**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-Q**

**(Mark one)**
| x | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** | ** ** |
|---|-----------------------------------------------------------------------------------------------|------------|

 

**Forthe quarterly period ended July 31, 2006**

**OR**
| o | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** | ** ** |
|---|------------------------------------------------------------------------------------------------|------------|

 

**Forthe transition period from                           to                          **

**Commissionfile number 0-29911**

**THE SCO GROUP, INC.**

**(Exact name of registrant asspecified in its charter)**

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

 

**355South 520 West**

**Suite100**

**Lindon,Utah 84042**

(Address of principal executive offices and zip code)

**(801)765-4999**

(Registrant’s telephone number, including area code)

Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  YES x  NO o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” inRule 12b-2 of the Exchange Act. (Check One): Large Accelerated Filer  o Accelerated filer  o Non-accelerated Filer  x

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).  (Check one):YES o NO x

As of September11, 2006, there were 21,093,981 shares of the Registrant’s common stock, $0.001par value per share, outstanding.

 

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**The SCOGroup, Inc.**

**Tableof Contents**
| PART I.  |   | FINANCIAL INFORMATION                                                                                                              |
|----------|--------|------------------------------------------------------------------------------------------------------------------------------------|
| Item 1.  |   | Unaudited Financial Statements                                                                                                     |
|     |   | Condensed Consolidated Balance Sheets as of July 31,  2006 and October 31, 2005                                                    |
|     |   | Condensed Consolidated Statements of Operations and  Comprehensive Loss for the three and nine months ended July 31, 2006 and 2005 |
|     |   | Condensed Consolidated Statements of Cash Flows for  the nine months ended July 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 6.  |   | Exhibits                                                                                                                           |
|     |   | Signatures                                                                                                                         |

 

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

 

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

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(in thousands, except per share data)**
| ** **                                                                                                     | ** ** | **July 31,2006** | ** ** | **October 31,2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------|------------|
|                                                                                                           |       |                  |       |                     |       |
| **ASSETS**                                                                                                     | ** ** | ** **            | ** ** | ** **               | ** ** |
|                                                                                                           |       |                  |       |                     |       |
| CURRENT ASSETS:                                                                                                |       |                  |       |                     |       |
| Cash and cash  equivalents                                                                                     |       | $                     | 8,861      |                     | $          | 4,272 |   |
| Restricted cash                                                                                                |       | 2,010                 |       | 5,690                    |       |
| Available-for-sale  marketable securities                                                                      |       | 5,099                 |       | 6,165                    |       |
| Accounts  receivable, net of allowance for doubtful accounts of $97 and $144, respectively                     |       | 4,072                 |       | 6,343                    |       |
| Other                                                                                                          |       | 1,720                 |       | 2,454                    |       |
| Total current  assets                                                                                          |       | 21,762                |       | 24,924                   |       |
|                                                                                                           |       |                  |       |                     |       |
| PROPERTY AND EQUIPMENT:                                                                                        |       |                  |       |                     |       |
| Computer and  office equipment                                                                                 |       | 2,184                 |       | 2,224                    |       |
| Leasehold  improvements                                                                                        |       | 316                   |       | 345                      |       |
| Furniture and  fixtures                                                                                        |       | 79                    |       | 96                       |       |
|                                                                                                           |       | 2,579                 |       | 2,665                    |       |
| Less accumulated  depreciation and amortization                                                                |       | (1,969                | )          | (2,087                   | )          |
| Net property and  equipment                                                                                    |       | 610                   |       | 578                      |       |
|                                                                                                           |       |                  |       |                     |       |
| OTHER ASSETS:                                                                                                  |       |                  |       |                     |       |
| Definite-lived  intangibles, net                                                                               |       | 677                   |       | 2,707                    |       |
| Other                                                                                                          |       | 423                   |       | 739                      |       |
| Total other  assets                                                                                            |       | 1,100                 |       | 3,446                    |       |
|                                                                                                           |       |                  |       |                     |       |
| Total assets                                                                                                   |       | $                     | 23,472     |                     | $          | 28,948 |   |
|                                                                                                           |       |                  |       |                     |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                 | ** ** | ** **            | ** ** | ** **               | ** ** |
|                                                                                                           |       |                  |       |                     |       |
| CURRENT LIABILITIES:                                                                                           |       |                  |       |                     |       |
| Accounts payable                                                                                               |       | $                     | 2,239      |                     | $          | 2,197 |   |
| Payable to  Novell, Inc.                                                                                       |       | 449                   |       | 2,815                    |       |
| Accrued payroll  and benefits                                                                                  |       | 1,734                 |       | 2,656                    |       |
| Accrued  liabilities                                                                                           |       | 3,087                 |       | 3,118                    |       |
| Deferred revenue                                                                                               |       | 2,875                 |       | 3,841                    |       |
| Royalties  payable                                                                                             |       | 272                   |       | 406                      |       |
| Income taxes  payable                                                                                          |       | 1,235                 |       | 1,222                    |       |
| Total current  liabilities                                                                                     |       | 11,891                |       | 16,255                   |       |
|                                                                                                           |       |                  |       |                     |       |
| LONG-TERM LIABILITIES                                                                                          |       | 227                   |       | 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, 21,391 and 18,331 shares  outstanding, respectively |       | 21                    |       | 18                       |       |
| Additional  paid-in capital                                                                                    |       | 259,780               |       | 246,985                  |       |
| Common stock  held in treasury; 297 and 290 shares, respectively                                               |       | (2,446                | )          | (2,414                   | )          |
| Warrants  outstanding                                                                                          |       | 856                   |       | 856                      |       |
| Accumulated  other comprehensive income                                                                        |       | 940                   |       | 834                      |       |
| Accumulated  deficit                                                                                           |       | (247,797              | )          | (234,942                 | )          |
| Total  stockholders’ equity                                                                               |       | 11,354                |       | 11,337                   |       |
|                                                                                                           |       |                  |       |                     |       |
| Total liabilities and  stockholders’ equity                                                               |       | $                     | 23,472     |                     | $          | 28,948 |   |

 

See accompanying notes tocondensed consolidated financial statements.

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**THE SCO GROUP, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS**

**(in thousands,except per share data)**
| ** **                                                    | ** ** | **Three Months Ended July 31,** | ** ** | **Nine Months Ended July 31,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                    | ** ** | **2006**                                            | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| REVENUE:                                                      |       |                                                |       |                                               |       |   |   |   |   |
| Products                                                      |       | $                                                   | 6,201      |                                               | $          | 7,953 |   | $ | 17,904 |   | $ | 23,095 |   |
| SCOsource  licensing                                          |       | 31                                                  |       | 32                                                 |       | 95 |   | 132 |   |
| Services                                                      |       | 1,189                                               |       | 1,368                                              |       | 3,891 |   | 4,249 |   |
| Total revenue                                                 |       | 7,421                                               |       | 9,353                                              |       | 21,890 |   | 27,476 |   |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| COST OF REVENUE:                                              |       |                                                |       |                                               |       |   |   |   |   |
| Products                                                      |       | 478                                                 |       | 695                                                |       | 1,559 |   | 1,902 |   |
| SCOsource  licensing                                          |       | 2,315                                               |       | 3,085                                              |       | 10,087 |   | 9,467 |   |
| Services                                                      |       | 666                                                 |       | 700                                                |       | 2,012 |   | 2,195 |   |
| Total cost of  revenue                                        |       | 3,459                                               |       | 4,480                                              |       | 13,658 |   | 13,564 |   |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| GROSS MARGIN                                                  |       | 3,962                                               |       | 4,873                                              |       | 8,232 |   | 13,912 |   |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| OPERATING EXPENSES:                                           |       |                                                |       |                                               |       |   |   |   |   |
| Sales and  marketing                                          |       | 3,111                                               |       | 2,935                                              |       | 8,656 |   | 8,849 |   |
| Research and  development                                     |       | 2,029                                               |       | 1,940                                              |       | 5,786 |   | 6,145 |   |
| General and  administrative                                   |       | 1,829                                               |       | 1,647                                              |       | 5,139 |   | 5,446 |   |
| Amortization of  intangibles                                  |       | 593                                                 |       | 593                                                |       | 1,778 |   | 1,779 |   |
| Total operating  expenses                                     |       | 7,562                                               |       | 7,115                                              |       | 21,359 |   | 22,219 |   |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| LOSS FROM OPERATIONS                                          |       | (3,600                                              | )          | (2,242                                             | )          | (13,127 | ) | (8,307 | ) |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| EQUITY IN INCOME (LOSS)  OF AFFILIATE                         |       | —                                              |       | (19                                                | )          | (8 | ) | 51 |   |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| OTHER INCOME, NET:                                            |       |                                                |       |                                               |       |   |   |   |   |
| Interest income                                               |       | 191                                                 |       | 122                                                |       | 542 |   | 257 |   |
| Other income  (expense), net                                  |       | (64                                                 | )          | (149                                               | )          | 46 |   | 1,025 |   |
| Total other  income (expense), net                            |       | 127                                                 |       | (27                                                | )          | 588 |   | 1,282 |   |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| LOSS BEFORE PROVISION  FOR INCOME TAXES                       |       | (3,473                                              | )          | (2,288                                             | )          | (12,547 | ) | (6,974 | ) |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| PROVISION FOR INCOME  TAXES                                   |       | (107                                                | )          | (84                                                | )          | (308 | ) | (321 | ) |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| NET LOSS                                                      |       | $                                                   | (3,580     | )                                                  | $          | (2,372 | ) | $ | (12,855 | ) | $ | (7,295 | ) |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| BASIC AND DILUTED NET  LOSS PER COMMON SHARE                  |       | $                                                   | (0.17      | )                                                  | $          | (0.13 | ) | $ | (0.62 | ) | $ | (0.41 | ) |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| WEIGHTED AVERAGE BASIC  AND DILUTED COMMON SHARES OUTSTANDING |       | 21,063                                              |       | 17,993                                             |       | 20,703 |   | 17,885 |   |
|                                                          |       |                                                |       |                                               |       |   |   |   |   |
| OTHER COMPREHENSIVE  LOSS:                                    |       |                                                |       |                                               |       |   |   |   |   |
| Net loss                                                      |       | $                                                   | (3,580     | )                                                  | $          | (2,372 | ) | $ | (12,855 | ) | $ | (7,295 | ) |
| Unrealized gain  on available-for-sale marketable securities  |       | 4                                                   |       | 5                                                  |       | 49 |   | 14 |   |
| Foreign currency  translation adjustment                      |       | 37                                                  |       | (128                                               | )          | 57 |   | (124 | ) |
| COMPREHENSIVE LOSS                                            |       | $                                                   | (3,539     | )                                                  | $          | (2,495 | ) | $ | (12,749 | ) | $ | (7,405 | ) |

 

See accompanying notes to condensed consolidatedfinancial statements.

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**THE SCOGROUP, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OFCASH FLOWS**

**(in thousands)**
| ** **                                                                                                | *** *** | **Nine Months Ended July 31,** | *** *** |
|-----------------------------------------------------------------------------------------------------------|--------------|----------------------------------------------------|--------------|
| ** **                                                                                                | *** *** | **2006**                                           | ** **   | **2005** | ** ** |
|                                                                                                      | * *     | * *                                           | * *     | * * | * * |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                                    |         |                                               |         |   |   |
| Net loss                                                                                                  |         | $                                                  | (12,855      | ) | $ | (7,295 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:                              |         |                                               |         |   |   |
| Amortization of  intangibles (including $252 and $251 classified as cost of SCOsource  licensing revenue) |         | 2,030                                              |         | 2,030 |   |
| Depreciation and  amortization                                                                            |         | 226                                                |         | 271 |   |
| Stock-based  compensation                                                                                 |         | 1,323                                              |         | 22 |   |
| Loss on disposal  of assets                                                                               |         | 8                                                  |         | 32 |   |
| Equity in  (income) loss of affiliate                                                                     |         | 8                                                  |         | (51 | ) |
| Changes in  operating assets and liabilities:                                                             |         |                                               |         |   |   |
| Restricted cash                                                                                           |         | 1,314                                              |         | 1,421 |   |
| Accounts  receivable, net                                                                                 |         | 2,271                                              |         | 1,691 |   |
| Other current  assets                                                                                     |         | 734                                                |         | (506 | ) |
| Other assets                                                                                              |         | —                                             |         | 31 |   |
| Accounts payable                                                                                          |         | 42                                                 |         | (6,517 | ) |
| Accrued payroll  and benefits                                                                             |         | (922                                               | )            | (1,099 | ) |
| Compensation to  law firms                                                                                |         | —                                             |         | (7,956 | ) |
| Accrued  liabilities                                                                                      |         | (31                                                | )            | (676 | ) |
| Deferred revenue                                                                                          |         | (966                                               | )            | (856 | ) |
| Royalties  payable                                                                                        |         | (134                                               | )            | (43 | ) |
| Income taxes  payable                                                                                     |         | 13                                                 |         | 44 |   |
| Long-term  liabilities                                                                                    |         | (111                                               | )            | (3 | ) |
| Net cash used in  operating activities                                                                    |         | (7,050                                             | )            | (19,460 | ) |
|                                                                                                      |         |                                               |         |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                                    |         |                                               |         |   |   |
| Purchase of  property and equipment                                                                       |         | (265                                               | )            | (233 | ) |
| Dividend  received                                                                                        |         | 308                                                |         | — |   |
| Purchase of  available-for-sale marketable securities                                                     |         | (6,441                                             | )            | (8,224 | ) |
| Proceeds from  sale of available-for-sale marketable securities                                           |         | 7,507                                              |         | 20,904 |   |
| Net cash  provided by investing activities                                                                |         | 1,109                                              |         | 12,447 |   |
|                                                                                                      |         |                                               |         |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                                    |         |                                               |         |   |   |
| Proceeds from  sale of common stock through employee stock purchase plan                                  |         | 613                                                |         | 720 |   |
| Proceeds from  exercise of common stock options                                                           |         | 35                                                 |         | 235 |   |
| Repurchase of  common stock                                                                               |         | (32                                                | )            | — |   |
| Proceeds from  sale of common stock in a private placement, net of offering costs                         |         | 9,809                                              |         | — |   |
| Net cash provided  by financing activities                                                                |         | 10,425                                             |         | 955 |   |
|                                                                                                      |         |                                               |         |   |   |
| NET INCREASE (DECREASE)  IN CASH AND CASH EQUIVALENTS                                                     |         | 4,484                                              |         | (6,058 | ) |
| EFFECT OF FOREIGN  EXCHANGE RATES ON CASH AND CASH EQUIVALENTS                                            |         | 105                                                |         | (109 | ) |
| CASH AND CASH  EQUIVALENTS, beginning of period                                                           |         | 4,272                                              |         | 12,693 |   |
| CASH AND CASH  EQUIVALENTS, end of period                                                                 |         | $                                                  | 8,861        |   | $ | 6,526 |   |
|                                                                                                      |         |                                               |         |   |   |
| SUPPLEMENTAL DISCLOSURE  OF CASH FLOW INFORMATION:                                                        |         |                                               |         |   |   |
|                                                                                                      |         |                                               |         |   |   |
| Cash paid for  income taxes                                                                               |         | $                                                  | 247          |   | $ | 259 |   |
|                                                                                                      |         |                                               |         |   |   |
| SUPPLEMENTAL SCHEDULE  OF NON-CASH FINANCING ACTIVITIES:                                                  |         |                                               |         |   |   |
|                                                                                                      |         |                                               |         |   |   |
| Increase (decrease) in  common stock subject to rescission                                                |         | $                                                  | (1,018       | ) | $ | 576 |   |

 

See accompanying notes tocondensed consolidated financial statements.

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**THESCO GROUP, INC. AND SUBSIDIARIES**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

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

The business of The SCO Group, Inc. (the “Company”,“we”, “us” or “our”) focuses on marketing reliable, cost-effective UNIXsoftware products and related services for the small-to-medium sized businessmarket, including replicated site franchises of Fortune 1000 companies.  The Company has operations in a number ofcountries that provide support services to customers and resellers. During theyear ended October 31, 2003, the Company initiated its SCOsource business toprotect and defend its UNIX intellectual property.  The Company acquired certain intellectualproperty rights surrounding UNIX and UNIX System V source code in May 2001 fromThe Santa Cruz Operation, which changed its name to Tarantella, Inc., and wassubsequently acquired by Sun Microsystems.

The Company incurred a net loss of $12,855,000for the nine months ended July 31, 2006 and during that same period used cashof $7,050,000 in its operating activities. A significant portion of the net loss and the cash used in operatingactivities was associated with the Company protecting and defending itsintellectual property rights.  As of July31, 2006, the Company had a total of $8,861,000 in cash and cash equivalents,$5,099,000 in available-for-sale marketable securities, and $2,010,000 inrestricted cash, of which $1,561,000 is designated to pay for experts,consultants and other expenses in the SCO Litigation, and the remaining$449,000 of restricted cash is payable to Novell for its retained binaryroyalty stream.

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

### **Basis of Presentation**

Theaccompanying unaudited condensed consolidated financial statements of theCompany have been prepared by the Company pursuant to the rules and regulationsof the Securities and Exchange Commission (“SEC”) on a basis consistent withthe Company’s audited annual financial statements and, in the opinion ofmanagement, reflect all adjustments, consisting only of normal recurringadjustments, necessary to present fairly the financial information set forththerein.  Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with U.S. generally accepted accounting principles have beencondensed or omitted pursuant to SEC rules and regulations, although theCompany believes that the following disclosures, when read in conjunction withthe audited annual financial statements and the notes thereto included in theCompany’s most recent annual report on Form 10-K, are adequate to make theinformation presented not misleading. Operating results for the three and nine months ended July 31, 2006 arenot necessarily indicative of the operating results that may be expected forthe year ending October 31, 2006.

### **Use of Estimates in the Preparation ofFinancial Statements**

Thepreparation of financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenue and expenses during the reporting periods.  Actual results could differ from theseestimates. The Company’s critical accounting policies and estimates include,among others, revenue recognition, allowances for

6

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doubtful accountsreceivable, impairment and useful lives of long-lived assets, litigationreserves, and valuation allowances against deferred income tax assets.

### **Revenue Recognition**

TheCompany recognizes revenue in accordance with Statement of Position (“SOP”)97-2, as modified by SOP 98-9.  TheCompany’s revenue has historically been from three sources: (i) product licenserevenue, primarily from product sales to resellers, end users and originalequipment manufacturers (“OEMs”); (ii) technical support service revenue,primarily from providing technical support and consulting services to endusers; and (iii) revenue from SCOsource licensing.

TheCompany recognizes product revenue upon shipment if a signed contract exists,the fee is fixed or determinable, collection of the resulting receivable isprobable and product returns are reasonably estimable.

Themajority of the Company’s revenue transactions relate to product-onlysales.  On occasion, the Company hasrevenue transactions 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.

TheCompany recognizes product revenue from OEMs when the software is sold by theOEM to an end-user customer.  Revenuefrom technical support services and consulting services is recognized as therelated services are performed.  Revenuefor maintenance is recognized ratably over the maintenance period.

TheCompany considers an arrangement with payment terms longer than the Company’snormal business practice not to be fixed or determinable, and revenue isrecognized when the fee becomes due.  TheCompany typically provides stock rotation rights for sales made through itsdistribution channel and sales to distributors are recognized upon shipment bythe distributor to end users.  For directsales not through the Company’s distribution channel, sales are typicallynon-refundable and non-cancelable.  TheCompany estimates its product returns based on historical experience andmaintains an allowance for estimated returns, which is recorded as a reductionto accounts receivable.

TheCompany’s SCOsource revenue to date has been primarily generated fromagreements to utilize the Company’s UNIX source code as well as fromintellectual property compliance agreements. The Company recognizes revenue from SCOsource agreements when a signedcontract exists, the fee is fixed or determinable, collection of the receivableis probable and delivery has occurred. If the payment terms extend beyond the Company’s normal payment terms,revenue is recognized as the payments become due.

7

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**Cash and Cash Equivalents**

TheCompany considers all investments purchased with original maturities of threemonths or less to be cash equivalents. Cash equivalents were $4,986,000 and $1,528,000 as of July 31, 2006 andOctober 31, 2005, respectively.  Cash was$3,875,000 and $2,744,000 as of July 31, 2006 and October 31, 2005,respectively.

**Available-for-Sale Marketable 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 $5,099,000 as of July 31, 2006.  Any available-for-sale marketable securitiesin an unrealized loss position as of July 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**

Basicnet loss per common share (“Basic EPS”) is computed by dividing net loss by theweighted average number of common shares outstanding.  Diluted net income per common share (“DilutedEPS”), if any, is computed by dividing net income by the sum of the weightedaverage number of common shares outstanding and the dilutive potential commonshare equivalents then outstanding. Potential common share equivalents consist of the weighted averagenumber of shares issuable upon the exercise of outstanding stock options andwarrants to acquire common stock.  Ifdilutive, the Company computes Diluted EPS using the treasury stock method.

Dueto the fact that for all periods presented the Company has incurred net losses,common share equivalents of 5,080,000 and 3,982,000 for the three and ninemonths ended July 31, 2006 and 2005, respectively, are not included in thecalculation of diluted net loss per common share because they areanti-dilutive.

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

Thefollowing table presents the activity related to definite-lived intangibleassets for the nine months ended July 31, 2006 as well as the remainingunamortized balances as of July 31, 2006:

|                                         | ** ** | **Carrying Value  as of  October 31, 2005** | ** ** | **Amortization  Expense for the  Nine Months   Ended July 31,  2006** | ** ** | **Carrying Value  as of  July 31, 2006** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| Definite-lived  intangible assets:      |       |                                                            |       |                                                                                                |       |                                                         |       |
| Distribution/reseller channel           |       | $                                                               | 2,318,000  |                                                                                                | $          | (1,739,000                                                   | )          | $ | 579,000 |   |
| Acquired technology                     |       | 337,000                                                         |       | (252,000                                                                                            | )          | 85,000                                                       |       |
| Trade name                              |       | 52,000                                                          |       | (39,000                                                                                             | )          | 13,000                                                       |       |
| Total  definite-lived intangible assets |       | $                                                               | 2,707,000  |                                                                                                | $          | (2,030,000                                                   | )          | $ | 677,000 |   |

 

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Ofthe $2,030,000 in amortization expense for the nine months ended July 31, 2006,$1,778,000 was classified as amortization of intangible assets in operatingexpenses and the remaining $252,000 was classified as cost of SCOsourcelicensing revenue.

**(4) COMMITMENTS AND CONTINGENCIES**

**Litigation**

*IBM Corporation*

On or about March6, 2003, the Company filed a civil complaint against IBM in the United StatesDistrict Court for the District of Utah, under the title The SCO Group, Inc. v.International Business Machines Corporation, Civil No. 2:03CV0294.  In this action, the Company claims, among otherthings, that IBM breached its UNIX source code licenses (both the IBM andSequent Computer Systems, Inc. “Sequent” licenses) by disclosing restrictedinformation concerning the UNIX source code and derivative works and relatedinformation in connection with its efforts to promote the Linux operatingsystem.  The Company’s complaintincludes, among other things, claims for breach of contract, unfaircompetition, tortious interference and copyright infringement.  As a result of IBM’s actions, the Company isrequesting damages in an amount to be proven at trial and seeking injunctiverelief.

On or about March6, 2003, the Company notified IBM that IBM was not in compliance with theCompany’s UNIX source code license agreement and on or about June 13, 2003, theCompany delivered to IBM a notice of termination of IBM’s UNIX source codelicense 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, the Company filed a second amended complaint which alleges nine causes ofaction that are similar to those set forth above, adds a new claim forcopyright infringement and removes the claim for misappropriation of tradesecrets.  IBM filed an answer and 14counterclaims.  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.

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On July 1,2005, the court issued a revised Scheduling Order establishing, among otherthings, discovery and motion deadlines over the next 18 months with a five-weekjury trial to commence on February 26, 2007.

Pursuant to thecourt’s July 1, 2005 Scheduling Order, the Company filed its Interim Disclosureof Material Misused by IBM on October 28, 2005. The Company’s report included a matrix that identified 217 separatetechnology disclosures that it contends IBM improperly made to enhance Linux inviolation of one or more contractual prohibitions governing IBM’s use of theCompany’s proprietary material.  TheCompany continued to review relevant materials, including evidence IBM hasproduced in discovery, and filed an updated report on December 22, 2005detailing IBM’s misuse of the Company’s proprietary material.  The Company’s December 22, 2005 reportincluded 294 total disclosures which the Company claims violate its contractualrights and copyrights.  These reports andthe disclosures identified are the result of analysis from experienced outsidetechnical consultants.

On February 13,2006, IBM filed a motion with the court seeking to limit the Company’sclaims.  IBM argues that of the 294 itemsidentified by the Company in the December 22, 2005 filing, 201 did not meet thelevel of specificity required by the court. IBM requested that the Company be limited to 93 items set forth in theDecember 22, 2005 filing which IBM claims meet the required level ofspecificity.  On June 28, 2006, theMagistrate Judge issued a ruling striking over 180 of the Company’s technologydisclosures from the case.  Although thisruling is a significant limitation of the number of technology disclosures theCompany challenged in its December 22, 2005 filing, it also means that over 100of our challenged items remain in the case. On July 13, 2006, the Company filed objections to the Magistrate Judge’sorder with the district court; those objections challenge the process and theresult embodied in the Magistrate Judge’s order and the Company expects ahearing to be set in the near future.

On June 8, 2006,IBM filed a motion to confine the Company’s claims to, and strike allegationsin excess of, the final disclosures.  Inthis motion, IBM claims that the Company’s technology expert reports go beyondthe disclosures contained in the Company’s December 22, 2005 submission to thecourt and that those expert reports should be stricken to that extent.  No hearing has been set on that motion and noruling has been made.  The Companybelieves that the motion lacks merit and has filed its opposition to themotion.

Both parties havefiled expert reports and expert discovery is under way.

*Novell, *Inc*.*

OnJanuary 20, 2004, the Company filed suit in Utah state court against Novell, Inc.for slander of title seeking relief for its alleged bad faith effort tointerfere with the Company’s ownership of copyrights related to the Company’sUNIX source code and derivative works and the Company’s UnixWare product.  The case is pending in the United StatesDistrict Court for the District of Utah under the caption, The SCOGroup, 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 or withdrawall representations it has made regarding its purported ownership of thosecopyrights 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

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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 additional claims.

On or about April10, 2006, Novell filed a motion to stay the case in Utah pending a request forarbitration that Novell and SuSE Linux, GmbH (“SuSE”) filed on the same date inthe International Court of Arbitration in France.  Through these proceedings, Novell claims thatthe Company granted SuSE the right to use its intellectual property through theCompany’s participation in the UnitedLinux initiative in 2002 and through itsacquisition of SuSE, Novell acquired SuSE’s rights as a member of UnitedLinux.  On May 26, 2006, the Company filed a responseto Novell’s motion to stay, and on June 27, 2006, we responded to Novell’srequest for arbitration.  On August 21,2006, the court ordered that the claims relating to the SuSE arbitration shouldbe stayed but the other claims in the case should proceed.

The three-personarbitration panel has been selected for the SuSE arbitration in Switzerland,and that process will be commencing in the near future.  The Company does not yet know the schedule ofthe proceedings.

*IPO Class Action Matter*

The Company is anissuer defendant in a series of class action lawsuits involving over 300issuers that have been consolidated under In re Initial Public OfferingSecurities 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.

The plaintiffs,the issuers and the insurance companies have negotiated an agreement to settlethe dispute between the plaintiffs and the issuers.  All parties, including the plaintiffs,issuers and insurance companies, have executed this settlement agreement andthe settlement 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 are laterasserted, this action will be dismissed with respect to the Company and itsdirectors.  If the settlement agreementis not approved by the court, the matter will continue unless anothersettlement agreement is reached.

The Company hasnotified its underwriters and insurance companies of the existence of theclaims.  Management believes, afterconsultation with legal counsel, that the ultimate outcome of this matter willnot have a material adverse effect on the Company’s results of operations orfinancial position and will not exceed the $200,000 self-insured retentionalready paid or accrued by the Company.

*Red Hat, Inc.*

On August 4,2003, Red Hat, Inc. filed a complaint against the Company.  The action is pending in the United StatesDistrict Court for the District of Delaware under the case caption, RedHat, Inc. v. The SCO Group, Inc., Civil No. 03-772.  Red Hat asserts that the Linux operating

11

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system does not infringeon the Company’s UNIX intellectual property rights and seeks a declaratoryjudgment for non-infringement of copyrights and no misappropriation of tradesecrets.  In addition, Red Hat claims theCompany has engaged in false advertising in violation of the Lanham Act,deceptive trade practices, unfair competition, tortious interference withprospective business opportunities, trade libel and disparagement.  On April 6, 2004, the court denied theCompany’s motion to dismiss this case; however, the court stayed the case andrequested status reports every 90 days regarding the case againstIBM.  Red Hat filed a motion forreconsideration, 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.

*Other Matters*

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 anddefense of the above-mentioned matters will be costly, and management expectsthe costs for legal fees and related expenses will be substantial.

A material, negative impact on the Company’s resultsof operations or financial position from the Red Hat, Inc., IPO Class Action,or Indian Distributor matters, or the IBM or Novell counterclaims is neitherprobable nor estimable.

TheCompany is a party to certain other legal proceedings arising in the ordinarycourse of business.  Management believes,after consultation 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.

**(5) COMMONSTOCK SUBJECT TO RESCISSION**

TheCompany believes certain shares and options granted under its EquityCompensation Plans were issued without complying with registration orqualification requirements under federal securities laws and the securitieslaws of certain states.  As a result,certain Plan participants had a right to rescind their purchases of sharesunder the Plans or recover damages if they no longer own the shares or holdunexercised options, subject to applicable statutes of limitations.  Additionally, regulatory authorities mayrequire the Company to pay fines or impose other sanctions.

AccountingSeries Release (“ASR”) No. 268 and Emerging Issues Task Force (“EITF”) TopicD-98 require 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 stock,which is outside of the Company’s and the holders’ control.  Consequently, common stock subject torescission is classified as temporary equity.

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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 accepted the Company’s offer to rescind thepurchase of approximately 7,300 shares. The Company made aggregate payments to such offerees of approximately$41,500, which included 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 remainder of the commonstock subject to rescission which totaled $1,018,000 as additional paid-incapital in permanent equity.

**(6) STOCKHOLDERS’ EQUITY**

**Issuance of Common Stock**

OnNovember 29, 2005, the Company entered into a Common Stock Purchase Agreement (“PurchaseAgreement”) with several institutional investors and one member of the Company’sboard of directors.  On November 30,2005, the Company sold to the investors approximately 2,852,000 shares of theCompany’s common stock for gross proceeds of approximately $10,005,000.  The costs to facilitate the private placementof the common stock were approximately $196,000.  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 SEC covering the resale ofthis common stock, and to use its commercially reasonable efforts to have suchregistration statement declared effective. On May 25, 2006, this registration statement was declared effective bythe SEC.

**Equity Plans**

The Company hasestablished the 1998 Stock Option Plan (the “1998 Plan”), 1999 Omnibus StockIncentive Plan (the “1999 Plan”), the 2002 Omnibus Stock Incentive Plan (the “2002Plan”) and the 2004 Omnibus Stock Incentive Plan (the “2004 Plan”) for theaward of stock options, stock appreciation rights, restricted stock, phantomstock rights, and stock bonuses to employees, executive officers, members ofthe Board of Directors and outside consultants. The Compensation Committee of the Board of Directors has the ability todetermine the terms of the option, the exercise price, the number of sharessubject to each option, and the exercisability of the options.  The Company’s current practice is for theCompensation Committee to recommend option grants subject to the approval andratification of the entire Board of Directors at regularly scheduled boardmeetings.  Under the terms of the 1998,1999, 2002 and 2004 Plans, options generally expire 10 years from the date ofgrant or within 90 days of termination. Options granted under these plans generally vest 25 percent after thecompletion of one year of service and then 1/36 per month for the remainingthree years and become 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.

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The Company hasalso established the ESPP, which is designed to allow eligible employees of theCompany and its participating subsidiaries to purchase shares of the Company’scommon stock, at semi-annual intervals, through periodic payroll deductions.

Priorto October 31, 2005, as permitted under Statement of Financial AccountingStandards (“SFAS”) No. 123, the Company accounted for its stock option plansfollowing the recognition and measurement principles of Accounting PrinciplesBoard (“APB”) Opinion No. 25, “Accounting for Stock issued to Employees,” andrelated interpretations.  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.

InDecember 2004, the Financial Accounting Standards Board (“FASB”) issued SFASNo. 123(R), “Share Based Payment.”  Thisstatement revised SFAS No. 123 by eliminating the option to account foremployee stock options under APB No. 25 and requires companies to recognize thecost of employee services received in exchange for awards of equity instrumentsbased on the grant-date fair value of those awards.

EffectiveNovember 1, 2005, the Company adopted the fair value recognition provisions ofSFAS 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 and ninemonths ended July 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 and nine months ended July 31, 2005 have not been restated.

Theeffect of accounting for stock-based awards under SFAS No. 123(R) for the threeand nine months ended July 31, 2006 was to record $490,000 and $1,323,000,respectively, of stock-based compensation expense.  For the three and nine months ended July 31,2006 and 2005, the Company has allocated stock-based compensation expense tothe following statement of operations captions:

|                                 | ** ** | **Three Months Ended July 31,** | ** ** | **Nine Months Ended July 31,** | ** ** |
|---------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                      | ** ** | **2006**                                            | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|                            |       |                                                |       |                                               |       |   |   |   |   |
| Cost of products                |       | $                                                   | 5,000      |                                               | $          | — |   | $ | 12,000 |   | $ | — |   |
| Cost of  SCOsource licensing    |       | 61,000                                              |       | —                                             |       | 171,000 |   | — |   |
| Cost of services                |       | 17,000                                              |       | —                                             |       | 46,000 |   | — |   |
| Sales and  marketing            |       | 102,000                                             |       | —                                             |       | 261,000 |   | 14,000 |   |
| Research and  development       |       | 41,000                                              |       | —                                             |       | 97,000 |   | 8,000 |   |
| General and  administrative     |       | 264,000                                             |       | —                                             |       | 736,000 |   | — |   |
| Total stock-based  compensation |       | $                                                   | 490,000    |                                               | $          | — |   | $ | 1,323,000 |   | $ | 22,000 |   |

 

Thefollowing pro-forma information, as required by SFAS No. 148, “Accounting forStock-Based Compensation-Transition and Disclosure, an amendment of FASBStatement No. 123,” is presented for comparative purposes and illustrates theeffect on net loss and net loss per common share for the three and nine monthsended July 31, 2005 as if the Company had applied the fair value recognitionprovisions of SFAS No. 123 to stock-based employee compensation prior toNovember 1, 2005:

14

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|                                                        | ** ** | **Three Months Ended  July 31, 2005** | ** ** | **Nine Months Ended  July 31, 2005** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                             | ** ** | ** **                                                | ** ** | ** **                                               | ** ** |
| Net loss:                                         |       |                                                      |       |                                                     |       |
| As reported                                            |       | $                                                         | (2,372,000 | )                                                        | $          | (7,295,000 | ) |
| Stock-based compensation included in reported net loss |       | —                                                    |       | 22,000                                                   |       |
| Stock-based compensation under fair value method       |       | (569,000                                                  | )          | (1,166,000                                               | )          |
| Pro forma net loss                                     |       | $                                                         | (2,941,000 | )                                                        | $          | (8,439,000 | ) |
| Net loss per  basic and diluted common share:          |       |                                                      |       |                                                     |       |
| As reported                                            |       | $                                                         | (0.13      | )                                                        | $          | (0.41 | ) |
| Pro forma                                              |       | $                                                         | (0.16      | )                                                        | $          | (0.47 | ) |

 

With respect to stock options granted during thethree and nine months ended July 31, 2006 and 2005, the assumptions used in theBlack-Scholes option-pricing model are as follows:  

|                                    | ** ** | **Three Months Ended July 31,** | ** ** | **Nine Months Ended July 31,** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                         | ** ** | **2006**                                            | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Risk-free  interest rate           |       | 5.0                                                 | %          | 4.1                                                | %          | 4.8 | % | 3.7 | % |
| Expected  dividend yield           |       | 0.0                                                 | %          | 0.0                                                | %          | 0.0 | % | 0.0 | % |
| Volatility                         |       | 66.2                                                | %          | 47.1                                               | %          | 63.4 | % | 65.0 | % |
| Expected exercise life  (in years) |       | 5.0                                                 |       | 2.7                                                |       | 5.0 |   | 2.7 |   |

 

The estimated fair value of stock options andESPP shares are amortized over the vesting period of the award.

Duringthe nine months ended July 31, 2006, the Company granted options to purchaseapproximately 1,065,000 shares of common stock with an average exercise priceof $3.84 per share.  None of these stockoptions were granted with an exercise price below the quoted market price onthe date of grant.  During the ninemonths ended July 31, 2006, options to purchase approximately 29,000 shares ofcommon stock were exercised with an average exercise price of $1.21 pershare.  As of July 31, 2006, there wereapproximately 4,845,000 stock options outstanding with a weighted averageexercise price of $4.11 per share.

** (7) CONCENTRATION OF CREDIT RISK**

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

Duringthe three and nine months ended July 31, 2006 and 2005, no single customeraccounted for more than 10 percent of total revenue.

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**(8) SEGMENT INFORMATION**

TheCompany’s resources are allocated and operating results managed to theoperating income (loss) level for each of the Company’s segments: UNIX andSCOsource.  Both segments are based onthe Company’s UNIX intellectual property. The UNIX business develops, sells and distributes UNIX server and mobileproducts and services through an extensive distribution channel and tocorporate end-users and the SCOsource business enforces and protects theCompany’s UNIX intellectual property.  Segmentdisclosures for the Company are as follows:

|                              | ** ** | **Three Months Ended July 31, 2006** | ** ** |
|------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                   | ** ** | **UNIX**                                                      | ** ** | **SCOsource** | ** ** | **Total** | ** ** |
|                         |       |                                                          |       |   |   |   |   |
| Revenue                      |       | $                                                             | 7,390,000  |   | $ | 31,000 |   | $ | 7,421,000 |   |
| Cost of revenue              |       | 1,144,000                                                     |       | 2,315,000 |   | 3,459,000 |   |
| Gross margin (deficit)       |       | 6,246,000                                                     |       | (2,284,000 | ) | 3,962,000 |   |
| Sales and  marketing         |       | 3,111,000                                                     |       | — |   | 3,111,000 |   |
| Research and  development    |       | 1,932,000                                                     |       | 97,000 |   | 2,029,000 |   |
| General and  administrative  |       | 1,781,000                                                     |       | 48,000 |   | 1,829,000 |   |
| Amortization of  intangibles |       | 593,000                                                       |       | — |   | 593,000 |   |
| Total operating expenses     |       | 7,417,000                                                     |       | 145,000 |   | 7,562,000 |   |
| Loss from  operations        |       | $                                                             | (1,171,000 | ) | $ | (2,429,000 | ) | $ | (3,600,000 | ) |

 

|                                | ** ** | **Three Months Ended July 31, 2005** | ** ** |
|--------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                     | ** ** | **UNIX**                                                      | ** ** | **SCOsource** | ** ** | **Total** | ** ** |
|                           |       |                                                          |       |   |   |   |   |
| Revenue                        |       | $                                                             | 9,321,000  |   | $ | 32,000 |   | $ | 9,353,000 |   |
| Cost of revenue                |       | 1,395,000                                                     |       | 3,085,000 |   | 4,480,000 |   |
| Gross margin (deficit)         |       | 7,926,000                                                     |       | (3,053,000 | ) | 4,873,000 |   |
| Sales and  marketing           |       | 2,935,000                                                     |       | — |   | 2,935,000 |   |
| Research and  development      |       | 1,843,000                                                     |       | 97,000 |   | 1,940,000 |   |
| General and  administrative    |       | 1,556,000                                                     |       | 91,000 |   | 1,647,000 |   |
| Amortization of  intangibles   |       | 593,000                                                       |       | — |   | 593,000 |   |
| Total operating expenses       |       | 6,927,000                                                     |       | 188,000 |   | 7,115,000 |   |
| Income (loss)  from operations |       | $                                                             | 999,000    |   | $ | (3,241,000 | ) | $ | (2,242,000 | ) |

 

|                              | ** ** | **Nine Months Ended July 31, 2006** | ** ** |
|------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                   | ** ** | **UNIX**                                                     | ** ** | **SCOsource** | ** ** | **Total** | ** ** |
|                         |       |                                                         |       |   |   |   |   |
| Revenue                      |       | $                                                            | 21,795,000 |   | $ | 95,000 |   | $ | 21,890,000 |   |
| Cost of revenue              |       | 3,571,000                                                    |       | 10,087,000 |   | 13,658,000 |   |
| Gross margin (deficit)       |       | 18,224,000                                                   |       | (9,992,000 | ) | 8,232,000 |   |
| Sales and  marketing         |       | 8,655,000                                                    |       | 1,000 |   | 8,656,000 |   |
| Research and  development    |       | 5,501,000                                                    |       | 285,000 |   | 5,786,000 |   |
| General and  administrative  |       | 4,994,000                                                    |       | 145,000 |   | 5,139,000 |   |
| Amortization of  intangibles |       | 1,778,000                                                    |       | — |   | 1,778,000 |   |
| Total operating expenses     |       | 20,928,000                                                   |       | 431,000 |   | 21,359,000 |   |
| Loss from  operations        |       | $                                                            | (2,704,000 | ) | $ | (10,423,000 | ) | $ | (13,127,000 | ) |

 

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|                                | ** ** | **Nine Months Ended July 31, 2005** | ** ** |
|--------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                     | ** ** | **UNIX**                                                     | ** ** | **SCOsource** | ** ** | **Total** | ** ** |
|                           |       |                                                         |       |   |   |   |   |
| Revenue                        |       | $                                                            | 27,344,000 |   | $ | 132,000 |   | $ | 27,476,000 |   |
| Cost of revenue                |       | 4,097,000                                                    |       | 9,467,000 |   | 13,564,000 |   |
| Gross margin (deficit)         |       | 23,247,000                                                   |       | (9,335,000 | ) | 13,912,000 |   |
| Sales and  marketing           |       | 8,695,000                                                    |       | 154,000 |   | 8,849,000 |   |
| Research and  development      |       | 5,846,000                                                    |       | 299,000 |   | 6,145,000 |   |
| General and  administrative    |       | 5,094,000                                                    |       | 352,000 |   | 5,446,000 |   |
| Amortization of  intangibles   |       | 1,779,000                                                    |       | — |   | 1,779,000 |   |
| Total operating expenses       |       | 21,414,000                                                   |       | 805,000 |   | 22,219,000 |   |
| Income (loss)  from operations |       | $                                                            | 1,833,000  |   | $ | (10,140,000 | ) | $ | (8,307,000 | ) |

 

Intangibleassets, which consist of the Company’s reseller channel, trade name andtechnology, have been assigned to the Company’s UNIX and SCOsource segments andconsist of the following as of July 31, 2006 and October 31, 2005: 

|                                        | ** ** | **July 31,  2006** | ** ** | **October 31,  2005** | ** ** |
|----------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| Intangible  assets:                    |       |                    |       |                       |       |
| UNIX (reseller channel and trade name) |       | $                       | 592,000    |                       | $          | 2,370,000 |   |
| SCOsource (UNIX technology)            |       | 85,000                  |       | 337,000                    |       |
| Total intangible  assets               |       | $                       | 677,000    |                       | $          | 2,707,000 |   |

 

17

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

*This Management’s Discussion andAnalysis of Financial Condition and Results of Operations and other parts ofthis quarterly report on Form 10-Q contain forward-looking statements thatinvolve risks and uncertainties. Forward-looking statements can also be identified by words such as “intends,”“anticipates,” “expects,” “believes,” “plans,” “predicts,” and similarterms.  Forward-looking statements arenot guarantees of future performance and our actual results may differsignificantly from the results discussed in the forward-lookingstatements.  Factors that might causesuch differences include, but are not limited to, those set forth below under “Forward-LookingStatements and Factors that May Affect Future Results and Financial Condition”and Part II, Item 1A – Risk Factors and elsewhere in this Form 10-Q. Thefollowing discussion 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 and nine months ended July 31, 2006 and 2005.  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 (“CalderaSystems”), on August 21, 1998, and reincorporated as a Delaware corporation onMarch 6, 2000.  In March 2000, wecompleted an initial public offering of our common stock.  On May 7, 2001, we formed a new holding companyin Delaware under the name of Caldera International, Inc. (“CalderaInternational”) to acquire substantially all of the assets and operations ofthe server and professional services groups of The Santa Cruz Operation.  In connection with this acquisition, CalderaSystems became a wholly owned subsidiary of Caldera International.  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. *OurUNIX business serves the needs of small-to-medium sized businesses, includingreplicated site franchisees of Fortune 1000 companies, by providing reliable,cost effective UNIX operating systems and software products to power computersrunning on Intel architecture.  Our largestsource of UNIX business revenue is derived from existing customers through ourworldwide, indirect, leveraged channel of partners which includes distributorsand independent solution providers.  Wehave operations in a number of countries that provide support and services tocustomers and resellers.  The otherprincipal channel for selling and marketing our UNIX products is throughexisting customers that have a large number of replicated sites or franchisees.

We access these companies through theirinformation technology or purchasing departments with our area sales managersin the United States and through our reseller channel in countries outside theUnited States.  In addition, we also sellour operating system 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.

18

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The following table shows the operating resultsof the UNIX business for the three and nine months ended July 31, 2006 and2005:
|                                | ** ** | **Three Months Ended July 31,** | ** ** |
|--------------------------------|------------|-----------------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
|                           |       |                                                |       |   |   |
| Revenue                        |       | $                                                   | 7,390,000  |   | $ | 9,321,000 |   |
| Cost of revenue                |       | 1,144,000                                           |       | 1,395,000 |   |
| Gross margin                   |       | 6,246,000                                           |       | 7,926,000 |   |
| Sales and  marketing           |       | 3,111,000                                           |       | 2,935,000 |   |
| Research and  development      |       | 1,932,000                                           |       | 1,843,000 |   |
| General and  administrative    |       | 1,781,000                                           |       | 1,556,000 |   |
| Amortization of  intangibles   |       | 593,000                                             |       | 593,000 |   |
| Total operating expenses       |       | 7,417,000                                           |       | 6,927,000 |   |
| Income (loss)  from operations |       | $                                                   | (1,171,000 | ) | $ | 999,000 |   |

 
|                                | ** ** | **Nine Months Ended July 31,** | ** ** |
|--------------------------------|------------|----------------------------------------------------|------------|
| ** **                     | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
|                           |       |                                               |       |   |   |
| Revenue                        |       | $                                                  | 21,795,000 |   | $ | 27,344,000 |   |
| Cost of revenue                |       | 3,571,000                                          |       | 4,097,000 |   |
| Gross margin                   |       | 18,224,000                                         |       | 23,247,000 |   |
| Sales and  marketing           |       | 8,655,000                                          |       | 8,695,000 |   |
| Research and  development      |       | 5,501,000                                          |       | 5,846,000 |   |
| General and  administrative    |       | 4,994,000                                          |       | 5,094,000 |   |
| Amortization of  intangibles   |       | 1,778,000                                          |       | 1,779,000 |   |
| Total operating expenses       |       | 20,928,000                                         |       | 21,414,000 |   |
| Income (loss)  from operations |       | $                                                  | (2,704,000 | ) | $ | 1,833,000 |   |

 

Revenuefrom our UNIX business decreased by $1,931,000, or 21%, for the three monthsended July 31, 2006 compared to the three months ended July 31, 2005 anddecreased by $5,549,000, or 20%, for the nine months ended July 31, 2006compared to the nine months ended July 31, 2005.  The revenue from this business has beendeclining over the last several periods primarily as a result of increasedcompetition from alternative operating systems, particularly Linux.  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.

Operating costs for our UNIX business increasedfrom $6,927,000 for the three months ended July 31, 2005 to $7,417,000 for thethree months ended July 31, 2006 and this increase was primarily attributableto stock-based compensation as a result of our adoption of SFAS No. 123(R).  Operating costs decreased slightlyfrom $21,414,000 for the nine months ended July 31, 2005 to $20,928,000 for thenine months ended July 31, 2006 and was primarily attributable to reducedheadcount and related costs offset by an increase in stock-based compensation.

The decline in our UNIX business revenue may beaccelerated if industry partners withdraw their support for our products.  The decline in our UNIX business and ourSCOsource business may cause industry partners, developers and hardware andsoftware vendors to choose

19

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not to support or certify to our UNIX operating systemproducts.  This would lead to anaccelerated decline in revenue and negative cash flows from our UNIX business.

*SCOsource Business. *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.

In an effort to protect and defend our UNIXintellectual property, we initiated ourSCOsource business.  Our SCOsourcerevenue for the years ended October 31, 2005 and 2004 was significantly lowerthan revenue generated during the year ended October 31, 2003, and we believeand allege our revenue and related revenue opportunities have been adverselyimpacted by Novell’s claim of UNIX copyright ownership, which may have causedpotential customers to delay or forego licensing with us until an outcome inthis legal matter has been reached.

The following table shows the operating resultsof the SCOsource business for the three and nine months ended July 31, 2006 and2005 (in thousands):
|                             | ** ** | **Three Months Ended July 31,** | ** ** |
|-----------------------------|------------|-----------------------------------------------------|------------|
| ** **                  | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
|                        |       |                                                |       |   |   |
| Revenue                     |       | $                                                   | 31,000     |   | $ | 32,000 |   |
| Cost of revenue             |       | 2,315,000                                           |       | 3,085,000 |   |
| Gross deficit               |       | (2,284,000                                          | )          | (3,053,000 | ) |
| Research and  development   |       | 97,000                                              |       | 97,000 |   |
| General and  administrative |       | 48,000                                              |       | 91,000 |   |
| Total operating expenses    |       | 145,000                                             |       | 188,000 |   |
| Loss from  operations       |       | $                                                   | (2,429,000 | ) | $ | (3,241,000 | ) |

 
|                             | ** ** | **Nine Months Ended July 31,** | ** **  |
|-----------------------------|------------|----------------------------------------------------|-------------|
| ** **                  | ** ** | **2006**                                           | ** **  | **2005** | ** ** |
|                        |       |                                               |        |   |   |
| Revenue                     |       | $                                                  | 95,000      |   | $ | 132,000 |   |
| Cost of revenue             |       | 10,087,000                                         |        | 9,467,000 |   |
| Gross deficit               |       | (9,992,000                                         | )           | (9,335,000 | ) |
| Sales and  marketing        |       | 1,000                                              |        | 154,000 |   |
| Research and  development   |       | 285,000                                            |        | 299,000 |   |
| General and  administrative |       | 145,000                                            |        | 352,000 |   |
| Total operating expenses    |       | 431,000                                            |        | 805,000 |   |
| Loss from  operations       |       | $                                                  | (10,423,000 | ) | $ | (10,140,000 | ) |

 

Revenue from our SCOsource business decreasedslightly from $32,000 for the three months ended July 31, 2005 to $31,000 forthe three months ended July 31, 2006 and decreased from $132,000 for the ninemonths ended July 31, 2005 to $95,000 for the nine months ended July 31, 2006.  Revenue in the above mentioned periods wasprimarily attributable to sales of our SCOsource IP agreements.

Cost of revenue, which primarily includes legaland professional fees incurred in connection with the SCO Litigation, decreasedfrom $3,085,000 for the three months ended July 

20

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31,2005 to $2,315,000 for the three months ended July 31, 2006.  The decrease in cost of revenue was primarilyattributable to the absence of the $2,000,000 quarterly payment for Boies,Schiller & Flexner LLP, Kevin McBride and Berger Singerman (the “Law Firms”) (which quarterly payments ended duringthe three months ended January 31, 2006), offset by increases in legal servicesprovide by technical, industry, damage and other experts in connection with theSCO Litigation.  Cost of revenueincreased from $9,467,000 for the nine months ended July 31, 2005 to$10,087,000 for the nine months ended July 31, 2006.  This increase was primarily attributable tosignificant work performed by technical, damage and industry experts and otherconsultants in connection with the SCO Litigation during the nine months endedJuly 31, 2006, offset by a reduction in expense associated with the quarterlypayments made to the Law Firms as only two quarterly payments were made duringthe nine months ended July 31, 2006 as compared to three quarterly paymentsmade during the nine months ended July 31, 2005.  Becauseof the unique and unpredictable nature of the SCO Litigation, the occurrenceand timing of certain expenses such as damage, industry and technical reviewand other consultants is difficult to predict, and it will be difficult topredict the total cost of revenue for the upcoming quarters.

Becauseof the uncertainties related to our SCOsource business, we are unable toestimate the amount 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**

Ourcritical accounting policies and estimates include the following:

·          Revenue recognition;

·          Deferred income tax assets and related valuationallowances;

·          Litigation reserves;

·          Impairmentand useful lives of long-lived assets; and

·          Allowances for doubtful accounts receivable.

*Revenue Recognition*.  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 license revenue, primarily from product sales to resellers,end users and OEMs; (ii) technical support service revenue, primarily fromproviding technical support and consulting services to end users; and (iii)revenue from SCOsource licensing.

Werecognize product revenue upon shipment if a signed contract exists, the fee isfixed or determinable, collection of the resulting receivable is probable andproduct returns are reasonably estimable.

Themajority of our revenue 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 of

21

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the undelivered elementsis deferred and the remaining portion of the license fee is recognized asrevenue in the period when persuasive evidence of an arrangement is obtainedassuming all other revenue recognition criteria are met.

Werecognize product revenue from OEMs when the software is sold by the OEM to anend-user customer.  Revenue fromtechnical support services and consulting services is recognized as the relatedservices are performed.  Revenue formaintenance is recognized ratably over the maintenance period.

Weconsider an arrangement with payment terms longer than our normal businesspractice, not to be fixed or determinable and revenue is recognized when thefee becomes due.  We typically providestock rotation rights for sales made through our distribution channel and salesto distributors are recognized upon shipment by the distributor to endusers.  For direct sales not through ourdistribution channel, sales are typically non-refundable andnon-cancelable.  We estimate our productreturns based on historical experience and maintain an allowance for estimatedreturns, which is recorded as a reduction to accounts receivable.

OurSCOsource revenue to date has been primarily generated from agreements toutilize our UNIX source code 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.

*Deferred Income 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.

*Litigation Reserves. *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.  A material, negative impact on our results ofoperations or financial position from the Red Hat, Inc., IPO Class Action, orIndian Distributor matters, or the IBM and Novell counterclaims is neitherprobable nor estimable.  Because thesematters are not probable or estimable, we have not recorded any reserves orcontingencies related to these legal matters. In the event that our assumptions used to evaluate these matters asneither probable nor estimable changes in future periods, we may be required torecord a liability for an adverse outcome, which could have a material adverseeffect on our results of operations and financial position.

*Impairment and 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.

22

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Write-downsof intangible assets may be necessary if the future fair value of these assetsis less than carrying value.  If theoperating trends for our UNIX or SCOsource businesses continue to decline, we maybe required to record an impairment charge in a future period related to thecarrying value of our long-lived assets.

*Allowance for 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 $97,000 as of July 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.

**Results of Operations**

Thefollowing table presents our results of operations for the three and ninemonths ended July 31, 2006 and 2005:
|                                                  | ** ** | **Three Months Ended July 31,** | ** ** | **Nine Months Ended July 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| **Statement of Operations Data:** | ** ** | **2006**                                            | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                             |       |                                                |       |                                               |       |   |   |   |   |
| Revenue:                                         |       |                                                |       |                                               |       |   |   |   |   |
| Products                                         |       | $                                                   | 6,201,000  |                                               | $          | 7,953,000 |   | $ | 17,904,000 |   | $ | 23,095,000 |   |
| SCOsource licensing                              |       | 31,000                                              |       | 32,000                                             |       | 95,000 |   | 132,000 |   |
| Services                                         |       | 1,189,000                                           |       | 1,368,000                                          |       | 3,891,000 |   | 4,249,000 |   |
| Total revenue                                    |       | 7,421,000                                           |       | 9,353,000                                          |       | 21,890,000 |   | 27,476,000 |   |
| Cost of revenue:                                 |       |                                                |       |                                               |       |   |   |   |   |
| Products                                         |       | 478,000                                             |       | 695,000                                            |       | 1,559,000 |   | 1,902,000 |   |
| SCOsource licensing                              |       | 2,315,000                                           |       | 3,085,000                                          |       | 10,087,000 |   | 9,467,000 |   |
| Services                                         |       | 666,000                                             |       | 700,000                                            |       | 2,012,000 |   | 2,195,000 |   |
| Total cost of revenue                            |       | 3,459,000                                           |       | 4,480,000                                          |       | 13,658,000 |   | 13,564,000 |   |
| Gross margin                                     |       | 3,962,000                                           |       | 4,873,000                                          |       | 8,232,000 |   | 13,912,000 |   |
| Operating expenses:                              |       |                                                |       |                                               |       |   |   |   |   |
| Sales and marketing                              |       | 3,111,000                                           |       | 2,935,000                                          |       | 8,656,000 |   | 8,849,000 |   |
| Research and development                         |       | 2,029,000                                           |       | 1,940,000                                          |       | 5,786,000 |   | 6,145,000 |   |
| General and administrative                       |       | 1,829,000                                           |       | 1,647,000                                          |       | 5,139,000 |   | 5,446,000 |   |
| Amortization of intangibles                      |       | 593,000                                             |       | 593,000                                            |       | 1,778,000 |   | 1,779,000 |   |
| Total operating expenses                         |       | 7,562,000                                           |       | 7,115,000                                          |       | 21,359,000 |   | 22,219,000 |   |
| Loss from operations                             |       | (3,600,000                                          | )          | (2,242,000                                         | )          | (13,127,000 | ) | (8,307,000 | ) |
| Equity in income (loss) of affiliate             |       | —                                              |       | (19,000                                            | )          | (8,000 | ) | 51,000 |   |
| Other income (expense), net                      |       | 127,000                                             |       | (27,000                                            | )          | 588,000 |   | 1,282,000 |   |
| Provision for income taxes                       |       | (107,000                                            | )          | (84,000                                            | )          | (308,000 | ) | (321,000 | ) |
| Net loss                                         |       | $                                                   | (3,580,000 | )                                                  | $          | (2,372,000 | ) | $ | (12,855,000 | ) | $ | (7,295,000 | ) |

 

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**THREEAND NINE MONTHS ENDED JULY 31, 2006 AND 2005**

### *Revenue*

|            | ** ** | **Three Months Ended July 31,** | ** ** |
|------------|------------|-----------------------------------------------------|------------|
| ** ** | ** ** | **2006**                                            | ** ** | **Change** | ** ** | **2005** | ** ** |
|       |       |                                                |       |   |   |   |   |
| Revenue    |       | $                                                   | 7,421,000  |   | (21 | )% | $ | 9,353,000 |   |
|            |            |                                                     |            |  |  |  |  |  |  |

 
|            | ** ** | **Nine Months Ended July 31,** | ** ** |
|------------|------------|--------------------------------|------------|
| ** ** | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|       |       |                           |       |   |   |   |   |
| Revenue    |       | $                              | 21,890,000 |   | (20 | )% | $ | 27,476,000 |   |
|            |            |                                |            |  |  |  |  |  |  |

 

Revenue for the three months ended July 31, 2006 decreased by$1,932,000, or 21%, from the three months ended July 31, 2005, and revenue forthe nine months ended July 31, 2006 decreased by $5,586,000, or 20%, from thenine months ended July 31, 2005.  Thesedecreases were primarily attributable to a continued decline in our UNIXbusiness as a result of continued competitive pressure from competing operatingsystems, particularly Linux.

Revenue generated from our UNIX business and SCOsource business is asfollows:
|                          | ** ** | **Three Months Ended July 31,** | ** ** |
|--------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **2006**                        | ** ** | **Change** | ** ** | **2005** | ** ** |
|                     |       |                            |       |   |   |   |   |
| UNIX revenue             |       | $                               | 7,390,000  |   | (21 | )% | $ | 9,321,000 |   |
| Percent of total revenue |       | 100                             | %          |   |   | 100 | % |
| SCOsource revenue        |       | 31,000                          |       | (3 | )% | 32,000 |   |
| Percent of total revenue |       | 0                               | %          |   |   | 0 | % |
|                          |            |                                 |            |  |  |  |  |  |  |

 
|                          | ** ** | **Nine Months Ended July 31,** | ** ** |
|--------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|                     |       |                           |       |   |   |   |   |
| UNIX revenue             |       | $                              | 21,795,000 |   | (20 | )% | $ | 27,344,000 |   |
| Percent of total revenue |       | 100                            | %          |   |   | 100 | % |
| SCOsource revenue        |       | 95,000                         |       | (28 | )% | 132,000 |   |
| Percent of total revenue |       | 0                              | %          |   |   | 0 | % |
|                          |            |                                |            |  |  |  |  |  |  |

 

The decrease inrevenue in the UNIX business of $1,931,000, or 21%, for the three months endedJuly 31, 2006 compared to the three months ended July 31, 2005 and the decreasein revenue of $5,549,000, or 20%, for the nine months ended July 31, 2006compared to the nine months ended July 31, 2005 was primarily attributable 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.

Sales of our UNIXproducts and services during the three and nine months ended July 31, 2006 wereprimarily to pre-existing customers.  OurUNIX business revenue depends significantly on our ability to market ourproducts to existing customers and to generate upgrades from existingcustomers.  Our UNIX revenue may decreaseif we are not successful with our existing customers or if we lose the supportof any of our existing hardware and software vendors or our key industrypartners withdraw their marketing and certification support or direct theirsupport to our competitors.

24

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*Products Revenue*
|                          | ** ** | **Three Months Ended July 31,** | ** ** |
|--------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **2006**                        | ** ** | **Change** | ** ** | **2005** | ** ** |
|                     |       |                            |       |   |   |   |   |
| Products revenue         |       | $                               | 6,201,000  |   | (22 | )% | $ | 7,953,000 |   |
| Percent of total revenue |       | 84                              | %          |   |   | 85 | % |
|                          |            |                                 |            |  |  |  |  |  |  |

 
|                          | ** ** | **Nine Months Ended July 31,** | ** ** |
|--------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|                     |       |                           |       |   |   |   |   |
| Products revenue         |       | $                              | 17,904,000 |   | (22 | )% | $ | 23,095,000 |   |
| Percent of total revenue |       | 82                             | %          |   |   | 84 | % |
|                          |            |                                |            |  |  |  |  |  |  |

 

Our products revenue consists of software licenses for UNIX productssuch as OpenServer and UnixWare, as well as sales of UNIX-relatedproducts.  Products revenue also includesrevenue derived 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.

The decrease inproducts revenue of $1,752,000, or 22%, for the three months ended July 31,2006 compared to the three months ended July 31, 2005 and the decrease inproducts revenue of $5,191,000, or 22%, for the nine months ended July 31, 2006compared to the nine months ended July 31, 2005 were primarily attributable todecreased sales of OpenServer and other products revenue primarily resultingfrom increased competition in the operating system market, particularly fromLinux.

Our productsrevenue was derived primarily from sales of our OpenServer and UnixWareproducts.  Other products revenueconsists mainly of product maintenance and other UNIX-related products.  Revenue for these products was as follows:
|                             | ** ** | **Three Months Ended July 31,** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | **2006**                        | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                            |       |   |   |   |   |
| OpenServer revenue          |       | $                               | 3,184,000  |   | (26 | )% | $ | 4,309,000 |   |
| Percent of products revenue |       | 51                              | %          |   |   | 54 | % |
| UnixWare revenue            |       | 2,592,000                       |       | 24 | % | 2,085,000 |   |
| Percent of products revenue |       | 42                              | %          |   |   | 26 | % |
| Other products revenue      |       | 425,000                         |       | (73 | )% | 1,559,000 |   |
| Percent of products revenue |       | 7                               | %          |   |   | 20 | % |
|                             |            |                                 |            |  |  |  |  |  |  |

 
|                             | ** ** | **Nine Months Ended July 31,** | ** ** |
|-----------------------------|------------|--------------------------------|------------|
| ** **                  | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                           |       |   |   |   |   |
| OpenServer revenue          |       | $                              | 10,176,000 |   | (22 | )% | $ | 12,987,000 |   |
| Percent of products revenue |       | 57                             | %          |   |   | 56 | % |
| UnixWare revenue            |       | 5,901,000                      |       | (11 | )% | 6,606,000 |   |
| Percent of products revenue |       | 33                             | %          |   |   | 29 | % |
| Other products revenue      |       | 1,827,000                      |       | (48 | )% | 3,502,000 |   |
| Percent of products revenue |       | 10                             | %          |   |   | 15 | % |
|                             |            |                                |            |  |  |  |  |  |  |

 

The decrease inrevenue for OpenServer for the three and nine months ended July 31, 2006compared to the three and nine months ended July 31, 2005 is primarily theresult of continued competition from other operating systems, particularlyLinux.  The increase in UnixWare revenuefor the three months ended July 31, 2006 compared to the three months ended

25

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July 31, 2005 isprimarily the result of increased sales to end-user customers.  The decrease in other products revenue isprimarily attributable to decreased sales of UNIX-related products anddecreased sales of product maintenance.

*SCOsourceLicensing Revenue*
|                             | ** ** | **Three Months Ended July 31,** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | **2006**                        | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                            |       |   |   |   |   |
| SCOsource licensing revenue |       | $                               | 31,000     |   | (3 | )% | $ | 32,000 |   |
|                             |            |                                 |            |  |  |  |  |  |  |

 
|                             | ** ** | **Nine Months Ended July 31,** | ** ** |
|-----------------------------|------------|--------------------------------|------------|
| ** **                  | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                           |       |   |   |   |   |
| SCOsource licensing revenue |       | $                              | 95,000     |   | (28 | )% | $ | 132,000 |   |
|                             |            |                                |            |  |  |  |  |  |  |

 

We initiated our SCOsource business for the purpose of protecting anddefending our intellectual property rights in our UNIX source code andderivative works.  SCOsource licensingrevenue was $32,000 for the three months ended July 31, 2005 compared to$31,000 for the three months ended July 31, 2006 and SCOsource licensingrevenue was $132,000 for the nine months ended July 31, 2005 compared to$95,000 for the nine months ended July 31, 2006.  Revenue in the above mentioned periods wasprimarily attributable to sales of our SCOsource IP agreements.

We are unable to predict the amount and timing of future SCOsourcelicensing revenue, and if generated, the revenue will be sporadic.

*Services Revenue*
|                          | ** ** | **Three Months Ended July 31,** | ** ** |
|--------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **2006**                        | ** ** | **Change** | ** ** | **2005** | ** ** |
|                     |       |                            |       |   |   |   |   |
| Services revenue         |       | $                               | 1,189,000  |   | (13 | )% | $ | 1,368,000 |   |
| Percent of total revenue |       | 16                              | %          |   |   | 15 | % |
|                          |            |                                 |            |  |  |  |  |  |  |

 
|                          | ** ** | **Nine Months Ended July 31,** | ** ** |
|--------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|                     |       |                           |       |   |   |   |   |
| Services revenue         |       | $                              | 3,891,000  |   | (8 | )% | $ | 4,249,000 |   |
| Percent of total revenue |       | 18                             | %          |   |   | 16 | % |
|                          |            |                                |            |  |  |  |  |  |  |

 

Services revenue consists primarily of technical support fees,engineering services fees, professional services fees and consulting fees.  These fees are typically charged and invoicedseparately from UNIX products sales.  Thedecrease in services revenue of $179,000, or 13%, for the three months endedJuly 31, 2006 as compared to the three months ended July 31, 2005 and thedecrease in services revenue of $358,000, or 8%, for the nine months ended July31, 2006 as compared to the nine months ended July 31, 2005 was primarilyattributable to a decrease in professional services revenue as well as from adecrease in support and engineering services contracts.

The majority of our support and professional services revenue continuesto be derived 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.

26

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*Cost of Products Revenue*
|                             | ** ** | **Three Months Ended July 31,** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | **2006**                        | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                            |       |   |   |   |   |
| Cost of products revenue    |       | $                               | 478,000    |   | (31 | )% | $ | 695,000 |   |
| Percent of products revenue |       | 8                               | %          |   |   | 9 | % |
|                             |            |                                 |            |  |  |  |  |  |  |

 
|                             | ** ** | **Nine Months Ended July 31,** | ** ** |
|-----------------------------|------------|--------------------------------|------------|
| ** **                  | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                           |       |   |   |   |   |
| Cost of products revenue    |       | $                              | 1,559,000  |   | (18 | )% | $ | 1,902,000 |   |
| Percent of products revenue |       | 9                              | %          |   |   | 8 | % |
|                             |            |                                |            |  |  |  |  |  |  |

 

Cost of products revenue consists of manufacturing costs, royalties tothird-party vendors, technology costs and overhead costs.  Cost of products revenue decreased by$217,000, or 31%, for the three months ended July 31, 2006 as compared to thethree months ended July 31, 2005 and cost of products revenue decreased by$343,000, or 18%, for the nine months ended July 31, 2006 as compared to thenine months ended July 31, 2005.  Thedecrease in the dollar amount of cost of products revenue was primarilyattributable to lower products revenue as margins did not vary considerably.

For the threemonths ending October 31, 2006, we expect the dollar amount of our cost ofproducts revenue to be generally consistent with the cost of products revenueincurred during the three months ended July 31, 2006 and that cost of productsrevenue as a percent of products revenue for the three months ending October31, 2006 will be generally consistent with that incurred during the threemonths ended July 31, 2006.

*Cost ofSCOsource Licensing Revenue*  
|                                     | ** ** | **Three Months Ended July 31,** | ** ** |
|-------------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **2006**                        | ** ** | **Change** | ** ** | **2005** | ** ** |
|                                |       |                            |       |   |   |   |   |
| Cost of SCOsource licensing revenue |       | $                               | 2,315,000  |   | (25 | )% | $ | 3,085,000 |   |
|                                     |            |                                 |            |  |  |  |  |  |  |

 
|                                     | ** ** | **Nine Months Ended July 31,** | ** ** |
|-------------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|                                |       |                           |       |   |   |   |   |
| Cost of SCOsource licensing revenue |       | $                              | 10,087,000 |   | 7 | % | $ | 9,467,000 |   |
|                                     |            |                                |            |  |  |  |  |  |  |

 

Cost of SCOsource licensing revenue includes legal and professional feesincurred in connection with our SCO Litigation, the salaries and relatedpersonnel costs of SCOsource employees, and an allocation of corporate costs.

Cost of SCOsource licensing revenue decreased by $770,000, or 25%,during the three months ended July 31, 2006 as compared to the three monthsended July 31, 2005.  The decrease incost of SCOsource licensing revenue was primarily attributable to the absenceof the $2,000,000 quarterly payment and related expense for the Law Firms(which quarterly payments ended during the three months ended January 31,2006), offset by increases in legal services provided by technical, industry,damage and other experts in connection with the SCO Litigation.  Cost of SCOsource licensing revenue increasedby $620,000, or 7%, during the nine months ended July 31, 2006 as compared tothe nine months ended July 31, 2005. This increase was primarily attributable to significant work performedby technical, damage and industry experts and other consultants in connectionwith the SCO Litigation during the nine months ended July 31, 2006, offset by areduction in expenses associated with the quarterly payments made to the LawFirms

27

----

as only two quarterly payments were made during thenine months ended July 31, 2006 as compared to three quarterly payments madeduring the nine months ended July 31, 2005.

Because of theunique and unpredictable nature of the SCO Litigation, the occurrence andtiming of certain expenses is difficult to predict, and will be difficult topredict for the upcoming quarters.  We will continue to make payments fortechnical, damage and industry experts, consultants and for 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 the three months ending October 31, 2006 to be higherthan the costs incurred for the three months ended July 31, 2006.

*Cost of Services Revenue*
|                             | ** ** | **Three Months Ended July 31,** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | **2006**                        | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                            |       |   |   |   |   |
| Cost of services revenue    |       | $                               | 666,000    |   | (5 | )% | $ | 700,000 |   |
| Percent of services revenue |       | 56                              | %          |   |   | 51 | % |
|                             |            |                                 |            |  |  |  |  |  |  |

 
|                             | ** ** | **Nine Months Ended July 31,** | ** ** |
|-----------------------------|------------|--------------------------------|------------|
| ** **                  | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                           |       |   |   |   |   |
| Cost of services revenue    |       | $                              | 2,012,000  |   | (8 | )% | $ | 2,195,000 |   |
| Percent of services revenue |       | 52                             | %          |   |   | 52 | % |
|                             |            |                                |            |  |  |  |  |  |  |

 

Cost of services revenue includes the salaries and related personnelcosts of employees delivering services revenue as well as third-party serviceagreements.  Cost of services revenuedecreased by $34,000, or 5%, for the three months ended July 31, 2006 comparedto the three months ended July 31, 2005 and decreased by $183,000, or 8%, forthe nine months ended July 31, 2006 as compared to the nine months ended July31, 2005.  This decrease wasprimarily attributable to reduced numbers of employees and related costs.

For the threemonths ending October 31, 2006, we expect the dollar amount of our cost ofservices revenue to be generally consistent with the cost of services revenueincurred during the three months ended July 31, 2006 and that cost of servicesrevenue as a percent of services revenue for the three months ending October31, 2006 will be generally consistent with that incurred during the threemonths ended July 31, 2006.

*Sales and Marketing*
|                              | ** ** | **Three Months Ended July 31,** | ** ** |
|------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **2006**                        | ** ** | **Change** | ** ** | **2005** | ** ** |
|                         |       |                            |       |   |   |   |   |
| Sales and marketing expenses |       | $                               | 3,111,000  |   | 6 | % | $ | 2,935,000 |   |
| Percent of total revenue     |       | 42                              | %          |   |   | 31 | % |
|                              |            |                                 |            |  |  |  |  |  |  |

 
|                              | ** ** | **Nine Months Ended July 31,** | ** ** |
|------------------------------|------------|--------------------------------|------------|
| ** **                   | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|                         |       |                           |       |   |   |   |   |
| Sales and marketing expenses |       | $                              | 8,656,000  |   | (2 | )% | $ | 8,849,000 |   |
| Percent of total revenue     |       | 40                             | %          |   |   | 32 | % |
|                              |            |                                |            |  |  |  |  |  |  |

 

Sales and marketing expenses consist of the salaries, commissions andother personnel costs of employees involved in the revenue generation process,as well as advertising and corporate allocations.  The increase in sales and marketing expensesof $176,000, or 6%, for the three months ended July 31, 2006 compared with thethree months ended July 31, 2005 was

28

----

primarilyattributable to increased travel costs, increased marketing costs associatedwith the release of our mobile services product offerings and from stock-basedcompensation.  The decrease in sales andmarketing expense of $193,000, or 2%, for the nine months ended July 31, 2006compared with the nine months ended July 31, 2005 was primarily attributableto decreased spending on co-operative advertising and decreased discretionaryspending, offset by increases in spending related to the release of our mobileservices product offerings and from stock-based compensation.  Included in sales and marketing expenses forthe three months ended July 31, 2006 and 2005 was $102,000 and $0,respectively, for stock-based compensation. Included in sales and marketing expenses for the nine months ended July31, 2006 and 2005 was $261,000 and $14,000, respectively, for stock-based compensation.

For the three months ending October 31, 2006, we anticipate that thedollar amount of sales and marketing expenses will be generally consistent withthat incurred during the three months ended July 31, 2006.

*Research and Development*
|                                   | ** ** | **Three Months Ended July 31,** | ** ** |
|-----------------------------------|------------|---------------------------------|------------|
| ** **                        | ** ** | **2006**                        | ** ** | **Change** | ** ** | **2005** | ** ** |
|                              |       |                            |       |   |   |   |   |
| Research and development expenses |       | $                               | 2,029,000  |   | 5 | % | $ | 1,940,000 |   |
| Percent of total revenue          |       | 27                              | %          |   |   | 21 | % |
|                                   |            |                                 |            |  |  |  |  |  |  |

 
|                                   | ** ** | **Nine Months Ended July 31,** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|
| ** **                        | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|                              |       |                           |       |   |   |   |   |
| Research and development expenses |       | $                              | 5,786,000  |   | (6 | )% | $ | 6,145,000 |   |
| Percent of total revenue          |       | 26                             | %          |   |   | 22 | % |
|                                   |            |                                |            |  |  |  |  |  |  |

 

Research and development expenses consist of the salaries and benefitsof software engineers, consulting expenses and corporate allocations.  Research and development expenses increasedby $89,000, or 5%, for the three months ended July 31, 2006 compared with thethree months ended July 31, 2005.  Theincrease in research and development expenses was primarily attributable toincreased travel costs and from stock-based compensation.  Research and development expenses decreasedby $359,000, or 6%, for the nine months ended July 31, 2006 compared with thenine months ended July 31, 2005, which was primarily attributable to decreasedpersonnel and personnel-related costs, offset by an increase in stock-basedcompensation.  Included in research anddevelopment expenses for the three months ended July 31, 2006 and 2005 was$41,000 and $0, respectively, of stock-based compensation.  Included in research and development expensesfor the nine months ended July 31, 2006 and 2005 was $97,000 and $8,000,respectively, of stock-based compensation.

For the three months ending October 31, 2006, we anticipate that thedollar amount of research and development expenses will be generally consistentwith that incurred during the three months ended July 31, 2006.

29

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*General and Administrative*
|                                     | ** ** | **Three Months Ended July 31,** | ** ** |
|-------------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **2006**                        | ** ** | **Change** | ** ** | **2005** | ** ** |
|                                |       |                            |       |   |   |   |   |
| General and administrative expenses |       | $                               | 1,829,000  |   | 11 | % | $ | 1,647,000 |   |
| Percent of total revenue            |       | 25                              | %          |   |   | 18 | % |
|                                     |            |                                 |            |  |  |  |  |  |  |

 
|                                     | ** ** | **Nine Months Ended July 31,** | ** ** |
|-------------------------------------|------------|--------------------------------|------------|
| ** **                          | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|                                |       |                           |       |   |   |   |   |
| General and administrative expenses |       | $                              | 5,139,000  |   | (6 | )% | $ | 5,446,000 |   |
| Percent of total revenue            |       | 23                             | %          |   |   | 20 | % |
|                                     |            |                                |            |  |  |  |  |  |  |

 

General and administrative expenses consist of the salaries and benefitsof finance, human resources, and executive management and expenses forprofessional services and corporate allocations.  General and administrative expenses increasedby $182,000, or 11%, during the three months ended July 31, 2006 as compared tothe three months ended July 31, 2005. The increase in general and administrative expenses was primarilyattributable to increased professional services costs and stock-basedcompensation, offset in part by decreased personnel and related costs.  General and administrative expenses decreasedby $307,000, or 6%, during the nine months ended July 31, 2006 as compared tothe nine months ended July 31, 2005.  Thedecrease in general and administrative expenses was primarily attributable todecreased personnel and related costs as well as decreased accounting and legalfees, offset, in part, by an increase in stock-based compensation.  Included in general and administrative expensesfor the three months ended July 31, 2006 and 2005 was $264,000 and $0,respectively, of stock-based compensation. Included in general and administrative expenses for the nine monthsended July 31, 2006 and 2005 was $736,000 and $0, respectively, of stock-basedcompensation.

For the three months ending October 31, 2006, we anticipate that thedollar amount of general and administrative expenses will be lower than thatincurred during the three months ended July 31, 2006.

*Amortization of Intangibles*
|                             | ** ** | **Three Months Ended July 31,** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | **2006**                        | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                            |       |   |   |   |   |
| Amortization of intangibles |       | $                               | 593,000    |   | 0 | % | $ | 593,000 |   |
| Percent of total revenue    |       | 8                               | %          |   |   | 6 | % |
|                             |            |                                 |            |  |  |  |  |  |  |

 
|                             | ** ** | **Nine Months Ended July 31,** | ** ** |
|-----------------------------|------------|--------------------------------|------------|
| ** **                  | ** ** | **2006**                       | ** ** | **Change** | ** ** | **2005** | ** ** |
|                        |       |                           |       |   |   |   |   |
| Amortization of intangibles |       | $                              | 1,778,000  |   | 0 | % | $ | 1,779,000 |   |
| Percent of total revenue    |       | 8                              | %          |   |   | 6 | % |
|                             |            |                                |            |  |  |  |  |  |  |

 

*Equity in Income (Loss) ofAffiliate*

Weaccount for our ownership interests in companies in which we own at least 20percent and less than 50 percent using the equity method of accounting.  Under the equity method, we record ourportion of the entity’s net income or net loss in our consolidated statementsof operations.

During the threemonths ended July 31, 2006 and 2005, we recorded $0 and $(19,000),respectively, that related to equity in income (loss) of SCO China, our30%-owned Chinese

30

----

company.  During the nine months ended July 31, 2006and 2005, we recorded $(8,000) and $51,000, respectively, that related toequity in income (loss) of SCO China.

*Other Income (Expense), net*

Other income(expense) consisted of the following components for the three and nine monthsended July 31, 2006 and 2005:
|                              | ** ** | **Three Months Ended July 31,** | ** ** | **Nine Months Ended July 31,** | ** ** |
|------------------------------|------------|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                   | ** ** | **2006**                                            | ** ** | **2005**                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|                         |       |                                                |       |                                               |       |   |   |   |   |
| Interest income              |       | $                                                   | 191,000    |                                               | $          | 122,000 |   | $ | 542,000 |   | $ | 257,000 |   |
| Other income  (expense), net |       | (64,000                                             | )          | (149,000                                           | )          | 46,000 |   | 1,025,000 |   |
| Total                        |       | $                                                   | 127,000    |                                               | $          | (27,000 | ) | $ | 588,000 |   | $ | 1,282,000 |   |

 

Interest incomeincreased by $69,000 and $285,000, respectively, from the three and nine monthsended July 31, 2005 as compared to the three and nine months ended July 31,2006 and was primarily attributable to higher interest rates earned on our cashand available-for-sale marketable securities balances as well as higher cashand available-for-sale marketable securities balances.   The higher cash balance is primarilyattributable to our equity financing described in Note 6 to the Notes toCondensed Consolidated Financial Statements.

The increase in otherincome (expense), net, of $85,000 from the three months ended July 31, 2005 ascompared to the three months ended July 31, 2006 was primarily attributable toa reduction in realized losses as a result of changes in foreign currency ratesand balances.  The decrease in otherincome (expense), net, of $979,000 from the nine months ended July 31, 2005 ascompared to the nine months ended July 31, 2006 was primarily attributable to(i) the collection of a $500,000 note receivable from Vintela, Inc., and (ii)proceeds of approximately $779,000 received from the sale of shares we held ofTroll Tech AS, which both occurred during the nine months ended July 31, 2005.

*Provision for Income Taxes*

The provision for income taxes was $107,000 for the three months endedJuly 31, 2006 and $84,000 for the three months ended July 31, 2005 and was$308,000 for the nine months ended July 31, 2006 and $321,000 for the ninemonths ended July 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.

**Liquidity and Capital Resources**

Our cash and cashequivalents balance increased from $4,272,000 as of October 31, 2005 to$8,861,000 as of July 31, 2006.  Duringthis same time period, our investment in available-for-sale marketablesecurities decreased from $6,165,000 to $5,099,000.  Our working capital also increased from$8,669,000 as of October 31, 2005 to $9,871,000 as of July 31, 2006.  The increase in the combined cash and cashequivalents and available-for-sale marketable securities balance was primarilyattributable to the issuance of approximately 2,852,000 shares of our commonstock for net proceeds of approximately $9,809,000 in November 2005 offset bycash expenditures related to the SCO Litigation.

Total cash andcash equivalents and available-for-sale marketable securities was $13,960,000as of July 31, 2006.  As of July 31,2006, we also had $2,010,000 of restricted cash, of which $1,561,000 is setaside to cover expert and other costs related to our SCO Litigation and$449,000 is set aside for royalties payable to Novell.

31

----

Weintend to use the cash and cash equivalents and available-for-sale marketablesecurities as of July31, 2006to run our UNIX business and pursue the SCO Litigation.

Our net cash usedin operating activities during the nine months ended July 31, 2006 was$7,050,000 and was attributable to a net loss of $12,855,000, non-cash items of$3,595,000 and changes in operating assets and liabilities of $2,210,000.

Our net cash used in operating activities duringthe nine months ended July 31, 2005 was $19,460,000.  Cash used in operating activities for thenine months ended July 31, 2005 was attributable to a net loss of $7,295,000,non-cash expenses of $2,304,000 and changes in operating assets and liabilitiesof $14,469,000.

Ourinvesting activities have historically consisted of equipment purchases and thepurchase and sale of available-for-sale marketable securities.  During the nine months ended July 31, 2006,cash provided by investing activities was $1,109,000, which was primarily aresult of sales, net of purchases, of available-for-sale marketable securitiesof $1,066,000 and a dividend received from our 30% owned Chinese company of$308,000, offset by purchases of equipment of $265,000.

Duringthe nine months ended July 31, 2005, cash provided by investing activities was$12,447,000, which was primarily a result of sales, net of purchases, ofavailable-for-sale marketable securities, of $12,680,000, which was offset, inpart, by purchases of equipment of $233,000.

Ourfinancing activities provided $10,425,000 of cash during the nine months endedJuly 31, 2006.  The primary sources ofcash were the net proceeds from the issuance of approximately 2,852,000 sharesof our common stock for $9,809,000, the exercise of options to acquire commonstock of $35,000 and proceeds of $613,000 received from the sale of commonstock through our employee stock purchase program, offset, in part, by therepurchase of shares of our common stock made in connection with the completionof our rescission offer of $32,000.

Ourfinancing activities provided $955,000 of cash during the nine months endedJuly 31, 2005 and consisted primarily of proceeds received from the exercise ofstock options of $235,000 and proceeds from the sale of shares of common stockto our employees through our employee stock purchase program of $720,000.

Ournet accounts receivable balance decreased from $6,343,000 as of October 31,2005 to $4,072,000 as of July 31, 2006, primarily as a result of lowerinvoicing and revenue generated during the three months ended July 31, 2006 ascompared to the three months ended October 31, 2005.  The majority of our accounts receivable arecurrent and our allowance for doubtful accounts was $97,000 as of July 31,2006, which represented approximately 2 percent of our gross accountsreceivable balance.  This percentage ofgross accounts receivable is consistent with our experience in prior periods,and we expect this trend to continue. Our write-offs of uncollectible accounts during the three and ninemonths ended July 31, 2006 and 2005 were not significant.

On October 31, 2004, we entered into anengagement agreement (the “Engagement Agreement”) with the Law Firms.  The Engagement Agreement supercedes andreplaces the original engagement agreement that was entered into in February2003.  The Engagement Agreement governs therelationship between us and the Law Firms in connection with their representationof us in the SCO Litigation, through the end of our current litigation withIBM.  Our purpose in entering into thisEngagement Agreement was to limit the cash expenditures needed to pursue theSCO Litigation.  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

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anyexpert, consulting and other expenses.  Asof July 31, 2006, we had paid theentire $26,000,000.

On June 5, 2006, we entered into an amendment tothe Engagement Agreement and agreed with the Law Firms to deposit an additional$5,000,000 into the escrow account to cover additional expert, consulting andother expenses.  Inthe event that we exhaust these funds, we will continue to pay for expert,consulting and other expenses through the conclusion of our litigation withIBM.  As of July 31, 2006, $1,561,000 remained in theescrow account and was classified as a component of restricted cash.

In addition to the cash expenditures mentionedabove, we must also pay one or more contingency fees upon any amount we or ourstockholders may receive as a result of a settlement, judgment, or a sale ofour Company.  The contingency fee amountspayable to the Law 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.

The Engagement Agreement specifically providesthat, except for the compensation obligations specifically described above, wewill not be obligated to pay any legal fees, whether hourly, contingent orotherwise, to the Law Firms, or any other law firms that may be engaged by theLaw Firms, in connection with the SCO Litigation through the end of the currentlitigation between us and IBM, including any appeals.

We have entered into operating leases for ourcorporate offices located in the United States and our international salesoffices.  We have commitments under theseleases that extend through the year ending October 31, 2008.

The following table summarizes our contractualoperating lease obligations as of July 31, 2006: 
|                              | ** ** | **Total** | ** ** | **Less than  1 year** | ** ** | **1 – 3 years** | ** ** | **3 -5 years** | ** ** | **More than  5 years** | ** ** |
|------------------------------|------------|-----------|------------|---------------------------------|------------|-------------------------------------|------------|--------------------------|------------|----------------------------------|------------|
|                         |       |      |       |                            |       |                                |       |                     |       |                             |       |
| Operating lease  obligations |       | $         | 2,030,000  |                            | $          | 1,425,000                           |       | $                        | 605,000    |                             | $          | — |   | $ | — |   |
|                              |            |           |            |                                 |            |                                     |            |                          |            |                                  |            |  |  |  |  |  |

 

Asof July 31, 2006, we did not have any long-term debt obligations, purchaseobligations or material capital lease obligations.

Ourability to reduce costs to offset revenue declines in our UNIX business islimited because of contractual commitments to maintain and support our existingUNIX customers.  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.

Inthe event that cash required to fund operations, the SCO Litigation andstrategic initiatives exceeds our current cash resources and cash generatedfrom operations, we will be required to reduce costs and perhaps raiseadditional capital.  We may not be ableto reduce costs in a manner that does not impair our ability to maintain ourUNIX business and pursue the SCO

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Litigation.  We may also not be able to raise capital forany number of reasons including those listed under Part II, Item 1A – RiskFactors.  If additional equity financingis available, it may not be available to us on attractive terms and may bedilutive to our existing stockholders. In addition, if our stock price declines, we may not be able to accessthe public equity markets on acceptable terms, if at all.  Our ability to effect acquisitions for stockwould also be impaired.

#### **Forward-LookingStatements and Factors That May Affect Future Results and Financial Condition**

#### *With the exception of historical facts, thestatements contained in Management’s Discussion and Analysis of FinancialCondition and Results of Operations are “forward-looking statements” within themeaning of the Private Securities Litigation Reform Act of 1995, which reflectour current expectations and beliefs regarding our future results ofoperations, performance and achievements. These statements are subject to risksand uncertainties and are based upon assumptions and beliefs that may or maynot materialize.  These forward-lookingstatements include, but are not limited to, statements concerning:*

·                              Our expectation that our sales channelshould continue to provide reliable UNIX operating systems for small-to-mediumsized business customers;

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

·                              Our intention to continue to pursue theSCO Litigation;

·                              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, andwhen generated, 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 three monthsending October 31, 2006 that the dollar amount of our cost of products revenueand that cost of products revenue as a percent of products revenue will begenerally consistent to that incurred during the three months ended July 31,2006;

·                              Our expectation for the three monthsending October 31, 2006 that the dollar amount of our cost of services revenueand that cost of services revenue as a percent of services revenue will begenerally consistent to that incurred during the three months ended July 31,2006;

·                              Our expectation for the three monthsending October 31, 2006 that the dollar amount of our sales and marketingexpenses will be generally consistent to that incurred during the three monthsended July 31, 2006;

·                              Our expectation for the three monthsending October 31, 2006 that the dollar amount of our research and developmentexpenses will be generally consistent to that incurred during the three monthsended July 31, 2006;

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·                              Our expectation for the three monthsending October 31, 2006 that the dollar amount of our general andadministrative expenses will be lower than that incurred during the threemonths ended July 31, 2006;

·                              Our intention to use cash and cashequivalents and available-for-sale securities to run our UNIX business andpursue the SCO Litigation;

·                              Our intention to continue to pay forexpert, consulting and other expenses through the conclusion of our litigationwith IBM;

·                              Our expectation for the three monthsending October 31, 2006 that because of the uniqueand unpredictable nature of the SCO Litigation, the occurrence and timing ofcertain expenses is difficult to predict, and will be difficult to predict forthe upcoming quarters;and

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

We wish to caution readers that our operatingresults are subject to various risks and uncertainties that could cause ouractual results and outcomes to differ materially from those discussed oranticipated, including the resolution of the SCO Litigation, competition fromother operating systems, particularly Linux, the amount and timing of SCOsourcelicensing revenue, our ability to enhance our UNIX operating systems andmaintain our UNIX business, and the factors set forth below in Part II, Item1A-Risk Factors.  We also wish to advisereaders not to place any undue reliance on the forward-looking statementscontained in this report, which reflect our beliefs and expectations only as ofthe date of this report.  We assume noobligation to update or revise these forward-looking statements to reflect newevents or circumstances or any changes in our beliefs or expectations, otherthan as required by law.

**ITEM 3.****                                                    ****QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

*ForeignCurrency Risk. *We haveforeign 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 foreign currenciessuch as the Euro, among others.  Ourrevenue can also be affected by general economic conditions in the UnitedStates, Europe and other international markets. Our results of operations may be affected in the short term byfluctuations in foreign currency exchange rates.

*Interest Rate Risk. *The primary objective ofour cash management strategy is to invest available funds in a manner thatassures maximum safety and liquidity and maximizes yield within suchconstraints.  We believe that a hypotheticalmovement in interest rates, either up or down, would not have a materialadverse impact on our cash and cash equivalents and available-for-salemarketable securities.  We do not borrowmoney for short-term investment purposes.

*Investment Risk. *We have invested inequity instruments of privately held and public companies in the technologyindustry for business and strategic purposes. Investments are accounted for under the cost method if our ownership isless than 20 percent and we are not able to exercise influence overoperations.  We account for our ownershipinterests in companies in which we own at least 20 percent and less than 50percent using the equity method of accounting. Under the equity method, we record our portion of the entity’s net incomeor net loss in our consolidated statements of operations.  Our investment policy is to regularly reviewthe assumptions and operating performance of these companies and to recordimpairment losses

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when events and circumstances indicate that these investmentsmay be impaired.  As of July 31, 2006,our investments balance totaled approximately $291,000 and consisted solely ofour investment in a 30% owned Chinese company.

Thestock market in general and the market for shares of technology companies in particular,has experienced 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.

**ITEM 4.****                               ****CONTROLS AND PROCEDURES**

*Evaluation of disclosure controls and 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 over financialreporting.*  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.

**PART II.****               ****OTHER INFORMATION**

**ITEM 1.****  LEGALPROCEEDINGS**

Certain legalproceedings in which we are involved are discussed in Part I, Item 3,of our Annual Report on Form 10-K for the year ended October 31,2005.  The following discussion islimited to certain recent developments concerning our legal proceedings andshould be read in conjunction with our Annual Report on Form 10-K.   In addition, for more information regardingour legal proceedings, please see Note 4 included in Part 1, Item 1.  Unaudited Financial Statements – Notes toCondensed Consolidated Financial Statements, which information is incorporatedherein by reference.

*IBMCorporation*

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 the court.  IBM requested that we be limited to 93 itemsset forth in the December 22, 2005 filing which IBM claims meet the requiredlevel of specificity.  On June 28, 2006,the Magistrate Judge issued a ruling striking over 180 of our technologydisclosures from the case.  Although thisruling is a significant limitation of the number of technology disclosures wechallenged in our December 22, 2005 filing, it also means that over 100 of ourchallenged items remain in the case.  OnJuly 13, 2006, we filed objections to the Magistrate Judge’s order with thedistrict court; those objections challenge the process and the result embodiedin the Magistrate Judge’s order and we expect a hearing to be set in the nearfuture.

On June 8, 2006,IBM filed a motion to confine our claims to, and strike allegations in excessof, the final disclosures.  In thismotion, IBM claims that our technology expert reports go beyond the disclosurescontained in our December 22, 2005 submission to the court and that those

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expert reports should be stricken to that extent.  No hearing has been set on that motion and noruling has been made.  We believe thatthe motion lacks merit and have filed an opposition to the motion.

Both parties have filed expert reportsand expert discovery is under way.

*Novell, Inc.*

Onor about April 10, 2006, Novell filed a motion to stay the case in Utah pendinga Request for Arbitration that Novell and SuSE Linux, GmbH (“SuSE”) filed onthe same date in the International Court of Arbitration in France.  Through these proceedings, Novell claims thatwe granted SuSE the right to use our intellectual property through ourparticipation in the UnitedLinux initiative in 2002 and through its acquisitionof SuSE, Novell acquired SuSE’s rights as a member of UnitedLinux.  On May 26, 2006, we filed a response toNovell’s motion to stay, and on June 27, 2006, we responded to Novell’s requestfor arbitration. On August 21, 2006, the court ordered that the claims relatingto the SuSE arbitration should be stayed but the other claims in the caseshould proceed.

The three-person arbitration panel hasbeen selected for the SuSE arbitration in Switzerland and that process will becommencing in the near future.  We do notyet know the schedule of the proceedings.

**ITEM1A.****              ****RISK FACTORS**

Investing in oursecurities involves a high degree of risk. In addition to the other information contained in this Form 10-Q, youshould consider the following risk factors before investing in our securities.

*We do not have a history of profitableoperations.*

Our year endedOctober 31, 2003 was the first full year we were profitable in ouroperating history.  Our profitability forthe year ended October 31, 2003 resulted primarily from our SCOsourcebusiness.  For the years ended October 31,2005 and 2004, we incurred net losses applicable to common stockholders of$10,726,000 and $16,227,000, respectively, and for the nine months ended July31, 2006 we incurred a net loss of $12,855,000. As of July 31, 2006, our accumulated deficit was $247,797,000.

If our revenuefrom the sale of our UNIX products and services continues to decline, we willneed to further reduce operating expenses to generate positive cash flow. Wemay not be able to further reduce operating expenses without damaging ourability to support our existing UNIX business. Additionally, we may not be ableto achieve profitability through additional cost-cutting actions.

*We may not prevail in our SCOLitigation, which may adversely affect our ability to continue in business.*

We continue topursue the SCO Litigation and believe in the merits of our cases.  In our action against IBM, we seek damagesfor claims generally relating to our allegation that IBM has inappropriatelyused and distributed our UNIX operating system  (including methods and concepts) andderivative works based on UNIX in connection with IBM’s efforts to promote theLinux operating system.  IBM hasresponded to our claims and brought counterclaims against us assertinggenerally that we do not have the right to assert claims based on our ownershipof UNIX intellectual property against IBM or others in the Linux market.  Discovery is continuing in the case.  If we do not prevail in our action againstIBM, or if IBM is successful in its counterclaims against us, our business andresults of operations would be materially harmed and we may not be able tocontinue in business.  The litigationwith IBM and others will be costly, and our costs for legal fees and relatedexpenses

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have been and will continue to be substantial and mayexceed 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 maybe, or may be perceived to be, adverse to us.

As a result of theSCO Litigation, participants in the Linux marketplace and others affiliatedwith IBM or sympathetic to the Linux movement have taken actions attempting tonegatively affect our business and our SCOsource efforts.  Linux proponents have taken a broad range ofactions against us, including, for example, attempting to influenceparticipants in the markets in which we sell our products to reduce oreliminate the amount of our products and services they purchase from us.  It is likely that similar efforts will continue.  There is a risk that additional participantsin our marketplace will view the SCO Litigation in a negative light, and we maylose support from such participants.  Anyof the foregoing could adversely affect our position in the marketplace, ourresults of operations, our stock price and our ability to stay in business.

As a response toour claim that our UNIX operating system and derivative works based on UNIX haveinappropriately been included in Linux, Novell has publicly asserted its beliefthat it owns certain rights in UNIX, and Novell filed 15 copyright applicationswith the United States Copyright Office related to UNIX.  Novell has claimed to have retained rightsrelated to UNIX source code licenses, including the license with IBM.  Novell asserts it has the right to takeaction on behalf of SCO in connection with such licenses, including terminationrights.  Novell has purported to veto ourtermination 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 UNIX, UNIX derivative works and our UnixWareproducts.  Novell twice unsuccessfullysought to have the case dismissed.

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.  Novell did not oppose our motion so ourSecond Amended Complaint has been filed. On or about April 10, 2006, Novell filed a motion to stay the case inUtah pending a Request for Arbitration that Novell and SuSE Linux, GmbH (“SuSE”)filed on the same date in the International Court of Arbitration inFrance.  Through these proceedings,Novell claims that we granted SuSE the right to use our intellectual propertythrough our participation in the UnitedLinux initiative in 2002 and through itsacquisition of SuSE, Novell acquired SuSE’s rights as a member ofUnitedLinux.  On May 26, 2006, we filed aresponse to Novell’s motion to stay, and on June 27, 2006, we responded toNovell’s request for arbitration. On August 21, 2006, the court ordered thatthe claims relating to the SuSE arbitration should be stayed but the otherclaims in the case should proceed.

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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 misappropriation of our UNIX product and derivative works based onUNIX into Linux violates our contracts and copyrights.  Increased negative perception and potentialconfusion about our claims in our marketplace could impede our continuedpursuit of the SCO Litigation and negatively impact our business.  For example, we believe that the decline inSCOsource revenue has been, in part, attributable to Novell’s claim of UNIXcopyright ownership, which may have caused potential customers to delay orforego licensing until an outcome in this legal matter has been reached.

*We operate in a highlycompetitive market and face significant competition from a variety of currentand potential sources; many of our current and potential competitors havegreater financial and technical resources than we do; thus, we may fail tocompete effectively.*

In the operatingsystem market, our competitors include IBM, Red Hat, Novell, Hewlett Packard,Sun, Microsoft and other Linux distributors. These and other competitors are aggressively pursuing the current UNIXoperating system market. Many of these competitors have access to substantiallygreater resources than we do.  The majorcompetitive alternative to our UNIX products is Linux.  The expansion of our competitors’ offeringsmay restrict the overall market available for our UNIX products, including somemarkets where we have been successful in the past.

Our future successmay depend in part on our ability to continue to meet the increasing needs ofour customers by supporting existing and emerging technologies.  If we do not enhance our products to meetthese evolving needs, we may not remain competitive and be able to sustain orgrow our business. Additionally, because technological advancement in the UNIXoperating system market and alternative operating system markets is progressingat an advanced pace, we will have to develop and introduce enhancements to ourexisting products and any new products on a timely basis to keep pace withthese developments, evolving industry standards and changing customerrequirements.  Our failure to meet any ofthese and other competitive pressures may render our existing products andservices obsolete, which would have an adverse impact on our revenue and operations.

The success of ourUNIX business will depend on the level of commitment and certification wereceive from industry partners and developers. In recent years, we have seen hardware and software vendors as well assoftware developers turn their certification and application development effortstoward Linux and elect not to continue to support or certify to our UNIXoperating system products.  If this trendcontinues, our competitive position will be adversely impacted and our futurerevenue from our UNIX business will decline. The decline in our UNIX business may be accelerated if industry partnerswithdraw their support from us for any reason, including our SCO Litigation.

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*If the market for UNIX continuesto contract, our business will be harmed.*

Our revenue fromthe sale of UNIX products has declined over the last several years.  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 may lose the support ofindustry partners leading to an accelerated decline in our UNIX products andservices revenue.*

The decline in ourUNIX business and our SCO Litigation may cause industry partners, developersand hardware and software vendors to choose not to support or certify to ourUNIX operating system products.  Thiswould lead to an accelerated decline in our UNIX products and services revenueand would adversely impact our results of operations and liquidity.

*Our claims relating to our UNIXintellectual property may subject us to additional legal 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 anddisparagement.  Although this case iscurrently stayed pending the resolution of our suit against IBM, we intend to vigorouslydefend this action.  However, if Red Hatis successful in its claim against us, our business and results of operationscould be materially harmed.

In addition,regulators or others in the Linux market and some foreign regulators haveinitiated or in the future may initiate legal actions against us, all of whichmay negatively impact our operations and future operating performance.

*We rely on our indirect saleschannel for distribution of our products, and any disruption of our channel atany level could adversely affect the sales of our products.*

We have atwo-tiered distribution channel.  Therelationships we have developed with resellers allow us to offer our productsand services to a much larger customer base than we would otherwise be able toreach through our own direct sales and marketing efforts.  Some solution providers also purchasesolutions through our resellers, and we anticipate they will continue to doso.  Because we usually sell indirectlythrough resellers, 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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*Our future SCOsource licensingrevenue is uncertain.*

We initiated theSCOsource licensing effort in the year ended October 31, 2003 to reviewthe 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 SCOsource licensingrevenue declined to only $829,000, and $166,000, respectively, and during thenine months ended July 31, 2006, our SCOsource licensing revenue was$95,000.  Because of the uncertaintiesrelated to SCOsource licensing revenue, we are unable to estimate the amountand timing of future SCOsource licensing revenue, if any.  If we do receive revenue from this source, itmay be sporadic and fluctuate from quarter to quarter.  Additionally, the success of theseinitiatives may depend on the strength of our intellectual property rights andcontractual claims regarding UNIX, including the strength of our claim thatunauthorized UNIX source code and derivative works are prevalent in Linux.

*Fluctuations in our operatingresults or the failure of our operating results to meet the expectations ofpublic market analysts and investors may negatively impact our stock price.*

Fluctuations inour 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.

Factors that mayaffect our results include:

·                                          abilityto successfully negotiate and complete licensing and other agreements relatedto our intellectual property;

·                                          theinterest level of resellers in recommending our UNIX business solutions to endusers and the introduction, development, timing, competitive pricing and marketacceptance of our products and services and those of our competitors;

·                                          theactivities of short sellers;

·                                          changesin general economic conditions, such as recessions, that could affect capitalexpenditures in the software industry;

·              results of,developments in, or costs of our SCO Litigation;

·                                          changesin business attitudes toward UNIX as a viable operating system compared toother competing systems, especially Linux;

·                                          thecontingency and other legal fees we may pay to the Law Firms representing us inour efforts to establish and defend our intellectual property rights; and

·                                          changesin attitudes of customers and partners due to the decline in our UNIX businessand our aggressive position against the inclusion of our UNIX code andderivative works in Linux.

We also experiencefluctuations in operating results in interim periods in Europe and the AsiaPacific regions due to seasonal slowdowns and economic conditions in theseareas.  Seasonal slowdowns in theseregions typically occur during the summer months.

As a result of thefactors listed above and elsewhere, it is possible that our results ofoperations may be below the expectations of public market analysts andinvestors in any particular period.  Thiscould 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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*Our foreign-based operations andsales create special problems, including the imposition of governmentalcontrols and taxes and fluctuations in currency exchange rates that could hurtour results.*

We have foreignoperations, including development facilities, sales personnel and customersupport operations in Europe, Latin America and Asia. These foreign operationsare subject to certain inherent risks, including:

·                                          potentialloss of developed technology through piracy, misappropriation, or more lenientlaws regarding intellectual property protection;

·                                          impositionof governmental controls, including trade restrictions and other taxrequirements;

·              fluctuations incurrency exchange rates and economic instability;

·              longer paymentcycles for sales in foreign countries; and

·              seasonal reductionsin business activity.

In addition,certain of our operating expenses are denominated in local currencies, creatingrisk of foreign currency translation losses that could harm our financialresults and cash flows.  When we generateprofits in foreign countries, our effective income tax rate is increased.

During the threemonths ended April 30, 2004, our Indian office was assessed withholding taxesby 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 packaged softwaredoes not qualify for royalty treatment and therefore would not be subject towithholding tax.  However, we may beunsuccessful in our appeal against the Tax Department and be obligated to paythe assessed taxable amounts.  Because ofour international operations, we may be subject to additional withholding orother taxes from other international jurisdictions.

*If we are unable to retain keypersonnel in an intensely competitive environment, our operations could beadversely affected.*

We need to retainour 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 continuedservice and coordination of our management team, particularly Darl C. McBride,our President and Chief Executive Officer.

*Our Engagement Agreement with theLaw Firms representing us in the SCO Litigation requires us to pay for expert,consulting and other costs, which could harm our liquidity position if thesecosts are higher than anticipated.*

On June 5, 2006,we entered into an amendment to the Engagement Agreement and agreed with theLaw Firms to deposit an additional $5,000,000 into the escrow account to coveradditional expert, consulting and other expenses.  In the event that we exhaust these funds, wewill continue to pay for expert, consulting and other expenses through theconclusion of our litigation with IBM. As we continue with discovery and other trial preparations, we may be requiredto place additional amounts into the escrow account, which could harm ourliquidity position.  As of July 31, 2006,we had a total of $13,960,000 in cash and cash equivalents andavailable-for-sale marketable securities and an additional $1,561,000 ofrestricted cash to be used to pursue the SCO Litigation.  Since October 31, 2004, we have spent$8,439,000 for expert,

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consulting and other costs as agreed to in theEngagement Agreement with our legal counsel in the SCO Litigation.

*We have issued options under ourequity compensation plans without complying with registration or qualificationrequirements under the securities laws of California, Georgia and possiblyother states, and, as a result, we may incur rescission liability for suchoptions and may face additional potential claims under state securities laws.*

In addition to theshares issued under the ESPP, we have granted options under our 1999 OmnibusStock Incentive Plan and 2002 Omnibus Stock Incentive Plan without complyingwith the registration or qualification requirements under the securities lawsof 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.

*Our stock price is volatile.*

The trading pricefor our common stock has been volatile during the last several years and ourshare 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.

*There are risks associated withthe potential exercise of our outstanding options.*

As of August 31,2006, we have issued outstanding options to purchase up to approximately4,843,000 shares of common stock with an average exercise price of $4.11 pershare.  The existence of such rights toacquire common stock at fixed prices may prove a hindrance to our efforts toraise future equity and debt funding, and the exercise of such rights willdilute the percentage ownership interest of our stockholders and may dilute thevalue of their ownership.  The possiblefuture sale of shares issuable on the exercise of outstanding options couldadversely affect the prevailing market price for our common stock.  Further, the holders of the outstanding stockoptions may exercise them at a time when we would otherwise be able to obtainadditional equity capital on terms more favorable to us.

*Common stock available for resalemay depress the market price of our common stock.*

We have filed apost-effective amendment to a registration statement with the Securities andExchange Commission (“SEC”), which has been declared effective, covering thepotential resale by two of our stockholders of up to 923,019 shares of commonstock, or 4.4% of our outstanding common stock. The selling stockholders arebound by certain selling limitations which limit the numbers of shares of ourcommon stock that may be sold at one time. In addition, we have filed a registration statement with the SEC, whichhas been declared effective, covering the potential resale by some of ourstockholders of up to 2,852,449 shares of our common stock, or 13.5% of ouroutstanding common stock.  The existenceof a substantial number of shares of common stock subject to immediate resalecould depress the market price for our common stock and impair our ability toraise needed capital.

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*Our stock price could declinefurther because of the activities of short sellers.*

Our stock hasattracted significant interest from short sellers.  The activities of short sellers could furtherreduce the price of our stock or inhibit increases in our stock price.

*The right of our Board ofDirectors to authorize additional shares of preferred stock could adverselyimpact the rights of holders of our common stock.*

Our Board ofDirectors currently has the right, with respect to the 5,000,000 shares of ourpreferred stock, to authorize the issuance of one or more additional series ofour preferred stock with such voting, dividend and other rights as ourdirectors determine.  The Board ofDirectors can designate new series of preferred stock without the approval ofthe holders of our common stock.  Therights of holders of our common stock may be adversely affected by the rightsof any holders of additional shares of preferred stock that may be issued inthe future, including without limitation, further dilution of the equityownership percentage of our holders of common stock and their voting power ifwe issue preferred stock with voting rights. Additionally, the issuance of preferred stock could make it more difficultfor a third party to acquire a majority of our outstanding voting stock.

*Our stockholder rights plan couldmake it more difficult for a hostile bid for our company or a change of controltransaction to succeed at current market prices for 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 acquired ifthe acquisition is opposed by our Board of Directors.

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

(a)                                  Exhibits

3.1                                 Amendedand Restated 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                                 Certificateof Amendment 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                                 Certificateof Amendment to Amended and Restated Certificate of Incorporation regardingchange of name to The SCO Group, Inc. (incorporated by reference to Exhibit 3.3to SCO’s Registration Statement on Form 8A12G/A (File No. 000-29911)).

3.4                                 Amendedand Restated Bylaws (incorporated by reference to Exhibit 3.4 to SCO’sRegistration Statement on Form 8-A12G/A (File No. 000-29911)).

3.5                                 Certificateof Designation 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                                 Certificateof Correction correcting the Certificate of Designation for Series A-1Convertible Preferred Stock (incorporated by reference to Exhibit 4.2 to SCO’sCurrent Report on Form 8-K filed on February 9, 2004 (File No. 000-29911)).

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10.1                           FirstAmendment to the Letter Agreement dated October 31, 2004 among The SCO Group,Inc., Boies, Schiller & Flexner LLP, Kevin McBride, and Berger Singerman(incorporated by reference to Exhibit 99.1 to SCO’s Current Report on Form 8-Kfiled on June 8, 2006).

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.

**ITEM 7.****            SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
| Date: September 13, 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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**EXHIBIT INDEX**
| Exhibit    | ** ** | ** **                                                                                                                                                                                                                                                                      |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number** | ** ** | **Exhibit Description**                                                                                                                                                                                                                                                         |
|       |       |                                                                                                                                                                                                                                                                            |
| 3.1        |       | Amended and Restated Certificate of Incorporation of  Caldera International, Inc. (incorporated by reference to Exhibit 3.1 to  SCO’s Registration Statement on Form 8-A12G/A (File No. 000-29911)).                                                                       |
|       |       |                                                                                                                                                                                                                                                                            |
| 3.2        |       | Certificate of Amendment to Amended and Restated  Certificate of Incorporation regarding consolidation of outstanding shares  (incorporated by reference to Exhibit 3.2 to SCO’s Registration Statement on  Form 8-A12G/A (File No. 000-29911)).                           |
|       |       |                                                                                                                                                                                                                                                                            |
| 3.3        |       | Certificate of Amendment to Amended and Restated  Certificate of Incorporation regarding change of name to The SCO Group, Inc.  (incorporated by reference to Exhibit 3.3 to SCO’s Registration Statement on  Form 8A12G/A (File No. 000-29911)).                          |
|       |       |                                                                                                                                                                                                                                                                            |
| 3.4        |       | Amended and Restated Bylaws (incorporated by  reference to Exhibit 3.4 to SCO’s Registration Statement on Form 8-A12G/A  (File No. 000-29911)).                                                                                                                            |
|       |       |                                                                                                                                                                                                                                                                            |
| 3.5        |       | Certificate of Designation for Series A-1  Convertible Preferred Stock (incorporated by reference to Exhibit 4.1 to  SCO’s Current Report on Form 8-K filed on February 9, 2004 (File No.  000-29911)).                                                                    |
|       |       |                                                                                                                                                                                                                                                                            |
| 3.6        |       | Certificate of Correction correcting the Certificate  of Designation for Series A-1 Convertible Preferred Stock (incorporated by  reference to Exhibit 4.2 to SCO’s Current Report on Form 8-K filed on  February 9, 2004 (File No. 000-29911)).                           |
|       |       |                                                                                                                                                                                                                                                                            |
| 10.1       |       | First Amendment to the Letter Agreement dated  October 31, 2004 among The SCO Group, Inc., Boies, Schiller & Flexner  LLP, Kevin McBride, and Berger Singerman (incorporated by reference to  Exhibit 99.1 to SCO’s Current Report on Form 8-K filed on June 8, 2006). |
|       |       |                                                                                                                                                                                                                                                                            |
| 31.1       |       | Certification of Darl C. McBride, President and  Chief Executive Officer, pursuant to Rule 13a-14(a) of the Exchange Act, as  adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                |
|       |       |                                                                                                                                                                                                                                                                            |
| 31.2       |       | Certification of Bert Young, Chief Financial  Officer, pursuant to Rule 13a-14(a) of the Exchange Act, as adopted pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                   |
|       |       |                                                                                                                                                                                                                                                                            |
| 32.1       |       | Certification of Darl C. McBride, President and  Chief Executive Officer, pursuant to Section 1350, Chapter 63 of Title 18,  United States Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002.                                                         |
|       |       |                                                                                                                                                                                                                                                                            |
| 32.2       |       | Certification of Bert Young, Chief Financial  Officer, pursuant to Section 1350, Chapter 63 of Title 18, United States  Code, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                             |

 

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