SCO Bleeds Red Ink, Delays Future OpenServer

by Timothy Prickett Morgan

Unix software maker The SCO Group announced its financial results for the fourth fiscal quarter of 2004 just before Christmas, and the results indicate that the pressure is mounting in its Unix-on-X86 software business. Unix software sales accounted for nearly all of the company's sales, but it's is dipping into the red ink because of the ongoing costs of its legal fight to protect its Unix intellectual property and a recent restructuring that saw SCO layoff more than a quarter of its employees.

SCO's CEO, Darl McBride, says that the company's core Unix business is cash-flow positive, even with considerably diminished Unix software sales compared with last year. In the fourth quarter ending October 31, SCO had software sales of $8.3 million, down 30.1 percent; services sales in the quarter were down 15.4 percent to $1.7 million. SCOsource intellectual property licensing revenue, which SCO was originally counting on as a means to fund its legal battles with IBM, Novell, and Red Hat, was only $120,000 in the quarter, a negligible amount compared with the $10.3 million that the company booked in the fourth quarter of fiscal 2003. After booking a $2.5 million restructuring charge to reduce the company's head count to under 200, paying a $3 million royalty to Novell (which it must do every quarter, apparently, according to a comment made by CFO Bert Young during a conference call with Wall Street analysts), and doling out $4.3 million in legal fees, SCO reported a net loss of $6.5 million, or 37 cents a share.

For the full year, SCO had sales of $42.8 million, down 46 percent from fiscal 2003, when the company was able to book $25.8 million in SCOsource intellectual property licenses for Unix, $45 million in Unix software sales, and $8.4 million in services sales. For fiscal 2004, Unix software sales are down 21.5 percent to $35.3 million and services sales are down 20.9 percent to $6.6 million. In fiscal 2003, even with substantial legal bills for the IBM lawsuit it launched in March 2003, SCO was able to bring $5.3 million, or $0.34 a share, to the bottom line, but in fiscal 2004, with Unix sales slipping, SCOsource licensing dried up, and legal costs continuing (even if they have been capped, thanks to an arrangement that SCO made with its lawyers, Boies, Schiller & Flexner), SCO had losses of $16.3 million, or $1.07 a share. Thanks to the cap on legal costs, SCO only owes Boies, Schiller & Flexner approximately $2 million for each of the next five quarters, and then a contingency fee that ranges, depending on the size of the award, from 20 to 33 percent of any award SCO gets as part of the settling of lawsuits or rulings in the cases. SCO has $34.1 million in cash and equivalents in the bank, and after paying off its lawyers, it has $7 million left over to give it some maneuvering room.

SCO is clearly counting on having more room than that, of course, and hopes that SCOoffice Server 4.1, a groupware and collaboration suite that was launched in August 2004, and the future "Legend" release of OpenServer, which was pushed out to the second calendar quarter of 2005, will help boost sales and bring more cash into the coffers. The Legend release was expected in the first quarter but has been pushed out a few months. McBride said that after pushing out 600 betas to partners in the summer and getting feedback, SCO decided that it would take a little more time with Legend. He did not elaborate on to what technical features needed tweaking. "There's nothing significant, and it is maybe a movement of a couple of months," he said. "We're just getting everything tightened down before it goes out."

The Legend update of OpenServer and a future kicker to UnixWare, OpenServer's bigger sibling X86 Unix platform, are also expected to get support for 64-bit Xeon and Opteron processors in 2005. Legend will also include an updated Java environment, with that likely to be support for Java 2 Enterprise Edition 1.4. Legend will also include the open-source PostgreSQL and MySQL relational databases, virtual private networking (VPN) technologies, and the SCOx Web Services Substrate development tool environment--the latter being announced in June 2004 with the UnixWare 7.1.4 update. This substrate is composed entirely of open-source code: the Apache 2.049 Web server, the Tomcat 4.1.30 Java application server, Perl 5.8.3, and PHP 4.3.5.

McBride said that because Legend was scheduled to ship at the end of the first quarter, the slip into the beginning of the first quarter will not have a material impact on revenue for fiscal 2005. "It will still have a good impact for the year," he said.

What McBride and Young did not talk about during the conference call was a report in the Salt Lake Tribune that said Ralph Yarro, a long-time confidant of Novell founder Ray Noorda, who is also chairman of SCO, had been fired as chairman of the Canopy Group, a venture-capital fund Noorda set up to invest in open-source technologies after he was ousted from Novell in late 1994. (By 2001, Canopy was said to be in control of $1 billion to $2 billion in assets, which were spread across dozens of companies, including SCO.)

Here's the funny bit: back in 1994, when commercial Linux distributor Caldera International was formed, it got backing from Noorda through Canopy Group. Yarro was president of Canopy at the time and soon became its chairman; he is also chairman of the board of Angel Partners, a Mormon foundation, and systems management software company Altiris. Yarro was also a member of the Corsair Unix-Linux development project at Novell, which was eventually killed off and reconstituted (in an indirect way) when Caldera bought SCO and intended to merge Unix and Linux for X86.

In 2002, before SCO filed its lawsuit, Canopy was the majority shareholder of SCO, which had changed its name from Caldera to The SCO Group after it acquired the Santa Cruz Operation, the main supplier of Unix on X86 servers and the volume leader in Unix shipments, in May 2001. There is a mystery surrounding the reason why Yarro was ousted as chairman of Canopy, which controlled 39.7 percent of the common stock of SCO on January 1, 2004. By the way, Yarro was also SCO's single largest individual shareholder, with a 39.5 percent stake in the company at the beginning of 2004, and a manager of the Noorda Family Trust. To say that Yarro had great sway at SCO and was probably directing its strategies is an understatement.

Now that Yarro is not in control of Canopy, which has brought in a chairman named William Muster from a New York-based consulting firm named Smooth Engine, according to the Salt Lake Tribune report, it is hard to say what hold Yarro has at SCO or how the company may change its tack, given these developments. Yarro's majority stake in SCO, through his own shares as well as those owned by Canopy, also explains why IBM didn't just buy SCO; no one could take control of SCO without Yarro's approval. This situation may have just changed now that Yarro is not in charge of Canopy. A lot depends on what Muster thinks about Canopy's investment in SCO and about the SCO-IBM lawsuit.

What seems clear is that Noorda always wanted to get control of Unix and use it to defeat Microsoft and other titans of the IT market, and Yarro is, in his own way, pursuing the strategy of his mentor, and seems like he is getting similar results to date: lots of animosity, the promise of a glorious payoff that may never happen, and a certain amount of cash in the short-term.