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Darl McBride of SCO Group: Giant killer

Tiny SCO has taken on the tech establishment by claiming that the Linux operating system is based on its Unix software. If it prevails, doing business could get a lot more expensive.

Even for a software company, SCO Group is a pip-squeak. But as its CEO, Darl McBride, likes to point out, "We have a footprint quite a bit larger than our $40 million in revenues would suggest."

That's an understatement. For starters, this bigfoot, though it has just 200 employees, distributes and delivers its products through 11,000 resellers in 82 countries. Lindon, Utah­based SCO's customers include McDonald's Corp. and Samsung Corp. They, along with thousands of small and medium-size businesses, use SCO's software to power servers that run on Intel Corp. chips and the Unix operating system.

But what gives the company such an outsize impact within the world of technology -- and makes it so fiercely controversial -- is that SCO contends that the wildly popular Linux operating system, which is employed by countless major corporations, infringes on its Unix intellectual property rights. McBride expects to prove in court that Linux -- which has evolved over the past decade in the open-source community, free of licensing fees -- is a close enough cousin of Unix to allow him to charge those corporate users (and their vendors) for potentially very expensive licenses.

In March 2003, SCO filed a suit against Linux promoter IBM Corp. in U.S. District Court in Salt Lake City seeking at least $1 billion in compensation for alleged licensing violations. Victory would strike a blow for fairness, McBride believes -- and also give him the capital to build SCO into a world-class systems developer.

The high-stakes trial is set to begin

in November 2005. Meanwhile, SCO has filed suit against Linux users AutoZone and DaimlerChrysler for alleged copyright infringement and breach of contract, respectively. The company has also taken action against Novell, the networking software company that happens to be SCO's former owner and likewise proclaims itself the owner of Unix.

The technology establishment is solidly in IBM's corner. Beaverton, Oregon­based Open Source Development Labs, a consortium backed by Hewlett-Packard Co., IBM, Intel and others, has formed a fund to fight claims like those SCO is pressing. Linux's revered inventor, Linus Torvalds, who works at OSDL, has called SCO "the most despised company in technology."

In a September hearing IBM attorney David Marriott accused SCO of not presenting supporting evidence because "simply put, it has none."

SCO, represented by superstar litigator David Boies, countered that IBM has failed to provide a "road map" to millions of lines of code that SCO says it needs to show the connections between Linux and Unix.

When McBride took over in June 2002, SCO shares were selling for 76 cents and the company was on the verge of being delisted from the Nasdaq Stock Market. After SCO filed its suit against IBM, its shares climbed steadily, from $2.10 to a peak of $22.92 the following October 17, on market expectations that it would receive at least some recompense. But as the case dragged on and industry opposition mounted, the stock sagged to about $3.50 as of mid-November.

"We are not backing down," the CEO says of the copyright battles. "We're David, and at least we have David on our side" -- a reference to Boies. "We have very strong claims, cash to fight this through to the end and, most important, we have truth on our side."

McBride, 45, became chief of SCO -- short for Santa Cruz Operation, after the California city where one of its development sites is located -- when it was a troubled Novell spin-off known as Caldera International. He quickly decided that if the company were to survive, it had to enforce the Unix licensing rights.

McBride recently discussed SCO's legal and business strategies with Institutional Investor Assistant Managing Editor Jeffrey Kutler.

What attracted you to SCO?

McBride: It was like a sleeping giant. Unix, which Novell had once bought for hundreds of millions of dollars, was just sitting there -- not merely underutilized, but not utilized. The company had burned through $100 million in cash, and the tank was pretty much empty. Six months after I arrived, we launched a plan to protect the value of the Unix intellectual property.

What were you doing before this?

I had spent eight years at Novell as the executive in charge of Novell Japan, which went from zero to $120 million in revenue in four years. During that period, in 1994, I helped spin Caldera out of Novell. I later broke off and did a couple of start-ups, most notably SBI Group, which did a roll-up of [technology consulting firms] Razorfish, Scient and Viant. [SBI was acquired in July by Internet marketing company AQuantive.] I was about ready to do another start-up when the board of Caldera approached me for this job.

Is SCO's core business being overshadowed by the legal fight?

There are two big operating systems in the world, Unix and Windows, and we happen to own one of them. The intellectual property ownership of Unix is one aspect of our business and is the subject of the legal wrangling. That gets most of the press these days, even though we have some exciting things going on in the other part of our business, which involves taking one of our own branches of the Unix tree and developing it around the Intel chip architecture. We have an installed base of 2 million servers divided into two segments: small and medium-size businesses and large chains, including CVS, Costco and McDonald's. These companies buy our Intel-based system because it's reliable and cheap. Our mean time between failures is three and a half years, while our competition's is measured in weeks or months.

What's the current state of the server business?

Thousands of companies each quarter are buying software from us. We also have an initiative within the company called Renovation through Innovation, which focuses on new ideas for launching server-based software in the Internet age -- moving toward a Web services approach, as opposed to a pure client-server model.

How do you divide your time?

Now that the legal train is going down the track and the core business is cash flow positive [gross margin of $8.8 million on $10.5 million in Unix revenue for the third fiscal quarter, ended July 31], I'm spending about a third of my time on the lawsuit, a third on the core business and a third looking at new growth opportunities. We are confident in our legal case and believe that once our claims are heard, we can focus on innovations and technologies for where we go next.

So the future business strategy is closely tied to what happens in court?

It really is. Our revenue line has been going south since 2001, when IBM pulled the plug on a joint development project with us [which began in 1998] and Linux began to take off. We feel that we got pushed into a corner. We either lie down and die or fight back and defend our rights. We believe those IP rights have significant value. Since taking that fight into the judicial system, we have come under extreme attack. We just want our case to be heard, and we are confident that we will prevail. At one time, we had a $250 million revenue stream, and we're capable of scaling back up to that size relatively quickly once we can focus on growth again.

How have you pressed for Linux licensing fees?

We racked up more than $20 million in license fees in the 2003 fiscal year, and we think we're well positioned for the future, based on our copyright ownership. But in January, after Novell filed registrations that created a conflict with those we had on file in the copyright office, we filed a "slander of title" suit against Novell. Now IBM, Novell and thousands of their allies around the world are posting messages on the Internet saying that Novell really owns the copyrights. That has had a chilling effect on our licensing program, and we're working to get these issues resolved.

How exposed are corporate users to Linux actions?

We have some companies coming in asking for licenses to run Linux. We do not offer or sell a license to run Linux; it's for the right to use our intellectual property, which others have improperly put into Linux. Our license thus provides safety to the end user from any issues we have. Other companies are taking a wait-and-see approach with respect to the litigation. In terms of direct action, we have filed an illustrative lawsuit against AutoZone for copyright infringement for their use of Linux, and pending further developments in that action, we are not actively addressing these issues with companies.

Has the notoriety helped SCO, all in all?

The market cap was $6 million when I joined; now it's $60 million. Of course, in the other corner you have IBM at $160 billion. But we get attention because of who we're fighting against and what side we're on: We have Unix contracts that AT&T wrote 20 years ago, which are very powerful, and we are just in the process of enforcing those property rights. We're in the heavyweight division now and had to toughen up a bit. We're going to win this, or we're going to die trying.

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