SCO Digs a Deeper Hole

Hey, if you're not making money the old-fashioned way, you might as well see what you can get through lawsuits. That seems to be the primary strategy these days at UNIX software provider SCO Group (Nasdaq: SCOX).

The trouble is, the company's litigious attempts at jump-starting revenue cost a lot more than they bring back. This morning's first-quarter earnings provide a revealing glimpse at this poorly executed strategy.

For those who need a brief recap, SCO appears to own a version of UNIX that it claims has been duplicated, at least in part, in the open-source operating system Linux. For months now, the company has been threatening to sue anyone who uses Linux without paying SCO a license fee. Verified targets have so far included IBM (NYSE: IBM) and Novell (Nasdaq: NOVL), which build and support Linux enterprise software.

In response to these shakedowns, a band of technology companies including other heavy-hitters like Intel (Nasdaq: INTC), Dell (Nasdaq: DELL), Red Hat (Nasdaq: RHAT), and Hewlett-Packard (NYSE: HPQ) formed a legal defense fund.

For the first quarter of fiscal 2004, revenues dropped 16% to $11.4 million. Losses totaled $2.3 million, or $0.16 per share, more than twice the $0.06 per-share loss from the period before.

But it gets worse. The red ink was tempered by a one-time benefit of $3.8 million related to a "change in fair value" of the derivative associated with its series A convertible preferred stock. Without this credit, the loss on operations would have amounted to over $0.37 per share. (Now we know why the maxim "Earnings are an opinion" makes sense.)

It's my opinion that SCO is doing everything wrong. In addition to the horrific, self-inflicted damage to its reputation, the licensing-lawsuit strategy is delivering a one-two punch to SCO's bottom line. Efforts to license Linux cost SCO $3.4 million in the first quarter. That's right, one-third of total revenue was wiped out. The payback? Twenty thousand dollars. That's not a typo. I know guys who make that much mowing lawns for a summer. Moreover, the balance sheet already currently lists $8 million in liabilities to legal firms. That number is likely to increase with the company's new lawsuit against AutoZone (NYSE: AZO).

With declining revenues, increasing losses, and an expensive and damaging litigation policy, SCO looks like one of the best short candidates I've seen in a while.

Got Linux questions? Consult the experts in the Fool's Linux User's Group.

Fool contributor Seth Jayson wonders how much SCO would charge him for a Linux license on his home-built PCs. He has no stake in any companies mentioned here.