10-Q/A 1 f66571e10-qa.txt AMENDMENT TO FORM 10-Q PERIOD ENDED JUNE 30, 2000 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM 10-Q/A [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000 [ ] 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 THIS CHARTER) CALIFORNIA 94-2549086 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 425 ENCINAL STREET, SANTA CRUZ, CALIFORNIA 95060 (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code (831) 425-7222 Indicate by check mark whether the registrant (1) has filed all reports 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 [ ] The number of shares outstanding of the registrant's common stock as of October __, 2000 was ____________. ================================================================================ 2 THE SANTA CRUZ OPERATION, INC. FORM 10-Q/A FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000 TABLE OF CONTENTS PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS PAGE A) CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED JUNE 30, 2000 AND 1999........1 B) CONSOLIDATED BALANCE SHEETS AS OF JUNE 30, 2000 AND SEPTEMBER 30, 1999........................2 C) CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED JUNE 30, 2000 AND 1999..................3 D) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS .........................4 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..................................................8 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............13 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K......................................14 SIGNATURES............................................................................15
3 Part I. Financial Information Item I. Financial Statements THE SANTA CRUZ OPERATION, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except earnings per share)
-------------------------------------------------------------------------------------------------------------------------- THREE MONTHS ENDED NINE MONTHS ENDED JUNE 30, JUNE 30, 2000 1999 2000 1999 (UNAUDITED) (UNAUDITED) -------------------------------------------------------------------------------------------------------------------------- NET REVENUES Licenses $ 23,493 $ 53,218 $ 104,743 $ 154,263 Services 3,438 3,842 11,383 11,241 -------------------------------------------------------------------------------------------------------------------------- Total net revenues 26,931 57,060 116,126 165,504 -------------------------------------------------------------------------------------------------------------------------- COST OF REVENUES Licenses 5,000 7,698 16,659 23,349 Services 4,680 4,976 15,110 14,149 -------------------------------------------------------------------------------------------------------------------------- Total cost of revenues 9,680 12,674 31,769 37,498 -------------------------------------------------------------------------------------------------------------------------- GROSS MARGIN 17,251 44,386 84,357 128,006 -------------------------------------------------------------------------------------------------------------------------- OPERATING EXPENSES: Research and development 9,532 10,772 31,742 31,630 Sales and marketing 20,969 24,657 69,991 71,982 General and administrative 5,348 4,473 13,856 12,957 Restructuring charges -- -- 5,887 -- -------------------------------------------------------------------------------------------------------------------------- Total operating expenses 35,849 39,902 121,476 116,569 -------------------------------------------------------------------------------------------------------------------------- OPERATING INCOME (LOSS) (18,598) 4,484 (37,119) 11,437 OTHER INCOME (EXPENSE): Interest income, net 408 458 1,600 1,532 Other income (expense), net (168) 598 1,577 1,034 -------------------------------------------------------------------------------------------------------------------------- Income (loss) before income taxes (18,358) 5,540 (33,942) 14,003 Income taxes 882 1,005 2,232 2,520 -------------------------------------------------------------------------------------------------------------------------- NET INCOME (LOSS) (19,240) 4,535 (36,174) 11,483 -------------------------------------------------------------------------------------------------------------------------- OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX Unrealized gain (loss) on available-for-sale equity securities (16,249) -- 5,416 -- Foreign currency translation adjustment (226) (26) (304) (879) -------------------------------------------------------------------------------------------------------------------------- COMPREHENSIVE INCOME (LOSS) $ (35,715) $ 4,509 $ (31,062) $ 10,604 -------------------------------------------------------------------------------------------------------------------------- EARNINGS (LOSS) PER SHARE: Basic $ (0.54) $ 0.13 $ (1.02) $ 0.33 Diluted $ (0.54) $ 0.13 $ (1.02) $ 0.32 -------------------------------------------------------------------------------------------------------------------------- SHARES USED IN EARNINGS (LOSS) PER SHARE CALCULATION: Basic 35,860 33,951 35,390 34,351 Diluted 35,860 36,082 35,390 35,521 ==========================================================================================================================
See accompanying notes to consolidated financial statements. 1 4
THE SANTA CRUZ OPERATION, INC. JUNE 30, SEPTEMBER 30, CONSOLIDATED BALANCE SHEETS 2000 1999 (In thousands) (UNAUDITED) -------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $ 12,078 $ 33,683 Short-term investments 19,267 29,161 Receivables, net 19,205 32,309 Available-for-sale equity securities 10,504 -- Deferred tax assets 3 1,202 Other current assets 5,042 6,310 -------------------------------------------------------------------------------------------------------- Total current assets 66,099 102,665 -------------------------------------------------------------------------------------------------------- Property and equipment, net 10,160 12,234 Purchased software and technology licenses, net 7,195 10,431 Long-term deferred tax assets 6,623 6,623 Other assets 7,349 7,331 -------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 97,426 $ 139,284 -------------------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Trade accounts payable $ 5,057 $ 7,482 Royalties payable 4,194 7,217 Income taxes payable 3,638 1,983 Deferred income taxes 2,388 -- Restructuring charge 4,042 -- Accrued expenses and other current liabilities 24,135 32,314 Deferred revenues 8,346 8,856 -------------------------------------------------------------------------------------------------------- Total current liabilities 51,800 57,852 -------------------------------------------------------------------------------------------------------- Long-term lease obligations 840 2,332 Long-term deferred revenues 1,465 2,571 Other long-term liabilities 4,755 6,191 -------------------------------------------------------------------------------------------------------- Total long-term liabilities 7,060 11,094 -------------------------------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY Common stock, no par value, net, authorized 100,000 shares Issued and outstanding 35,948 and 34,346 shares 105,491 106,201 Accumulated other comprehensive income 5,520 408 Accumulated deficit (72,445) (36,271) -------------------------------------------------------------------------------------------------------- Total shareholders' equity 38,566 70,338 -------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 97,426 $ 139,284 ========================================================================================================
See accompanying notes to consolidated financial statements. 2 5 THE SANTA CRUZ OPERATION, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
-------------------------------------------------------------------------------------------- NINE MONTHS ENDED JUNE 30, 2000 1999 (UNAUDITED) -------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $(36,174) $ 11,483 Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities - Depreciation and amortization 8,827 9,434 Exchange (gain) loss (115) (166) Changes in operating assets and liabilities - Receivables 12,632 (3,253) Other current assets 1,231 3,519 Other assets 1,370 1,224 Royalties payable (3,030) 1,397 Trade accounts payable (2,336) (113) Income taxes payable 1,780 1,187 Restructuring charge 4,042 -- Accrued expenses and other current liabilities (6,783) 2,932 Deferred revenues (1,526) (3,968) -------------------------------------------------------------------------------------------- Net cash provided by (used for) operating activities (20,082) 23,676 -------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (2,601) (4,773) Purchases of software and technology licenses (617) (2,266) Sales of short-term investments 20,570 20,576 Purchases of short-term investments (10,676) (22,029) Investments in other assets (3,554) (138) -------------------------------------------------------------------------------------------- Net cash provided by (used for) investing activities 3,122 (8,630) -------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments on capital leases (2,274) (2,678) Net proceeds from sale of common stock 11,978 1,690 Repurchases of common stock (12,786) (10,806) Other long-term liabilities (1,339) (1,184) -------------------------------------------------------------------------------------------- Net cash used for financing activities (4,421) (12,978) -------------------------------------------------------------------------------------------- Effects of exchange rate changes on cash and cash equivalents (224) (716) -------------------------------------------------------------------------------------------- Change in cash and cash equivalents (21,605) 1,352 Cash and cash equivalents at beginning of period 33,683 23,758 -------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 12,078 $ 25,110 -------------------------------------------------------------------------------------------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Non-cash financing and investing activities- Unrealized gain on available-for-sale equity securities $ 9,002 $ -- Assets recorded under capital leases 20 21 --------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements. 3 6 THE SANTA CRUZ OPERATION, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- 1. BASIS OF PRESENTATION In the opinion of management, the accompanying unaudited, consolidated statements of operations, balance sheets and statements of cash flows have been prepared in accordance with generally accepted accounting principles and include all material adjustments (consisting of only normal recurring adjustments) necessary for their fair presentation. The financial statements include the accounts of the Company and its wholly owned subsidiaries after all material intercompany balances and transactions have been eliminated. The Notes to Consolidated Financial Statements contained in the fiscal year 1999 report on Form 10-K should be read in conjunction with these Consolidated Financial Statements. The consolidated interim results presented are not necessarily indicative of results to be expected for a full year. Certain reclassifications have been made for consistent presentation. The September 30, 1999 balance sheet was derived from audited financial statements, and is included for comparative purposes. 2. RESTRUCTURING CHARGE During the second quarter of fiscal 2000, the Company announced and completed a restructuring plan, which resulted in a one-time charge of $5.9 million. The charge included a reduction in headcount of approximately 70 employees, write-offs of certain acquired technologies, write-offs of certain fixed assets, and elimination of non-essential facilities. Of the $5.9 million charge, $4.6 million related to cash expenditures and $1.3 million related to non-cash charges. Included in the non-cash charges were technology write offs of $667,000, resulting from the termination of product development which no longer had alternative future use. The Company has restructured its business operations into three independent divisions, each with a separate management team and dedicated development, marketing and sales organizations - the Server Software Division, the Tarantella Division and the Professional Services Division. The Company believes this reorganization creates independent focused teams that can pursue revenue in their respective markets and was effective April 1, 2000. The Company believes that as a result of creating these independent, focused organizations the Company will be better able to control and measure the success of these businesses. The restructuring charge related to cash expenditures included $3.6 million for severance costs and $1.0 million for facilities costs. The majority of the reduction in force was in product development for the Server Software Division. As of June 30, 2000, a total of 56 positions have been eliminated. The Company anticipates that the majority of the payments will be made by the end of fiscal 2000. The restructuring charge payable can be summarized as follows:
Reduction (In thousands) in Force Facilities Technology Other Total -------------------------------------------------------------------------------------------------- Restructuring charge accrued $ 3,574 $ 1,052 $ 667 $ 594 $ 5,887 Quarterly payments/adjustments (1,740) (36) -- (69) (1,845) -------------------------------------------------------------- Accrual at June 30, 2000 $ 1,834 $ 1,016 $ 667 $ 525 $ 4,042 ==============================================================
Included in the facilities charge are amounts relating to the abandonment of certain leased space at the Company's Watford UK facility. This space is being reconfigured in preparation for subletting. The restructuring provision includes the estimated costs associated with the reconfiguring and the rent associated with the empty space prior to sublet. The fixed assets for the employees in Watford, UK and US facilities, totaling $594,000 in net book value, will be disposed. 3. SEGMENT INFORMATION For the quarter ended June 30, 2000, the Company reviewed the performance of its three divisions - the Server Software Division, the Tarantella Division, and the Professional Services Division. Each segment markets the Company's software products and services to companies in a number of industries including 4 7 telecommunications, manufacturing and government bodies. These products and services are either sold directly by each segment's sales force or are sold to end users through distributors or OEMs. The following table presents information about reportable segments (in thousands):
Three Months Ended Nine Months Ended June 30, June 30, 2000 1999 2000 1999 ------------------------- ------------------------- (unaudited) Net Revenues: Server software division $ 24,757 $ 54,346 $ 107,129 $ 155,908 Tarantella division 2,528 2,223 8,519 7,795 Professional services division 842 912 3,018 2,222 Corporate adjustments (1,196) (421) (2,540) (421) --------- --------- --------- --------- Total net revenues $ 26,931 $ 57,060 $ 116,126 $ 165,504 ========= ========= ========= ========= Gross Margin: Server software division $ 16,715 $ 43,215 $ 80,598 $ 123,792 Tarantella division 1,854 1,734 6,412 5,982 Professional services division (591) (563) (1,926) (1,768) Corporate adjustments (727) -- (727) --------- --------- --------- --------- Total gross margin $ 17,251 $ 44,386 $ 84,357 $ 128,006 ========= ========= ========= ========= Operating Income (Loss): Server software division ($ 8,510) $ 7,626 ($ 15,909) $ 19,116 Tarantella division (8,538) (2,271) (11,895) (5,011) Professional services division (1,550) (871) (3,428) (2,668) Corporate adjustments -- -- (5,887) -- --------- --------- --------- --------- Total operating income (loss) $ (18,598) $ 4,484 $ (37,119) $ 11,437 ========= ========= ========= =========
The following table presents information about geographical segments (in thousands):
Three Months Ended Nine Months Ended June 30, June 30, 2000 1999 2000 1999 ------------------------- ------------------------- (unaudited) Net Revenues: United States $12,228 $24,869 $ 48,819 $ 71,434 Canada and Latin America 1,635 3,174 5,761 9,546 Europe, Middle East, India and Africa 10,797 23,719 50,897 69,402 Asia Pacific 2,009 4,970 7,428 14,661 Corporate adjustments 262 328 3,221 461 ------- ------- -------- -------- Total net revenues $26,931 $57,060 $116,126 $165,504 ======= ======= ======== ========
The following table presents information about long-lived assets by geography (in thousands):
June 30, 2000 September 30, 1999 Long-lived Assets United States $26,757 $31,058 Canada and Latin America 181 122 Europe, Middle East, India And Africa 4,126 5,234 Asia Pacific 263 155 Other international operations -- 50 ------- ------- Total long-lived assets $31,327 $36,619 ======= =======
Revenue is allocated to geographical segments based on the location from which the sale is satisfied and long-lived asset information is based on the physical location of the asset. 4. INVESTMENTS On November 17, 1999, Rainmaker completed an initial public offering of its common stock. On such date, the shares of Series D preferred stock held by the Company automatically converted into shares of Rainmaker's common stock on a one-for-one basis. In connection with Rainmaker's initial public offering, the Company has agreed not to sell or otherwise dispose of any of these shares for a period extending 180 days from the date of the prospectus covering the initial common stock subject to compliance with securities laws, including volume limitations. At June 30, 2000, the Company held 3,705,767 shares of Rainmaker's common stock. The Company considers there to be available for sale securities and accordingly records the shares at fair market value, based on quoted market prices with any unrealized gains and losses included in accumulated other comprehensive income. Unrealized gains on the Rainmaker investments are as follows (in thousands): Fair market value $9,959 Cost 1,251 ------ Gross unrealized gain $8,708 ======
The Company has established a partial valuation allowance against its gross deferred tax assets and has recorded a deferred tax liability to the extent of estimated tax on the unrealized gain on its investment in Rainmaker. The valuation allowance has been reversed to the extent of the deferred tax liability with this reduction being recorded in accumulated other comprehensive income as it does not come from ongoing operations. 5. COMPREHENSIVE INCOME The components of other comprehensive income are as follows (in thousands):
Three Months Ended Nine Months Ended June 30, June 30, 2000 1999 2000 1999 ----------------------- ----------------------- (unaudited) Net income (loss) $(19,240) $ 4,535 $(36,174) $ 11,483 Other comprehensive income (loss): Foreign currency translation adjustment (226) (26) (304) (879) Unrealized gain (loss) on equity security (20,122) -- 9,002 -- Gross tax benefit (provision) on 9,212 -- (2,388) -- unrealized loss/gain Reversal (provision) of deferred tax valuation allowance (note 4) (5,339) -- (1,198) -- -------- -------- -------- -------- Total comprehensive income (loss) $(35,715) $ 4,509 $(31,062) $ 10,604 ======== ======== ======== ========
6. EARNINGS (LOSS) PER SHARE (EPS) DISCLOSURES The Company calculates earnings (loss) per share in accordance with the provisions of Statement of Financial Accounting Standards No. 128 (SFAS 128), Earnings Per Share. SFAS 128 requires the presentation of basic and diluted earnings per share. Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS is computed giving effect to all dilutive potential common shares that were outstanding during the period. Dilutive potential common shares consist of the incremental common shares issuable upon the 5 8 exercise of stock options for all periods. Basic and diluted earnings per share were calculated as follows during the three month and nine month periods ended June 30, 2000 and 1999:
(In thousands, except per share data) Three Months Ended Nine Months Ended June 30, June 30, 2000 1999 2000 1999 ----------------------- ------------------------ (unaudited) Basic: Weighted average shares 35,860 33,951 35,390 34,351 ======== ======== ======== ======== Net income (loss) $(19,240) $ 4,535 $(36,174) $ 11,483 ======== ======== ======== ======== Earnings (loss) per share $ (0.54) $ 0.13 $ (1.02) $ 0.33 ======== ======== ======== ======== Diluted: Weighted average shares 35,860 33,951 35,390 34,351 Common equivalent shares from stock options and warrants 0 2,131 0 1,170 -------- -------- -------- -------- Shares used in per share calculation 35,860 36,082 35,390 35,521 ======== ======== ======== ======== Net income (loss) $(19,240) $ 4,534 $(36,174) $ 11,483 ======== ======== ======== ======== Earnings (loss) per share $ (0.54) $ 0.13 $ (1.02) $ 0.32 ======== ======== ======== ======== Options outstanding at 6/30/00 and at 6/30/99 not included in computation of diluted EPS because the exercise price was greater than the average market price 3,103 1,608 1,644 2,381 Options outstanding at 6/30/00 and at 6/30/99 not included in computation of diluted EPS because their inclusion would have an anti-dilutive effect 7,537 -- 8,996 --
7. RECENT ACCOUNTING PRONOUNCEMENTS In June 2000, the Financial Accounting Standards Board issued Financial Accounting Standard No. 138 (FAS 138), Accounting for Certain Derivative Instruments - an amendment of FAS 133, Accounting for Derivative instruments and Hedging Activities. FAS 138 shall be effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. The Company does not expect this to have a material impact on our financial position and results of operations. In March 2000, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation - an interpretation of APB Opinion No. 25. FIN 44 clarifies the application of Opinion 25 for (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a plan qualifies as a noncompensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 is effective July 1, 2000, but certain conclusions cover specific events that occur after either December 15, 1998, or January 12, 2000. The adoption of the conclusions covering the specific events after either December 15, 1998 or January 12, 2000 did not have a material effect on the financial position or results of operations of the Company. Management believes that the impact of the remaining provisions of FIN 44 will not have a material effect on the financial position or results of operations of the Company. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial Statements, which provides guidance on the recognition, presentation and disclosure of revenue in financials filed with the SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosures related to revenue recognition policies. The Company must adopt SAB 101 in the first quarter of fiscal 2001. Management is in the process of evaluating SAB 101 and the recently issued frequently asked questions and answers but believes that the implementation of SAB 101 will not have a material effect on the financial position or results of operations of the Company. In December 1998, the Accounting Standards Executive Committee issued Statement of Position 98-9 (SOP 98-9), Modification of SOP 97-2 Software Revenue Recognition. SOP 98-9 amends SOP 97-2 to require that an entity recognize revenue for multiple element arrangements by means of the "residual method" when (1) there is vendor-specific objective evidence ("VSOE") of the fair values of all the undelivered elements that are not accounted for by means of long-term contract accounting, (2) VSOE of fair value does not exist for one or more of the delivered elements, and (3) all revenue recognition criteria of SOP 97-2 (other than the requirement for VSOE of the fair value of each delivered element) are satisfied. The provisions of SOP 98-9 that extend the deferral of certain paragraphs of SOP 97-2 became effective December 15, 1998. These paragraphs of SOP 97-2 and SOP 98-9 were effective for transactions entered into for fiscal years beginning after March 15, 1999. Retroactive application is prohibited. The adoption of SOP 98-9 did not have a significant impact on the Company's financial statements. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities, which establishes accounting and reporting standards for derivative instruments and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. In June 1999, the FASB issued Statement of Financial Accounting Standards No. 137 (No. 137), Accounting for Derivative Instruments - Deferral of the Effective Date of SFAS Statement No. 133. SFAS 137 defers the effective date of SFAS 133 until June 15, 2000. Management does not believe this will have a material effect on the Company's financial statements. The Company will adopt SFAS 133 as required for its first quarterly filing of fiscal year 2001. 6 9 8. SUBSEQUENT EVENT On August 1, 2000, the Company entered into an agreement with Caldera Systems, Inc. in which Caldera Systems, Inc. will acquire the Company's Server Software and Professional Services Divisions. Caldera Systems, Inc. will form a new holding company, Caldera, Inc., to acquire assets from the Company's Server Software Division and the Company's Professional Services Division, including its employees, products and channel resources. Caldera, Inc. will have exclusive distribution rights for the SCO OpenServer product line. SCO will receive a 28% ownership interest in Caldera, Inc., which is estimated to be an aggregate of approximately 17.54 million shares of Caldera stock (including approximately 2 million shares reserved for employee options assumed by Caldera, Inc. for options currently held by SCO employees joining Caldera, Inc.), and $7.0 million in cash. In conjunction with the acquisition, The Canopy Group, Inc., a major stockholder of Caldera Systems, Inc., has agreed to loan $18.0 million to the Company. The terms of this loan are still to be negotiated but both parties have agreed the terms will be reasonable and customary. Further, Caldera Systems, Inc. has agreed to loan $7.0 million to the Company in the form of a short-term note repayable at the consummation of the transaction between SCO and Caldera Systems, Inc. SCO will retain its Tarantella Division and the SCO OpenServer revenue stream and intellectual properties. The boards of directors of both companies have unanimously approved the acquisition which is subject to the approval of Caldera Systems, Inc. and The Santa Cruz Operation, Inc. stockholders, and regulatory agencies, as well as meeting certain other closing conditions. The companies anticipate closing the transaction during October 2000. During the fourth quarter of fiscal 2000, the Company announced a restructuring plan, which resulted in a one-time charge of approximately $7 million. The restructuring includes plans to eliminate various regional offices in the United States, United Kingdom, Latin America and Asia Pacific. The charge includes a reduction in total headcount of approximately 157 employees write offs to certain fixed assets and the elimination of nonessential facilities. The restructuring charges will affect the Server division of the Company. The Company plans to eliminate various regional offices in the United States, United Kingdom, Latin America and Asia Pacific. The US regional facilities and the Watford, UK leases have been or will be vacated and restored, and subsequently sub-let or terminated by the second quarter of 2001. The remaining international offices also plan to be vacated immediately. The sublease income is expected to cover the full amount of the lease. The restructuring charge includes $4.6 million for the costs associated with the reduction in force, $1.8 million related to the costs of planned facility elimination and changes, and $0.6 million related to costs associated with the disposal of fixed assets. 7 10 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS In addition to historical information contained herein, this Discussion and Analysis contains forward-looking statements. These statements involve risks and uncertainties and can be identified by the use of forward-looking terminology such as "estimates," "projects," "anticipates," "plans," "future," "may," "will," "should," "predicts," "potential," "continue," "expects," "intends," "believes," and similar expressions. Examples of forward-looking statements include those relating to financial risk management activities and the adequacy of financial resources for operations. These and other forward-looking statements are only estimates and predictions. While the Company believes that the expectations reflected in the forward-looking statements are reasonable, 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 expectations 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 for the three months ended June 30, 2000 decreased 53% to $26.9 million from $57.0 million in the same period in fiscal 1999. For the nine months ended June 30, 2000, net revenues decreased 30% to $116.1 million from $165.5 million for the nine months ended June 30, 1999. The decline in revenue performance was worldwide across most geographies and is attributable to delays in large project deals as well as continued customer delays due to Year 2000 issues and other market factors. The recovery of the customer channel from the impact of Year 2000 has been slower than expected. No one customer accounted for more than 10% of net revenues in the third quarter ended June 30, 2000 or in the same period in the prior year. License revenue for the three months ended June 30, 2000 was $23.5 million compared to $53.2 million in the same quarter of fiscal 1999. For the nine months ended June 30, 2000, license revenue was $104.7 million compared to $154.3 million for the same period in 1999. This decline is attributed to the lack of channel recovery from the impact of Y2K as well as delays in large project deals. Service revenues decreased to $3.4 million for the three months ended June 30, 2000, from $3.8 million in the same period in 1999, a decline of 11%. The decline of $0.4 million was primarily due to professional services in Italy where a consulting contract that was in place in the third quarter of fiscal 1999 did not reoccur in fiscal 2000. For the nine months ended June 30, 2000, service revenue totaled $11.4 million compared to $11.2 million in the same period of fiscal 1999, a 1% increase. Service revenue was 13% of the total revenue for the third quarter, compared to 7% in the prior fiscal year. This increase is due to the decline in total revenue. International revenues continue to represent a significant portion of total net revenues comprising 54% of the revenues for the third fiscal quarter of 2000 and 56% for the same quarter in fiscal 1999. COSTS AND EXPENSES Cost of license revenues for the three months ended June 30, 2000 decreased by 35% to $5.0 million compared to $7.7 million in the same period of fiscal 1999. For the nine months ended June 30, 2000, cost of license revenues decreased 29% to $16.7 million from $23.3 million for the nine months ended June 30, 1999. The declining cost of revenues is primarily due to lower sales. Additionally, material costs continue to decline as a result of the increasing number of internet orders. This was partially offset due to an increase in royalty expense due to a higher-royalty bearing product mix for the third quarter. Cost of service revenues for the three months ended June 30 decreased by 6% to $4.7 million compared to $5.0 million in the same period of fiscal 1999. This decline is primarily a result of reduced staffing levels in the support organization due to a realignment of this organization. For the nine months ended June 30, 2000, cost of service revenues increased 7% to $15.1 million from $14.1 million for the same nine months period in fiscal 1999. The year over year increase is primarily due to higher labor costs in both support and professional services due to focal increases and the staffing mix, and increased travel in the professional services area. Total cost of revenues as a percentage of net revenues increased to 36% in the third quarter of fiscal 2000 from 22% in the same period of 1999. For the nine months periods ended June 30, 2000 and 1999, cost of revenues represented 27% and 23% of net revenues, respectively. The percentage increases are due to the decline in total revenue. A significant portion of cost of goods sold is fixed and the decrease in revenue seriously impacted gross margin. These fixed costs include technology and overhead costs. Additionally, there was an increase in the royalty expense due to a higher-royalty bearing product mix. Research and development expenses decreased 12% to $9.5 million in the third quarter of fiscal 2000 from $10.8 million in the comparable quarter of fiscal 1999, or 35% and 19% of net revenues, respectively. The decrease in spending was primarily due to lower labor costs driven by lower headcount as a result of a planned reduction in force. For the nine months ended June 30, 2000, research and development expenses increased to $31.7 million compared to $31.6 million for the same period in 1999. This represented 27% of net revenues in fiscal 2000 and 8 11 19% in fiscal 1999. The increase in spending for the nine month period relates primarily to one-time technology charges. Sales and marketing expenses decreased 15% to $21.0 million in the third quarter of fiscal 2000 from $24.7 million for the comparable quarter of the prior year. Sales and marketing expenses represented 78% of net revenues in the third quarter of fiscal 2000 and 43% in 1999. For the nine months ended June 30, 2000, sales and marketing expenses decreased to $70.0 million (60% of net revenues) from $72.0 million (43% of net revenues) for the same period of the prior fiscal year. The decline is due to reductions in sales program costs that vary directly with revenue, including commissions and cooperative advertising. General and administrative expenses increased to $5.3 million for the third quarter of fiscal 2000 from $4.5 million for the comparable quarter of fiscal 1999, representing 20% and 8% of net revenues, respectively. For the nine months ended June 30, 2000, general and administrative expenses increased to $13.9 million, or 12% of net revenues, compared to $13.0 million, or 8% of net revenues, for the same period in 1999. The increase in general and administrative expenses is primarily driven by the transfer of certain staff from other functions due to the creation of the Company's divisions. Non-recurring charges of $5.9 million were incurred in the second quarter of fiscal 2000 related to a worldwide restructuring, representing 5% of net revenues for the nine month period ending June 30, 2000. The charge included a reduction in headcount of approximately 70 employees, write-offs of certain acquired technologies, write-offs of certain fixed assets, and elimination of non-essential facilities. Of the $5.9 million charge, $4.6 million related to cash expenditures and $1.3 million related to non-cash charges. Included in the non-cash charges were technology write offs of $667,000, resulting from the termination of product development which no longer had alternative future use. The Company has restructured its business operations into three independent divisions, each with a separate management team and dedicated development, marketing and sales organizations - the Server Software Division, the Tarantella Division and the Professional Services Division. The Company believes this reorganization creates independent focused teams that can pursue revenue in their respective markets and was effective April 1, 2000. The Company believes that as a result of creating these independent, focused organizations the Company will be better able to control and measure the success of these businesses. The restructuring charge related to cash expenditures included $3.6 million for severance costs and $1.0 million for facilities costs. The majority of the reduction in force was in product development for the Server Software Division. As of June 30, 2000, a total of 56 positions have been eliminated. The Company anticipates that the majority of the payments will be made by the end of fiscal 2000. Included in the facilities charge are amounts relating to the abandonment of certain leased space at the Company's Watford UK facility. This space is being reconfigured in preparation for subletting. The restructuring provision includes the estimated costs associated with the reconfiguring and the rent associated with the empty space prior to sublet. The fixed assets for the employees in Watford, UK and US facilities, totaling $594,000 in net book value, will be disposed. Other income consists of net interest income, foreign exchange gain and loss, and realized gain and loss on investments, as well as other miscellaneous income and expense items. For the third quarter of fiscal 2000, net interest income was $0.4 million, compared to $0.5 million for the same quarter of fiscal 1999. For the nine months ended June 30, 2000, net interest income was $1.6 million as compared to $1.5 million for the same period in 1999. Other expense was $0.2 million in the third quarter of fiscal 2000, compared to income of $0.6 million for the same period of fiscal 1999. For the nine months ended June 30, 2000, other income was $1.6 million as compared to $1.0 million for the same period in 1999. The year to date growth in other income was due to the gain on the sale of an equity security investment. The provision for income taxes was $0.9 million for the third quarter of fiscal 2000 compared to $1.0 million for the same period of the prior fiscal year, and $2.2 million for the nine months ended June 30, 2000, compared to $2.5 million for the corresponding fiscal 1999 period. The tax provisions for the third quarter and nine month periods of the current fiscal year reflect foreign taxes payable. The tax provisions for the third quarter and nine month periods of fiscal 1999 reflects foreign taxes payable and the realization of certain U.S. deferred tax assets for which a valuation allowance was previously established. Net loss for the third quarter of fiscal 2000 was $19.2 million compared to net income of $4.5 million for the same quarter in fiscal 1999. For the nine months ended June 30, 2000, net loss was $36.2 million compared to net income of $11.5 million in the same period in 1999. SEGMENT INFORMATION. The Company began reviewing its performance on the basis of its three divisions during the third quarter of fiscal 2000. Prior year financial information has been restated for divisional comparison purposes and is disclosed in Note 3. SERVER SOFTWARE DIVISION. Net revenues for the server division for the three months ended June 30, 2000 decreased 54% to $25.8 million from $54.3 million in the same period in fiscal 1999. For the nine months ended June 30, 2000, net revenues decreased 31% to $107.1 million from $155.9 million for the nine months ended June 30, 1999. The decline in revenue performance was worldwide across most geographies and is due to continued customer delays due to Year 2000 issues as well as other market factors. Gross margin for the server division declined 61% to $16.7 million for the third quarter of fiscal 2000 compared to $43.2 million for the same period of fiscal 1999. Gross margin for the nine month period declined 35% to $80.6 million as compared to $123.8 million for fiscal 1999. The decline in gross margin is mainly attributable to lower sales. The server division's operating loss for the three months ended June 30, 2000 was $8.5 million, a decline of $16.1 million from the operating income of $7.6 million in the same period of fiscal 1999. For the nine months ended June 30, 2000, the server division's operating loss was $15.9 million, compared to operating income of $19.1 million for the nine months ended June 30, 1999. The decline is due to the reduced revenue levels in fiscal 2000. TARANTELLA DIVISION. Net revenues for the Tarantella division for the three months ended June 30, 2000 increased 14% to $2.5 million from $2.2 million in the three months ended June 30, 1999. For the nine months ended June 30, 2000, net revenues increased 9% to $8.5 million from $7.8 million in the same period of fiscal 1999. The revenue growth includes several new enterprise accounts. Additionally, the division began shipments of both Tarantella Express for Linux and Tarantella Enterprise II ASP Edition products during the quarter. Gross margin for the Tarantella division was $1.9 million for the three months ended June 30, 2000 compared with gross margin of $1.7 million for the same period in fiscal 1999, a decrease of 7%. Gross margin for the nine months ended June 30, 2000 was $6.4 million compared to $6.0 million for the same nine month period in fiscal 1999. This was a decline of 2%. As the Company continues to develop new products in the Tarantella family, there will continue to be some variations in the gross margin percentages. The operating loss reported by the Tarantella division for the three months ended June 30, 2000 was $8.5 million as compared to a loss of $2.3 million in fiscal 1999. The operating loss for the nine month period ended June 30, 2000 was $11.9 million compared to a loss of $5.0 million for the same period of fiscal 1999. The Company is developing a dedicated, focused team for the Tarantella division and has increased the resources used by the division. PROFESSIONAL SERVICES DIVISION. Net revenues for the professional services division for the three month period ended June 30, 2000 remained relatively flat at $0.8 million compared to $0.9 million for the same period in fiscal 1999. Net revenues for the nine months ending June 30, 2000 were $3.0 million, an increase of 36% when compared to fiscal year 1999 revenues of $2.2 million. The revenue growth can be attributed to the results of a dedicated professional services organization. Gross margin for the professional services division remained stable with a loss of $0.6 million for both the three month periods ended June 30, 2000 and 1999. The gross margin for the nine month period was a loss of $1.9 million in fiscal 2000 compared to a loss of $1.8 million in fiscal 1999. The operating loss for the professional services division for the three months ended June 30, 2000 was $1.6 million, an increase of 78% compared to the operating loss of $0.9 million in fiscal 1999. For the nine month period ending June 30, 2000, the professional services division reported a loss of $3.4 million as compared to a loss of $2.7 million for the same period of fiscal 1999. The higher loss is due primarily to an increase in the staffing levels of the division. This increase is to support the division's independent focus. 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 9 12 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'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 and cash balances could be adversely affected, and such effect could be substantial and could result in an operating loss and depletion of the Company's cash balances. In such event, it may not be possible for the Company to secure sources of cash to maintain operations. The Company experiences seasonality of revenues for both the European market and the U.S. federal government market. 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 allowed for stock balancing and are accompanied by compensating and offsetting orders. Revenues are 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. The Company depends on information received from external sources in evaluating the inventory levels at distribution partners in the determination of reserves for the return of materials not sold, stock rotation and price protection. Significant effort has gone into developing systems and procedures for determining the appropriate reserve level. Substantial portions of the Company's revenues are derived from sales to customers outside the United States. Trade sales to international customers represented 54% and 56% of total revenues for the third quarter of fiscal 2000 and 1999, respectively. A substantial portion of the international revenues of the Company's U.K. subsidiary are denominated in the U.S. dollar, and operating results can vary with changes in the U.S. dollar exchange rate to the U.K. pound sterling. 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'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 book value of the Company's purchased software and technology 10 13 licenses may be reduced materially in the near future and, therefore, could create an adverse impact on the Company's future reported earnings. On August 1, 2000, the Company entered into an agreement with Caldera Systems, Inc. ("Caldera") in which Caldera will acquire the Company's Server Software Division and its Professional Services Division. This transaction involves a number of risks, including but not limited to i) the potential disruption of the Company's business that might result from employee or customer uncertainty, and lack of focus following announcement of the transaction in connection with integrating the operations of Caldera and the Company; ii) the risk that the announcement of the transaction could result in decisions by customers to defer purchases of products; iii) the substantial charges to be incurred due to the transaction; iv) the difficulties of managing geographically dispersed operations; and v) the possibility that the transactions contemplated in the agreement with Caldera might not be consummated. Further, once the aforesaid transaction is consummated, the ongoing operations will be significantly altered. The Company's revenues will be derived from only two product lines - Tarantella products, which have only been recently introduced by the Company, and OpenServer products, which are mature products to be distributed on the Company's behalf by Caldera. While the Company believes that its staffing plan following the consummation of the transaction is reasonable, it is possible that the Company may find itself to be overstaffed or, on the other hand, unable to retain sufficient staff to sustain efficient operations. Following the close of the transaction, the company will hold in its treasury a significant investment in Caldera, the value of which may be subject to significant fluctuations. 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 is exposed to equity price risk regarding the marketable portion of equity securities in its portfolio of investments entered into for the promotion of business and strategic objectives. This risk will increase significantly after the consummation of the transaction with Caldera. The Company is exposed to fluctuations in the market values of our portfolio investments. The Company maintains investment portfolio holdings of various issuers, types and maturities. These securities are generally classified as available for sale and consequently, are recorded on the balance sheet at fair value with unrealized gains or losses reported as a separate component of accumulated other comprehensive income, net of tax. Part of this portfolio includes minority equity investments in several publicly traded companies, the values of which are subject to market price volatility. The Company has also invested in several privately held companies, many of which can still be considered in the startup or development stages. These investments are inherently risky as the market for the technologies or products they have under development are typically in the early stages and may never materialize. The Company could lose its entire initial investment in these companies. The Company typically does not attempt to reduce or eliminate its market exposure pertaining to these equity securities. As the Company determines whether its tax carryforwards will more likely than not be utilized in the future, or as new tax legislation is enacted, the Company's effective tax rate is subject to change. In the event that the Company does not show sufficient profitability in the future, the Company may be required to write off portions of the net deferred tax assets previously recognized in income up to the entire amount of $7.8 million. 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 11 14 stocks of high technology companies, could cause the price of the Company's stock to fluctuate substantially over short periods. The Company is aware of the issues associated with the new European economic and monetary union (the "EMU"). One of the changes resulting from this union required EMU member states to irrevocably fix their respective currencies to a new currency, the Euro, on January 1, 1999. On that day, the Euro became a functional legal currency within these countries. During the next two years, business in the EMU member states will be conducted in both the 25 existing national currencies, such as the Franc or Deutsche Mark, and the Euro. As a result, companies operating in or conducting business in EMU member states will need to ensure that their financial and other software systems are capable of processing transactions and properly handling these currencies, including the Euro. The Company has done a preliminary assessment of the impact the EMU formation will have on both its internal systems and the products it sells and has commenced appropriate actions. The Company has not yet determined all of the cost related to addressing this issue, and there can be no assurance that this issue and its related costs will not have a materially adverse affect on the Company's business, operating results and financial condition. LIQUIDITY AND CAPITAL RESOURCES Cash, cash equivalents and short-term investments were $31.3 million at June 30, 2000, representing 32% of total assets. The six month decrease in cash and short-term investments of $31.5 million was primarily attributable to the decrease in revenue and a decrease in sales linearity, resulting in lower cash collections. The Company's operating activities used cash of $20.1 million for the first nine months of fiscal 2000, compared to $23.7 million provided by operating activities for fiscal 1999. Cash provided by investing activities during the nine month period was $3.1 million in fiscal 2000 compared to $8.6 million used for investing activities in fiscal 1999. In both fiscal 2000 and 1999 cash was used for purchases of property and equipment, common stock repurchases and short-term investments. The sales of short-term investments contributed to the cash provided by investing activities for fiscal 2000. Cash used for financing activities was $4.4 million for the first nine months of fiscal 2000 compared with $13.0 million for the same period in fiscal 1999. In both fiscal 2000 and 1999, proceeds from the issuance of common stock were more than offset by the Company's stock repurchases and payments on capital lease obligations. The Company's financial position may be improved by one or any combination of the following: an increase in revenues, a decrease in expenses or by raising additional working capital from external sources. The Company believes that the sale of the Server and Professional Services Divisions to Caldera will substantially reduce expenses, but not in the short-term as the Company will be required to maintain staffing until the consummation of the transaction. At June 30, 2000, the Company had available lines of credit of approximately $15.9 million. The Company maintains a $0.9 million line of credit internationally under which the Company had $0.8 million in outstanding borrowings. The domestic line of credit of $15.0 million required that the Company maintain certain financial ratios with which the Company was not in compliance as of June 30, 2000, and received a waiver for the specific violation. The Company does not have any outstanding borrowings against this line of credit. The Company believes that its existing cash and short-term investments, funds generated from operations and available borrowing capabilities will be sufficient to meet its operating requirements through at least the end of the fiscal year. Further, the Company is engaged in transactions with Caldera and the Canopy Group, Inc. regarding loans of up to $25.0 million, as well as potential equity financing provided by other parties. The Company's third quarter ended June 30, 2000 Days Sales Outstanding (DSO) was 64.2 days, a decrease of 0.8 days from the second quarter of fiscal 2000, and an increase of 14.2 days when compared to September 30, 1999 DSO. The Company is engaged in a systematic repurchase of the Company's Common Stock for the funding of its employee stock programs. Additionally, the Company is authorized to buy back up to 6,000,000 additional shares under a non-systematic repurchase program. As of June 30, 2000, 3,104,050 shares had been repurchased and retired under this non-systematic program. As of June 30, 2000, the Company had an equity investment in Rainmaker Systems, Inc. having a fair market value of $8.7 million and a cost basis of $1.3 million. The fair market value of this investment could fluctuate substantially due to changing stock prices. This investment is available-for-sale, and the Company may choose to sell a portion of this investment position in the future. 12 15 RECENT ACCOUNTING PRONOUNCEMENTS In June 2000, the Financial Accounting Standards Board issued Financial Account Standard No. 138 (FAS 138), Accounting for Certain Derivative Instruments - an amendment of FAS 133, Accounting for Derivative Instruments and Hedging Activities. FAS 138 shall be effective for all fiscal quarters of all fiscal years beginning after June 15, 2000. The Company does not expect this to have a material impact on our financial position and results of operations. In March 2000, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation - an interpretation of APB Opinion No. 25. FIN 44 clarifies the application of Opinion 25 for (a) the definition of employee for purposes of applying Opinion 25, (b) the criteria for determining whether a plan qualifies as noncompensatory plan, (c) the accounting consequence of various modifications to the terms of a previously fixed stock option or award, and (d) the accounting for an exchange of stock compensation awards in a business combination. FIN 44 is effective July 1, 2000, but certain conclusions cover specific events that occur after either December 15, 1998 or January 12, 2000. The adoption of the conclusions covering the specific events after either December 15, 1998 or January 12, 2000 did not have a material effect on the financial position or results of operations of the Company. Management believes that the impact of the remaining provisions of FIN 44 will not have a material effect on the financial position or results of operations of the Company. In December 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 (SAB 101), Revenue Recognition in Financial Statements, which provides guidance on the recognition, presentation and disclosure of revenue in financials filed with the SEC. SAB 101 outlines the basic criteria that must be met to recognize revenue and provides guidance for disclosures related to revenue recognition policies. The Company must adopt SAB 101 in the first quarter of fiscal 2001. Management is in the process of evaluating SAB 101 and the recently issued frequently asked questions and answers but believes that the implementation of SAB 101 will not have a material effect on the financial position or results of operations of the Company. In December 1998, the Accounting Standards Executive Committee issued Statement of Position 98-9 (SOP 98-9), Modification of SOP 97-2 Software Revenue Recognition. SOP 98-9 amends SOP 97-2 to require that an entity recognize revenue for multiple element arrangements by means of the "residual method" when (1) there is vendor-specific objective evidence ("VSOE") of the fair values of all the undelivered elements that are not accounted for by means of long-term contract accounting, (2) VSOE of fair value does not exist for one or more of the delivered elements, and (3) all revenue recognition criteria of SOP 97-2 (other than the requirement for VSOE of the fair value of each delivered element) are satisfied. The provisions of SOP 98-9 that extend the deferral of certain paragraphs of SOP 97-2 became effective December 15, 1998. These paragraphs of SOP 97-2 and SOP 98-9 were effective for transactions entered into for fiscal years beginning after March 15, 1999. Retroactive application is prohibited. The adoption of SOP 98-9 did not have a significant impact on the Company's financial statements. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative Instruments and Hedging Activities, which establishes accounting and reporting standards for derivative instruments and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. In June 1999, the FASB issued Statement of Financial Accounting Standards No. 137 (No. 137), Accounting for Derivative Instruments - Deferral of the Effective Date of SFAS Statement No. 133. SFAS 137 defers the effective date of SFAS 133 until June 15, 2000. Management does not believe this will have a material effect on the Company's financial statements. The Company will adopt SFAS 133 as required for its first quarterly filing of fiscal year 2001. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information called for by this item is provided under the paragraph beginning with the sentence "The Company is exposed to equity price risk regarding the marketable portion of equity securities in its portfolio of investments entered into for the promotion of business and strategic objectives," under the caption "Factors That May Affect Future Results" under Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations. 13 16 PART II. OTHER INFORMATION ITEM 6. EXHIBITS (a) Exhibits 27 Financial Data Schedule. (b) Report on Form 8-K On August 11, 2000, the Company filed a Current Report on Form 8-K to report that the Company and Caldera Systems, Inc. (Caldera) entered into an Agreement and Plan of Reorganization dated August 1, 2000, in which Caldera will acquire the Company's Server Software and Professional Services Divisions. ITEMS 1, 2, 4 AND 5 ARE NOT APPLICABLE AND HAVE BEEN OMITTED. 14 17 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The Santa Cruz Operation, Inc. Date: November 6, 2000 By: /s/ Randall Bresee ------------------------------------------- Randall Bresee Senior Vice President, Chief Financial Officer By: /s/ Jenny Twaddle ------------------------------------------- Jenny Twaddle Vice President, Corporate Controller 15 18 EXHIBIT INDEX
Exhibits Description -------- ----------- 27 Financial Data Schedule.