**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

| (Mark  one)                                                                                                                                                                               |       |                                                      |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|
| **ý**                                                                                                                                                                                | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  OF**  |
| ** **                                                                                                                                                                                | ** ** | **THE SECURITIES EXCHANGE ACT OF 1934**                   |
| ** **                                                                                                                                                                                | ** ** | ** **                                                |
| **For the quarterly period ended January 31, 2006**                                                                                                                                       |
| **OR**                                                                                                                                                                                    |
| ** **                                                                                                                                                                                | ** ** | ** **                                                |
| **o**                                                                                                                                                                                     | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF** |
| ** **                                                                                                                                                                                | ** ** | **THE SECURITIES EXCHANGE ACT OF 1934**                   |
| ** **                                                                                                                                                                                | ** ** | ** **                                                |
| **For  the transition period from               to             ** |
|                                                                                                                                                                                      |       |                                                      |

**Commissionfile number 0-29911**

 

**THE SCO GROUP, INC.**

(Exactname of registrant as specified in its charter)

 

| **Delaware**                     | **87-0662823**          |
|----------------------------------|-------------------------|
| (State  or other jurisdiction of | (I.R.S.  Employer       |
| incorporation  or organization)  | Identification  Number) |

 

**355South 520 West**

**Suite100**

**Lindon,Utah 84042**

(Addressof principal executive offices and zip code)

 

**(801)765-4999**

(Registrant’stelephone number, including area code)

 

Indicate by check mark whether the Registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.   YES ý     NO o

 

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, or a non-acceleratedfiler.  See definition of “acceleratedfiler” and “large accelerated filer” in Rule 12b-2 of the Exchange Act (Checkone):

 

| Large  Accelerated Filer o | Accelerated  filer o | Non-accelerated  Filer ý |
|---------------------------------|---------------------------|------------------------------------|

 

Indicate by check mark whether the registrantis a shell company (as defined in Rule 12b-2 of the Exchange Act).     YES o     NO ý

 

*As of March 14, 2006, there were 20,993,848 shares of theRegistrant’s common stock, $0.001 par value per share, outstanding.*

* *

 

 

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**The SCO Group, Inc.**

 

**Table of Contents**

 

 
|     |                                                                                                                         |   |
|----------|------------------------------------------------------------------------------------------------------------------------------|--------|
| PART  I. | FINANCIAL INFORMATION                                                                                                        |   |
|     |                                                                                                                         |   |
| Item 1.  | Unaudited Financial Statements                                                                                               |   |
|     |                                                                                                                         |   |
|     | Condensed Consolidated Balance Sheets as of January  31, 2006 and October 31, 2005                                           |   |
|     |                                                                                                                         |   |
|     | Condensed Consolidated Statements of Operations and  Comprehensive Loss for the three months ended January 31, 2006 and 2005 |   |
|     |                                                                                                                         |   |
|     | Condensed Consolidated Statements of Cash Flows for  the three months ended January 31, 2006 and 2005                        |   |
|     |                                                                                                                         |   |
|     | Notes to Condensed Consolidated Financial Statements                                                                         |   |
|     |                                                                                                                         |   |
| Item 2.  | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                  |   |
|     |                                                                                                                         |   |
| Item 3.  | Quantitative  and Qualitative Disclosures About Market Risk                                                                  |   |
|     |                                                                                                                         |   |
| Item 4.  | Controls  and Procedures                                                                                                     |   |
|     |                                                                                                                         |   |
| PART II. | OTHER  INFORMATION                                                                                                           |   |
|     |                                                                                                                         |   |
| Item 1.  | Legal  Proceedings                                                                                                           |   |
|     |                                                                                                                         |   |
| Item 1A. | Risk Factors                                                                                                                 |   |
|     |                                                                                                                         |   |
| Item 2.  | Unregistered  Sales of Equity Securities and Use of Proceeds                                                                 |   |
|     |                                                                                                                         |   |
| Item 6.  | Exhibits                                                                                                                     |   |
|     |                                                                                                                         |   |
|     | Signatures                                                                                                                   |   |

 

 

2

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| **PART I.** | ** ** | **FINANCIAL INFORMATION**          |
|-------------|------------|------------------------------------|
| **ITEM 1.** | ** ** | **UNAUDITED FINANCIAL STATEMENTS** |

 

**THE SCO GROUP, INC. ANDSUBSIDIARIES**

 

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(in thousands, except per share data)**

 

 
| ** **                                                                                                    | ** ** | **January 31,** | ** ** | **October 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|
| ** **                                                                                                    | ** ** | **2006**        | ** ** | **2005**        | ** ** |
|                                                                                                          |       |            |       |            |       |
| **ASSETS**                                                                                                    |       |            |       |            |       |
|                                                                                                          |       |            |       |            |       |
| CURRENT ASSETS:                                                                                               |       |            |       |            |       |
| Cash and cash equivalents                                                                                     |       | $               | 12,018     |            | $          | 4,272 |   |
| Restricted cash                                                                                               |       | 2,670           |       | 5,690           |       |
| Available-for-sale marketable securities                                                                      |       | 7,196           |       | 6,165           |       |
| Accounts receivable, net of allowance for doubtful accounts of $136  and $144, respectively                   |       | 4,917           |       | 6,343           |       |
| Other current assets                                                                                          |       | 2,151           |       | 2,454           |       |
| Total current assets                                                                                          |       | 28,952          |       | 24,924          |       |
|                                                                                                          |       |            |       |            |       |
| PROPERTY AND EQUIPMENT:                                                                                       |       |            |       |            |       |
| Computer and office equipment                                                                                 |       | 2,029           |       | 2,224           |       |
| Leasehold improvements                                                                                        |       | 289             |       | 345             |       |
| Furniture and fixtures                                                                                        |       | 70              |       | 96              |       |
|                                                                                                          |       | 2,388           |       | 2,665           |       |
| Less accumulated depreciation and amortization                                                                |       | (1,825          | )          | (2,087          | )          |
| Net property and equipment                                                                                    |       | 563             |       | 578             |       |
|                                                                                                          |       |            |       |            |       |
| OTHER ASSETS:                                                                                                 |       |            |       |            |       |
| Definite-lived intangibles, net                                                                               |       | 2,030           |       | 2,707           |       |
| Other assets                                                                                                  |       | 731             |       | 739             |       |
| Total other assets                                                                                            |       | 2,761           |       | 3,446           |       |
|                                                                                                          |       |            |       |            |       |
| Total assets                                                                                                  |       | $               | 32,276     |            | $          | 28,948 |   |
|                                                                                                          |       |            |       |            |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                |       |            |       |            |       |
|                                                                                                          |       |            |       |            |       |
| CURRENT LIABILITIES:                                                                                          |       |            |       |            |       |
| Accounts payable                                                                                              |       | $               | 2,241      |            | $          | 2,197 |   |
| Payable to Novell, Inc.                                                                                       |       | 912             |       | 2,815           |       |
| Accrued payroll and benefits                                                                                  |       | 1,836           |       | 2,656           |       |
| Accrued liabilities                                                                                           |       | 3,366           |       | 3,118           |       |
| Deferred revenue                                                                                              |       | 3,637           |       | 3,841           |       |
| Royalties payable                                                                                             |       | 390             |       | 406             |       |
| Income taxes payable                                                                                          |       | 1,159           |       | 1,222           |       |
| Total current liabilities                                                                                     |       | 13,541          |       | 16,255          |       |
|                                                                                                          |       |            |       |            |       |
| LONG-TERM LIABILITIES                                                                                         |       | 335             |       | 338             |       |
|                                                                                                          |       |            |       |            |       |
| COMMITMENTS AND CONTINGENCIES (Note 4)                                                                        |       |            |       |            |       |
|                                                                                                          |       |            |       |            |       |
| COMMON STOCK SUBJECT TO RESCISSION (Note 5)                                                                   |       | —          |       | 1,018           |       |
|                                                                                                          |       |            |       |            |       |
| STOCKHOLDERS’ EQUITY:                                                                                    |       |            |       |            |       |
| Common stock, $0.001 par value; 45,000 shares authorized, 21,289 and  18,331 shares outstanding, respectively |       | 21              |       | 18              |       |
| Additional paid-in capital                                                                                    |       | 258,630         |       | 246,985         |       |
| Common stock held in treasury; 297 and 290 shares, respectively                                               |       | (2,446          | )          | (2,414          | )          |
| Warrants outstanding                                                                                          |       | 856             |       | 856             |       |
| Accumulated other comprehensive income                                                                        |       | 862             |       | 834             |       |
| Accumulated deficit                                                                                           |       | (239,523        | )          | (234,942        | )          |
| Total stockholders’ equity                                                                               |       | 18,400          |       | 11,337          |       |
|                                                                                                          |       |            |       |            |       |
| Total liabilities and stockholders’ equity                                                               |       | $               | 32,276     |            | $          | 28,948 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

3

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**THE SCO GROUP, INC. AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS ANDCOMPREHENSIVE LOSS**

**(in thousands, except per share data)**

 

 
| ** **                                                         | ** ** | **Three Months Ended  January 31,** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                         | ** ** | **2006**                            | ** ** | **2005** | ** ** |
|                                                               |       |                                |       |   |   |
| REVENUE:                                                           |       |                                |       |   |   |
| Products                                                           |       | $                                   | 6,000      |   | $ | 7,304 |   |
| SCOsource licensing                                                |       | 30                                  |       | 70 |   |
| Services                                                           |       | 1,313                               |       | 1,491 |   |
| Total revenue                                                      |       | 7,343                               |       | 8,865 |   |
|                                                               |       |                                |       |   |   |
| COST OF REVENUE:                                                   |       |                                |       |   |   |
| Products                                                           |       | 584                                 |       | 644 |   |
| SCOsource licensing                                                |       | 4,010                               |       | 3,493 |   |
| Services                                                           |       | 637                                 |       | 749 |   |
| Total cost of revenue                                              |       | 5,231                               |       | 4,886 |   |
|                                                               |       |                                |       |   |   |
| GROSS MARGIN                                                       |       | 2,112                               |       | 3,979 |   |
|                                                               |       |                                |       |   |   |
| OPERATING EXPENSES:                                                |       |                                |       |   |   |
| Sales and marketing                                                |       | 2,688                               |       | 2,944 |   |
| Research and development                                           |       | 1,871                               |       | 2,088 |   |
| General and administrative                                         |       | 1,592                               |       | 1,763 |   |
| Amortization of intangibles                                        |       | 592                                 |       | 593 |   |
| Total operating expenses                                           |       | 6,743                               |       | 7,388 |   |
|                                                               |       |                                |       |   |   |
| LOSS FROM OPERATIONS                                               |       | (4,631                              | )          | (3,409 | ) |
|                                                               |       |                                |       |   |   |
| EQUITY IN INCOME (LOSS) OF AFFILIATE                               |       | (8                                  | )          | 53 |   |
|                                                               |       |                                |       |   |   |
| OTHER INCOME (EXPENSE):                                            |       |                                |       |   |   |
| Interest income                                                    |       | 152                                 |       | 37 |   |
| Other income (expense), net                                        |       | (7                                  | )          | 472 |   |
| Total other income, net                                            |       | 145                                 |       | 509 |   |
|                                                               |       |                                |       |   |   |
| LOSS BEFORE PROVISION FOR INCOME TAXES                             |       | (4,494                              | )          | (2,847 | ) |
|                                                               |       |                                |       |   |   |
| PROVISION FOR INCOME TAXES                                         |       | (87                                 | )          | (114 | ) |
|                                                               |       |                                |       |   |   |
| NET LOSS                                                           |       | $                                   | (4,581     | ) | $ | (2,961 | ) |
|                                                               |       |                                |       |   |   |
| BASIC AND DILUTED NET LOSS PER COMMON SHARE                        |       | $                                   | (0.23      | ) | $ | (0.17 | ) |
|                                                               |       |                                |       |   |   |
| WEIGHTED AVERAGE BASIC AND DILUTED COMMON  SHARES OUTSTANDING      |       | 20,062                              |       | 17,751 |   |
|                                                               |       |                                |       |   |   |
| OTHER COMPREHENSIVE LOSS                                           |       |                                |       |   |   |
| Net loss                                                           |       | $                                   | (4,581     | ) | $ | (2,961 | ) |
| Unrealized gain (loss) on available-for-sale marketable securities |       | 34                                  |       | (3 | ) |
| Foreign currency translation adjustment                            |       | (6                                  | )          | 62 |   |
| COMPREHENSIVE LOSS                                                 |       | $                                   | (4,553     | ) | $ | (2,902 | ) |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

4

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**THE SCO GROUP, INC. AND SUBSIDIARIES**

 

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in thousands)**

 
| ** **                                                                                             | ** ** | **Three Months Ended  January 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                             | ** ** | **2006**                            | ** ** | **2005** | ** ** |
|                                                                                                   |       |                                |       |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                  |       |                                |       |   |   |
| Net loss                                                                                               |       | $                                   | (4,581     | ) | $ | (2,961 | ) |
| Adjustments to reconcile net loss to net cash used in operating  activities:                           |       |                                |       |   |   |
| Amortization of intangibles (including $85 and $83 classified as cost  of SCOsource licensing revenue) |       | 677                                 |       | 676 |   |
| Depreciation and amortization                                                                          |       | 79                                  |       | 94 |   |
| Stock-based compensation                                                                               |       | 401                                 |       | 15 |   |
| Loss on disposal of assets                                                                             |       | 5                                   |       | 14 |   |
| Equity in (income) loss of affiliate                                                                   |       | 8                                   |       | (53 | ) |
| Changes in operating assets and liabilities:                                                           |       |                                |       |   |   |
| Restricted cash                                                                                        |       | 1,117                               |       | 202 |   |
| Accounts receivable, net                                                                               |       | 1,426                               |       | 685 |   |
| Other current assets                                                                                   |       | 303                                 |       | (97 | ) |
| Other assets                                                                                           |       | —                              |       | 36 |   |
| Accounts payable                                                                                       |       | 44                                  |       | (6,476 | ) |
| Accrued payroll and benefits                                                                           |       | (820                                | )          | (1,103 | ) |
| Compensation to law firms                                                                              |       | —                              |       | (7,956 | ) |
| Accrued liabilities                                                                                    |       | 248                                 |       | (28 | ) |
| Deferred revenue                                                                                       |       | (204                                | )          | 642 |   |
| Royalties payable                                                                                      |       | (16                                 | )          | (69 | ) |
| Income taxes payable                                                                                   |       | (63                                 | )          | (217 | ) |
| Other long-term liabilities                                                                            |       | (3                                  | )          | — |   |
| Net cash used in operating activities                                                                  |       | (1,379                              | )          | (16,596 | ) |
|                                                                                                   |       |                                |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                  |       |                                |       |   |   |
| Purchase of property and equipment                                                                     |       | (69                                 | )          | (45 | ) |
| Purchase of available-for-sale marketable securities                                                   |       | (1,031                              | )          | (5,600 | ) |
| Proceeds from sale of available-for-sale marketable securities                                         |       | —                              |       | 18,410 |   |
| Net cash (used in) provided by investing activities                                                    |       | (1,100                              | )          | 12,765 |   |
|                                                                                                   |       |                                |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                  |       |                                |       |   |   |
| Proceeds from sale of common stock through employee stock purchase  plan                               |       | 301                                 |       | 373 |   |
| Proceeds from exercise of common stock options                                                         |       | 23                                  |       | 198 |   |
| Repurchase of common stock                                                                             |       | (32                                 | )          | — |   |
| Proceeds from sale of common stock in a private placement, net of  offering costs                      |       | 9,905                               |       | — |   |
| Net cash provided by financing activities                                                              |       | 10,197                              |       | 571 |   |
|                                                                                                   |       |                                |       |   |   |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                                   |       | 7,718                               |       | (3,260 | ) |
| EFFECT OF FOREIGN EXCHANGE RATES ON CASH                                                               |       | 28                                  |       | 53 |   |
| CASH AND CASH EQUIVALENTS, beginning of period                                                         |       | 4,272                               |       | 12,693 |   |
| CASH AND CASH EQUIVALENTS, end of period                                                               |       | $                                   | 12,018     |   | $ | 9,486 |   |
|                                                                                                   |       |                                |       |   |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                                      |       |                                |       |   |   |
|                                                                                                   |       |                                |       |   |   |
| Cash paid for income taxes                                                                             |       | $                                   | 125        |   | $ | 196 |   |
|                                                                                                   |       |                                |       |   |   |
| SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITIES:                                                |       |                                |       |   |   |
|                                                                                                   |       |                                |       |   |   |
| Increase (decrease) in common stock subject to rescission                                              |       | $                                   | (1,018     | ) | $ | 893 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

5

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**THE SCO GROUP, INC. AND SUBSIDIARIES**

 

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

 

## **(1)ORGANIZATION AND DESCRIPTION OF BUSINESS**

Thebusiness of The SCO Group, Inc. (the “Company”) focuses on marketing reliable,cost-effective UNIX software products and related services for thesmall-to-medium sized business market, including replicated site franchises ofFortune 1000 companies.  The Company hasoperations in a number of countries that provide support services to customersand resellers. During the year ended October 31, 2003, the Company initiatedits SCOsource business to protect its UNIX intellectual property.  The Company acquired certain intellectualproperty rights surrounding UNIX and UNIX System V source code from TheSanta Cruz Operation, which changed its name to Tarantella, Inc., and wassubsequently acquired by Sun Microsystems, in May 2001.

Duringthe three months ended January 31, 2006, the Company used cash of $1,379,000 inits operating activities.  As of January31, 2006, the Company had a total of $12,018,000 in cash and cash equivalents,$7,196,000 in available-for-sale marketable securities, and $2,670,000 inrestricted cash, of which $1,758,000 is designated to pay for experts,consultants and other expenses in the SCO Litigation (as defined herein), ifneeded, and the remaining $912,000 of restricted cash is payable to Novell forits retained binary royalty stream.

## **(2) SIGNIFICANT ACCOUNTING POLICIES**

### **Basis of Presentation**

The accompanyingunaudited condensed consolidated financial statements of the Company have beenprepared by the Company pursuant to the rules and regulations of the Securitiesand Exchange Commission (“SEC”) on a basis consistent with the Company’saudited annual financial statements, and, in the opinion of management, reflectall adjustments, consisting only of normal recurring adjustments, necessary topresent fairly the financial information set forth therein.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with U.S.generally accepted accounting principles have been condensed or omittedpursuant to SEC rules and regulations, although the Company believes that thefollowing disclosures, when read in conjunction with the audited annual financialstatements and the notes thereto included in the Company’s most recent annualreport on Form 10-K, are adequate to make the information presented notmisleading.  Operating results for thethree months ended January 31, 2006 are not necessarily indicative of theresults that may be expected for the year ending October 31, 2006.

### **Use of Estimates in the Preparation of FinancialStatements**

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenue and expenses during the reporting periods.  Actual results could differ from theseestimates.  The Company’s criticalaccounting policies and estimates include, among others, revenue recognition,allowances for doubtful accounts receivable, impairment and useful lives of long-lived assets, litigation reserves,and valuation allowances against deferred income tax assets.

 

6

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### **Revenue Recognition**

The Company recognizesrevenue in accordance with Statement of Position (“SOP”) 97-2, as modified bySOP 98-9.  The Company’s revenue hashistorically been from three sources: (i) product license revenue, primarilyfrom product sales to resellers, end users and original equipment manufacturers(“OEMs”); (ii) technical support service revenue, primarily from providingtechnical support and consulting services to end users; and (iii) revenue fromSCOsource licensing.

The Company recognizesproduct revenue upon shipment if a signed contract exists, the fee is fixed ordeterminable, collection of the resulting receivable is probable and productreturns are reasonably estimable.

The majority of theCompany’s revenue transactions relate to product-only sales.  On occasion, the Company has revenuetransactions that have multiple elements (such as software products,maintenance, technical support services, and other services).  For software agreements that have multipleelements, the Company allocates revenue to each component of the contract basedon the relative fair value of the elements. The fair value of each element is based on vendor specific objectiveevidence (“VSOE”).  VSOE is establishedwhen such elements are sold separately. The Company recognizes revenue when the criteria for product revenuerecognition set forth above have been met. If VSOE of all undelivered elements exists, but VSOE does not exist forone or more delivered elements, then revenue is recognized using the residualmethod.  Under the residual method, thefair value of the undelivered elements is deferred and the remaining portion ofthe license fee is recognized as revenue in the period when persuasive evidenceof an arrangement is obtained assuming all other revenue recognition criteriaare met.

The Company recognizesproduct revenue from OEMs when the software is sold by the OEM to an end-usercustomer.  Revenue from technical supportservices and consulting services is recognized as the related services areperformed.  Revenue for maintenance is recognizedratably over the maintenance period.

The Company considers anarrangement with payment terms longer than the Company’s normal businesspractice not to be fixed or determinable, and revenue is recognized when thefee becomes due.  The Company typicallyprovides stock rotation rights for sales made through its distribution channeland sales to distributors are recognized upon shipment by the distributor toend users.  For direct sales not throughthe Company’s distribution channel, sales are typically non-refundable andnon-cancelable.  The Company estimatesits product returns based on historical experience and maintains an allowancefor estimated returns, which is recorded as a reduction to accounts receivable.

The Company’s SCOsourcerevenue to date has been primarily generated from agreements to utilize theCompany’s UNIX source code as well as from intellectual property complianceagreements.  The Company recognizesrevenue from SCOsource agreements when a signed contract exists, the fee isfixed or determinable, collection of the receivable is probable and deliveryhas occurred.  If the payment termsextend beyond the Company’s normal payment terms, revenue is recognized as thepayments become due.

**Cash and CashEquivalents**

The Company considersall investments purchased with original maturities of three or fewer months tobe cash equivalents.  Cash equivalentswere $9,555,000 and $1,528,000 as of January 31, 2006 and October 31, 2005,respectively.  Cash was $2,463,000 and$2,744,000 as of January 31, 2006 and October 31, 2005, respectively.

 

7

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**Available-for-SaleMarketable Securities**

Available-for-salemarketable securities are recorded at fair market value, based on quoted marketprices, and unrealized gains and losses are recorded as a component ofcomprehensive loss.  Realized gains andlosses, which are calculated based on the specific-identification method, arerecorded in operations as incurred.

                Available-for-salemarketable securities totaled $7,196,000 as of January 31, 2006.  Any available-for-sale marketable securitiesin an unrealized loss position as of January 31, 2006 were not impaired atacquisition and the decline in fair value is primarily attributable to interestrate fluctuations.  A decline in themarket value of any available-for-sale marketable security below cost that isdeemed other than temporary results in a charge to earnings and establishes anew basis for the security.

**Net Loss per Common Share**

Basic net loss percommon share (“Basic EPS”) is computed by dividing net loss by the weightedaverage number of common shares outstanding. Diluted net income per common share (“Diluted EPS”), if any, is computedby dividing net income by the sum of the weighted average number of commonshares outstanding and the dilutive potential common share equivalents thenoutstanding.  Potential common shareequivalents consist of the weighted average number of shares issuable upon theexercise of outstanding stock options and warrants to acquire commonstock.  If dilutive, the Company computesDiluted EPS using the treasury stock method.

The excludedanti-dilutive common share equivalents of 4,874,000 and 3,784,000 as of January31, 2006 and 2005, respectively, are not included in the computation of DilutedEPS as their effect would have decreased Diluted EPS.

** ****(3) DEFINITE-LIVED INTANGIBLE ASSETS**

The following tableshows the activity related to definite-lived intangible assets for the threemonths ended January 31, 2006 as well as the remaining unamortized balances asof January 31, 2006 (in thousands):

| ** **                             | ** ** | **As of  October 31, 2005** | ** **       | **Three Months  Ended  January 31, 2006** | ** ** | **As of  January 31, 2006** | ** ** |
|----------------------------------------|------------|-----------------------------|------------------|-------------------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | ** **                  | **Amortization** | ** **                                | ** ** |
| ** **                             | ** ** | **Carrying Value**          | ** **       | **Expense**                               | ** ** | **Carrying Value**          | ** ** |
| Definite-lived intangible assets:      |       |                        |             |                                      |       |                        |       |
| Distribution/reseller channel          |       | $                           | 2,318            |                                      | $          | (579                        | )          | $ | 1,739 |   |
| Acquired technology                    |       | 337                         |             | (85                                       | )          | 252                         |       |
| Trade name                             |       | 52                          |             | (13                                       | )          | 39                          |       |
| Total definite-lived intangible assets |       | $                           | 2,707            |                                      | $          | (677                        | )          | $ | 2,030 |   |

 

Of the $677,000 inamortization expense, $592,000 was classified as amortization of intangibleassets in operating expenses and the remaining $85,000 was classified as costof SCOsource licensing revenue.

 

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**(4) COMMITMENTS AND CONTINGENCIES**

**Litigation**

*IBMCorporation*

Onor about March 6, 2003, the Company filed a civil complaint against IBM in theUnited States District Court for the District of Utah, under the title The SCOGroup, Inc. v. International Business Machines Corporation, Civil No.2:03CV0294.  In this action, the Companyclaims, among other things, that IBM breached its UNIX source code licenses(both the IBM and Sequent Computer Systems, Inc. “Sequent” licenses) bydisclosing restricted information concerning the UNIX source code andderivative works and related information in connection with its efforts topromote the Linux operating system.  TheCompany’s complaint includes, among other things, claims for breach ofcontract, unfair competition, tortious interference and copyrightinfringement.  As a result of IBM’sactions, the Company is requesting damages in an amount to be proven at trialand seeking injunctive relief.

Onor about March 6, 2003, the Company notified IBM that IBM was not in compliancewith the Company’s UNIX source code license agreement and on or about June 13,2003, the Company delivered to IBM a notice of termination of IBM’s UNIX sourcecode license agreement, which underlies IBM’s AIX software.  On or about August 11, 2003, the Company senta similar notice terminating the Sequent source code license.  IBM disputes the Company’s right to terminatethose licenses.  In the event the Company’stermination of those licenses is valid, the Company believes IBM is exposed tosubstantial damages and injunctive relief claims based on its continued use anddistribution of the AIX operating system. On June 9, 2003, Novell sent the Company a notice purporting to waivethe Company’s claims against IBM regarding its license breaches.  The Company does not believe that Novell hadthe right to take any such action relative to the Company’s UNIX source coderights.

                On February 27, 2004, theCompany filed a second amended complaint which alleges nine causes of actionthat are similar to those set forth above, adds a new claim for copyrightinfringement and removes the claim for misappropriation of trade secrets.  IBM filed an answer and fourteencounterclaims.  Among other things, IBMhas asserted that the Company does not have the right to terminate IBM’s UNIXlicense and IBM has claimed that the Company has breached the GNU GeneralPublic License and has infringed certain patents held by IBM.  IBM’s counterclaims include claims for breachof contract, violation of the Lanham Act, unfair competition, intentionalinterference with prospective economic relations, unfair and deceptive tradepractices, promissory estoppel, patent infringement and a declaratory judgmentclaim for non-infringement of copyrights. On October 6, 2005, IBM voluntarily dismissed with prejudice its claimsfor patent infringement.

OnFebruary 9, 2005, the court denied three motions for partial summaryjudgment that IBM had filed on the Company’s contract claims, on IBM’s eighthcounterclaim for copyright infringement, and on IBM’s tenth counterclaim for adeclaration of non-infringement of the Company’s copyrights.  The court denied each of those motionswithout prejudice to IBM’s renewing or refiling the motions after discovery iscomplete.  The court also denied theCompany’s motion to stay or dismiss IBM’s tenth counterclaim.  The court ordered that no further dispositivemotions could be filed until the close of discovery.

OnJuly 1, 2005, the court issued a revised Scheduling Order establishing,among other things, discovery and motion deadlines over the next 18 months witha five-week jury trial to commence on February 26, 2007.

 

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Pursuantto the court’s July 1, 2005 Scheduling Order, the Company filed its InterimDisclosure of Material Misused by IBM on October 28, 2005.  The Company’s report includes a matrix thatidentifies 217 separate technology disclosures that it contends IBM improperlymade to enhance Linux in violation of one or more contractual prohibitionsgoverning IBM’s use of the Company’s proprietary material.  The Company continued to review relevantmaterials, including evidence IBM has produced in discovery, and filed anupdated report on December 22, 2005 detailing IBM’s misuse of the Company’sproprietary material.  The Company’sDecember 22, 2005 report includes 294 total disclosures which the Companyclaims violate its contractual rights and copyrights.  These reports and the disclosures identifiedare the result of analysis from experienced outside technical consultants.  On February 13, 2006, IBM filed a motion withthe court seeking to limit the Company’s claims.  IBM argues that of the 294 items identifiedby the Company in the December 22, 2005 filing, 201 did not meet the level ofspecificity required by the court.  IBMrequested that the Company be limited to 93 items set forth in the December 22,2005 filing which IBM claims meet the required level of specificity.  The Company disagrees with IBM’s motion andanalysis and filed an opposition brief under seal with the court.  Discovery is ongoing in the case as theparties prepare for trial.

*Novell, Inc.*

OnJanuary 20, 2004, the Company filed suit in Utah state court againstNovell, Inc. for slander of title seeking relief for its alleged bad faitheffort to interfere with the Company’s ownership of copyrights related to theCompany’s UNIX source code and derivative works and the Company’s UnixWareproduct.  The case is pending in theUnited States District Court for the District of Utah under the caption, TheSCO Group, Inc. v. Novell, Inc., Civil No. 2:04CV00139.  In the lawsuit, the Company requestedpreliminary and permanent injunctive relief as well as damages.  Through these claims, the Company seeks torequire Novell to assign to the Company all copyrights that the Companybelieves Novell has wrongfully registered, prevent Novell from representing anyownership interest in those copyrights and require Novell to retract orwithdraw all representations it has made regarding its purported ownership ofthose copyrights and UNIX itself.

Novellhas filed two motions to dismiss claiming, among other things, that Novell’sfalse statements were not uttered with malice and are privileged under thelaw.  The court denied both of Novell’smotions to dismiss.  On July 29, 2005,Novell filed its Answer and Counterclaims against the Company, assertingcounterclaims for the Company’s alleged breaches of the Asset PurchaseAgreement between Novell and the Company’s predecessor-in-interest, The SantaCruz Operation, Inc., for slander of title, restitution/unjust enrichment, anaccounting related to Novell’s retained binary royalty stream, and fordeclaratory relief regarding Novell’s alleged rights under the Asset PurchaseAgreement.  On December 6, 2005, ascheduling order was entered by the court setting a schedule of discovery andmotions leading up to a trial in June 2007. On or about December 30, 2005, the Company filed a motion for leave toamend its complaint to assert additional claims against Novell includingcopyright infringement, unfair competition and a breach of Novell’s limitedlicense to use the Company’s UNIX code. Novell has consented to the Company’s filing of these additionalclaims.  Discovery is commencing in thecase.

*DaimlerChryslerCorporation*

Onor about March 3, 2004, the Company brought suit against DaimlerChryslerCorporation for its alleged violations of its UNIX license agreement with theCompany.  The lawsuit alleges thatDaimlerChrysler breached its UNIX software agreement by failing to provide anadequate or timely certification of its compliance with that agreement as theCompany requested. The lawsuit, filed in Oakland County Circuit Court in theState of Michigan, requests 

 

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thecourt to declare that DaimlerChrysler has violated the certificationrequirements of its UNIX software agreement, permanently enjoin DaimlerChryslerfrom further violations of the UNIX software agreement, issue a mandatoryinjunction requiring DaimlerChrysler to remedy the effects of its pastviolations of the UNIX software agreement and award the Company damages in anamount to be determined at trial together with costs, attorneys’ fees and anysuch other or different relief that the court may deem to be equitable andjust.

                Inresponse to DaimlerChrysler’s motion to dismiss, the court grantedDaimlerChrysler’s motion as to the substance of DaimlerChrysler’scertification, but denied the motion as to whether the certification wastimely.  Based on this ruling, theCompany filed a motion to stay the case pending the clarification of certainissues in the IBM litigation.  The court deniedthe motion to stay and based on a stipulation of the parties, the court signedan order of dismissal without prejudice. The appellate court has dismissed our appeal of the July 21, 2004ruling finding that the order was not a final, appealable order.

*AutoZone, Inc.*

Onor about March 2, 2004, the Company brought suit againstAutoZone, Inc. for its alleged violations of the Company’s UNIX copyrightsthrough its use of Linux.  The lawsuitalleges copyright infringement by AutoZone by, among other things, runningversions of the Linux operating system that contain proprietary material fromUNIX System V.  The lawsuit, filed inUnited States District Court in Nevada, requests injunctive relief againstAutoZone’s further use or copying of any part of the Company’s copyrightedmaterials and also requests damages as a result of AutoZone’s infringement inan amount to be proven at trial.  Inresponse to AutoZone’s motion to transfer the case to Tennessee or stay thecase, the federal court in Nevada granted AutoZone’s motion to stay the case,with 90-day status reports to the court, and denied without prejudice AutoZone’smotion to transfer the case to Tennessee. The court allowed the parties to take limited expedited discoveryrelating to the issue of preliminary injunctive relief which discovery wasconcluded in May 2005.

                TheCompany concluded the initial discovery allowed by the court and filed itsreport with the court on May 27, 2005. Contrary to AutoZone’s own statements to the court, the Company found throughdiscovery, including depositions and other admissions of AutoZone, manyinstances of copying of programs containing the Company’s OpenServer code.  AutoZone has represented that it has nowremoved all of the Company’s code and proprietary information it copied or usedin its migration to Red Hat Linux. Because AutoZone represents it has removed or otherwise is not using theCompany’s code and proprietary information, the Company currently does notintend to move for a preliminary injunction. AutoZone does not admit that it violated the Company’s rights or causedit damage in that migration process, which are still points of dispute betweenthe parties.  Given the stay issued bythe court in the case, the Company reserves the right to pursue infringementand damages in the future based on these issues and other issues stayed by thecourt.

*IPOClass Action Matter*

TheCompany is an issuer defendant in a series of class action lawsuits involvingover 300 issuers that have been consolidated under In re Initial PublicOffering Securities Litigation, 21 MC 92 (SAS). The consolidated complaint alleges, among other things, certainimproprieties regarding the underwriters’ conduct during the Company’s initialpublic offering and the failure to disclose such conduct in the registrationstatement in violation of the Securities Act of 1933, as amended.

Theplaintiffs, the issuers and the insurance companies have negotiated anagreement to settle the dispute between the plaintiffs and the issuers.  All parties, including the plaintiffs, 

 

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issuersand insurance companies, have executed this settlement agreement and thesettlement agreement has been submitted to the court for approval.  If the settlement agreement is approved bythe court, and if no cross-claims, counterclaims or third-party claims arelater asserted, this action will be dismissed with respect to the Company andits directors.

TheCompany has notified its underwriters and insurance companies of the existenceof the claims.  Management believes,after consultation with legal counsel, that the ultimate outcome of this matterwill not have a material adverse effect on the Company’s results of operationsor financial position and will not exceed the $200,000 self-insured retentionalready paid or accrued by the Company.

*RedHat, Inc.*

OnAugust 4, 2003, Red Hat, Inc. filed a complaint against theCompany.  The action is pending in theUnited States District Court for the District of Delaware under the case caption,Red Hat, Inc. v. The SCO Group, Inc., Civil No. 03-772.  Red Hat asserts that the Linux operatingsystem does not infringe on the Company’s UNIX intellectual property rights andseeks a declaratory judgment for non-infringement of copyrights and nomisappropriation of trade secrets.  Inaddition, Red Hat claims the Company has engaged in false advertising inviolation of the Lanham Act, deceptive trade practices, unfair competition,tortious interference with prospective business opportunities, trade libel anddisparagement.  On April 6, 2004,the court denied the Company’s motion to dismiss this case; however, the courtstayed the case and requested status reports every 90 days regarding thecase against IBM.  Red Hat filed a motionfor reconsideration, which the court denied on March 31, 2005.  The Company intends to vigorously defend thisaction.  In the event the stay is liftedand Red Hat is allowed to pursue its claims, the Company will likely assertcounterclaims against Red Hat.

*OtherMatters*

InApril 2003, the Company’s former Indian distributor filed a claim inIndia, requesting summary judgment for payment of approximately $1,428,000, andan order that the Company trade in India only through the distributor and/orgive a security deposit until the claim is paid.  The distributor claims that the Company isresponsible to repurchase certain software products and to reimburse thedistributor for certain other operating costs. Management does not believe that the Company is responsible to reimbursethe distributor for any operating costs and also believes that the returnrights related to any remaining inventory have lapsed.  The distributor additionally requested thatthe Indian courts grant interim relief in the form of attachment of local assets.  These requests for interim relief have failedin the court, and discovery has commenced and hearings on the main claims havebeen held and are ongoing.  The Companyintends to vigorously defend this action.

Pursuit and defense of theabove-mentioned matters will be costly, and management expects the costs forlegal fees and related expenses will be substantial.

The ultimate outcome orpotential negative effect on the Company’s results of operations or financialposition of the Red Hat, Inc., IPO Class Action, or Indian Distributor mattersis neither probable nor estimable.

The Company is a partyto certain other legal proceedings arising in the ordinary course ofbusiness.  Management believes, afterconsultation with legal counsel, that the ultimate outcome of these legalproceedings will not have a material adverse effect on the Company’s results ofoperations or financial position.

 

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**(5)COMMON STOCK SUBJECT TO RESCISSION**

The Company believescertain shares and options granted under its Equity Compensation Plans wereissued without complying with registration or qualification requirements underfederal securities laws and the securities laws of certain states.  As a result, certain Plan participants had aright to rescind their purchases of shares under the Plans or recover damagesif they no longer own the shares or hold unexercised options, subject toapplicable statutes of limitations. Additionally, regulatory authorities may require the Company to payfines or impose other sanctions. 

Accounting SeriesRelease (“ASR”) No. 268 and Emerging Issues Task Force (“EITF”) Topic D-98require that stock subject to rescission or redemption requirements outside thecontrol of the Company to be classified outside of permanent equity.  Theexercise of the rescission right is at the holders’ discretion, but exercise ofthat right may depend in part on the fair value of the Company’s common stockwhich is outside of the Company’s and the holders’ control.  Consequently, common stock subject torescission is classified as temporary equity.

InDecember 2005, the Company offered to rescind a total of 337,289 shares ofcommon stock issued under its 2000 Employee Stock Purchase Plan (the “ESPP”) tocurrent and former employees while they resided in any of California,Connecticut, Illinois, New Jersey, Utah, Texas or Washington.  These shares represented all of the ESPPshares the Company issued to residents of these states for which a purchasercould claim a rescission right.  Therescission offer was intended to address the Company’s rescission liabilityrelating to its federal and state securities laws compliance issues by allowingthe holders of the shares covered by the rescission offer to rescind theunderlying securities transactions and sell those securities back to theCompany or recover damages, as the case may be.

Therescission offer concluded on January 20, 2006. As of that date, 14 offerees had accepted the Company’s offer to rescindthe purchase of approximately 7,300 shares. The Company made aggregate payments to such offerees of approximately$41,500, which includes approximately $31,800 for the purchase of the sharesand approximately $9,700 in statutory interest and damages.  As a result of the rescission offer, theCompany believes it has extinguished its state rescission liability andmitigated its federal rescission liability to anyone to whom the rescissionoffer was made for noncompliance with the registration or qualificationrequirements of federal and state securities laws as they relate to the sharesissued under the ESPP.  Upon the close ofthe rescission offer, the Company reclassified the $1,018,000 of common stocksubject to rescission as additional paid-in capital in permanent equity.

**(6) STOCKHOLDERS’ EQUITY**

**Issuance of Common Stock**

On November 29, 2005,the Company entered into a Common Stock Purchase Agreement (“Purchase Agreement”)with several institutional investors and one member of the Company’s board ofdirectors.  On November 30, 2005, theCompany sold to the investors approximately 2,852,000 shares of the Company’scommon stock for gross proceeds of approximately $10,005,000.  The costs to date to facilitate the privateplacement of the common stock are approximately $100,000.  The shares issued to the institutionalinvestors were issued at $3.50 per share and the shares issued to the boardmember were issued at $3.92 per share. Pursuant to the Purchase Agreement, the Company agreed to use its bestefforts to file a registration statement with the Securities and ExchangeCommission (“SEC”) covering the resale of this common stock, and to use itscommercially reasonable efforts to have such registration statement declaredeffective.   On December 22, 2005, theCompany filed a registration statement with the Securities 

 

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andExchange Commission, and on March 1, 2006, the Company filed a pre-effectiveamendment to this registration statement. As of the date the Company filed this Form 10-Q, the registrationstatement had not been declared effective by the SEC.

**Equity Plans**

TheCompany has established the 1998 Stock Option Plan (the “1998 Plan”), 1999Omnibus Stock Incentive Plan (the “1999 Plan”), the 2002 Omnibus StockIncentive Plan (the “2002 Plan”) and the 2004 Omnibus Stock Incentive Plan (the“2004 Plan”) for the award of stock options, stock appreciation rights,restricted stock, phantom stock rights, and stock bonuses to employees,executive officers, members of the Board of Directors and outsideconsultants.  The Compensation Committeeof the Board of Directors has the ability to determine the terms of the option,the exercise price, the number of shares subject to each option, and the exercisabilityof the options.  Under the terms of the1998, 1999, 2002 and 2004 Plans, options generally expire 10 years from thedate of grant or within 90 days of termination. Options granted under these plans generally vest at 25 percent after thecompletion of one year of service and then 1/36 per month for the remainingthree years and would be fully vested at the end of four years.   Pursuant to the terms of their grantagreements, certain of the options granted under these plans may be subject toaccelerated vesting upon a change in control of the Company.

The Company has alsoestablished the 2000 Employee Stock Purchase Plan, as amended, which isdesigned to allow eligible employees of the Company and its participatingsubsidiaries to purchase shares of the Company’s common stock, at semi-annualintervals, through periodic payroll deductions.

Prior to October 31,2005, as permitted under Statement of Financial Accounting Standards (“SFAS”)No. 123, the Company accounted for its stock option plans following therecognition and measurement principles of Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock issued to Employees,” and relatedinterpretations.  Accordingly, nostock-based compensation expense had been reflected in the Company’s statementsof operations as all options granted had an exercise price equal to the marketvalue of the underlying common stock on the date of grant and the relatednumber of shares granted was fixed at that point in time.

In December 2004, theFASB issued SFAS No. 123(R), “Share Based Payment.”  This statement revised SFAS No. 123 byeliminating the option to account for employee stock options under APB No. 25and requires companies to recognize the cost of employee services received inexchange for awards of equity instruments based on the grant-date fair value ofthose awards.

Effective November 1,2005, the Company adopted the fair value recognition provisions of SFAS No.123(R) using the modified prospective application method.  Under this transition method, the Companyrecorded compensation expense on a straight-line basis for the three monthsended January 31, 2006, for: (a) the vesting of options granted prior toNovember 1, 2005 (based on the grant-date fair value estimated in accordancewith the original provisions of SFAS No. 123, and previously presented in thepro-forma footnote disclosures), and (b) stock-based awards granted subsequentto November 1, 2005 (based on the grant-date fair value estimated in accordancewith the provisions of SFAS No. 123(R)). In accordance with the modified prospective application method, resultsfor the three months ended January 31, 2005 have not been restated.

 

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The effect of adoptingSFAS No. 123(R) as of November 1, 2005 for the three months ended January 31,2006 was to record $401,000 of stock-based compensation expense.  For the three months ended January 31, 2006 and2005, the Company has allocated stock-based compensation expense to thefollowing statement of operations and comprehensive loss captions (inthousands):

| ** **                             | ** ** | **Three Months Ended  January 31,** | ** ** |
|----------------------------------------|------------|------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                 | ** ** | **2005** | ** ** |
|                                   |       |                                     |       |   |   |
| Cost of products                       |       | $                                        | 2          |   | $ | — |   |
| Cost of SCOsource licensing            |       | 53                                       |       | — |   |
| Cost of services                       |       | 12                                       |       | — |   |
| Sales and marketing                    |       | 68                                       |       | 7 |   |
| Research and development               |       | 20                                       |       | 8 |   |
| General and administrative             |       | 246                                      |       | — |   |
| Total stock-based compensation expense |       | $                                        | 401        |   | $ | 15 |   |

 

The following pro-formainformation, as required by SFAS No. 148, “Accounting for Stock-BasedCompensation-Transition and Disclosure, an amendment of FASB Statement No. 123,”is presented for comparative purposes and illustrates the effect on net lossand net loss per common share for the three months ended January 31, 2005 as ifthe Company had applied the fair value recognition provisions of SFAS No. 123to stock-based employee compensation prior to November 1, 2005 (in thousands):

| ** **                                             | ** ** | **Three Months Ended  January 31, 2005** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------|------------|
| Net loss:                                              |       |                                     |       |
| As reported                                            |       | $                                        | (2,961     | ) |
| Stock-based compensation included in reported net loss |       | 15                                       |       |
| Stock-based compensation under fair value method       |       | (194                                     | )          |
| Pro forma net loss                                     |       | $                                        | (3,140     | ) |
| Net loss per basic and diluted common share:           |       |                                     |       |
| As reported                                            |       | $                                        | (0.17      | ) |
| Pro forma                                              |       | $                                        | (0.18      | ) |

 

Withrespect to stock options granted during the three months ended January 31, 2006and 2005, the assumptions used in the Black-Scholes option-pricing model are asfollows:  

| ** **                         | ** ** | **Three Months  Ended January 31,** | ** ** |
|------------------------------------|------------|-------------------------------------|------------|
| ** **                         | ** ** | **2006**                            | ** ** | **2005** | ** ** |
| Risk-free interest rate            |       | 4.4                                 | %          | 3.4 | % |
| Expected dividend yield            |       | 0.0                                 | %          | 0.0 | % |
| Volatility                         |       | 63                                  | %          | 89 | % |
| Expected exercise life (in  years) |       | 5.0                                 |       | 2.7 |   |

 

Theestimated fair value of stock options and ESPP shares are amortized over thevesting period of the award.

During the three monthsended January 31, 2006, the Company granted options to purchase approximately839,000 shares of common stock with an average exercise price of $3.78 pershare.  None of these stock options weregranted with an exercise price below the quoted market price on the date ofgrant.  During the three months endedJanuary 31, 2006, options to purchase approximately 17,000 shares of commonstock were exercised with an average exercise

 

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priceof $1.36 per share.  As of January 31,2006, there were approximately 4,639,000 stock options outstanding with aweighted average exercise price of $4.11 per share.

** (7) CONCENTRATION OF CREDIT RISK**

As of January 31, 2006 and October 31,2005, the Company had no customers who made up more than 10 percent of theaccounts receivable balance.

During the three monthsended January 31, 2006 and 2005, no single customer accounted for more than 10percent of total revenue.

** (8) SEGMENT INFORMATION**

The Company’s resourcesare allocated and operating results managed to the operating income (loss)level for each of the Company’s segments: UNIX and SCOsource.  Both segments are based on the Company’s UNIXintellectual property.  The UNIX businesssells and distributes UNIX products and services through an extensivedistribution channel and to corporate end-users and the SCOsource businessenforces and protects the Company’s UNIX intellectual property.  Segment disclosures for the Company are asfollows (in thousands):

| ** **                   | ** ** | **Three Months Ended January 31, 2006** | ** ** |
|------------------------------|------------|-----------------------------------------|------------|
| ** **                   | ** ** | **UNIX**                                | ** ** | **SCOsource** | ** ** | **Total** | ** ** |
|                         |       |                                    |       |   |   |   |   |
| Revenue                      |       | $                                       | 7,313      |   | $ | 30 |   | $ | 7,343 |   |
| Cost of revenue              |       | 1,221                                   |       | 4,010 |   | 5,231 |   |
| Gross margin (deficit)       |       | 6,092                                   |       | (3,980 | ) | 2,112 |   |
| Sales and marketing          |       | 2,688                                   |       | — |   | 2,688 |   |
| Research and development     |       | 1,777                                   |       | 94 |   | 1,871 |   |
| General and administrative   |       | 1,532                                   |       | 60 |   | 1,592 |   |
| Amortization of  intangibles |       | 592                                     |       | — |   | 592 |   |
| Total operating expenses     |       | 6,589                                   |       | 154 |   | 6,743 |   |
| Loss from operations         |       | $                                       | (497       | ) | $ | (4,134 | ) | $ | (4,631 | ) |

 

| ** **                    | ** ** | **Three Months Ended January 31, 2005** | ** ** |
|-------------------------------|------------|-----------------------------------------|------------|
| ** **                    | ** ** | **UNIX**                                | ** ** | **SCOsource** | ** ** | **Total** | ** ** |
|                          |       |                                    |       |   |   |   |   |
| Revenue                       |       | $                                       | 8,795      |   | $ | 70 |   | $ | 8,865 |   |
| Cost of revenue               |       | 1,393                                   |       | 3,493 |   | 4,886 |   |
| Gross margin (deficit)        |       | 7,402                                   |       | (3,423 | ) | 3,979 |   |
| Sales and marketing           |       | 2,797                                   |       | 147 |   | 2,944 |   |
| Research and development      |       | 1,976                                   |       | 112 |   | 2,088 |   |
| General and administrative    |       | 1,672                                   |       | 91 |   | 1,763 |   |
| Amortization of  intangibles  |       | 593                                     |       | — |   | 593 |   |
| Total operating expenses      |       | 7,038                                   |       | 350 |   | 7,388 |   |
| Income (loss) from operations |       | $                                       | 364        |   | $ | (3,773 | ) | $ | (3,409 | ) |

 

 

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Intangible assets, whichconsist of the Company’s reseller channel, trade name and technology, have beenassigned to the Company’s UNIX and SCOsource segments and consist of thefollowing as of January 31, 2006 and October 31, 2005 (in thousands): 

| ** **                             | ** ** | **January 31,  2006** | ** ** | **October 31,  2005** | ** ** |
|----------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| Intangible assets:                     |       |                  |       |                  |       |
| UNIX (reseller channel and trade name) |       | $                     | 1,778      |                  | $          | 2,370 |   |
| SCOsource (UNIX technology)            |       | 252                   |       | 337                   |       |
| Total intangible assets                |       | $                     | 2,030      |                  | $          | 2,707 |   |

 

 

 

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**ITEM 2.****                 ****MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS**

*This Management’s Discussion and Analysis ofFinancial Condition and Results of Operations and other parts of this quarterlyreport on Form 10-Q contain forward-looking statements that involve risks anduncertainties.  Forward-lookingstatements can also be identified by words such as “intends,” “anticipates,” “expects,”“believes,” “plans,” “predicts,” and similar terms.  Forward-looking statements are not guaranteesof future performance and our actual results may differ significantly from theresults discussed in the forward-looking statements.  Factors that might cause such differencesinclude, but are not limited to, those set forth below under “Forward-LookingStatements and Factors that May Affect Future Results and Financial Condition”and Item 1A—Risk Factors and elsewhere in this Form 10-Q. The followingdiscussion should be read in conjunction with our unaudited condensedconsolidated financial statements and notes thereto included in this Form 10-Qand our audited consolidated financial statements included in our annual reporton Form 10-K for the year ended October 31, 2005 filed with the Securities andExchange Commission and management’s discussion and analysis containedtherein.  All information presentedherein is based on the three months ended January 31, 2006.  We assume no obligation to revise or updateany forward-looking statements for any reason, except as required by law.*

 

**Overview**

*Historical Background. *Weoriginally incorporated as Caldera Systems, Inc., a Utah corporation (aspreviously defined, “Caldera Systems”), on August 21, 1998, and reincorporatedas a Delaware corporation on March 6, 2000. In March 2000, we completed an initial public offering of our commonstock.  On May 7, 2001, we formed a new holding companyin Delaware under the name of Caldera International, Inc. (as previouslydefined, “Caldera International”) to acquire substantially all of the assetsand operations of the server and professional services groups of The Santa CruzOperation.  In connection with thisacquisition, Caldera Systems became a wholly owned subsidiary of CalderaInternational.  Formerholders of shares and options to purchase shares of Caldera Systems received anequal number of shares and options to purchase shares in Caldera International.  OnMay 16, 2003, our stockholders approved our corporate name change to The SCOGroup, Inc.

**Business Focus**

*UNIX Business. *Our UNIX business serves the needs of small-to-mediumsized businesses, including replicated site franchisees of Fortune 1000companies, by providing reliable, cost effective UNIX operating systems andsoftware products to power computers running on Intel architecture.  Our largest source of UNIX business revenueis derived from existing customers through our worldwide, indirect, leveragedchannel of partners which includes distributors and independent solutionproviders.  We have operations in anumber of countries that provide support and services to customers andresellers.  The other principal channelfor selling and marketing our UNIX products is through existing customers thathave a large number of replicated sites or franchisees.

Weaccess these corporations through their information technology or purchasingdepartments with our area sales managers in the United States and through ourreseller channel in countries outside the United States.  In addition, we also sell our operatingsystem products to original equipment manufacturers (“OEMs”).  Our sales of UNIX products and servicesduring the last several fiscal years have been primarily to pre-existing UNIXcustomers and not newly acquired customers. Our UNIX business revenue depends significantly on our ability to marketand sell our products to existing customers and to generate upgrades fromexisting customers.

 

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Thefollowing table shows the operating results of the UNIX business for the threemonths ended January 31, 2006 and 2005 (in thousands):

| ** **                    | ** ** | **Three Months Ended January 31,** | ** ** |
|-------------------------------|------------|------------------------------------|------------|
| ** **                    | ** ** | **2006**                           | ** ** | **2005** | ** ** |
|                          |       |                               |       |   |   |
| Revenue                       |       | $                                  | 7,313      |   | $ | 8,795 |   |
| Cost of revenue               |       | 1,221                              |       | 1,393 |   |
| Gross margin                  |       | 6,092                              |       | 7,402 |   |
| Sales and marketing           |       | 2,688                              |       | 2,797 |   |
| Research and development      |       | 1,777                              |       | 1,976 |   |
| General and administrative    |       | 1,532                              |       | 1,672 |   |
| Amortization of intangibles   |       | 592                                |       | 593 |   |
| Total operating expenses      |       | 6,589                              |       | 7,038 |   |
| Income (loss) from operations |       | $                                  | (497       | ) | $ | 364 |   |

Revenue from our UNIX business decreased by$1,482,000, or 17 percent, for the three months ended January 31, 2006 comparedto the three months ended January 31, 2005. The revenue from this business has been declining over the last severalquarters primarily as a result of increased competition from alternativeoperating systems, particularly Linux. We believe the inclusion of our UNIX code and derivative works in Linuxhas been a contributor to the decline in our UNIX business because users ofLinux generally do not pay for the operating system itself, but pay forservices and maintenance.  The Linuxoperating system competes directly with our OpenServer and UnixWare productsand has taken significant market share from these products.

Inan effort to try to sustain profitability in our UNIX business, we havedecreased our operating costs.  Operatingcosts for our UNIX business decreased from $7,038,000 for the three monthsended January 31, 2005 to $6,589,000 for the three months ended January 31,2006.  These cost reductions haveprimarily been attributable to reduced headcount and continued operationalefficiencies generated in our UNIX business as well as from the consolidationof certain facilities.

Inour UNIX business, we have reduced the number of full-time equivalent employeesfrom 165 as of January 31, 2005 to 156 as of January 31, 2006.  We have taken these headcount reductions andreduced other discretionary spending while still maintaining a worldwidepresence.  Based on our cost-cuttingactions, we anticipate that our UNIX business will continue to generatepositive cash flow throughout the year ending October 31, 2006.

Thedecline in our UNIX business revenue may be accelerated if industry partnerswithdraw their support for our products. The decline in our UNIX business and our SCOsource business may causeindustry partners, developers and hardware and software vendors to choose notto support or certify to our UNIX operating system products.  This would lead to an accelerated decline inrevenue and, potentially, negative cash flow from our UNIX business.

*SCOsourceBusiness.  *During the year ended October 31, 2003, webecame aware that our UNIX code and derivative works had been inappropriatelyincluded by others in the Linux operating system.  We believe the inclusion of our UNIX code andderivative works in Linux has been a contributor to the decline in our UNIXbusiness because users of Linux generally do not pay for the operating systemitself, but pay for services and maintenance. The Linux operating system competes directly with our OpenServer andUnixWare products and has taken significant market share from these products.

Inan effort to protect and defend our UNIX intellectual property, weinitiated our SCOsource business.  OurSCOsource revenue for the years ended October 31, 2005 and 2004 wassignificantly lower than revenue generated during the year ended October 31,2003, and we 

 

19

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believe and allege our revenue and relatedrevenue opportunities have been adversely impacted by Novell’s claim of UNIXcopyright ownership, which may have caused potential customers to delay orforego licensing with us until an outcome in this legal matter has beenreached.

Thefollowing table shows the operating results of the SCOsource business for thethree months ended January 31, 2006 and 2005 (in thousands):

| ** **                 | ** ** | **Three Months Ended January 31,** | ** ** |
|----------------------------|------------|------------------------------------|------------|
| ** **                 | ** ** | **2006**                           | ** ** | **2005** | ** ** |
|                       |       |                               |       |   |   |
| Revenue                    |       | $                                  | 30         |   | $ | 70 |   |
| Cost of revenue            |       | 4,010                              |       | 3,493 |   |
| Gross deficit              |       | (3,980                             | )          | (3,423 | ) |
| Sales and marketing        |       | —                             |       | 147 |   |
| Research and development   |       | 94                                 |       | 112 |   |
| General and administrative |       | 60                                 |       | 91 |   |
| Total operating expenses   |       | 154                                |       | 350 |   |
| Loss from operations       |       | $                                  | (4,134     | ) | $ | (3,773 | ) |

 

Revenuefrom our SCOsource business decreased from $70,000 for the three months endedJanuary 31, 2005 to $30,000 for the three months ended January 31, 2006.  Revenue in both of the above mentionedperiods was primarily attributable to sales of our SCOsource IPagreements.  Cost of revenue, whichprimarily includes legal and professional fees incurred in connection with theSCO Litigation, increased from $3,493,000 for the three months ended January31, 2005 to $4,010,000 for the three months ended January 31, 2006.  This increase was primarily attributable towork performed by technical and other experts in connection with the SCOLitigation.   We expect cost of revenueto decrease in the future, since we have made our final payment to Boies,Schiller & Flexner LLP, Kevin McBride and Berger Singerman (the “Law Firms”)pursuant to the Engagement Agreement as described in “Liquidity and Capital Resources”below.   However, we will continueto pay for expert, consulting and other expenses through the conclusion of ourlitigation with IBM.

Because of theuncertainties related to our SCOsource business, we are unable to estimate theamount and timing of future SCOsource licensing revenue.  We are unlikely to generate significantrevenue from our SCOsource business unless and until we prevail in our SCOLitigation.  Additionally, the success ofthe SCOsource business may depend on the strength of our intellectual propertyrights and claims regarding UNIX, including our claims against Novell and thestrength of our claim that unauthorized UNIX source code and derivative worksare contained in Linux.

**Critical Accounting Policies**

Our criticalaccounting policies and estimates include the following:

•                              Revenue recognition;

•                              Deferred income tax assets and relatedvaluation allowances;

•                              Litigation reserves;

•                              Impairment and useful lives of long-livedassets; and

•                              Allowances for doubtful accountsreceivable.

*RevenueRecognition*.  We recognize revenue in accordance withStatement of Position (“SOP”) 97-2, as modified by SOP 98-9.  Our revenue has historically been from threesources: (i) product 

 

20

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license revenue, primarily from product sales toresellers, end users and original equipment manufacturers (“OEMs”); (ii)technical support service revenue, primarily from providing technical supportand consulting services to end users; and (iii) revenue from SCOsourcelicensing.

We recognize productrevenue upon shipment if a signed contract exists, the fee is fixed ordeterminable, collection of the resulting receivable is probable and productreturns are reasonably estimable.

The majority of ourrevenue transactions relate to product-only sales.  On occasion, we have revenue transactionsthat have multiple elements (such as software products, maintenance, technicalsupport services, and other services). For software agreements that have multiple elements, we allocate revenueto each component of the contract based on the relative fair value of theelements.  The fair value of each elementis based on vendor specific objective evidence (“VSOE”).  VSOE is established when such elements aresold separately.  We recognize revenuewhen the criteria for product revenue recognition set forth above have beenmet.  If VSOE of all undelivered elementsexists, but VSOE does not exist for one or more delivered elements, thenrevenue is recognized using the residual method.  Under the residual method, the fair value ofthe undelivered elements is deferred and the remaining portion of the licensefee is recognized as revenue in the period when persuasive evidence of anarrangement is obtained assuming all other revenue recognition criteria aremet.

We recognize productrevenue from OEMs when the software is sold by the OEM to an end-usercustomer.  Revenue from technical supportservices and consulting services is recognized as the related services areperformed.  Revenue for maintenance isrecognized ratably over the maintenance period.

We consider anarrangement with payment terms longer than our normal business practice, not tobe fixed or determinable and revenue is recognized when the fee becomesdue.  We typically provide stock rotationrights for sales made through our distribution channel and sales todistributors are recognized upon shipment by the distributor to end users.  For direct sales not through our distributionchannel, sales are typically non-refundable and non-cancelable.  We estimate our product returns based onhistorical experience and maintain an allowance for estimated returns, which isrecorded as a reduction to accounts receivable.

Our SCOsource revenue todate has been primarily generated from agreements to utilize our UNIX sourcecode as well as from intellectual property compliance agreements.  We recognize revenue from SCOsourceagreements when a signed contract exists, the fee is fixed or determinable,collection of the receivable is probable and delivery has occurred.  If the payment terms extend beyond our normalpayment terms, revenue is recognized as the payments become due.

*DeferredIncome Tax Assets and Related Valuation Allowance*.  The amount, and ultimate realization, of ourdeferred income tax assets depends, in part, upon the tax laws in effect, ourfuture earnings, if any, and other future events, the effects of which cannotbe determined.  We have provided avaluation allowance of $69,239,000 against our entire net deferred income taxassets as of October 31, 2005.  Thevaluation allowance was recorded because of our history of net operating lossesand the uncertainties regarding our future operating profitability and taxableincome.

*LitigationReserves. *We are party to a number of legal matters described inmore detail elsewhere in this quarterly report on Form 10-Q.  Pursuitand defense of these matters will be costly, and management expects the costsfor legal fees and related expenses will be substantial.  The ultimate outcome or potential negativeeffect on our results of operations or 

 

21

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financial position of the Red Hat, Inc., IPOClass Action, or Indian Distributor matters is neither probable norestimable.  Because these matters are notprobable or estimable, we have not recorded any reserves or contingenciesrelated to these legal matters.  In theevent that our assumptions used in evaluating these matters as neither probablenor estimable change in future periods, we may be required to record aliability for an adverse outcome, which could have a material adverse effect onour results of operations or financial position.

*Impairmentand Useful Lives of Long-lived Assets*.  We review our long-lived tangible andintangible assets for impairment when events or changes in circumstancesindicate that the carrying value of an asset may not be recoverable.  We evaluate, at each balance sheet date,whether events and circumstances have occurred which indicate possibleimpairment.  The carrying value of along-lived asset is considered impaired when the anticipated cumulativeundiscounted cash flows of the related asset or group of assets is less thanthe carrying value.  In that event, aloss is recognized based on the amount by which the carrying value exceeds theestimated fair market value of the long-lived asset.  Economic useful lives of long-lived assetsare assessed and adjusted as circumstances dictate.

Write-downs ofintangible assets may be necessary if the future fair value of these assets isless than carrying value.  If theoperating trends for our UNIX or SCOsource businesses continue to decline, wemay be required to record an impairment charge in a future period related tothe carrying value of our long-lived assets.

*Allowancefor Doubtful Accounts Receivable*.  We offercredit terms on the sale of our products to a majority of our customers andrequire no collateral from these customers. We perform ongoing credit evaluations of our customers’ financialcondition and maintain an allowance for doubtful accounts based upon ourhistorical collection experience and expected collectibility of all accountsreceivable and apply these policies consistently.  Our allowance for doubtful accountsreceivable, which is determined based on our historical experience and aspecific review of customer balances, was $136,000 as of January 31, 2006.  Our past experience has resulted in minimaldifferences from the actual amounts provided for bad debts and our recordedestimates.  However, our actual bad debtsin future periods may differ from our current estimates and the differences maybe material, which may have an adverseimpact on our future accounts receivable and cash position.

 

22

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**Results of Operations**

                        The following table presents ourresults of operations for the three months ended January 31, 2006 and 2005 (inthousands):
| ** **                           | ** ** | **Three Months Ended January 31,** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|
| ** **                           | ** ** | **2006**                           | ** ** | **2005** | ** ** |
| **Statement of Operations Data:**    |       |                               |       |   |   |
| Revenue:                             |       |                               |       |   |   |
| Products                             |       | $                                  | 6,000      |   | $ | 7,304 |   |
| SCOsource licensing                  |       | 30                                 |       | 70 |   |
| Services                             |       | 1,313                              |       | 1,491 |   |
| Total revenue                        |       | 7,343                              |       | 8,865 |   |
| Cost of revenue:                     |       |                               |       |   |   |
| Products                             |       | 584                                |       | 644 |   |
| SCOsource licensing                  |       | 4,010                              |       | 3,493 |   |
| Services                             |       | 637                                |       | 749 |   |
| Total cost of revenue                |       | 5,231                              |       | 4,886 |   |
| Gross margin                         |       | 2,112                              |       | 3,979 |   |
| Operating expenses:                  |       |                               |       |   |   |
| Sales and marketing                  |       | 2,688                              |       | 2,944 |   |
| Research and development             |       | 1,871                              |       | 2,088 |   |
| General and administrative           |       | 1,592                              |       | 1,763 |   |
| Amortization of intangibles          |       | 592                                |       | 593 |   |
| Total operating expenses             |       | 6,743                              |       | 7,388 |   |
| Loss from operations                 |       | (4,631                             | )          | (3,409 | ) |
| Equity in income (loss) of affiliate |       | (8                                 | )          | 53 |   |
| Other income, net                    |       | 145                                |       | 509 |   |
| Provision for income taxes           |       | (87                                | )          | (114 | ) |
| Net loss                             |       | $                                  | (4,581     | ) | $ | (2,961 | ) |

 

**THREEMONTHS ENDED JANUARY 31, 2006 AND 2005**

### ***Revenue***

| ** ** | ** ** | **Three Months Ended January 31,** | ** ** |
|------------|------------|-----------------------------------------|------------|
| ** ** | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|       |       |                                    |       |   |   |   |   |
| Revenue    |       | $                                       | 7,343,000  |   | (17 | )% | $ | 8,865,000 |   |
|            |            |                                         |            |  |  |  |  |  |  |

 

Revenuefor the three months ended January 31, 2006 decreased by $1,522,000, or 17%,from the three months ended January 31, 2005. This decrease was primarily attributable to a continued decline in ourUNIX business as a result of continued competitive pressure from competingoperating systems, particularly Linux.

Revenuegenerated from our UNIX business and SCOsource business is as follows:

| ** **               | ** ** | **Three Months Ended January 31,** | ** ** |
|--------------------------|------------|-----------------------------------------|------------|
| ** **               | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|                     |       |                                    |       |   |   |   |   |
| UNIX revenue             |       | $                                       | 7,313,000  |   | (17 | )% | $ | 8,795,000 |   |
| Percent of total revenue |       | 100                                     | %          |   |   | 99 | % |
| SCOsource revenue        |       | 30,000                                  |       | (57 | )% | 70,000 |   |
| Percent of total revenue |       | 0                                       | %          |   |   | 1 | % |
|                          |            |                                         |            |  |  |  |  |  |  |

 

Thedecrease in revenue in the UNIX business of $1,482,000 for the three monthsended January 31, 2006 compared to the three months ended January 31, 2005 wasprimarily attributable 

 

23

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tocontinued competition from other operating systems, particularly Linux.  We anticipate that for the remainder of theyear ending October 31, 2006 our UNIX business and the related revenue from theUNIX business will face significant competition from Linux and other operatingsystems.

Salesof our UNIX products and services during the three months ended January 31,2006 were primarily to pre-existing customers. Our UNIX business revenue depends significantly on our ability to marketour products to existing customers and to generate upgrades from existingcustomers.  Our UNIX revenue may be lowerthan currently anticipated if we are not successful with our existing customersor if we lose the support of any of our existing hardware and software vendorsor our key industry partners withdraw their marketing and certification supportor direct their support to our competitors.

*Products Revenue*

| ** **               | ** ** | **Three Months Ended January 31,** | ** ** |
|--------------------------|------------|-----------------------------------------|------------|
| ** **               | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|                     |       |                                    |       |   |   |   |   |
| Products revenue         |       | $                                       | 6,000,000  |   | (18 | )% | $ | 7,304,000 |   |
| Percent of total revenue |       | 82                                      | %          |   |   | 82 | % |
|                          |            |                                         |            |  |  |  |  |  |  |

 

Ourproducts revenue consists of software licenses for UNIX products such asOpenServer and UnixWare, as well as sales of UNIX-related products.  Products revenue also includes revenuederived from OEMs, distribution partners and large accounts.  We rely heavily on our two-tier distributionchannel and any disruption in our distribution channel could have an adverseimpact on future revenue.

Thedecrease in products revenue of $1,304,000, or 18%, for the three months endedJanuary 31, 2006 compared to the three months ended January 31, 2005 wasprimarily attributable to decreased sales of OpenServer, UnixWare and other productsprimarily resulting from increased competition in the operating system market,particularly from Linux.

Ourproducts revenue was derived primarily from sales of our OpenServer andUnixWare products.  Other productsrevenue consists mainly of product maintenance and other UNIX-relatedproducts.  Revenue for these products wasas follows:

| ** **                  | ** ** | **Three Months Ended January 31,** | ** ** |
|-----------------------------|------------|-----------------------------------------|------------|
| ** **                  | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                                    |       |   |   |   |   |
| OpenServer revenue          |       | $                                       | 3,622,000  |   | (10 | )% | $ | 4,013,000 |   |
| Percent of products revenue |       | 60                                      | %          |   |   | 55 | % |
| UnixWare revenue            |       | 1,725,000                               |       | (19 | )% | 2,136,000 |   |
| Percent of products revenue |       | 29                                      | %          |   |   | 29 | % |
| Other products revenue      |       | 653,000                                 |       | (43 | )% | 1,155,000 |   |
| Percent of products revenue |       | 11                                      | %          |   |   | 16 | % |
|                             |            |                                         |            |  |  |  |  |  |  |

 

Thedecreases in revenue for OpenServer and UnixWare are primarily the result ofcontinued competition from other operating systems, particularly Linux.  The decrease in other products revenue isprimarily attributable to decreased sales of product maintenance due to fewercustomers renewing or ordering product maintenance.

 

24

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*SCOsourceLicensing Revenue*

| ** **                  | ** ** | **Three Months Ended January 31,** | ** ** |
|-----------------------------|------------|-----------------------------------------|------------|
| ** **                  | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                                    |       |   |   |   |   |
| SCOsource licensing revenue |       | $                                       | 30,000     |   | (57 | )% | $ | 70,000 |   |
|                             |            |                                         |            |  |  |  |  |  |  |

 

Weinitiated our SCOsource business for the purpose of protecting and defending ourintellectual property rights in our UNIX source code and derivative works.  SCOsource licensing revenue was $30,000 forthe three months ended January 31, 2006 compared to $70,000 for the threemonths ended January 31, 2005.

Weare unable to predict the amount and timing of future SCOsource licensingrevenue, and if generated, the revenue will be sporadic.

*Services Revenue*

| ** **               | ** ** | **Three Months Ended January 31,** | ** ** |
|--------------------------|------------|-----------------------------------------|------------|
| ** **               | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|                     |       |                                    |       |   |   |   |   |
| Services revenue         |       | $                                       | 1,313,000  |   | (12 | )% | $ | 1,491,000 |   |
| Percent of total revenue |       | 18                                      | %          |   |   | 17 | % |
|                          |            |                                         |            |  |  |  |  |  |  |

 

Servicesrevenue consists primarily of technical support fees, engineering servicesfees, professional services fees and consulting fees.  These fees are typically charged and invoicedseparately from UNIX products sales.  Thedecrease in services revenue of $178,000, or 12%, for the three months endedJanuary 31, 2006 as compared to the three months ended January 31, 2005, wasprimarily attributable to a decrease in the dollar amount of support andengineering services fees as well as to the decrease in products revenue.

Themajority of our support and professional services revenue continues to bederived from services for UNIX-based operating system products.  Our future level of services revenue dependsin part on our ability to generate UNIX products revenue from new customers aswell as to renew annual support and services agreements with existing UNIXcustomers.

*Cost of Products Revenue*

| ** **                  | ** ** | **Three Months Ended January 31,** | ** ** |
|-----------------------------|------------|-----------------------------------------|------------|
| ** **                  | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                                    |       |   |   |   |   |
| Cost of products revenue    |       | $                                       | 584,000    |   | (9 | )% | $ | 644,000 |   |
| Percent of products revenue |       | 10                                      | %          |   |   | 9 | % |
|                             |            |                                         |            |  |  |  |  |  |  |

 

Costof products revenue consists of manufacturing costs, royalties to third-partyvendors, technology costs and overhead costs. Cost of products revenue decreased by $60,000, or 9%, for the threemonths ended January 31, 2006 as compared to the three months ended January 31,2005.  This decrease in the dollar amountof cost of products revenue was primarily attributable to lower productsrevenue as margins did not vary considerably.

Forthe remaining quarters of the year ending October 31, 2006, we expect thedollar amount of our cost of products revenue to be generally consistent withthe cost of products revenue incurred during the three months ended January 31,2006 and that cost of products revenue as a percent of products revenue for theremaining quarters of the year ending October 31, 2006 will be generallyconsistent with that incurred during the three months ended January 31, 2006.

 

25

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*Cost ofSCOsource Licensing Revenue*  

| ** **                          | ** ** | **Three Months Ended January 31,** | ** ** |
|-------------------------------------|------------|-----------------------------------------|------------|
| ** **                          | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|                                |       |                                    |       |   |   |   |   |
| Cost of SCOsource licensing revenue |       | $                                       | 4,010,000  |   | 15 | % | $3,493,000 |   |
|                                     |            |                                         |            |  |  |  |  |  |

 

Costof SCOsource licensing revenue includes legal and professional fees incurred inconnection with our SCO Litigation, the salaries and related personnel costs ofSCOsource employees, and an allocation of corporate costs.

Costof SCOsource licensing revenue increased by $517,000, or 15%, during the threemonths ended January 31, 2006 as compared to the three months ended January 31,2005.  The increase in costs for thethree months ended January 31, 2006 compared to the three months ended January31, 2005 was primarily attributable to increased legal costs for expert andtechnical consultants incurred in connection with our SCO Litigation.

We anticipate that the dollar amount of our cost ofSCOsource licensing revenue for the remaining quarters of the year endingOctober 31, 2006 will be lower than the costs incurred for the three monthsended January 31, 2006 as we made our final $2,000,000 payment on December 1,2005 that was due to the Law Firms.  Wewill continue to make payments for expert, consulting and other fees.  However, future legal fees may includecontingency payments made to the Law Firms as a result of a settlement,judgment, or a sale of our Company, which could cause the cost of SCOsourcelicensing revenue for any of the remaining quarters of the year ending October31, 2006 to be higher than the costs incurred for the three months endedJanuary 31, 2006.

*Cost of Services Revenue*

| ** **                  | ** ** | **Three Months Ended January 31,** | ** ** |
|-----------------------------|------------|-----------------------------------------|------------|
| ** **                  | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                                    |       |   |   |   |   |
| Cost of services revenue    |       | $                                       | 637,000    |   | (15 | )% | $ | 749,000 |   |
| Percent of services revenue |       | 49                                      | %          |   |   | 50 | % |
|                             |            |                                         |            |  |  |  |  |  |  |

 

Costof services revenue includes the salaries and related personnel costs of employeesdelivering services revenue as well as third-party service agreements.  Cost of services revenue decreased by$112,000, or 15%, for the three months ended January 31, 2006 compared to thethree months ended January 31, 2005. This decrease was attributable to reduced numbers of employeesand related costs and the elimination of certain third-party support contracts.

Forthe remaining quarters of the year ending October 31, 2006, we expect thedollar amount of our cost of services revenue to be generally consistent withthe cost of services revenue incurred during the three months ended January 31,2006 and that cost of services revenue as a percent of services revenue for theremaining quarters of the year ending October 31, 2006 will be generally consistentwith that incurred during the three months ended January 31, 2006.

*Sales and Marketing*

| ** **                   | ** ** | **Three Months Ended January 31,** | ** ** |
|------------------------------|------------|-----------------------------------------|------------|
| ** **                   | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|                         |       |                                    |       |   |   |   |   |
| Sales and marketing expenses |       | $                                       | 2,688,000  |   | (9 | )% | $ | 2,944,000 |   |
| Percent of total revenue     |       | 37                                      | %          |   |   | 33 | % |
|                              |            |                                         |            |  |  |  |  |  |  |

 

Salesand marketing expenses consist of the salaries, commissions and other personnelcosts of employees involved in the revenue generation process, as well asadvertising and corporate allocations. The decrease in sales and marketing expenses of $256,000, or 9%, for thethree months ended January 31, 2006 compared with the three months endedJanuary 31, 2005 

 

26

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wasprimarily attributable to decreased spending on co-operative advertising and lowerpremises costs for our international sales offices.  Included in sales and marketing expenses forthe three months ended January 31, 2006 and 2005 was $68,000 and $7,000,respectively, for stock-based compensation. Our sales and marketing full-time equivalent employees increased from 50as of January 31, 2005 to 53 as of January 31, 2006.

Forthe remaining quarters of the year ending October 31, 2006, we anticipate thatthe dollar amount of sales and marketing expenses will be generally consistentwith that incurred during the three months ended January 31, 2006.

*Research and Development*

| ** **                        | ** ** | **Three Months Ended January 31,** | ** ** |
|-----------------------------------|------------|-----------------------------------------|------------|
| ** **                        | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|                              |       |                                    |       |   |   |   |   |
| Research and development expenses |       | $                                       | 1,871,000  |   | (10 | )% | $ | 2,088,000 |   |
| Percent of total revenue          |       | 25                                      | %          |   |   | 24 | % |
|                                   |            |                                         |            |  |  |  |  |  |  |

 

Researchand development expenses consist of the salaries and benefits of softwareengineers, consulting expenses and corporate allocations.  Research and development expenses decreasedby $217,000, or 10%, for the three months ended January 31, 2006 compared withthe three months ended January 31, 2005, which was primarily attributable todecreased personnel and personnel-related costs.  Included in research and development expensesfor the three months ended January 31, 2006 and 2005 was $20,000 and $8,000,respectively, of stock-based compensation. Our research and development full-time equivalent employees decreasedfrom 55 as of January 31, 2005 to 49 as of January 31, 2006.

Forthe remaining quarters of the year ending October 31, 2006, we anticipate thatthe dollar amount of research and development expenses will be generallyconsistent with that incurred during the three months ended January 31, 2006.

*General and Administrative*

| ** **                          | ** ** | **Three Months Ended January 31,** | ** ** |
|-------------------------------------|------------|-----------------------------------------|------------|
| ** **                          | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|                                |       |                                    |       |   |   |   |   |
| General and administrative expenses |       | $1,592,000                              |       | (10 | )% | $1,763,000 |   |
| Percent of total revenue            |       | 22                                      | %          |   |   | 20 | % |

 

Generaland administrative expenses consist of the salaries and benefits of finance,human resources, and executive management and expenses for professionalservices and corporate allocations. General and administrative expenses decreased by $171,000, or 10%,during the three months ended January 31, 2006 as compared to the three monthsended January 31, 2005.  The decrease ingeneral and administrative expenses was primarily attributable to lowerpersonnel and related costs and decreased professional service fees attributedto accounting, auditing and legal work, offset, in part, by stock-basedcompensation.  Included in general andadministrative expenses for the three months ended January 31, 2006 and 2005was $246,000 and $0, respectively, of stock-based compensation.  Our general and administrative full-timeequivalent employees decreased from 31 as of January 31, 2005 to 27 as of January31, 2006.

Forthe remaining quarters of the year ending October 31, 2006, we anticipate thatthe dollar amount of general and administrative expenses will be generallyconsistent to that incurred during the three months ended January 31, 2006.

 

27

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*Amortization of Intangibles*

| ** **                   | ** ** | **Three Months Ended January 31,** | ** ** |
|------------------------------|------------|-----------------------------------------|------------|
| ** **                   | ** ** | **2006**                                | ** ** | **Change** | ** ** | **2005** | ** ** |
|                         |       |                                    |       |   |   |   |   |
| Amortization of  intangibles |       | $                                       | 592,000    |   | 0 | % | $ | 593,000 |   |
| Percent of total revenue     |       | 8                                       | %          |   |   | 7 | % |
|                              |            |                                         |            |  |  |  |  |  |  |

 

During the three monthsended January 31, 2006 and 2005, we expensed $592,000 and $593,000,respectively, for the amortization of intangible assets with definite lives.

*Equityin Income (Loss) of Affiliate*

We account for ourownership interests in companies in which we own at least 20 percent and lessthan 50 percent using the equity method of accounting.  Under the equity method, we record ourportion of the entities’ net income or net loss in our consolidated statementsof operations.  As of January 31, 2006,the carrying value of our investments was $599,000 and was related to our 30percent ownership in a Chinese company.

Duringthe three months ended January 31, 2006 and 2005, we recorded $(8,000) and$53,000, respectively, that related to equity in income (loss) of the Chinesecompany.

*OtherIncome (Expense), net*

Otherincome (expense) consisted of the following components for the three monthsended January 31, 2006 and 2005:

| ** **                   | ** ** | **Three Months Ended January 31,** | ** ** |
|------------------------------|------------|-----------------------------------------|------------|
| ** **                   | ** ** | **2006**                                | ** ** | **2005** | ** ** |
|                         |       |                                    |       |   |   |
| Interest income              |       | $                                       | 152,000    |   | $ | 37,000 |   |
| Other income (expense),  net |       | (7,000                                  | )          | 472,000 |   |
| Total                        |       | $                                       | 145,000    |   | $ | 509,000 |   |

 

Interestincome increased by $115,000 from the three months ended January 31, 2005 ascompared to the three months ended January 31, 2006 and was primarilyattributable to higher interest rates earned on our cash and available-for-salemarketable securities balances as well as higher cash and available-for-salemarketable securities balances.   Thehigher cash balance is primarily attributable to our recently completed financingdescribed in Note 6 to the Notes to Condensed Consolidated FinancialStatements.

Thedecrease in other income (expense), net, of $479,000 was primarily attributableto the collection of a $500,000 note receivable from Vintela, Inc. during thethree months ended January 31, 2005.

*Provision for Income Taxes*

The provision for income taxes was $87,000 for thethree months ended January 31, 2006 and $114,000 for the three months endedJanuary 31, 2005.  Our provision for income taxes isprimarily related to earnings in foreign subsidiaries as well as fromwithholding taxes on revenue generated in certain foreign locations.

**Liquidityand Capital Resources**

                Our cash and cash equivalentsbalance increased from $4,272,000 as of October 31, 2005 to $12,018,000 as ofJanuary 31, 2006.  During this same timeperiod, our investment in available-for-sale marketable securities increasedfrom $6,165,000 to $7,196,000.  Ourworking capital also 

 

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increasedfrom $8,669,000 as of October 31, 2005 to $15,411,000 as of January 31,2006.  All of these increases wereattributable to the issuance of approximately 2,852,000 shares of our commonstock for net proceeds of approximately $9,905,000 in November 2005.

Totalcash and cash equivalents and available-for-sale marketable securities were$19,214,000 as of January 31, 2006.  As ofJanuary 31, 2006, we also had $2,670,000 of restricted cash, of which$1,758,000 is set aside to cover expert and other costs related to our SCOLitigation and $912,000 is set aside for royalties payable to Novell.

We intend to use thecash and cash equivalents and available-for-sale marketable securities as of January31, 2006to pursue our SCO Litigation and to run our UNIX business.

Our net cash used inoperating activities during the three months ended January 31, 2006 was$1,379,000 and was attributable to a net loss of $4,581,000, non-cash items of$1,170,000 and changes in operating assets and liabilities of $2,032,000.

Ournet cash used in operating activities during the three months ended January 31,2005 was $16,596,000.  Cash used in operating activities for thethree months ended January 31, 2005 was attributable to a net loss of$2,961,000, non-cash expenses of $746,000 and changes in operating assets andliabilities of $14,381,000.

Our investing activitieshave historically consisted of equipment purchases, investing in strategicpartners and the purchase and sale of available-for-sale marketable securities.

During the three monthsended January 31, 2006, cash used in investing activities was $1,100,000, whichwas primarily a result of purchases of available-for-sale marketable securitiesof $1,031,000, and purchases of equipment of $69,000.

During the three monthsended January 31, 2005, cash provided by investing activities was $12,765,000,which was primarily a result of sales, net of purchases, of available-for-salemarketable securities, of $12,810,000, which was offset, in part, by purchasesof property and equipment of $45,000.

Our financing activitiesprovided $10,197,000 of cash during the three months ended January 31,2006.  The primary sources of cash werethe net proceeds from the issuance of approximately 2,852,000 shares of ourcommon stock for $9,905,000, the exercise of options to acquire common stock of$23,000 and proceeds of $301,000 received from the sale of common stock throughour ESPP, offset, in part, by the repurchase of shares of our common stock madein connection with the completion of our rescission offer of $32,000.

Our financing activitiesprovided $571,000 of cash during the three months ended January 31, 2005 andconsisted primarily of proceeds received from the exercise of stock options of$198,000 and proceeds from the purchase of shares of common stock by ouremployees through our ESPP of $373,000.

Our net accountsreceivable balance decreased from $6,343,000 as of October 31, 2005 to$4,917,000 as of January 31, 2006, primarily as a result of lower invoicing andrevenue generated during the three months ended January 31, 2006 as compared tothe three months ended October 31, 2005. The majority of our accounts receivable are current and our allowancefor doubtful accounts was $136,000 as of January 31, 2006, which representedapproximately 3 percent of our gross accounts receivable balance.  This percentage of gross accounts receivableis consistent with our experience in prior periods, and we expect this trend tocontinue.  Our write-offs ofuncollectible accounts during the three months ended January 31, 2006 and 2005were not significant.

 

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OnOctober 31, 2004, we entered into an engagement agreement (the “EngagementAgreement”) with the Law Firms.  TheEngagement Agreement supercedes and replaces the original engagement agreementthat was entered into in February 2003. The Engagement Agreement governs the relationship between us and the LawFirms in connection with their representation of us in the SCO Litigation,through the end of our current litigation with IBM.  Our purpose in entering into this EngagementAgreement was to limit the cash expenditures needed to pursue the SCOLitigation.  The Engagement Agreementprovides for the payment of approximately $26,000,000 for all attorneys’ feesin connection with the SCO Litigation through the end of our current litigationwith IBM and the escrow of at least $5,000,000 for the payment of any expert,consulting and other expenses.  As of January31, 2006, we had paid the entire $26,000,000. Asof January 31, 2006, $1,758,000 remained in the escrow account and wasclassified as a component of restricted cash. In the event that weexhaust this remaining balance, we will continue to pay for expert, consultingand other expenses through the conclusion of our litigation with IBM.

Inaddition to the cash expenditures mentioned above, we must also pay one or morecontingency fees upon any amount we or our stockholders may receive as a resultof a settlement, judgment, or a sale of our Company.  The contingency fee amounts payable to theLaw Firms will be, subject to certain credits and adjustments, as follows:

•                  33 percent of any aggregate recoveryamounts received up to $350,000,000;

•                  plus 25 percent of any aggregate recoveryamounts above $350,000,000 but less than or equal to $700,000,000;

•                  plus 20 percent of any aggregate recoveryamounts in excess of $700,000,000.

TheEngagement Agreement specifically provides that, except for the compensationobligations specifically described above, we will not be obligated to pay anylegal fees, whether hourly, contingent or otherwise, to the Law Firms, or anyother law firms that may be engaged by the Law Firms, in connection with theSCO Litigation through the end of the current litigation between us and IBM,including any appeals.

Wehave entered into operating leases for our corporate offices located in theUnited States and our international sales offices.  We have commitments under these leases thatextend through the year ending October 31, 2008.

Thefollowing table summarizes our contractual operating lease obligations as ofJanuary 31, 2006: 
| ** **                   | ** ** | **Total** | ** ** | **Less than  1 year** | ** ** | **1 - 3 years** | ** ** | **3 -5 years** | ** ** | **More than  5 years** | ** ** |
|------------------------------|------------|-----------|------------|-----------------------|------------|-----------------|------------|----------------|------------|------------------------|------------|
|                         |       |      |       |                  |       |            |       |           |       |                   |       |
| Operating lease  obligations |       | $         | 3,353,000  |                  | $          | 1,790,000       |       | $              | 1,563,000  |                   | $          | — |   | $ | — |   |
|                              |            |           |            |                       |            |                 |            |                |            |                        |            |  |  |  |  |  |

 

As of January 31, 2006,we did not have any long-term debt obligations, purchase obligations, otherlong-term liabilities or material capital lease obligations.

Our ability to reducecosts to offset revenue declines in our UNIX business is limited because ofcontractual commitments to maintain and support our existing UNIXcustomers.  This decline in our UNIX business may beaccelerated if industry partners withdraw their support as a result of the SCOLitigation.  In addition, the SCOLitigation may cause industry partners, developers and hardware and softwarevendors to choose not to support or certify to our UNIX operating systemproducts.  This would lead to anaccelerated decline in our UNIX products and services revenue.  Ifour UNIX products and services revenue is less than expected, our liquiditywill be adversely impacted.

 

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In the event that cashrequired to fund operations, the SCO Litigation and strategic initiativesexceeds our current cash resources and cash generated from operations, we willbe required to reduce costs and perhaps raise additional capital.  We may not be able to reduce costs in amanner that does not impair our ability to maintain our UNIX business andpursue the SCO Litigation.  We may alsonot be able to raise capital for any number of reasons including those listedunder Item 1A—Risk Factors.  Ifadditional equity financing is available, it may not be available to us onattractive terms and may be dilutive to our existing stockholders.  In addition, if our stock price declines, wemay not be able to access the public equity markets on acceptable terms, if atall.  Our ability to effect acquisitionsfor stock would also be impaired.

#### ***Forward-Looking Statements and Factors That May AffectFuture Results and Financial Condition***

#### ***With the exception of historicalfacts, the statements contained in Management’s Discussion and Analysis ofFinancial Condition and Results of Operations are “forward-looking statements”within the meaning of the Private Securities Litigation Reform Act of 1995,which reflect our current expectations and beliefs regarding our future resultsof operations, performance and achievements. These statements are subject torisks and uncertainties and are based upon assumptions and beliefs that may ormay not materialize.  Theseforward-looking statements include, but are not limited to, statementsconcerning:***

•                              Our belief that the future success of ourSCOsource initiatives will depend on our ability to protect our intellectualproperty;

•                              Our intention to vigorously defend legalclaims and counterclaims brought against us by others;

•                              Our intention to continue to pursue theSCO Litigation;

•                              Our expectation that our UNIX businesswill generate positive cash flow during the year ending October 31, 2006;

•                              Our belief that our allowance fordoubtful accounts receivable will remain consistent with our prior experience;

•                              The strength of our intellectual propertyrights and contractual claims regarding UNIX generally and specifically thestrength of our claim that unauthorized UNIX source code and derivatives ofUNIX source code are prevalent in Linux;

•                              Our belief that competition from Linuxwill continue during the year ending October 31, 2006 and future periods;

•                              Our expectation that we will continue tobe unable to predict the amount and timing of SCOsource licensing revenue, and ifgenerated, the revenue will be sporadic;

•                              Our expectation that future servicesrevenue will depend in part on our ability to generate UNIX products revenuefrom new customers as well as the renewal of annual support and servicesagreements from existing UNIX customers;

•                              Our expectation for the remainingquarters of the year ending October 31, 2006 that the dollar amount of our costof products revenue and as a percent of products revenue will be generallyconsistent to that generated during the three months ended January 31, 2006;

•                              Our expectation for the remainingquarters of the year ending October 31, 2006 that the dollar amount of our costof services revenue and as a percent of services revenue will be generallyconsistent to that generated during the three months ended January 31, 2006;

 

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•                              Our expectation for the remainingquarters of the year ending October 31, 2006 that the dollar amount of oursales and marketing expenses will be generally consistent to that generatedduring the three months ended January 31, 2006;

•                              Our expectation for the remainingquarters of the year ending October 31, 2006 that the dollar amount of our researchand development expenses will be generally consistent to that generated duringthe three months ended January 31, 2006;

•                              Our expectation for the remainingquarters of the year ending October 31, 2006 that the dollar amount of ourgeneral and administrative expenses will be generally consistent to thatgenerated during the three months ended January 31, 2006;

•                              Our expectation for the remainingquarters of the year ending October 31, 2006 that the cost of SCOsourcelicensing revenue will be less than that generated during the three monthsended January 31, 2006, exclusive of any contingent payments; and

•                              Our belief that certain legal actions towhich we are a party will not have a material adverse effect on us.

Wewish to caution readers that our operating results are subject to various risksand uncertainties that could cause our actual results and outcomes to differmaterially from those discussed or anticipated, including the success of ourSCOsource business, competition from other operating systems, particularlyLinux, the amount and timing of SCOsource licensing revenue, our ability toenhance our UNIX operating systems and maintain our UNIX business, and thefactors set forth in “Item 1A—Risk Factors”.  We also wish to advise readers not to placeany undue reliance on the forward-looking statements contained in this report,which reflect our beliefs and expectations only as of the date of thisreport.  We assume no obligation toupdate or revise these forward-looking statements to reflect new events orcircumstances or any changes in our beliefs or expectations, other than asrequired by law.

**ITEM3.****                 ****QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

*Foreign Currency Risk. *Wehave foreign offices and operations in Europe and Asia.  As a result, a portion of our revenue isderived from sales to customers outside the United States.  Our international revenue is denominated inU.S. dollars, Euros and United Kingdom Pounds. Most of the operating expenses related to our foreign-based operationsare denominated in foreign currencies and therefore operating results areaffected by changes in the U.S. dollar exchange rate in relation to foreigncurrencies such as the Euro, among others. If the U.S. dollar further weakens compared to the Euro, our operatingexpenses for foreign operations will be higher when translated back into U.S.dollars.  Our revenue can also beaffected by general economic conditions in the United States, Europe and otherinternational markets.  Our results ofoperations may be affected in the short term by fluctuations in foreigncurrency exchange rates.

*Interest Rate Risk. *Theprimary objective of our cash management strategy is to invest available fundsin a manner that assures maximum safety and liquidity and maximizes yieldwithin such constraints.  We believe thata hypothetical movement in interest rates, either up or down, would not have amaterial adverse impact on our cash and cash equivalents and available-for-salemarketable securities.  We do not borrowmoney for short-term investment purposes.

*Investment Risk. *Wehave invested in equity instruments of privately held and public companies inthe technology industry for business and strategic purposes.  Investments are accounted for under the costmethod if our ownership is less than 20 percent and we are not able to exerciseinfluence over operations.  Ourinvestment policy is to regularly review the assumptions and operatingperformance of these companies and to record impairment losses 

 

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when events and circumstances indicate thatthese investments may be impaired.  As ofJanuary 31, 2006, our investments balance totaled approximately $599,000 andconsisted solely of our investment in a 30% owned Chinese company.

The stock market ingeneral, and the market for shares of technology companies in particular, hasexperienced price fluctuations.  Inaddition, factors such as new product introductions by our competitors ordevelopments in the SCO Litigation may have a significant impact on the marketprice of our common stock.  Furthermore,quarter-to-quarter fluctuations in our results of operations may have asignificant impact on the market price of our common stock.  These conditions could cause the price of ourcommon stock to fluctuate substantially over short periods of time.

**ITEM4.****                 ****CONTROLS AND PROCEDURES**

*Evaluation of disclosure controlsand procedures.*  Under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, we evaluated the effectiveness of the design andoperation of our disclosure controls and procedures (as defined in Rule13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)).  Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that, as of the end ofthe period covered by this report, our disclosure controls and procedures wereeffective.

*Changes in internal control overfinancial reporting.*  During the most recent fiscal quarter coveredby this report, there has been no change in our internal control over financialreporting (as defined in Rule 13a-15(f) under the Exchange Act) that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

**PARTII.****               ****OTHER****INFORMATION**

**ITEM 1.        ****       ****LEGAL****PROCEEDINGS**

*IBM Corporation*

On February 13, 2006, IBM filed a motionwith the Court seeking to limit our claims. IBM argues that of the 294 items identified by us in our December 22,2005 filing, 201 did not meet the level of specificity required by theCourt.  IBM requested that we be limitedto 93 items set forth in the December 22, 2005 filing which IBM claims meet therequired level of specificity.  Wedisagree with IBM’s motion and analysis and filed an opposition brief underseal with the Court.

**ITEM 1A.****              ****RISK FACTORS**

Investingin our securities involves a high degree of risk. In addition to the otherinformation contained in this Form 10-Q, you should consider the followingrisk factors before investing in our securities.

*We donot have a history of profitable operations.*

Ouryear ended October 31, 2003 was the first full year we were profitable inour operating history.  Our profitabilityfor the year ended October 31, 2003 resulted primarily from our SCOsourcebusiness.  For the years ended October31, 2005 and 2004, we incurred net losses applicable to common stockholders of$10,726,000 and $16,227,000, respectively, and for the three months endedJanuary 31, 2006 we incurred a net loss of $4,581,000.  As of January 31, 2006, our accumulateddeficit was $239,523,000.

Ifour revenue from the sale of our UNIX products and services continues todecline, we will need to further reduce operating expenses to generate positivecash flow. We may not be able to further reduce operating expenses withoutdamaging our ability to support our existing UNIX business. Additionally, wemay not be able to achieve profitability through additional cost-cuttingactions.

 

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 OurUNIX products and services revenue has declined over the last several yearsprimarily as a result of continued competition from alternative operatingsystems, particularly Linux. In our results of operations, we recognize revenuefrom agreements for support and maintenance contracts and other long-termcontracts that have been previously invoiced and are included in deferredrevenue. Our future UNIX revenue may be adversely impacted and may continue todecline if we are unable to replenish these deferred revenue balances withlong-term maintenance and support contracts or replace them with othersustainable revenue streams. If we are unable to generate positive cash flowand profitable operations, our business will be adversely impacted.

*We maynot prevail in our SCO Litigation, which may adversely affect our ability tocontinue in business.*

Wecontinue to pursue the SCO Litigation and believe in the merits of ourcases.  In our action against IBM, weseek damages for claims generally relating to our allegation that IBM hasinappropriately used and distributed our UNIX source code and derivative worksin connection with its efforts to promote the Linux operating system.  IBM has responded to our claims and broughtcounterclaims against us asserting generally that we do not have the right toassert claims based on our ownership of UNIX intellectual property against IBMor others in the Linux market.  Discoveryis continuing in the case.  If we do notprevail in our action against IBM, or if IBM is successful in its counterclaimsagainst us, our business and results of operations would be materially harmedand we may not be able to continue in business. The litigation with IBM and others will be costly, and our costs forlegal fees and related expenses have been and will continue to be substantialand may exceed our capital resources. Additionally, the market price of our common stock may be negativelyaffected as a result of developments in our legal action against IBM that may be,or may be perceived to be, adverse to us.

Asa result of the SCO Litigation, participants in the Linux marketplace andothers affiliated with IBM or sympathetic to the Linux movement have takenactions attempting to negatively affect our business and our SCOsourceefforts.  Linux proponents have taken abroad range of actions against us, including, for example, attempting toinfluence participants in the markets in which we sell our products to reduceor eliminate the amount of our products and services they purchase fromus.  We expect that similar effortslikely will continue.  There is a riskthat additional participants in our marketplace will negatively view the SCOLitigation, and we may lose support from such participants.  Any of the foregoing could adversely affectour position in the marketplace, our results of operations and our stock priceand our ability to stay in business.

Asa response to our claim that our UNIX source code and derivative works haveinappropriately been included in Linux, Novell has publicly asserted its beliefthat it owns certain copyrights in our UNIX source code, and it has filed 15copyright applications with the United States Copyright Office related toUNIX.  Novell has claimed to haveretained rights related to UNIX source code licenses, including the licensewith IBM.  Novell asserts it has theright to take action on behalf of SCO in connection with such licenses,including termination rights.  Novell haspurported to veto our termination of the IBM, Sequent and SGI licenses.  We have asserted that we obtained the UNIXbusiness, source code, claims and copyrights when we acquired the assets andoperations of the server and professional services groups from The Santa CruzOperation in May 2001, which had previously acquired all such assets andrights from Novell in 1995 pursuant to an asset purchase agreement, asamended.  In January 2004, inresponse to Novell’s actions, we brought suit against Novell for slander oftitle seeking relief for Novell’s alleged bad faith effort to interfere withour rights related to our UNIX source code and derivative works and ourUnixWare products.  Novell twiceunsuccessfully sought to have the case dismissed.

 

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OnJuly 29, 2005, Novell filed its Answer and Counterclaims against us, assertingcounterclaims for our alleged breaches of the Asset Purchase Agreement betweenNovell and our predecessor-in-interest, The Santa Cruz Operation, Inc., forslander of title, restitution/unjust enrichment, an accounting related toNovell’s retained binary royalty stream, and for declaratory relief regardingNovell’s alleged rights under the Asset Purchase Agreement.  On or about December 30, 2005, we filed amotion for leave to amend our complaint to assert additional claims againstNovell, including copyright infringement, unfair competition and a breach ofNovell’s limited license to use our UNIX source code.

Notwithstandingour assertions of full ownership of critical UNIX-related intellectual propertyrights, as set forth above, including copyrights, and even if we are successfulin our legal action against Novell and end users such as AutoZone andDaimlerChrysler, the efforts of Novell and the other Linux proponents describedabove may cause further damage to our business including our ability tomonetize our UNIX assets.  These effortsof Linux proponents also may increase the negative view some participants inour marketplace have regarding our SCO Litigation and may contribute tocreating confusion in the marketplace about the validity of our claim that theunauthorized use of our UNIX source code and derivative works in Linux violatesour contracts and copyrights.  Increasednegative perception and potential confusion about our claims in our marketplacecould impede our continued pursuit of the SCO Litigation and negatively impactour business.  For example, we believethat our decrease in SCOsource revenue has been, in part, attributable toNovell’s claim of UNIX copyright ownership, which may have caused potentialcustomers to delay or forego licensing until an outcome in this legal matterhas been reached.

*Weoperate in a highly competitive market and face significant competition from avariety of current and potential sources; many of our current and potentialcompetitors have greater financial and technical resources than we do; thus, wemay fail to compete effectively.*

Inthe operating system market, our competitors include IBM, Red Hat, Novell,Hewlett Packard, Sun, Microsoft and other Linux distributors.  These and other competitors are aggressivelypursuing the current UNIX operating system market. Many of these competitorshave access to substantially greater resources than we do.  The major competitive alternative to our UNIXproducts is Linux.  The expansion of ourcompetitors’ offerings may restrict the overall market available for our UNIXproducts, including some markets where we have been successful in the past.

Ourfuture success may depend in part on our ability to continue to meet theincreasing needs of our customers by supporting existing and emergingtechnologies.  If we do not enhance ourproducts to meet these evolving needs, we may not remain competitive and beable to sustain or grow our business. Additionally, because technologicaladvancement in the UNIX operating system market and alternative operatingsystem markets is progressing at an advanced pace, we will have to develop andintroduce enhancements to our existing products and any new products on atimely basis to keep pace with these developments, evolving industry standardsand changing customer requirements.  Ourfailure to meet any of these and other competitive pressures may render ourexisting products and services obsolete, which would have an adverse impact onour revenue and operations.

Thesuccess of our UNIX business will depend on the level of commitment andcertification we receive from industry partners and developers.  In recent years, we have seen hardware andsoftware vendors as well as software developers turn their certification andapplication development efforts toward Linux and elect not to continue tosupport or certify to our UNIX operating system products.  If this trend continues, our competitiveposition will be adversely impacted and our future revenue from our UNIXbusiness will decline.  The decline in 

 

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ourUNIX business may be accelerated if industry partners withdraw their supportfrom us for any reason, including our SCO Litigation.

*If themarket for UNIX continues to contract, our business will be harmed.*

Ourrevenue from the sale of UNIX products has declined over the last severalyears.  This decrease in revenue has beenattributable primarily to increased competition from other operating systems,particularly Linux.  Our sales of UNIXproducts and services are primarily to existing customers. If the demand forUNIX products continues to decline, and we are unable to develop UNIX productsand services that successfully address a market demand, our UNIX revenue willcontinue to decline, industry participants may not certify to our operatingsystem and products, we may not be able to attract new customers or retainexisting customers and our business and results of operations will be adverselyaffected.  Because of the long adoptioncycle for operating system purchases and the long sales cycle of our operatingsystem products, we may not be able to reverse these revenue declines quickly.

*We maylose the support of industry partners leading to an accelerated decline in ourUNIX products and services revenue.*

Thedecline in our UNIX business and our SCO Litigation may cause industrypartners, developers and hardware and software vendors to choose not to supportor certify to our UNIX operating system products.  This would lead to an accelerated decline inour UNIX products and services revenue and would adversely impact our resultsof operations and liquidity.

*Ourclaims relating to our UNIX intellectual property may subject us to additionallegal proceedings.*

InAugust 2003, Red Hat brought a lawsuit against us asserting that the Linuxoperating system does not infringe on our UNIX intellectual property rights andseeking a declaratory judgment for non-infringement of copyrights and nomisappropriation of trade secrets.  Inaddition, Red Hat claims we have engaged in false advertising in violation ofthe Lanham Act, deceptive trade practices, unfair competition, tortiousinterference with prospective business opportunities, and trade libel and disparagement.  Although this case is currently stayedpending the resolution of our suit against IBM, we intend to vigorously defendthis action.  However, if Red Hat issuccessful in its claim against us, our business and results of operationscould be materially harmed.

Inaddition, regulators or others in the Linux market and some foreign regulatorshave initiated or in the future may initiate legal actions against us, all ofwhich may negatively impact our operations and future operating performance.

*We relyon our indirect sales channel for distribution of our products, and anydisruption of our channel at any level could adversely affect the sales of ourproducts.*

Wehave a two-tiered distribution channel. The relationships we have developed with resellers allow us to offer ourproducts and services to a much larger customer base than we would otherwise beable to reach through our own direct sales and marketing efforts.  Some solution providers also purchase solutionsthrough our resellers, and we anticipate they will continue to do so.  Because we usually sell indirectly throughresellers, we cannot control the relationships through which resellers,solution providers or equipment integrators purchase our products.  In turn, we do not control the presentationof our products to end users.  Therefore,our sales could be affected by disruptions in the relationships between us andour resellers, between our resellers and solution providers, or betweensolution providers and end users.  Also,resellers and solution providers may choose not to emphasize our products totheir customers.  Any of theseoccurrences could diminish the effectiveness of our distribution channel andlead to decreased sales.

 

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*Ourfuture SCOsource licensing revenue is uncertain.*

Weinitiated the SCOsource licensing effort in the year ended October 31,2003 to review the status of UNIX licensing and sublicensing agreements.  This effort resulted in the execution of twosignificant vendor license agreements and generated $25,846,000 in revenueduring the year ended October 31, 2003. During the years ended October 31, 2004, and 2005, our SCOsourcelicensing revenue declined to only $829,000, and $166,000, respectively, andduring the three months ended January 31, 2006, our SCOsource licensing revenuewas $30,000.  Because of a lack ofhistorical experience and the uncertainties related to SCOsource licensingrevenue, we are unable to estimate the amount and timing of future SCOsourcelicensing revenue, if any.  If we doreceive revenue from this source, it may be sporadic and fluctuate from quarterto quarter.  Additionally, the success ofthese initiatives may depend on the strength of our intellectual propertyrights and contractual claims regarding UNIX, including the strength of ourclaim that unauthorized UNIX source code and derivative works are prevalent inLinux.

*Fluctuationsin our operating results or the failure of our operating results to meet theexpectations of public market analysts and investors may negatively impact ourstock price.*

Fluctuationsin our operating results or our failure to meet the expectations of analysts orinvestors, even in the short-term, could cause our stock price to declinesignificantly.  Because of the potentialfor significant fluctuations in our SCOsource licensing revenue in anyparticular period, you should not rely on comparisons of our results ofoperations as an indication of future performance.

Factorsthat may affect our results include:

•                                          ability tosuccessfully negotiate and complete licensing and other agreements related toour intellectual property;

•                                          the interestlevel of resellers in recommending our UNIX business solutions to end users andthe introduction, development, timing, competitive pricing and marketacceptance of our products and services and those of our competitors;

•                                          the activitiesof short sellers;

•                                          changes ingeneral economic conditions, such as recessions, that could affect capitalexpenditures in the software industry;

•              results of, or developments in,our SCO Litigation;

•                                          changes inbusiness attitudes toward UNIX as a viable operating system compared to othercompeting systems, especially Linux;

•                                          the contingencyand other legal fees we may pay to the Law Firms representing us in our effortsto establish and defend our intellectual property rights; and

•                                          changes inattitudes of customers and partners due to the decline in our UNIX business andour aggressive position against the inclusion of our UNIX code and derivative worksin Linux.

Wealso experience fluctuations in operating results in interim periods in Europeand the Asia Pacific regions due to seasonal slowdowns and economic conditionsin these areas.  Seasonal slowdowns inthese regions typically occur during the summer months.

Asa result of the factors listed above and elsewhere, it is possible that ourresults of operations may be below the expectations of public market analystsand investors in any particular period. This could cause our stock price to decline. If revenue falls below ourexpectations, and we are unable to quickly reduce our spending in response, ouroperating results will be lower than expected. Our stock price may fall inresponse to these events.

 

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*Ourforeign-based operations and sales create special problems, including theimposition of governmental controls and taxes and fluctuations in currencyexchange rates that could hurt our results.*

Wehave foreign operations, including development facilities, sales personnel andcustomer support operations in Europe, Latin America and Asia. These foreignoperations are subject to certain inherent risks, including:

•                                          potential lossof developed technology through piracy, misappropriation, or more lenient lawsregarding intellectual property protection;

•                                          imposition ofgovernmental controls, including trade restrictions and other tax requirements;

•                                          fluctuations incurrency exchange rates and economic instability;

•                                          longer paymentcycles for sales in foreign countries; and

•                                          seasonalreductions in business activity.

Inaddition, certain of our operating expenses are denominated in localcurrencies, creating risk of foreign currency translation losses that couldharm our financial results and cash flows. When we generate profits in foreign countries, our effective income taxrate is increased.

Duringthe three months ended April 30, 2004, our Indian office was assessedwithholding taxes by the Government of India Income Tax Department.  The Tax Department assessed a 15 percentwithholding tax on certain revenue transactions in India that the TaxDepartment deemed royalty revenue under the Income Tax Act. We have filed anappeal with the Tax Department and believe that revenue from our packagedsoftware does not qualify for royalty treatment and therefore would not besubject to withholding tax.  However, wemay be unsuccessful in our appeal against the Tax Department and be obligatedto pay the assessed taxable amounts. Because of our international operations, we may be subject to additionalwithholding or other taxes from other international jurisdictions.

*If weare unable to retain key personnel in an intensely competitive environment, ouroperations could be adversely affected.*

Weneed to retain our key management, technical and support personnel.  Competition for qualified professionals inthe software industry is intense, and departures of existing personnel could bedisruptive to our business and might result in the departure of otheremployees.  The loss or departure of anyofficers or key employees could harm our ability to implement our business planand could adversely affect our operations. Our future success depends to a significant extent on the continued serviceand coordination of our management team, particularly Darl C. McBride, ourPresident and Chief Executive Officer.

*OurEngagement Agreement with the Law Firms representing us in the SCO Litigationrequires us to pay for expert, consulting and other costs, which could harm ourliquidity position if these costs are higher than anticipated.*

Asof January 31, 2006, we had a total of $19,214,000 in cash and cash equivalentsand available-for-sale marketable securities and an additional $1,758,000 ofrestricted cash to be used to pursue the SCO Litigation.  Since October 31, 2004, we have spent$3,242,000 for expert, consulting and other costs as agreed in the EngagementAgreement with our legal counsel in the SCO Litigation.  As we continue with discovery and other trialpreparations during the year ending October 31, 2006, we believe that we willspend the $1,758,000 remaining in escrow and we may be required to placeadditional amounts into the escrow account, which could harm our liquidityposition.

 

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*We haveissued options under our equity compensation plans without complying withregistration or qualification requirements under the securities laws ofCalifornia, Georgia and possibly other states, and, as a result, we may incurrescission liability for such options and may face additional potential claimsunder state securities laws.*

Inaddition to the shares issued under the ESPP, we have granted options under our1999 Omnibus Stock Incentive Plan and 2002 Omnibus Stock Incentive Plan withoutcomplying with the registration or qualification requirements under thesecurities laws of California, Georgia and possibly other states.  We may face rescission liability to planparticipants holding unexercised stock options in these states.  Additionally, regulatory authorities mayrequire us to pay fines or they may impose other sanctions upon us, and we mayface other claims by plan participants other than rescission claims.

*Ourstock price is volatile.*

Thetrading price for our common stock has been volatile during the last severalyears and our share price has changed dramatically over short periods.  We believe that changes in our stock priceare affected by the factors mentioned above under the caption entitled *“Fluctuations in our operating results or the failure of our operatingresults to meet the expectations of public market analysts and investors maynegatively impact our stock price”*as well as from changing publicperceptions concerning the strength of our intellectual property claims andother factors beyond our control.  Publicperception can change quickly and without any change or development in ourunderlying business or litigation position. An investment in our stock is subject to such volatility and,consequently, is subject to significant risk.

*Thereare risks associated with the potential exercise of our outstanding options.*

Asof February 28, 2006, we have issued outstanding options to purchase up toapproximately 4,634,000 shares of common stock with an average exercise priceof $4.11 per share.  The existence ofsuch rights to acquire common stock at fixed prices may prove a hindrance toour efforts to raise future equity and debt funding, and the exercise of suchrights will dilute the percentage ownership interest of our stockholders andmay dilute the value of their ownership. The possible future sale of shares issuable on the exercise ofoutstanding options could adversely affect the prevailing market price for ourcommon stock.  Further, the holders ofthe outstanding stock options may exercise them at a time when we wouldotherwise be able to obtain additional equity capital on terms more favorableto us.

*Commonstock available for resale may depress the market price of our common stock.*

Wehave filed a post-effective amendment to a registration statement with theSecurities and Exchange Commission (“SEC”), which has been declared effective,covering the potential resale by one of our shareholders of up to 1,105,153shares of common stock, or 5.3% of our outstanding common stock.  In addition, we have filed a registrationstatement with the SEC, which has not been declared effective, covering thepotential resale by some of our shareholders of up to 2,852,449 shares of ourcommon stock, or 13.6% of our outstanding common stock.  The existence of a substantial number ofshares of common stock subject to immediate resale could depress the marketprice for our common stock and impair our ability to raise needed capital.

*Ourstock price could decline further because of the activities of short sellers.*

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

 

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*Theright of our Board of Directors to authorize additional shares of preferredstock could adversely impact the rights of holders of our common stock.*

OurBoard of Directors currently has the right, with respect to the 5,000,000shares of our preferred stock, to authorize the issuance of one or moreadditional series of our preferred stock with such voting, dividend and otherrights as our directors determine.  TheBoard of Directors can designate new series of preferred stock without theapproval of the holders of our common stock. The rights of holders of our common stock may be adversely affected bythe rights of any holders of additional shares of preferred stock that may beissued in the future, including without limitation, further dilution of theequity ownership percentage of our holders of common stock and their votingpower if we issue preferred stock with voting rights.  Additionally, the issuance of preferred stockcould make it more difficult for a third party to acquire a majority of ouroutstanding voting stock.

*Ourstockholder rights plan could make it more difficult for a hostile bid for ourcompany or a change of control transaction to succeed at current market pricesfor our stock.*

We have adopted a stockholder rightsplan.  The power given to the Board ofDirectors by the stockholder rights plan may make it more difficult for achange of control of our company to occur or for our company to be acquiredwhen the acquisition is opposed by our Board of Directors.

**ITEM 2.****               ****UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

*Issuer Purchases of EquitySecurities.*** **
| ** **               | ** ** | **Total Number of  Shares Purchased (1)** | ** ** | **Average Price  Paid per Share** | ** ** | **Total Number of  Shares  Purchased as  Part of Publicly  Announced Plan** | ** ** | **Maximum  Number of  Shares that May  Yet to be  Purchased Under  the Plan(2)** | ** ** |
|--------------------------|------------|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
|                     |       |                                      |       |                              |       |                                                                        |       |                                                                             |       |
| November 1-30, 2005 |       | —                                    |       | $                                 | —     |                                                                        | —     |                                                                             | —     |   |
| December 1-31, 2005 |       | —                                    |       | —                            |       | —                                                                      |       | —                                                                           |       |
| January 1-31, 2006  |       | 7,300                                     |       | 4.36                              |       | —                                                                      |       | —                                                                           |       |
| Total                    |       | 7,300                                     |       | $                                 | 4.36       |                                                                        | —     |                                                                             |       |   |

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(1)          TheCompany purchased these shares pursuant to the rescission offer completed onJanuary 20, 2006.  As of that date, 14offerees had accepted the Company’s offer to rescind the purchase ofapproximately 7,300 shares.  The Companymade aggregate payments to such offerees of approximately $41,500, which includesapproximately $31,800 for the purchase of the shares and approximately $9,700in statutory interest and damages.

(2)          OnMarch 10, 2004, our Board of Directors authorized the repurchase of up to1,500,000 shares of common stock in the open-market or private transactions.The plan expired on March 10, 2006. At the time of expiration, the Companyhad repurchased 290,000 shares of common stock pursuant to this plan.

**ITEM 6.****               ****EXHIBITS**

(a)                                  Exhibits

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

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

 

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

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

3.5                                 Certificate ofDesignation for Series A-1 Convertible Preferred Stock (incorporated byreference to Exhibit 4.1 to SCO’s Current Report on Form 8-K filed on February9, 2004 (File No. 000-29911)).

3.6                                 Certificate ofCorrection correcting the Certificate of Designation for Series A-1 ConvertiblePreferred Stock (incorporated by reference to Exhibit 4.2 to SCO’s CurrentReport on Form 8-K filed on February 9, 2004 (File No. 000-29911)).

31.1                           Certificationof Darl C. McBride, President and Chief Executive Officer, pursuant to Rule13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

31.2                           Certificationof Bert B. Young, Chief Financial Officer, pursuant to Rule 13a-14(a) of theExchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1                           Certificationof Darl C. McBride, President and Chief Executive Officer, pursuant to Section1350, Chapter 63 of Title 18, United States Code, as adopted pursuant toSection 906 of the Sarbanes-Oxley Act of 2002.

32.2                           Certificationof Bert B. Young, Chief Financial Officer, pursuant to Section 1350, Chapter 63of Title 18, United States Code, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

**                               ****SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
| Date: March 17, 2006 | THE SCO GROUP, INC. |
|----------------------|---------------------|
|                 |                |
|                 | By:                 | /s/ Bert B. Young |
|                 |                | Bert B. Young |
|                 |                | Duly Authorized Officer  and |
|                 |                | Chief Financial Officer |
|                 |                | (Principal Financial and |
|                 |                | Accounting Officer) |

** **

** **

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** **

**EXHIBITINDEX**

** **

** **

**Exhibit**

**Number**                                                                 ExhibitDescription

** **

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

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

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

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

3.5                                 Certificate ofDesignation for Series A-1 Convertible Preferred Stock (incorporated byreference to Exhibit 4.1 to SCO’s Current Report on Form 8-K filed on February9, 2004 (File No. 000-29911)).

3.6                                 Certificate ofCorrection correcting the Certificate of Designation for Series A-1 ConvertiblePreferred Stock (incorporated by reference to Exhibit 4.2 to SCO’s CurrentReport on Form 8-K filed on February 9, 2004 (File No. 000-29911)).

31.1                           Certificationof Darl C. McBride, President and Chief Executive Officer, pursuant to Rule13a-14(a) of the Exchange Act, as adopted pursuant to Section 302 of theSarbanes-Oxley Act of 2002.

31.2                           Certificationof Bert Young, Chief Financial Officer, pursuant to Rule 13a-14(a) of theExchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of2002.

32.1               Certification of Darl C. McBride, President andChief Executive Officer, pursuant to Section 1350, Chapter 63 of Title 18,United States Code, as adopted pursuant to Section 906 of the Sarbanes-OxleyAct of 2002.

**32.2**                           Certification of Bert Young, Chief Financial Officer, pursuant toSection 1350, Chapter 63 of Title 18, United States Code, as adopted pursuantto Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

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