 and filed with the SEC June 2004:

"The Company recorded a loss on impairment of long-lived assets totaling $2,139,000, which related to an impairment on intangible assets of $973,000 and an impairment of goodwill of $1,166,000 for the three and six months ended April 30, 2004. The impairment related to goodwill and intangible assets acquired in connection with the acquisition of Vultus, Inc. ('Vultus') in June 2003. The Company concluded that an impairment-triggering event occurred during the three months ended April 30, 2004 as an impending partnership that would solidify the Vultus revenue and cash flow opportunities did not materialize. Additionally, the Company had a reduction in force that impacted the Company's ability to move the Vultus initiative forward on a stand-alone basis. Consequently, the Company has concluded that no significant future cash flows related to its Vultus assets would be realized. The Company performed an impairment analysis of its recorded goodwill related to the Vultus reporting unit in accordance with SFAS No. 142. Additionally, an impairment analysis of the intangible assets was performed in accordance with SFAS No. 144. As a result of these analyses, the Company wrote-down the carrying value of its goodwill related to the Vultus acquisition from $1,166,000 to $0 and wrote-down intangible assets related to its Vultus acquisition from $973,000 to $0."

And now you know the rest of the Vultus story. Angel Partners is listed on Guidestar as a charity that isn't required to file IRS returns because:

"EIN: 87-0647451 - This organization is not required to file an annual return with the IRS because its income is less than $25,000. It is a 501(c)(03) public charity"

But that last year's S3 shows that Angel Partners had 36,656 shares of SCO it intended to sell. They'd have to be bumbling idiots not to have made $25,000 if they sold that stock, judging from this chart of daily prices between June and December of 2003. I have seen a lot of speculation about this, and I'm not familiar with 501(3)(c) regulations in detail. [ PDF of booklet 557] The IRS has another booklet, "Compliance Guide for 501(c)(3) Tax Exempt Organizations" [pdf], and on page 11, it confirms that most such organizations must file a form 990 on their income annually, but organizations whose "annual gross receipts", however they define that, are "normally" less than $25,000 are exempt from this requirement. I gather that means you don't lose your exemption for one fabulous windfall year.

These accounting and investing guys are so creative, I think they should copyright their work. Wait, no. These are *ideas*, so I guess a patent would be better. You think I'm horsing around, don't you? Actually, according to the Wall St. Journal, that's exactly what is now happening, investment advisers and estate planners are patenting their strategies. Of course, you need a subscription to read the copyrighted article, and I surely can't share it with you on pain of boiling oil being poured on my web site, but it's about these new patents, which represent a further reduction of ideas in the world you can use. And bear in mind that using the idea is verboten even if you independentlly think of it yourself. Once it's patented, you can't use it unless you cross someone's palm with silver or have a patent yourself to cross-license with. Now there's a concept. I'll let you use my patent on 2 + 2 = 4 if you'll let me use the multiplication tables. They claim this is all to promote innovation and creativity, but I can't see how reducing the ideas the world can work with results in progress.

Ralph Yarro is on the board of a number of companies besides SCO and Canopy. In his bio blurb for Power Innovations, it tells us this:

"Under Ralph's direction, the Canopy Group has identified and invested in promising open source and Internet infrastructure technologies. Canopy's greatest strength lies in providing the companies that produce these technologies a sheltered environment in which they can grow and develop. Canopy companies are strongly encouraged to work with each in synergistic partnerships.

"Ralph is the Chairman of the Board for the Canopy Group. He also serves as Chairman of the Board of Trustees of Angel Partners, a 501(c)3 support organization for the Church of Jesus Christ of Latter-Day Saints and a Trustee for the Noorda Family Trust, the Scenic View Center, and the Worth of a Soul Foundation. He is the Chairman of the Board of Directors of Altiris, AP Software, Caldera Systems, Center 7, Coresoft, and Helius. He sits on the Board of Directors for: the Canopy Group, 2NetFX, Arcanvs, Cogito, DataCrystal, Expressware, Global Prime, The Guy Store, HomePipeLine, Interworks, Lineo, MTI, ManageMyMoney, Nombas, Profit Pro, Recruit Search, Troll Tech and TugNut."

Synergy seems too small a word. That info needs updating. Altiris recently tossed him overboard, so they claim in Forbes. I hate to direct any hits to Forbes, because they endlessly attack Linux, but that is who reported it:

"Chief Executive Gregory Butterfield says some potential customers have confronted him saying they would not do business with anyone affiliated with Canopy or SCO. . . .

"All in all, Butterfield says, the SCO affiliation is 'not positive' and 'a nuisance.' So Butterfield is quietly trying what lots of other people would love to do--get away from his family. He did a stock offering that diluted Canopy's share in the company to 8% from 18%. Then in April Altiris dumped its chairman, Ralph Yarro, who happens to be head of both Canopy and SCO, and another Canopy director."

For that matter, I wondered if there was an angle to reporting it, like getting a story in the record that says folks are boycotting SCO. That could come in handy in a law suit down the road, I'm guessing. Altiris' most recent SEC filing says Yarro and Darcy Mott resigned:

"In April 2004, we announced changes to our Board of Directors made to enhance the overall effectiveness of our Board and maintain sound corporate governance practices. We named Gregory S. Butterfield, our President and Chief Executive Officer, to the additional title of Chairman, replacing the resigning chairman, Ralph J. Yarro III (a Board member since 1998). Darcy G. Mott (a Board member since 2000) also resigned at that time."

The August 2003 stock offering alluded to in the Forbes report did reduce Canopy holdings, because Canopy sold off 2 million shares. There is a picture of Darcy Mott and Yarro on the Power Innovations site, if you are curious, by the way.

If thoughts of piercing the corporate veil are flooding your brain, the year-old Groklaw story has some information on that subject.

BayStar

SCO's S3, filed on June 22, lays out the offering of 2,105,263 shares of common stock, and that would be BayStar this time:

"All of these shares are issuable to the selling stockholder in connection with an agreement between the selling stockholder and us under which we have agreed to repurchase from the selling stockholder all outstanding shares of our Series A-1 Convertible Preferred Stock. The price at which the selling stockholder may sell the shares will be determined by the prevailing market price for the shares or in negotiated transactions. We will not receive any proceeds from the sale or distribution of the common stock by the selling stockholder.

"Our common stock is quoted on the Nasdaq SmallCap Market under the trading symbol "SCOX." On June 18, 2004, the last price for our common stock, as reported by the Nasdaq SmallCap Market, was $5.03."

The SEC has to approve the SCO/BayStar deal, by the way:

"On May 31, 2004, we entered into an agreement with BayStar to repurchase and retire BayStar's 40,000 Series A-1 shares. Terms of the agreement require us to pay to BayStar $13,000,000 in cash and issue 2,105,263 shares of our common stock, which consideration will be payable and issuable upon the effectiveness of a registration statement covering the resale of the common stock issued to BayStar, of which this prospectus is a part. In the event that the SEC does not declare the registration statement effective, the repurchase transaction with BayStar will not be completed. Upon completion of the repurchase transaction, all Series A-1 shares will be cancelled and retired and the rights and preferences of the Series A-1 shares will be terminated. The transaction will also eliminate BayStar's contractual rights and will include a general release by both parties. . . .

"Although we do not believe we are obligated to redeem BayStar's Series A-1 shares pursuant to the redemption notice, if we were required to pay cash to redeem BayStar's Series A-1 shares pursuant to the redemption notice or otherwise pursuant to the Certificate of Designation for the Series A-1 shares, it would have a material and adverse impact on our liquidity, which may require us to obtain additional sources of cash to sustain operations.

 "On May 31, 2004, we entered into an agreement with BayStar to repurchase and retire BayStar's 40,000 Series A-1 shares for $13,000,000 in cash and the issuance to BayStar of the 2,105,263 shares of our common stock that are covered by this prospectus. The repurchase transaction will not close unless the registration statement, of which this prospectus is a part, is declared effective by the SEC. If we fail to cause such registration statement to be declared effective, then our repurchase agreement with BayStar may terminate. If the agreement terminates, BayStar may attempt to enforce its redemption notice, unless it is otherwise rescinded."

The SEC has to approve it because what's good for BayStar may not be good for the rest of the shareholders. I'm starting to sound like SCO: "may not be". I think I may safely say that these documents indicate that what's good for BayStar is decidedly not so good for the rest of the shareholders. That is particularly true if the SEC doesn't approve the deal and BayStar starts to flex its muscles, and do you doubt they would?

"Depending on the amount of assets we have available for distribution to stockholders upon a liquidation event when Series A-1 shares remain outstanding, we may be required to distribute all such assets or a portion of such assets that exceeds BayStar's pro rata ownership of our common stock assuming full conversion of the Series A-1 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."
BayStar would also then retain its veto power over SCO taking on any new indebtedness or selling or transferring "any material assets or intellectual property to a third party" not to mention this:

"The Certificate of Designation also provides that BayStar, as a holder of Series A-1 shares, has a participation right entitling it to purchase its 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 BayStar 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 BayStar, as it currently holds all outstanding Series A-1 shares. 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."

One would think. I suggest reading that entire section, actually. One odd thing is that while they mention that BayStar asked for a redemption, they still aren't telling us why. Since the SEC has not yet approved the agreement, I would think that would be a risk factor that ought to be disclosed, no? How else can a person thinking of purchasing the stock evaluate the associated risks? The 10Q says that BayStar's notice didn't state a reason for their allegation of a breach of the agreement, but surely by now SCO knows why BayStar thought they saw a breach. But this is all it says, both in the 10Q and the S3 that I could find:

"On April 15, 2004, we received a redemption notice from BayStar requesting that we immediately redeem 20,000 Series A-1 shares then held by BayStar. The redemption notice asserted that BayStar is entitled to redemption of its the Series A-1 shares under the Certificate of Designation, Preferences and Rights for the Series A-1 shares because we allegedly had breached certain provisions of our February 5, 2004 exchange agreement. BayStar's redemption notice did not provide specific information regarding the factual basis for our alleged breaches of the exchange agreement, but we do not believe we have breached the exchange agreement. As a result, we do not believe we are obligated to redeem BayStar's Series A-1 shares."
Surely during the negotiations, the reasons for BayStar's action must have come up, but this pretends they got a notice and that is all they know. If the SEC does approve the agreement, then BayStar is contractually free from SCO and they agree not to sue each other, I gather, from this in the 10Q:

"Upon completion of the repurchase transaction, all Series A-1 shares will be cancelled and retired and the rights and preferences of the Series A-1 shares will be terminated. The transaction will also eliminate BayStar's contractual rights and will include a general release by both parties."

If you are curious as to how many shares of common stock there are, there is an answer:

"This prospectus relates to the sale or distribution of up to 2,105,263 shares of common stock by the selling stockholder. We will not receive any proceeds from the sales of these shares. The shares subject to the prospectus represent approximately 12.1 percent of our issued and outstanding common stock."

The 10Q says:

"As of June 11, 2004, there were 15,335,432 shares of the Registrant's common stock, $0.001 par value per share, outstanding."

Does that math compute? I'm no math whiz, so maybe you can make that reach 12.1 per cent.

SCO can buy back their own shares. They can also issue tons more preferred stock, as they wish:

"Our board of directors currently has the right, with respect to the 4,920,000 shares of our preferred stock not designated as 80,000 Series A-1 shares, to authorize the issuance of one or more additional series of our preferred stock with such voting, dividend and other rights as our directors determine. The board of directors can designate new series of preferred stock without the approval of the holders of our common stock, subject to the approval rights of BayStar as the holder of our outstanding Series A-1 shares as described above. The rights of holders of our common stock may be adversely affected by the rights of any holders of additional shares of preferred stock that may be issued in the future, including without limitation, further dilution of the equity ownership percentage of our holders of common stock and their voting power if we issue preferred stock with voting rights. Additionally, the issuance of preferred stock could make it more difficult for a third party to acquire a majority of our outstanding voting stock."

On BayStar, there is a footnote 2 that tells us a bit more about them:

"BayStar Capital Management, LLC, a Delaware limited liability company, is the general partner of BayStar Capital II, L.P. 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, L.P. Neither BayStar Capital Management, LLC nor BayStar Capital II, L.P. is an affiliate of a registered broker-dealer."

On the Litigation Front

SCO also details some recent developments on the litigation front, but the important part is that they say they are going to file an amended claim for special damages in the Novell matter. They remind us that August 4 is the date for the next hearing in the IBM matter, on IBM's noninfringement summary judgment motion, and July 21 for a hearing in DaimlerChrysler. The date listed for AutoZone in this SEC filing was later changed, as you know.

AutoZone

They view the AutoZone case as a DMCA action:

"Additionally, we have begun notifying selected Linux end users in writing of violations we allege under the Digital Millennium Copyright Act related to our copyrights contained in Linux. In concert with these notification efforts, in March 2004, and we brought suit against DaimlerChrysler Corporation for its alleged violations of its UNIX software agreement with us by failing to certify its compliance with such agreement as required by us. We also brought suit against AutoZone, Inc. for its alleged violations of our UNIX copyrights through its use of Linux."

Then in the 10Q, it describes AutoZone as being sued for "use" of Linux:

"On or about March 2, 2004, we brought suit against AutoZone, Inc. for its alleged violations of our UNIX copyrights through its use of Linux. Specifically, the lawsuit alleges that AutoZone is infringing our UNIX copyrights by, among other things, running versions of the Linux operating system that contain code, structure, sequence and/or organization from our proprietary UNIX System V code in violation of our copyrights. The lawsuit filed in U.S. District Court in Nevada requests injunctive relief against AutoZone's further use or copying of any part of our copyrighted materials and also requests damages as a result of AutoZone's infringement in an amount to be proven at trial. "

They are suing to block AutoZone from being able to continue to *use* Linux? Under what legal theory? They certainly aren't direct infringers. As the Grokster decision [pdf] points out, contributory infringement requires more than just use:

". . . Defendants correctly point out that in order to be liable under a theory of contributory infringement, they must have actual knowledge of infringement at a time when they can use that knowledge to stop the particular infringement. In other words, Plaintiffs' notices of infringing conduct are irrelevant if they arrive when Defendants do nothing to facilitate, and cannot do anything to stop, the alleged infringement."

Boies may have some personal concept in mind that no one has ever tried before, using the DMCA at its most outstretched interpretation, but it brings to mind Eben Moglen's illustration of Barnes and Noble, that no one sues you for reading a book you bought that turns out to have copyright-infringing material in it. You sue the party that put the infringing material in the book, not the reader of the book who bought and paid for it in good faith. And of course it all depends, regardless of the theory, on there actually being infringing material in Linux, which must be proved, and that you also have ownership of the copyrights involved. More likely, they intend to rely on their contract. Last year, in an SEC filing, they said this:

"UNIX System V was initially developed by AT&T Bell Labs and over 30,000 licensing and sublicensing agreements have been entered into for the use and distribution of UNIX. These licenses led to the development of several derivative works based on UNIX System V, including our own SCO UnixWare and SCO OpenServer, Sun's Solaris, IBM's AIX, SGI's IRIX, HP's UX, Fujitsu's ICL DRS/NX, Siemens' SINIX, Data General's DG-UX, and Sequent's DYNIX/Ptx. These operating systems are all derivative works based upon, or modifications of the original UNIX System V source code currently owned by us. As such, we retain the right to control certain uses of all UNIX-based derivative works and to prohibit use of UNIX and UNIX-based derivative works for others and to prohibit the unauthorized disclosure of UNIX and UNIX-based derivative works to third parties, including open source developers."

So maybe they have some kind of DMCA/contract offspring idea. Boies is nothing if not interesting.

Novell

But by far the most interesting part of the litigation story in this S3 is the positioning you can see in their story about the copyright dispute with Novell and their perception of why nobody wants to do business with them:

"As a further response to our SCOsource initiatives and claim that our UNIX source code and derivative works have inappropriately been included in Linux, Novell has publicly asserted its belief that it owns certain copyrights in our UNIX source code, and it has filed 15 copyright applications with the United States Copyright Office related to UNIX. 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. Novell has purported to veto our termination of the IBM, Sequent and SGI licenses. We have repeatedly asserted that we obtained the UNIX business, source code, claims and copyrights when we acquired the assets and operations of the server and professional services groups from The Santa Cruz Operation (now Tarantella, 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. In January 2004, in response to Novell's actions, we brought suit against Novell for slander of title seeking relief for Novell's alleged bad faith effort to interfere with our copyrights related to our UNIX source code and derivative works and our UnixWare products.

        "Notwithstanding our assertions of full ownership of UNIX-related intellectual property rights, as set forth above, including copyrights, and even if we are successful in our legal action against Novell and end users such as AutoZone and DaimlerChrysler, 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 SCOsource 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. These efforts of Linux proponents also may increase the negative view some participants in our marketplace have regarding our legal actions against IBM, Novell and end users such as AutoZone and DaimlerChrysler and regarding 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 source code and derivative works 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. Additionally, if we fail in our lawsuit against Novell and end users such as AutoZone and DaimlerChrysler, the negative perception and confusion in our marketplace about our intellectual property rights and claims likely would increase significantly, and the effectiveness of our SCOsource initiatives could be materially harmed.. . .

"The decline in our UNIX business may be accelerated if industry partners withdraw their support from us as a result of our SCOsource initiatives and in particular any lawsuit against end users violating our intellectual property and contractual rights, such as our lawsuits against AutoZone and DaimlerChrysler."

That second to last sentence is so funny, because it indicates that even if they lose all their law suits, they will view that as "confusing" the marketplace. True believers, indeed. I don't think the rest of us will find such an outcome the least bit confusing as to their IP rights and claims.

There is also this craftily worded acknowledgement that "other regulators or others in the Linux community have initiated or in the future may initiate legal actions against us, all of which may negatively impact our operations or future operating performance." Other regulators? Other than which regulator? They also caution potential investors (and if any are still reading this deep into the S3 with that goal I can't help but marvel) that there are these further factors to consider: the contingency fees they may pay to their law firms and "changes in attitudes of customers and partners due to our aggressive position against the inclusion of our UNIX code and derivative works in Linux and our lawsuits against end users violating our intellectual property and contractual rights." Think they'll tell the judge in the Novell case that this is why they are sinking like a stone? Or will they say it's all Novell's fault? Three guesses. Well, you only need one.

Paying the Piper

And speaking of careful wording, what do you make of this? ". . . our agreement with the law firms may also be construed to include contingency fee payments in connection with issuances of our equity securities." May be construed? Does it or doesn't it? Inquiring minds want to know. Here is what they said on that subject in October 17, 2003 in their 8K:

"Arrangement with Counsel

"SCO announced that it is in the process of finalizing a modification of the engagement with the law firm representing SCO in the protection of SCO's intellectual property rights. As part of this modification, which is subject to a definitive agreement, the law firm would receive a contingent fee of 20 percent of the proceeds from certain events related to is protection of SCO's intellectual property rights, including certain licensing fees, settlements, judgments, equity financings or a sale of SCO during the pendancy of litigation or through settlement, subject to certain agreed upon credits for amounts received as discounted hourly fees or prior contingency payments. In addition, this modification may result in the payment to such law firm of up to $1,000,000 and the issuance of up to 400,000 shares of SCO's common stock."

How would you say they construed it themselves back then? Links to all the contracts and more information can be found in an article I did last December.

Of course, there could be some huge payoffs to their lawyers ahead, they warn:

"During fiscal year 2003, we expanded our efforts with the law firms assisting us with our pursuit of our intellectual property claims and currently expect to devote substantially more financial resources to this effort. In addition to paying fees at reduced hourly rates to these firms, our agreement with the law firms provides that we will pay the law firms a contingency fee of 20 percent of the proceeds from specified events related to the protection of our intellectual property rights. These events may include settlements, judgments, certain licensing fees, subject to certain exceptions, and a sale of our company during the pendancy of litigation or through settlement, subject to agreed upon credits for amounts received as discounted hourly fees and unused retainer fees. Additionally, our agreement with the law firms may also be construed to include contingency fee payments in connection with our issuance of equity securities, which may harm our results of operations as we anticipate that these costs to the law firms will be expensed as incurred."

The 10Q does say, after reporting the dismal SCOSource revenue for the quarter that they "anticipate that revenue from vendor licenses and IP licenses will increase during the last two quarters of fiscal year 2004."

The Taxman Cometh

Oh, and SCO shuttered its UK presence and has applied for "administrative relief", transferring its base to Ireland:

"In March 2003, in connection with management's decision to establish strategic European headquarters in Dublin, Ireland, and our United Kingdom ("UK") subsidiary, SCO Group, Ltd., not performing at expected levels, we determined that SCO Group, Ltd would be wound up. On March 26, 2003, the board of directors of SCO Group, Ltd., obtained administrative relief in accordance with Rule 2.2 of the Insolvency Rules 1986 of the UK. In connection with the approved administrative relief, the operations of SCO Group, Ltd. were transferred to an administrator that was appointed by the court to complete the winding-up process. As of April 30, 2003, the operations of SCO Group, Ltd. were no longer under our control. The winding-up of SCO Group, Ltd. resulted in a net restructuring charge during the quarter ended April 30, 2003 of $136,000. The net reversal for the first two quarters of fiscal year 2003 was a result of the restructuring charge discussed above related to our UK subsidiary and additional adjustments to previously recorded restructuring charges for actual payments made."

What is the difference between the UK and Ireland? Not lower rents. This may give you some insight, from the 10Q:

"During the three months ended April 30, 2004, the Indian branch received a withholding tax assessment from the Government of India Income Tax Department ('Tax Department') for the period of April 2000 through March 2001. During the April 2000 through March 2001 period, SCO Group, Ltd. was owned by The Santa Cruz Operation (now Tarantella, Inc.), and not us. We acquired SCO Group, Ltd. in May 2001 as part of an asset purchase.         "The Tax Department assessed SCO Group, Ltd. with a 15 percent withholding tax on certain revenue transactions in India that the Tax Department deemed royalty revenue under the Indian Income Tax Act. The total amount of the withholding tax is $396,000. We were not aware of this liability until March 2004, when we received the formal tax assessment from the Tax Department, as we believed that we had been appropriately accounting for the revenue and related taxes on transactions in India.         "We have filed an appeal with the Tax Department and believe that our packaged software does not qualify for 'royalties' treatment and would therefore not be subject to withholding tax. Additionally, as described above in this Item 2., under the caption 'Restructuring Charges (Reversals),' SCO Group, Ltd, the company on which the assessment was levied, has filed for bankruptcy in the UK. Although we intend to vigorously defend this tax assessment, there can be no assurance we will prevail against the Tax Department.        

"We have recorded the charge for $396,000 in the in the second and first two quarters of fiscal year 2004 as a component of our provision for income taxes. In addition, we believe that the Tax Department probably will pursue similar assessments on SCO Group, Ltd. for taxable periods subsequent to March 2001. Because of this probability, and our inability to determine at this point if we may prevail against the Tax Department, we have accrued the full amount of the estimated withholding tax of $314,000 for these subsequent periods as provision for income taxes in our statements of operations for the second quarter and first two quarters of fiscal year 2004."

Talk about running for the hills. And how do you like them distinguishing themselves from Santa Cruz? Now, when the tax man is calling, they aren't Santa Cruz after all and aren't celebrating their 25th year in the UNIX business? They have that slogan on their web site: "1979 - 2004 Celebrating 25 years of UNIX® Solutions". And SCOForum this year is supposedly about celebrating that anniversary. Woops. I think they need to rewrite their complaint in the IBM law suit too. Here they've been telling the world they are Santa Cruz, and somebody in India is taking them up on it. Go figure. If the tax man doesn't get them, they think they have enough to pay off BayStar, if the SEC agrees, and then last about 12 months:

"We believe that we will have sufficient cash resources to complete the Series A-1 repurchase transaction and fund our current operations for at least the next 12 months."

Sometimes I think about the folks who bought the licenses. How will they feel when SCO loses at trial, I wonder? Like a dope, I imagine. Ever play a shell game? If you've never been to NYC, maybe not. But on the streets of the big city, there are hustlers ready to play, if you are foolish enough to think it's a fair game and agree to turn over your money and then studiously try to follow the pea's transit from shell to shell. Of course, real New Yorkers won't play, because they know how the game comes out. Only the guys running the shell game win. So the hustlers look for tourists, simple folk from Dubuque or Kansas, who never heard of the game and think they can make some easy money.

There is no way to read these documents without realizing that the company appears to be in a tight spot, fighting for its very life, as I read it, and a lot of things would have to turn around for them to even survive. They gambled everything on the IP claims that now don't look so strong. Not that they ever looked strong. It was always a long shot. They assumed maybe that Linux was loosely managed and vulnerable. Those proprietary dudes all steal other peoples' code, I gather, and so they assumed that Linux was the same. They were wrong. And they seriously miscalculated the world's reaction to their scheme, as it has been called in several legal documents so far.

And now, unless they have some ace in the hole, they are left swinging in the breeze. Which may be better than what happens to them next.


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