-----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, MLQzQ4NeorDuQcfMQpf1+Y9xMaV5YnQCpC/p4GYAsxmMMUnHQrzTbgDQKxcRhXhc +1SMBpRBp9IsBnqM1Hi/pw== /in/edgar/work/0001095811-00-004420/0001095811-00-004420.txt : 20001109 0001095811-00-004420.hdr.sgml : 20001109 ACCESSION NUMBER: 0001095811-00-004420 CONFORMED SUBMISSION TYPE: 10-K405/A PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 20001108 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SANTA CRUZ OPERATION INC CENTRAL INDEX KEY: 0000851560 STANDARD INDUSTRIAL CLASSIFICATION: [7372 ] IRS NUMBER: 942549086 STATE OF INCORPORATION: CA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K405/A SEC ACT: SEC FILE NUMBER: 000-21484 FILM NUMBER: 755393 BUSINESS ADDRESS: STREET 1: 425 ENCINAL STREET STREET 2: PO BOX 1900 CITY: SANTA CRUZ STATE: CA ZIP: 95060 BUSINESS PHONE: 4084277172 10-K405/A 1 f66568e10-k405a.txt AMENDMENT TO FORM 10-K405 YEAR ENDED SEPT.30,1999 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------------- FORM 10-K-A [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1999 [ ] 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 (I.R.S. Employer of incorporation Identification No.) or organization) 400 ENCINAL STREET, SANTA CRUZ, CALIFORNIA 95060 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (831) 425-7222 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: PREFERRED SHARE PURCHASE RIGHTS COMMON STOCK, NO PAR VALUE 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 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 [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 __________ as reported on the Nasdaq National Market was approximately $_________. 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 October 25, 2000, registrant had 36,166,763 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the 1999 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 22, 2000 delivered to shareholders in connection with the Annual Meeting of Shareholders to be held February 22, 2000 are incorporated by reference into Part III. ================================================================================ 2 THE SANTA CRUZ OPERATION, INC. FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1999 TABLE OF CONTENTS
PART I PAGE NUMBER Item 1. Business 1 Item 2. Properties 15 Item 3. Legal Proceedings 16 Item 4. Submission of Matters to a Vote of Security Holders 16 Executive Officers of the Registrant 16 PART II Item 5. Market for Registrant's Common Stock and Related Stockholder Matters 19 Item 6. Selected Financial Data 19 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 19 Item 8. Financial Statements and Supplementary Data 19 Item 9. Changes in and Disagreement with Accountants on Accounting and Financial Disclosures 20 PART III Item 10. Directors and Executive Officers of the Registrant 21 Item 11. Executive Compensation 21 Item 12. Security Ownership of Certain Beneficial Owners and Management 21 Item 13. Certain Relationships and Related Transactions 21 PART IV Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K 22 Signatures 24
3 PART I ITEM 1. BUSINESS NOTE: This report contains 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 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. INTRODUCTION Founded in 1979, SCO went public on the Nasdaq Stock Exchange (Nasdaq: SCOC) in 1993. SCO is a global developer and provider of server software for networked business computing. The Company is the world's leading provider of UNIX(R) server operating systems, and creator of the award-winning Tarantella(R) software, which provides users with instant web-browser access to applications running on a wide range of networked servers, including mainframes, minicomputers, Windows(R) NT(TM), and UNIX System servers. SCO also provides a full range of Professional Consulting and Engineering Services for audits, deployment, and maintenance. SCO Professional Services are available for SCO OpenServer, UnixWare, Tarantella, Linux and Open Source systems. SCO has 20 years of experience developing UNIX system, open system, and open source software. SCO owns the intellectual property for UNIX system technology and Tarantella web-enabling software. Headquartered in Santa Cruz, California, SCO has sales representatives in more than 80 countries. SCO products are sold and distributed worldwide by more than 15,000 resellers, distributors, systems integrators and computer manufacturers. VISION AND MISSION: SERVER-BASED NETWORK COMPUTING SCO's vision is that server-based network computing powers all enterprises. SCO's mission is to create, market, and support the server software that system builders choose for networked business computing. IMPORTANCE OF SERVER-BASED NETWORK COMPUTING A major drawback of today's PC-centric client/server model is the high cost of system administration, maintenance, and software updates. When businesses move to a server-based network computing model, they can administer and update client software from the server, saving inordinate amounts of time and money. Companies that adopt a server-based computing model can understand their customers better, reach wider potential markets, bring products to market faster, and improve their overall customer satisfaction levels. COMPANY STRATEGY SCO's business strategy is threefold: 1) to provide the leading UNIX server software for high-volume Intel processor based servers; 2) to web-enable existing and new applications with server-based software across multiple platforms; and 3) to provide technical expertise to companies via its Professional Services organization. ADVANTAGES OF SCO SERVER SYSTEMS Business-critical servers running SCO system software combine the best qualities of stand-alone 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 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 low cost, 4) support for multiple users performing multiple tasks, 5) high-level security, 6) reliability and manageability, 7) support for a wide 1 4 range of client devices, including not only Microsoft Windows PC desktops and laptops, but also UNIX workstations, thin clients, and the browser-based network computers known as NCs, and 8) expert service and support. BENEFITS TO CUSTOMERS SCO products deliver four key advantages to customers: - - Server-based Computing - SCO server software makes it easier to deploy, secure, manage, and grow applications and information systems. - - Client Independence - SCO server software supports many kinds of client devices, so that businesses can choose the device that best suits a task. - - Evolutionary Systems - SCO server software protects current hardware and software investments while enabling businesses to adopt the latest technological advances. - - Global Services - SCO delivers the expert consulting, training, and technical support services that businesses worldwide require. IMPORTANCE OF INTEL PROCESSORS SCO has focused primarily on Intel processor based servers because of Intel's dominant position in the microprocessor-based computer market and the potential of Intel processor based servers in the growing market for server-based network computing. Intel processor based servers offer price-performance value that derives from their high volume, relatively low cost, and global availability from numerous competing system vendors. Industry analysts generally agree that, as Intel processor based servers continue to provide increasingly greater performance at an affordable price, they will increasingly displace the more costly RISC processor based servers that currently dominate high-end server environments. SCO has supported each successive generation of Intel processors, beginning in 1983, delivering an extensive line of highly reliable and stable UNIX operating system products over the past 17 years. During that period, SCO has also developed optional layered and Internet software products for the Intel platform, as well as new Tarantella web-enabling software that runs on many different kinds of servers, including not only Intel processor based servers, but also RISC processor based servers. 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 most recent Pentium, Pentium II and Pentium Pro(R) processors. Looking to the future, SCO and IBM are cooperatively developing a new high-volume enterprise UNIX System for Intel's next generation of 64-bit processors, the first of which is called Itanium(TM). SCO software is compatible with Intel processor based servers offered by virtually all of the major hardware vendors. Because SCO products support multiple processors and can execute multiple applications simultaneously, they are especially well suited for business critical servers that provide data access and business-critical applications to users throughout the enterprise. IMPORTANCE OF UNIX OPERATING SYSTEMS SCO bases its server operating system software on the UNIX System, which has been in use since the 1970s. The UNIX System is a native multi-user, multi-tasking technology that allows application programs to be separated from operating system tasks such as control of peripheral devices, communications, memory management and file management. This provides a standardized, protected environment in which the applications operate. This results in much higher reliability, because multiple applications and users cannot interfere with each other. It also simplifies application development because the operating system handles many complex functions that might otherwise have to be delegated to the application. UNIX Systems are well known for their reliability, availability, scalability, and security features. Reliability and availability refer to the extremely high mean time between failures on UNIX Systems, and to the UNIX System's ability to "failover" to a backup system without shutting down operations. Scalability refers to the UNIX operating system's ability to scale easily up from uni-processor to multi-processor systems, including clustered systems of multiple processors each. Security refers to the UNIX 2 5 System's ability to resist access by unauthorized persons over a network, or over the Internet, for example. UNIX Systems from SCO meet US government-level C2 and B2 security requirements. SCO believes that UNIX System technology is only the beginning of the solution, and that considerable value must be added to the basic technology 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 UNIX Systems that have in the past dominated the technical and scientific workstation market are unacceptable. These proprietary versions of UNIX systems run on proprietary, RISC processor-based, hardware architectures that are more expensive than Intel processor based architectures. Because these versions of the UNIX System are tied to particular hardware vendors, they can lock customers into a long-term business relationship with a single vendor. Vendor lock-in can make it difficult for customers to introduce new technology from other vendors into their information systems without disrupting their current operations and having to replace hardware and software at great cost. Applications that run on these proprietary UNIX Systems usually come from the same vendor as well, or must be developed specifically for these proprietary systems. Business and government organizations require broad availability of third-party application 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 that make it easier to produce and deploy these applications across multiple hardware architectures. In addition, these customers require a high level of support, including consulting services and training, as well as continual product enhancements to incorporate new technology and industry standards. This is why SCO has committed itself to building its systems on open system technologies (standards-based technologies that support multiple hardware and software systems in a networked environment) that run on Intel processor based servers. SCO has a long tradition of integrating leading-edge technologies from other vendors into its own UNIX operating systems, providing customers with best-of-breed solutions. In addition, SCO acquired ownership of UNIX System technology in fiscal year 1996 from Novell Corporation, which had earlier acquired it from AT&T's UNIX System Laboratories, the original developer. SCO therefore now controls the source UNIX system technology, enabling the Company to continue developing new versions of the UNIX System for high-volume Intel processor based systems that compete successfully against proprietary RISC based systems on performance and price. Because these Intel processor based servers are available from multiple hardware vendors around the world, customers preserve their freedom to choose their system providers. TARGET 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. Key targeted industries include retail and telecommunications. The Company continues to drive the Small and Medium Business (SMB) market forward with new products, such as SCO OpenServer Release 5.0.5, which incorporates the latest Internet and multimedia technologies, and the new UnixWare 7 Business Edition. Many of today's largest retail chains, with numerous replicated sites, depend on SCO OpenServer to run their day-to-day operations. For enterprise environments, SCO delivers high-end editions of UnixWare 7 and UnixWare 7 NonStop Clusters. 3 6 Meanwhile, SCO is also accelerating its growth into the enterprise computing market with Tarantella. Tarantella provides virtually any client device on the network with secure, Web browser access to any server application on the network. 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, 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 to support its Windows Integration strategy. 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 2K Suite. In addition, SCO offers Tarantella, the Company's web-enabling software. 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, a NC, a character terminal or a PC. SUPPORTING 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 processor-based computers and its support for a wide range of hardware vendors. Applications written for the SCO environment run on over 2,700 types of 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, Computer Associates, Informix, Lotus, Microsoft, Oracle, Novell, Progress, and Sybase. In total, over 15,000 independent software vendors (ISVs), representing over 15,000 business-critical applications support SCO UNIX Systems. DELIVERING COMPREHENSIVE SUPPORT SERVICES SCO continues to expand its delivery of support services to meet the needs of customers using complex, multivendor computer systems. The Professional Services division of SCO offers a series of Linux-related services to help enterprise customers evaluate and manage the cost, benefits and risk of Open Source technologies. These new services are part of SCO's ongoing strategy to fully support the increasingly popular network computing model, which favors heterogeneous client devices and application environments from multiple vendors. 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 resellers 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 (www.sco.com). PROVIDING TRUE OPEN SYSTEMS PRODUCTS 4 7 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 that 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. DISTRIBUTING PRODUCTS WORLDWIDE In contrast to operating system software for stand-alone PCs and small networks, system software for business critical servers requires sophisticated distribution and support. Over the past 16 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. EVANGELIZING 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. EXECUTING 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, distribution and representative offices throughout the world including those in the U.K., France, Germany, Italy, Denmark, India, 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. BRIEF HISTORY OF SCO PRODUCTS - - 1983 - SCO(R) XENIX(R) System V, a packaged version of the UNIX(R)operating system. - - 1985 - SCO XENIX 286, its first operating system for the 32-bit Intel(R) microprocessor environment. - - 1987 - SCO XENIX 386. - - 1989 - SCO UNIX System V/386, its first UNIX trademarked commercial product for Intel processor based platforms. - - 1990 - SCO Open Desktop(R), a graphical version of SCO UNIX System V/386. - - 1993 - SCO OpenServer(TM) software family, a complete line of advanced server. - - 1993 - SCO Open Desktop family, a complete line of advanced workstation (client) operating systems. 5 8 - - 1995 - SCO OpenServer family, which integrated SCO OpenServer and SCO Open Desktop product lines. - - 1995 - SCO Vision family of client-integration products, which integrate Windows(R) PCs with UNIX servers from all major UNIX system vendors. - - 1995 - SCO created an Optional Services Products division which provides middleware to enhance the capabilities of SCO OpenServer Systems, as well as UNIX Servers from other vendors. - - 1995 - SCO acquired the UnixWare(R)product line and UNIX system technology from Novell, Inc. - - 1997 - Tarantella web-enabling software. - - 1998 - UnixWare 7 Operating System. - - 1998 - SCO joined with IBM to begin developing new high-volume enterprise UNIX System for 64-bit processor servers, called "Project Monterey." This product line is designed to run on Intel IA-32, Intel IA-64 and IBM microprocessor systems that range from entry-level servers to large enterprise environments. - - 1999 - UnixWare 7 Release 7.1 Operating System, featuring SCO's new Webtop technology based on Tarantella software. - - 1999 - New series of Linux-related Professional Services offerings to assist enterprise customers evaluate and manage the cost, benefits and risk of Open Source technologies. CURRENT PRODUCTS The Company offers three categories of products: (1) UNIX server operating system products, which include optional server products, (2) Tarantella software, and (3) SCO Vision 2K Suite. UNIX SERVER OPERATING SYSTEM PRODUCTS UNIXWARE 7 UnixWare(R) 7 has been built from the ground up to support distributed network computing on cost-efficient Intel(R) processor-based servers. Running on the new generation of "enterprise-class" Intel processors, UnixWare 7 delivers a new level of power, value and versatility to businesses of all sizes. Now customers can dramatically simplify and increase their business operations and better understand their customers' to gain a powerful competitive advantage in their markets. UnixWare 7 is supported by leading enterprise application vendors, and backed by more enterprise hardware manufacturers than any other UNIX server environment. As an applications server, UnixWare 7 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. UnixWare 7 features the industry's first integrated Webtop, based on the award-winning SCO(R) Tarantella(TM) technology. Now applications can be instantly Web-enabled, taking businesses swiftly into the Internet age. UnixWare 7 NonStop Clusters greatly extends the record-breaking availability and scalability of the UnixWare 7 operating system by creating a computing environment made up of nodes (individual servers) that communicate via a high-speed interconnect. These "clusters" of nodes enable massive scaling of applications and provide a reliable fail-over environment should one of the nodes become disabled. UNIXWARE 7 EDITIONS UnixWare 7 Base Edition - Base-line services for building dedicated or specialized server environments, such as telecommunications equipment and other embedded systems. It also excels as a powerful graphical workstation. 6 9 UnixWare 7 Business Edition - For small businesses or workgroups requiring file and print services, reliable access to diverse applications, and the ability to expand system capability as the organization grows. UnixWare 7 Departmental Edition - For departmental servers in medium or large organizations to run applications and reliably share business critical information with any client including PCs, NCs, terminals and any Java-enabled browser client. UnixWare 7 Enterprise Edition - For medium-to-high-end enterprise servers to run large-scale business applications and databases for decision support and on-line transaction processing. UnixWare 7 Data Center Edition - For the highest-end multi-purpose servers demanding 24x7x365 availability, supporting hundreds or thousands of end-users by supplying access to a wide range of applications from a variety of clients. UNIXWARE 7 NONSTOP CLUSTERS RELEASE 7.1 UnixWare 7 NonStop Clusters provide totally dependable access to your business-critical data and applications. UnixWare 7 NonStop Clusters software links individual "nodes" - whole computers, each running its own copy of the operating system - such that they act and appear as a single system. If one node goes down, or if an application fails on a particular node, processes are actively migrated and resumed. If a node needs to be taken off-line, for maintenance or upgrading, the rest of the cluster continues to service its users. Other nodes in the cluster take care of new connections or instances of applications. In this way, downtime, planned or unplanned, is eliminated. UNIXWARE 7 ReliantHA 1.1 UnixWare 7 ReliantHA extends the high performance, Reliability, Availability and Scalability (RAS) characteristics of the UnixWare 7 server operating system editions to provide continuous monitoring and fault detection of applications, resources and entire nodes. In the event of a failure, automated recovery scripts are initiated to enable rapid or transparent restoration of services, depending on the application. PROJECT MONTEREY - THE HIGH-VOLUME ENTERPRISE UNIX PLATFORM SCO has joined with IBM, with support from Intel, to deliver the leading high-volume, enterprise UNIX system for the 21st century. With more OEM backing than any other commercial UNIX system being developed for Intel's forthcoming Itanium(TM) 64-bit processor, Project Monterey continues to gain ISV support and customer acceptance as the next UNIX system standard. As part of Project Monterey, IBM supports UnixWare 7 as its standard commercial UNIX for Intel IA-32 environments, further enhancing SCO's overall market visibility (see www.projectmonterey.com). SCO OPENSERVER 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. 7 10 BASE SCO OPENSERVER OPERATING SYSTEMS SCO OpenServer Enterprise System - In addition to the critical business applications, SCO OpenServer Enterprise System reliably provides a variety of network services including file and print services for both UNIX(R) and Windows systems, E-Mail services, web services, Internet connectivity, and calendar services. SCO OpenServer Host System - The SCO OpenServer Host System is an excellent platform for delivering highly reliable, non-networked multi-user solutions. SCO OpenServer Development System - The SCO OpenServer Development System is comprised of a core set of development tools that can be easily augmented with over 200 third-party products to create the most robust and efficient development environment. SCO OpenServer Desktop System - The Desktop System excels at running client-side, transaction-based applications, accessing databases and networked information, and providing file/resource sharing and communications across a range of peer, server and host environments. SCO OPTIONAL SERVICES PRODUCTS SCO Optional Services Products provide enhancements to extend the SCO OpenServer or UnixWare 7 product standard configurations with services that support customers' unique environment and needs. SCO OPTIONAL SERVICES PRODUCTS FOR UNIXWARE 7 NetWare Services 4.10 - With NetWare Services a UnixWare application server can easily and transparently be accessed by NetWare clients, enabling seamless integration into existing Novell environments. SCO Advanced File and Print Services - SCO Advanced File and Print Server 4.0 enables enterprise-wide, scalable file and printer sharing with PCs running Microsoft Windows 95, Windows 98, Windows NT, Windows 3.x, OS/2 and MS-DOS. SCO Merge - SCO Merge runs Windows and DOS applications on SCO OpenServer and UnixWare 7 systems. Windows 95,Windows 3.1, and DOS applications run simultaneously with business critical UNIX applications. A common filesystem allows Windows, DOS, and UNIX users to share data. Windows, DOS, and UNIX users simultaneously share printers and other standard PC peripherals. SCO VisionFS - SCO VisionFS for UnixWare 7 and SCO OpenServer provides high-performance robust SMB file and printer sharing from UNIX(R) Systems to PC clients running Windows, and provides basic access to server applications. SCO ARCserveIT6.6 from Computer Associates - A comprehensive, network backup, restore and data management system for enterprise networks. It is an ideal system for managing the backup of large servers and heterogeneous networks. UnixWare 7 Online Data Manager - This is a cost-effective, enterprise-class storage management solution for high availability and online volume management. It provides software RAID Levels 0, 1, 5, 10 (striping, mirroring, striping distributed parity and striped mirroring) as well as disk spanning capabilities. UnixWare 7 Disk Mirroring - UnixWare 7 Disk Mirroring provides increased data availability by providing fault tolerance against failures and faster access via software RAID Level 1 (simple disk mirroring). SCO OPTIONAL SERVICES PRODUCTS FOR SCO OPENSERVER 5 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 8 11 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. SCO ARCserve/Open from Cheyenne - Multi-platform Network Backup and Restore. - ARCserve/Open is an easy-to-use, high-performance, comprehensive data management tool for enterprise networks. ARCserve/Open provides the robust feature set that administrators require and the simplicity necessary for end-users to do their own backups. SCO Doctor and SCO Doctor for Networks(TM) - The SCO Doctor and SCO Doctor for Networks are advanced systems management tools that 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. SCO Merge - SCO Merge runs Windows and DOS applications on SCO OpenServer and UnixWare 7 systems. Windows 95,Windows 3.1, and DOS applications run simultaneously with business critical UNIX applications. A common filesystem allows Windows, DOS, and UNIX users to share data. Windows, DOS, and UNIX users simultaneously share printers and other standard PC peripherals. SCO VisionFS - SCO VisionFS for UnixWare 7 and SCO OpenServer provides high-performance robust SMB file and printer sharing from UNIX(R) Systems to PC clients running Windows, and provides basic access to server applications. TARANTELLA Tarantella is software that provides centralized deployment and management of server-based applications. It is designed for IT professionals who need to provide users with instant access to applications and services, and provides centralized deployment and management of server-based applications. Unlike some competing products, (for example, Citrix products) Tarantella enables centralized management of application access. Tarantella uses standard protocols and leverages Internet standards. It is a non-invasive technology, and has a customizable Webtop. A low-risk, drop-in solution, Tarantella continually monitors and optimizes performance and provides a single access point for all of a user's applications. Tarantella dramatically lowers the total cost of ownership by supporting hardware and software already in use, by eliminating the cost of installing software on clients, and by providing centralized system administration. With Tarantella, organizations can move their current applications onto the network without rewriting code or disrupting their current operations. SCO VISION2K SUITE The SCO Vision2K Suite 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, Windows 95, and Windows 98. It's also available on many UNIX platforms, including Sun Solaris, HP-UX, IBM AIX, UnixWare and SCO OpenServer. SCO Vision2K - Bringing together Windows, UNIX and the Internet - SCO Vision2K is a new generation of best of breed Windows to UNIX integration products. Going beyond simply accessing UNIX applications, SCO Vision2K adopts the principles of centralized management, server deployment and Internet integration and cuts the cost of ownership of your existing PC networks. Individual products offer Windows access to X applications (SCO XVision Eclipse) and character-based applications (SCO TermVision) server-based file and print sharing (SCO VisionFS) and database connectivity (SCO SQL- 9 12 Retriever). Together they form a tightly integrated suite that meets all your Windows to UNIX connectivity needs. SCO SuperVision - Remote Management of Windows Desktops - SCO(R) SuperVision(TM) is supplied with SCO XVision Eclipse, SCO TermVision and SCO SQL-Retriever. It provides centralized management functionality. From a central location, system administrators can make configuration changes or control which applications users have access to and then distribute updates from a UNIX server to a large community of PCs in a single stroke. These changes can be made immediately, on demand or the next time the PC is connected to the network. SCO SuperVision also works over modem links allowing administrators to manage remote users just as easily as those on the LAN. SCO VisionFS - Server-Based 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) Eclipse is a proven 32-bit PC X server that exploits the strengths of Windows(R) and the UNIX(R) system to give fast, intuitive access to X applications. It is Internet ready and delivers X applications across the enterprise via the intranet. SCO(R) XVision(R) Eclipse 3D is used for displaying 3D imaging applications on a Windows PC. 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 - Premier Motif, which provides Windows management technology, 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 enhancements, many not found in any other vendor's Motif implementation. SALES AND DISTRIBUTION 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. 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 10 13 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 180 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 third fiscal quarter of 1998, the Company made a decision to eliminate channel inventories and record a reserve for the return of remaining channel stock in connection with its preparations for electronic licensing and distribution. This decision adversely affected the Company's operating results for fiscal 1998. 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 (SMB). 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. SCO also has a dedicated account team that manages the relationships with government agencies in the U.S., while Government sales outside the U.S. are managed by SCO regional management or by OEMs, major distributors or major resellers. 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: 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 - includes 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 - consists 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 - includes technical advisory and support services as well as access to early product releases for application developers; and Engineering Services - consists 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 11 14 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 processor-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 Inc. and is now a primary driving force behind this open systems platform. During the third quarter of fiscal 1997, 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, Pentium II, Pentium Pro(R) and the forthcoming 64-bit Itanium processor. 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 has taken strong steps to mitigate operating system date processing errors that might occur with the onset of the Year 2000 (Y2K). SCO has: - - made ongoing updates of information and resources available at its Year 2000 website (www.sco.com/year2000); - - issued a Year 2000 Date Processing Limited Warranty for Designated Software that defines how we expect our products to perform when processing dates in the Year 2000; - - produced an SCO Year 2000 Whitepaper detailing how Year 2000 affects SCO products and what products are covered by the Year 2000 Date Processing Limited Warranty; - - performed Year 2000 testing of all currently offered SCO products; - - issued fixes for Year 2000 problems that have been detected in currently SCO supported products; - - created a project team to maintain a consistent Year 2000 policy for our customers and to coordinate cross functional activities; - - created a Year 2000 committee to test, verify or upgrade internal systems and third party vendor software to insure continued operation of our infrastructure; - - provided an email service where customers can subscribe to receive notice of Year 2000 information updates; - - developed an on-line Year 2000 Discussion Forum newsgroup; and - - developed a Year 2000 support coverage schedule advertising our services and the mechanism for accessing this schedule. 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, code-named Monterey64. 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 12 15 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. The teams build the SCO Vision2K Suite of products, and develop Tarantella products, which extend SCO's "any-client" proposition to server-centric 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 can be 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, 2000. There can be 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 operating systems is very competitive and rapidly changing. The Company encounters significant competition from a limited number of direct competitors including Microsoft, Novell, IBM and Sun Microsystems, which offer hardware-independent multi-user operating systems for Intel platforms, and from OEMs such as Hewlett-Packard, IBM, Olivetti and Sun Microsystems, which offer their own versions of the UNIX System on a variety of RISC and Intel CPU-based hardware. Competition from companies selling versions of the Linux Operating System has also increased. Many 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. Competitive systems not based on Intel microprocessors are offered by Hewlett-Packard, IBM, and Sun Microsystems, 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. Over recent years, operating systems such as GNU, Linux, FreeBSD and others developed using collaborative and "open source" techniques have gained popularity with highly technical users, and some integrators. Some of SCO's competitors may exploit this technology to build competitive products, or the 13 16 market for SCO's products may be reduced by either technical users using these products or the products becoming easier to use and more stable. 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. 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 servers. The market for Microsoft Windows on personal computers for personal productivity is substantially larger than the market for UNIX Systems on Intel computers. Because the Company competes in a smaller market than the personal productivity market addressed by 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 the server-centric model. 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. SCO's Tarantella product faces competition from products using technologies to deploy applications, such as terminal emulation, compression systems, virtual private networks, and also faces competition from products taking a similar approach to web-enabling applications. These include offerings from companies such as WRQ, Hummingbird and Graphon. In addition, products that deploy Windows applications only can be configured with additional functions such as terminal emulators to provide functional behavior similar to that of Tarantella. These products include CITRIX, NCD WinCenter, and Microsoft Windows Terminal Server. SCO is targeting Tarantella products and services into the enterprise market where SCO does not have a strong range of partners and where the SCO brand is little known, making alternative suppliers a competitive threat. SCO's Tarantella products run on Solaris, AIX, HP/UX and other UNIX operating systems, and therefore are dependent on continued use of these products in the target markets. Tarantella aims to support many different server types and client types, but it is possible that client or server vendors could "close" access to their products to prevent customers from using Tarantella. 14 17 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. 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. EMPLOYEES As of September 30, 1999, the Company had 1,207 employees, including 359 in product development, 454 in sales and marketing, 151 in customer support services, and 243 in finance, manufacturing and distribution services and administration. The Company's success depends in part on its executive officers, none of which 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 Murray Hill, 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. 15 18 The Company's field operations occupy leased facilities in 12 locations in the United States. In addition, the Company's subsidiaries and sales and representative offices in France, Germany, Italy, Spain, Sweden, Denmark, Singapore, Australia, China, India, Canada, Brazil 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 No material legal proceedings are pending to which the Company is a party or to which any property of the Company is subject. 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 1999. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company as of September 30, 1999 were as follows:
Name Age Position with the Company - ---- --- -------------------------- Douglas L. Michels 45 President and Chief Executive Officer Ray Anderson 41 Senior Vice President, New Ventures John Luhtala(1) 56 Senior Vice President, Operations, and Chief Financial Officer David McCrabb 51 Executive Vice President, Worldwide Sales and Field Operations Jack Moyer 50 Senior Vice President, Human Resources Mike Orr 48 Senior Vice President, Worldwide Marketing Steve Sabbath 52 Senior Vice President, Law and Corporate Affairs, and Secretary Geoff Seabrook 51 Senior Vice President, Corporate Development Jenny Twaddle(1) 35 Corporate Controller and Acting Chief Financial Officer James Wilt 53 Senior Vice President, Products
- -------- (1) Mr. Luhtala left the Company in December 1999. Ms. Twaddle, Corporate Controller, was named Acting Chief Financial Officer at his departure. 16 19 Mr. Michels was named President and Chief Executive Officer in April 1998. Mr. Michels is the principal architect of the Company's technology strategy and served as the head of product development between June 1997 and April 1998 and as Chief Technical Officer between February 1993 and June 1997. Mr. Michels has been a director of the Company since 1979 and served as the Company's Executive Vice President between 1979, when he co-founded the Company, and April 1998. Mr. Michels is one of the founders of Uniforum, a UNIX(R) user consortium, and served as its President from 1989 to 1990. Mr. Anderson was named Senior Vice President, New Ventures in July 1999. Between April 1998 and July 1999, he served as Senior Vice President, Marketing. Between June 1997 and April 1998, he served as Senior Vice President, Marketing, Products Division. Between December 1994 and June 1997, 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. 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. Mr. McCrabb was named Executive Vice President, Worldwide Sales and Field Operations in April 1998. Between January 1995 and June 1997, he served as Vice President, Marketing and Channel Sales, then as Senior Vice President, Market Planning between July 1997 and April 1998. 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. Moyer was named Senior Vice President, Human Resources in January 1998. He has served as Vice President, Human Resources since 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. Orr was named Senior Vice President, Worldwide Marketing in July 1999. Prior to joining the Company, between June 1998 and June 1999, Mr. Orr served as Vice President, Sales and Marketing at Splash Technology. From August 1988 to June 1998, Mr. Orr served in various senior management positions at Amdahl. From August 1974 to August 1988, Mr. Orr served in various management positions at IBM. Mr. Sabbath was named Senior Vice President, Law and Corporate Affairs, and Secretary in January 1998. Between 1993 and 1997, he served as Vice President, Law and Corporate Affairs, and Secretary and served as Vice President, Legal Affairs between 1991 and 1993. 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, Corporate Development in April 1998. Since joining the Company in 1989, Mr. Seabrook has held a number of strategic positions, including Senior Vice President and General Manager, EMEIA. Prior to joining the Company, Mr. Seabrook served as Vice President International Operations at Century Data Inc. Ms. Twaddle was named Acting Chief Financial Officer in December 1999. Ms. Twaddle has served as the Corporate Controller since April 1999. Between August 1997 and April 1999 she served as Assistant Corporate Controller and between March 1997 and August 1997 she served as the Americas Controller. 17 20 Prior to joining the Company, between June 1993 and March 1997, Ms Twaddle served as Corporate Controller for Information Storage Devices. Mr. Wilt was named Senior Vice President, Products in April 1998. Since joining the Company in 1983, Mr. Wilt has held a number of strategic positions both in the U.S. and in Europe including those of Vice President, Business Development and Vice President, International. Mr. Wilt formerly held management positions in sales, marketing, and planning at Xerox, Honeywell and Amdahl. 18 21 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 1998: First Quarter 4.00 6.38 Second Quarter 3.38 5.31 Third Quarter 3.88 6.38 Fourth Quarter 2.75 4.94 Fiscal 1999: First Quarter 3.25 5.59 Second Quarter 4.00 5.88 Third Quarter 5.38 7.06 Fourth Quarter 6.44 14.13
On December 15, 1999, there were approximately 8,900 holders of the Company's Common Stock. ITEM 6. SELECTED FINANCIAL DATA The information set forth on page 12 of the 1999 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 13 through 20 of the 1999 Annual Report to Shareholders is incorporated herein by reference. ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK The information set forth on pages 19 through 20 of the 1999 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 reports of independent accountants set forth on pages 21 through 39 of the 1999 Annual Report to Shareholders are incorporated herein by reference. - - Consolidated Statements of Operations for each of the years in the three-year period ended September 30, 1999 - - Consolidated Balance Sheets as of September 30, 1999 and 1998 - - Consolidated Statements of Shareholders' Equity (Deficit) for each of the years in the three-year period ended September 30, 1999 - - Consolidated Statements of Cash Flows for each of the years in the three-year period ended September 30, 1999 - - Notes to Consolidated Financial Statements - - Reports of Independent Accountants - - Quarterly Financial Information 19 22 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES On December 30, 1997, the Company changed its independent auditors from KPMG LLP to PricewaterhouseCoopers LLP as previously reported on Form 8-K filed with the Securities and Exchange Commission on January 7, 1998 (File No 0-21484). There were no disagreements with any of the Company's independent accountants during the fiscal years ended September 30, 1999 and 1998. 20 23 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 22, 2000 (the "Proxy Statement"). Such information is incorporated herein by reference. Information with respect to Executive Officers and Officers may be found on pages 16 through 18 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. 21 24 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE 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 26
The independent auditors' reports with respect to the above-listed financial statement schedule appears on page 25 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) 10.11 Software License Agreement with Locus Computing Corporation effective January 11, 1989. (1) 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)(8) 10.20 1994 Incentive Stock Option Plan and form of Incentive Stock Option Agreement. (3)(8) 10.21 401(k) Plan, as amended. (1) (8) 10.23 Revised 1993 Employee Stock Purchase Plan. (5) (8)
22 25 10.24 1993 Director Stock Option Plan. (1) (8) 10.34 Shareholders' Rights Agreement. (6) 10.35 Change-in-control agreement between the Company and certain key management. (8) 10.36 Employment Agreement with Alok Mohan. (7) 13 Annual Report to Shareholders. 21.1 Subsidiaries of Registrant. 23.1 Consent of Independent Accountants. 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. (6) Incorporated by reference to the Form 8-A12G filed on September 18, 1997. (7) Incorporated by reference to the Form 10-K filed on December 23, 1998. (8) Designates management contracts or compensatory plans, contracts or arrangements. - -------------------------------------------------------------------------------- (b) Reports on Form 8-K. No reports on Form 8-K were filed during the last quarter of fiscal 1999. 23 26 THE SANTA CRUZ OPERATIONS, INC. 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/ Randy Bressee By: /s/ Steven M. Sabbath ---------------------------------- ----------------------- Randy Bressee Steven M. Sabbath Senior Vice President, Senior Vice President, Chief Financial Officer Law and Corporate Affairs Date: November 6, 2000 & Secretary Date: November 6, 2000 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/ Douglas L. Michels - ----------------------------------- Douglas L. Michels President, Chief Executive Officer and Director Date: November 6, 2000 /s/ Alok Mohan /s/ Robert M. McClure - --------------------------------- ------------------------------ Alok Mohan Robert M. McClure Chairman of the Board of Directors Director Date: November 6, 2000 Date: November 6, 2000 /s/ Gilbert P. Williamson /s/ R. Duff Thompson - --------------------------------- ------------------------------ Gilbert P. Williamson R. Duff Thompson Director Director Date: November 6, 2000 Date: November 6, 2000 /s/ Ronald Lachman /s/ Ninian Eadie - --------------------------------- ------------------------------ Ronald Lachman Ninian Eadie Director Director Date: November 6, 2000 Date: November 6, 2000 24 27 INDEPENDENT ACCOUNTANTS' REPORT The Board of Directors and Shareholders of The Santa Cruz Operation, Inc.: Under date of October 22, 1999, except for Note 17, which is as of December 1, 1999, we reported on the consolidated balance sheets of The Santa Cruz Operation, Inc. and subsidiaries as of September 30, 1999 and 1998, and the related consolidated statements of operations, shareholders' equity (deficit), and cash flows for the years then ended, as contained in the 1999 annual report to shareholders. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K/A for the year 1999. 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/ PricewaterhouseCoopers LLP San Jose, California October 22, 1999 The Board of Directors and Shareholders of The Santa Cruz Operation, Inc.: Under date of October 22, 1997, we reported on the consolidated statements of operations, shareholders' equity (deficit), and cash flows of The Santa Cruz Operation, Inc. and subsidiaries for the year ended September 30, 1997. These consolidated financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K/A for the year 1999. In connection with our audit of the aforementioned consolidated financial statements, we also audited the related financial statement schedule for the year ended September 30, 1997, as listed under Item 14(a) 2. 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 audit. 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, for the year ended September 30, 1997. /s/ KPMG LLP Mountain View, California October 22, 1997 25 28 THE SANTA CRUZ OPERATION, INC. SCHEDULE II/RULE 5-04 VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED SEPTEMBER 30, 1999, 1998 AND 1997 (In thousands)
BALANCE CHARGED AT TO BALANCE BEGINNING REVENUES AT END OF OR OF DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS PERIOD --------- -------- ---------- ------- Year Ended September 30, 1999 Allowance for returns $10,637 $ 9,505 $13,034 $ 7,108 Allowance for doubtful accounts 1,545 209 640 1,114 ------- -------- ------- ------- Total allowance $12,182 $ 9,714 $13,674 $ 8,222 ======= ======== ======= ======= Year Ended September 30, 1998 Allowance for returns $ 9,136 $ 18,200 $16,699 $10,637 Allowance for doubtful accounts 1,743 (132) 66 1,545 ------- -------- ------- ------- Total allowance $10,879 $ 18,068 $16,765 $12,182 ======= ======== ======= ======= 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 ======= ======== ======= =======
26 29 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) 10.11 Software License Agreement with Locus Computing Corporation effective January 11, 1989. (1) 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)(8) 10.20 1994 Incentive Stock Option Plan and form of Incentive Stock Option Agreement. (3)(8) 10.21 401(k) Plan, as amended. (1) (8) 10.23 Revised 1993 Employee Stock Purchase Plan. (5) (8) 10.24 1993 Director Stock Option Plan. (1) (8) 10.34 Shareholders' Rights Agreement. (6) 10.35 Change-in-control agreement between the Company and certain key management. (8) 10.36 Employment Agreement with Alok Mohan. (7) 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. (6) Incorporated by reference to the Form 8-A12G filed on September 18, 1997. (7) Incorporated by reference to the Form 10-K filed on December 23, 1998. (8) Designates management contracts or compensatory plans, contracts or arrangements. EX-13 2 f66568ex13.txt EXHIBIT 13 1 Exhibit 13 THE SANTA CRUZ OPERATION, INC. SELECTED FIVE YEAR FINANCIAL INFORMATION
Fiscal Year Ended September 30, -------------------------------------------------------- (In thousands, except per share data) 1999 1998 1997 1996 1995 -------- -------- -------- -------- -------- Net revenues $ 223,624 $ 171,900 $ 193,660 $ 207,890 $ 199,329 Cost of revenues 48,603 45,898 55,315 54,402 54,133 -------- -------- -------- -------- -------- Gross margin 175,021 126,002 138,345 153,488 145,196 Operating expenses 158,648 139,595 154,939 177,069 151,688 -------- -------- -------- -------- -------- Operating income (loss) 16,373 (13,593) (16,594) (23,581) (6,492) Other income (expense): Interest income, net 1,942 2,261 2,291 2,302 2,703 Other income (expense), net 1,939 226 (866) (394) (363) -------- -------- -------- -------- -------- Income (loss) before income taxes 20,254 (11,106) (15,169) (21,673) (4,152) Income taxes 3,396 3,559 1 741 1,956 -------- -------- -------- -------- -------- Net income (loss) 16,858 (14,665) (15,170) (22,414) (6,108) Other comprehensive income (loss), net of tax (884) 653 936 (213) 264 -------- -------- -------- -------- -------- Comprehensive income (loss) $ 15,974 $(14,012) $(14,234) $(22,627) $ (5,844) -------- -------- -------- -------- -------- Earnings (loss) per share-basic $ 0.49 $ (0.41) $ (0.41) $ (0.62) $ (0.20) Earnings (loss) per share-diluted $ 0.46 $ (0.41) $ (0.41) $ (0.62) $ (0.20) -------- -------- -------- -------- -------- Shares used in per share calculation-basic 34,232 35,817 36,628 36,179 30,922 Shares used in per share calculation-diluted 36,402 35,817 36,628 36,179 30,922 ======== ======== ======== ======== ========
September 30, --------------------------------------------------- (In thousands) 1999 1998 1997 1996 1995 -------- -------- -------- -------- --------- Cash, equivalents and short-term investments $ 62,844 $ 51,076 $ 51,711 $ 54,831 $ 46,890 Working capital 42,242 32,221 46,164 61,935 60,539 Total assets 139,284 131,189 146,665 166,807 131,870 Long-term liabilities 8,523 12,027 9,545 9,332 7,521 Shareholders' equity 70,338 60,135 81,462 101,581 82,182 ======== ======== ======== ======== ========
2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW SCO is a global leader in server software for networked business computing, and the world's leading provider of UNIX(R) server operating systems. SCO is also the creator of the award-winning Tarantella(R) software, which provides instant Web-browser access to applications running on a wide range of networked servers. SCO sells and supports its products through a worldwide network of more than 15,000 distributors, resellers, system integrators and OEMs. SCO's mission is to create, market and support the server software that system builders choose for networked business computing. SCO believes that server-based network computing, which is based on Internet and web technologies, enables businesses to dramatically improve their customer information flow and business transaction efficiencies. Companies that adopt a server-based network computing model can understand their customers better, reach wider potential markets, bring products to market faster and improve their overall customer satisfaction levels. With server-based computing and SCO products and services, IT professionals can immediately leverage their existing investments, deploy applications faster and dramatically cut the cost of systems administration and management. 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 Year 2000 compliance, 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 software licenses and fees for services, which include engineering services, consulting, custom engineering, support and training. Net revenues were $223.6 million in fiscal 1999, an increase of 30% from $171.9 million in fiscal 1998. In fiscal 1998, net revenues decreased by 11% from $193.7 million in fiscal 1997. Revenues are net of a provision for estimated future returns for stock balancing and excess quantities above levels the Company believes are appropriate in its distribution channels. The stronger revenue performance across all geographies is attributable to several factors including the ease of electronic licensing, increased customer contacts as a result of added sales resources and Y2K upgrade sales. The fiscal 1998 decline was directly related to the Company's decision to eliminate channel inventories and a one time right of return for channel stock in connection with its preparations for electronic licensing and distribution. In connection with this, the Company recorded a reserve against revenue of approximately $16.1 million. For the fiscal years ended September 30, 1999, 1998 and 1997, no single customer accounted for greater than 10% of the Company's license revenues. 3 International revenues continue to be a significant portion of net revenues, comprising 56% of the revenues for fiscal 1999 and 51% and 55% for 1998 and 1997, respectively. 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 product families, geographic regions and 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 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 revenues as a percentage of net revenues decreased to 22% in fiscal 1999 from 27% in fiscal 1998, which in turn was a decrease from 29% in fiscal 1997. The 5% decline from 1999 to 1998 resulted from reduced royalty rates as a result of a settlement negotiated during 1998 with a technology provider and reduced technology costs together with the impact of stable fixed costs over higher unit sales volume. In addition, material costs are declining as a result of increasing e-commerce trade. Reduced royalty rates and a significant retroactive royalty credit of approximately $2.6 million, coupled with reduced technology costs were partially offset by stable fixed costs over lower unit sales volume to net to the two percentage point decline in cost from 1997 to 1998. During the year ended September 30, 1998 the Company reached a settlement of a royalty dispute with one of its technology providers. As a result of this dispute an element of past royalties were forgiven and an additional retroactive refund was received. In total approximately $2.6 million was credited to royalty expense during the year ended September 30, 1998. In addition the Company received both a reduction in ongoing royalty rate and a reduction in the scope of royalty bearing products. 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 service revenues includes documentation, consulting and personnel related expenses associated with providing such services. 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 decreased 2% to $40.8 million in fiscal 1999 from $41.4 million in fiscal 1998, which was a decrease of 10% from the fiscal 1997 spending of $46.1 million. Research and development expenses represented 18% of net revenues for fiscal 1999 and 24% of net revenues for both fiscal 1998 and 1997. The decrease in research and development expenses during 1999 can be attributed to lower depreciation and hardware expenses. The 1998 decrease in research and development expenses in absolute dollars was primarily attributable to reducing staffing levels in conjunction with a restructuring of operations. SALES AND MARKETING Sales and marketing expenses increased 22% to $97.1 million for fiscal 1999, compared to $79.6 million in fiscal 1998 and $79.5 million in fiscal 1997. Sales and marketing expenses represented 43%, 46% and 41% of total net revenues in fiscal 1999, 1998 and 1997, respectively. The increase is due principally to an increase in the size of our direct sales force and commissions as well as sales program costs that vary directly with increased sales. While flat in absolute terms, the Company retargeted 1998 and 1997 marketing spending towards reseller training, independent software vendor recruitment and higher corporate brand awareness. GENERAL AND ADMINISTRATIVE General and administrative expenses increased 12% in fiscal 1999 to $20.8 million compared to $18.6 million in fiscal 1998. In fiscal 1998, general and administrative expenses decreased by 11% from $20.9 million in fiscal 1997. General and administrative expenses represented 9% of total net revenues for fiscal 1999 and 11% for fiscal 1998 and fiscal 1997. The fiscal 1999 increase was due to increased corporate bonuses as a result of exceeding Company performance goals and a movement of certain staff from other functions. Reduced headcount, lower legal expenses and lower discretionary spending resulted in the fiscal 1998 decline in absolute dollars. 4 NON-RECURRING CHARGES A worldwide restructuring during the third quarter of fiscal 1997 resulted in a one-time charge of $8.4 million or 4% of 1997 revenues. The charge includes a 10% reduction in headcount of $3.4 million, elimination of lease obligations for 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. 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 decreased in fiscal 1999 to $1.9 million compared to $2.3 million for fiscal years 1998 and 1997. Other income was $1.9 million for fiscal 1999, $0.2 million for fiscal 1998 and an expense of $0.9 million in fiscal 1997. The fiscal 1999 growth in other income was primarily due to the gain on the sale of an investment position in a domestic channel distribution partner of $3.3 million, net of an asset impairment in another investment position of $1.0 million. The change in 1998 was principally due to foreign exchange gains earned in the Company's European subsidiaries. INCOME TAXES In fiscal 1999, 1998 and 1997, the Company's effective income tax rates were 17%, (32)% and 0%, respectively. The fiscal 1999 tax primarily reflects foreign income taxes, while the prior years reflect losses and expenses without tax benefit for which a valuation allowance has been established. For an analysis of income taxes, see Note 12 of Notes to Consolidated Financial Statements. Management has established a partial valuation allowance against its gross deferred tax assets as of September 30, 1999. The valuation allowance has been established at the level sufficient to reduce gross deferred tax assets to amounts which are deemed to be, more likely than not, recoverable. Such analysis has been based on recent profitability, managements forecasts of amounts recoverable in future years and assets which will be recovered against future profits of the Company's overseas operation, which have historically been profitable. Realization of the net deferred tax assets is dependent upon generating sufficient taxable income prior to the expiration of loss and credit carryforwards. Although realization is not assured, management believes that it is more likely than not that all of the net deferred tax assets will be realized. In the event that the Company does not show sufficient profitability in the subsequent fiscal quarters, the Company may be required to write off portions of the net deferred tax assets previously recognized up to the entire amount of $7.8 million. NET INCOME (LOSS) The Company reported net income of $16.9 million in fiscal 1999 and net losses of $14.7 million and $15.2 million in fiscal 1998 and 1997, respectively. The positive trend in fiscal 1999 is driven by strong revenue performance, which is directly related to the increasing importance of server-based computing. The fiscal 1998 and 1997 net losses were primarily attributable to lower revenues, absolute increases in operating expense 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's staffing and operating 5 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. 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 56%, 51% and 55% of total revenues for fiscal 1999, 1998 and 1997, respectively. A substantial portion of the international revenues of the Company's U.K. subsidiary are denominated in U.S. dollars, 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 6 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. 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. YEAR 2000 ISSUES Background. The approach of Year 2000 is causing a great deal of concern and discussion in the computer industry. There are many varieties of Year 2000 problems. One major concern is the accurate dating of files and transactions beginning January 1, 2000. For many years, software has represented dates using the MM/DD/YY format (or some variant), which allows for the display of only the last two digits of the year. With the upcoming transition from 99 to 00, dating problems may occur on systems that interpret a YY value of 00 incorrectly. The Company must address the millennium issues from a perspective of both developing and selling software products and also maintaining internal Company operations. Actions Taken. The Company has taken steps to mitigate operating system date processing errors that might occur with the onset of the Year 2000 (Y2K). The Company has: 7 - - made ongoing updates of information and resources available at its Year 2000 website (http://www.sco.com/year2000); - - issued a Year 2000 Date Processing Limited Warranty for Designated Software that defines how we expect our products to perform when processing dates in the Year 2000; - - produced an SCO Year 2000 White Paper detailing how Year 2000 affects SCO products and what products are covered by the Year 2000 Date Processing Limited Warranty; - - performed Year 2000 testing of all currently offered SCO products; - - issued fixes for Year 2000 problems that we have detected in currently SCO supported products; - - created a project team to maintain a consistent Year 2000 policy for our customers and to coordinate cross functional activities; - - created a Year 2000 committee to test, verify or upgrade internal systems and third party vendor software to insure continued operation of our infrastructure; - - provided an email service where customers can subscribe to receive notice of Year 2000 information updates; - - developed an on-line Year 2000 Discussion Forum newsgroup; and - - developed a Year 2000 support coverage schedule advertising our services and the mechanism for accessing this schedule. Software Sold to Customers. SCO believes that it has substantially identified and resolved all potential Year 2000 problems in software products under warranty that it develops and markets. However, management also believes that it is not possible to determine with complete certainty that all Year 2000 problems affecting the Company's software products have been identified or corrected due to 1) the complexity of these products, 2) the fact that these products interact with other third party vendor products and 3) the operation on computer systems which are not under the Company's control. Internal Infrastructure. The Company has created an Information Management Year 2000 Program, which addresses the Company's internal business operations and represents all of the Company's information management functions. The Company has a dedicated Year 2000 team to manage our worldwide operations as we prepare for the transition to the next millennium. The Company believes that it has identified, modified, upgraded and replaced substantially all of the major computers, telephone and networking equipment, software applications and related equipment used in connection with its internal operations to minimize the possibility of a material disruption to its business. Suppliers. The Company has ongoing communications with third party suppliers of the major computers, software, and other equipment used, operated or maintained by the Company to identify and, to the extent possible, resolve issues involving the Year 2000 problem. The Company believes that all key issues related to the Year 2000 have been identified. However, the Company has limited or no control over the actions of these third party suppliers. Thus, while the Company expects that it will be able to resolve any significant Year 2000 problems with these systems, there can be no assurance that these suppliers will resolve any or all Year 2000 problems with these systems before the occurrence of a material disruption to the business of the Company or any of its customers. Any failure of these third parties to resolve Year 2000 problems with their systems in a timely manner could have a material adverse effect on the Company's business, financial condition and results of operation. Costs. We do not separately account for Year 2000 related expenses but estimate that our expenses incurred to date to address Year 2000 issues have been $0.7 million. We expect that we may incur additional compliance related expenses of up to $0.2 million. If these costs are higher than we anticipate, it could adversely impact our operating results. Assessment of Consequences. The Company expects to identify and resolve all Year 2000 problems that could materially adversely affect its business operations and products. The exposure on the product side is possible provision of free upgrade software to a few customers. However, management believes that it is not possible to determine with complete certainty that all Year 2000 problems affecting the Company have 8 been identified or corrected. The number of devices and permutations are too numerous. The Company is prepared for the likelihood of a few operational inconveniences and diversion of attention from ordinary business. However, the Company believes that there will be no adverse material effect on the Company's business or results of operations. Contingency Plans. The Company is in the process of developing contingency plans in the event that the Company's systems or products prove to not be Year 2000 compliant. The Company is currently reviewing its key business activities to develop plans to support ongoing business operations in the event of a disruption and expects these plans to be in place at the end of the calendar year. However, the Company cannot give any assurance that these contingency plans will be effective in preventing Year 2000 related disruptions in the business which could have a material adverse impact on the Company's business, operating results and financial condition. Disclaimer. The discussion of the Company's efforts, and management's expectations, relating the Year 2000 compliance are forward-looking statements. The Company's ability to achieve Year 2000 readiness and the level of incremental costs associated therewith, could be adversely impacted by, among other things, the availability and cost of programming and testing resources, vendor's ability to modify proprietary software and unanticipated problems identified in the ongoing review. LIQUIDITY AND CAPITAL RESOURCES Cash, cash equivalents and short-term investments were $62.8 million at September 30, 1999, an increase of $11.8 million from September 30, 1998. The increase is primarily a result of cash generated by operations. The Company's operating activities provided cash of $28.3 million in fiscal 1999, $9.5 million in fiscal 1998 and $15.0 million in fiscal 1997. Cash used for investing activities during fiscal 1999, 1998 and 1997 was $7.2 million, $3.2 million and $14.8 million, respectively. In fiscal 1999, 1998 and 1997, cash was used to fund purchases of technology, property and equipment, common stock repurchases and short-term investments. Cash used for financing activities was $10.4 million, $6.2 million and $10.0 million for fiscal 1999, 1998 and 1997, respectively. In fiscal 1999, 1998 and 1997, proceeds from the issuance of common stock were more than offset by the Company's stock repurchases and payments on capital lease obligations. At September 30, 1999, the Company's principal sources of liquidity included cash and short-term investments and available bank lines of credit of approximately $15.9 million against which the Company had $0.5 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. 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 2000. RECENT ACCOUNTING PRONOUNCEMENTS 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. 9 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. In April 1998, the Accounting Standards Executive Committee issued SOP 98-5, Reporting on the Costs of Start-Up Activities. This standard requires companies to expense the costs of start-up activities and organization costs as incurred. In general, SOP 98-5 is effective for fiscal years beginning after December 15, 1998. The adoption of SOP 98-5 does not have a material impact on our financial statements. In March 1998, the Accounting Standards Executive Committee issued SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which provides guidance on accounting for the cost of computer software developed or obtained for internal use. SOP 98-1 is effective for financial statements for fiscal years beginning after December 15, 1998. The adoption of SOP 98-1 does not have a material impact on our financial statements. 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. QUANTITATIVE DISCLOSURES ABOUT MARKET RISK MARKET-RATE SENSITIVE INSTRUMENTS AND RISK MANAGEMENT The following discussion about the Company's risk-management activities includes "forward-looking statements" that involve risk and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. The following tables summarize the financial instruments and derivative commodity instruments held by the Company at September 30, 1999, which are sensitive to changes in interest rates and foreign exchange rates. The Company uses forward foreign exchange contracts to manage these foreign exchange exposures associated with underlying assets, liabilities and anticipated transactions. The Company uses these instruments to reduce risk by essentially creating offsetting market exposures. The instruments held by the Company are not leveraged and are held for purposes other than trading. In the normal course of business, the Company also faces risks that are either nonfinancial or nonquantifiable. Such risks principally include technology risk, country risk, credit risk and legal risk, and are not represented in the following tables. INTEREST-RATE RISK This table presents descriptions of the financial instruments that are held by the Company at September 30, 1999 and which are sensitive to changes in interest rates. Such securities are anticipated to be used for current operations and are, therefore, classified as current assets, even though maturities may extend beyond one year. The fair value of these instruments approximates the carrying costs. 10 Maturity Date for Short-Term Investments Year Ended September 30,
(In thousands) 2000 2001 2002 Total ------- ------ ----- ------ U.S. Treasury notes $ 751 $ 836 $1,451 $ 3,038 Government agency bonds - 2,001 203 2,204 Corporate bonds 14,397 4,433 5,089 23,919 ------- ------ ------ ------- $15,148 $7,270 $6,743 $29,161 Average interest rate 5.74% 6.21% 5.53% ------- ------ ------ -------
FOREIGN-EXCHANGE RISK The table below provides information about derivative financial instruments that are sensitive to foreign currency exchange rates. The information is presented in U.S. dollar equivalents, the reporting currency of the Company. The Company purchases foreign-exchange contracts to hedge foreign currency exposure for underlying assets, liabilities and other obligations. The purpose of the Company's foreign-currency hedging activities is to protect the Company from the risk that the eventual net cash resulting from foreign denominated transactions will be adversely affected by changes in exchange rates. The table below presents the contract amounts, foreign exchange strike rate and the contract term as of September 30, 1999 and 1998. Forward Contracts September 30, 1999
(In thousands) Contract 1 Contract 2 Contract 3 ---------- ---------- ---------- Purchased three forward contracts Premium paid: $ 30 $ 31 $ 5 Contract amount: 2,000 2,000 2,206 Forward strike rate (United States Dollar/GB Pounds): 1.6140 1.6150 Forward strike rate (Italian Lira/GB Pounds): 2,938 Term of contract: 2 months 3 months 3 months -------- -------- --------
Forward Contracts September 30, 1998
(In thousands) Contract 1 Contract 2 ---------- ---------- Purchased two forward contracts Premium paid: 2 1 Contract amount: 500 1,000 Forward strike rate (USD/GBP): 1.6293 1.6757 Term of contract: 4 months 2 months -------- --------
As of September 30, 1999 and 1998 the fair value of these contracts was not significant. 11 THE SANTA CRUZ OPERATION, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended September 30, ------------------------------------- (In thousands, except per share data) 1999 1998 1997 --------- --------- --------- Net revenues $ 223,624 $ 171,900 $ 193,660 Cost of revenues 48,603 45,898 55,315 --------- --------- --------- Gross margin 175,021 126,002 138,345 --------- --------- --------- Operating expenses: Research and development 40,770 41,393 46,130 Sales and marketing 97,079 79,644 79,536 General and administrative 20,799 18,558 20,900 Non-recurring charges - - 8,373 --------- --------- --------- Total operating expenses 158,648 139,595 154,939 --------- --------- --------- Operating income (loss) 16,373 (13,593) (16,594) Other income (expense): Interest income, net 1,942 2,261 2,291 Other income (expense), net 1,939 226 (866) --------- --------- --------- Income (loss) before income taxes 20,254 (11,106) (15,169) Income taxes 3,396 3,559 1 --------- --------- --------- Net income (loss) 16,858 (14,665) (15,170) Other comprehensive income (loss), net of tax Foreign currency translation adjustment (884) 653 936 --------- --------- --------- Comprehensive income (loss) $ 15,974 $ (14,012) $ (14,234) --------- --------- --------- Earnings (loss) per share: Basic $ 0.49 $ (0.41) $ (0.41) Diluted $ 0.46 $ (0.41) $ (0.41) --------- --------- --------- Shares used in earnings (loss) per share calculation: Basic 34,232 35,817 36,628 Diluted 36,402 35,817 36,628 ========= ========= =========
See accompanying notes to consolidated financial statements. 12 THE SANTA CRUZ OPERATION, INC. CONSOLIDATED BALANCE SHEETS
September 30, ----------------------------- (In thousands) 1999 1998 --------- ---------- ASSETS Current assets: Cash and cash equivalents $ 33,683 $ 23,758 Short-term investments 29,161 27,318 Receivables, net 32,309 28,633 Deferred tax assets 1,202 3,487 Other current assets 6,310 8,052 --------- --------- Total current assets 102,665 91,248 --------- --------- Property and equipment, net 12,234 12,929 Purchased software and technology licenses, net 10,431 13,013 Other assets 13,954 13,999 --------- --------- Total assets $ 139,284 $ 131,189 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Royalties payable $ 7,217 $ 5,062 Trade accounts payable 7,482 7,655 Income taxes payable 1,983 1,876 Accrued expenses and other current liabilities 32,314 28,590 Deferred revenues 11,427 15,844 --------- --------- Total current liabilities 60,423 59,027 --------- --------- Long-term lease obligations 2,332 3,427 Other long-term liabilities 6,191 8,600 --------- --------- Total long-term liabilities 8,523 12,027 --------- --------- Commitments and contingencies (note 10) Shareholders' equity: Common stock, no par value, net of note receivable of $97 and $92 from an officer of the Company, authorized 100,000 shares Issued and outstanding 34,346 and 35,049 shares 106,201 111,972 Accumulated other comprehensive income 408 1,292 Accumulated deficit (36,271) (53,129) --------- --------- Total shareholders' equity 70,338 60,135 --------- --------- Total liabilities and shareholders' equity $ 139,284 $ 131,189 ========= =========
See accompanying notes to consolidated financial statements. 13 THE SANTA CRUZ OPERATION, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated Note Other Total Common Stock Receivable Comprehensive Accumulated Shareholders' (In thousands) Shares Amount from Officer Income Deficit Equity ------------ ---------- ------------ ------------- ---------- ---------- BALANCES, SEPTEMBER 30, 1996 37,106 $ 125,256 $(84) $ (297) $(23,294) $101,581 Issuance under stock option and purchase plans 872 2,985 -- -- -- 2,985 Common stock repurchases (1,528) (9,110) -- -- -- (9,110) Interest on note -- -- (4) -- -- (4) Stock option income tax benefit -- 244 -- -- -- 244 Other comprehensive income -- -- -- 936 -- 936 Net loss -- -- -- -- (15,170) (15,170) --------- --------- ---- ------ -------- -------- BALANCES, SEPTEMBER 30, 1997 36,450 $ 119,375 $(88) $ 639 $(38,464) $ 81,462 Issuance under stock option and purchase plans 659 1,960 -- -- -- 1,960 Common stock repurchases (2,060) (9,271) -- -- -- (9,271) Interest on note -- -- (4) -- -- (4) Other comprehensive income -- -- -- 653 -- 653 Net loss -- -- -- -- (14,665) (14,665) --------- --------- ---- ------ -------- -------- BALANCES, SEPTEMBER 30, 1998 35,049 $ 112,064 $(92) $1,292 $(53,129) $ 60,135 Issuance under stock option and purchase plans 1,721 7,107 -- -- -- 7,107 Common stock repurchases (2,424) (14,034) -- -- -- (14,034) Interest on note -- -- (5) -- -- (5) Stock option income tax benefit -- 1,161 -- -- -- 1,161 Other comprehensive loss -- -- -- (884) -- (884) Net income -- -- -- -- 16,858 16,858 --------- --------- ---- ------ -------- -------- BALANCES, SEPTEMBER 30, 1999 34,346 $ 106,298 $(97) $ 408 $(36,271) $ 70,338 ========== ========= ==== ====== ======== ========
See accompanying notes to consolidated financial statements. 14 THE SANTA CRUZ OPERATION, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended September 30, ------------------------------------------ (In thousands) 1999 1998 1997 -------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 16,858 $ (14,665) $ (15,170) Adjustments to reconcile net income (loss) to net cash provided by operating activities - Depreciation and amortization 12,140 14,363 17,084 Deferred tax assets -- 205 (1,017) Exchange (gain) loss 20 (605) -- Stock option income tax benefit 1,161 -- 244 Changes in operating assets and liabilities- Receivables (4,971) 8,147 10,630 Other current assets 2,545 (2,024) 2,736 Other assets 502 2,362 857 Royalties payable 2,135 (6,197) 618 Trade accounts payable (15) 608 (4,155) Income taxes payable 176 703 (1,132) Accrued expenses and other current liabilities 4,158 (1,977) 3,714 Deferred revenues (6,409) 8,555 627 -------- -------- -------- Net cash provided by operating activities 28,300 9,475 15,036 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (3,816) (1,410) (1,796) Purchases of software and technology licenses (2,633) (2,995) (5,188) Sales of short-term investments 26,811 31,514 17,006 Purchases of short-term investments (28,654) (30,346) (22,726) Changes in other assets 1,058 25 (2,128) -------- -------- -------- Net cash used for investing activities (7,234) (3,212) (14,832) -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments on capital leases (3,626) (2,759) (1,627) Net proceeds from issuance of common stock 7,107 1,960 2,985 Repurchases of common stock (14,034) (9,271) (9,110) Changes in other long-term liabilities 158 3,883 (2,224) -------- -------- -------- Net cash used for financing activities (10,395) (6,187) (9,976) -------- -------- -------- Effects of exchange rate changes on cash and cash equivalents (746) 457 932 -------- -------- -------- Change in cash and cash equivalents 9,925 533 (8,840) Cash and cash equivalents at beginning of year 23,758 23,225 32,065 -------- -------- -------- Cash and cash equivalents at end of year $ 33,683 $ 23,758 $ 23,225 -------- -------- -------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid - Income taxes $ 3,319 $ 2,192 $ 2,168 Interest 544 766 643 Non-cash financing and investing activities - Assets recorded under capital leases $ 1,978 $ 4,701 $ 4,063 Assets written off against restructuring reserve -- 568 125 ======== ======== ========
See accompanying notes to consolidated financial statements. 15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES THE COMPANY The Santa Cruz Operation, Inc. (SCO), or the Company, is a global leader in server software for networked business computing, and the world's leading provider of UNIX(R) server operating systems. 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 with less than 20% ownership 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. Such estimates include the allowances for bad debt, product returns and certain accrued expenses and liabilities, and the valuation allowance for deferred tax assets. 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 included in other comprehensive income. As of September 30, 1999 and 1998, unrealized gains or losses on such investments were not significant. Realized gains and losses, which are calculated based on the specific identification method, are recorded in operations as incurred. 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 owned by the Company. Technology licenses represent payments for the rights to use and integrate 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 ten 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 estimated 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 value of the asset exceeds the projected discounted future operating cash flows. 16 SOFTWARE DEVELOPMENT COSTS Statement of Financial Accounting Standards No. 86 provides for the capitalization of certain software development costs once technological feasibility is established. 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, 1999, 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 The Company's revenue is derived primarily from two sources, across many industries: (i) products license revenue, derived primarily from product sales to resellers and end users, including large scale enterprises and royalty revenue, derived primarily from initial license fees and ongoing royalties from product sales by source code OEMs; and (ii) service and support revenue, derived primarily from providing software updates, support and education and consulting services to end users. The Company adopted the provisions of Statement of Position 97-2, or SOP 97-2, Software Revenue Recognition, as amended by Statement of Position 98-4, Deferral of the Effective Date of Certain Provisions of SOP 97-2, effective October 1, 1998. SOP 97-2 supercedes Statement of Position 91-1, Software Revenue Recognition, and delineates the accounting for software product and maintenance revenue. Under SOP 97-2, the Company recognizes product revenue upon shipment if a signed contract exists, the fee is fixed and determinable, collection of resulting receivables is probable and product returns are reasonably estimable, except for sales to distributors, which are recognized upon sale by the distributor to resellers or end users. Estimated product returns are recorded upon recognition of revenue from customers having rights of return, including exchange rights for unsold products and product upgrades. In 1998 and 1997, the Company's revenue recognition policy was the same as set forth above. For contracts with multiple obligations (e.g. deliverable and undeliverable products, maintenance and other services), the Company allocates revenue to each component of the contract based on objective evidence of its fair value, which is specific to the Company. The Company recognizes revenue allocated to undelivered products when the criteria for product revenue set forth above are met. The Company recognizes revenue from maintenance fees and fees for ongoing customer support and product updates ratably over the period of the underlying contracts. Payments for maintenance and support contracts are generally made in advance and are non-refundable. For revenue allocated to education and consulting services or derived from the separate sale of such services, the Company recognizes revenue as the related services are performed. In 1998 and 1997, the revenue recognition policy for maintenance, education and consulting services was the same as set forth above. The Company recognizes product revenue from royalty payments upon receipt of quarterly royalty reports from OEMs related to their product sales. The Company performs ongoing credit evaluations of its customers' financial condition and does not require collateral. The Company maintains allowances for potential credit losses and such losses have been within management's expectations. 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 maximum 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 1999, 1998 and 1997, cooperative advertising expense totaled approximately $10.5 million, $9.2 million and $8.6 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. 17 COMPUTATION OF EARNINGS PER SHARE The Company has adopted the provisions of Statement of Financial Accounting Standards No. 128 (SFAS 128), Earnings Per Share, effective December 31, 1997. 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 by giving effect to all dilutive potential common shares that were outstanding during the period. For the Company, dilutive potential common shares consist of the incremental common shares issuable upon the exercise of stock options for all periods. In accordance with SFAS 128, all prior period earnings per share amounts have been restated to reflect this method of calculation. A reconciliation of the numerator and denominator used in the calculation of basic and diluted earnings per share is provided as follows (in thousands, except per share amounts):
Fiscal Year Ended September 30, ------------------------------------ 1999 1998 1997 ------- ----------- -------- Numerator - Earnings (loss) per share, basic and diluted Net income (loss) $16,858 $ (14,665) $(15,170) ======= ========== ======== Denominator - Earnings (loss) per share, basic Weighted average common shares outstanding 34,232 35,817 36,628 ======= ========== ======== Earnings (loss) per share - basic $ 0.49 $ (0.41) $ (0.41) ======= ========== ======== Denominator - Earnings (loss) per share, diluted Weighted average common shares outstanding 34,232 35,817 36,628 Effect of dilutive securities - common stock options and warrants 2,170 -- -- ------- ---------- -------- Shares used in per share calculation 36,402 35,817 36,628 ======= ========== ======== Earnings (loss) per share - diluted $ 0.46 $ (0.41) $ (0.41) ======= ========== ========
Certain shares of common stock issuable upon exercise of stock options were excluded from the calculation of diluted earnings per share because the options' exercise price was greater than the average market price of the common shares. For fiscal 1999, 1998 and 1997 these excluded options were 3,190,168, 10,345,506 and 8,545,517, respectively. The price range of the excluded options was $6.06 to $12.00 for 1999 and $0.41 to $12.00 for 1998 and 1997, respectively. COMPREHENSIVE INCOME In the first quarter of fiscal 1999, the Company adopted SFAS No. 130, Reporting Comprehensive Income. Under SFAS 130 the Company is required to report comprehensive income, which includes the Company's net income, as well as changes in equity from other sources. In the Company's case, the only change in equity included in comprehensive income is the foreign currency cumulative translation adjustment. The adoption of SFAS 130 had no impact on the Company's net income, balance sheet or shareholders' equity. SEGMENT INFORMATION In 1999, the Company adopted Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information. SFAS 131 supercedes SFAS 14, Financial Reporting for Segments of a Business Enterprise. Under the new standard the Company is required to use the "management" approach to reporting its segments. The management approach designates the internal organization used by management for making operating decisions and assessing performance as the source of the Company's segments. The adoption of SFAS 131 had no impact on the Company's net income, balance sheet or shareholders' equity. RECENT ACCOUNTING PRONOUNCEMENTS 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 18 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. We do not expect the provisions of SOP 98-9 to have a significant impact on our current revenue recognition policies. 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 recognizes all derivatives as either assets or liabilities in the statement of financial position and measures those instruments at fair value. Management has not yet evaluated the effects of this change on its operations. Implementation of this standard has recently been delayed by the FASB for a 12-month period. The Company will adopt SFAS 133 as required for its first quarterly filing of fiscal year 2001. In April 1998, the Accounting Standards Executive Committee issued SOP 98-5, Reporting on the Costs of Start-Up Activities. This standard requires companies to expense the costs of start-up activities and organization costs as incurred. In general, SOP 98-5 is effective for fiscal years beginning after December 15, 1998. The adoption of SOP 98-5 does not have a material impact on our financial statements. In March 1998, the Accounting Standards Executive Committee issued SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which provides guidance on accounting for the cost of computer software developed or obtained for internal use. SOP 98-1 is effective for financial statements for fiscal years beginning after December 15, 1998. The adoption of SOP 98-1 does not have a material impact on our financial statements. 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. 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 U.S. dollars at the exchange rate prevailing on the balance sheet date. Revenues, costs and expenses are translated at average rates of exchange prevailing during the period. Translation adjustments resulting from translation of intercompany accounts 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, 1999 and 1998, the Company had foreign exchange contracts, all having maturities of 90 days or less, to sell approximately $6,206,000 and $1,500,000 in U.S. dollars, respectively. 19 The fair value of these contracts at September 30, 1999 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. As of September 30, 1999 and 1998 the following contracts were outstanding.
September 30, 1999 ---------------------------------------- (In thousands) Contract 1 Contract 2 Contract 3 ---------- ---------- ---------- Purchased three forward contracts Premiums paid: $ 30 $ 31 $ 5 Contract amount 2,000 2,000 2,206 Forward strike rate (United States Dollars/GB Pounds): 1.6140 6.6150 Forward strike rate (Italian Lira/GB Pounds): 2,938 Term of contract: 2 months 3 months 3 months
September 30, 1998 ------------------------ (In thousands) Contract 1 Contract 2 ---------- ---------- Purchased two forward contracts Premium paid: 2 1 Contract amount: 500 1,000 Forward strike rate (United States Dollars/GB Pounds): 1.6293 1.6757 Term of contract: 4 months 2 months
FAIR VALUE OF FINANCIAL INSTRUMENTS Carrying amounts of certain of the Company's financial instruments, including cash and cash equivalents, accrued payroll and other accrued liabilities, approximate fair value because of their short maturities. The fair values of investments are determined using quoted market prices for those securities or similar financial instruments. NOTE 2 - CASH AND CASH EQUIVALENTS
September 30, ------------------- (In thousands) 1999 1998 ------- -------- Bank demand deposits $ 6,859 $ 1,035 Money market accounts 26,524 20,660 Corporate bonds 300 2,063 -------- -------- $ 33,683 $ 23,758 ======== ========
NOTE 3 - SHORT-TERM INVESTMENTS
September 30, -------------------- (In thousands) 1999 1998 -------- -------- U.S. Treasury notes $ 3,038 $ 4,078 Government agency bonds 2,204 7,153 Corporate bonds 23,919 16,087 -------- -------- $ 29,161 $ 27,318 ======== ========
At September 30, 1999, investments with maturity dates ranging from 91 days to one year totaled $9.4 million, and investments with maturity dates ranging from one year to three years totaled $19.8 million. NOTE 4 - RECEIVABLES
September 30, -------------------- (In thousands) 1999 1998 -------- -------- Trade accounts receivable $ 40,531 $ 40,815 Less allowance for returns and doubtful accounts (8,222) (12,182) -------- -------- $ 32,309 $ 28,633 ======== ========
The Company generates a significant portion of its revenues through distributors of computer software in North America, Europe, South America 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 fiscal 1999, 1998 and 1997, no one customer's balance exceeded 10% of trade receivables or accounted for greater than 10% of the Company's revenues. 20 NOTE 5 - PROPERTY AND EQUIPMENT
September 30, -------------------- (In thousands) 1999 1998 -------- -------- Computer and office equipment $ 41,146 $ 43,218 Furniture and fixtures 8,516 8,467 Leasehold improvements 8,472 8,001 -------- -------- 58,134 59,686 Less accumulated depreciation and amortization (45,900) (46,757) -------- -------- $ 12,234 $ 12,929 ========= ========
Depreciation and amortization expense was $6.4 million, $6.9 million and $7.5 million during fiscal 1999, 1998 and 1997, respectively. NOTE 6 - PURCHASED SOFTWARE AND TECHNOLOGY LICENSES
September 30, ------------------- (In thousands) 1999 1998 -------- -------- Purchased software and technology licenses, at cost $ 35,429 $ 33,791 Less accumulated amortization (24,998) (20,778) ------- -------- $ 10,431 $ 13,013 ======== ========
Amortization expense was $5.3 million, $6.6 million and $7.8 million during fiscal 1999, 1998 and 1997, respectively. NOTE 7 - BANK LINE OF CREDIT At September 30, 1999, the Company had available lines of credit of approximately $15.9 million. The company signed an agreement for a domestic line of credit of $15.0 million on September 30, 1999. The agreement provides that the Company may borrow an amount up to $15.0 million at the prime rate and is collateralized by accounts receivable. This line of credit was not utilized during fiscal 1999. 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, 1999. The Company also maintains a $0.9 million line of credit internationally under which the Company had $0.5 million in outstanding borrowings at September 30, 1999. The interest rate on borrowings made against this line of credit during fiscal 1999 was 2.2%. NOTE 8 - ROYALTIES PAYABLE Royalties payable represent obligations to pay authors of certain software products under licensing agreements. Two corporate shareholders accounted for $0.4 million and $0.6 million of the royalties payable balance at September 30, 1999 and 1998, respectively, and $1.2 million, $(2.1) million and $4.2 million of royalty expense (income) for fiscal 1999, 1998 and 1997, respectively. 21 NOTE 9 - ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
September 30, --------------------- (In thousands) 1999 1998 -------- -------- Accrued wages, commissions, bonuses $ 12,664 $ 9,316 Accrued advertising 6,016 4,531 Accrued fringe benefits 1,898 1,703 Capital lease obligations 2,952 3,505 Other accrued expenses 8,784 9,535 -------- ------- $ 32,314 $28,590 ======== =======
NOTE 10 - COMMITMENTS AND CONTINGENCIES 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, 1999 were as follows:
Capital Operating (In thousands) Leases Leases --------- ----------- Year Ending September 30, 2000 $ 3,267 $ 7,664 2001 1,853 6,930 2002 492 6,182 2003 -- 5,009 2004 -- 4,934 Later years, through 2020 -- 14,036 --------- ---------- Total minimum lease payments 5,612 $ 44,755 ========== Less amount representing interest 328 --------- Present value of net minimum capital lease payments 5,284 Less current installments of obligations under capital leases 2,952 --------- Obligations under capital leases, excluding current installments $ 2,332 =========
The cost of assets recorded under capital leases was $13.0 million and $11.5 million at September 30, 1999 and 1998, respectively. Accumulated amortization on those dates was $7.9 million and $4.5 million, respectively. Rent expense amounted to approximately $8.0 million, $8.1 million and $8.6 million in fiscal 1999, 1998 and 1997, respectively. Included in the Company's operating lease commitments are facilities leased from Encinal Partners, a partnership which includes both the Company President and Chief Executive Officer and a principal shareholder. 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 22 facilities is between one and six years. Rent expense for these facilities amounted to approximately $1.4 million in each of fiscal 1999, 1998 and 1997. CONTINGENCIES In December 1995, the Company acquired from Novell certain assets related to UnixWare. As consideration, the Company may be required to make cash payments periodically 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 payment obligation will terminate at the end of calendar year 2002. From time to time, the Company and its subsidiaries may experience claims in the ordinary course of business, including among others employee legal actions and alleged trademark infringements. Due to the nature of these matters, it is not possible to either determine the range of loss that may result from them or their ultimate resolution. NOTE 11 - SHAREHOLDERS' EQUITY PREFERRED STOCK The Company is authorized to issue 20,000,000 shares of Preferred Stock. As of September 30, 1999, 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 1999, 1998 and 1997, employees purchased 589,968, 567,647 and 431,351 shares at an average per share price of $3.52, $3.07 and $4.81, respectively. The number of shares reserved for issuance under the Purchase Plan increased by 750,000 shares in February 1999. As of September 30, 1999, 1,360,149 shares were reserved for future issuance. 1994 INCENTIVE STOCK OPTION PLAN As of September 30, 1999, the Company had authorized 17,013,665 shares of Common Stock for issuance under the 1994 Incentive Stock Option Plan (the "Option Plan"). 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 stock option committee of the Company's Board of Directors 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 non-employee directors of the Company and is administered by the Board of Directors. In February of 1999, the number of shares available for issuance under the Director Plan was increased by 200,000 shares from 950,000 shares to 1,150,000 shares. A summary of the status of the Company's stock option plans as of September 30, 1999, 1998 and 1997, and changes during the years then ended is presented below: 23
(In thousands, except 1999 1998 1997 per share data) ------------------------ ----------------------- ------------------------- Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Option and Director Plans Shares Price Shares Price Shares Price ----------- ---------- ----------- --------- --------- ------------ Outstanding at beginning of year 10,349 $ 4.80 8,558 $ 5.25 6,419 $ 6.93 Granted 3,009 6.50 3,102 3.87 8,345 5.43 Exercised (1,131) 4.44 (91) 2.37 (441) 2.08 Cancelled (736) 5.25 (1,220) 5.80 (5,765) 7.62 ----------- ---------- --------- Outstanding at end of year 11,491 5.25 10,349 4.80 8,558 5.25 =========== ========== ========= Options exercisable at year-end 4,480 $ 5.08 3,484 $ 5.17 1,678 $ 5.54 Weighted-average fair value of options granted during the year $ 3.61 $ 2.19 $ 2.13 ========== ========= ==========
The following table summarizes information about stock options outstanding at September 30, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------------------- -------------------------------------- Number Number Outstanding Weighted-Avg Exercisable Range of at 9/30/99 Remaining Weighted-Avg at 9/30/99 Weighted-Avg Exercise Price (000) Contractual Life Exercise Price (000) Exercise Price - ------------------------------------------------------------------------------- -------------------------------------- $ 1.25 - 1.50 78 1.6 years $ 1.41 78 $ 1.41 2.00 - 3.00 501 8.1 2.55 166 2.49 3.19 - 4.75 3,909 8.4 4.21 1,264 4.15 4.81 - 7.15 6,036 7.6 5.54 2,760 5.45 7.25 - 10.50 924 8.8 9.27 169 8.52 12.00 - 12.00 43 3.6 12.00 43 12.00 --------- --------- $ 1.25 - 12.00 11,491 8.0 years $ 5.25 4,480 $ 5.08 ========= ========= - ------------------------------------------------------------------------------------------------------------------------
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 its employee stock options and other stock-based compensation granted subsequent to September 30, 1996 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 1999, 1998 and 1997: risk-free interest rate of 5.27% for 1999, 5.45% for 1998, and 6.19% for 1997; dividend yield of 0%; volatility factor of the expected market price of the Company's common stock of 65% for 1999 and 1998 and 55% for 1997; an average turnover rate of 15% and a four year and five year expected life for options granted to employees and executives, respectively. 24 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 1999, 1998 and 1997: risk-free interest rates of 4.91%, 5.31% and 5.31%, respectively; dividend yield of 0%; volatility factors of 65% for 1999 and 1998 and 55% for 1997; and six month expected life. The weighted average fair value of the ESPP rights granted in 1999, 1998 and 1997 was $1.31, $1.27 and $1.71, respectively.
(In thousands, except Fiscal Year Ended per share price) September 30, ------------------------------------- 1999 1998 1997 --------- -------- -------- Pro forma net income (loss) $10,464 $(20,664) $(18,625) Pro forma earnings (loss) per share Basic $ 0.31 $ (0.58) $ (0.51) Diluted $ 0.29 $ (0.58) $ (0.51)
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, 1999, 1998 and 1997, the purchases and retirements of common stock under the systematic plan were 1,038,000 shares, 1,115,000 shares and 843,000 shares, respectively. Under the non-systematic repurchase plan, the Company may repurchase up to 6,000,000 shares of its common stock. During the fiscal years ended September 30, 1999, 1998 and 1997, 1,386,000, 945,050 and 685,000 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 2000. SHAREHOLDER RIGHTS In September 1997, the Company adopted a Shareholder Rights Plan which provides existing shareholders 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 takeover attempts not approved by the Company's Board of Directors. The rights expire in September 2007. NOTE 12 - INCOME TAXES Income (loss) before income taxes for fiscal 1999, 1998 and 1997 include foreign pretax profit (loss) of approximately $6.6 million, $(3.0) million and $2.2 million, respectively. The components of income taxes are as follows: 25
Fiscal Year Ended September 30, ------------------------------- (In thousands) 1999 1998 1997 ------ ------ ------- Current: Federal $ 500 $ - $ (846) State 20 20 (774) Foreign 2,876 3,334 2,394 ------ ------ ------- Total current 3,396 3,354 774 ------ ------ ------- Deferred: Federal - - 1,450 State - - (308) Foreign - 205 (2,159) ------ ------ ------- Total deferred - 205 (1,017) ------ ------ ------- Charge in lieu of income tax expense related to employee stock options - - 244 ------ ------ ------- $3,396 $3,559 $ 1 ====== ====== =======
Income taxes differ from the amount computed by applying the statutory federal income tax rate to income (loss) before income taxes as follows:
Fiscal Year Ended September 30, ----------------------------------- (In thousands) 1999 1998 1997 ------- ------- ------- Statutory federal income tax (benefit) at 34% $ 6,887 $(3,776) $(5,157) State income tax (benefit), net of federal effect 247 (338) (714) Foreign taxes less related tax benefit, if any 669 3,659 502 Losses and expenses without tax benefit - 4,014 5,836 Current utilization of losses (4,407) - - Other, net - - (466) ------- ------- ------- $ 3,396 $ 3,559 $ 1 ======= ======= =======
The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows: 26
Fiscal Year Ended September 30, ------------------------------------ (In thousands) 1999 1998 1997 -------- -------- -------- Deferred tax assets: Accruals and reserve accounts $ 7,613 $ 9,732 $ 6,130 Property and equipment 1,641 1,477 2,696 Net operating loss carryforward 7,032 18,550 9,644 Research credit 7,602 7,105 6,715 Foreign tax and other credits 12,346 1,020 1,986 -------- -------- -------- Total gross deferred tax assets 36,234 37,884 27,171 Less valuation allowance (26,885) (26,330) (17,452) -------- -------- -------- Net deferred tax assets 9,349 11,554 9,719 -------- -------- -------- Deferred tax liabilities: Amortization 1,525 3,730 1,690 -------- -------- -------- Total deferred tax liabilities 1,525 3,730 1,690 -------- -------- -------- Net tax assets and liabilities $ 7,824 $ 7,824 $ 8,029 ======== ======== ========
The net change in the total valuation allowance for the years ended September 30, 1999, 1998 and 1997, was an increase of approximately $0.6 million, $8.9 million and $7.9 million, respectively. Subsequently recognized tax benefits relating to the valuation allowance for deferred tax assets as of September 30, 1999 will be allocated to income tax benefit and additional paid in capital in the amounts of $25.8 million and $1.1 million, respectively. The Company's management believes the uncertainty regarding the timing of the realization of net deferred tax assets requires a valuation allowance. As a result a valuation has been established to reduce gross deferred tax assets to the level that management believes will, more likely than not, be recovered. Management has based this analysis on future projections, the Company's recent history of profits and on the amounts which will be recovered based on profitable operations in a number of the Company's foreign subsidiaries. At September 30, 1999, the Company has net operating loss carryforwards of approximately $22.0 million which expire in fiscal years 2012 through 2018, and foreign tax credit and research credit carryforwards of approximately $11.3 million and $6.4 million, respectively, which expire in fiscal 2000 through 2013. At September 30, 1999, the cumulative unremitted foreign earnings of the Company were not material. The Company 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 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 were outsourced and elements of general and administration functions were consolidated. The restructuring charge payable and payments against it can be summarized as follows: 27
Reduction (In thousands) in Force Facilities Technology Other Total ------- ------- ------- ------- ------- Restructuring charge accrued $ 3,359 $ 1,925 $ 1,433 $ 1,656 $ 8,373 Fiscal 1997 payments / write-offs (2,551) (485) (1,433) (1,055) (5,524) ------- ------- ------- ------- ------- Accrual at end of fiscal 1997 808 1,440 - 601 2,849 Fiscal 1998 payments / write-offs (798) (758) - (601) (2,157) ------- ------- ------- ------- ------- Accrual at end of fiscal 1998 10 682 - - 692 Fiscal 1999 payments / write-offs (10) (682) - - (692) ------- ------- ------- ------- ------- Accrual at end of fiscal 1999 $ - $ - $ - $ - $ - ======= ======= ======= ======= =======
NOTE 14 - INVESTMENTS In November 1996, the Company purchased $2.0 million of convertible debentures of a domestic distribution channel partner. In February 1999, the Company elected to convert, in its entirety, the debenture into shares of preferred stock. In the event the partner has not consummated an underwritten public offering or other liquidity event by March 2001 which returns to the Company its entire $2.0 million investment, the Company shall be entitled to redeem the preferred shares for $2.0 million plus 6% per annum per year on such amount commencing March 1999. Said sum may be paid immediately upon redemption or may be paid in up to six equal quarterly installments of principal plus interest, at an interest rate equal to the prime rate, adjusted quarterly. The Company's ownership of preferred stock in the distribution partner represents 19.9% of the distribution company's equity, and the Company has the right to have one Board member who has observation rights only. The Company accounts for the investment using the cost method as it is not deemed to exert significant influence. During 1999 the Company recorded an impairment charge of $1.0 million to adjust the value of its investment in the net assets of the distribution partner. In January 1995, the Company purchased 10% of the preferred stock of Rainmaker Systems, Inc. ("Rainmaker"), another of the Company's domestic distribution partners, in exchange for cash, product and equipment valued at $1.0 million. In addition, the Company loaned $1.0 million to Rainmaker in exchange for convertible debentures. In February 1999, the Company exchanged the preferred stock and debentures for shares of Series D Convertible Participating Preferred Stock (the "Series D Preferred"). The Company sold a portion of these shares and this investment is valued at $1.4 million at September 30, 1999. On August 30, 1999 the Company entered into a "Put and Call" agreement which allows it to sell up to 307,692 shares of Rainmaker stock at a price of $6.50 per share. As of September 30, 1999 there were no exercises against this agreement. The Company does not have a position on the Board of Directors. Due to the relatively small number of shares held by the Company, the Company does not have the ability to exercise influence over Rainmaker, and consequently, the Company's investment is accounted for under the cost method. As of September 30, 1999, the Company held 4,013,459 shares of Rainmaker preferred stock, at a cost basis of $0.3377 per share. For the year ended September 30, 1999, the Company sold 1,704,011 shares, resulting in a net gain of $3,271,860. At September 30, 1999 and 1998, the Company had accounts receivable outstanding with these related parties of $3.2 million and $1.5 million, respectively. Sales to the related parties were $24.8 million for fiscal 1999, $18.6 million for fiscal 1998 and $18.3 million for fiscal 1997. NOTE 15 - INDUSTRY AND GEOGRAPHIC SEGMENT INFORMATION The Company has adopted the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of an Enterprise and Related Information, effective for fiscal years beginning after December 31, 1997. SFAS 131 supercedes SFAS 14, Financial Reporting for Segments of a Business Enterprise. SFAS 131 changes current practice under SFAS 14 by establishing a new framework on which to base segment reporting and also requires interim reporting of segment information. The Company reviews performance on the basis of geographical segments. The Company uses analysis of segment revenues and gross margin in order to make preliminary decisions of resource allocation. No information on total assets by segment is reviewed. The accounting policies used by each segment comply with the policies used in the consolidated financial statements. 28 Each segment markets the Company's software products to companies in a number of industries including telecommunications, manufacturing and government bodies. These products 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 as well as information on long lived assets by geography. Revenue is allocated to 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.
Fiscal Year Ended September 30, ------------------------------------ (In thousands) 1999 1998 1997 -------- -------- -------- NET REVENUES: United States $ 96,809 $ 83,037 $ 84,483 Canada and Latin America 12,606 9,801 9,660 Europe, Middle East, India and Africa 95,270 63,379 78,370 Asia Pacific 18,161 14,471 18,751 Corporate Adjustments 778 1,212 2,396 -------- -------- -------- Total net revenues $223,624 $171,900 $193,660 ======== ======== ======== GROSS MARGIN: (1) United States $ 73,576 Canada and Latin America 9,276 Europe, Middle East, India and Africa 76,943 Asia Pacific 14,615 Corporate Adjustments 611 -------- Total gross margin $175,021 ======== LONG-LIVED ASSETS United States $ 31,058 $ 34,779 $ 40,264 Canada and Latin America 122 15 37 Europe, Middle East, India and Africa 5,234 4,897 4,177 Asia Pacific 155 200 315 Other international operations 50 50 50 -------- -------- -------- Total long-lived assets $ 36,619 $ 39,941 $ 44,843 ======== ======== ========
(1) Gross margin by geography was not tracked by the Company prior to fiscal year 1999. In 1999, 1998 and 1997 no single customer accounted for 10% or more of the Company's net revenues. NOTE 16 - EMPLOYEE BENEFIT PLAN SAVINGS PLAN The Company maintains an employee savings plan, which qualifies under section 401(k) of the Internal Revenue Code. Under the plan, participating U.S. employees may defer up to 20% of their pre-tax salary, up to certain statutory limits. The Company matches 50% of employee contributions up to the lower of 6% of the employee's annual salary or $3,000. For fiscal 1999, 1998 and 1997, the Company's total contributions towards the 401(k) plan amounted to $1.0 million, $0.9 million and $0.9 million, respectively. 29 NOTE 17 - SUBSEQUENT EVENTS On November 17, 1999, Rainmaker completed an initial public offering of its common stock. On such date, the shares of Series D Preferred 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. The Company will account for these shares as available for sale securities and records them at fair market value, based on quoted market prices with any unrealized gains or losses included as part of accumulated other comprehensive income. As the Company has recorded a valuation allowance for a portion of its deferred tax assets, the tax effect of any unrealized gain will be recorded against the valuation allowance recorded. Any resulting reversal of the valuation allowance will be recorded in accumulated other comprehensive income as the reversal does not relate to an item included in the statement of operation. Rainmaker's common stock is traded on the Nasdaq National Market under the symbol "RMKR." In December 1999, the Company purchased $0.3 million of convertible debentures of a strategic partner. The Company may convert the debentures at any time prior to December 2001 into 333,333 shares of preferred stock. The Company has the right to invest up to an additional $0.7 million in exchange for similar debentures, such right to expire in June 2000. The Company also has a warrant to purchase up to 666,666 shares of preferred stock, such warrants to expire December 2004. If the Company elects not to convert the debentures prior to December 2001, the strategic partner shall immediately pay the principal sum owing plus accrued interest. The Company's equity ownership is less than 5% and as the Company does not have the ability to exercise significant influence over the strategic partner, the Company's investment will be accounted for under the cost method. NOTE 18 - SUBSEQUENT EVENTS (UNAUDITED) SUBSEQUENT EVENTS 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. 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. 30 REPORTS OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of The Santa Cruz Operation, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of shareholders' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of The Santa Cruz Operation, Inc. and its subsidiaries at September 30, 1999 and 1998, and the results of their operations and their cash flows for each of the years then ended, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP San Jose, California October 22, 1999 except for Note 17 which is as of December 1, 1999 To the Board of Directors and Shareholders of The Santa Cruz Operation, Inc. We have audited the accompanying consolidated statements of operations, shareholders' equity (deficit) and cash flows of The Santa Cruz Operation, Inc. and subsidiaries for the year 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 audit. We conducted our audit 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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of The Santa Cruz Operation, Inc. and subsidiaries for the year ended September 30, 1997, in conformity with generally accepted accounting principles. KPMG LLP Mountain View, California October 22, 1997 31 THE SANTA CRUZ OPERATION, INC. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
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) 1999 1999 1999 1998 1998 1998(1) 1998 1997 -------- -------- -------- -------- ------- -------- -------- ------- Net revenues $ 58,120 $ 57,060 $ 55,738 $ 52,706 $48,622 $ 25,241 $ 50,540 $47,497 Cost of revenues 11,955 12,353 12,427 11,868 10,473 10,126 12,953 12,346 ------ ------ ------ ------ ------ ------ ------ ------ Gross margin 46,165 44,707 43,311 40,838 38,149 15,115 37,587 35,151 ------ ------ ------ ------ ------ ------ ------ ------ Operating expenses: Research and development 10,328 10,265 10,287 9,890 10,066 10,157 10,411 10,759 Sales and marketing 26,143 24,267 23,612 23,057 20,393 20,445 19,187 19,619 General and administrative 4,758 5,691 5,777 4,573 5,078 4,626 4,250 4,604 ------ ------ ------ ------ ------ ------ ------ ------ Total operating expenses 41,229 40,223 39,676 37,520 35,537 35,228 33,848 34,982 ------ ------ ------ ------ ------ ------ ------ ------ Operating income (loss) 4,936 4,484 3,635 3,318 2,612 (20,113) 3,739 169 Other income (expense): Interest income, net 410 458 498 576 637 679 470 475 Other income (expense), net 905 598 446 (10) 230 (53) (52) 101 ------ ------ ------ ------ ------ ------ ------ ------ Income (loss) before income taxes 6,251 5,540 4,579 3,884 3,479 (19,487) 4,157 745 Income taxes 876 1,005 735 780 800 1,482 956 321 ------ ------ ------ ------ ------ ------ ------ ------ Net income (loss) 5,375 4,535 3,844 3,104 2,679 (20,969) 3,201 424 Other comprehensive income (loss), net of tax (5) (26) (597) (256) 317 (46) 159 223 ------ ------ ------ ------ ------ ------ ------ ------ Comprehensive income (loss) $ 5,370 $ 4,509 $ 3,247 $ 2,848 $ 2,996 ($21,015) $ 3,360 $ 647 ------ ------ ------ ------ ------ ------ ------ ------ Earnings (loss) per share: Basic $ 0.16 $ 0.13 $ 0.11 $ 0.09 $ 0.08 ($ 0.59) $ 0.09 $ 0.01 Diluted $ 0.14 $ 0.13 $ 0.11 $ 0.09 $ 0.08 ($ 0.59) $ 0.09 $ 0.01 ------ ------ ------ ------ ------ ------ ------ ------ Shares used in earnings (loss) per share calculation: Basic 33,880 33,951 34,339 34,757 35,221 35,611 36,094 36,345 Diluted 38,319 36,082 35,394 35,321 35,408 35,611 36,431 37,094 ====== ====== ====== ====== ====== ====== ====== ======
(1) During the three months ended June 30, 1998 the Company recorded a reserve of $16.1 million in respect of a one term return right granted to the Company's and the elimination of the remaining balance of channel inventory. EX-21.1 3 f66568ex21-1.txt EXHIBIT 21.1 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 Australia SCO do Brasil Ltda. Brazil SCO Canada, Company Canada The Santa Cruz Operation (France) SARL France The Santa Cruz Operation (Deutschland) GmbH Germany The Santa Cruz Operation (Italia) Srl Italy SCO, Kabushiki Kaisha Japan Nihon SCO Limited Japan The Santa Cruz Operation de Mexico, S. DE R.L. DE C.V. Mexico The Santa Cruz Operation Limited UK The Santa Cruz Operation (Asia) Ltd. Delaware The Santa Cruz Operation Latin America, Inc. Delaware SCO Foreign Sales Corporation U.S. Virgin Islands
EX-23.1 4 f66568ex23-1.txt EXHIBIT 23.1 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders The Santa Cruz Operation, Inc.: We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-79583) of Santa Cruz Operations of our reports dated October 22, 1999 except for note 17 which is as of December 1, 1999 and October 22, 1999 relating to the financial statements and financial statement schedule, which appears in this Form 10-K/A. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP San Jose, California November 6, 2000 The Board of Directors The Santa Cruz Operation, Inc.: We consent to incorporation by reference in the registration statement (No. 333-79583) on Form S-8 of The Santa Cruz Operation, Inc. of our reports dated October 22, 1997, relating to the consolidated statements of operations, shareholders' equity (deficit) and cash flows of The Santa Cruz Operation, Inc. and subsidiaries for the year ended September 30, 1997, and the related schedule, which reports appear or are incorporated by reference in the September 30, 1999, annual report on Form 10-K/A of The Santa Cruz Operation, Inc. /s/ KPMG LLP Mountain View, California November 6, 2000 EX-27.1 5 f66568ex27-1.txt FINANCIAL DATA SCHEDULE
5 1,000 12-MOS SEP-30-1999 OCT-01-1998 SEP-30-1999 33,683 29,161 40,531 (8,222) 796 102,665 58,134 (45,900) 139,284 60,423 0 0 0 106,201 (35,863) 139,284 208,466 223,624 30,051 48,603 158,648 0 3,881 20,254 3,396 16,858 0 0 0 16,858 0.49 0.46
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