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SCO's 2nd Quarter Financial Call - as text
Sunday, June 05 2005 @ 10:59 AM EDT

Here's the transcript of SCO's Second Quarter 2005 financial conference call, thanks to several willing volunteers. Special thanks go to Laomedon and Jon Ingram.

Darl McBride makes reference to SCO's recent filing of its Report Regarding Discovery in the AutoZone case. It's important to point out that AutoZone has issued a statement that it will be filing a response, to correct what it calls "material misstatements" in that report. If they can prove material misstatements, then would it not create a problem for SCO, if they have repeated the material misstatements in the conference call and in their 8-K filing with the SEC? I'm working on a transcript of the Report now and will have it for you shortly.

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

Operator: Good day everyone and welcome to The SCO Group's second quarter 2005 earnings conference call. Today's call is being recorded.

At this time, for opening remarks and introductions, I will turn the call over to Mr. Blake Stowell, public relations director. Mr. Stowell, please go ahead.

00:16

Blake Stowell: Thanks. Good day, everyone, and welcome to the S.C.O. Group's fiscal second quarter 2005 financial earnings conference call. At this time everyone is in listen-only mode. Later a question-and-answer session will be opened. During that question-and-answer session the company will only be taking questions on the company's core Unix business. Today's call is being recorded.

Participating on the call today are Darl McBride, President and Chief Executive Officer, and Bert Young, Chief Financial Officer. Each of you should have a copy of the press release issued this afternoon containing our results, which we'll be discussing further in this call.

I wish to point out to the participants on today's conference call that the information provided during this call will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are made only as of the day of this conference call, and we undertake no obligation to update or revise the forward-looking information, whether as a result of new information, future developments or otherwise. Our performance is subject to significant risks and uncertainties, known and unknown, that could cause our results to differ materially from those that may be anticipated by the forward-looking statements. These risks and uncertainties may cause our actual results, level of activity, performance or achievements to be materially different from any projections or future results implied by those forward-looking statements. Accordingly you should not place implied . . . Accordingly you should not place undue reliance on these forward-looking statements. For a full discussion of these and other risks and uncertainties, please see our Annual Report on Form 10-K for the fiscal year ended October 31, 2004 and other reports we have filed with the SEC, all available at www.sco.com.

I will now turn the call over to Darl McBride, President and Chief Executive Officer of the S.C.O. Grouping.

02:10

Darl McBride: OK, thanks, Blake, and thanks, everyone, for joining us on today's call. The second quarter was a productive, business-as-usual quarter for SCO, free of some of the media drama of recent quarters. Our core Unix business continued to operate profitably, and we increased revenues in that business over last quarter as a result of solid performance across all geographies. As we've said before, we believe that business will continue to generate positive operating results and will remain cash flow positive throughout the remaining quarters of fiscal 2005.

Strategically, we continue to focus on commercial success in the marketplace. I'll speak more specifically on this later, but we look forward to launching SCO OpenServer 6 later this month. At the same time we remain committed to pursuing our legal strategy in the courtroom and are well positioned to see it through to its conclusion. I now turn this call over to Bert Young, our CFO, for an overview of our company's financial results. Bert?

[3:16]

Bert Young: Thanks, Darl. Good afternoon, everyone. The company reported revenue of 9.3 million for the 2nd quarter of fiscal year 2005, as compared to revenue of 10.1 million for the comparable quarter of the prior year. The net loss for the 1st quarter was 2.0 million or 11 cents per diluted common share compared to a net loss of 14.7 million or a $1.04 per diluted common share reported in the comparable quarter of the prior year. Revenue for the first two quarters of fiscal year 2005 was 18.1 million compared to revenue of 21.5 million for the first two quarters of fiscal year 2004. The net loss for the first two quarters was 4.9 million or 28 cents per diluted common share compared to a net loss of 17.2 million or $1.23 per diluted common share for the first two quarters of fiscal year 2004.

Revenue for the Unix business was 9.2 million vs. 10.1 million for the prior quarter. UNIX revenue was down year over year, primarily as a result of continued competitive pressure for operating systems. However, as noted by Darl, revenue for the second quarter was slightly higher than revenue in the first quarter. For the second quarter of 2005 the cost of revenue for the Unix business was 1.3 million resulting in a gross margin of 7.9 million or 86%.

Cost and expenses for the Unix business were 7.4 million. Cost for sales and marketing and research and development were in line with our expectations, but our general and administrative costs were unusually high, due to the additional legal and accounting cost incurred in connection with the restatement of our 2004 quarterly financial statements and quarterly reports. We expect that sales and marketing and R&D cost will continue to stay at their current levels and that G&A costs will decrease to a level that was incurred in the first quarter of fiscal year 2005.

As a management team, we are pleased the Unix business continues to operate profitably. Revenue derived from SCOSource licensing was $30,000 for the quarter. As we have stated in prior quarters, we caution that predicting this revenue stream is very challenging and will continue to be difficult to predict. As in previous quarters, we are continuing to classify legal and professional fees and other costs and expenses that directly related to enforcement of our intellectual property rights as cost of revenue. For the second quarter of fiscal year 2005, these costs were 2.9 million, however down from the prior quarter as the result of less-than-anticipated spending for escrow-related expenses. Before turning to our cash discussion, one other positive development for the quarter occurred as SCO sold shares of TrollTech AS it had owned since 1999 in a private transaction for total proceeds of $779,100. The company accounted for the sale as a component of other income in its second quarter and year-to-date statements of operations.

[6:45]

Cash and cash equivalents and available-for-sale securities were approximately 14.2 million at April 30th, 2005. In addition, approximately 4 million remains in an escrow account and is classified as a component of restricted cash as of April 30th, leaving the company with 18.2 million in cash. As we have done in previous quarters, If you deduct the 3 quarterly payments of 2 million each that we have to make over the next three quarters to Boies, Schiller & Flexner, and the remaining escrow balance of 4 million, we will have a total of 8.2 million after the litigation expenses have been subtracted. If you recall from last quarter, this number was 7.4 million, so our efforts in quarter 2 yielded a positive cash result. With that, I'll hand things back to you, Darl.

[7:40]

McBride: OK, Thanks, Bert. I'd like to spend the remainder of our call on our business performance and prospects. We were pleased with the performance of our Unix business, and that business is focused on generating positive cash flow despite a very challenging business environment. Key customer wins during the quarter include COSTCO, Thompson Financial, McDonalds, Goodyear, CTC Chile, Siemens, Dolland and Aitchison in the UK, ARGOS, also in the UK, People's Bank of India, Converse, and Carre Foure out of France.

The company continues to receive great feedback from the product beta testers of the prerelease version of our OpenServer 6 product, code-named Legend. In some cases, the product has seen double the performance in product benchmarks compared to the previous version of SCO OpenServer. Upon its release, SCO OpenServer 6 will support numerous applications, including UnixWare, and SCO OpenServer apps, JAVA apps, and applications that run on MySQL, PostgressSQL, Tomcat, Apache and many other popular environments. The company will also continue to include backward compatibility for applications that have run on previous versions of SCO OpenServer.

The company will host a significant product launch event in New York City on June 22nd, which will be attended by many of SCO's software and hardware partners, key customers, as well as members of the media and the analyst community. In addition to our June launch for SCO OpenServer 6, we have scheduled our annual SCO forum event August 7th to 9th at the MGM Grand Hotel in Las Vegas. We look forward to another great gathering this year for our resellers and our software and hardware partners.

It's been less that 2 months since we provided the last litigation update, so we don't have a lengthy report for you this time but we have had a couple of important developments since we last reported which I'll explain briefly.

First, in our last call we reported that the United States Magistrate had ordered IBM to produce code and revision information that we have been seeking for some time. In response, IBM filed a motion asking the Magistrate to reconsider some aspects of that order. On April 19th, the Magistrate Judge ruled on IBM's Motion for Reconsideration, giving IBM some relief on deadlines and some other matters, but strongly reaffirmed the court's prior order, directing IBM to turn over the information we had requested, including both public and private information regarding its development of, and contributions to, Linux. We look forward to reviewing this information, which we believe will be very helpful in putting together the technical side of our case. We look forward to having this information delivered to us by July 18th.

[10:12]

On April 28 the Court issued an order denying various media entities' requests to intervene in the case for the purposes of unsealing certain documents filed with the court. However, the court directed the parties to take another look at their sealed filings, and unseal any documents that are not properly filed under seal. As a result of that order, many important documents will be unsealed by the parties in the coming weeks.

The hearing on Novell's second Motion to Dismiss our case was held on May 25th. The judge took the matter under advisement, though we're optimistic that the court will allow us to conduct discovery in this case.

We'd also like to mention that we've now concluded the initial discovery in the AutoZone case, and filed our report last Friday, May 27th, with the Federal Court in Nevada. Let me just summarize what the report says.

Contrary to Autozone's various statements to the court, SCO found through its discovery, including sworn depositions, and other admissions directly from AutoZone, many instances of copying of programs containing SCO OpenServer code. AutoZone has represented that it has now removed all of the SCO code and proprietary information that it copied or used in its migration to Red Hat Linux. Because they claim they have now removed all of the SCO code and proprietary information, SCO is not going to move for a preliminary injunction at this time. Autozone does not admit that it violated SCO's rights, or caused SCO damage in that migration process, which are still points of dispute between the parties. Given the stay issued by the Court in the case, we reserve the right to pursue infringement and damages at some future point. It's important to remember that issues regarding the broader problems we allege are in Linux as they relate to our contractual and IP rights have been stayed by the court in Nevada, so our report does not address those issues. As I mentioned, we reserve our rights to pursue those claims once the stay is lifted.

The discovery we undertook in the Autozone case was limited in scope to issues surrounding any SCO code or libraries, or other proprietary information used or copied by AutoZone in migrating to Linux, and did not address the Linux issues that are being litigated in the IBM case in Utah.

I'd now like to take a second and point out something we think this report demonstrates. There have been a lot of questions as to SCO's motives behind these various court cases, and suggestions in the media that we're off-base in trying to find our code in other peoples' systems. I think this report shows, by Autozone's own admissions, they copied our code. At any rate, we could spend a lot of time on all these points that I've mentioned today, but that's not the purpose of this call, and so we'll not be discussing this in any greater detail, and we will not be responding to any questions about this in the Q&A session.

If you want additional information about the Magistrate's ruling on IBM's Motion For Reconsideration; the court's ruling on the Motion to Intervene by the media, or which documents have been unsealed as a result of that order; or additional information about the Report we have filed in the AutoZone case, you should should obtain copies of these documents from the respective courts, read them, and draw your own conclusions about their importance.

Thank you for understanding that we really can't go into greater detail or discussion about these matters that will be played out in the courts.

With that, I will now turn the call over to the operator, to open up the phone lines for questions.

Operator: Thank you, Mr. McBride. The question-and-answer session will be conducted electronically. If you would like to ask a question, please do so by pressing the star key, followed by the digit 'one' on your Touchtone telephone. If you are using a speakerphone, please make sure your mute function is turned off, so that your signal will reach our equipment. We will proceed in the order you signal and take as many questions as time permits. Once again please press star-1 on your telephone to ask a question at this time. We will pause for a moment to assemble our roster.

15:27

We will take our first question from Al Petrofsky, a private investor.

Al Petrofsky: Hello?

McBride: Hello, Al.

Petrofsky: Oh hi. Um. Congratulations on the Unix numbers. Those look pretty good.

McBride: We felt good about the quarterly performance. Thanks.

15:42

Petrofsky: Great. Um. Last quarter you had 50 people in sales and marketing and 55 in product development. Do you have those numbers handy for this quarter?

Young: Yeah. There's really no change in head count, uh, this quarter from previous quarter.

Petrofsky: OK, and now on Bay Star, aah, the BayStar, at this point they still can't sell those million shares of common stock they have, right?

Young: Yeah, the uh, probably the answer to that question is really the status on the S-1 filing. Uhm, we have received information from the SEC. They've chosen not to review our S-1 filing, and so we should be effective with the BayStar S-1 filing any day, really. Tomorrow, the following day, we should be effective and at that point, BayStar shares will be registered in a way that they can sell them again, if that's what they choose to do.

Petrofsky: Ok. Now, in the deal last year, you agreed to take care of registration, and BayStar agreed to limit its selling to 10% of the NASDAQ volume. so . . .

Young: No, it was 10% of the trailing 5-day SCO volume.

16:52

Petrofsky: Right. Uh, right. I meant the trading of SCO on NASDAQ.

Young: Yeah.

Petrofsky: Now .. so is BayStar still going to stick to that volume limit, even though you didn't keep the registration in order?

17:01

Young: Yeah, so the agreement continues. There's no change in that agreement at all.

Petrofsky: OK. And they're not.. there's not going to be some kind of catch-up provision, so that they can sell 10% of the volume over those months that they missed?

Young: We've had no discussions like that with them, no.

Petrofsky: OK. So as far as you know they're OK with it.. just [indistinct].

Young: As far as we know, they'll adhere to the agreement that that we had in place. They were adhering to it before and now they'll adhere to it afterwards.

Petrofsky: OK. I mean, so in the few months you have not been adhering to it, right? [indistinct]

Young: Well, the agreement had, our obligation was to do our best effort at keeping the registration effective.

Petrofsky: I see.

17:45 Young: And when we missed that NASDAQ filing, then we made our best efforts to get that filing effective, which is now this S-1 being effective here in a day or two.

Petrofsky: I see. OK. Um, you-know, I see that the rescission liability is now $850,000. Do you think you'll get that resolved this quarter?

Young: Um, we will begin. . . Our expectation is in this quarter, we expect to begin the rescission offer , that we will make to our employees. I doubt at the end of quarter three that number will be eliminated completely. But we may resolve a good portion of that liability -- but over quarter three and quarter 4 we will expect that rescission liability to begin to resolve itself.

18:35

Operator: And again, as a reminder it is star-1 to signal for questions.

We'll go next to Bob Mims, Salt Lake Tribune.

Bob Mims: Uh, hi Darl. How are you?

McBride: Good. How are you, Robert?

Mims: Good. Um, I was hoping for -- It's probably obvious I'm a reporter, but you might explain it for an 8-year-old. You have decreased revenues and yet your, um, your net losses have been dramatically improved. I estimate around a 75% improvement there. Certainly the TrollTech sale doesn't begin to account for that. Are there one or two or three areas of cost-cutting perhaps that might account for this improvement?

McBride: Yeah, go ahead, Bert.

Young: Yeah, you're right, Bob, to mention the TrollTech. That's clearly a big amount of benefit in other income that affects our -- improves the net loss for the quarter. The other area, really, is the upside in revenue from the previous quarter. Just if you take costs, uh, out of our Unix business, quarter over quarter. There was a little bit of an increase in costs in our GNA area.

Mims: Uh hmm.

Young: But the additional revenue this quarter over last quarter would account for, you-know, the upside in profitability of the business. The other thing I mentioned on the call is, we did have a drop in expenses -- the expenses in the lawsuit. Those are the expenses we categorized in the -- when we talk about the escrow account.

20:12

Mims: OK.

Young: Those were almost $400,000 less this quarter than the previous quarter.

Mims: Very good, thank you.

McBride: One other comment I'd make, Bob, with respect to our overall Unix business. We have not released into the marketplace the level of operating system upgrades that we're doing this month for nearly six years, so we're confident that our program going forward with SCO OpenServer 6, that has been a multi-year, multi-million dollar development effort, is going to provide customers with increased performance and response, security enhancements that they haven't seen before. You know, we've had a revenue decline for a number of years here. We're in a very intense competitive environment, and we're now shipping a product here that we believe is going to provide some stability on a going-forward basis.

Mims: Some of your big Unix customers, who perhaps have been a little shy of publicity lately, will they be coming out to support you at Yankee Stadium?

McBride: We're got a number of folks who have signed up for the event, and, so you know ... so yes, there's going to be ... well, I don't know the exact numbers right now, but ... well over 100 folks there, a number of those customers, that will be showing up at that event.

Mims: Thank you.

McBride: Thank you, Bob.

Operator: There are no questions remaining on our roster. Mr. McBride, I'll turn it back over to you for any additional and closing remarks.

McBride: Okay, great. A quiet Q&A session. Fine, let's see ... so let's go ahead and wrap this up. I think, you know, if you step back and look at where we are, from a summary standpoint, during Q2 we kept focused on the Unix business and moving our litigation efforts forward. The company's Unix business is continuing to generate solid cashflow. Legal fees are in line with expectations. We are looking forward to launching the new SCO OpenServer product in June, and we've made solid progress with regard to our litigation effort and are looking forward to having our cases heard. So, with that, that's basically all we have for today. Thanks for joining the call, and we'll look forward to speaking to you again soon.

Operator: Once again, this will conclude today's presentation. Your participation is appreciated. You may disconnect at this time.


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