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SCO's 10Q - Woe is SCO
Thursday, March 26 2009 @ 05:16 PM EDT

SCO's 10Q for the quarterly period ending January 31, 2009 is now available, and it paints a glum picture indeed:
 The Company incurred a net loss of $459,000 for the three months ended January 31, 2009, and during that same period generated cash of $337,000 from its operating activities. As of January 31, 2009, the Company had a total of $1,836,000 in cash and $3,766,000 in restricted cash, of which $1,500,000 is designated to pay for experts, consultants and other expenses in connection with the litigation between the Company and IBM, Novell and Red Hat (the “SCO Litigation”), $2,266,000 is payable to Novell for the post bankruptcy petition retained binary royalty stream.
They seem to be losing their customers:
Revenue from the UNIX business decreased by $1,775,000, or 36%, for the three months ended January 31, 2009 compared to the three months ended January 31, 2008....Our sales of UNIX products and services are primarily to existing customers.
So... they are selling mostly to prior customers, who are leaving them at a noticeable clip. Um. This is the wonderful asset that SCO hopes to base its bankruptcy reorganization play on? I'm sure their money is safe, though. Wait:
The Company has $250,000 of cash that is federally insured. All remaining amounts of cash as well as restricted cash exceed federally insured limits.
Huh? How about more than one bank? Or a fund that is in TARP and can ensure it all? I mean, restricted cash owed just to Novell is $2,266,000, and it's not insured? That's not all they owe, either. Whazzup widdat?

SCO gallantly charges forward, relying on the appeal of SCO v. Novell to make what they owe Novell from the trial moot:
On March 4, 2009, we filed our brief for our appeal with the Tenth Circuit Court. The Tenth Circuit Court has placed the case on the calendar for oral argument on May 6, 2009. With the expedited appeal, and early hearing date, we are hopeful a decision on the appeal could be forthcoming in the next five to eight months, but it could be several months beyond that time frame.
See? It could still all come right in the end for SCO. Well. Maybe not so much, as they acknowledge in another section about all that they owe to Novell:
As a result of the Court’s judgment of July 16, 2008 against the Company, as of January 31, 2009, the Company has accrued $3,562,000 including the related interest. However, the Company continues to contest this liability. The Company believes that the Court erred and that there are strong grounds to have the adverse rulings embodied in the Final Judgment reversed on appeal. However, in the event that the Company’s assets are further depleted or encumbered, the Company may not be in a financial position to see the appeal of those rulings through to a conclusion or continue the litigation.
Ah... rats. I guess that means all this SCO fun might not last forever after all. It just feels like forever.

And lo and behold, here's what they say about what SCOsource was about:

The Company’s SCOsource revenue to date has been primarily generated from agreements to utilize the Company’s UNIX source code as well as from intellectual property agreements.
I know. UnixWare and UNIX are the same thing, the tree trunk and the leaves. Snort.

Here are the sections that are most interesting, I think, but we have the entire filing here, just in case:

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

(1) ORGANIZATION AND DESCRIPTION OF BUSINESS

    The SCO Group, Inc. (the “Company”) markets reliable, cost-effective UNIX software products and related services for the small-to-medium sized business market, including replicated site franchises of Fortune 1000 companies. In 2003, the Company established its SCOsource business to market, protect and defend its intellectual property surrounding the UNIX operating system which it acquired in 2001 from The Santa Cruz Operation (“Santa Cruz”), which changed its name to Tarantella, Inc., and was subsequently acquired by Sun Microsystems.

     The Company incurred a net loss of $459,000 for the three months ended January 31, 2009, and during that same period generated cash of $337,000 from its operating activities. As of January 31, 2009, the Company had a total of $1,836,000 in cash and $3,766,000 in restricted cash, of which $1,500,000 is designated to pay for experts, consultants and other expenses in connection with the litigation between the Company and IBM, Novell and Red Hat (the “SCO Litigation”), $2,266,000 is payable to Novell for the post bankruptcy petition retained binary royalty stream.

     On August 10, 2007, the federal judge overseeing the Company’s lawsuit with Novell, Inc. (“Novell”) ruled in favor of Novell on several of the summary judgment motions that were before the United States District Court in Utah (the “Court”). The effect of these rulings was to significantly reduce or to eliminate certain of the Company’s claims in both the Novell case (“Novell Litigation”) and the IBM case, and possibly others (collectively, the “SCO Litigation”). The Court ruled that Novell was the owner of the UNIX and UnixWare copyrights that existed at the time of the 1995 Asset Purchase Agreement between Novell and Santa Cruz (the “APA”), and that Novell retained broad rights to waive the Company’s contract claims against IBM. The Court ruled that the Company owns the copyrights to post-APA UnixWare code and derivatives and that it has certain other ownership rights in the UNIX technology. The Company was directed to accept Novell’s waiver of its UNIX contract claims against IBM. In addition, the Court determined that certain SCOsource licensing agreements that SCO executed in fiscal year 2003 included older SVRx licenses and that SCO was possibly required to remit some portion of the proceeds to Novell. Over the Company’s objection, a bench trial was set to begin on September 17, 2007, and the federal judge was to determine what portion, if any, of the proceeds of the SCOsource agreements is attributable to such SVRx licenses and should be remitted to Novell, as well as whether SCO had authority to enter into such SVRx licenses....           

     On July 16, 2008, the Court entered its Findings of Fact, Conclusions of Law, and Order, ruling that (1) the SCOsource agreements with Linux end-users were not SVRx licenses and therefore Novell was not entitled to revenue from those agreements and that SCO had the authority to enter into such agreements; (2) the 2003 SCOsource agreement with Microsoft contained an SVRx license that was incidental to the UnixWare license in the agreement, and therefore the Company was authorized to enter into that SVRx license and Novell was not entitled to revenue from the agreement; and (3) the 2003 SCOsource agreement with Sun contained an unauthorized amendment of a prior UNIX buy out agreement, and Novell was entitled to $2,547,817 of the revenue from the Sun agreement as attributable to that amendment. The Court directed Novell to file a brief identifying the amount of prejudgment interest it sought based on this award. On August 29, 2008, Novell filed an Unopposed Submission Regarding Prejudgment Interest, informing the Court that the parties had agreed that Novell was entitled to $918,122 in prejudgment interest through that date, plus $489 per day until the entry of final judgment, based on the Court’s $2,547,817 award.

     In its ruling of July 16, 2008, the Court also directed Novell to file a proposed Final Judgment consistent with the Court’s trial and summary judgment orders. In its proposed submission to the Court in compliance with this order, Novell took the position that final judgment could not be entered because certain of SCO’s claims are stayed pending arbitration and the imposition of a constructive trust remained an open question in the Bankruptcy Court. Subsequently, in order to expedite the entry of final judgment, the Company sought to resolve these issues with Novell and agreed to an extension of Novell’s deadline for filing its submission. Based on the Company’s tracing of Sun’s payments under its 2003 SCOsource agreement, Novell agreed that only $625,487 of SCO’s current assets were traceable as trust funds. SCO also proposed dismissing its stayed claims with prejudice on the basis of the Court’s ruling that Novell owns the pre-APA UNIX copyrights in the Court’s summary judgment order of August 10, 2007. On August 29, 2008, in its Submission Regarding the Entry of Final Judgment, Novell informed the Court of the parties’ agreement as to the trust amount, but Novell stood by its position that final judgment could not be entered in light of the stayed claims. On September 15, 2008, the Company filed papers arguing for the entry of final judgment.

     On November 20, 2008, after further negotiations between the parties, the Court entered a Final Judgment, incorporating the material rulings from the August 10, 2007 and July 16, 2008 rulings as explained above. On November 25, 2008, the Company filed a notice of appeal of that Final Judgment, including adverse rulings in the Court’s summary judgment order of August 10, 2007. On January 23, 2009, the Company filed an unopposed motion for an expedited appeal with the United States Court of Appeals for the Tenth Circuit (the “Tenth Circuit Court”) which was granted by the Tenth Circuit Court on January 29, 2009. On March 4, 2009, the Company filed its brief for its appeal with the Tenth Circuit Court. The Tenth Circuit Court has placed the case on the calendar for oral argument on May 6, 2009. With the expedited appeal, and early hearing date, the Company is hopeful a decision on the appeal could be forthcoming in the next five to eight months, but it could be several months beyond that time frame.

     On March 13, 2009, the Court denied the Company’s motion to stay the taxation of costs relating to the trial and final judgment. These costs total $127,432, and relate to such things as transcription charges and deposition expenses. According to the Court’s order these costs will be added to the issues that are on appeal with the Tenth Circuit Court and resolved through that appeal.

     As a result of the Court’s judgment of July 16, 2008 against the Company, as of January 31, 2009, the Company has accrued $3,562,000 including the related interest. However, the Company continues to contest this liability. The Company believes that the Court erred and that there are strong grounds to have the adverse rulings embodied in the Final Judgment reversed on appeal. However, in the event that the Company’s assets are further depleted or encumbered, the Company may not be in a financial position to see the appeal of those rulings through to a conclusion or continue the litigation.

Bankruptcy Filing

                    ...  On February 13, 2008, the Company entered into a Memorandum of Understanding (the “MOU”) with Stephen Norris Capital Partners, LLC (“SNCP”), a Delaware limited liability company, whereby SNCP agreed to provide financing to fund the Company’s plan of reorganization filed on February 29, 2008. On the same day, the Debtors filed a disclosure statement in connection with the plan of reorganization, under the terms contemplated by the MOU.

     On February 29, 2008, the Debtors filed their joint Chapter 11 Plan of Reorganization (the “Plan”) and Disclosure Statement in Connection with the Plan (the “Disclosure Statement”). A hearing to approve the adequacy of the Disclosure Statement was scheduled before the Bankruptcy Court on April 2, 2008. The April 2, 2008 hearing proceeded as a status conference regarding the Debtors’ progress towards a new MOU with SNCP. Therefore, the Debtors indicated that they were not presently seeking approval of the adequacy of the Disclosure Statement, which would need to be amended to reflect the changes to the MOU....

           On January 8, 2009, the Debtors filed their Amended Reorganization Plan and Disclosure Statement. Under the proposed plan, the Debtors intend to hold an open auction to sell certain assets of the Company including its mobility business assets and its OpenServer operating system assets and business. Through this sale, the Debtors hope to obtain enough consideration to pay their creditors and continue their operations as set forth in the plan. In the event that the asset sale does not generate enough cash to meet the aforementioned objectives, the Company will scale back its operations and costs, and initiate other strategies to implement the plan of reorganization. In the event that certain SCO assets are not sold, SCO will continue to sell and support its UNIX and mobility businesses and will also focus on the following key provisions: (a) an enhanced pricing and discount strategy, (b) an updated “true-up” licensing program with current customers, (c) reducing overall operating costs, (d) delivering SCO UNIX Virtual product lines for VMware and Hyper-V to allow SCO legacy applications to run on modern hardware, and (e) shipping FCmobilelife and FCtasks for the iPhone with a new pricing structure.

     Under the priority scheme established by the Bankruptcy Code, unless creditors agree otherwise, post-petition liabilities and prepetition liabilities must be satisfied in full before stockholders are entitled to receive any distribution or retain any property under a plan of reorganization. ...A plan of reorganization could result in holders of the Company’s stock receiving no distribution on account of their interests and cancellation of their existing stock. If certain requirements of the Bankruptcy Code are met, a plan of reorganization can be confirmed notwithstanding its rejection by the class comprising the interests of the Company’s equity security holders.

     If the Debtors’ plan is not confirmed by the Bankruptcy Court, it is unclear whether the Company would be able to reorganize its businesses and what, if anything, holders of claims against the Company would ultimately receive with respect to their claims. If an alternative reorganization could not be agreed upon, it is possible that the Debtors’ bankruptcy cases could be converted to a liquidation under Chapter 7 and the Company would have to liquidate its assets, in which case it is likely that holders of claims would receive substantially less favorable treatment than they would receive if the Company were to emerge as a viable, reorganized entity, and stockholders would likely receive nothing from the liquidation.

     As a result of both the District Court’s August 10, 2007 and July 16, 2008 rulings in the Novell litigation and the uncertainties surrounding the confirmation of the Debtors’ Amended Reorganization Plan, among other matters, there is substantial doubt about the Company’s ability to continue as a going concern.

Going Concern

     The Debtors are operating pursuant to Chapter 11 of the Bankruptcy Code and continuation of the Company as a going concern is contingent upon, among other things, the Debtors’ ability (i) to construct and obtain confirmation of a plan of reorganization under the Bankruptcy Code; (ii) to reduce payroll and benefits costs and liabilities under the bankruptcy process; (iii) to achieve profitability; (iv) to achieve sufficient cash flows from operations; and (v) to obtain financing sources to meet the Company’s future liquidity needs. The negative operating trends the Company is experiencing as well as the aforementioned judgment in favor of Novell create substantial doubt as to the Company’s ability to continue as a going concern. The accompanying consolidated financial statements do not reflect any adjustments relating to the recoverability of assets and the classification of liabilities that might result from the outcome of these uncertainties. In addition, the acceptance by the Bankruptcy Court of a plan of reorganization could materially change the amounts and classifications reported in the consolidated financial statements. The consolidated financial statements do not give effect to any adjustments to the carrying value of assets or amounts of liabilities that might be necessary as a consequence of confirmation of a plan of reorganization....

     The Company’s SCOsource revenue to date has been primarily generated from agreements to utilize the Company’s UNIX source code as well as from intellectual property agreements....

Cash and Cash Equivalents

     The Company considers all investments purchased with original maturities of three or fewer months to be cash equivalents. There were no cash equivalents as of January 31, 2009 and October 31, 2008. Cash was $1,836,000 and $1,237,000 as of January 31, 2009 and October 31, 2008, respectively. In October 2008, the Emergency Economic Stabilization Act of 2008 temporarily increased the FDIC deposit insurance from $100,000 to $250,000 per depositor through December 31, 2009. The Company has $250,000 of cash that is federally insured. All remaining amounts of cash as well as restricted cash exceed federally insured limits. To date, the Company has not experienced a material loss or lack of access to its invested cash. However, no assurance can be provided that access to the Company’s invested cash will not be impacted by adverse economic conditions in the financial markets....

(3) COMMITMENTS AND CONTINGENCIES

IBM Corporation

    On or about March 6, 2003, the Company filed a civil complaint against IBM. The case is pending in the United States District Court for the District of Utah (the “Court”), under the title The SCO Group, Inc. v. International Business Machines Corporation, Civil No. 2:03CV0294. ...

     Both parties filed expert reports and substantially finished expert discovery. IBM filed six motions for summary judgment which, if granted in whole or in substantial part, could resolve the Company’s claims in IBM’s favor or substantially reduce the Company’s claims. The Company filed three motions for summary judgment.

     As a result of the judge’s order of August 10, 2007, in the SCO v. Novell case, several of the Company’s claims against IBM may be dismissed. These claims include its claims that IBM breached its UNIX license agreements and the Company’s claims arising from its termination of IBM’s UNIX licenses. The Company believes that the Court’s August 10, 2007 ruling does not resolve certain claims in the case, or aspects of those claims, including the Company’s claim for unfair competition arising out of the Project Monterey initiative in the late 1990’s. IBM has taken the position that the Court’s ruling of August 10, 2007 in the Novell case resolves all of the Company’s claims against IBM in IBM’s favor. The Company disputes this position. IBM’s counterclaims against the Company remain in the case subject to pending motions for summary judgment. The IBM case is also currently stayed due to the Company’s filing of Chapter 11 bankruptcy.

Novell, Inc.

    ...       On July 16, 2008, the Court entered its Findings of Fact, Conclusions of Law, and Order, ruling that (1) the SCOsource agreements with Linux end-users were not SVRx licenses and therefore Novell was not entitled to revenue from those agreements and that SCO had the authority to enter into such agreements; (2) the 2003 SCOsource agreement with Microsoft contained an SVRx license that was incidental to the UnixWare license in the agreement, and therefore the Company was authorized to enter into that SVRx license and Novell was not entitled to revenue from the agreement; and (3) the 2003 SCOsource agreement with Sun contained an unauthorized amendment of a prior UNIX buy out agreement, and Novell was entitled to $2,547,817 of the revenue from the Sun agreement as attributable to that amendment. The Court directed Novell to file a brief identifying the amount of prejudgment interest it sought based on this award. On August 29, 2008, Novell filed an Unopposed Submission Regarding Prejudgment Interest, informing the Court that the parties had agreed that Novell was entitled to $918,122 in prejudgment interest through that date, plus $489 per day until the entry of final judgment, based on the Court’s $2,547,817 award.

    In its ruling of July 16, 2008, the Court also directed Novell to file a proposed Final Judgment consistent with the court’s trial and summary judgment orders. In its proposed submission to the court in compliance with this order, Novell took the position that final judgment could not be entered because the Company’s claims were stayed pending arbitration and the imposition of a constructive trust remained an open question in the Bankruptcy Court. Subsequently, in order to expedite the entry of final judgment, the Company sought to resolve these issues with Novell and agreed to an extension of Novell’s deadline for filing its submission. Based on the Company’s tracing of Sun’s payments under its 2003 SCOsource agreement, Novell agreed that only $625,487 of the Company’s current assets were traceable as trust funds. The Company also proposed dismissing its stayed claims with prejudice on the basis of the Court’s ruling that Novell owns the pre-APA UNIX copyrights in the Court’s summary judgment order of August 10, 2007. On August 29, 2008, in its Submission Regarding the Entry of Final Judgment, Novell informed the Court of the parties’ agreement as to the trust amount, but Novell stood by its position that final judgment could not be entered in light of the stayed claims. On September 15, 2008, the Company filed papers arguing for the entry of final judgment.

     On November 20, 2008, after further negotiations between the parties, the Court entered a Final Judgment, incorporating the material rulings from the August 10, 2007 and July 16, 2008 rulings as explained above. On November 25, 2008, the Company filed a notice of appeal of that Final Judgment, including the adverse rulings in the Court’s summary judgment order of August 10, 2007. On January 23, 2009, the Company filed an unopposed motion for an expedited appeal with the United States Court of Appeals for the Tenth Circuit (the “Tenth Circuit Court”) which was granted by the Tenth Circuit Court on January 29, 2009. On March 4, 2009, the Company filed its brief for its appeal with Tenth Circuit Court. The Tenth Circuit Court has placed the case on the calendar for oral argument on May 6, 2009. With the expedited appeal, and early hearing date, the Company is hopeful a decision on the appeal could be forthcoming in the next five to eight months, but it could be several months beyond that time frame.

     On March 13, 2009, the Court denied the Company’s motion to stay the taxation of costs relating to the trial and final judgment. These costs total $127,432, and relate to such things as transcription charges and deposition expenses. According to the Court’s order these costs will be added to the issues that are on appeal with the Tenth Circuit Court and resolved through that appeal.

     As a result of the Court’s judgment of July 16, 2008 against the Company, as of January 31, 2009, the Company has accrued $3,562,000 including the related interest, which amount is included in Liabilities Subject to Compromise. However, the Company continues to contest this liability. The Company believes that the Court erred and that there are strong grounds to have the adverse rulings embodied in the Final Judgment reversed on appeal....           

AutoZone, Inc.

     On March 2, 2004, the Company filed suit against AutoZone, Inc., in the Federal District Court for the District of Nevada (the “Nevada District Court”). The Company brought a single claim for copyright infringement based on AutoZone’s use of UNIX copyrighted materials in Linux and asked the Nevada District Court to impose a preliminary injunction against AutoZone. On August 6, 2004, the Nevada District Court granted AutoZone’s motion to stay the case pending resolution of the IBM, Novell, and Red Hat litigations.... On September 22, 2008, the Nevada District Court held a status conference on the case and decided to lift the stay effective December 31, 2008. On January 6, 2009, the assigned Magistrate Judge issued an order directing the parties to file a proposed discovery plan and scheduling order by January 16, 2009. On that date, the parties filed a Joint Discovery Plan and Scheduling Order proposing January 15, 2010 as the deadline for the parties to complete fact discovery. On February 27, 2009, the parties filed initial disclosures in the case and the case will proceed pursuant to the schedule set forth above....     

Operating under the U.S. Bankruptcy Code may restrict our ability to pursue our business strategies....

        In addition, if a trustee is appointed to operate the Debtors in Chapter 11 (or the case is converted to a case under Chapter 7), the trustee would assume control of our assets, including the SCO Litigation.

We suffered a significant setback in our lawsuit with Novell that has significantly limited our claims and raises substantial doubt about our ability to continue as a going concern and we may not prevail in our lawsuits with IBM, Novell and others....

   

     We must continue to pay for expert, consulting and other expenses through the conclusion of our litigation with IBM and Novell. As we continue with the appeals and litigation, we may be required to place additional amounts into the escrow account, which could further reduce our liquidity position....

Our Engagement Agreement with the Law Firms representing us in the SCO Litigation requires us to pay for expert, consulting and other costs, which could harm our liquidity position....

As of January 31, 2009, we had a total of $1,836,000 in cash and an additional $1,500,000 of restricted cash to be used to pursue the SCO Litigation and to cover any amounts required to be put into constructive trust under the Novell judgment. Since October 31, 2004, we have spent a total of $13,499,000 for expert, consulting and other costs and fees as agreed to in the Engagement Agreement with the Law Firms in the SCO Litigation. In light of the Chapter 11 filings, these arrangements are subject to Bankruptcy Court approval.

     Our revenue from the sale of UNIX products has declined over the last several years.... Additionally, with the recent adverse summary judgment rulings in our lawsuit with Novell and our entry into Chapter 11, customers may likely determine to no longer buy our products and services. Because of the long adoption cycle for operating system purchases and the long sales cycle of our operating system products, we may not be able to reverse these revenue declines quickly.

     Our stock has attracted significant interest from short sellers. The activities of short sellers could further reduce the price of our stock or inhibit increases in our stock price.


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