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McBride: Me, Inc. is From Vultus/And Some Nuggets From SCO's 424B3
Saturday, September 24 2005 @ 04:02 PM EDT

SCO CEO Darl McBride has acknowledged publicly that Me, Inc., its new services offering, is indeed Vultus-based, just as I wrote last Monday that I suspected. Here's the proof, in Larry Greenemeier's article in Information Week:
Largely overshadowed by the IBM lawsuit was SCO's July 2003 acquisition of Vultus Inc., a company with tools for developing Web services that small and midsize businesses could build atop their SCO Unix infrastructures. At the time, SCO called its Web-services initiative SCOx and envisioned that Vultus' WebFace Web-application development environment would let customers transform archaic green screens into more dynamic browser-based interfaces. "There wasn't a lot of interest in that, though," McBride admitted. This forced SCO to find some other way to make use of its investment in Vultus and led to the emergence of the Me Inc. Web services for mobile applications.

As I pointed out in my coverage of the Me, Inc. announcement, something about this story doesn't sound right. First, I have a problem with the chronology. Second, I have a related question about SCO writing off the Vultus deal.

On the value of Vultus, let's look at what SCO told us Vultus offered, back when they acquired it, and see if it matches the current McBride characterization, that it "let customers transform archaic green screens into more dynamic browser-based interfaces". Here is what SCO told us Vultus did, back at the time of the acquisition:

The Web Services acquisition is a key element of SCOx, a framework that will allow SCO, its resellers and developers to provide the benefits of Web Services to enterprise customers, small-to-medium businesses (SMBs) and branch offices.

SCO WebFace Solution Suite substantially lowers development costs by providing an integrated development environment that is specifically designed to help developers rapidly create and deploy feature-rich, secure, intelligent Web application interfaces that can easily reface any existing or new application. Built on the SCO UNIX operating system, ebusiness services and industry standards (such as XML, SOAP and UDDI), SCOx and WebFace will provide the tools and foundation to allow partners to easily migrate legacy systems to the Web, seamlessly integrate service-oriented architectures and build next generation applications in a Web Services framework.

This step is strategic in bringing together a Web Services framework that SCO can provide to our customers,” said Jeff Hunsaker, Senior VP of Marketing, The SCO Group. “SCO is targeting web services as a platform for growth. We look forward to introducing many of these technologies at SCO Forum August 17-20 in Las Vegas.”

The WebFace Solution Suite is a next generation Web application development environment, allowing customers to easily create and deploy applications in a browser without the need for installed plug-ins or Java. WebFace Solution Suite—consisting of WebFace Browser Application Platform and WebFace Studio— enables developers to migrate existing applications onto the Web, regardless of operating system or back-end technology. In addition, WebFace greatly enhances the end-user experience for SOAs and seamlessly integrates with any Web Services platform, such as J2EE, WebSphere, WebLogic or .NET.

”The bottom line is better service to SCO customers through cost-effective Web solutions and technologies,” explains Mike Meservy, CEO, Vultus, Inc. “We’re extremely excited to introduce Web Service-enabling technology into the SCO channel and developer network. We’re also excited about SCO’s Global Services division and the key role it will play in supporting current and future WebFace customers, as the technology grows and expands across multiple industry segments.”

A significant benefit of this acquisition includes a professional services team that is skilled in complex Web application migration, integration and development.

Does that sound to you like it offered no cash flow possibilities? McBride now says that customers weren't interested and so SCO found "some other way to make use of its investment". But when I look at the chronology, I have a question as to when customers had time to express a lack of interest.

SCO tells us that Me, Inc. is "a multi-year development effort by SCO and builds on technologies that the company gained through a Web Services technology acquisition in 2003," now acknowledged to be Vultus. So at what point did Vultus become of no value, and at what point did the Me, Inc. brainstorm give Vultus value after all?

Let's parse out the timing precisely. SCO announced that it had acquired Vultus in July of 2003. For more on the SCO Vultus deal, you can read Frank Hayes' article from July of 2003, SCO's Shell Game. SCO told the SEC in their 10-Q for the period ended July 31, 2003 the following:

(3) ACQUISITION OF VULTUS, INC.

Under the terms of an Asset Acquisition Agreement (the “Vultus Agreement”) dated June 6, 2003, the Company acquired substantially all of the assets of Vultus, Inc. (“Vultus”), a corporation engaged in the web services interface business, in exchange for the issuance of 167,590 shares of the Company’s common stock, of which The Canopy Group (“Canopy”), the Company’s principal stockholder, received 36,656 shares, and the assumption of approximately $215,000 in accrued liabilities of Vultus. In addition, the Company assumed the obligations of Vultus under two secured notes payable to Canopy totaling $1,073,000. In connection with the assumption of the notes payable to Canopy, Canopy agreed to accept the issuance of 137,684 shares of the Company’s common stock in full satisfaction of the obligations. Canopy was a stockholder and significant debt holder of Vultus. The Company extended employment offers to most of the former employees of Vultus. Vultus is expected to be an integral part of the Company’s web services strategy.

The following table summarizes the components of the consideration paid to Vultus (in thousands, except per share data):

Consideration paid:
Fair value of common stock issued (305,274 shares at $8.06 per share) - $2,461
Assumed liabilities - $215
Direct expenses - $45
Total consideration - $2,721

The $8.06 per share value of the common stock issued was determined based on the average market price of the Company’s common stock for the two days before and the day of signing the Vultus Agreement.

The Company accounted for the acquisition of Vultus as a business combination in accordance with SFAS No. 141. SFAS No. 141 requires that the total purchase price, including direct fees and expenses, be allocated to the assets acquired based upon their respective fair values. No current assets or tangible assets of significant value were acquired. Based on the nature and status of the research and development projects at the date of acquisition, none of the purchase price has been allocated to in-process research and development. The purchase price has been allocated to the intangible assets acquired as follows (in thousands):

Purchase price allocation:
Acquired technology (Estimated useful life of two years) - $1,555
Goodwill - $1,166
Total - $2,721

All of the amounts assigned to goodwill are expected to be deductible for tax purposes.

(4) INTANGIBLE ASSETS

In July 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets.” Under SFAS No. 142, goodwill and other intangible assets with indefinite lives are no longer amortized, but rather are assessed annually for impairment. The Company adopted SFAS No. 142 on November 1, 2001, the beginning of fiscal year 2002. All of the Company’s identifiable intangible assets are deemed to have finite lives and are amortized over their remaining useful lives.

Identifiable intangible assets are the result of the acquisition of certain assets and operations from Tarantella, the acquisition of the WhatIfLinux technology from Acrylis, Inc, and the acquisition of certain assets from Vultus.

The following table summarizes the components of intangible assets and their useful lives as of July 31, 2003 (in thousands):

Estimated Useful Life - Gross Carrying Amount - Accumulated Amortization - Net Book Value
Amortizable intangible assets:
Distribution/reseller channel - 5 years - $11,626 - $4,093 - $7,533
Acquired technology – Tarantella - 5 years - $1,687 - $594 - $1,093
Acquired technology – Acrylis - 2 years - $871 - $763 - $108
Acquired technology – Vultus - 2 years - $1,555 - $193 - $1,362
Trade name and trademarks - 5 years - $261 - $92 - $169
Total intangible assets - - $16,000 - $5,735 - $10,265

The changes in the carrying amount of goodwill are as follows (in thousands):

Balance as of October 31, 2002 - $______
Goodwill attributable to the Vultus acquisition - $1,166
Balance as of July 31, 2003 - $1,166

So, that was the story in July of 2003, when they acquired Vultus and told us in their press release how wonderful Vultus was and how it would be a vehicle for SCO growth. They tell us now, September 2005, that Me, Inc. has been a "multi-year" development effort. So when did development on Me, Inc. begin? The day after they wrote the 10-Q? A week? A month? Conceivable, I suppose, and McBride's words in Information Week imply something like that. But for Me, Inc. to be a multi-year effort, I think they had to have begun developing it by September of 2003, no? So they offered Vultus from July to September of 2003 and found no interest and then embarked on Me, Inc. development? Maybe.

But that doesn't seem to adequately explain that in their 10-Q filed for the period ended in April of 2004, they reported under the heading "Impairment of Long-Lived Assets" that the goodwill and intangible assets of Vultus had been impaired by certain events and that they didn't think there would ever be any cash flow from the Vultus acquisition:

We performed an impairment analysis as of April 30, 2004 in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," and determined that the goodwill and intangible assets related to the Vultus technology, which we acquired from Vultus, Inc. ("Vultus") in June 2003, had been impaired. We concluded that an impairment-triggering event occurred during the second quarter of fiscal year 2004 as an impending partnership that would solidify the Vultus revenue and cash flow opportunities did not materialize. Additionally, we had a reduction in force that impacted our ability to move the Vultus initiative forward on a stand-alone basis. Consequently, we have concluded that no significant future cash flows related to its Vultus assets would be realized. As a result of these analyses, we wrote-down the carrying value of our goodwill related to the Vultus acquisition from $1,166,000 to $0 and wrote-down intangible assets related to our Vultus acquisition from $973,000 to $0.

If that was their lugubrious conclusion in April of 2004, and they were being truthful, we have to assume that they had not yet begun development of Me, Inc., don't we? In SCO's SEC filing, 424B3, dated September 13, 2005, they summarize the Vultus deal:

We recorded a loss on impairment of long-lived assets totaling $2,139,000 for the nine months ended July 31, 2004. The impairment related to goodwill and intangible assets acquired in connection with our acquisition of Vultus, Inc. (“Vultus”) in June 2003. We 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. Consequently, we concluded that no significant future cash flows related to our Vultus assets will be realized. We performed an impairment analysis of our 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, we wrote-down the carrying value of our goodwill related to our Vultus acquisition from $1,166,000 to $0, and wrote-down the intangible assets related to our Vultus acquisition from $973,000 to $0. . . .

During the three months ended July 31, 2005 and 2004, we recorded $593,000 for the amortization of intangible assets with definite lives. For the nine months ended July 31, 2005 and 2004, we recorded $1,779,000 and $1,973,000, respectively, in amortization. The decrease of $194,000, or 10 percent, from the nine months ended July 31, 2005 compared to the nine months ended July 31, 2004 was primarily attributable to reduced amortization expense recorded on certain assets acquired from Vultus in June 2003 that were written down to $0 during the year ended October 31, 2004.

To review, SCO acquired Vultus in June of 2003, it was declared worthless in April of 2004, it's now September of 2005, and in their announcement of Me, Inc. SCO described it as "a multi-year development effort". So when did Me, Inc. begin development and transform the Vultus acquisition into a cash flow possibility? And, if, when SCO told the SEC that "no significant future cash flows related to its Vultus assets would be realized," Me, Inc. was already in full development, were they truthful? If not yet in development as of April of 2004, is it accurate to describe Me, Inc. as a multi-year development effort, as now claimed in the press release and in SCO's 8-K and September 19, 2005 424B3? Are we talking SCO math, as in, "one year plus one day equals a SCO multi-year"? I can't make it all jibe otherwise. Perhaps others more knowledgeable than I am can use the raw data I have collected to make it all work out, but I can't see how.

424B3 Nuggets

Speaking of impaired intangible assets, SCO writes the following in its 424B3, Prospectus Supplement to Prospectus Dated June 2, 2005, dated September 13, 2005:

Impairment of Long-lived Assets.

We review our long-lived assets for impairment when events or changes in circumstances indicate that the book value of an asset may not be recoverable. We evaluate, at each balance sheet date, whether events and circumstances have occurred which indicate possible impairment. The carrying value of a long-lived asset is considered impaired when the anticipated cumulative undiscounted cash flows of the related asset or group of assets is less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the estimated fair value of the long-lived asset.

If the operating trends for our UNIX or SCOsource businesses decline, we may be required to record an impairment charge in a future period related to the carrying value of our long-lived assets.

And here's a few more interesting tidbits:

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment, an amendment of FASB Statements Nos. 123 and 95,” which requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in the consolidated statements of operations and comprehensive loss. The accounting provisions of SFAS No. 123R are effective for our first fiscal year beginning after July 1, 2005, which will require us to adopt SFAS No. 123R for the three months ending January 31, 2006. Although we are in the process of determining whether the adoption of SFAS No. 123R will result in future amounts that are similar to the amounts reported in our pro forma disclosure under SFAS No. 123, adoption of SFAS No. 123R could have a material impact on our results of operations. . . .

Risk Factors . . .

There are risks associated with the potential exercise of our outstanding options.

As of August 31, 2005, we have issued and outstanding options to purchase up to approximately 3,871,000 shares of common stock with an average exercise price of $4.28 per share. The existence of such rights to acquire common stock at fixed prices may prove a hindrance to our efforts to raise future equity and debt funding, and the exercise of such rights will dilute the percentage ownership interest of our stockholders and may dilute the value of their ownership. The possible future sale of shares issuable on the exercise of outstanding options could adversely affect the prevailing market price for our common stock. Further, the holders of the outstanding rights may exercise them at a time when we would otherwise be able to obtain additional equity capital on terms more favorable to us.

The issuance of common shares to BayStar may have an adverse impact on the market value of our stock and the existing holders of our common stock.

We previously had an effective registration statement on Form S-3 relating to the sale or distribution by BayStar as a selling stockholder of the 2,105,263 shares of common stock issued to BayStar in connection with our repurchase completed in July 2004 of all Series A-1 shares previously held by BayStar. When we failed to file our Annual Report on Form 10-K for the year ended October 31, 2004 in a timely fashion, we became ineligible to use Form S-3, our registration statement ceased to be effective and BayStar’s ability to resell shares pursuant to that registration statement terminated. Consequently, we prepared a post-effective amendment to Form S-3 on Form S-1 for the resale of BayStar’s shares. When that registration statement was declared effective by the SEC, BayStar was again able to resell its shares. We will not receive any proceeds from the sales of the shares covered by such registration statement. The shares that may be sold or distributed pursuant to such registration statement represent approximately 6 percent of our outstanding common stock. The sale of the block of stock covered by such registration statement, or even the possibility of its sale, may adversely affect the trading market for our common stock and reduce the price available in that market. . . .

Our claims relating to our UNIX intellectual property may subject us to additional legal proceedings.

In August 2003, Red Hat brought a lawsuit against us asserting that the Linux operating system does not infringe on our UNIX intellectual property rights and seeking a declaratory judgment for non-infringement of copyrights and no misappropriation of trade secrets. In addition, Red Hat claims we have engaged in false advertising in violation of the Lanham Act, deceptive trade practices, unfair competition, tortious interference with prospective business opportunities, and trade libel and disparagement. Although this case is currently stayed pending the resolution of our suit against IBM, we intend to vigorously defend this action. However, if Red Hat is successful in its claim against us, our business and results of operations could be materially harmed.

In addition, regulators or others in the Linux market and some foreign regulators have initiated or in the future may initiate legal actions against us, all of which may negatively impact our operations and future operating performance.

The heading of the final entry under Risk Factors appears to be SCO's recognition that if Red Hat prevails, SCO very possibly could be flooded with lawsuits from all over the world, from kernel authors, other vendors, businesses harmed by the FUD, and government regulators. Talk about the levees giving way.

And finally, there are some exhibits listed as attached that sound worth reading:

3.1 - Amended and Restated Certificate of Incorporation of Caldera International, Inc. (incorporated by reference to Exhibit 3.1 to SCO’s Registration Statement on Form 8-A12G/A (File No. 000-29911)).

3.2 - Certificate of Amendment to Amended and Restated Certificate of Incorporation regarding consolidation of outstanding shares (incorporated by reference to Exhibit 3.2 to SCO’s Registration Statement on Form 8-A12G/A (File No. 000-29911)).

3.3 - Certificate of Amendment to Amended and Restated Certificate of Incorporation regarding change of name to The SCO Group, Inc. (incorporated by reference to Exhibit 3.3 to SCO’s Registration Statement on Form 8A12G/A (File No. 000-29911)).

3.4 - Amended and Restated Bylaws (incorporated by reference to Exhibit 3.4 to SCO’s Registration Statement on Form 8-A12G/A (File No. 000-29911)).

I gather these are paper exhibits? If anyone finds them, please let me know. Update: Groklaw's Fogey found them for us. They are the old ones from before, so less interesting. I wondered if they had made further changes, but not so.


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