December 21, 2004

Analysis: Bad numbers but puzzling 'optimistic' outlook for SCO Group

Author: Chris Preimesberger

The SCO Group reported its quarterly profit-and-loss and business operations statements today, and -- surprise! -- the news wasn't good.
  • Total quarterly revenue fell to $10.08 million from $24.3 million a year ago -- by any measure a steep loss of nearly 59 percent.
  • Total year-to-date revenue nosedived about 57 percent, from $79.2 million to $42.8 million.
  • Licensing fees -- SCO's bread-and-butter business -- dropped from $10.3 million at this time last year to a mere $120,000 this quarter -- by any measure a precipitous drop of nearly 99 percent.
  • Cash and "cash equivalents" are down from $64 million in 2003 to $19.7 million now. That's a cash burn rate of $44 million in one year -- nearly the same amount ($50 million) as SCO's well-documented PIPE deal with BayStar Capital and the Royal Bank of Canada in October 2003.
  • The stock value has fallen about 77 percent from a 52-week high of $19.31 to its current level of $4.51.
  • According to CFO Bert Young, SCO Group will have only $7 million in operating cash remaining after this quarter.

Yet CEO Darl McBride told a conference-call audience: "We have reason to be optimistic. Our core business is cash-positive, we've capped our legal fees, we've cut our operating costs, and we've closed the book on the BayStar (preferred stock) involvement. We're looking forward to some positive legal judgments this next year involving our IP."

What is wrong with this picture?

Is Mr. McBride looking at the same numbers his company just published? Are we reading them incorrectly? Or is SCO Group playing some kind of game, thinking nobody is really going to look closely at the numbers?

Something I want to mention about this conference call: No hardball questions were asked. SCO Group undoubtedly selected only certain people it expected to ask fluff questions, and fluff questions they got. So we couldn't get to the bottom of these incongruencies. If I were a stockholder, I'd be very angry at this opacity.

Did yours truly ask a question? I had several lined up:

  • How will the recent sacking of both the CEO and CFO of its parent company, Canopy Group, affect SCO's business strategy? Canopy is SCO Group's largest single stakeholder.
  • How can SCO Group look ahead with optimism, with only $7 million in the bank? It had $63 million in the bank a year ago.
  • How is SCO Group going to look for new business, especially with all its public relations problems? The Unix space is not exactly growing.

However, I was not called upon during the 38-minute (only about 15 of those were for questions) conference. (Most calls of this kind last about an hour.) All callers are asked to provide their names, affiliations, and phone numbers upon registering, and when asked, I pressed "Star-1" immediately to get into the queue to ask a question. But no dice.

SCO Group controlled this public information session from start to finish, carefully stating positive-sounding messages that conflict openly with the numbers on the page.

For those of you who, for whatever reason, cannot access the SCO Group report, we provide it here in its entirely:

--------------------------------

NEWS RELEASE
THE SCO GROUP
Dec. 21, 2004

The SCO Group Announces Fourth Quarter and Fiscal 2004 Results

LINDON, Utah, Dec. 21 /PRNewswire-FirstCall/ -- The SCO Group, Inc.
(Nasdaq: SCOX), owner of the UNIX operating system and a leading provider of
UNIX-based solutions, today reported results for its fiscal fourth quarter and
year ended October 31, 2004.

Revenue for the fourth quarter of fiscal year 2004 was $10,075,000 as
compared to $24,290,000 from the comparable quarter of the prior year. The
decrease in revenue in the fourth quarter of fiscal year 2004 from the
comparable quarter of the prior year was primarily due to a decrease in
SCOsource licensing revenue to $120,000 from $10,316,000 and from continued
competitive pressures on the Company's UNIX products and services.

The net loss attributable to common stockholders for the fourth quarter of
fiscal year 2004 was $6,516,000, or ($0.37) per diluted common share, as
compared to a net loss attributable to common stockholders of $1,568,000, or
($0.12) per diluted common share for the comparable quarter of the prior year.
Included in the net loss attributable to common stockholders for the fourth
quarter of fiscal year 2004 were charges related to a restructuring of
continuing operations, reductions in force and dispositions of long-lived
assets totaling $2,702,000.

"Fourth Quarter achievements demonstrate continued progress at SCO," said
Darl McBride, president and CEO, The SCO Group. "The management team has
maintained its commitment to operate our core UNIX business profitably. With
the benefit of additional efficiency improvements now in place, we expect the
UNIX business will generate cash during fiscal year 2005. During the fourth
quarter we also completed an agreement to cap the legal fees relating to the
pending contract and intellectual property litigation. The combination of
these two positive actions positions us well to pursue our strategy to protect
our contractual and intellectual property rights on behalf of our customers,
employees and shareholders."

For fiscal year 2004, revenue was $42,809,000 compared to revenue for
fiscal year 2003 of $79,254,000. For fiscal year 2004, the net loss
attributable to common stockholders was $16,227,000, or ($1.07) per diluted
common share, compared to net income attributable to common stockholders of
$5,304,000, or $0.34 per diluted common share. Cash and available-for-sale
securities were $31,449,000 at October 31, 2004. In addition, $5,000,000 was
placed in an escrow account and is classified as a component of restricted
cash as of October 31, 2004. This cash will be used to pay for certain
expenses associated with our intellectual property litigation.

UNIX Business Highlights

The fourth quarter of fiscal year 2004 marked the third consecutive
quarter of stable revenue for the UNIX business. The Company's management
team continued to make operating improvements in this business to help it
generate positive cash flow in fiscal year 2005. Additionally, the Company
anticipates releasing the next version of its OpenServer product, code-named
Legend, during the first half of 2005. This product will mark the culmination
of a significant product development effort and reinforces the Company's
investment in its ongoing UNIX business.

During the fourth quarter, the Company launched a new version to its
collaboration product, SCOoffice Server 4.1, which has been gaining acceptance
in various markets throughout the world. In addition, the Company launched
its SCO Marketplace initiative targeted to third-party developers who wish to
participate with the Company in development projects that will benefit and
enhance future SCO products.

Litigation Agreement

On November 4, 2004 the Company filed a Form 8-K with the Securities and
Exchange Commission indicating it had finalized an amended engagement
agreement with the law firms representing the Company in its current
litigation. The revised engagement agreement limits the Company's attorneys
fees after September 1, 2004 associated with its intellectual property
litigation to approximately $31 million (other than contingency fees) and will
enable the Company to finance the litigation through to its conclusion,
including any necessary appeals. The revised engagement agreement will also
lower the Company's ongoing quarterly costs associated with its intellectual
property litigation.

Outlook

The following statements are forward looking and actual results may differ
materially. See the discussion of certain risks and uncertainties related to
this financial outlook at the end of this release under "Forward-Looking
Statements."

With the attorneys fees associated with the Company's litigation capped
and a core UNIX business expected to generate positive cash flow during fiscal
year 2005, the Company is in position to pursue its existing litigation
through to its conclusion. The Company will continue to protect its UNIX
contractual and intellectual property rights and to aggressively pursue its
claims through the judicial system.

Conference Call

As previously announced, The SCO Group will host a conference call at
5:00 p.m. EDT today, December 21, 2004, to discuss its fourth quarter and year
end results. To participate in the teleconference, please call 800-565-5442
or 913-981-5591; confirmation code: 818639, approximately five minutes prior
to the time stated above. A listen-only Web cast of the call will be
broadcast live with a replay available the following day. The Web cast and
replay may be accessed from http://ir.sco.com/medialist.cfm.

About SCO

The SCO Group, Inc. (Nasdaq: SCOX) helps millions of customers in more
than 82 countries to grow their businesses everyday. Headquartered in Lindon,
Utah, SCO has a worldwide network of more than 11,000 resellers and 4,000
developers. SCO Global Services provides reliable localized support and
services to partners and customers. For more information on SCO products and
services, visit http://www.sco.com.

SCO and the associated SCO logo are trademarks or registered trademarks of
The SCO Group, Inc. in the U.S. and other countries. UNIX is a registered
trademark of The Open Group. All other brand or product names are or may be
trademarks of, and are used to identify products or services of, their
respective owners.

Forward-Looking Statements

This press release, particularly the "Outlook" section, contains forward-
looking statements representing our current expectations and beliefs,
including, among other things: (i) the expectation that we will continue to
pursue our strategy to protect our intellectual property rights and that we
are well positioned to do so; (ii) the expectation that we will generate
positive cash flow from our UNIX business in fiscal year 2005; (iii) the
expectation that our revised engagement agreement with the law firms
representing us in our intellectual property litigation will lower our ongoing
quarterly litigation costs and enable us to finance the litigation through to
its conclusion, including appeals; and (iv) the anticipated release of the
next version of OpenServer in the first half of 2005. These forward-looking
statements and related assumptions are subject to risks and uncertainties that
could cause actual results and outcomes to differ materially from any forward-
looking statements contained herein. These risks and uncertainties include,
without limitation: (a) risks that we will not be successful in our efforts to
protect and enforce our intellectual property rights; (b) risks that our core
UNIX business may continue to decline; (c) risks that we will face increasing
competition from competing providers of operating system products and
services, particularly Linux; (d) risks that the U.S. and international
economic and political conditions will worsen and adversely affect technology
purchases; (e) risks that our SCOsource licensing initiatives will yield fewer
licenses or less licensing revenue than anticipated or that such licensing
revenue will not be generated when or in amounts currently anticipated; (f)
risks that we will require more capital to sustain our business objectives
than we have and that such capital may not be available; and (g) other risks
and uncertainties set forth in our filings with the Securities and Exchange
Commission. These forward-looking statements speak only as of the date
hereof, and we undertake no obligation to update such forward-looking
statements after the date hereof.


                     Condensed Consolidated Balance Sheets
                                (in thousands)
 
                                                   October 31,   October 31, 
                                                      2004           2003 
    Assets: 
     Cash and cash equivalents                       $19,693        $64,428 
     Restricted cash                                   8,283          2,025 
     Available-for-sale securities                    11,756          4,095 
     Accounts receivable, net                          6,638          9,282 
     Other current assets                              1,870          2,450 
      Total current assets                            48,240         82,280 
     Property and equipment, net                         649          1,148 
     Goodwill and intangibles, net                     5,413         10,452 
     Other assets                                      1,098          1,072 
      Total assets                                   $55,400        $94,952 
     
    Liabilities: 
     Accounts payable                                 $7,854         $1,978 
     Accrued payroll and accrued expenses              7,224          8,506 
     Accrued compensation to law firms                 7,956         10,556 
     Deferred revenue                                  4,877          5,501 
     Derivative related to Series A  
      convertible preferred stock                         --         15,224 
     Other current liabilities                         4,916          3,347 
      Total current liabilities                       32,827         45,112 
     Long-term liabilities                               343            508 
     Minority interest                                    --            145 
     Convertible preferred stock                          --         29,671 
    Stockholders' equity                              22,230         19,516 
      Total liabilities and stockholders' equity     $55,400        $94,952 
 
 
 
                Condensed Consolidated Statements of Operations
                     (in thousands, except per share data)
 
                                 Three Months Ended           Year Ended 
                                     October 31,              October 31, 
                                  2004        2003        2004        2003 
     
    Products revenue             $8,296     $12,012     $35,352     $45,028 
    Services revenue              1,659       1,962       6,628       8,380 
    SCOsource licensing revenue     120      10,316         829      25,846 
      Total revenue              10,075      24,290      42,809      79,254 
    Cost of products revenue        857         729       3,221       4,405 
    Cost of services revenue        861       1,346       4,134       6,354 
    Cost of SCOsource licensing  
     revenue                      4,257       5,288      19,743       9,163 
      Total cost of revenue       5,975       7,363      27,098      19,922 
      Gross margin                4,100      16,927      15,711      59,332 
    Operating expenses: 
      Sales and marketing         3,086       5,971      17,038      24,392 
      Research and development    2,445       2,870      10,612      11,012 
      General and administrative  1,833       1,705       8,308       6,230 
      Compensation to law firms      --       8,956          --       8,956 
      Restructuring and other     2,486          --       2,486         498 
      Amortization of intangibles   593         895       2,566       3,190 
      Write-down of investment       --         250          --         250 
      Loss on impairment of  
       long-lived assets            216         164       2,355         164 
      Stock-based compensation       51         277         919       1,204 
       Total operating expenses  10,710      21,088      44,284      55,896 
    Income (loss) from  
     operations                  (6,610)     (4,161)    (28,573)      3,436 
    Equity in income (loss)  
     of affiliates                   (4)        109         111         (62) 
    Other income, net               223       2,886       6,507       2,827 
    Income (loss) before  
     income taxes                (6,391)     (1,166)    (21,955)      6,201 
    Provision for income taxes     (125)       (279)     (1,395)       (774) 
    Net income (loss)            (6,516)     (1,445)    (23,350)      5,427 
    Dividends on convertible  
     preferred stock                 --        (123)      7,123        (123) 
    Net income (loss)  
     applicable to common  
     stockholders               $(6,516)    $(1,568)   $(16,227)     $5,304 
    Basic net income (loss)  
     per common share            $(0.37)     $(0.12)     $(1.07)      $0.43 
    Diluted net income (loss)  
     per common share            $(0.37)     $(0.12)     $(1.07)      $0.34 
    Weighted average basic  
     common shares outstanding   17,436      13,371      15,155      12,261 
    Weighted average diluted  
     common shares outstanding   17,436      13,371      15,155      15,679 




SOURCE  The SCO Group, Inc.
    -0-                             12/21/2004


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