SCO to cap legal expenses

Lawyers to get bigger share of any settlement in Linux suits in exchange for billing less up front.

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By Stephen Shankland
Staff Writer, CNET

The SCO Group, committed to an expensive legal attack against Linux, said Tuesday it has removed some financial uncertainty from its future by working out an agreement to cap payments to its law firm.

The company has signed a letter of intent with its law firm, Boies, Schiller & Flexner, to restructure its fee agreement, Chief Financial Officer Bert Young said in a conference call announcing financial results for SCO's third quarter of fiscal 2004, which ended July 31. In the quarter, SCO had a net loss of $7.4 million on revenue of $11.2 million.

Under the new fee agreement, which SCO expects to be completed in coming weeks, the company will limit its payments to $31 million for the entire case, but the law firm stands to gain a larger fraction of any settlement SCO achieves. Under the new agreement, the firm's contingency payment, which is currently 20 percent of a settlement, would be between 20 and 33 percent, depending on the size of the settlement, Young said.

"You can think of it as replacing cash with contingency," Young said.

Because SCO had cash and for-sale securities worth a total of $43 million as of July 31, the new fee agreement will mean the company is assured of having at least $12 million in cash regardless of the outcome of its legal case, he said.

Decatur Jones securities analyst Dion Cornett, who owns no SCO shares, applauded the move. "It was very smart of them, figuring a way to cap the legal expenses," he said in an interview. "Improving predictability and removing risk is the most important thing for shareholders," he said, though he remains "skeptical" that SCO will prevail in its legal case.

SCO's legal costs are mounting as the company pursues its cases. It spent $7.3 million in the most recent quarter, nearly half of the $15 million it has spent in the last five quarters, Young said. SCO expects $7.3 million to be a "high-water mark," Chief Executive Darl McBride said.

SCO was a small and largely insignificant technology seller until it launched its attack on Linux--an operating system it once sold alongside its two versions of Unix. The Lindon, Utah, company claims in lawsuits that IBM violated its Unix contract with SCO by moving proprietary Unix technology into open-source Linux, that earlier Unix owner Novell transferred its Unix copyrights to SCO, and that AutoZone's use of Linux violates SCO's Unix copyrights.

The Linux legal action pushed SCO's stock above $22 in 2003, but the price has since dropped back down. On Tuesday, it dropped 13 cents, or 3 percent, to close at $3.80.

There were bright spots in its most recent quarter. Though revenue declined to $11.2 million from $20.1 million in the year-ago quarter, it increased compared to the fiscal second quarter's $10.1 million.

"I was pretty pleased with the execution of the company. I was honestly shocked to see revenue up $1 million sequentially," Cornett said, though he said he still expects the core Unix business to gradually erode.

Another bright spot was in August, when SCO closed a contentious transaction with BayStar Capital, which had arranged a $50 million investment in 2003. BayStar had balked more than once.

In addition, the SCOsource effort, which includes the lawsuits as well as a largely unsuccessful attempt to sell Unix intellectual property licenses to Linux users, fared better in the most recent quarter. It generated $678,000 in revenue, compared to $11,000 in the second quarter of fiscal 2004.

The company continues to try to sell its Unix products, and indeed its Unix division was profitable in the quarter, McBride said. More cost-cutting will take place in the current quarter to reduce expenses, SCO said.

SCO also announced its board has approved a revised shareholder rights plan designed to make a hostile takeover harder, though no such attempts are under way, McBride said.

"Where the share prices are at now, we are concerned about somebody who would be opportunistic. What's to keep IBM or somebody else from coming in and taking (SCO) out at a much lower price than the claims you have on the table?" he asked.

SCO predicted revenue of $10 million to $12 million for its current quarter.