-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, UM1H/AdEczX3/AXvsFPbTCLv3h4m53R3JCmIS2npknGmQm5fqsYKqCKUJ9/8jJAZ mbGONZ/z4TwnmyZJek81Qw== 0000891618-97-005047.txt : 19971224 0000891618-97-005047.hdr.sgml : 19971224 ACCESSION NUMBER: 0000891618-97-005047 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971223 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: SANTA CRUZ OPERATION INC CENTRAL INDEX KEY: 0000851560 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 942549086 STATE OF INCORPORATION: CA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-21484 FILM NUMBER: 97743618 BUSINESS ADDRESS: STREET 1: 400 ENCINAL STREET STREET 2: PO BOX 1900 CITY: SANTA CRUZ STATE: CA ZIP: 95060 BUSINESS PHONE: 4084277172 10-K405 1 FORM 10-K FOR THE PERIOD ENDED SEPTEMBER 30, 1997 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-K [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____________ TO _______________ ---------- COMMISSION FILE NUMBER 0-21484 THE SANTA CRUZ OPERATION, INC. (Exact name of registrant as specified in its charter) CALIFORNIA 94-2549086 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 400 ENCINAL STREET, SANTA CRUZ, CALIFORNIA 95060 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (408) 425-7222 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Registrant became subject to such filing requirements on May 25, 1993 as a result of its initial public offering. Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on December 12, 1997 as reported on the Nasdaq National Market was approximately $74,966,400. Shares of Common Stock held by each executive officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of December 12, 1997, registrant had 36,202,255 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the 1997 Annual Report to Shareholders are incorporated by reference into Parts I, II and IV. Portions of the definitive Proxy Statement dated on or about January 16, 1998 to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held February 17, 1998 are incorporated by reference into Part III. ================================================================================ 2 THE SANTA CRUZ OPERATION, INC. FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997 TABLE OF CONTENTS
PART I PAGE NUMBER Item 1. Business 1 Item 2. Properties 13 Item 3. Legal Proceedings 13 Item 4. Submission of Matters to a Vote of Security Holders 13 Executive Officers of the Registrant 13 PART II Item 5. Market for Registrant's Common Stock and Related Stockholder Matters 16 Item 6. Selected Financial Data 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Item 8. Financial Statements and Supplementary Data 16 Item 9. Changes in and Disagreement with Accountants on Accounting and Financial Disclosures 16 PART III Item 10. Directors and Executive Officers of the Registrant 17 Item 11. Executive Compensation 17 Item 12. Security Ownership of Certain Beneficial Owners and Management 17 Item 13. Certain Relationships and Related Transactions 17 PART IV Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K 18 Signatures 20
3 PART I ITEM 1. BUSINESS INTRODUCTION The Santa Cruz Operation, Inc. (SCO or the Company) was incorporated in California in 1979 and shipped its first product, SCO(R) XENIX(R) System V, a packaged version of the UNIX(R) operating system, in 1983. In 1985, the Company introduced its first operating system for the 32-bit Intel(R) microprocessor environment, SCO XENIX 286, and followed with its SCO XENIX 386 in 1987. The Company first shipped its UNIX trademarked commercial product, SCO UNIX System V/386, for the Intel CPU-based platforms in 1989 and followed with an integrated, graphical version of this product, SCO Open Desktop(R), in 1990. In 1993, the Company introduced two families of systems software--SCO OpenServer(TM) products, a complete line of advanced server and SCO Open Desktop products, a complete line of advanced workstation (client) operating systems. In 1995, SCO integrated these products into a single line, called the SCO OpenServer family. SCO also introduced its SCO Vision family of client-integration products, which integrate Windows(R) PC's with UNIX Servers from all major UNIX vendors. SCO also created a Layered Server Products division which has the mission of providing middleware that enhances the capabilities of SCO OpenServer Systems, as well as UNIX Servers from other vendors. In fiscal year 1996, SCO acquired the UnixWare(R)product line and UNIX system technology from Novell, Inc. In 1997, the Company introduced an Application Broker for Network Computing, announced a release strategy for UnixWare 7, and restructured to increase overall efficiency, placing all of the Company's development groups under Doug Michels, SCO's co-founder, executive vice president, and chief technology officer. SCO's mission is to be the leading supplier of UNIX System software for business-critical, Network Computing environments. Network Computing offers businesses a more powerful, reliable, and cost-effective way to share business-critical applications and information with people anywhere in the world. The two key elements of Network Computing are, first, powerful, scalable, and reliable servers; and, second, support for a wide range of clients. SCO also offers an Application Broker for Network Computing- Tarantella. Tarantella runs on any UNIX server, and provides any Java client - NC, PC, terminal, or workstation - with access to existing applications running on any kind of server in the network - mainframe, mini, UNIX or NT server. By leveraging SCO's core strengths - UNIX servers and Tarantella - SCO can move businesses to Network Computing at their own pace, enabling them to utilize their existing systems and giving them the broadest choices of technologies and partners. SCO's product solutions are available through a global network of more than 15,000 SCO distributors and resellers. Through our strategic partnerships with the world's leading computer vendors, technology providers and support providers, SCO will continue to deliver the industry's most advanced and reliable products, backed by expert local support around the world. INDUSTRY BACKGROUND Traditionally, mainframes and minicomputers have formed the basis of enterprise computing in large, complex organizations. These organizations have generally used custom applications to perform business-critical tasks such as general accounting, inventory management, transaction processing, manufacturing control and branch management. These applications typically involve processing and managing large quantities of data and must provide continuous availability of data to many users, while ensuring data integrity and security. Despite their performance and functionality, these mainframe and minicomputer "legacy" systems are based on proprietary hardware and operating software architectures and are increasingly perceived to be difficult, time-consuming, and expensive to implement, maintain, and support. In addition, these systems provide limited interoperability with other information resources and systems commonly used in organizations today, provide limited user access to data maintained in these systems, and often use difficult, non-intuitive character-based user interfaces. In the past fifteen years, Intel CPU-based computers have proliferated in both large and small organizations primarily as a result of steadily improving price-performance and the development of local-area networking software. Recent generations of Intel processors, the i486 and Pentium(R) processors, together with declining costs for both system memory and data storage, have for the first time given PCs the power to process large volumes of business-critical data. These developments have accelerated the emergence of a new computing paradigm in which central processing on mainframes or minicomputers is being replaced by processing distributed between desktop PC or workstation "clients," which handle user interface and application logic, and Business Critical Servers responsible for shared access to enterprise data, business-critical applications, database management, and data security. This approach, in principle, combines the efficiency of desktop processing with access to enterprise-wide data and 1 4 applications. However, the leading operating system for Intel CPU-based client PCs (Microsoft(R) MS-DOS(R), often used with the Microsoft Windows user interface or the newer Windows NT(R) workstation and server operating systems) and the leading networking operating system for PC-based local-area networks, Novell(R) NetWare(R), do not offer the performance, stability, scalability, data security, network connectivity, or support for heterogeneous clients (not only PCs, but also Xterminals, character-based terminals, UNIX workstations, PDAs, and the emerging class of network computers or NCs) required by many organizations for Business Critical Servers. As a result, most PC-based networks offer only a limited version of client/server computing, in which the key functions of shared data access, database management, data security and business-critical applications are handled by mainframes and minicomputers acting as servers, or by microprocessor-based servers utilizing reduced-instruction set (RISC) architectures. Because of operating system and hardware limitations, as well as high hardware costs, these server strategies fail to capture the full price-performance benefits of client/server computing. One of the problems of the PC-centric client/server model is the high cost of system administration, maintenance, and software updates. When businesses move to a server-centric model of client/server computing, called Network Computing, they can administer and update client software from the server, saving inordinate amounts of time and money. This is why SCO supports the server-centric Network Computing model. SCO bases its system software for Business Critical Servers on the UNIX System, which has been in use since the 1970s. The UNIX System is a 32-bit native multi-user, multitasking technology. Operating systems based on the UNIX System allow application programs to be separated from operating system tasks such as control of peripheral devices, communications, memory management and file management, thus providing a standardized protected environment in which the applications operate. The result is much higher reliability because multiple applications and users cannot interfere with each other and easier application development because many complex functions are handled by the operating system. SCO believes, however, that UNIX technology is only the beginning of the solution, and that considerable value must be added to the basic technology in order to create a family of products that solve complex customer requirements for Business Critical Servers. Business and government organizations are increasingly demanding adherence to standards-based open systems to protect their computing investment and avoid reliance on a single vendor's hardware or software. For such customers, the proprietary implementations of the UNIX System that dominate the technical and scientific workstation market are unacceptable. These proprietary versions of UNIX systems run on hardware architectures that are expensive relative to PCs, are tied to the proprietary hardware of particular vendors and have failed to meet the increasing demand for hardware-independent, Intel CPU-based systems. Business and government organizations also require broad availability of third-party applications software so that they can use predefined solutions and, to the extent possible, avoid having to develop custom applications. When custom applications are required, these customers need a development environment and tools which enable such applications to be easily produced and implemented and run across multiple hardware architectures. Lastly, these customers require a high level of customer support in the form of consulting and training, as well as continual product enhancements to incorporate new technology and industry standards. SCO has focused on Intel CPU-based computers because of their dominant position in the microprocessor-based computer market and their potential in the emerging client/server market. SCO's years of experience in supporting each successive generation of Intel processors has resulted in highly reliable and stable UNIX operating system products. The Company's extensive engineering capabilities and product enhancement programs support complex, networked Business Critical Servers across the full range of Intel microprocessors, including the Pentium and Pentium Pro processors. The Company's software is compatible with Intel CPU-based computers offered by virtually all of the major hardware vendors. Because SCO products support multiple processors and can execute several applications simultaneously, they are especially well suited for Business Critical Servers that provide data access and business-critical applications to users throughout the enterprise. THE SCO SOLUTION SCO brings the power of the UNIX System and the freedom of open systems to the Intel CPU-based server environment. Since introducing its first operating software in 1983, SCO has shipped about 2.3 million licenses to multi-user computer environments worldwide. The Company's innovations have included shipping a packaged version of the UNIX System in 1983, shipping a graphical, 32-bit UNIX operating system for Intel PCs in 1990 and shipping a packaged UNIX operating system for Intel CPU-based multiprocessing computers in 1993. The Company introduced a family of client-integration and layered server software in 1995. In 1996, the Company introduced its Internet family of server products. In 1997, the Company introduced the world's first Application 2 5 Broker for Network Computing, and announced a release strategy for its next-generation, UNIX operating system, which is initially targeted at high-end departmental computing and enterprise environments. Based on its experience in the marketplace, the Company believes that its products support more Intel CPU-based computers, applications, networks, and peripherals than those of any other UNIX System software. Business Critical Servers running SCO software are especially designed to support networked applications running on traditional client/server architectures and on the new server-centric Internet/intranet architecture, enabling organizations ranging from small businesses to large corporations and government agencies to implement enterprise-wide computing solutions. SCO has developed significant expertise in implementing powerful and stable UNIX operating systems for Business Critical Servers, and has built a multi-tiered distribution channel of direct sales personnel, value-added resellers (VARs), original equipment manufacturers (OEMs) and distributors to reach and support thousands of end-user customers. SCO BUSINESS CRITICAL SERVERS Business Critical Servers running SCO system software combine the best qualities of standalone PCs (personal productivity, ease of use and price-performance value) with the traditional strengths of UNIX System servers (business-critical applications, data management, security, and network administration). SCO Business Critical Servers feature the following performance characteristics to meet customer requirements: 1) support for business-critical, transaction-based applications, 2) capabilities for providing a permanent, auditable history of operations, 3) top performance and scalability at the lowest cost, 4) support for multiple users performing multiple tasks, 5) high-level security, 6) reliability and manageability, 7) support for a wide range of client devices, including not only Microsoft Windows PC desktops and laptops, but also UNIX workstations, Xterminals, character-based terminals, PDAs, and the new network computers known as NCs, and 8) expert service and support. STRATEGY The Company's strategy is to continue providing the most reliable and robust system software for Business Critical Servers that run the critical day-to-day business operations of large and small organizations. That includes Network Computing environments. The Company's future success will depend in large part on the continued growth of the UNIX System market for business and governmental organizations as well as the Company's ability to continue to license additional products and product enhancements to existing customers and to identify and market its products to new markets and customers. There can be no assurance that the Company will be able to sustain revenue growth and profitability on a quarterly or annual basis. Key elements of SCO's strategy include: FOCUS ON TARGET MARKETS SCO focuses its products, industry relationships, distribution and support strategy on three key business opportunities: primary information systems for small and medium-sized businesses; replicated systems for use in distributed information systems in medium-sized and large organizations, including Fortune 1000 corporations; and business-critical enterprise systems for large and medium-sized businesses. Key targeted industries include retail, finance and banking, government, distribution, telecommunications, transportation and manufacturing. INTEGRATING WINDOWS PCS AND DIVERSE CLIENTS WITH UNIX SERVERS SCO intends to provide the best server for Network Computing, which means providing the best server for a wide range of client devices, including not only Microsoft Windows PC desktops and laptops, but also UNIX workstations, Xterminals, character-based terminals, PDAs (Personal Digital Assistants), and network computers or NCs. The goal of this strategy is to enable organizations to take full advantage of cost-effective client devices that can run the new Java-based applications and exchange information across the Internet and corporate intranets. SCO continues also to support its Windows Integration strategy, which is to make it as easy to connect a network of Windows PCs to all major UNIX servers as it is to connect a standard data terminal. The four cornerstones of this strategy are solutions for: connectivity between SCO servers and Windows desktops; manageability of Windows desktops from SCO servers; the ability to take advantage of users' Windows skills by making SCO UNIX System applications appear and behave like those on Windows; and interoperability between Windows and UNIX System applications. SCO provides a full line of Windows Integration Products, called the SCO Vision Family. 3 6 In addition, SCO now offers Tarantella, the Company's new Application Broker for Network Computing. Tarantella enables customers to deliver both new and existing applications to any Java technology-enabled client. These applications include Windows, UNIX system, and mainframe applications. The clients can be palmtop devices, Web TV, a mobile phone, an NC, a character terminal, or a PC SUPPORT A WIDE RANGE OF APPLICATIONS Because purchase decisions are often driven by the availability of applications, SCO has positioned its products as a strategic platform for developers of business applications. Developers write software compatible with SCO's products because of SCO's leadership in the UNIX market for Intel CPU-based computers and its support for a wide range of hardware vendors. Applications written for the SCO environment run on over 2,700 computers and peripherals, and can be readily ported to proprietary or other RISC-based UNIX systems, thus expanding the market opportunity for the developer. SCO places particular emphasis on ensuring that SCO Business Critical Servers provide optimal support for the leading client/server applications, the new Java system-based applications, and the leading relational database management systems. Major software vendors that offer application software for the SCO environment include Banyan, Borland, Computer Associates, Informix, Lotus, Microsoft, Oracle, Novell, Progress, and Sybase. In total, SCO UNIX Systems are supported by over 12,000 independent software vendors (ISVs), representing over 15,000 business-critical applications. DELIVER COMPREHENSIVE SUPPORT SERVICES SCO continues to expand its delivery of support services to meet the needs of customers using complex, multivendor computer systems. SCO also works closely with resellers and OEMs to offer channel-delivered support programs to meet the needs of customers in its target markets. SCO Services offerings include a range of telephone support options, a CD-based SCO Support Library, on-line services, and high-level consulting and engineering services. These flexible services give customers a choice of support plans and pricing models. In addition, Comprehensive education and training programs for reseller and end users are available though the Company's Advanced Education Centers. Information on these programs is available on the Services and Support page of the SCO Web site. SUPPLY MIDDLEWARE FOR MULTIPLE HARDWARE PLATFORMS Middleware products and technologies represent a class of system software that enhances the basic operating system. SCO's Layered Server Products division is tasked with providing middleware for SCO OpenServer Systems, as well as other UNIX servers. PROVIDE TRUE OPEN SYSTEMS PRODUCTS Because customers are increasingly reluctant to be restricted to a single computer vendor, the Company has designed its software products to support industry-accepted open systems standards. Open systems are those systems which conform to established industry standards such as I20, XPG-4, Spec 1170, DCE and OSF/Motif(R) from The Open Group, POSIX(R) from IEEE, Federal Information Processing Standard (FIPS) from the National Institute of Standards (NIST), and Internet standards. SCO continuously works with standards organizations such as The Open Group to assure continued conformance to open systems standards. Industry standards may be established by organizations composed of vendors, by government agencies, by academic institutions, or by market acceptance. Industry standards typically are based on specifications which allow competing implementations. Because these standards are open, competitors can readily access the technology to include in their products. Industry standards offer the customer a cost-effective computing solution by providing a high degree of compatibility and interoperability among hardware, software, network and peripheral products. Based on published directories listing vendors and applications, the Company believes there are currently over 15,000 business-critical software solutions compatible with SCO's products. LEVERAGED RESEARCH AND DEVELOPMENT SCO has developed extensive expertise in sourcing, enhancing and integrating third-party technologies to provide true open system software solutions. For example, the SCO Open Server Enterprise System seamlessly integrates open system technologies from a number of different third-party software providers to produce a package that operates as one cohesive product. In this way, SCO leverages its engineering resources by building upon the technologies developed by the technical staffs at numerous other companies. 4 7 DISTRIBUTE PRODUCTS WORLDWIDE In contrast to operating system software for standalone PCs and small networks, system software for Business Critical Servers requires sophisticated distribution and support. Over the past 12 years, SCO has developed a highly trained, multi-tiered, value-added distribution and support infrastructure. This worldwide network includes over 15,000 resellers and distributors. These parties implement and support specific solutions for corporate, government and smaller business customers by integrating SCO's products with those of other vendors. SCO and its distribution network work together to provide comprehensive support services ranging from engineering and consulting services to technical support and training and education. EVANGELIZE TO DEVELOPERS AND EDUCATIONAL INSTITUTIONS SCO maintains developer and reseller programs to assist independent software developers (ISVs) and channel partners in both the development and marketing of SCO Business Critical Servers. SCO developer and reseller programs include joint marketing campaigns, information exchange, and special access to product updates, enhancements, and new releases. The Company has established a program to focus on the use of SCO products at schools and universities, and makes free copies of its UNIX server licenses available to non-commercial organizations. EXECUTE GLOBAL STRATEGY The Company's products are designed to support customers throughout the world, with local language versions available for Europe, Asia, and Latin America. SCO maintains sales and distribution offices throughout the world including those in the U.K., France, Germany, Italy, Denmark, Australia, Singapore, Japan, Canada, Hong Kong, China, Mexico, and throughout the U.S. In addition, the Company has established design and development centers in the U.K. and the U.S. to meet company-wide and local product development requirements. International operations are subject to certain risks, including staffing and managing foreign operations, fluctuations in foreign currency exchange rates and regulatory requirements. A substantial portion of the Company's international net revenues are priced in the U.K. pound sterling, and operating results can vary with changes in the U.S. dollar exchange rate for such currency. PRODUCTS AND PRODUCT ARCHITECTURE PRODUCT ARCHITECTURE SCO provides a family of products for Business Critical Servers, as well as for specialized business and development workstations used with Business Critical Servers in many client/server installations. These products are based on a UNIX System kernel to which SCO has added extensive capabilities. The Company's products include the following components: operating systems, networking, user interfaces, client integration software, middleware and development tools. Operating systems are the instructions which interact with the microprocessor in a computer, allowing it to perform basic functions such as displaying information, processing inputs and storing and retrieving data. Operating systems also provide a platform for running applications which perform useful functions for end users, including database access, communications services, spreadsheets, and various utilities. Networking systems support numerous third-party local and wide-area networking products to allow enterprise-wide distributed computing. SCO's user interfaces provide an easy-to-use graphical desktop environment that enables users to access an organization's entire computing environment. SCO's Client Integration software integrates client devices, such as Windows PCs and NCs, with UNIX servers. Middleware adds additional capabilities, such as networking, system and network management, software distribution and backups. Development tools enable developers and customers to develop and maintain applications on SCO systems. The Company has structured its product families to take advantage of the modular nature of the overall architecture. Depending on their requirements, customers can purchase packages ranging from a basic multi-user host system to a comprehensive enterprise server system, all of which operate with the Company's development tools. 5 8 PRODUCTS The Company offers two categories of products: (1) UNIX server products, which include layered server products such as SCO's Internet Family of products, and (2) client-integration products, which include Tarantella. SCO UNIXWARE PRODUCTS SCO UnixWare 2.1 Application Server provides multi-user application services to businesses that put high demands on system reliability, performance, security, and networking. Built on the latest release of System V UNIX (SVR4.2 MP), SCO UnixWare 2.1 is the most modern and advanced release of the UNIX operating system on the market. SCO UnixWare 2.1 Application Server was designed from the ground up to be a high-performance, multi-processing release of the UNIX operating system while maintaining compatibility with the millions of UNIX systems already deployed by SCO and other market leaders. As an applications server, SCO UnixWare 2.1 provides all of the facets of business critical computing -- including built-in security, reliability, and fault tolerance -- on a standard, cost-effective, and high-performance Intel single- or multi-processor hardware platform. It supports thousands of enterprise, commercial, and industrial-grade applications and has established performance records running leading database systems from Oracle, Sybase, and Informix. One of the striking things about the SCO UnixWare system's consistent record breaking performance is that these records were not established on proprietary hardware from a single supplier, but on standard technology components from several vendors. With Intel's establishment of its MP Spec, hardware vendors can compete in developing increasingly high-performance systems that will automatically support the SCO UnixWare system. With the SCO UnixWare 2.1 system providing an open, standards based operating platform, and numerous hardware manufacturers supporting an open SMP(TM) implementation, customers are assured of increasing performance, increasing value, and the luxury of choice. SCO OPENSERVER PRODUCTS The SCO OpenServer system is today's leading UNIX server operating system for Intel processor-based platforms. Businesses use SCO OpenServer systems to simplify and speed business operations, better understand and respond to their customers' needs, and achieve a competitive advantage. SCO OpenServer systems are exceptional at running multi-user, transaction-based DBMS and business applications, communications gateways, mail and messaging servers in both host and client/server environments. SCO OpenServer Release 5 combines minicomputer-level reliability and availability with the Intel platform's exceptional price/performance, value and flexibility. Unlike other advanced operating systems, SCO OpenServer Systems revolutionize business productivity without obsoleting existing business critical systems, applications or data. Designed expressly for business critical computing, SCO OpenServer systems deliver what today's organizations are seeking -- exceptional value and price/performance, extensible networking with existing LANs and WANs, easy integration with Windows desktops, built-in Internet access and services, simplified administration and management, and outstanding scalability for long term growth. Base SCO OpenServer Operating Systems-- SCO OpenServer Enterprise System: The Enterprise System is a 32-bit, multi-user, multitasking X/Open(R) UNIX System-compliant operating system with integrated graphics, multi-protocol networking, Internet services, mail and messaging services, and remote systems administration and software management. SCO OpenServer Host System: The Host System is a 32-bit, multi-user, multitasking, X/Open UNIX System-compliant operating system with integrated graphics and simple PC connectivity and mail and messaging services. It can be easily upgraded to the Enterprise System when client/server or networking capabilities are required. SCO OpenServer Desktop System: The Desktop System is an advanced, single-user operating system that delivers secure workstation capabilities and performance on cost-effective Intel platforms. SCO OpenServer Internet FastStart: The Internet FastStart system enables users to take full advantage of the Internet, providing advanced Network Computing features. SCO LAYERED SERVER PRODUCTS SCO Layered Server Products include The SCO Internet Family of products, plus SCO Advanced File and Print Server, SCO(R) ARCserve(R)/Open from Cheyenne(R), and SCO Doctor(TM). 6 9 The SCO Internet Family. The SCO Internet Family provides Internet access for corporate LANs. By using the family of products as an Internet gateway, organizations can provide users with access to the vast resources of the Internet while providing advanced security; publish information for internal and external audience; create corporate intranets, and conduct electronic commerce The SCO Internet Family provides everything needed to get up and running on the web quickly. It includes multi-line PPP, multi-homing support, Netscape Navigator(TM), and Netscape Communications Server(TM). Installation and configuration are made simple via a HTML-based tool that guides the installer painlessly through the entire install process. It also supports TCP/IP, IPX/SPX(TM), NFS(R), NIS, DNS, PPP, SMTP, POP networking protocols, and includes network install capability. Additional SCO Internet Family Product Options -- For customers with existing SCO servers, or those who wish to extend their Internet functionality, the SCO Internet Family also has a number of layered products. These include Netscape Commerce Server(TM), Netscape Communications Server, The Netscape Proxy Server(TM), Netscape Navigator, SCO Internet to NetWare Gateway, SCO Internet Security Package, and SCO PPP from Morning Star. SCO Advanced File and Print Server - Seamless Integration of UNIX Servers and Windows. The SCO Advanced File and Print Server, when used with SCO OpenServer Release 5, creates a UNIX system based network operating system that allows file and printer access to PCs running Microsoft Windows 95, Windows NT, Windows 3.x, OS/2(R), and MS-DOS. Fully backward compatible with LAN Manager Release 2.2, SCO Advanced File and Print Server is based on the newest Microsoft NT networking technology and is peer-to-peer compatible with Microsoft NT. Because Advanced File and Print Server is actually based on NT technology, the server appears to the desktop clients exactly as if it were an NT server. SCO Advanced File and Print Server provides a highly integrated environment allowing PCs to access files and printers in the native Windows format while accessing mission-critical business applications running on the server. UNIX directories are accessed as Windows network drives and UNIX printers are accessed as if they were connected directly to the desktop PC. SCO ARCserve/Open -- Multi-platform Network Backup and Restore. SCO ARCserve/Open is an easy-to-use, high-performance, comprehensive data management tool for enterprise networks. Developed by Cheyenne Software, the industry leader in backup and restore technology, SCO ARCserve/Open delivers a business critical data management system. SCO ARCserve/Open brings a unique combination of ease-of-use, automation, high performance, and reliability to the SCO platform. It provides the robust feature set that administrators require and the simplicity necessary for end-users to do their own backups. Utilizing an intuitive Motif interface, SCO ARCserve/Open makes managing the backup of large servers and heterogeneous networks simple. Ease-of-use is enhanced by the Auto Pilot feature, which provides full automation of the data management process, including tape rotation. High throughput is provided by an efficient backup engine which optimizes performance of each tape drive. Even greater throughput is achieved with the Parallel Streaming feature, which supports simultaneous backup to multiple tape devices. SCO Doctor -- Pro-Active Remote Systems Management. The SCO Doctor advanced systems management tool is the first to address the many UNIX system configurations in use today. SCO Doctor incorporates advanced process monitoring, accurate diagnosis and automatic problem correction. Notification of alerts can be communicated to the administrator via pop-ups on the Doctor console, the built-in pager support, or by e-mail notices. Alerts, in turn, invoke intelligent action programs to automatically correct the problem or notify the system administrator that intervention is required. It supports diverse network protocols. The Doctor agent collects data from a variety of sources including the UNIX kernel, operating system configuration, the file system, standard UNIX performance monitoring commands and local utilities, as well as third party applications. SCO Doctor can be customized to meet a wide range of customer requirements. Views, reports, action programs, alerts, data collection subagents and file transfer programs can easily be customized using Tcl scripting commands. SCO Doctor for Networks(TM) systems management tool is an enhanced version of Doctor that can manage small networks or large installations of several thousand systems over a LAN or WAN. If required, support staff can use the "connect-back" capability of Doctor for Networks for live monitoring of the remote system and perform further diagnosis of problems via the simultaneous log-in facility. SCO Doctor Agent supports SNMP traps and provides extensive system query information through the Doctor enterprise MIB. Doctor for Networks supports everything from low-speed async dial-up modems to TCP/IP, PPP, SLIP and e-mail-enabled transports. It provides uncompromised operation over low-speed phone lines to ensure that the widest range of UNIX systems can, at last, 7 10 "afford" to be managed. It includes a full-featured set of facilities for file transfer, remote command execution and remote login facilities. By incorporating powerful remote communications features, the need to purchase a separate communications product is eliminated. SCO CLIENT-INTEGRATION PRODUCTS / THE SCO VISION FAMILY The SCO Vision family includes powerful and extensible Windows to UNIX Systems integration products, providing a "best of both worlds" solution - the reliability and scalability of UNIX Systems and the plug-and-play ease of Microsoft Windows. These products are available and optimized for all Windows platforms, including 3.1, NT, and Windows 95. SCO Vision97 - Bringing together Windows, UNIX and the Internet SCO Vision97 integrates Windows, UNIX and the Internet for just a little more than the price of a PC-X server. SCO Vision97 is a new generation of Windows to UNIX integration products, designed to bring the benefits of the new Internet computing model to Windows PC users. Going beyond simply accessing UNIX applications, SCO Vision97 adopts the principles of centralized management, server deployment and Internet integration and cuts the cost of ownership of existing PC networks. Individual products offer access to X and character-based applications, server-based file and print sharing and ODBC middleware. Together they form a tightly integrated suite that is designed for Network Computing. SCO SuperVision - Remote Management of Windows Desktops SCO(R) SuperVision(TM) gives system administrators the power to remotely manage, configure and control SCO Vision Family desktops on the corporate network. By allowing updates to all desktops in a single stroke, SCO SuperVision can dramatically cut the cost of managing and supporting large groups of Windows users. SCO SuperVision will manage both PC's directly connected to the network and those connected remotely over a modem link. SCO VisionFS - Microsoft File and Print Services SCO VisionFS(TM) provides Microsoft file and print services from any UNIX server (HP, Sun, IBM, Digital, SCO etc.) to Windows PCs. It makes a UNIX server appear like any other Windows machine on the network. No software has to be installed on the PC to allow access to files and printers on the UNIX server. Using the SCO VisionFS smart server approach delivers dramatic cost savings in installation, administration and maintenance of PCs, compared to NFS client solutions. SCO TermVision - The Business Critical Terminal Emulator SCO(R) TermVision(TM) is a powerful 32-bit terminal emulation package which presents UNIX character-based applications, files and services in Windows terms for Windows users. SCO TermVision increases efficiencies, flattens the learning curve and reduces administration overhead with a combination of highly configurable emulators, secure and intelligent communications, and facilities for remote administration. SCO XVision - The Transparent PC X Server for Microsoft Windows SCO(R) XVision(R) is the world's first transparent PC X server - designed so that all users see is Microsoft Windows. Using a transparent interface, SCO XVision can reduce the cost and need for training and support. Users can use XVision and Windows applications side by side without even knowing it. SCO SQL-Retriever - ODBC Middleware for Simultaneous Access to Multiple Databases SCO(R) SQL-Retriever(TM) is an Open Database Connectivity (ODBC) middleware product designed to provide simultaneous access to a range of UNIX databases. SCO SQL-Retriever also supports the Java Database Base Connectivity (JDBC) protocol, for full access to databases across Internet/intranet networks. With SCO SQL-Retriever users can link Windows spreadsheets, development tools, report writers or Windows databases with all popular UNIX databases. PC users can take advantage of Windows productivity tools to present their text-based databases with all popular UNIX databases. PC users can take advantage of Windows productivity tools to present their text-based database information in a more flexible way. Developers can use SCO SQL-Retriever to create distributed applications working with multiple hosts and databases without needing to buy proprietary database tools for each. Premier Motif - The Business Critical Motif 8 11 Premier Motif is a complete service for Motif developers including software and support. SCO ensures that users invest their time in developing applications rather than debugging or developing Motif itself. Premier Motif has developed from over four years' experience as the world's leading third party Motif supplier. Premier Motif focuses on providing the highest quality Motif libraries, refining and enhancing OSF/Motif and ensuring a robust and portable development base. SCO has taken OSF/Motif and added numerous bug fixes and enhancements, many not found in any other vendor's Motif implementation. MARKETS The Company targets three major market segments: (1) primary information systems for small and medium-sized businesses, (2) replicated systems for use in distributed information systems in medium-sized and large organizations, including Fortune 1000 Corporations, and (3) business-critical enterprise servers for large and medium-sized businesses. The Company's products are used in a wide variety of applications, including commercial applications such as POS systems, customized computing systems for various vertical business areas and general business systems. Key targeted industries include retail, finance and banking, government, distribution, telecommunications, transportation and manufacturing. Sophisticated applications currently running on SCO Business Critical Servers include banking teller systems, reservation systems, customer service information systems and financial dealer trading systems. SALES AND DISTRIBUTION Over the past 12 years, SCO has developed a highly trained and diverse sales and distribution channel of over 15,000 resellers and distributors. These channel partners are selected for their expertise and experience. Depending on the type of relationship with SCO, they may receive discounts off list prices. In some cases, the contractual arrangements require minimum purchases and are generally terminable by either party. The Company permits selected resellers to return a limited amount of product for stock balancing, provided a new equivalent order is received. In the event the Company reduced product prices, the Company's standard terms for these resellers provide credit for inventory ordered in the previous 90 days, which can be applied against future purchases. The Company, as a matter of policy, does not allow product returns for a refund. In the fourth fiscal quarter of 1995, the Company increased its provision for exchange of products in its international operations which adversely affected its operating results. During the third fiscal quarter of 1997, the Company reduced its channel inventory across all product lines resulting in reduced revenues. There can be no assurance that stock balancing and exchanges in the future will not adversely affect the Company's operating results. The SCO sales and distribution channels focus on three major customer groups: Small and Medium-Sized Businesses. SCO works with VARs and authorized resellers which develop and/or sell business solutions to small and medium-sized businesses. Corporate Customers. In the U.S., and for selected customers across Europe, SCO has developed a major account team that builds and manages the relationships with customers in targeted industries as well as with the Company's channel partners who support these customers. In smaller markets this role is filled by major distributors. SCO provides direct support to major corporate customers. In addition, support is provided by OEMs who market SCO solutions on their hardware, systems integrators who develop project-specific solutions integrating SCO products with other vendors' products, and VARs who provide industry-specific, ready-to-use solutions. Government Customers. In the U.S., SCO has a dedicated account team that manages the relationships with government agencies. Government sales outside the U.S. are managed by SCO regional management or by OEMs, major distributors or major resellers. SCO also works with federal system integrators who integrate products from various vendors and provide support services for complete projects. CUSTOMER SUPPORT AND SERVICE Because of the business-critical use of SCO's products, customer support and services have become essential to achieve a high level of customer satisfaction. The Company's services are designed to support its wide range of customers, from small and medium-sized businesses to large enterprises, both at the end user and reseller levels. The Company, through its worldwide customer support and service staff and its authorized third-party education, support and channel partners, offers a variety of support and services: 9 12 * Technical Support includes a variety of support offerings including online support through the World Wide Web, a dial-up bulletin board and varying levels of telephone support for channel partners and corporate accounts; * Educational Services include courseware and instruction guides provided to approximately 140 Authorized Education Centers, which in turn provide training and education materials to both end users and resellers in local languages; * Consulting Services consist of direct assistance, including on-site technical personnel for extended assignment, and integration, implementation and deployment of applications on SCO platforms for branch automation and other large business environments; * Developer Services include technical advisory and support services as well as access to early product releases for application developers; and * Engineering Services consist of engineering personnel who assist OEMs to port and support SCO products on their hardware platforms. The Company sells support services to end users on an annual contract or as-needed basis. Options are available so that customers can tailor the support solution to meet their specific needs. Electronic access is available through the World Wide Web, remote or local bulletin boards and through discussion groups on CompuServe and the Internet. Software updates, enhancements, and bug fixes are also available electronically. SCO also supports end users via Authorized Support Centers and Premier Service Centers. The Company also provides its support services to distributors, VARs, OEMs and integrators. PRODUCT DEVELOPMENT Since its inception, the Company has focused considerable resources on the development and integration of UNIX systems and open systems software technologies and standards for Intel CPU-based computers. SCO has developed skills in operating systems, user interfaces, networking, porting and applications software support. The Company's development strategy is based upon utilizing and building upon technologies it owns, such as UNIX Systems technologies as well as products already available in the marketplace. In December of 1995, SCO purchased the UNIX Systems technologies from Novell Corporation and is now a primary driving force behind this open systems platform. During the third quarter of fiscal 1997, SCO restructured to increase overall efficiency. SCO integrated the efforts of its various development teams to deliver the features and functionality businesses expect from SCO systems faster and more efficiently. SCO devotes considerable resources to ongoing product testing and quality assurance to support product reliability. The Company believes that its abilities to integrate product technologies, to incorporate a wide variety of standards into its products, and to continue to offer enhancements to its existing products are essential to maintaining its competitiveness in the marketplace. SCO has introduced development tools which allow developers to write applications which take advantage of the increased power of the ongoing Intel family of processors, including the Pentium and Pentium pro. In addition, the Company now offers localized versions of its core business critical servers, including SCO UnixWare products in English, French, Italian, German, Spanish, and Japanese, and SCO Open Server products in French, German, Chinese and Japanese. SCO product development is comprised of one integrated organization that implements SCO's two product strategies--UNIX servers and Client Integration products. The UNIX server development teams are responsible for the core operating systems and services including SCO OpenServer, SCO UnixWare, and the forthcoming 64-bit UNIX system. They are also responsible for additional OS services such as SCO(R) Merge(TM), Virtual Disk Manager and On Line Data Manager (RAID subsystems), Development Systems, and new technology development projects that are UNIX kernel-related such as clustering and NUMA support. In addition, they are responsible for many layered server functions that extend the capabilities of the core operating systems. These services include file and print services, system management and backup services, and, most important, Internet services. The Client integration Development teams are responsible for SCO's "Windows integration" and "any-client integration" products and services. SCO's strategy is to integrate almost any client with almost any UNIX server. 10 13 The teams build the SCO Vision family of products which includes SCO Vision97, SCO XVision, SCO TermVision, SCO SuperVision, SCO SQL-Retriever. They also develop Tarantella products, which extend SCO's "any-client" proposition to Network Computing environments. The market for the Company's products is characterized by rapidly changing technology, evolution of new industry standards, and frequent introductions of new products and product enhancements. The Company's success will depend upon its continued ability to enhance its existing products, to introduce new products on a timely and cost-effective basis to meet evolving customer requirements, to achieve market acceptance for new product offerings, and to respond to emerging industry standards and other technological changes. There can be no assurance that the Company will be successful in developing new products or enhancing its existing products or that such new or enhanced products will receive market acceptance. The Company's success also depends upon its ability to license from third parties and to incorporate into its products new technologies that become industry standards. There is no assurance that the Company will continue to obtain such licenses on favorable terms or that it will successfully incorporate such third-party technologies into its own products. The Company anticipates new releases of products in the fiscal year ending September 30, 1998. There is no assurance that such new releases will not be affected by technical problems or "bugs", as is common in the software industry. Furthermore, there can be no assurance that these or other future product introductions will not be delayed. Delays in the availability, or a lack of market acceptance, of new or enhanced products could have an adverse effect on the Company's business. There can be no assurance that product introductions in the future will not disrupt product revenues and adversely affect operating results. COMPETITION The market for Intel operating systems is very competitive and rapidly changing. The Company currently encounters significant competition from a limited number of direct competitors including IBM, Microsoft, and Sun Microsystems, which offer hardware-independent multi-user operating systems for Intel platforms, and from OEMs such as AT&T, DEC, Hewlett-Packard, IBM, Olivetti, Sun Microsystems and Unisys, which offer their own versions of the UNIX System on a variety of RISC and Intel CPU-based hardware. Many of these hardware competitors also offer SCO's system software products, either through direct OEM agreements or indirectly through the various distribution channels used by the Company. In addition, to the extent the Company's products penetrate the markets for larger and multiprocessor servers, SCO will increasingly face competition from IBM's AS/400, DEC's Alpha-based servers, and Sequent servers. Competitive systems not based on Intel microprocessors are offered by DEC, Hewlett Packard, IBM, and Sun, among others. These systems are sold with operating system software which is based upon the UNIX System and offer many of the benefits of the Company's products. The Company also expects to receive increasing direct competition on the Intel platform from OEM versions of the UNIX System and from such hardware-independent operating systems as Microsoft Windows NT and SunSoft's Solaris for Intel. The Company expects Microsoft Windows NT (server and workstation) to continue to offer significant and increasing competition to UNIX System products, including SCO products. Many of these competitors and potential competitors have significantly greater financial resources, more technical personnel and more extensive marketing and distribution capabilities than the Company. The major factors that affect the competitive market for the Company's products include product reliability, availability of user applications, compliance with industry standards, ease of use, networking capability, breadth of hardware compatibility, quality of support and customer services, product performance and price. In addition, certain competitive products may have advantages compared to certain SCO products. Microsoft Windows NT has greater name recognition than the Company's products and is being designed to run on a greater range of processors. The Company's exclusive focus on system software may be a competitive disadvantage to those competitors which offer a wider range of products. The Company may also be at a disadvantage relative to those competitors who have greater financial resources, larger technical staffs, and more extensive marketing and distribution capabilities. There can be no assurance that either existing or new competitors will not develop products that are superior to the Company's products for basic desktop and certain server applications for the UNIX System. If competition were to cause the Company to reduce its prices significantly, the Company's results of operations could be adversely affected. The Company's future success will depend in large part on the following conditions: the continued growth of the UNIX market for business and governmental organizations, the Company's ability to continue to license additional products and product enhancements to existing customers, and the ability to identify and market its products to new markets and customers. There can be no assurance that future competition will not have a material adverse effect on the Company's results of operations. 11 14 The Company's strategy is to offer products that conform to industry standards. Industry standards may be established by organizations composed of vendors, by government agencies, by academic institutions, or by market acceptance. Industry standards typically are based on specifications for which there can be competing implementations. Because standards are open (not proprietary), competitors can readily access the technology to include in their products, and SCO does not believe that offering products conforming to industry standards will provide SCO with a competitive advantage. The Company's products are offered primarily for multi-user computer environments on Intel CPU-based computers. The market for MS-DOS and Windows on personal computers for personal productivity is substantially larger than the market for UNIX Systems on Intel CPU-based computers. Because the Company competes in a smaller market than the personal productivity market addressed by MS-DOS and Windows, the Company's potential for future growth will depend in part on the extent to which the UNIX market continues to grow. The existence of a number of different versions of UNIX operating systems may have adversely affected the growth of the UNIX market compared to alternative operating systems. However, the emergence of such technologies as the Internet, the World Wide Web, Java, network computers and the TCP/IP networking protocol as de facto industry standards has helped strengthen the position of UNIX system as an operating system that functions consistently across a broad range of hardware platforms and computing architectures such as Host, Client/Server and now Network Computing. In addition, SCO is working with The Open Group, a major international standards group, to support the implementation of standard application programming interfaces (APIs) that will support applications compatibility across different versions of UNIX systems. To date, SCO and other major UNIX vendors have adopted varying schedules for compliance with these API specifications, and there can be no assurance this effort will be successful. PROPRIETARY RIGHTS The Company attempts to protect its software with a combination of copyright, trademark, and trade secret laws, employee and third-party nondisclosure agreements, license agreements, and other methods of protection. Despite these precautions, it may be possible for unauthorized third parties to copy certain portions of the Company's products or reverse engineer or obtain and use information the Company regards as proprietary. While the Company's competitive position may be affected by its ability to protect its intellectual property rights, the Company believes that trademark and copyright protections are less significant to the Company's success than other factors, such as the knowledge, ability, and experience of the Company's personnel, name recognition, and ongoing product development and support. The Company's software products are generally licensed to end users on a "right-to-use" basis pursuant to a perpetual license. The Company licenses its products to end users primarily under "shrink-wrap" license (i.e., licenses included as part of the product packaging). Shrink-wrap licenses, which are not negotiated with or signed by individual end-user licensees, are intended to take effect upon opening of the product package. Certain provisions of such licenses, including provisions protecting against unauthorized use, copying, transfer, and disclosure of the licensed product, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect the Company's intellectual property rights to the same extent as do the laws of the U.S. As the number of software products in the industry increases and the functionality of these products further overlaps, the Company believes that software products will increasingly become subject to infringement claims. There can be no assurance that third parties will not assert infringement claims against the Company and/or against the Company's suppliers of technology. In general, the Company's suppliers have agreed to indemnify the Company in the event any such claim involves supplier-provided software or technology, but any such claim, whether or not involving a supplier, could require the Company to enter into royalty arrangements or result in costly litigation. The Company depends on the availability of technology from third parties. Most of the software licensed by the Company is written to comply with industry standards and because the licensor is seeking to broaden its market it is made widely available on a non-exclusive basis by the licensor. As a result, this software is also readily available to competitors of the Company which want to incorporate such software into their products. SCO has several license agreements with Microsoft pursuant to which Microsoft has provided software technology to SCO, including XENIX. Microsoft has rights to terminate its licenses with SCO in the event of the acquisition of SCO by a competitor of Microsoft, which may affect any such acquisition. SCO believes that, if such an acquisition occurred and Microsoft canceled these licenses, SCO could obtain alternative technology from other sources and could incorporate such technology into SCO's products, or alternatively, SCO could continue operations without such technology with no material impact to its business. However, the loss of any significant third-party license, or the inability to license additional technology as required, could have a materially adverse effect on the Company's results of operations until such time as the Company could replace such technology. 12 15 EMPLOYEES As of September 30, 1997, the Company had 1,082 employees, including 334 in product development, 345 in sales and marketing, 159 in customer support services, and 244 in finance, manufacturing and distribution services and administration. The Company's success depends in part on its executive officers, none of whom are subject to long-term employment contracts. The loss of any current executive officer could adversely affect the Company's business. The success of the Company also depends in part on its ability to attract and retain qualified technical, managerial, and marketing personnel. Competition for such personnel is intense in the software industry and there can be no assurance that the Company will be successful in attracting and retaining such personnel. ITEM 2. PROPERTIES The Company is headquartered in Santa Cruz, California, where it leases administrative, sales and marketing, product development and distribution facilities. The Company leases additional facilities for administration, sales and marketing and product development in Mountain Heights Center, New Jersey and Watford, England. The leases for the Company's facilities expire at various dates through 2020. The Company has renewal options, at fair market value, under many of these leases and believes that in any event additional or alternative space adequate to serve the Company's foreseeable needs would be available on commercially reasonable terms. The Company's field operations occupy leased facilities in 12 locations in the United States. In addition, the Company's subsidiaries and sales offices in France, Germany, Italy, Spain, Sweden, Denmark, Singapore, Australia, China and Mexico lease space for their operations. Worldwide, the Company leases property in 38 locations consisting of an aggregate of approximately 370,000 square feet. The Company believes that these facilities are adequate for its needs in the foreseeable future. ITEM 3. LEGAL PROCEEDINGS In August 1993, a securities class action lawsuit was filed in Superior Court of San Francisco, California against the Company, one current employee, three former employees and the Company's underwriters. The lawsuit alleged violations of the Securities Act of 1993, pertaining to alleged misrepresentations and omissions in the Company's Registration Statement and Prospectus in connection with its initial public offering. Subject to final court approval, this matter was settled in October 1997 for an immaterial amount. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth fiscal quarter of 1997. EXECUTIVE OFFICERS AND OFFICERS OF THE REGISTRANT The executive officers and officers of the Company as of September 30, 1997 were as follows:
Name Age Position with the Company - ---- --- ------------------------- EXECUTIVE OFFICERS: Alok Mohan 49 President and Chief Executive Officer Edwin Adams 53 Senior Vice President and General Manager, The Americas Ray Anderson 39 Senior Vice President, Marketing, Products Division James Clark 57 Senior Vice President, Asia/Pacific Operations John Luhtala 54 Senior Vice President, Operations, and Chief Financial Officer David McCrabb 49 Senior Vice President, Market Planning Douglas L. Michels 43 Executive Vice President, Chief Technical Officer
13 16 Jack Moyer 48 Vice President, Human Resources Steve Sabbath 50 Vice President, Law and Corporate Affairs and Secretary Geoff Seabrook 49 Senior Vice President, and General manager, EMEIA OFFICERS: Helene Mann-Bouchard 37 Vice President, Worldwide Customer Delivery Systems James Wilt 51 Vice President, Business Development
Mr. Mohan has served as President since December 1994 and as Chief Executive Officer since July 1995. In December 1994, he was elected as a director and assumed the position of President, Chief Operating Officer and Chief Financial Officer. Prior to this appointment, beginning in May 1994, Mr. Mohan served as Senior Vice President, Operations and Chief Financial Officer. Prior to joining the Company, Mr. Mohan was employed with NCR, where he served as Vice President and General Manager of the Workstation Products Division from January 1990 until July 1993 before assuming the position of Vice President of Strategic Planning and Controller, with responsibility for financial planning and analysis as well as worldwide reporting, from July 1993 to May 1994. Mr. Adams was named Senior Vice President and General Manager, The Americas in December 1994. From May 1993 to December 1994, he served as the Company's as Vice President, The Americas, Field Operations. Mr. Adams served as Senior Vice President of Sales and Marketing for Telebit from June 1992 until May 1993. From October 1988 to June 1992, he served as Vice President of Marketing and Vice President of Sales for Oracle. Mr. Anderson was named Senior Vice President, Marketing, Products Division in June 1997. Between June 1997 and December 1994, Mr. Anderson served as Senior Vice President and Managing Director, Client Integration Division. Mr. Anderson was named Senior Vice President of SCO and Managing Director of IXI Limited when SCO acquired IXI Limited in February 1993. Mr. Anderson was a founder of IXI Limited and served as its Managing Director commencing in 1987. Dr. Clark was named Senior Vice President, Asia/Pacific Operations in November 1996. Prior to joining the Company, Dr. Clark held various senior executive positions with AT&T Bell Laboratories commencing in September 1989 as well as served as a professor at the Queensland University of Technology, School of Data Communications, Brisbane, Australia. Mr. Luhtala was named Senior Vice President and Chief Financial Officer in January 1997. Prior to joining the Company, between May 1996 and December 1996, Mr. Luhtala served as Chief Financial Officer and Vice President, Mergers, Acquisitions and Joint Ventures at SyQuest Technology. From February 1987 to May 1996, Mr. Luhtala served in various financial management positions with Amdahl. Ms. Mann-Bouchard joined the Company in 1984 and held various positions until December 1994 when she became Vice President, Worldwide Manufacturing Distribution and Information Services. In July 1995, Ms. Mann-Bouchard was named Vice President, Worldwide Customer Delivery Systems. Mr. McCrabb was named Senior Vice President, Market Planning in July 1997. Between January 1995 and June 1997, he served as Vice President, Marketing and Channel Sales in January 1995. Prior to joining the Company, Mr. McCrabb served as Vice President and General Manager for Applied Digital Data Systems, a wholly owned subsidiary of NCR, since February 1994. From November 1989 to February 1992, he served as Vice President, Sales and Marketing for Primary Access Corporation. Mr. Michels is the principal architect of the Company's technology strategy and has served as the head of product development since June 1997. Mr. Michels has served as Chief Technical Officer since February 1993 and as a director of the Company since 1979. Mr. Michels has served as the Company's Executive Vice President since he co-founded the Company in 1979. Mr. Michels is one of the founders of Uniforum, a UNIX(R) user consortium, and served as its President from 1989 to 1990. 14 17 Mr. Moyer was named Vice President, Human Resources in August 1995. Prior to joining the Company, Mr. Moyer served as Vice President, Human Resources for the following companies: Ore Ida Foods from 1992 to August 1995; Maspar Computer Corporation from November 1991 until November 1992; Businessland from January 1985 until November 1991. Mr. Moyer's senior human resources management experience also includes positions at National Mirconetics, Inc. and National Semiconductor Corp. Mr. Sabbath was named Vice President, Law and Corporate Affairs and Secretary in February 1993. Between 1991 and 1993, he served as Vice President, Legal Affairs. Prior to joining the Company, between February 1988 and January 1991, Mr. Sabbath was the Deputy General Counsel for Sun Microsystems, Inc., a manufacturer of UNIX system-based hardware and software. Mr. Seabrook was named Senior Vice President, and General Manager, EMEIA in January 1996. Joining the Company in 1989, Mr. Seabrook has held a number of strategic positions. Prior to joining the Company, Mr. Seabrook served as Vice President International Operations at Century Data Inc. Mr. Wilt was named Vice President, Business Development in August 1991. Joining the Company in 1983, Mr. Wilt has held a number of strategic positions both in the US and in Europe including that of Vice President, International. Mr. Wilt formerly held management positions in sales, marketing, and planning at Xerox, Honeywell and Amdahl. 15 18 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The following required information is filed as a part of the report: The Company has not paid cash dividends on its common stock. The Company's common stock is traded over-the-counter and is quoted on the Nasdaq National Market under the symbol "SCOC". The following table sets forth the range of high and low closing sale prices for the Common Stock:
Low Sale Price High Sale Price -------------- --------------- Fiscal 1996: First Quarter 5-5/8 8-3/8 Second Quarter 5-5/8 7-1/2 Third Quarter 6-5/8 8-7/8 Fourth Quarter 5-5/8 7-1/4 Fiscal 1997: First Quarter 6-1/4 7-3/8 Second Quarter 6-1/4 8-1/2 Third Quarter 3-1/4 6-5/16 Fourth Quarter 3-11/16 7-1/16
On December 12, 1997, there were approximately 6,800 holders of the Company's Common Stock. ITEM 6. SELECTED FINANCIAL DATA The information set forth on page 10 of the 1997 Annual Report to Shareholders is incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information set forth on pages 11 through 15 of the 1997 Annual Report to Shareholders is incorporated herein by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following financial statements and supplementary financial information for the Company and report of independent auditors set forth on pages 16 through 31 of the 1997 Annual Report to Shareholders are incorporated herein by reference. o Consolidated Statements of Operations for each of the years in the three year period ended September 30, 1997 o Consolidated Balance Sheets as of September 30, 1997 and 1996 o Consolidated Statements of Shareholders' Equity for each of the years in the three year period ended September 30, 1997 o Consolidated Statements of Cash Flows for each of the years in the three year period ended September 30, 1997 o Notes to Consolidated Financial Statements o Report of Independent Auditors o Quarterly Financial Information ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES None 16 19 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information with respect to Directors may be found under the caption "Election of Directors" of the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held February 17, 1998 (the "Proxy Statement"). Such information is incorporated herein by reference. Information with respect to Executive Officers and Officers may be found on pages 13 through 15 hereof, under the caption "Executive Officers and Officers of the Registrant." ITEM 11. EXECUTIVE COMPENSATION The information set forth under the caption "Executive Compensation and Other Matters" of the Company's Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information set forth under the caption "Record Date and Principal Share Ownership" of the Company's Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information set forth under the captions "Certain Transactions with Management" and "Compensation Committee Interlocks and Insider Participation" of the Company's Proxy Statement is incorporated herein by reference. 17 20 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Documents filed as part of Form 10-K 1. Financial Statements The financial statements of the Company as set forth under Item 8 of this report on Form 10-K are incorporated herein by reference. 2. Financial Statement Schedule
Schedule Page Number Description Number -------- ----------- ------ II Valuation and Qualifying Accounts 22
The independent auditors' report with respect to the above-listed financial statement schedule appears on page 21 of this report on Form 10-K. Financial statement schedules other than those listed above have been omitted since they are either not required, not applicable, or the information is shown in the financial statements or notes thereto. 3. Exhibit Listing
Exhibit Number Description ------- ----------- 2.0 Asset Purchase Agreement By and Between The Santa Cruz Operation, Inc. and Novell, Inc. (4) 3.1 Restated Articles of Incorporation of Registrant. (2) 3.2 Bylaws of Registrant, as amended. (5) 4.1 Specimen Common Stock Certificate of Registrant. (1) 10.1 Packaged Goods Product Agreement (contract #1292-8196) with Microsoft Corporation effective April 1, 1988 and amended December 19, 1989 and May 3, 1991. (1) 10.2 Binary Distribution Product Agreement (contract #1292-8195) with Microsoft Corporation effective April 1, 1988 and amended December 19, 1989 and May 3, 1991. (1) 10.3 License Agreement for MS-DOS (contract #1292-7352) with Microsoft Corporation effective August 1, 1987 and amended January 22, 1988, April 1, 1990 and November 12, 1991. (1) 10.4 License Agreement for Key Microsoft Products (contract #1292-8197) with Microsoft Corporation effective September 22, 1988 and amended September 10, 1990 and July 3, 1991. (1) 10.5 License Agreement for Microsoft C Compiler (contract #1292-6007) with Microsoft Corporation effective May 15, 1985 and amended July 24, 1986 and August 28, 1986. (1) 10.6 Microsoft-SCO Technology Schedule as of July 20, 1989. (1) 10.7 Software Agreement with AT&T Information Systems, Inc. effective May 6, 1987, as amended. (1) 10.8 Sublicensing Agreement with AT&T Information Systems, Inc. effective August 23, 1989, as amended. (1) 10.9 Letter Agreement between The Santa Cruz Operation, Inc. and UNIX System Laboratories dated as of September 30, 1992. (1) 10.10 Application Compatibility Cooperation Agreement with AT&T Information Systems, Inc. effective August 21, 1990. (1) 10.11 Software License Agreement with Locus Computing Corporation effective January 11, 1989. (1)
18 21 10.12 Lease with Encinal Partnership No. 1 commencing May 1, 1991 (100 Pioneer Street). (1) 10.13 Lease with Encinal Partnership No. 1 commencing January 1, 1989 (425 Encinal Street). (1) 10.14 Lease with Wave Crest Development, Inc. commencing August 1, 1987 (440 Encinal Street). (1) 10.15 Lease with Wave Crest Development, Inc. commencing June 1, 1988 (400 Encinal Street). (1) 10.16 Lease with Wave Crest Development, Inc. commencing July 1, 1988 (399 Encinal Street). (1) 10.17 Form of Indemnification Agreement. (1) 10.18 Master Registration Rights Agreement as amended. (1) 10.19 1993 Stock Purchase Plan and form of Stock Purchase Agreement. (3) 10.20 1994 Incentive Stock Option Plan and form of Incentive Stock Option Agreement. (3) 10.21 401(k) Plan, as amended. (1) 10.22 Series C Preferred Stock Purchase Agreement dated May 22, 1989, with Microsoft Corporation, as amended. (1) 10.23 Revised 1993 Employee Stock Purchase Plan. (5) 10.24 1993 Director Stock Option Plan. (1) 10.25 Proxies granted to Mr. Lawrence Michels by Lee Richard Kaplan, Barbara Michels, David Michels, Dia Michels, Geri Snyder, Robert Spector, Hugh Spector, Franklin Spector and Shereen Spector on April 8, 1985. (1) 10.26 Proxy granted to Douglas Michels on Aril 18, 1985. (1) 10.28 Proxy granted to Lawrence Michels by Jordan Michels. (1) 10.32 Form of Letter Agreement with Lars H. Turndal. (1) 10.33 Lease with Pinn Brothers Properties commencing May 19, 1992 (320, 324 and 300 Encinal). (1) 13 Annual Report to Shareholders. 21.1 Subsidiaries of Registrant. 23.1 Consent of Independent Auditors. 27.1 Financial Data Schedule
(1) Incorporated by reference to Registration Statement 33-60548 on Form S-1. (2) Incorporated by reference to the Form 10-K filed on December 24, 1993. (3) Incorporated by reference to the Form 10-K filed on December 23, 1994. (4) Incorporated by reference to the Form 8-K filed on December 20, 1995. (5) Incorporated by reference to the Form 10-K filed on December 22, 1995. - -------------------------------------------------------------------------------- (b) Reports on Form 8-K. No reports on Form 8-K were filed during the last quarter of fiscal 1997. 19 22 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized. THE SANTA CRUZ OPERATION, INC. By: /s/ John W. Luhtala By: /s/ Steven M. Sabbath --------------------------------- ---------------------------------- John W. Luhtala Steven M. Sabbath Senior Vice President, Operations, Vice President, and Chief Financial Officer Law and Corporate Affairs & Secretary Date: December 23, 1997 Date: December 23, 1997 KNOW ALL PERSONS BY THEIR PRESENCE, that each person whose signature appears below constitutes and appoints Steven M. Sabbath, his attorney-in-fact, with the power of substitution, for him in any and all capacities, to sign any amendments to this report on Form 10-K and to file the same, with exhibits thereto other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated: /s/ Alok Mohan - -------------------------------------- Alok Mohan President, Chief Executive Officer and Director Date: December 23, 1997 /s/ Douglas L. Michels /s/ Robert M. McClure - -------------------------------------- ------------------------------ Douglas L. Michels Robert M. McClure Executive Vice President, Chief Technical Director Officer and Director Date: December 23, 1997 Date: December 23, 1997 /s/ Enzo Torresi /s/ Gilbert P. Williamson - -------------------------------------- ------------------------------ Enzo Torresi Gilbert P. Williamson Director Director Date: December 23, 1997 Date: December 23, 1997 /s/ Ronald Lachman /s/ Jean-Francois Heitz - -------------------------------------- ------------------------------ Ronald Lachman Jean-Francois Heitz Director Director Date: December 23, 1997 Date: December 23, 1997 /s/ Ninian Eadie /s/ R. Duff Thompson - -------------------------------------- ------------------------------ Ninian Eadie R. Duff Thompson Director Director Date: December 23, 1997 Date: December 23, 1997
20 23 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders of The Santa Cruz Operation, Inc.: Under date of October 22, 1997, we reported on the consolidated balance sheets of The Santa Cruz Operation, Inc. and subsidiaries as of September 30, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended September 30, 1997, as contained in the 1997 annual report to stockholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1997. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG Peat Marwick LLP San Jose, California October 22, 1997 21 24 THE SANTA CRUZ OPERATION, INC. SCHEDULE II/RULE 5-04 VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED SEPTEMBER 30, 1997, 1996 AND 1995 (In thousands)
BALANCE AT CHARGED TO BALANCE BEGINNING REVENUES OR AT END OF DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS OTHER (1) PERIOD - ----------- ---------- ----------- ---------- --------- ---------- Year Ended September 30, 1997 Allowance for returns $ 9,245 $33,115 $33,224 -- $ 9,136 Allowance for doubtful accounts 1,885 349 491 -- 1,743 ---------- ----------- ---------- --------- ---------- Total allowance $11,130 $33,464 $33,715 -- $10,879 ========== =========== ========== ========= ========== Year Ended September 30, 1996 Allowance for returns $11,110 $24,643 $26,508 -- $ 9,245 Allowance for doubtful accounts 2,285 635 1,035 -- 1,885 ---------- ----------- ---------- --------- ---------- Total allowance $13,395 $25,278 $27,543 -- $11,130 ========== =========== ========== ========= ========== Year Ended September 30, 1995 Allowance for returns $ 4,904 $27,015 $20,853 $ 44 $11,110 Allowance for doubtful accounts 1,924 701 493 153 2,285 ---------- ----------- ---------- --------- ---------- Total allowance $ 6,828 $27,716 $21,346 $197 $13,395 ========== =========== ========== ========= ==========
(1) Adjustment for purchase of Visionware Limited 22 25 EXHIBIT INDEX
Exhibit Number Description - ------- ----------- 2.0 Asset Purchase Agreement By and Between The Santa Cruz Operation, Inc. and Novell, Inc. (4) 3.1 Restated Articles of Incorporation of Registrant. (2) 3.2 Bylaws of Registrant, as amended. (5) 4.1 Specimen Common Stock Certificate of Registrant. (1) 10.1 Packaged Goods Product Agreement (contract #1292-8196) with Microsoft Corporation effective April 1, 1988 and amended December 19, 1989 and May 3, 1991. (1) 10.2 Binary Distribution Product Agreement (contract #1292-8195) with Microsoft Corporation effective April 1, 1988 and amended December 19, 1989 and May 3, 1991. (1) 10.3 License Agreement for MS-DOS (contract #1292-7352) with Microsoft Corporation effective August 1, 1987 and amended January 22, 1988, April 1, 1990 and November 12, 1991. (1) 10.4 License Agreement for Key Microsoft Products (contract #1292-8197) with Microsoft Corporation effective September 22, 1988 and amended September 10, 1990 and July 3, 1991. (1) 10.5 License Agreement for Microsoft C Compiler (contract #1292-6007) with Microsoft Corporation effective May 15, 1985 and amended July 24, 1986 and August 28, 1986. (1) 10.6 Microsoft-SCO Technology Schedule as of July 20, 1989. (1) 10.7 Software Agreement with AT&T Information Systems, Inc. effective May 6, 1987, as amended. (1) 10.8 Sublicensing Agreement with AT&T Information Systems, Inc. effective August 23, 1989, as amended. (1) 10.9 Letter Agreement between The Santa Cruz Operation, Inc. and UNIX System Laboratories dated as of September 30, 1992. (1) 10.10 Application Compatibility Cooperation Agreement with AT&T Information Systems, Inc. effective August 21, 1990. (1) 10.11 Software License Agreement with Locus Computing Corporation effective January 11, 1989. (1)
26 10.12 Lease with Encinal Partnership No. 1 commencing May 1, 1991 (100 Pioneer Street). (1) 10.13 Lease with Encinal Partnership No. 1 commencing January 1, 1989 (425 Encinal Street). (1) 10.14 Lease with Wave Crest Development, Inc. commencing August 1, 1987 (440 Encinal Street). (1) 10.15 Lease with Wave Crest Development, Inc. commencing June 1, 1988 (400 Encinal Street). (1) 10.16 Lease with Wave Crest Development, Inc. commencing July 1, 1988 (399 Encinal Street). (1) 10.17 Form of Indemnification Agreement. (1) 10.18 Master Registration Rights Agreement as amended. (1) 10.19 1993 Stock Purchase Plan and form of Stock Purchase Agreement. (3) 10.20 1994 Incentive Stock Option Plan and form of Incentive Stock Option Agreement. (3) 10.21 401(k) Plan, as amended. (1) 10.22 Series C Preferred Stock Purchase Agreement dated May 22, 1989, with Microsoft Corporation, as amended. (1) 10.23 Revised 1993 Employee Stock Purchase Plan. (5) 10.24 1993 Director Stock Option Plan. (1) 10.25 Proxies granted to Mr. Lawrence Michels by Lee Richard Kaplan, Barbara Michels, David Michels, Dia Michels, Geri Snyder, Robert Spector, Hugh Spector, Franklin Spector and Shereen Spector on April 8, 1985. (1) 10.26 Proxy granted to Douglas Michels on Aril 18, 1985. (1) 10.28 Proxy granted to Lawrence Michels by Jordan Michels. (1) 10.32 Form of Letter Agreement with Lars H. Turndal. (1) 10.33 Lease with Pinn Brothers Properties commencing May 19, 1992 (320, 324 and 300 Encinal). (1) 13 Annual Report to Shareholders. 21.1 Subsidiaries of Registrant. 23.1 Consent of Independent Auditors. 27.1 Financial Data Schedule
(1) Incorporated by reference to Registration Statement 33-60548 on Form S-1. (2) Incorporated by reference to the Form 10-K filed on December 24, 1993. (3) Incorporated by reference to the Form 10-K filed on December 23, 1994. (4) Incorporated by reference to the Form 8-K filed on December 20, 1995. (5) Incorporated by reference to the Form 10-K filed on December 22, 1995. EX-13 2 ANNUAL REPORT TO SHAREHOLDERS 1 EXHIBIT 13 THE SANTA CRUZ OPERATION, INC. SELECTED FIVE YEAR FINANCIAL INFORMATION
Fiscal Year Ended September 30, ------------------------------------------------------------- (In thousands, except per share data) 1997 1996 1995 1994 1993 - --------------------------------------------------------------------------------------------------------- Net revenues $ 193,660 $ 207,890 $ 199,329 $ 184,068 $ 178,243 Cost of revenues 55,315 54,402 54,133 51,953 52,292 - --------------------------------------------------------------------------------------------------------- Gross margin 138,345 153,488 145,196 132,115 125,951 Operating expenses 154,939 177,069 151,688 113,490 108,559 - --------------------------------------------------------------------------------------------------------- Operating earnings (loss) (16,594) (23,581) (6,492) 18,625 17,392 - --------------------------------------------------------------------------------------------------------- Other income (expense): Interest income, net 2,291 2,302 2,703 1,829 381 Other expense, net (866) (394) (363) (561) (427) - --------------------------------------------------------------------------------------------------------- Profit (loss) before income taxes (15,169) (21,673) (4,152) 19,893 17,346 - --------------------------------------------------------------------------------------------------------- Income taxes 1 741 1,956 5,647 3,500 - --------------------------------------------------------------------------------------------------------- Net profit (loss) $ (15,170) $ (22,414) $ (6,108) $ 14,246 $ 13,846 - --------------------------------------------------------------------------------------------------------- Net profit (loss) per share $ (0.41) $ (0.62) $ (0.20) $ 0.45 $ 0.47 - --------------------------------------------------------------------------------------------------------- Weighted average shares outstanding 36,628 36,179 30,922 31,941 29,527 - --------------------------------------------------------------------------------------------------------- September 30, ------------------------------------------------------------- (In thousands) 1997 1996 1995 1994 1993 - --------------------------------------------------------------------------------------------------------- Working capital $ 46,164 $ 61,935 $ 60,539 $ 77,291 $ 60,072 Total assets 146,665 166,807 131,870 138,574 111,276 Long-term obligations 9,545 9,332 7,521 1,084 1,898 Shareholders' equity 81,462 101,581 82,182 89,644 70,531 - ---------------------------------------------------------------------------------------------------------
2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW SCO's mission is to be the software that system builders choose for Network Computing. SCO is the world's leading supplier of UNIX server and host systems, with a worldwide market share of over 36%, and worldwide market share of over 78% of UNIX Systems on the Intel platform. SCO sells and supports its products through a worldwide network of distributors, resellers, system integrators and OEMs. SCO is committed to bringing Network Computing to business-critical environments because it can dramatically lower the total cost of computing and is ideal for supporting heterogeneous systems and networks. Network Computing was built on UNIX system technologies, and, as the leading provider of UNIX servers, SCO will continue to enhance its product line to support the new generation of network computers and Java based business-critical applications. In addition to historical information contained herein, this Discussion and Analysis may contain forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Company undertakes no obligation to publicly release the results of any revision to these forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. RESULTS OF OPERATIONS NET REVENUES The Company's net revenues are derived from two primary sources, software licenses and fees for services which include engineering services, consulting, custom engineering, support and training. Net revenues were $193.7 million in fiscal 1997, a 7% decrease from $207.9 million in fiscal 1996 and were $199.3 million in fiscal 1995, an increase of 4% from fiscal 1995 to fiscal 1996. Beginning in fiscal 1996, net revenues included revenues derived from UnixWare packaged product shipments and source license revenue related to the acquisition of the UNIX assets from Novell, Inc. which occurred in December of 1995. Beginning in fiscal 1995, net revenues included revenues from Visionware Limited (Visionware) which was acquired in December of 1994. Revenue is net of a provision for estimated future returns for stock balancing and excess quantities above levels the Company believes are appropriate in its distribution channel partners. LICENSE REVENUES License revenues were $174.6 million in fiscal 1997 as compared to $189.0 million in fiscal 1996 and $177.5 million in fiscal 1995, representing a decrease of 8% in fiscal 1997 over 1996 and an increase of 6% in fiscal 1996 over 1995. License revenues were approximately 90% of total net revenues for fiscal 1997 and 91% and 89% of total net revenues for fiscal 1996 and 1995, respectively. The fiscal 1997 decline resulted from significant planned reduction in channel inventories across all product lines in the third quarter. The fiscal 1995 to 1996 license revenue increase was primarily attributable to unit volume increases (as opposed to price increases) of the Company's operating systems and layered products. For the fiscal years ended September 30, 1997, 1996 and 1995, no single customer accounted for greater than 10% of the Company's license revenues. SERVICE REVENUES Revenue from services remained relatively constant in fiscal 1997 at $19.1 million, a 1% increase over the $18.9 million level of 1996. Service revenues of 1996 decreased 13% from $21.8 million in fiscal 1995. The decrease in service revenues in fiscal 1996 was primarily attributable to the Company's decision to transition responsibility for the training and support of its product offerings to its 3 channel partners in the first half of fiscal 1996. As a result, training and support revenues recognized by the Company decreased in 1996. COST OF REVENUES COST OF REVENUES The Company's overall cost of revenues as a percentage of net revenues can be affected by mix changes in net revenue contribution between licenses and services, between product families, between geographic regions and between channels of distribution, since both price and cost characteristics associated with these revenue streams can vary greatly. The Company can also experience fluctuations in gross margin percentage as net revenues increase or decrease since certain costs of revenues including technology, service, product assembly and distribution act as fixed costs within certain volume ranges. COST OF LICENSE REVENUES Cost of license revenues includes royalties paid to certain software vendors, amortization of acquired technologies, product packaging, documentation and all costs associated with the acquisition of components, assembling of finished products, warehousing and shipping. Cost of license revenues as a percentage of license revenues increased to 21% for fiscal 1997 from 19% in fiscal 1996 and 1995. Higher scrap and obsolescence charges plus the impact of stable fixed costs over lower unit sales volume accounted for the major portion of the increase in 1997. Reduced third party royalty payments associated with the purchase of the UNIX assets from Novell and the purchase of TCP/IP networking technology (both of which occurred in the first half of fiscal 1996) were primary factors in the reduced license costs in fiscal 1996. COST OF SERVICE REVENUES Cost of service revenues includes documentation, consulting and personnel related expenses associated with providing such services. Cost of service revenues as a percentage of service revenues remained at 94% in fiscal 1997 as in 1996, but had increased from 91% in 1995. The fiscal 1996 increase in cost of service revenues as a percentage of service revenues resulted primarily from incremental support costs for product offerings associated with the acquisition of the UNIX assets from Novell. RESEARCH AND DEVELOPMENT The Company invests in research and development both for new products and to provide continuing enhancements to current products. Research and development expenses increased 18% to $46.1 million in fiscal 1997 from $39.0 million in fiscal 1996. In fiscal 1996, research and development expenses increased 21% from fiscal 1995 total expenditures of $32.2 million. Research and development expenses represented 24%, 19% and 16% of total net revenues in fiscal 1997, 1996 and 1995, respectively. The 1997 spending increase as a percentage of sales was primarily attributable to personnel costs relating to accelerated development of next generation operating systems and technology focused on internet-enabled products. The fiscal 1995 to 1996 increase in research and development spending was principally due to increased personnel and facility costs associated with the acquisition of the UNIX assets acquired from Novell and to increased spending levels associated with the development and release of layered products. To date, the Company has expensed as incurred all of its software development costs before reaching technological feasibility, which is defined as reaching a working model. SALES AND MARKETING Sales and marketing expenses, at $79.5 million, remained even with 1996 spending of $79.4 million. This represented a 4% decline from the 1995 level of $82.5 million. Sales and marketing expenses represented 41%, 38% and 41% of total net revenues in fiscal 1997, 1996 and 1995, respectively. While flat in absolute terms, the Company retargeted 1997 marketing spending towards reseller training, 4 independent software vendor recruitment and higher corporate brand awareness. The fiscal 1995 to fiscal 1996 decrease was primarily attributable to decreased project spending in corporate and channel marketing, as well as decreased sales personnel related costs in the United States and Europe. These decreases were partially offset by increased cooperative advertising expenses and by increased spending levels in Japan in order to support new products associated with the acquisition of the UNIX assets from Novell. GENERAL AND ADMINISTRATIVE General and administrative expenses increased by 3% to $20.9 million in fiscal 1997 from $20.3 million in fiscal 1996 and by 8% in fiscal 1996 from $18.9 million in fiscal 1995. General and administrative expenses represented 11% of total net revenues for fiscal 1997, 10% for 1996 and 9% for 1995. The increased spending in 1997 was primarily attributable to a one-time charge for settlement of litigation. In 1996, increased spending was due to personnel related costs associated with the purchase and assimilation of the UNIX assets from Novell. ( See Note 14 of Notes to Consolidated Financial Statements.) NON-RECURRING CHARGES A worldwide restructuring during the third quarter of fiscal 1997 resulted in a one-time charge of $8.4 million, 4% of 1997 revenues. The charge includes a 10% reduction in headcount of $3.4 million, elimination of lease obligations of non-essential facilities of $1.9 million and a write-off of certain acquired technologies of $1.4 million. Of the $8.4 million, $5.3 million related to cash expenditures and $3.1 million related to non-cash charges. The Company anticipates that the majority of the payments will be made by fiscal 1998. Non-recurring charges were $38.4 million representing 18% of total revenues in fiscal 1996. The charges primarily related to UnixWare products which had not yet reached technological feasibility and were incurred in the first fiscal quarter of 1996. Non-recurring charges of $14.1 million, which primarily related to Visionware products which had not yet reached technological feasibility, were incurred in the first fiscal quarter of 1995. Additional non-recurring costs of $4.0 million were incurred in the fourth fiscal quarter of 1995 resulting from a worldwide restructuring that included an 8% workforce reduction. OTHER INCOME (EXPENSE) Other income and expense consists of interest income net of interest expense, foreign exchange gains and losses, and other miscellaneous items. Net interest income was $2.3 million for fiscal 1997 and 1996 and $2.7 million for 1995. The net interest income decrease in fiscal 1996 from 1995 was primarily attributable to a decrease in the weighted average interest bearing balances maintained throughout the year. Other expense was $.9 million for fiscal 1997 and $.4 million for fiscal 1996 and 1995. The change in 1997 was due to a foreign exchange loss of $.6 million associated with the settlement of an intercompany loan to the Company's U.K. subsidiary. INCOME TAXES In fiscal 1997, 1996 and 1995, the Company's effective income tax rates were 0%, (3)% and (47)%, respectively. The fiscal 1997 rate primarily reflects the establishment of a valuation allowance for fiscal 1997 losses. The fiscal 1996 rate reflects non-deductible, non-recurring charges related to the acquisition of the UNIX assets and a change in the valuation allowance for deferred tax assets, while the fiscal 1995 rate reflects non-deductible, non-recurring charges related to the acquisition of Visionware. For an analysis of income taxes, see Note 12 of Notes to Consolidated Financial Statements. NET PROFIT (LOSS) 5 The Company reported net losses of $15.2 million, $22.4 million and $6.1 million in fiscal 1997, 1996 and 1995, respectively. The fiscal 1997, 1996 and 1995 net losses were primarily attributable to absolute increases in operating expenses and non-recurring charges. FACTORS THAT MAY AFFECT FUTURE RESULTS The Company's future operating results may be affected by various uncertain trends and factors which are beyond the Company's control. These include adverse changes in general economic conditions and rapid or unexpected changes in the technologies affecting the Company's products. The process of developing new high technology products is complex and uncertain and requires accurate anticipation of customer needs and technological trends. The industry has become increasingly competitive and, accordingly, the Company's results may also be adversely affected by the actions of existing or future competitors, including the development of new technologies, the introduction of new products, and the reduction of prices by such competitors to gain or retain market share. The Company's results of operations could be adversely affected if it were required to lower its prices significantly. The Company participates in a highly dynamic industry and future results could be subject to significant volatility, particularly on a quarterly basis. The Company's revenues and operating results may be unpredictable due to the Company's shipment patterns. The Company operates with little backlog of orders because its products are generally shipped as orders are received. In general, a substantial portion of the Company's revenues have been booked and shipped in the third month of the quarter, with a concentration of these revenues in the latter half of that third month. In addition, the timing of closing of large license contracts and the release of new products and product upgrades increase the risk of quarter to quarter fluctuations and the uncertainty of quarterly operating results. The Company periodically may adjust the level of inventory held in its distribution channels which may also cause quarter-to-quarter fluctuations. The Company's staffing and operating expense levels are based on an operating plan and are relatively fixed throughout the quarter. As a result, if revenues are not realized in the quarter as expected, the Company's expected operating results could be adversely affected, and such effect could be substantial and could result in an operating loss. The Company experiences seasonality of revenues for both the European and the U.S. federal government markets. European revenues during the quarter ending June 30 are historically lower or relatively flat compared to the prior quarter. This reflects a reduction of customer purchases in anticipation of reduced selling activity during the summer months. Sales to the U.S. federal government generally increase during the quarter ending September 30. This seasonal increase is primarily attributable to increased purchasing activity by the U.S. federal government prior to the close of its fiscal year. Additionally, net revenues for the first quarter of the fiscal year are typically lower or relatively flat compared to net revenues of the prior quarter. The overall cost of revenues may be affected by changes in the mix of net revenue contribution between licenses and services, product families, geographical regions and channels of distribution, as the costs associated with these revenues may have substantially different characteristics. The Company may also experience a change in margin as net revenues increase or decrease since technology costs, service costs and production costs are fixed within certain volume ranges. The Company's results of operations could be adversely affected if it were to lower its prices significantly. In the event the Company reduced its prices, the Company's standard terms for selected distributors provide credit for inventory ordered in the previous 180 days, such credits to be applied against future purchases. The Company, as a matter of policy, does not allow product returns for refund. Product returns are generally allowances for stock balancing and are accompanied by compensating and offsetting orders. Revenue is net of a provision for estimated future stock balancing and excess quantities above levels the Company believes are appropriate in its distribution channels. The Company monitors the quantity and mix of its product sales. 6 The Company's effective tax rate is subject to change based on the ability of the Company to utilize its tax carryforwards and as new tax legislation is enacted. A substantial portion of the Company's revenues are derived from outside the United States. Trade sales to international customers represented 55%, 53% and 60% of total revenues for fiscal 1997, 1996 and 1995, respectively. A substantial portion of these international revenues are denominated in the U.K. pound sterling and operating results can vary with changes in the U.S. dollar exchange rate for such currency. The Company's revenues can also be affected by general economic conditions in the United States, Europe and other international markets. The Company's operating strategy and pricing take into account changes in exchange rates over time. However, the Company's results of operations may be significantly affected in the short term by fluctuations in foreign currency exchange rates. The Company has adopted a strategy of reviewing and forecasting all material foreign denominated assets and liabilities to cover any potential transactional gain or loss which may occur should exchange rates change significantly. The Company may employ hedging instruments to offset uncovered exposure. The Company's policy is to amortize purchased software and technology licenses using the straight-line method over the remaining estimated economic life of the product, or on the ratio of current revenues to total projected product revenues, whichever is greater. Due to competitive pressures, it is reasonably possible that those estimates of anticipated future gross revenues, the remaining estimated economic life of the product, or both will be reduced significantly in the near future. As a result, the carrying amount of the Company's purchased software and technology licenses may be reduced materially in the near future and, therefore, could create an adverse impact on the Company's future reported earnings. The Company continually evaluates potential acquisition candidates. Such candidates are selected based on products or markets which are complementary to those of the Company's. Acquisitions involve a number of special risks, including the successful combination of the companies in an efficient and timely manner, the coordination of research and development and sales efforts, the retention of key personnel, the integration of the acquired products, the diversion of management's attention to assimilation of the operations and personnel of the acquired companies, and the difficulty of presenting a unified corporate image. The Company's operations and financial results could be significantly affected by such an acquisition. The Company's continued success depends to a significant extent on senior management and other key employees. None of these individuals is subject to a long-term employment contract or a non-competition agreement. Competition for qualified people in the software industry is intense. The loss of one or more key employees or the Company's inability to attract and retain other key employees could have a material adverse effect on the Company. The stock market in general, and the market for shares of technology companies in particular, have experienced extreme price fluctuations, which have often been unrelated to the operating performance of the affected companies. In addition, factors such as new product introductions by the Company or its competitors may have a significant impact on the market price of the Company's Common Stock. Furthermore, quarter-to-quarter fluctuations in the Company's results of operations caused by changes in customer demand may have a significant impact on the market price of the Company's stock. These conditions, as well as factors which generally affect the market for stocks of high technology companies, could cause the price of the Company's stock to fluctuate substantially over short periods. LIQUIDITY AND CAPITAL RESOURCES 7 The Company has financed its operations through combinations of net proceeds from the Company's initial public offering, bank borrowings, equipment lease lines and cash flow generated from operations. As of September 30, 1997, the Company's principal sources of liquidity included cash and short-term investments of $51.7 million and available bank lines of credit of approximately $17 million against which the Company had $.7 million in outstanding borrowings. The Company does not believe it will require borrowing capacity greater than the amount available under these lines of credit for at least the next twelve months. See Notes 2, 3 and 7 of Notes to the Consolidated Financial Statements. Working capital has been used to acquire capital equipment, products and technology, and to make facilities improvements. The Company's operating activities provided cash of $13.4 million in fiscal 1997, $27.0 million in fiscal 1996 and $2.8 million in fiscal 1995. Cash provided by (used for) investing activity during fiscal 1997, 1996 and 1995 was $(13.2) million, $(21.4) million and $6.4 million, respectively. In fiscal 1997 and 1996, cash provided by operations was used to fund purchases of technology, property and equipment, common stock repurchases and short-term investments. In fiscal 1995, proceeds from short-term investments were used to fund the purchase of Visionware, as well as the purchase of property and equipment. Cash provided by (used for) financing activities was $(10.0) million, $(5.3) million and $(5.0) million for fiscal 1997, 1996 and 1995, respectively. In fiscal 1997, 1996 and 1995, proceeds from the sale of Common Stock were more than offset by the Company's stock repurchases and payments on capital lease obligations. The Company believes that its existing cash and cash equivalents, short-term investments, funds generated from operations and available borrowing capabilities will be sufficient to meet its operating requirements through at least fiscal 1998. 8 THE SANTA CRUZ OPERATION, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended September 30, ----------------------------------- (In thousands, except per share data) 1997 1996 1995 - -------------------------------------------------------------------------------------------------- Net revenues: Licenses $ 174,552 $ 189,032 $ 177,534 Services 19,108 18,858 21,795 - -------------------------------------------------------------------------------------------------- Net revenues 193,660 207,890 199,329 - -------------------------------------------------------------------------------------------------- Cost of revenues: Licenses 37,272 36,633 34,342 Services 18,043 17,769 19,791 - -------------------------------------------------------------------------------------------------- Total cost of revenues 55,315 54,402 54,133 - -------------------------------------------------------------------------------------------------- Gross margin 138,345 153,488 145,196 - -------------------------------------------------------------------------------------------------- Operating expenses: Research and development 46,130 39,009 32,208 Sales and marketing 79,536 79,359 82,493 General and administrative 20,900 20,338 18,893 Non-recurring charges 8,373 38,363 18,094 - -------------------------------------------------------------------------------------------------- Total operating expenses 154,939 177,069 151,688 - -------------------------------------------------------------------------------------------------- Operating loss (16,594) (23,581) (6,492) Other income (expense): Interest income, net 2,291 2,302 2,703 Other expense, net (866) (394) (363) - -------------------------------------------------------------------------------------------------- Loss before income taxes (15,169) (21,673) (4,152) - -------------------------------------------------------------------------------------------------- Income taxes 1 741 1,956 - -------------------------------------------------------------------------------------------------- Net loss $ (15,170) $ (22,414) $ (6,108) - -------------------------------------------------------------------------------------------------- Net loss per share $ (0.41) $ (0.62) $ (0.20) - -------------------------------------------------------------------------------------------------- Common and common equivalents used in computing net loss per share 36,628 36,179 30,922 - --------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements 9 THE SANTA CRUZ OPERATION, INC. CONSOLIDATED BALANCE SHEETS
September 30, ---------------------- (In thousands, except for share data) 1997 1996 - ------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $ 23,225 $ 32,065 Short-term investments 28,486 22,766 Receivables, net 36,546 47,176 Deferred tax assets 6,631 6,152 Other current assets 6,934 9,670 - ------------------------------------------------------------------------------------------- Total current assets 101,822 117,829 - ------------------------------------------------------------------------------------------- Property and equipment, net 13,666 15,546 Purchased software and technology licenses, net 16,523 19,908 Other assets 14,654 13,524 - ------------------------------------------------------------------------------------------- Total assets $ 146,665 $ 166,807 - ------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Royalties payable $ 11,262 $ 10,644 Trade accounts payable 8,600 12,755 Income taxes payable 1,101 3,369 Accrued expenses and other current liabilities 27,230 22,288 Deferred revenues 7,465 6,838 - ------------------------------------------------------------------------------------------- Total current liabilities 55,658 55,894 - ------------------------------------------------------------------------------------------- Other long-term liabilities 9,545 9,332 - ------------------------------------------------------------------------------------------- Shareholders' equity: Common stock, net of notes receivable of $88 from an officer of the Company, authorized 100,000,000 shares Issued and outstanding 36,450,115 and 37,105,892 shares 119,287 125,172 Cumulative translation adjustment 639 (297) Accumulated deficit (38,464) (23,294) - ------------------------------------------------------------------------------------------- Total shareholders' equity 81,462 101,581 - ------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 146,665 $ 166,807 - -------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements 10 THE SANTA CRUZ OPERATION, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Cumulative Retained Total ---------------------- Translation Earnings Shareholders' (In thousands) Shares Amount Adjustment (Deficit) Equity - -------------------------------------------------------------------------------------------------- BALANCES, SEPTEMBER 30, 1994 30,586 $ 84,764 $ (348) $ 5,228 $ 89,644 Issuance under stock option and purchase plans 904 3,263 -- -- 3,263 Common stock repurchases (760) (7,489) -- -- (7,489) Visionware purchase 114 1,075 -- -- 1,075 Stock option income tax benefit -- 1,533 -- -- 1,533 Translation adjustment -- -- 264 -- 264 Net loss -- -- -- (6,108) (6,108) - -------------------------------------------------------------------------------------------------- BALANCES, SEPTEMBER 30, 1995 30,844 $ 83,146 $ (84) $ (880) $ 82,182 Issuance under stock option and purchase plans 823 2,734 -- -- 2,734 Common stock repurchases (689) (4,744) -- -- (4,744) UNIX asset purchase 6,128 43,773 -- -- 43,773 Stock option income tax benefit -- 263 -- -- 263 Translation adjustment -- -- (213) -- (213) Net loss -- -- -- (22,414) (22,414) - -------------------------------------------------------------------------------------------------- BALANCES, SEPTEMBER 30, 1996 37,106 $ 125,172 $ (297) $(23,294) $ 101,581 Issuance under stock option and purchase plans 872 2,981 -- -- 2,981 Common stock repurchases (1,528) (9,110) -- -- (9,110) Stock option income tax benefit -- 244 -- -- 244 Translation adjustment -- -- 936 -- 936 Net loss -- -- -- (15,170) (15,170) - -------------------------------------------------------------------------------------------------- BALANCES, SEPTEMBER 30, 1997 36,450 $ 119,287 $ 639 $(38,464) $ 81,462 - --------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 11 THE SANTA CRUZ OPERATION, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended September 30, --------------------------------- (In thousands) 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(15,170) $(22,414) $ (6,108) Adjustments to reconcile net loss to net cash provided by operating activities - Depreciation and amortization 16,312 16,151 10,369 Fixed assets received in lieu of payment -- -- (467) Charge for purchased research and development -- 38,363 11,177 Deferred tax assets (1,017) (1,842) (4,673) Stock option income tax benefit 244 263 1,533 Changes in operating assets and liabilities, net of acquisitions - Receivables 10,630 (2,167) (5,176) Other current assets 2,736 (336) (226) Royalties payable 618 5,002 (543) Trade accounts payable (4,155) 2,548 176 Income taxes payable (1,132) 423 (4,350) Accrued expenses and other current liabilities 3,714 (7,333) 1,318 Deferred revenue 627 (1,673) (272) - -------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 13,407 26,985 2,758 - -------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (1,796) (4,874) (9,940) Purchase of software and technology licenses (5,188) (5,953) (4,868) Sales of short-term investments 17,006 15,514 57,647 Purchases of short-term investments (22,726) (23,464) (20,851) Purchase of Visionware -- -- (13,675) Changes in other assets (499) (2,658) (1,960) - -------------------------------------------------------------------------------------------------------------- Net cash provided by (used for) investing activities (13,203) (21,435) 6,353 - -------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments on capital leases (1,627) (3,924) (1,353) Net proceeds from sale of common stock 2,981 2,742 3,263 Repurchases of common stock (9,110) (4,752) (7,489) Other long-term liabilities (2,224) 588 575 - -------------------------------------------------------------------------------------------------------------- Net cash used for financing activities (9,980) (5,346) (5,004) - -------------------------------------------------------------------------------------------------------------- Effects of exchange rate changes on cash and cash equivalents 936 (213) 264 - -------------------------------------------------------------------------------------------------------------- Change in cash and cash equivalents (8,840) (9) 4,371 Cash and cash equivalents at beginning of year 32,065 32,074 27,703 - -------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 23,225 $ 32,065 $ 32,074 - -------------------------------------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid - Income taxes $ 2,168 $ 1,955 $ 8,545 Interest 643 147 254 Non-cash financing and investing activities - Assets recorded under capital leases $ 4,063 $ 2,676 $ 29 Networking technology buyout (see Note 6) -- 8,205 -- Purchase of UNIX assets with common stock -- 43,773 -- - --------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements 12 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES THE COMPANY SCO is a leading provider of UNIX-based, open system software. The Company's products enable business and government organizations of all sizes to integrate technologies and products from different vendors to create cost-effective, powerful, networked information systems that perform highly complex, mission-critical business functions. SCO has built an experienced distribution and development infrastructure to support its products. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the Company and its wholly and majority-owned subsidiaries. All significant intercompany transactions and balances have been eliminated. Investments in companies less than 20% owned are carried at lower of cost or net realizable value. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RECLASSIFICATIONS Certain reclassifications have been made for consistent presentation. CASH EQUIVALENTS AND INVESTMENTS The Company considers all highly liquid investments with an original maturity of 90 days or less at the date of acquisition to be cash equivalents. Short-term investments include instruments with lives ranging from 91 days to three years. The Company classifies its investments in certain debt and equity securities as available-for-sale. Such investments are recorded at fair market value, based on quoted market prices, and unrealized gains and losses are reported as a separate component of shareholders' equity. As of September 30, 1997 and 1996, unrealized gains or losses on such investments were not significant. The cost of securities is based on the specific identification method. PROPERTY AND EQUIPMENT Property and equipment are stated at cost and, except for assets recorded under capital lease and leasehold improvements, are depreciated using the straight-line method over the estimated useful lives of the assets, ranging from three to five years. Leasehold improvements and assets recorded under capitalized leases are amortized using the straight-line method over the lesser of the remaining term of the lease or the estimated economic life of the asset, ranging from one to ten years. PURCHASED SOFTWARE AND TECHNOLOGY LICENSES Purchased software consists of core intellectual property rights which the Company owns. Technology licenses represent payments for the rights to use and integrate completed third party technology into the Company's product offerings. Amounts capitalized are amortized on a straight-line basis over the estimated product life, ranging from three to six years, or on the ratio of current revenues to total projected product revenues, whichever is greater. ACCOUNTING FOR LONG-LIVED ASSETS The Company reviews property and equipment and purchased software and technology licenses for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is measured by comparison of its carrying amount to future net cash flows the assets are expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair market value. SOFTWARE DEVELOPMENT COSTS Statement of Financial Accounting Standard No. 86 provides for the capitalization of certain software development costs once technological feasibility is established. 13 Capitalized costs are then amortized on a straight-line basis over the estimated product life, or on the ratio of current revenues to total projected product revenues, whichever is greater. Through September 30, 1997, the Company believes its process for developing software was essentially completed concurrent with the establishment of technological feasibility, and accordingly, no software development costs have been capitalized to date. REVENUE RECOGNITION Revenue from sales of software and software documentation products is generally recognized upon product shipment provided that no significant vendor obligations remain and collection of the resulting receivable is probable. For those agreements which provide the customer the right to multiple copies in exchange for a nonrefundable fixed fee, revenue is recognized at delivery of the product master of the first copy. Revenue is deferred for estimated future returns for stock balancing and excess quantities above levels the Company believes are appropriate in the distribution channels. Revenue from support contracts, including support bundled with software licenses, is recognized ratably over the term of the contract. The Company has entered into agreements whereby it licenses products to original equipment manufacturers. These agreements generally provide for nonrefundable commitment fees which are recognized upon contract signing, product acceptance and delivery. Such commitment fees received prior to product acceptance are deferred. The Company also provides contract engineering services, including the porting of system software, consulting, design and product review. Revenues from these services are recognized on the percentage-of-completion method unless refundable. If payments are refundable, revenues are deferred until customer acceptance. The Company's existing revenue recognition policies comply with the provisions of the American Institute of Certified Public Accountants Statement of Position 91-1, Software Revenue Recognition. COOPERATIVE ADVERTISING The Company expenses advertising costs as incurred. The Company reimburses certain qualified customers for a portion of the advertising costs related to their promotion of the Company's products. The Company's liability for reimbursement is accrued at the time revenue is recognized as a percentage of the qualified customer's net revenue derived from the Company's products. For 1997, 1996 and 1995 cooperative advertising expense totaled approximately $8.6 million, $8.2 million and $6.2 million, respectively. INCOME TAXES The Company records income taxes using an asset and liability approach that results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's consolidated financial statements or tax returns. In estimating future tax consequences, all expected future events other than enactment of changes in tax laws are considered. When necessary, a valuation allowance is recorded to reduce tax assets to an amount whose realization is more likely than not. NET LOSS PER SHARE Net loss per share is computed based on weighted average number of common shares outstanding and dilutive common equivalent shares from the assumed exercise of stock options using the treasury stock method. RECENT ACCOUNTING PRONOUNCEMENTS In October 1997, the AICPA issued Statement of Position (SOP) 97-2, Software Revenue Recognition, which supersedes SOP 91-1. The Company will be required to adopt SOP 97-2 prospectively for software transactions entered into beginning October 1, 1998. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements such as software products, upgrades, enhancements, postcontract customer support, installation and training, to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on evidence which is specific to the vendor. The revenue allocated to software products, including specified upgrades or enhancements generally is recognized upon delivery of the products. The 14 revenue allocated to postcontract customer support generally is recognized ratably over the term of the support and revenue allocated to service elements generally is recognized as the services are performed. If a vendor does not have evidence of the fair value for all elements in a multiple-element arrangement, all revenue from the arrangement is deferred until such evidence exists or until all elements are delivered. The Company's management is currently evaluating whether the adoption of SOP 97-2 will have a material impact on the Company's results of operations. The Financial Accounting Standards Board issued Statements of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share, in February 1997. SFAS No. 128 requires the presentation of basic earnings per share (EPS) for all companies, and diluted EPS for companies with complex capital structures or potentially dilutive securities, such as convertible debt, options and warrants. SFAS No. 128 is effective for annual and interim periods ending after December 15, 1997. The Company expects that basic EPS and diluted EPS will not differ materially from earnings per share as presented in the accompanying consolidated financial statements. STOCK-BASED COMPENSATION The Company accounts for its stock-based compensation plans using the intrinsic value method. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. FOREIGN CURRENCY TRANSLATION The functional currency of the Company's foreign subsidiaries is the local foreign currency. All assets and liabilities denominated in foreign currencies are translated into US dollars at the exchange rate on the balance sheet date. Revenues, costs and expenses are translated at average rates of exchange prevailing during the period. Translation adjustments are accumulated as a separate component of shareholders' equity. Gains and losses resulting from foreign currency transactions are included in the consolidated statements of operations and have not been significant. HEDGING OF FOREIGN CURRENCY TRANSACTIONS The Company utilizes foreign currency forward exchange contracts to hedge foreign currency market exposures of underlying assets, liabilities and other obligations. The Company does not use forward exchange contracts for speculative or trading purposes. The Company's accounting policies for these instruments are based on the Company's designation of such instruments as hedging transactions. The criteria the Company uses for designating an instrument as a hedge include the instrument's effectiveness in risk reduction and one-to-one matching of forward exchange contracts to underlying transactions. Gains and losses on currency forward contracts that are designated and effective as hedges of firm commitments are deferred and recognized in income in the same period that the underlying transactions are settled. Gains and losses on currency forward contracts that are designated and effective as hedges of existing transactions are recognized in income in the same period as losses and gains on the underlying transactions are recognized and generally offset. Gains and losses on any instruments not meeting the above criteria would be recognized in income in the current period. The Company transacts business in various foreign currencies. During 1997, the Company established hedging programs to protect against exposure on certain foreign denominated transactions through the use of foreign currency forward exchange contracts. At September 30, 1997, the Company had foreign exchange contracts, all having maturities of 90 days or less, to purchase approximately $7,875,000 and sell approximately $2,250,000 in British Pounds. The fair value of these contracts at September 30, 1997 is not significant. The counterparties to these contracts are substantial and credit worthy multinational commercial banks. The risks of counterparty nonperformance associated with these contracts are not considered to be significant. 15 NOTE 2 - CASH AND CASH EQUIVALENTS
September 30, --------------------- (In thousands) 1997 1996 - --------------------------------------------------- Bank demand deposits $ -- $ 4,160 Certificates of deposit 2,173 676 Money market accounts 21,052 23,652 Corporate bonds -- 3,577 - --------------------------------------------------- $23,225 $32,065 - ---------------------------------------------------
NOTE 3 - SHORT-TERM INVESTMENTS
September 30, --------------------- (In thousands) 1997 1996 - --------------------------------------------------- U.S. Treasury bills $ -- $ 119 U.S. Treasury notes 4,643 3,462 Certificates of deposit 1,145 1,136 Government agency bonds 10,351 10,450 Corporate bonds 12,347 7,599 - --------------------------------------------------- $28,486 $22,766 - ---------------------------------------------------
At September 30, 1997, investments with maturity dates ranging from 91 days to 1 year totaled $5.2 million, and investments with maturity dates ranging from 1 year to 3 years totaled $23.3 million. NOTE 4 - RECEIVABLES
September 30, ------------------------ (In thousands) 1997 1996 - ------------------------------------------------------------- Trade accounts receivable $ 47,425 $ 58,306 Less allowance for returns and doubtful accounts (10,879) (11,130) - ------------------------------------------------------------- $ 36,546 $ 47,176 - -------------------------------------------------------------
The Company generates a significant portion of its revenues through distributors of personal computer software in North America, Europe and the Pacific Rim. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses. For the fiscal years ended September 30, 1997, 1996 and 1995, no one customer's balance exceeded 10% of trade receivables or accounted for greater than 10% of the Company's revenues. 16 NOTE 5 - PROPERTY AND EQUIPMENT
September 30, ------------------------ (In thousands) 1997 1996 - ---------------------------------------------------------------- Computer and office equipment $ 39,098 $ 34,284 Furniture and fixtures 7,469 7,245 Leasehold improvements 7,540 6,719 - ---------------------------------------------------------------- 54,107 48,248 Less accumulated depreciation and amortization (40,441) (32,702) - ---------------------------------------------------------------- $ 13,666 $ 15,546 - ----------------------------------------------------------------
NOTE 6 - PURCHASED SOFTWARE AND TECHNOLOGY LICENSES
September 30, ------------------------ (In thousands) 1997 1996 - -------------------------------------------------------------- Purchased software and technology licenses, at cost $ 22,279 $ 23,128 Less accumulated amortization (5,756) (3,220) - -------------------------------------------------------------- $ 16,523 $ 19,908 - --------------------------------------------------------------
In March of 1996, the Company purchased a fully paid up license enabling it to integrate and distribute certain networking technology in perpetuity. Under the terms of the purchase agreement, consideration of $9.0 million is due in three equal installments with the final payment due in March of 1998. Installment payments of $3.0 million were made during both fiscal 1996 and 1997. The present value of the license is included in purchased software and technology licenses in the Company's consolidated balance sheet. Amortization expense of $1.4 million in 1997 and $1.0 million in 1996 is included in cost of license revenues in the Company's consolidated statements of operations. NOTE 7 - BANK LINE OF CREDIT At September 30, 1997, the Company had available lines of credit of approximately $17.0 million. The domestic credit agreement provides that the Company may borrow an amount equal to 75% of eligible accounts receivable, subject to a total of $15.0 million. The interest rate on the domestic line of credit is the prime rate and borrowings are unsecured. This line of credit was not used during fiscal 1997. The line of credit requires that the Company maintain certain financial ratios, all of which the Company was in compliance with as of September 30, 1997. The Company maintains a $2.0 million line of credit internationally under which the Company had $.7 million in outstanding borrowings at September 30, 1997. The interest rate on borrowings made against this line of credit during fiscal 1997 was 2.125%. NOTE 8 - ROYALTIES PAYABLE Royalties payable represent obligations to pay authors of certain software products under licensing agreements. Two corporate shareholders accounted for $8.3 million and $7.6 million of the royalties payable balance at September 30, 1997 and 1996 respectively, and $4.2 million and $4.1 million of royalty expense for fiscal 1997and 1996, respectively. One of the aforementioned shareholders accounted for $7.4 million of royalty expense for fiscal 1995. 17 NOTE 9 - ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
September 30, --------------------- (In thousands) 1997 1996 - --------------------------------------------------------------- Accrued wages, commissions, bonuses $ 7,236 $ 6,211 Accrued advertising 3,829 4,030 Accrued fringe benefits 2,488 2,075 Other accrued expenses 13,677 9,972 - --------------------------------------------------------------- $27,230 $22,288 - ---------------------------------------------------------------
NOTE 10 - COMMITMENTS LEASE COMMITMENTS Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) and future minimum capital lease payments as of September 30, 1997 were as follows:
Capital Operating (In thousands) Leases Leases - ------------------------------------------------------------------------------ Year Ending September 30, 1998 $ 2,492 $ 8,141 1999 2,149 6,143 2000 744 5,787 2001 75 5,408 2002 27 4,949 Later years, through 2020 -- 23,766 ------- -------- Total minimum lease payments 5,487 $ 54,194 ======== Less amount representing interest 494 ------- Present value of net minimum capital lease payments 4,993 Less current installments of obligations under capital leases 2,171 - ------------------------------------------------------------------------------ Obligations under capital leases, excluding current installments $ 2,822 - ------------------------------------------------------------------------------
The cost of assets recorded under capital leases was $7.4 million and $3.6 million at September 30, 1997 and 1996, respectively. Accumulated amortization on those dates was $2.2 million and $1.4 million, respectively. Rent expense amounted to approximately $8.6 million, $8.2 million and $7.4 million in fiscal 1997, 1996 and 1995, respectively. Included in the Company's operating lease commitments are facilities leased from Encinal Partners, a partnership which includes both a Company Executive Vice President and a principal stockholder. The Company's Board of Directors has reviewed and approved the lease agreements and determined that the lease agreements entered into by the Company are equivalent to agreements that would be negotiated with independent third parties on an "arms-length" basis. The remaining lease term of these facilities is between one and eight years. Rent expense for these facilities amounted to approximately $1.4 million in each of fiscal 1997, 1996 and 1995. 18 SAVINGS PLANS The Company has a savings plan, which qualifies under section 401(k) of the Internal Revenue Code. Under the plan, participating U.S. employees may defer up to 25% of their pre-tax salary, but not more than the statutory limits. Beginning January 1995 the Company began a contribution matching program which was phased-in over three years. The Company matched 50% of employee's contribution up to $1,000 or 2% of employee's annual salary for 1995; up to $2,000 or 4% of employee's annual salary for 1996; and up to $3,000 or 6% of employee's annual salary for 1997 and thereafter. For fiscal 1997, 1996 and 1995, the Company's total contributions towards the 401(k) plan amounted to $.9 million, $.5 million and $.2 million, respectively. NOTE 11 - SHAREHOLDERS' EQUITY PREFERRED STOCK The Company is authorized to issue 20,000,000 shares of Preferred Stock, of which 930,000, 1,950,000, 5,500,000 and 850,000 were designated Series A, Series B, Series C and Series C-1 Preferred Stock, respectively. As of September 30, 1997, there were no shares of Preferred Series stock either issued or outstanding. 1993 EMPLOYEE STOCK PURCHASE PLAN The Company has an Employee Stock Purchase Plan (ESPP) for all eligible employees which is administered by the Board of Directors. Under the ESPP, shares of the Company's ESPP stock may be purchased at six-month intervals at 85% of the fair market value on the first or last day of each six-month period whichever is lower. Employees may purchase shares through payroll deductions of up to 10% of gross compensation during an offering period. During 1997, 1996 and 1995, employees purchased 431,351, 317,722 and 376,047 shares at an average per share price of $4.81, $5.47 and $5.67, respectively. The number of shares reserved for issuance under the Purchase Plan increased by 750,000 shares in February 1997. As of September 30, 1997, 1,017,764 shares were reserved for future issuance. 1994 INCENTIVE STOCK OPTION PLAN As of September 30, 1997, the Company had authorized 13,013,665 shares of Common Stock for issuance under the 1994 Incentive Stock Option Plan (the "Option Plan"), respectively. The Company's Board of Directors administers the Option Plan and determines the terms of the options granted under the Option Plan, including the exercise price, number of shares subject to each option and the exercisability thereof. In addition, the Company's stock committee is authorized to grant up to 20,000 shares to an individual employee or consultant under the terms of the Option Plan. The exercise price of all incentive options granted under the Option Plan must be at least equal to the fair market value. Options granted under the Option Plan prior to January 31, 1996 generally become exercisable over a five year period. Effective January 31, 1996, the vesting period for subsequent grants was changed to four years. The term of each option is ten years. 1993 DIRECTOR OPTION PLAN The Company's 1993 Director Option Plan (the "Director Plan") provides for the granting of nonstatutory stock options to nonemployee directors of the Company and is administered by the Board of Directors. In February of 1997, the number of shares available for issuance under the Director Plan was increased by 200,000 shares from 550,000 shares to 750,000 shares. A summary of the status of the Company's stock option plans as of September 30, 1997, 1996 and 1995, and changes during the years then ended on those dates is presented below: 19
(In thousands, except 1997 1996 1995 per share price) --------------------- --------------------- --------------------- Weighted- Weighted- Weighted- Average Average Average Shares Exercise Shares Exercise Shares Exercise Option and Director Plans (000) Price (000) Price (000) Price - ----------------------------------------------------------------------------------------------------------- Outstanding at beginning of year 6,419 $ 6.93 6,244 $ 6.60 4,470 $ 4.48 Granted 8,345 5.43 1,424 7.03 2,730 9.35 Exercised (441) 2.08 (506) 1.96 (528) 2.17 Cancelled (5,765) 7.62 (743) 7.73 (428) 7.52 ------ ----- ----- Outstanding at end of year 8,558 5.25 6,419 6.93 6,244 6.60 ====== ===== ===== Options exercisable at year-end 1,678 $ 5.54 2,468 $ 5.73 2,007 $ 3.84 Weighted-average fair value of options granted during the year $ 2.13 $ 3.48 - -----------------------------------------------------------------------------------------------------------
The following table summarizes information about stock options outstanding at September 30,1997: (In thousands)
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------------- ------------------------------- Range of Number Weighted-Avg Number Exercise Price Outstanding Remaining Weighted-Avg Exercisable Weighted-Avg $2.00 increments at 9/30/97 Contractual Life Exercise Price at 9/30/97 Exercise Price - ----------------------------------------------------------------------------------------------------- $ .41 - 1.50 265 2.2 years $ 1.19 265 $ 1.19 2.00 - 3.75 489 7.4 3.28 156 2.45 4.38 - 5.63 5,580 8.9 4.89 395 5.32 6.00 - 7.75 1,823 7.2 6.56 606 6.63 8.00 - 9.75 283 5.1 8.76 162 8.78 10.00 - 12.00 118 4.7 11.10 94 11.22 -------- - ------- $ .41 - 12.00 8,558 8.1 $ 5.25 1,678 $ 5.54 ======== = ======= - -----------------------------------------------------------------------------------------------------
PRO FORMA FAIR VALUE ACCOUNTING FOR STOCK-BASED COMPENSATION SFAS No. 123, Accounting for Stock-Based Compensation, requires pro forma information regarding net income and earnings per share be determined as if the Company had accounted for it's employee stock options and other stock-based compensation granted subsequent to September 30, 1995 under the fair value method of that statement. The fair value of the options granted under the Incentive Option Plan and the Director Option Plan was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1997 and 1996: risk-free interest rate of 6.19% for 1997 and 5.97% for 1996; dividend yield of 0%; volatility factor of the expected market price of the Company's common stock of 55%; and a four year and five year expected life for options granted to non-executives and executives, respectively. 20 The fair value for the Employee Stock Purchase Plan rights were also estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions for 1997 and 1996: risk-free interest rates of 5.31% and 5.34%; dividend yield of 0%; volatility factor of 55%; and six month expected life. The weighted average fair value of the ESPP rights granted in 1997 and 1996 was $ 1.71 and $ 2.01, respectively.
(In thousands, except Fiscal Year Ended per share price) September 30, ------------------------ 1997 1996 - -------------------------------------------------------- Pro forma net loss (18,625) (23,376) Pro forma loss per share (0.51) (0.65) - --------------------------------------------------------
During the initial phase-in period, the effects of applying SFAS No. 123 for recognizing compensation expense may not be representative of the effects on the reported net income or loss for future years because the options granted by the Company vest over several years and additional awards may be made in the future. COMMON STOCK REPURCHASES The Company repurchases its common stock on the open market, both systematically and non-systematically. Under the systematic stock repurchase plan, shares of common stock are repurchased to help negate the dilutive effects of the Incentive Stock Option Plan and the Employee Stock Purchase Plan. For the fiscal years ended September 30, 1997, 1996 and 1995, the purchases and retirements of common stock under the systematic plan were 843,000 shares, 601,000 shares and 760,000 shares, respectively. Under the non-systematic repurchase plan, the Company may repurchase up to 4,000,000 shares of its common stock. During the fiscal years ended September 30, 1997 and 1996, 685,000 and 88,000 shares, respectively, were repurchased and retired under the non-systematic plan. Both the systematic and non-systematic plans have been approved for continuance into fiscal 1998. SHAREHOLDER RIGHTS In September 1997, the Company adopted a Shareholder Rights Plan which provides existing stockholders with the right to purchase a partial share of preferred stock for each share of common stock owned by the shareholder in the event of certain changes in the Company's ownership. These rights may serve as a deterrent to certain unauthorized takeover attempts which are not in the best interests of shareholders. The rights expire in September 2007. NOTE 12 - INCOME TAXES Loss before income taxes for fiscal 1997, 1996 and 1995 include foreign pretax profit (loss) of approximately $2.2 million, $2.2 million and $(.9) million, respectively. The components of income taxes are as follows: 21
Fiscal Year Ended September 30, ------------------------------- (In thousands) 1997 1996 1995 - ------------------------------------------------------------- Current: Federal $ (846) $ 301 $ 4,352 State (774) 814 (390) Foreign 2,394 1,205 1,134 - ------------------------------------------------------------- Total current 774 2,320 5,096 - ------------------------------------------------------------- Deferred: Federal 1,450 (1,684) (3,751) State (308) (568) (928) Foreign (2,159) 410 6 - ------------------------------------------------------------- Total deferred (1,017) (1,842) (4,673) - ------------------------------------------------------------- Charge in lieu of income tax expense related to employee stock options 244 263 1,533 - ------------------------------------------------------------- $ 1 $ 741 $ 1,956 =============================================================
Income taxes differ from the amount computed by applying the statutory federal income tax rate to loss before income taxes as follows:
Fiscal Year Ended September 30, --------------------------------- (In thousands) 1997 1996 1995 - -------------------------------------------------------------------------- Statutory federal income tax benefit at 34% $ (5,157) $ (7,369) $ (1,412) State income tax (benefit), net of federal effect (714) 162 (870) Non-deductible purchased research and development 104 2,239 4,022 Foreign income taxed at different rates 502 577 778 Research credit (2,122) (258) (400) Change in the total valuation allowance 7,854 5,398 (173) Other, net (466) (8) 11 - ------------------------------------------------------------------------- $ 1 $ 741 $ 1,956 =========================================================================
The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented as follows: 22
Fiscal Year Ended September 30, ---------------------------------- (In thousands) 1997 1996 1995 - ---------------------------------------------------------------------- Deferred tax assets: Accruals and reserve accounts $ 6,130 $ 7,685 $ 4,822 Property and equipment 2,696 142 988 Purchased software -- 5,005 -- Net operating loss carryforwards 9,644 -- -- Research credit 6,715 4,593 4,030 Other credits 1,986 -- 683 - ---------------------------------------------------------------------- Total gross deferred tax assets 27,171 17,425 10,523 Less valuation allowance (17,452) (9,598) (4,200) - ---------------------------------------------------------------------- Net deferred tax assets 9,719 7,827 6,323 - ---------------------------------------------------------------------- Deferred tax liabilities: Purchased software 1,690 815 1,153 - ---------------------------------------------------------------------- Total deferred tax liabilities 1,690 815 1,153 - ---------------------------------------------------------------------- Net tax assets and liabilities $ 8,029 $ 7,012 $ 5,170 ======================================================================
The net change in the total valuation allowance for the years ended September 30, 1997, 1996 and 1995 was an increase (decrease) of approximately $7.9 million, $5.4 million and $(.2) million, respectively. The Company's management believes the uncertainty regarding the timing of the realization of net deferred tax assets requires a valuation allowance. At September 30, 1997, the Company has net operating losses of $26.8 million which expire in fiscal 2012, and foreign tax and research credit carryforwards of approximately $2.0 million and $6.7 million, respectively, which expire in fiscal 1998 through 2012. At September 30, 1997, the foreign subsidiaries of the Company had cumulative unremitted foreign earnings of approximately $2.8 million. Had these earnings been repatriated during fiscal 1997, the incremental U.S. tax liability would not have been material after taking into account underlying foreign tax credits and the Company's unused carryforwards. The management intends to reinvest these earnings indefinitely. NOTE 13 - RESTRUCTURING CHARGE A worldwide restructuring during the third quarter of fiscal 1997 resulted in a one-time charge of $8.4 million. The charge included a 10% reduction in headcount, elimination of lease obligations of non-essential facilities and a write-off of certain acquired technologies. The majority of the reduction of force was in manufacturing, product development and marketing. Of the $8.4 million, $5.3 million related to cash expenditures and $3.1 million related to non-cash charges. As of September 30,1997, a total of 94 positions have been eliminated. As a result of this restructuring, the Company realigned its product development organization, eliminated some research and development programs and focused product marketing. Additionally, some key manufacturing processes have been outsourced and elements of general and administration functions have been consolidated. The Company anticipates that the majority of the payments will be made by fiscal 1998. The restructuring charge payable and payments against it can be summarized as follows: 23
Reduction (In thousands) in Force Facilities Technology Other Total - ------------------------------------------------------------------------------------------------------ Restructuring charge accrued $ 3,359 $ 1,925 $ 1,433 $ 1,656 $ 8,373 Payments / write-offs (2,551) (485) (1,433) (1,055) (5,524) - ------------------------------------------------------------------------------------------------------ Accrual at end of year $ 808 $ 1,440 $ -- $ 601 $ 2,849 ======================================================================================================
NOTE 14 - ACQUISITIONS VISIONWARE LIMITED In December 1994, the Company completed the acquisition of Visionware Limited (Visionware), a developer and distributor of PC connectivity software, for $13.7 million in cash and 114,342 shares of common stock. Non-recurring charges of $14.1 million were incurred in fiscal 1995 for costs associated with the acquisition, of which $11.2 million related to non-tax deductible purchased research and development for Visionware products which had not yet reached technological feasibility and $2.9 million related to redundant facilities and other one-time acquisition related charges. Intangibles of $5.2 million, arising from the business acquisition, are amortized on the straight-line basis over estimated useful lives ranging from three to seven years. Amortization expense amounted to $.9 million in fiscal 1997 and 1996 and $.7 million in fiscal 1995 and is included in cost of license revenues in the Company's Consolidated Statements of Operations. The acquisition has been accounted for using the purchase method of accounting and, therefore, the results of operations of Visionware have been included in the consolidated financial statements since December 1994. UNIX ASSETS In December 1995, the Company acquired from Novell certain assets related to UnixWare including the core intellectual property. The consideration consisted of 6,127,500 newly issued shares of non-registered common stock. Additionally, cash payments to Novell with a present value of $84 million will be paid periodically by SCO to Novell provided certain unit volumes of UNIX distribution are achieved. To date, distribution unit volume of UNIX has not reached levels which have required the Company to make cash payments to Novell. Such payments terminate at the end of calendar year 2002. Non-recurring charges of $38.4 million were incurred in fiscal 1996 for costs allocated to in-process research and development. The Company also purchased core intellectual property totaling $5.8 million, software technology licenses totaling $5.5 million and intangibles of $1.7 million. NOTE 15 - INVESTMENTS In November 1996, the Company purchased $2.0 million of convertible debentures of a domestic distribution channel partner. The debentures can be converted, in whole or in part, at any time prior to maturity on November 18, 1998, for preferred stock equal to 19.9% of the fully diluted common stock outstanding. If the Company does not convert the debenture, the partner will repay all principal and interest in twelve equal quarterly installments commencing December 31, 1998. In January 1995, the Company purchased 10% of another domestic distribution channel partner's preferred stock in exchange for cash, product and equipment valued at $1.0 million. In addition, the Company has loaned $1.0 million to this partner . The loan matures on July 1, 1998, but may be converted at any time prior to maturity for an additional 10% of either the partner's preferred stock or common stock. Interest on the outstanding borrowing is due and payable at the loan's maturity. At September 30, 1997, the Company had accounts receivable outstanding with the related parties of $3.9 million. Sales to the related parties for fiscal 1997 were $18.3 million. One of the parties accounted for 24 receivables of $1.6 million as of September 30, 1996, and sales of $7.7 million and $4.6 million for fiscal 1996 and 1995, respectively. NOTE 16 - INFORMATION BY GEOGRAPHIC AREA
Fiscal Year Ended September 30, ------------------------------------- (In thousands) 1997 1996 1995 - ---------------------------------------------------------------------------- NET REVENUES: United States $ 113,328 $ 125,759 $ 111,530 Europe 77,931 80,603 87,799 Other international operations 2,401 1,528 -- - ---------------------------------------------------------------------------- Total net revenues $ 193,660 $ 207,890 $ 199,329 ============================================================================ TRANSFERS BETWEEN GEOGRAPHIC AREAS: United States $ 13,205 $ 16,894 $ 23,807 Europe 2,136 916 945 - ---------------------------------------------------------------------------- Total transfers $ 15,341 $ 17,810 $ 24,752 ============================================================================ OPERATING EARNINGS (LOSS): United States $ (17,496) $ (29,017) $ (5,111) Europe 1,999 2,864 121 Other international operations 189 120 (1,052) Eliminations (1,286) 2,452 (450) - ---------------------------------------------------------------------------- Operating loss $ (16,594) $ (23,581) $ (6,492) ============================================================================ IDENTIFIABLE ASSETS: United States $ 117,068 $ 135,040 $ 108,078 Europe 32,816 31,930 33,280 Other international operations 3,728 3,860 5,310 Eliminations (6,947) (4,023) (14,798) - ---------------------------------------------------------------------------- Total assets $ 146,665 $ 166,807 $ 131,870 ============================================================================
Intercompany sales between geographic areas are accounted for at prices representative of unaffiliated party transactions. "Other international operations" includes a subsidiary in Japan. NOTE 17 - SUBSEQUENT EVENT In August 1993, a securities class action lawsuit was filed against the Company. In November 1997, the lawsuit was settled for an insignificant amount, subject to final court approval. The settlement was fully provided for at September 30, 1997. 25 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders of The Santa Cruz Operation, Inc. We have audited the accompanying consolidated balance sheets of The Santa Cruz Operation, Inc. and subsidiaries as of September 30, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended September 30, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Santa Cruz Operation, Inc. and subsidiaries as of September 30, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1997, in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP San Jose, California October 22, 1997 26 THE SANTA CRUZ OPERATION, INC. QUARTERLY FINANCIAL INFORMATION
Three Months Ended --------------------------------------------------------------------------------------------- (In thousands, except Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, per share data) 1997 1997 1997 1996 1996 1996 1996 1995 - ----------------------------------------------------------------------------------------------------------------------------- Net revenues: Licenses $47,060 $ 26,728 $ 48,918 $ 51,846 $ 50,162 $ 49,404 $ 46,291 $ 43,175 Services 4,739 4,438 5,169 4,762 5,052 4,623 4,444 4,739 - ----------------------------------------------------------------------------------------------------------------------------- Net revenues 51,799 31,166 54,087 56,608 55,214 54,027 50,735 47,914 - ----------------------------------------------------------------------------------------------------------------------------- Cost of revenues: Licenses 9,205 8,371 10,385 9,311 9,912 10,266 8,530 7,925 Services 4,595 4,455 4,642 4,351 4,333 4,491 4,374 4,571 - ----------------------------------------------------------------------------------------------------------------------------- Total cost of revenues 13,800 12,826 15,027 13,662 14,245 14,757 12,904 12,496 - ----------------------------------------------------------------------------------------------------------------------------- Gross margin 37,999 18,340 39,060 42,946 40,969 39,270 37,831 35,418 - ----------------------------------------------------------------------------------------------------------------------------- Operating expenses: Research and development 10,825 11,055 12,284 11,966 11,071 10,617 9,376 7,945 Sales and marketing 17,868 20,197 20,695 20,776 20,386 19,575 19,676 19,722 General and administrative 4,776 5,523 5,365 5,236 5,141 5,201 5,284 4,712 Non-recurring charges -- 8,373 -- -- -- -- -- 38,363 - ----------------------------------------------------------------------------------------------------------------------------- Total operating expenses 33,469 45,148 38,344 37,978 36,598 35,393 34,336 70,742 - ----------------------------------------------------------------------------------------------------------------------------- Operating earnings (loss) 4,530 (26,808) 716 4,968 4,371 3,877 3,495 (35,324) Other income (expense): Interest income, net 630 396 628 637 646 547 480 629 Other income (expense), net 157 (661) (45) (317) (90) (16) (94) (194) - ----------------------------------------------------------------------------------------------------------------------------- Profit (loss) before income taxes 5,317 (27,073) 1,299 5,288 4,927 4,408 3,881 (34,889) - ----------------------------------------------------------------------------------------------------------------------------- Income taxes 798 (2,444) 325 1,322 855 1,102 970 (2,186) - ----------------------------------------------------------------------------------------------------------------------------- Net profit (loss) $ 4,519 ($24,629) $ 974 $ 3,966 $ 4,072 $ 3,306 $ 2,911 ($32,703) - ----------------------------------------------------------------------------------------------------------------------------- Net profit (loss) per share $ 0.12 ($ 0.67) $ 0.03 $ 0.11 $ 0.11 $ 0.09 $ 0.08 ($ 0.99) - ----------------------------------------------------------------------------------------------------------------------------- Weighted average shares outstanding 37,720 36,547 37,522 37,683 38,150 38,502 38,164 32,968 - -----------------------------------------------------------------------------------------------------------------------------
27 DIRECTORS AND OFFICERS
BOARD OF DIRECTORS CORPORATE OFFICERS DIVISIONAL OFFICERS NINIAN EADIE ALOK MOHAN*+ MICK ADAMSON President and Chief Executive Vice President and General JEAN-FRANCOIS HEITZ Officer Manager, The Americas Tarantella Business Unit RONALD LACHMAN ED ADAMS+ Senior Vice President and SHEILA BAKER ROBERT MCCLURE General Manager, Vice President, Strategic Business The Americas Development DOUG MICHELS ALOK MOHAN RAY ANDERSON+ EDMUNDO COSTA Senior Vice President, Vice President, The Americas, R. DUFF THOMPSON Marketing, Channel Sales Products Division ENZO TORRESI DAVE CUSS JIM CLARK+ Regional Vice President, (Nordic, GIL WILLIAMSON Senior Vice President and Benelux, Iberia, General Manager, Middle East, and Africa) Asia/Pacific Operations CHRIS FLYNN JOHN LUHTALA*+ Regional Vice President, (Germany, Senior Vice President, France, Operations, and UK and India) Chief Financial Officer SHAMIM FORMOSO HELENE MANN-BOUCHARD Vice President, The Americas, Vice President, Worldwide Partner Programs Customer Delivery Systems NIMER MAABADI DAVID MCCRABB+ Vice President, The Americas, Senior Vice President, Market Canada and Latin Planning America DOUG MICHELS LISA OZIMEK Executive Vice President and Vice President, Platform Chief Technology Officer Technology Group ANTONIO PRIVITERA JACK MOYER+ Regional Vice President, (Italy, Vice President, Human Greece, Resources Turkey, Eastern Europe, and Central Asia) STEVE SABBATH*+ RON RASMUSSEN Vice President, Law and Vice President, Volume Systems Corporate Af fairs, Group Secretary CHRIS SCHEYBELER GEOFF SEABROOK+ Vice President, Client Integration Senior Vice President and Development General Manager, EMEIA CHARLIE SCIORRA Vice President, U.S. Sales JAMES WILT Vice President, Business CRAIG SCOBIE Development Vice President, U.S. Project Area RICHARD TREADWAY Vice President, Segment Business Development
* Elected by Board of Directors + Executive Officer subject to the provisions of Section 16(b) of the Securities Exchange Act of 1934 EX-21.1 3 SUBSIDIARIES OF REGISTRANT 1 EXHIBIT 21.1 THE SANTA CRUZ OPERATION, INC. (A CALIFORNIA CORPORATION) SUBSIDIARIES
NAME OF SUBSIDIARY PLACE OF INCORPORATION The Santa Cruz Operation Pty. Limited New South Wales SCO Canada, Inc. Ontario The Santa Cruz Operation (France) SARL France The Santa Cruz Operation (Deutschland) GmbH Germany The Santa Cruz Operation (Italia) Srl Italy The Santa Cruz Operation Limited UK The Santa Cruz Operation de Mexico, S. DE R.L. DE C.V. Mexico The Santa Cruz Operation (Asia) Ltd. Delaware SCO Foreign Sales Corporation U.S. Virgin Islands SCO, Kabushiki Kaisha Japan The Santa Cruz Operation Latin America, Inc. Delaware Nihon SCO Limited Japan
EX-23.1 4 CONSENT OF INDEPENDENT AUDITORS 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders The Santa Cruz Operation, Inc.: We consent to incorporation by reference in the registration statement (No. 33-24913) on Form S-8 of The Santa Cruz Operation, Inc. of our reports dated October 22, 1997, relating to the consolidated balance sheets of The Santa Cruz Operation, Inc. and subsidiaries as of September 30, 1997 and 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended September 30, 1997, and the related schedule, which reports appear or are incorporated by reference in the September 30, 1997 annual report on Form 10-K of The Santa Cruz Operation, Inc. /s/ KPMG Peat Marwick LLP -------------------------------- San Jose, California December 18, 1997 EX-27.1 5 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS SEP-30-1997 OCT-01-1996 SEP-30-1997 23,225 28,486 47,425 (10,879) 1,510 101,822 54,107 (40,441) 146,665 55,658 0 0 0 119,287 (37,825) 146,665 174,552 193,660 37,272 55,315 154,939 0 1,425 (15,169) 1 (15,170) 0 0 0 (15,170) (0.41) (0.41)
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