Recent Developments
Novell, Inc. Ruling
On August 10, 2007, the federal judge overseeing our lawsuit with Novell, Inc. ("Novell") ruled in favor of Novell on several of the summary judgment motions that were before the United States District Court in Utah (the "Court"). The effect of these rulings was to significantly reduce or eliminate certain of our claims in both the Novell and IBM cases, and possibly others. The Court ruled that Novell was the owner of the UNIX and UnixWare copyrights that existed at the time of the 1995 Asset Purchase Agreement and that Novell retained broad rights to waive our contract claims against IBM. The Court ruled that we own the copyrights to post 1995 derivatives and that we have certain other ownership rights and licenses in the UNIX technology. We were directed to accept Novell's waiver of our UNIX contract claims against IBM. In addition, the Court determined that certain SCOsource licensing agreements that we executed in fiscal year 2003 included older SVRx licenses and that we were possibly required to remit some portion of the proceeds to Novell. Over our objection, a bench trial was set to begin on September 17, 2007 and the federal judge was to determine what portion, if any, of the proceeds of the SCOsource agreements is attributable to such SVRx licenses and should be remitted to Novell. The range of the payment to Novell is from a de minimis amount to in excess of $30,000,000, the latter amount being the amount claimed by Novell, plus interest. Novell has sought to impose a constructive trust on our current funds traceable to those sources, which could result in a freeze of our assets, and the Court indicated that it would address that issue as well. It is our desire and intent to appeal the adverse August 10, 2007 summary judgement ruling as soon as that opportunity is available to us. However, we must go through further legal proceedings before we can take such an appeal. In the event that any substantial amount of our assets are frozen or if our assets or resources are further depleted, we may not be able to appeal the adverse August 10, 2007 ruling.
The trial of these issues, however, was stayed as a result of our filing a voluntary petition for relief under Chapter 11 of the Bankruptcy Code on September 14, 2007. Our management and Board of Directors determined that filing for relief under Chapter 11 of the United States Bankruptcy Code was appropriate and necessary. As a result of both the Court's August 10, 2007 ruling and our entry into Chapter 11, among other matters, there is substantial doubt about our ability to continue as a going concern including continuing the SCO litigation or appealing the adverse ruling of August 10, 2007. Absent a significant cash payment to Novell for this matter, management believes that the undiscounted future cash flows generated by us will be sufficient to recover the carrying amounts of our long-lived assets over their expected remaining useful lives. However, if a significant cash payment is required, or significant assets are put under a constructive trust, the carrying amounts of our long-lived assets may not be recovered (which totaled $359,000 as of October 31, 2007). Our statements do not include any adjustments that might result from the outcome of these uncertainties. The bankruptcy court in Delaware has ruled that it will retain jurisdiction over the constructive trust issue but lifted the stay to allow Novell's claims for amounts due under the SCOsource agreements and our authority to enter into those licenses to go to trial in federal court in Utah. A four-day bench trial has been scheduled for April 29, 2008 in the U.S. District Court in Utah. Novell has determined to file a motion for summary judgment on the issue of whether we had the authority to enter into the SCOsource licenses and we are currently briefing that motion. The bankruptcy court in Delaware also ruled that the bankruptcy stay applies to the SuSE arbitration proceeding pending in Europe.
We intend to maintain business operations throughout the reorganization process. Subject to the bankruptcy court's approval, we will use our cash, cash equivalents, restricted cash and subsequent cash inflows to meet our working capital needs throughout the reorganization process.

Bankruptcy Filing
On September 14, 2007, The SCO Group, Inc. and its wholly owned subsidiary, SCO Operations, Inc. (the "Debtors") filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). The Debtors' Chapter 11 cases are being jointly administered under Case Nos. 07-11337 and 07-11338. The Debtors will continue to operate their businesses as "debtors-in-possession" under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. Our foreign subsidiaries were not included in the filings and will continue their business operations. Our foreign subsidiaries, as non-debtors, are not subject to the requirements of the Bankruptcy Code and are not subject to Bankruptcy Court supervision.
In connection with our cases, we filed motions with the Bankruptcy Court requesting, among other things, the ability to maintain our existing bank accounts and cash management systems, permission to pay pre-bankruptcy wage-related items, the establishment of procedures relating to utility providers and authority to employ temporary employees, in an effort to minimize any disruption the filings might otherwise cause. On September 18, 2007, the Bankruptcy Court granted the relief requested. As debtors-in-possession, we continue to exercise control over our assets and business, subject to the supervision of the Bankruptcy Court and the requirements under the Bankruptcy Code and bankruptcy rules. We will continue operating and will file a plan of reorganization with the Bankruptcy Court in due course.
As a result of the Chapter 11 filings, realization of assets and liquidation of liabilities are subject to uncertainty. While operating as debtors-in-possession under the protection of Chapter 11 of the Bankruptcy Code, the Debtors may sell or otherwise dispose of assets and liquidate or settle liabilities for amounts other than those reflected in the consolidated financial statements, in the ordinary course of business, or, if outside the ordinary course of business, subject to Bankruptcy Court approval.
In addition, under the priority scheme established by the Bankruptcy Code, unless creditors agree otherwise, post-petition liabilities and prepetition liabilities must be satisfied in full before shareholders are entitled to receive any distribution or retain any property under a plan of reorganization. The ultimate recovery by creditors and/or shareholders, if any, will not be determined until confirmation of a plan or plans of reorganization. No assurance can be given as to what values, if any, will be ascribed in the Chapter 11 cases to each of these constituencies or what types or amounts of distributions, if any, they would receive. A plan of reorganization could result in holders of our stock receiving no distribution on account of their interests and cancellation of their existing stock. If certain requirements of the Bankruptcy Code are met, a plan of reorganization can be confirmed notwithstanding its rejection by our equity security holders and notwithstanding the fact that such equity security holders do not receive or retain any property on account of their equity interests under the plan. Accordingly, we urge that the appropriate caution be exercised with respect to existing and future investments in any of these securities as the value and prospects are highly speculative.
Under the supervision of the Bankruptcy Court, we may decide to pursue various strategic alternatives as deemed appropriate by our Board of Directors to serve the best interests of the Company and our stakeholders, including asset sales or strategic partnerships.
As a result of our having filed for protection under Chapter 11 of the U.S. Bankruptcy Code, Nasdaq has used its authority under Marketplace Rules 4300, 4450(f) and IM-4300 to delist our securities from The Nasdaq Capital Market effective December 27, 2007.

Upon delisting from the Nasdaq Capital Market, our stock is traded on the Pink Sheets. In order to trade on the Pink Sheets, there must be market makers for our stock. Without a number of market makers in our stock, our stock would be less liquid than it would otherwise be, and the value of our stock could decrease.
Business Focus
UNIX Business. Our UNIX business serves the needs of small-to-medium sized businesses as well as replicated site franchisees of Fortune 1000 companies, by providing reliable, cost effective UNIX software technology for distributed, embedded and network-based systems. Our UNIX business includes our mobility product and services offerings. Our largest source of UNIX business revenue is derived from existing customers through our worldwide, indirect, leveraged channel of partners, which includes distributors and independent solution providers. We have a presence in a number of countries that provide support and services to customers and resellers. The other principal channel for selling and marketing our UNIX products is through existing customers that have a large number of replicated sites or franchisees.
We access these companies through their information technology or purchasing departments with our Area Sales Managers ("ASMs") in the United States and through our reseller channel in countries outside the United States. In addition, we also sell our operating system products to original equipment manufacturers ("OEMs"). Our sales of UNIX products and services during the last several years have been primarily to existing UNIX customers as opposed to newly acquired customers. Our UNIX business revenue depends significantly on our ability to market and sell our products to existing customers and to generate upgrades from existing customers.
The following table and footnote shows the operating results of the UNIX business for the years ended October 31, 2007, 2006 and 2005:

                                              2007         2006         2005
                                                      (In thousands)
            Revenue                         $ 21,623     $ 29,123     $ 35,838
            Cost of revenue                    3,291        4,896        5,466

            Gross margin                      18,332       24,227       30,372


            Sales and marketing                9,686       12,048       11,680
            Research and development           6,077        7,666        7,948
            General and administrative         5,527        6,669        6,604
            Other (1)                              -        2,371        2,372

            Total operating expenses          21,290       28,754       28,604

            Income (loss) from operations   $ (2,958 )   $ (4,527 )   $  1,768

(1) For the year ended October 31, 2007, other costs were $0. For the years ended October 31, 2006 and 2005 other costs consisted of $2,371 and $2,372, respectively for amortization of intangibles.

Revenue from our UNIX business decreased by $7,500,000, or 26%, for the year ended October 31, 2007 compared to the year ended October 31, 2006, in spite of a general price increase of 20% in May 2007. Revenue from our UNIX business decreased $6,715,000, or 19%, for the year ended October 31, 2006 compared to the year ended October 31, 2005. The revenue from our UNIX business has been declining over the last several years primarily as a result of continued competition from alternative operating systems, particularly Linux and from the negative

publicity of the SCO Litigation. We believe that the inclusion of our UNIX code and derivative works in Linux has been a contributor to the decline in our UNIX business revenue because users of Linux generally do not pay for the operating system itself, but for services and maintenance. The Linux operating system competes directly with our OpenServer and UnixWare products and has taken significant market share from these products.
Operating expenses for our UNIX business were $28,604,000 for the year ended October 31, 2005 and were $28,754,000 for the year ended October 31, 2006 and decreased to $21,290,000 for the year ended October 31, 2007. The decrease in operating expenses for the year ended October 31, 2007 was primarily attributable to reduced headcount and related costs as a result of staff reductions in October 2006 and the elimination of amortization expense from intangible assets, partially offset by increased costs incurred as a result of our bankruptcy for legal and professional fees. Our intangible assets became fully amortized during the three months ended October 31, 2006.
The decline in our UNIX business revenue may be accelerated if industry partners withdraw their support as a result of our SCO Litigation, or Chapter 11 bankruptcy filing. The decline in our UNIX business, the SCO Litigation and our Chapter 11 bankruptcy filing may cause industry partners, developers and hardware and software vendors to choose not to support or certify to our UNIX operating system products. This would lead to an accelerated decline in revenue from our UNIX business.
SCOsource Business. During the year ended October 31, 2003, we became aware that our UNIX code and derivative works had been inappropriately included by others in the Linux operating system. We believe the inclusion of UNIX code and derivative works in Linux has been a contributor to the decline in our UNIX business because users of Linux generally do not pay for the operating system itself, but pay for services and maintenance. The Linux operating system competes directly with our OpenServer and UnixWare products and has taken significant market share from these products.
In an effort to establish, protect and defend our UNIX intellectual property rights, we initiated our SCOsource business. We have incurred significant legal costs in an effort to defend and protect our UNIX intellectual property rights and subject to Bankruptcy Court approval, expect that costs and expenses for this business for the year ending October 31, 2008 will be significant.
The following table shows the results of operations for the SCOsource business for the years ended October 31, 2007, 2006 and 2005:

                                           2007         2006          2005
                                                    (In thousands)
            Revenue                      $     33     $     116     $     166
            Cost of revenue                 3,580        12,307        12,847

            Gross margin (deficit)         (3,547 )     (12,191 )     (12,681 )


            Sales and marketing                 -             1           154
            Research and development            -           379           389
            General and administrative          -           259           443

            Total operating expenses            -           639           986

            Loss from operations         $ (3,547 )   $ (12,830 )   $ (13,667 )

Revenue from our SCOsource business for the years ended October 31, 2007, 2006 and 2005 was primarily attributable to sales of our SCOsource IP agreements.
Cost of revenue from the SCOsource business was $12,847,000 for the year ended October 31, 2005, $12,307,000 for the year ended October 31, 2006 and decreased to $3,580,000 for the year ended October 31, 2007. Cost of revenue was primarily comprised of legal fees and other costs and expenses incurred in connection with the SCO Litigation. During the year ended October 31, 2006, we made the final quarterly payment of $2,000,000 to Boies, Schiller & Flexner LLP and Kevin McBride (the "Law Firms") (which quarterly payments ended during the three months ended January 31, 2006). Berger Singerman, P.A. ("Berger") was also a member of this group of Law Firms. With the consent of the Company, the engagement of this firm was mutually terminated. The last payment received by Berger was during November 2004. In addition to the expenses incurred above, we must pay one or more contingency fees upon any amount that we or our stockholders may receive as a result of a settlement, judgment, or a sale of our Company.
Because of the unique and unpredictable nature of the SCO Litigation, the occurrence and timing of certain expenses such as damage, industry and technical review and other consultants is difficult to predict, and it will be difficult to predict the total cost of revenue for the upcoming quarters.
The decrease in operating expenses was primarily attributable to decreased personnel and related costs.
Critical Accounting Estimates
The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles and our discussion and analysis of our financial condition and results of operations requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Note 2 of the notes to consolidated financial statements in Part II, Item 8 of this Form 10-K describes the significant accounting policies and methods used in preparation of our consolidated financial statements. We base our estimates on historical experience, current trends, future projections, and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates. We believe the following to be our critical accounting estimates because they are important to the portrayal of our financial position and results of operations and they are based on matters that are inherently uncertain.
Our critical accounting policies and estimates include the following:
• Revenue recognition;

• Valuation allowances against deferred income tax assets;

• Litigation reserves;

• Useful lives and impairment of property and equipment; and

• Allowances for doubtful accounts receivable.

Revenue Recognition. We recognize revenue in accordance with Statement of Position ("SOP") 97-2, as modified by SOP 98-9. Our revenue has historically been from three sources: (i) product license revenue, primarily from product sales to resellers, end users and OEMs; (ii) technical support service revenue, primarily from providing technical support and consulting services to end users; and (iii) revenue from SCOsource licensing.

We recognize product revenue upon shipment if a signed contract exists, the fee is fixed or determinable, collection of the resulting receivable is probable and product returns are reasonably estimable.
The majority of our revenue transactions relate to product-only sales. On occasion, we have revenue transactions that have multiple elements (such as software products, maintenance, technical support services, and other services). For software agreements that have multiple elements, we allocate revenue to each component of the contract based on the relative fair value of the elements. The fair value of each element is based on vendor specific objective evidence ("VSOE"). VSOE is established when such elements are sold separately. We recognize revenue when the criteria for product revenue recognition set forth above have been met. If VSOE of all undelivered elements exists, but VSOE does not exist for one or more delivered elements, then revenue is recognized using the residual method. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the license fee is recognized as revenue in the period when persuasive evidence of an arrangement is obtained assuming all other revenue recognition criteria are met.
We recognize product revenue from OEMs when the software is sold by the OEM to an end-user customer. Revenue from technical support services and consulting services is recognized as the related services are performed. Revenue for maintenance is recognized ratably over the maintenance period.
We consider an arrangement with payment terms longer than our normal business practice not to be fixed or determinable and revenue is recognized when the fee becomes due. We typically provide stock rotation rights for sales made through our distribution channel and sales to distributors are recognized upon shipment by the distributor to end users. For direct sales not through our distribution channel, sales are typically non-refundable and non-cancelable. We estimate our product returns based on historical experience and maintain an allowance for estimated returns, which is recorded as a reduction to accounts receivable and revenue.
Our SCOsource revenue to date has been primarily generated from agreements to utilize our UNIX source code and related technology as well as from intellectual property compliance agreements. We recognize revenue from SCOsource agreements when a signed contract exists, the fee is fixed or determinable, collection of the receivable is probable and delivery has occurred. If the payment terms extend beyond our normal payment terms, revenue is recognized as the payments become due.
Valuation Allowances Against Deferred Income Tax Assets. The amount, and ultimate realization, of our deferred income tax assets depends, in part, upon the tax laws in effect, our future earnings, if any, and other future events, the effects of which cannot be determined. We provided a valuation allowance of $78,570,000 against our entire net deferred income tax assets as of October 31, 2007. The valuation allowance was recorded because of our history of net operating losses and the uncertainties regarding our future operating profitability and taxable income.
Litigation Reserves. We are party to a number of legal matters described in more detail elsewhere in this Form 10-K. Pursuit and defense of these matters will be costly, and management expects the costs for legal fees and related expenses will be substantial. A material, negative impact on our results of operations or financial position from the Red Hat, Inc., IPO Class Action, or Indian Distributor matters, or the IBM and Novell counterclaims is not estimable. Because these matters are not estimable, we have not recorded any reserves or contingencies related to these legal matters. In the event that our assumptions used to evaluate these matters change in

future periods, we may be required to record a liability for an adverse outcome, which could have a material adverse effect on our results of operations, financial position and liquidity.
Useful Lives and Impairment of Property and Equipment. We review our long-lived assets for impairment at each balance sheet date and when events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The carrying value of a long-lived asset is considered impaired when the anticipated cumulative undiscounted cash flows of the related asset or group of assets is less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the estimated fair market value of the long-lived asset. Economic useful lives of long-lived assets are assessed and adjusted as circumstances dictate.
Write-downs of long-lived assets may be necessary if, in the future, the fair value of these assets is less than the carrying value. If the operating trends for our UNIX or SCOsource businesses continue to decline, or a definitive negative judgment requiring cash payments to third parties or significant assets to be placed under a constructive trust is issued in various litigation matters, we may be required to record an impairment charge in a future period related to the carrying value of our long-lived assets.
Allowance for Doubtful Accounts Receivable. We offer credit terms on the sale of our products to a majority of our customers and require no collateral from these customers. We perform ongoing credit evaluations of our customers' financial condition and maintain an allowance for doubtful accounts receivable based upon our historical collection experience and a specific review of customer balances to determine expected collectibility. Our policies for determining allowances for doubtful accounts receivable have been applied consistently. Our allowance for doubtful accounts receivable was $85,000 as of October 31, 2007. We have not experienced material differences from the actual amounts provided for bad debts and our recorded estimates. However, our actual bad debts in future periods may differ from our current estimates and the differences may be material, which may have an adverse impact on our future accounts receivable and cash position.

Results of Operations
The following table presents our consolidated results of operations for the years ended October 31, 2007, 2006 and 2005:

                                                 Years Ended October 31,
                                             2007         2006          2005
                                                      (In thousands)
           Statement of Operations Data:
           Revenue:
           Products                        $ 17,488     $  24,063     $  30,190
           SCOsource                             33           116           166
           Services                           4,135         5,060         5,648

           Total revenue                     21,656        29,239        36,004
. . .