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 to eliminate certain of the Company's claims in both the Novell case ("Novell Litigation") and the IBM case, and possibly others (collectively, the "SCO Litigation"). 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 between Novell and Santa Cruz (the "APA"), and that Novell retained broad rights to waive our contract claims against IBM. The Court ruled that we own the copyrights to post-APA UnixWare code and derivatives and that we have certain other ownership rights in the UNIX technology. We were directed to accept Novell's waiver of the Company's 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, as well as whether we had authority to enter into such SVRx licenses. Based on Novell's allegations, the potential payment to Novell for those SVRx licenses ranged from a de minimis amount to in excess of $30,000,000, the latter amount being the amount claimed by Novell, plus interest.
The trial of these issues, however, was automatically stayed as a result of our filing a voluntary petition 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") on September 14, 2007. On October 4, 2007, Novell filed a Motion for Relief from Automatic Stay. On November 27, 2007, the Bankruptcy Court modified the automatic stay to permit Novell to pursue the trial scheduled in the Court on the allocation of proceeds from the SCOsource agreements and the question of our alleged lack of authority to enter into them, but the Bankruptcy Court retained jurisdiction to determine whether to impose a constructive trust on any amounts found to be payable to Novell. The Bankruptcy Court also ruled that the automatic stay applies to the SuSE arbitration proceeding pending in Europe. Upon the modification of the automatic stay, the Court scheduled a four-day trial on those matters for which the Bankruptcy Court modified the automatic stay, which started on April 29, 2008 and concluded on May 2, 2008.
On December 21, 2007, Novell filed a motion for summary judgment on the issue of whether we had the authority to enter into the SCOsource licenses. The parties fully briefed the motion, and the Court set oral argument on this and any other pending motions for summary judgment for April 30, 2008. On March 7, 2008, we filed a Motion for Judgment on the Pleadings on Novell's Claims for Money or Claim for Declaratory Relief, in which we argued, based on Novell's version of the facts, that either its claims for money from SCOsource agreements or its claim seeking a declaration that SCO lacked the authority to enter into those agreements must fail. The Court heard oral arguments on this motion, as well as Novell's pending motion for summary judgment, on the second day of trial, April 30, 2008.
From April 29 through May 2, 2008, the Court held a bench trial on Novell's monetary claim for certain portions of fees we received from the SCOsource agreements and on whether we had the authority to enter into those agreements. Prior to the commencement of the trial, Novell conceded that it would not be making a claim to a portion of the fees paid to us by Microsoft in 2003 and Novell therefore reduced the principal amount of its claim to $19,979,561. After the trial and arguments, the Court took all matters under advisement and stated it would attempt to issue a ruling without undue delay.
On July 16, 2008, the Court entered its Findings of Fact, Conclusions of Law, and Order, ruling that (1) the SCOsource agreements with Linux end-users were not SVRx licenses and therefore Novell was not entitled to revenue from those agreements and that SCO had the authority to enter into such agreements; (2) the 2003 SCOsource agreement with Microsoft contained an SVRx License that was incidental to the UnixWare license in the agreement, and therefore we were authorized to enter into that SVRx license and Novell was not entitled to revenue from the agreement; and (3) the 2003 SCOsource agreement with Sun contained an unauthorized amendment of a prior UNIX buy out agreement, and Novell was entitled to $2,547,817 of the revenue from the Sun agreement as attributable to that amendment. The Court directed Novell to file a brief identifying the amount of prejudgment interest it sought based on this award. On August 29, 2008, Novell filed an Unopposed Submission Regarding Prejudgment Interest, informing the Court that the parties had agreed that Novell was entitled to $918,122 in prejudgment interest through that date, plus $489 per day until the entry of final judgment, based on the Court's $2,547,817 award.

In its ruling of July 16, 2008, the Court also directed Novell to file a proposed Final Judgment consistent with the Court's trial and summary judgment orders. In its proposed submission to the Court in compliance with this order, Novell took the position that final judgment could not be entered because certain of our claims are stayed pending arbitration and the imposition of a constructive trust remained an open question in the Bankruptcy Court. Subsequently, in order to expedite the entry of final judgment, we sought to resolve these issues with Novell and agreed to an extension of Novell's deadline for filing its submission. Based on our tracing of Sun's payments under its 2003 SCOsource agreement, Novell agreed that only $625,487 of our current assets were traceable as trust funds. We also proposed dismissing our stayed claims with prejudice on the basis of the Court's ruling that Novell owns the pre-APA UNIX copyrights in the Court's summary judgment order of August 10, 2007. On August 29, 2008, in its Submission Regarding the Entry of Final Judgment, Novell informed the Court of the parties' agreement as to the trust amount, but Novell stood by its position that final judgment could not be entered in light of the stayed claims. On September 15, 2008, we filed papers arguing for the entry of final judgment.
On November 20, 2008, after further negotiations between the parties, the Court entered a Final Judgment, incorporating the material rulings from the August 10, 2007 and July 16, 2008 rulings as explained above. On November 25, 2008, we filed a notice of appeal of that Final Judgment, including the Court's summary judgment order of August 10, 2007. On January 23, 2009, we filed an unopposed motion for an expedited appeal with the United States Court of Appeals for the Tenth Circuit (the "Tenth Circuit Court") which was granted by the Tenth Circuit Court on January 29, 2009. On March 4, 2009, we filed our brief for our appeal with the Tenth Circuit Court. The Tenth Circuit Court has placed the case on the calendar for oral argument on May 6, 2009. With the expedited appeal, and the early hearing date, the Company is hopeful a decision on the appeal could be forthcoming in the next five to eight months, but it could be several months beyond that time frame.
On March 13, 2009, the Court denied our motion to stay the taxation of costs relating to the trial and final judgment. These costs total $127,432, and relate to such things as transcription charges and deposition expenses. According to the Court's order these costs will be added to the issues that are on appeal with the Tenth Circuit Court and resolved through that appeal.
As a result of the Court's judgment of July 16, 2008 against us, as of January 31, 2009, we have accrued $3,562,000 including the related interest. However, we, continue to contest this liability. We believe that the Court erred, and that there are strong grounds to have the adverse rulings embodied in the Final Judgment reversed on appeal. However, in the event that our assets are further depleted or encumbered, we may not be in a financial position to see the appeal of those rulings through to a conclusion or continue the litigation. Bankruptcy Filing
On September 14, 2007, The SCO Group, Inc. and its wholly owned subsidiary, SCO Operations, Inc. (collectively, the "Debtors"), filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code in the Bankruptcy Court for the District of Delaware. The Debtors' Chapter 11 cases are being jointly administered under Case No. 07-11337(KG). The Debtors continue to exercise control over their assets and 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. Our foreign subsidiaries, as non-debtors, are not subject to the requirements of the Bankruptcy Code and are not subject to Bankruptcy Court supervision.
On September 18, 2007, the Bankruptcy Court granted the Debtors' motions to maintain their existing bank accounts and cash management systems, to pay pre-bankruptcy wage-related items, to establish procedures relating to utility providers and to employ temporary employees.
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.
On February 13, 2008, we entered into a Memorandum of Understanding (the "MOU") with Stephen Norris Capital Partners, LLC, a Delaware limited liability company ("SNCP"), whereby SNCP agreed to provide financing to fund our plan of reorganization filed on February 29, 2008. On the same day, we filed a disclosure statement in connection with the plan of reorganization, under the terms contemplated by the MOU.

On February 29, 2008, the Debtors filed their joint Chapter 11 Plan of Reorganization (the "Plan") and Disclosure Statement in Connection with the Plan (the "Disclosure Statement"). A hearing to approve the adequacy of the Disclosure Statement was scheduled before the Bankruptcy Court on April 2, 2008. The April 2, 2008 hearing proceeded as a status conference regarding the Debtors' progress towards a new Memorandum of Understanding ("MOU") with Stephen Norris Capital Partners, LLC. Therefore, the Debtors indicated that they were not presently seeking approval of the adequacy of the Disclosure Statement, which would need to be amended to reflect the changes to the MOU.
On May 12, 2008, the Debtors filed a motion seeking an extension of their exclusive periods to submit and solicit acceptances of an amended or new plan of reorganization to August 11 and October 13, 2008, respectively. A hearing to consider that motion was scheduled for June 17, 2008. The Bankruptcy Court granted the motion on June 17, 2008. The Debtors filed another motion for an extension of their exclusive periods to submit and solicit acceptances of a plan of reorganization to a date 45 and 105 days, respectively, following an entry of a final judgment in the Novell Litigation. The hearing on that motion was conducted on September 16, 2008, at which time the Bankruptcy Court granted the motion for an extension of our exclusive period to submit a plan of reorganization to December 31, 2008 and our exclusive period to solicit acceptances to March 2, 2009.
On January 8, 2009, the Debtors filed their Amended Reorganization Plan and Disclosure statement. Under the proposed plan, we intend to hold an open auction to sell certain assets of the Company including our mobility business assets and our OpenServer operating system assets and business. Through this sale, the Debtors hope to obtain enough consideration to pay their creditors and continue their operations as set forth in the plan. In the event that the asset sale does not generate enough cash to meet the aforementioned objectives, we will scale back our operations and costs, and initiate other strategies to implement the plan of reorganization. In the event that certain Company assets are not sold, we will continue to sell and support our UNIX and mobility business and will also focus on the following key provisions: (a) an enhanced pricing and discount strategy, (b) an updated "true-up" licensing program with current customers,
(c) reducing overall operating costs, (d) delivering SCO UNIX Virtual product lines for VMware and Hyper-V to allow SCO legacy applications to run on modern hardware and (e) shipping FCmobilelife and FCtasks for the iPhone with a new pricing structure. 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 stockholders are entitled to receive any distribution or retain any property under a plan of reorganization. The ultimate recovery to creditors and/or stockholders, 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, or as to the timing of such distributions, if any. 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 the class comprising the interests of our equity security holders. If our Plan is not confirmed by the Bankruptcy Court, it is unclear whether we would be able to reorganize our businesses and what, if anything, holders of claims against us would ultimately receive with respect to their claims. If an alternative reorganization could not be agreed upon, it is possible that our bankruptcy case could be converted to a liquidation under Chapter 7 and we would have to liquidate our assets, in which case it is likely that holders of claims would receive substantially less favorable treatment than they would receive if we were to emerge as a viable, reorganized entity; and stockholders would likely receive nothing from the liquidation. As a result of the District Court's August 10, 2007 and July 16, 2008 rulings and the uncertainties surrounding the confirmation of our Amended Reorganization Plan, among other matters, there is substantial doubt about our ability to continue as a going concern. 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 corporations 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 and not 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 shows the operating results of the UNIX business for the three months ended January 31, 2009 and 2008:

                                          Three Months Ended January 31,
                                           2009                    2008
                                                  (In thousands)
         Revenue                      $         3,097         $         4,872
         Cost of revenue                          358                     719

         Gross margin                           2,739                   4,153

         Sales and marketing                    1,326                   2,741
         General and administrative               810                     924
         Research and development                 722                   1,273

         Total operating expenses               2,858                   4,938

         Loss from operations         $          (119 )       $          (785 )

Revenue from the UNIX business decreased by $1,775,000, or 36%, for the three months ended January 31, 2009 compared to the three months ended January 31, 2008. The revenue from this business has been declining over the last several years primarily as a result of increased competition from alternative operating systems, particularly Linux, and from continuing negative publicity from the SCO Litigation and our filing for Chapter 11 bankruptcy. We believe the inclusion of our 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.
Operating costs for the UNIX business decreased from $4,938,000 for the three months ended January 31, 2008, a decrease of $2,080,000 or 42%, to $2,858,000 for the three months ended January 31, 2009. This decrease was primarily attributable to cost reduction initiatives, including reduced headcount and related costs, and reduced leased facilities and other reductions.
The decline in our UNIX business revenue will continue if the factors that have contributed to the decline described above continue or industry partners continue to withdraw their support for our products. The decline in our UNIX business and our SCOsource business 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 and an increase in negative cash flows 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 our 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. We expect that costs and expenses for this business for the year ending October 31, 2009 will continue to be significant.
The following table shows the operating results of the SCOsource business for the three months ended January 31, 2009 and 2008:

                                          Three Months Ended January 31,
                                            2009                   2008
                                                  (In thousands)
          Revenue                      $            -         $            -
          Cost of revenue                         109                    267

          Gross margin                           (109 )                 (267 )

          Sales and marketing                       -                      -
          General and administrative                -                      -
          Research and development                  -                      -

          Total operating expenses                  -                      -

          Loss from operations         $         (109 )       $         (267 )

Revenue from our SCOsource business was $0 for the three months ended January 31, 2009 and January 31, 2008.
Cost of revenue, which primarily includes legal and professional fees incurred in connection with defending our UNIX intellectual property rights in the SCO Litigation, decreased from $267,000, a decrease of $158,000 or 59%, for the three months ended January 31, 2008 to $109,000 for the three months ended January 31, 2009. This decrease was due to fewer legal services provided by technical, industry, damage and other experts in connection with the SCO Litigation. In addition to the expenses incurred above, we may pay one or more contingency fees upon certain amounts 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 consulting is difficult to predict; it is therefore difficult to predict the total cost of SCOsource revenue in the future.
Because of the uncertainties related to our SCOsource business, the success of the SCOsource business depends on the strength of our intellectual property rights and claims regarding UNIX, including our claims against Novell and the strength of our claim that unauthorized UNIX source code and derivative works are contained in Linux.
Critical Accounting Policies
Our critical accounting policies and estimates include the following:
• Revenue recognition;

• Valuation allowances against net 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.
We recognize product revenues 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 revenues from OEMs when the software is sold by the OEM to an end-user customer. Revenues from technical support services and consulting services are recognized as the related services are performed. Revenues for maintenance are 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 and revenue is recognized upon shipment. 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. . . .