SCO Continues to Struggle Against Linux in Q3

Published: September 7, 2006

by Timothy Prickett Morgan

Server software maker and mobile application development tool wannabe SCO Group yesterday reported its financial results for its fiscal third quarter ended July 31, and once again the company's sales were in decline due to competitive pressures. And once again, the company's top brass singled out Linux as the main culprit that is putting a damper on its revenues.

In the quarter, SCO said that it booked $7.4 million in sales, a 21 percent drop from the prior year's third quarter. Product sales, which were comprised mostly of OpenServer and UnixWare Unix operating system licenses, accounted for $6.2 million in sales and dropped by 22 percent year-over-year. SCOsource licensing (which SCO offers to Unix licensing partners and customers seeking an indemnification from any fallout after its $3 billion Unix-Linux lawsuit goes to trial in February 2007) accounted for a mere $31,000. Other services revenues, relating mostly to maintenance on OpenServer and UnixWare products but also including other professional services, made up nearly $1.2 billion in sales during the quarter, a decline of only 13 percent.

SCO's legal fees were, as has been the case for the past couple of years, a big hit on the books during the quarter, with the company shelling out $2.3 million in legal costs. Bert Young, SCO's chief financial officer, said in a conference call with Wall Street analysts that the company had $1.5 million in an escrow account that was set aside for legal expenses, and that when this was drawn down the company would have to put another $5 million into the account. SCO exited the quarter with $14 million in cash and equivalents. The company has said that it would have enough funds to make it to the February 2007 trial, and barring a stupendous collapse in its sales--much more severe than it is experiencing--the numbers show that it will make it, even though losses are mounting.

During the quarter, SCO's Unix business had only $478 million in costs, giving it an 85 percent gross margin. This is a very good business, when judged by those numbers. Even SCO's services business has decent gross margins of about 44 percent. If Linux is hurting SCO's top line, fighting the legal battle with IBM is really hurting its bottom line. SCO went into the red to the tune of $3.6 million in the quarter, for a loss of 17 cents a share. For the nine months of fiscal 2006, SCO booked $21.9 million in sales, down 20 percent, and a net loss of $12.9 million, compared to a net loss in the first three months of fiscal 2005.

Darl McBride, SCO's president and chief executive officer, said on the call that Tim Negris, who had been hired as senior vice president of marketing back in March, is now working as a "strategic consultant" for SCO. He did not elaborate on why Negris was no longer a full-time employee, but said that Sandy Gupta, who heads up Unix development at the company, had assumed some of Negris' responsibilities. Negris was formerly a vice president of marketing at IBM's Software Group and was a key executive at database maker Oracle before that. Negris is perhaps most famous as the person who coined the term "thin client."

As you might imagine, SCO wanted to talk a bit about its Me Inc mobile services application development platform, and it did. McBride touted the partnership SCO forged in the third quarter that will see Microsoft integrate its Visual Studio development tools with SCO's Me Inc tools. He added that SCO was working with the NetBeans community for a similar integration, and had secured relationships with Palm for the use of the Me Inc tools for application development on Palm handhelds and with Day-Timers to create the DT4 application, which is an electronic version of the popular Day-Timer planner.

This doesn't have much to do with the Unix business, and until SCO and IBM either settle their lawsuit--which seems unlikely--or the case concludes, SCO is going to have to get its money from Unix. "We are working to deliver solid Unix products and mobile services to turn revenue around," explained McBride. He said that the company was committed to generating positive cash flow during fiscal 2007, and he was optimistic about the mobile services SCO was branching into, even though he conceded that the company did not have the proper amount of money to invest in them because of the burden of the lawsuit. "While the amount of money we are making may not be material yet, we are encouraged by our partnerships," McBride said of the Me Inc tools.

As for that Unix business, McBride said that many customers who years ago were threatening to move did not, and even those that did move to Linux or Windows did not do so as quickly or as completely as SCO had once feared they might. "The tone I see out there right now is cautious optimism with regard to our platforms," said McBride. "Years ago, there was more doom and gloom because people thought we may not survive."

OpenServer is still the workhorse for SCO, and Young said that product mix has not changed all that much in a few years. OpenServer licenses make up about 60 percent of SCO's sales in any given quarter, with perhaps 25 to 30 percent coming from UnixWare licenses. The remaining 10 to 15 percent, he said, came from Unix services and support. With OpenServer 6 scaling a lot further than prior OpenServer releases, and having the capability to run UnixWare applications, you would think that the product mix would be shifting away from UnixWare, which is more expensive, and toward OpenServer, which costs less. But, UnixWare and OpenServer work, and people don't mess with them--just like other legacy Unix platforms.