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Selectica 10-Q 2007

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-Q

 


(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to            

COMMISSION FILE NUMBER 000-29637

 


SELECTICA, INC.

(Exact Name of Registrant as Specified in Its Charter)

 


 

DELAWARE   77-0432030
(State of Incorporation)   (IRS Employer Identification No.)

1740 TECHNOLOGY DR. SUITE 450, SAN JOSE, CA 95134

(Address of Principal Executive Offices)

(408) 570-9700

(Registrant’s Telephone Number, Including Area Code)

 


Indicate by a check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports); and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b of the Exchange Act. (Check one):

Large accelerated filer  ¨                Accelerated filer  ¨                Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company as defined in Rule 12b-2 of the Exchange Act.    YES  ¨    NO  x

The number of shares outstanding of the registrant’s common stock, par value $0.0001 per share, as of November 1, 2007, was 28,407,299.

 



Table of Contents

FORM 10-Q

SELECTICA, INC.

INDEX

 

PART I    FINANCIAL INFORMATION   
ITEM 1:    Financial Statements (unaudited)   
   Condensed Consolidated Balance Sheets as of September 30, 2007 and March 31, 2007    4
   Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2007 and 2006    5
   Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2007 and 2006    6
   Notes to Condensed Consolidated Financial Statements    7
ITEM 2:    Management’s Discussion and Analysis of Financial Condition and Results of Operations    15
ITEM 3:    Quantitative and Qualitative Disclosures about Market Risk    20
ITEM 4:    Controls and Procedures    21
PART II    OTHER INFORMATION   
ITEM 1:    Legal Proceedings    22
ITEM 1A:    Risk Factors    23
ITEM 2:    Unregistered Sales of Equity Securities and Use of Proceeds    31
ITEM 3:    Defaults Upon Senior Securities    31
ITEM 4:    Submission of Matters to a Vote of Security Holders    31
ITEM 5:    Other Information    31
ITEM 6:    Exhibits    31
Signatures    32

 

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Table of Contents

The words “Selectica”, “we”, “our”, “ours”, “us”, and the “Company” refer to Selectica, Inc. In addition to historical information, this Form 10-Q contains forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations” and “Risk Factors.” You should carefully review the risks described in other documents the Company files from time to time with the Securities and Exchange Commission, including the quarterly reports on Form 10-Q to be filed by the Company in 2007. Readers are cautioned not to place undue reliance on the forward-looking statements, including statements regarding the Company’s expectations, beliefs, intentions or strategies regarding the future, which speak only as of the date of this annual report on Form 10-Q. The Company undertakes no obligation to release publicly any updates to the forward-looking statements included herein after the date of this document.

 

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Table of Contents

PART I: FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

SELECTICA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)

 

    

September 30,

2007

   

March 31,

2007 *

 
     (unaudited)        

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 15,949     $ 30,165  

Short-term investments

     35,883       27,285  

Accounts receivable, net of allowance for doubtful accounts of $18 and $116, respectively

     2,000       1,778  

Prepaid expenses and other current assets

     823       567  
                

Total current assets

     54,655       59,795  

Property and equipment, net

     1,934       1,992  

Intangible assets

     205       309  

Other assets

     643       531  

Long-term investments

     —         1,009  
                

Total assets

   $ 57,437     $ 63,636  
                

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Accounts payable

   $ 2,229     $ 3,014  

Accrued payroll and related liabilities

     916       920  

Other accrued liabilities

     14,495       4,367  

Deferred revenues

     2,244       2,251  
                

Total current liabilities

     19,884       10,552  
                

Other long term liabilities

     7,377       3,171  
                

Contingencies (See Note 9)

    

Stockholders’ equity:

    

Common stock

     4       4  

Additional paid-in capital

     299,822       299,476  

Accumulated deficit

     (236,996 )     (216,889 )

Accumulated other comprehensive income (loss)

     6       (18 )

Treasury stock

     (32,660 )     (32,660 )
                

Total stockholders’ equity

     30,176       49,913  
                

Total liabilities and stockholders’ equity

   $ 57,437     $ 63,636  
                

See accompanying notes.

 

* Derived from audited consolidated financial statements

 

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SELECTICA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)

 

    

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
     2007     2006     2007     2006  

Revenues:

        

License

   $ 1,091     $ 293     $ 2,802     $ 761  

Services

     2,891       2,703       5,521       7,451  
                                

Total revenues

     3,982       2,996       8,323       8,212  

Cost of revenues:

        

License

     53       865       112       980  

Services

     885       1,874       1,903       4,443  
                                

Total cost of revenues

     938       2,739       2,015       5,423  
                                

Gross profit

     3,044       257       6,308       2,789  

Operating expenses:

        

Research and development

     1,139       2,149       2,317       4,251  

Sales and marketing

     1,136       1,779       3,061       3,662  

General and administrative

     1,360       2,599       2,738       4,455  

Legal settlement

     16,118       —         16,118       —    

Restructuring

     572       —         662       —    

Professional fees related to stock option investigation

     1,297       —         3,148       —    
                                

Total operating expenses

     21,622       6,527       28,039       12,328  
                                

Loss from operations

     (18,578 )     (6,270 )     (21,736 )     (9,539 )

Interest and other income, net

     800       882       1,868       1,600  
                                

Loss before provision for income taxes

     (17,778 )     (5,388 )     (19,868 )     (7,939 )

Provision for income taxes

     38       35       244       64  
                                

Net loss

   $ (17,816 )   $ (5,423 )   $ (20,112 )   $ (8,003 )
                                

Basic and diluted net loss per share

   $ (0.63 )   $ (0.18 )   $ (0.71 )   $ (0.26 )
                                

Weighted-average shares of common stock used in computing basic and diluted net loss per share

     28,407       30,552       28,407       30,997  

See accompanying notes.

 

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Table of Contents

SELECTICA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)

 

     Six Months Ended
September 30,
 
     2007     2006  

Operating activities

    

Net loss

   $ (20,112 )   $ (8,003 )

Adjustments to reconcile net loss to net cash used in operating activities:

    

Depreciation

     228       285  

Amortization

     104       104  

(Gain) on disposition of property and equipment

     (90 )     (33 )

Stock based compensation

     346       888  

Changes in assets and liabilities:

    

Accounts receivable (net)

     (222 )     1,558  

Prepaid expenses and other current assets

     (256 )     823  

Other assets

     (112 )     (52 )

Accounts payable

     (785 )     (919 )

Accrued payroll and related liabilities

     (4 )     (170 )

Other accrued liabilities and long term liabilities

     14,334       (79 )

Deferred revenues

     (7 )     903  
                

Net cash used in operating activities

     (6,576 )     (4,695 )
                

Investing activities

    

Purchase of capital assets

     (81 )     (207 )

Purchase of short-term investments

     (44,186 )     (16,624 )

Purchase of long term investments

     —         (168 )

Proceeds from maturities of short-term investments

     35,612       30,022  

Proceeds from maturities of long-term investments

     1,009       —    

Proceeds from disposal of fixed assets

     6       33  
                

Net cash provided by / used in investing activities

     (7,640 )     13,056  
                

Financing activities

    

Purchase of treasury stock

     —         (4,397 )

Proceeds from issuance of common stock

     —         148  
                

Net cash provided by financing activities

     —         (4,249 )
                

Net increase (decrease) in cash and cash equivalents

     (14,216 )     4,112  

Cash and cash equivalents at beginning of the period

     30,165       12,628  
                

Cash and cash equivalents at end of the period

   $ 15,949     $ 16,740  
                

See accompanying notes.

 

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Table of Contents

SELECTICA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Basis of Presentation

The condensed consolidated balance sheet as of September 30, 2007, the condensed consolidated statements of operations for the three months ended September 30, 2007 and 2006, and the condensed consolidated statement of cash flows for the three months ended September 30, 2007 and 2006 have been prepared by the Company and are unaudited. In the opinion of management, all necessary adjustments (which include normal recurring adjustments) have been made to present fairly the financial position at September 30, 2007, and the results of operations for the three months ended September 30, 2007 and 2006 and cash flows for the three months ended September 30, 2007 and 2006. Interim results are not necessarily indicative of the results for a full fiscal year. The consolidated balance sheet as of March 31, 2007 has been derived from the audited consolidated financial statements at that date.

Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2007.

2. Summary of Significant Accounting Policies

There have been no material changes to any of our critical accounting policies and estimates as disclosed in our report on Form 10-K for the year ended March 31, 2007.

Customer Concentrations

A limited number of customers have historically accounted for a substantial portion of the Company’s revenues.

Customers who accounted for at least 10% of total revenues were as follows:

 

    

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
     2007     2006     2007     2006  

Customer A

   45 %   40 %   28 %   31 %

Customer B

   *     *     10 %   *  

Customer C

   11 %   13 %   10 %   12 %

Customer D

   *     16 %   *     11 %

* Customer account was less than 10% of total revenues.

Customers who accounted for at least 10% of net accounts receivable were as follows:

 

     September 30,
2007
    March 31,
2007
 

Customer A

   52 %   50 %

Customer B

   12 %   13 %

Customer C

   11 %   21 %

* Customer account was less than 10% of net accounts receivable.

Accumulated and Other Comprehensive Loss

SFAS 130 establishes standards for reporting and displaying comprehensive net income or loss and its components in stockholders’ equity. However, it has no impact on the net loss as presented in the Company’s financial statements. Accumulated other comprehensive loss is comprised of net unrealized gains (losses) on available for sale securities of approximately $6,000 and $(18,000) at September 30, 2007 and March 31, 2007, respectively.

 

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Table of Contents

The components of comprehensive loss, net of related income tax, for the three and six months ended September 30, 2007 and 2006 are as follows:

 

    

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
     2007     2006     2007     2006  
     (In thousands)  

Net loss

   $ (17,816 )   $ (5,423 )   $ (20,112 )   $ (8,003 )

Change in unrealized gain on securities

     (79 )     78       24       87  
                                

Comprehensive loss

   $ (17,895 )   $ (5,345 )   $ (20,088 )   $ (7,916 )
                                

Segment Information

The Chief Operating Decision Maker (“CODM”), as defined by SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (SFAS No. 131), is our President and Chief Executive Officer. The CODM allocates resources to and assesses the performance of each operating segment using information about its revenue and operating income (loss) before interest and taxes.

We report the financial results of the following operating segments:

 

   

Sales Configuration Solutions. Software includes configurator and pricer solutions.

 

   

Contract Management Solutions. Software consists of contract management solutions.

We have sales and marketing, engineering, finance, and administration groups. We generally allocate the expenses of these groups to the operating segments and are included in the operating results reported below.

We do not identify or allocate assets by operating segment, nor does the CODM evaluate operating segments using discrete asset information. We do not allocate stock option investigation fees, litigation settlement costs, restructuring, interest and other income, interest expense, or taxes to operating segments.

The following is a summary of our net sales, costs of sales, gross profit and loss from operations by product and consolidated total for the periods presented below (in thousands):

 

     Three Months Ended
September 30,
    Six Months Ended
September 30,
 
     2007     2006     2007     2006  
     (in thousands)  

Sales Configuration Solutions:

        

Revenue

   $ 3,054     $ 2,706     $ 6,016     $ 7,518  

Cost of Sales

     567       2,572       1,246       5,084  
                                

Gross Profit

     2,487       134       4,770       2,434  

Income (loss) from Operations

     1,369       (3,729 )     2,262       (4,932 )

Contract Management Solutions:

        

Revenue

     928       290       2,307       694  

Cost of Sales

     371       167       769       334  
                                

Gross Profit

     557       123       1,538       360  

Loss from Operations

     (1,618 )     (2,541 )     (3,727 )     (4,625 )

Consolidated

        

Revenue

     3,982       2,996       8,323       8,212  

Cost of Sales

     938       2,739       2,015       5,418  
                                

Gross Profit

     3,044       257       6,308       2,794  

Loss from Operations

     (249 )     (6,270 )     (1,465 )     (9,557 )

 

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3. Concurrent Transaction

In May 2006, the Company entered into an exchange contract with Azul, whereby Azul would receive two years of the Company’s on-demand products, Contract Management and Fastraq, installation, training and other services and the Company would receive, in exchange, two high-speed servers and the required power systems. The value of the transaction was $208,454. There was no monetary exchange. The Company utilized its list price to establish the value of the assets received, which included a 5% discount. The Company accounted for this transaction in accordance with APB No. 29, “Accounting for Nonmonetary Transactions” and SFAS No. 153, “Exchanges of Nonmonetary Transactions – an amendment to APB 29”. During the first quarter of fiscal 2007 the Company had received the two servers, but had not placed them into service. The Company does not plan to resell the servers. Azul had not implemented the product nor had any of the negotiated services begun as of September 30, 2006.

The Company placed the servers into service in the second quarter of fiscal 2007, and will depreciate the servers over a period of three years. The Company will recognize the service work when all required elements for revenue recognition are satisfied and will recognize the subscription revenue pro-rata over the 2-year term of the agreement.

The Company, from time to time, purchases professional services from a value-added reseller. The Company records the cost of the professional services purchased as a reduction of license or services revenue recorded from the reseller. The Company recognized approximately $19,000 and $14,000 of revenue for the six months ended September 30, 2007 and 2006, from the value-added reseller respectively.

4. Related Party Transaction

In connection with the resignation of Dr. Sanjay Mittal, Chief Executive Officer, the Company agreed to have him continue as Chief Technical Advisor (“CTA”). Pursuant to this arrangement, Dr. Mittal received $20,000 per month for his services and this arrangement would continue until either party terminated the CTA service. In March 2005, Dr. Mittal’s role as CTA was terminated and he received a lump-sum severance payment of $412,500 in addition to the amount paid for outside services. In July 2005 Dr. Mittal agreed to provide hourly consulting services relating to patent litigation which was settled in February 2006. As a result his consulting agreement terminated. On July 21, 2006 Dr. Mittal resigned as a member of the Board of Directors and agreed to provide hourly consulting services for a period of at least 12 months. Dr. Mittal was paid $15,000 and $25,000 for consulting services for the three and six months ended September 30, 2007 and $15,000 for the three and six months ended September 30, 2006.

5. Stockholders’ Equity

Stock Repurchase

In December 2005, the Board of Directors approved a stock buyback program to repurchase up to $25.0 million worth of stock in the open market subject to certain criteria as determined by the Board. As of September 30, 2007, approximately $13.9 million remains available to be used under this program. The Board also dissolved the previous stock buyback program initiated in May 2003. Pursuant to the plan, the Company expects to repurchase shares in the open market from time to time based on market conditions. During the three months ended September 30, 2007, the Company did not repurchase any shares of its common stock. During the three months ended September 30, 2006, the Company repurchased 1,206,431 shares of its common stock.

6. Income Taxes

On July 13, 2006, the Financial Accounting Standards Board (“FASB”) released FIN 48 which applies to all US GAAP financial statements for public and private enterprises alike and provides a definitive, comprehensive accounting model with prescriptive disclosure requirements related to income tax uncertainties. FIN 48 defines the threshold for recognizing the benefits of tax-return positions in the financial statements as “more-likely-than-not” (“MLTN”) to be sustained by the taxing authority. The interpretation contains guidance on recognition, derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), on April 1, 2007. The Company does not believe the total amount of unrecognized benefit as of September 30, 2007 will increase or decrease significantly in the next twelve months. The Company’s foreign tax returns, including the United States, are subject to routine compliance review by the various tax authorities. The Company accrues for foreign tax contingencies based upon its best estimate of the additional taxes, interest and penalties expected to be paid. These estimates are updated over time as more definitive information becomes available from taxing authorities, completion of tax audits, expiration of statute of limitations, or upon occurrence of other events.

The Company recorded a provision for income taxes of approximately $38,000 and $35,000 for the three months ended September 30, 2007 and September 30, 2006, respectively. The company recorded a provisions for income taxes of approximately $244,000 and $64,000 for the six months ended September 30, 2007 and September 30, 2006, respectively. The provision relates to state franchise taxes in the U.S. and foreign taxes on interest income in India.

 

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We adopted the provisions of FIN 48 at the beginning of our fiscal year 2008. As a result of the implementation of FIN 48, we recognized no increase in the liability for unrecognized tax benefits, which was fully reserved in previous periods. Upon completing the FIN 48 analysis the Company determined the total amount of unrecognized tax benefits at the date of adoption was approximately $9.6 million. There is approximately $7.0 million of unrecognized tax benefit due to Federal net operating loss set to expire before possible utilization. There is approximately $2.6 million of benefits related to various federal and state research credits which lack sufficient supporting documentation. If these benefits were recognized they would increase our deferred tax assets and lower our effective tax rate.

Statement of Financial Accounting Standards No. 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based upon the weight of available evidence, which includes the Company’s historical operating performance and the reported cumulative net losses in all prior years, the Company has provided a full valuation allowance against its net deferred tax assets. The Company evaluates the realizability of the deferred tax assets on a quarterly basis.

7. Stock-Based Compensation

Effective April 1, 2006, the Company adopted the provisions of SFAS No. 123R. SFAS No. 123R establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period, which is the vesting period. All of the Company’s stock compensation is accounted for as an equity instrument. The Company previously applied APB No. 25 and related interpretations and provided the required pro forma disclosures of SFAS No. 123.

Equity Incentive Program

The Company’s equity incentive program is a broad-based, retention program comprised of stock option plans and an employee stock purchase plan designed to align stockholder and employee interests. For a description of the Company’s equity plans, see the notes to consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended March 31, 2007.

Valuation Assumptions

The Company estimates the fair value of each stock option on the date of grant using a Black-Scholes option-pricing model, consistent with the provisions of SFAS No. 123R, SAB No. 107 and the Company’s prior period pro forma disclosures of net loss, including stock-based compensation (determined under a fair value method as prescribed by SFAS No. 123) to determine the fair value of stock options and employee stock purchase plan shares. The determination of the fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by the stock price as well as assumptions regarding a number of complex and subjective variables. These variables include expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate and expected dividends.

The Company estimates the expected term of options granted by calculating the average term from the Company’s historical stock option exercise experience. The Company estimates the volatility of its stock options by using historical volatility in accordance with SAB No. 107. The Company believes its historical volatility is representative of its estimate of expectations of the expected term of its equity instruments. The Company bases the risk-free interest rate that is use in the option-pricing model on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. The Company does not anticipate paying any cash dividends in the foreseeable future and therefore uses an expected dividend yield of zero in the option-pricing model. The Company is required to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses predicted data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. All share based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are the vesting periods.

If factors change and the Company employs different assumptions for estimating stock-based compensation expense in future periods or if it decides to use a different option-pricing model, the future periods may differ significantly from what has been recorded in the current period and could materially affect operating income (loss), net income (loss) and net income (loss) per share.

 

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The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable, characteristics not present in our option grants and employee stock purchase plan shares. Existing option-pricing models, including the Black-Scholes and lattice binomial models, may not provide reliable measures of the fair values of our stock-based compensation. Consequently, there is a risk that the Company’s estimates of the fair values of its stock-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, expiration, early termination or forfeiture of those stock-based payments in the future. Certain stock-based payments, such as employee stock options, may expire worthless or otherwise result in zero intrinsic value as compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, value may be realized from these instruments that are significantly higher than the fair values originally estimated on the grant date and reported in the Company’s financial statements. There currently is no market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these option-pricing models, nor is there a means to compare and adjust the estimates to actual values.

The Company calculated the fair value of its employee stock options at the date of grant with the following weighted average assumptions:

 

     Three Months Ended
September 30,
 
     2007    2006  

Risk-free interest rate

   N/A    4.61 %

Dividend yield

   N/A    0.00 %

Expected volatility

   N/A    39.98 %

Expected option life in years

   N/A    3.23  

The following table summarizes activity under the equity incentive plans for the indicated periods:

 

    

Shares available

for grant (in
thousands)

    Options Outstanding
       Number of shares    

Weighted-average
exercise price

per share

Outstanding at June 30, 2007

   10,663     3,216,797     $ 3.35

Options granted

   —       —         —  

Options exercised

   —       —         —  

Options cancelled

   371     (370,639 )     4.88

Plan shares expired

   (18 )   —         2.76
              

Outstanding at September 30, 2007

   11,016     2,846,158     $ 3.20
              

The intrinsic value is calculated as the difference between the market value as of September 30, 2007 and the exercise price of the shares. The market value of the Company’s common stock as of September 30, 2007 was $1.75 as reported by the NASDAQ National Market. The aggregate intrinsic value of stock options outstanding at September 30, 2007 was $4,485 of which $0 was related to exercisable options. The aggregate intrinsic value of stock options outstanding at September 30, 2006 was $60,087 of which $55,382 was related to exercisable options.

Due to the ongoing stock investigation there were no stock options or awards issued during the quarter or six months ended September 30, 2007.

 

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The options outstanding and exercisable at September 30, 2007 were in the following exercise price ranges:

 

     Options Outstanding    Options Vested

Range of Exercise Prices

   Shares   

Weighted-

Average

Remaining

Contractual

Life (Years)

   Shares   

Weighted-

Average

Exercise

Price Per
Share

$ 1.68 — $ 2.42

   691,000    4.10    437,500    $ 2.35

$ 2.45 — $ 2.47

   614,000    8.99    146,603      2.46

$ 2.50 — $ 2.85

   629,000    2.07    534,352      2.68

$ 3.01 — $ 3.40

   572,444    3.75    374,661      3.32

$ 3.44 — $ 63.48

   339,714    4.00    335,450      5.34
               

$ 1.68 — $ 63.48

   2,846,158    4.62    1,828,566    $ 3.20
               

The following table summarizes the Company’s outstanding weighted average options for the indicated period:

 

     Three Months Ended
September 30,
   Six Months Ended
September 30,
     2007    2006    2007    2006

Weighted average options with strike price below FMV

   25,000    1,079,238    83,500    1,433,988

Weighted average options with strike price at FMV

   —      —      —      —  

Weighted average options with strike price above FMV

   2,821,158    4,623,658    2,762,158    4,268,908

The weighted average remaining contractual term of all options outstanding at September 30, 2007 is 4.6 years. Prior to the adoption of SFAS No. 123R, the Company accounted for forfeitures upon occurrence. SFAS No. 123R requires forfeitures to be estimated at the time of grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. Based on the Company’s estimates of future forfeiture rates, the Company has assumed an annualized forfeiture rate of 20% for its options.

1999 Employee Stock Purchase Plan (“ESPP”)

The price paid for the Company’s common stock purchased under the ESPP is equal to 85% of the lower of the fair market value of the Company’s common stock at the beginning of each offering period or at the end of each offering period. The compensation expense in connection with the ESPP for the three and six months ended September 30, 2007 was $6,003 and $14,905 respectively. The compensation expense in connection with the ESPP for the three and six months ended September 30, 2006 was $56,403 and $107,976. During the three and six months ended September 30, 2007, there were no shares issued under the ESPP due to the ongoing stock option investigation. During the three months ended September 30, 2006, there were 18,289 shares issued under the ESPP at a weighted average purchase price of $2.30 per share.

The Company calculated the fair value of rights granted under its employee stock purchase plan at the date of grant using the following weighted average assumptions:

 

     Six Months Ended
September 30,
 
     2007     2006  

Risk-free interest rate

     4.64 %     3.61 %

Dividend yield

     0.00 %     0.00 %

Expected volatility

     55.10 %     61.29 %

Expected life in years

     1.25       1.16  

Weighted average fair value at grant date

   $ 1.16     $ 1.37  

8. Computation of Basic and Diluted Net Loss Per Share

Basic and diluted net loss per common share is presented in conformity with SFAS No. 128, “Earnings Per Share” (“SFAS 128”), for all periods presented. In accordance with SFAS 128, basic and diluted net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the period.

 

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The Company excludes potentially dilutive securities from its diluted net loss per share computation when their effect would be antidilutive to net loss per share amounts. The following common stock equivalents were excluded from the net loss per share computation:

 

     Three Months Ended
September 30,
   Six Months Ended
September 30,
     2007    2006    2007    2006
     (In thousands)    (In thousands)

Options excluded due to the exercise price exceeding the average fair market value of the Company’s common stock during the period

   2,821    4,624    2,762    4,269

Options excluded for which the exercise price was at or less than the average fair market value of the Company’s common stock during the period but were excluded as inclusion would decrease the Company’s net loss per share

   25    1,079    84    1,434
                   

Total common stock equivalents excluded from diluted net loss per common share

   2,846    5,703    2,846    5,703
                   

9. Litigation and Contingencies

Selectica is involved in lawsuits, claims and proceedings which arise in the ordinary course of business. In accordance with SFAS No. 5 “Accounting for Contingencies,” Selectica records a provision for a liability when management believes that it is both probable that a liability has been incurred and Selectica can reasonably estimate the amount of the loss. On October 9, 2007 Selectica Inc. and Versata Software Inc.reached a settlement of a patent lawsuit. Selectica paid Versata $10 million on October 9, 2007 and agreed to pay an additional amount of not more than $7.5 million in quarterly payments. The quarterly payments are based on 10% of revenues from the Company’s Configuration, Pricing or Quoting (CPQ or Sales Execution Segment) products and services and a 50% revenue share of CPQ revenue from new Company CPQ customers that are currently Versata customers and to whom Versata makes an introduction to Selectica. The Company agreed that its quarterly payments will be the greater of the sum calculated by the percentages of CPQ revenues or $200,000. Selectica believes it has adequate provisions for such matters. This one time charge reduced earnings per share by $0.57 for both the three and six months ending September 30, 2007.

On October 23, 2007 Selectica and Stephen Bennion, Vice President and General Manager of the Company’s Sales Configuration Business entered into a Separation Arrangement. Pursuant to the terms of the Separation Agreement, Mr. Bennion was placed on a paid leave of absence October 5, 2007 through December 27, 2007, at which time Mr. Bennion’s employment with the Company will terminate. Under the Separation Agreement, on December 27, 2007 Mr. Bennion will receive a payment of $50,000 representing his target bonus for fiscal 2008, and will continue to receive payments equal to his base salary and health insurance premiums for himself and his dependents for a period ending not later than August 21, 2008. The Company estimates this one time charge will impact future earnings by approximately $292,000 in the third quarter related to this separation agreement.

10. Restructuring

The restructuring accrual and the related utilization for the fiscal years ended March 31, 2007, 2006 and for the six months ended September 30, 2007 were, respectively (in thousands):

 

     Severance and
Benefits
    Excess
Facilities and
other
    Total  

Balance, March 31, 2006

   $ —       $ —       $ —    
                        

Additional accruals — Plan

     488       6,392       6,880  

Amounts paid in cash — Plan

     (385 )     (652 )     (1,037 )
                        

Balance, March 31, 2007

     103       5,740       5,843  

Additional accruals — Plan

       235       235  

Amounts paid in cash — Plan

     (85 )     (1,607 )     (1,692 )

Sublease loan

       (624 )     (624 )
                        

Net balance, September 30, 2007

   $ 18     $ 3,744     $ 3,762  
                        

 

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During the fiscal year 2007, the Company continued with cost reduction efforts under a restructuring plan. On December 31, 2006 the company relocated the corporate headquarters to a smaller facility. As a result of the relocation the company recorded a one time charge of approximately $6.0 million, consisting principally of net present value of remaining lease payments estimated at $5.3 million in addition to a remaining net book value of leasehold improvements on the old facility of approximately $0.6 million. In addition, the company made a reduction in staff of 19 employees which represented 15% of the workforce. Headcount reductions consisted of 9 in research and development, 3 in professional services, 6 in sales and marketing and 1 in general administration and finance. These headcount reductions resulted in charges of approximately $385,000, consisting principally of severance payments and benefits, of which $165,000 was included in research and development expense, $52,000 included in cost of revenues, $120,000 in general and administrative expense and $48,000 in sales and marketing expense.

The company also elected to cease operations in the United Kingdom as of March 31, 2007. This resulted in headcount reductions of three people along with approximately $0.1 million in costs. In an effort to reduce operating expenses the company announced the closure of the India office during the second quarter. The company expects to complete the closure by December 31, 2007. The company incurred minimal restructuring charges, primarily employee severance costs.

11. Recent Accounting Pronouncements

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS No. 159). SFAS No. 159 permits companies to choose to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS No. 159 is effective for the Company beginning in the first quarter of fiscal year 2009, although earlier adoption is permitted. We are currently evaluating the impact that SFAS No. 159 will have on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157). The purpose of SFAS No. 157 is to define fair value, establish a framework for measuring fair value, and enhance disclosures about fair value measurements. The measurement and disclosure requirements are effective for the Company beginning in the first quarter of fiscal year 2009. We are currently evaluating the impact that SFAS No. 157 will have on our consolidated financial statements.

 

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ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In addition to historical information, this quarterly report contains forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Management’s Discussion and Analysis” as well as in Part II Item 1A “Risk Factors.” Actual results could differ materially. Important factors that could cause actual results to differ materially include, but are not limited to; the level of demand for Selectica’s products and services; the intensity of competition; Selectica’s ability to effectively manage product transitions and to continue to expand and improve internal infrastructure; risks associated with potential acquisitions; and adverse financial, customer and employee consequences that might result to us if litigation were to be resolved in an adverse manner to us. For a more detailed discussion of the risks relating to our business, readers should refer to Part II Item 1A found later in this report entitled “Risks Factors.” Readers are cautioned not to place undue reliance on the forward-looking statements, including statements regarding our expectations, beliefs, intentions or strategies regarding the future, which speak only as of the date of this quarterly report. We assume no obligation to update these forward-looking statements.

Overview

We are a leading provider of sales configuration and contract management software used by companies to manage the contracting process for their products and services. Historically, our solutions have been successfully implemented at a number of companies such as IBM, Cisco Systems, Dell, Rockwell and GE Healthcare. However, these types of large system sales have declined significantly in recent years as the market has shifted toward smaller scale, more focused system implementations and away from the large, custom project implementations that we have historically provided.

In response to this shift, we began focusing more internal resources on the contract management market, beginning with the acquisition of certain assets of Determine Software in May 2005. Our contract management products extend our business model by permitting us to offer a broader range of on-premise or hosted solutions for our customers. These products are targeted at small to large businesses interested in using application software to manage configurable product and service offerings, though automated pricing management, contract management, and compliance. We expect sales of our contract management products to account for an increasing percentage of overall sales in the future. In response to these business developments, we reduced our operating costs through the reduction of personnel and other costs.

Quarterly Financial Overview

Independent Directors Stock Option Investigation

In November 2006, Selectica’s Board of Directors formed a Special Committee to conduct a voluntarily review of its historical stock option grants. The Special Committee retained independent legal counsel and independent forensic and technical specialists to assist in the investigation. The investigation covered option grants made to all employees, directors and consultants during the period from January 2000 through November 2006. The Special Committee found instances wherein incorrect measurement dates were used to account for certain option grants. Due to this investigation the Company was not able to file its Form 10-Q for the first quarter of fiscal 2008 by the filing deadline. We incurred approximately $1.3 million in additional professional fees related to legal, audit and consulting fees during the quarter ended September 30, 2007.

For the three months ended September 30, 2007, our revenues were approximately $4.0 million with license revenues representing 27% and services revenues representing 73% of total revenues. In addition, approximately 54% of our quarterly revenue came from two customers. License margins for the quarter were 95% and services margins were 69%. Net loss for the quarter was approximately $17.8 million or $0.63 per share. Net loss for the quarter excluding the Versata litigation settlement was $1.7 million or $0.06 per share. For the three months ended September 30, 2006, our revenues were approximately $3.0 million with license revenues representing 10% and services revenues representing 90% of total revenues. In addition, approximately 69% of our quarterly revenue came from three customers. License margins for the quarter were (195)% and services margins were 31%. Net loss for the quarter was approximately $5.4 million or $0.18 per share.

Critical Accounting Policies and Estimates

There have been no material changes to any of our critical accounting policies and estimates as disclosed in our report on Form 10-K for the year ended March 31, 2007.

 

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The following table shows how our revenues have been recognized:

 

     Three Months Ended
September 30,
    Six Months Ended
September 30,
 
     2007     2006     2007     2006  

As a Percentage of Total Revenues:

        

Contract accounting

   41 %   56 %   39 %   63 %

Residual method

   —       —       —       —    

Subscription method (includes maintenance)

   59 %   44 %   61 %   37 %
                        

Total revenues

   100 %   100 %   100 %   100 %
                        

Customer billing occurs in accordance with contract terms. Customer advances and amounts billed to customers in excess of revenue recognized are recorded as deferred revenues. The majority of our contracts have been accounted for on the completed contract method upon achievement of milestones or final acceptance from the customer.

Related Party Transaction and Severance Agreement

In connection with the resignation of Dr. Sanjay Mittal, Chief Executive Officer, the Company agreed to have him continue as Chief Technical Advisor (“CTA”). Pursuant to this arrangement, Dr. Mittal received $20,000 per month for his services and this arrangement would continue until either party terminated the CTA service. In March 2005, Dr. Mittal’s role as CTA was terminated and he received a lump-sum severance payment of $412,500 in addition to the amount paid for outside services. In July 2005 Dr. Mittal agreed to provide hourly consulting services relating to patent litigation which was settled in February 2006. As a result his consulting agreement terminated. On July 21, 2006 Dr. Mittal resigned as a member of the Board of Directors and agreed to provide hourly consulting services for a period of at least 12 months. Dr. Mittal was paid $15,000 and $25,000 for consulting services for the three and six months ended September 30, 2007 and $15,000 for the three and six months ended September 30, 2006.

Factors Affecting Operating Results

A small number of customers account for a significant portion of our total revenues. We expect that our revenue will continue to depend upon a limited number of customers. If we were to lose a customer, it would have a significant impact upon future revenue. Customers who accounted for at least 10% of total revenues were as follows:

 

    

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
     2007     2006     2007     2006  

Customer A

   45 %   40 %   28 %   31 %

Customer B

   *     *     10 %   *  

Customer C

   11 %   13 %   10 %   12 %

Customer D

   *     16 %   *     11 %

Customer E

   *     *     *     *  

 

* Customer account was less than 10% of total revenues.

To date, we have foreign activities in India, Canada and some European countries because we believe international markets represent an avenue for growth. We anticipate that our exposure to foreign currency fluctuations will continue since we have not adopted a hedging program to protect us from risks associated with foreign currency fluctuations.

We have incurred significant losses since inception and, as of September 30, 2007, we had an accumulated deficit of approximately $237 million. We believe our success depends on the growth of our customer base and the development of the emerging configuration, pricing management, quoting solutions and the contract management and compliance market. In the early 2000’s, we underwent certain restructuring activities and did so again during the fiscal years of 2007 and 2006.

In view of the rapidly changing nature of our business, we believe that period-to-period comparisons of revenues and operating results are not necessarily meaningful and should not be relied upon as indications of future performance. Our operating history has been volatile and makes it difficult to forecast future operating results. This was evidenced by the decline in revenue in fiscal 2007 and 2006.

 

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Because our services tend to be specific to each customer and how that customer will use our products, and because each customer sets different acceptance criteria, it is difficult for us to accurately forecast the amount of revenue that will be recognized on any particular customer contract during any quarter or fiscal year. As a result, we base our revenue estimates, and our determination of associated expense levels, on our analysis of the likely revenue recognition events under each contract during a particular period. Although the value of customer contracts signed during any particular quarter or fiscal year is not an accurate indicator of revenues that will be recognized during any particular quarter or fiscal year, in general, if the value of customer contracts signed in any particular quarter or fiscal year is lower than expected, revenue recognized in future quarters and fiscal years will likely be negatively effected.

Results of Operations:

Revenues

 

     Three Months Ended
September 30,
    Six Months Ended
September 30,
 
     2007     2006     Change     2007     2006     Change  
     (in thousands, except percentages)  

License

   $ 1,091     $ 293     $ 798     $ 2,802     $ 761     $ 2,041  

Percentage of total revenues

     27 %     10 %     272 %     34 %     9 %     268 %

Services

     2,891       2,703       188       5,521       7,451       (1,930 )

Percentage of total revenues

     73 %     90 %     7 %     66 %     91 %     (26 )%

Total revenues

   $ 3,982     $ 2,996     $ 986     $ 8,323     $ 8,212     $ 111  

License. For the three and six months ending September 30, 2007, license revenues increased by approximately $0.8 and $2.0 million respectively compared to the three and six months ending September 30, 2006. We expect license revenues to continue to fluctuate in future periods as a percentage of total revenues and in absolute dollars depending on the number and size of new license contracts.

Services. Services revenues are comprised of fees from consulting, maintenance, training, subscription revenue and out-of pocket reimbursement. During the six months ending September 30, 2007, services revenues decreased compared to the period ending September 30, 2006. The decrease primarily related to fewer service opportunities provided by new license agreements as bookings of license agreements during fiscal 2007 continued to decline, offset by our clients’ demand for additional services to expand their initial customized application and revenue generated by our on-demand offerings. Maintenance revenues represented 62% and 57% of total services revenues for the three months ended September 30, 2007 and September 30, 2006, respectively. Maintenance revenues represented 63% and 43% of total services revenues for the six months ended September 30, 2007 and September 30, 2006, respectively.

We expect services revenues to continue to fluctuate in future periods as a percentage of total revenues and in absolute dollars. This will depend on the number and size of new software implementations and follow-on services to our existing customers. We expect maintenance revenue to fluctuate in absolute dollars and as a percentage of services revenues with respect to the number of maintenance renewals, and number and size of new contracts. In addition, maintenance renewals are extremely dependent upon customer satisfaction and the level of need to make changes or upgrade versions of our software by our customers. Fluctuations in services revenue are also due to timing of revenue recognition, achievement of milestones, customer acceptance, changes in scope or renegotiated terms, and additional services.

Cost of revenues

 

     Three Months Ended
September 30,
    Six Months Ended
September 30,
 
     2007     2006     Change     2007     2006     Change  
     (in thousands, except percentages)  

Cost of license revenues

   $ 53     $ 865     $ (812 )   $ 112     $ 980     $ (868 )
                                                

Percentage of license revenues

     5 %     295 %     -94 %     4 %     129 %     89 %

Cost of services revenues

   $ 885     $ 1,874     $ (989 )   $ 1,903     $ 4,443     $ (2,540 )
                                                

Percentage of services revenues

     31 %     69 %     -53 %     34 %     60 %     -57 %

 

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Cost of License Revenues. The cost of license revenues consists of a nominal allocation of research and development fees, royalty fees associated with third-party software, and data transmission costs. During the three and six months ended September 30, 2007 the approximate decrease of $0.8 million and $0.9 million respectively is due to a $600,000 write off in September 30, 2006 of prepaid royalties to a reseller. We expect cost of license revenues to maintain a relatively consistent level in absolute dollars.

Cost of Services Revenues. The cost of services revenues is comprised mainly of salaries and related expenses of our services organization plus certain allocated expenses. During the three and six months ended September 30, 2007, these costs decreased 53% and 57% respectively compared to the same period in 2006 primarily due to a decrease in salaries and facilities expense. We expect cost of services revenues to fluctuate as a percentage of service revenues and we plan to reduce our investment in cost of services revenues in absolute dollars over the next year as necessary to balance expense levels with projected revenues.

Gross Margins

Gross margins percentages for services revenues and license revenues for the respective periods are as follows:

 

    

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
     2007     2006     2007     2006  

License

   95 %   -195 %   96 %   -29 %

Services

   69 %   31 %   66 %   40 %

Gross Margin — Licenses. Because we have certain license costs that are fixed, gross margins fluctuate until we have sufficient license revenues. License margins may also fluctuate due to embedded third-party software. When license software products are sold with royalty bearing software, margins are lower than when license software without such third party products are sold. Accordingly, margins will vary based on gross license revenue and product mix. Due to significantly higher license revenues to offset the fixed license costs, we experienced higher license gross margins during the three and six months ended September 30, 2007 compared to the three and six months ending September 30, 2006.

Gross Margin — Services. During the three and six months ended September 30, 2007, revenues from services increased by approximately $0.2 million and decreased by approximately $1.9 million respectively. Gross margin increased to 69% and 66% for the three and six months ended September 30, 2007. While services revenues decreased, we were able to decrease our costs correspondingly in order to improve the services margin compared to the three and six months ended September 30, 2006.

We expect that our overall gross margins will continue to fluctuate due to the timing of services and license revenue recognition and will continue to be adversely affected by lower margins associated with services revenues. The impact on our gross margin will depend on the mix of services we provide, whether the services are performed by our in-house staff or third party consultants, and the overall utilization rates of our professional services organization.

Operating Expenses

Research and Development Expenses

 

    

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
     2007     2006     Change     2007     2006     Change  
     (in thousands, except percentages)  

Research and development

   $ 1,139     $ 2,149     $ (1,010 )   $ 2,317     $ 4,251     $ (1,934 )
                                                

Percentage of total revenues

     28 %     72 %     -47 %     28 %     52 %     -45 %

Research and development expenses consist primarily of salaries and related costs of our engineering, quality assurance, technical publications efforts and certain allocated expenses. The decrease of approximately $1.0 and $1.9 million in research and development expenses during the three and six months ending September 30, 2007 respectively compared to the three months September 30, 2006 was primarily attributable to a staff reduction and decreases in costs for facilities, overhead and benefits.

 

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Sales and Marketing

 

    

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
     2007     2006     Change     2007     2006     Change  
     (in thousands, except percentages)  

Sales and marketing

   $ 1,136     $ 1,779     $ (643 )   $ 3,061     $ 3,622     $ (561 )
                                                

Percentage of total revenues

     28 %     59 %     -36 %     37 %     44 %     -15 %

Sales and marketing expenses consist primarily of salaries and related costs for our sales and marketing organization, sales commissions, expenses for travel and entertainment, trade shows, public relations, collateral sales materials, advertising and certain allocated expenses. The decrease of approximately $0.6 for the three and six months ended September 30, 2007 in sales and marketing expenses over the same period in 2006 is due to a staff reduction and lower facilities costs.

General and Administrative

 

    

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
     2007     2006     Change     2007     2006     Change  
     (in thousands, except percentages)  

General and administrative

   $ 1,360     $ 2,599     $ (1,239 )   $ 2,738     $ 4,455     $ (1,717 )
                                                

Percentage of total revenues

     34 %     87 %     -48 %     33 %     54 %     -39 %

General and administrative expenses consist mainly of personnel and related costs for general corporate functions, including finance, accounting, legal, human resources, bad debt expense and certain allocated expenses. The decrease of approximately $1.2 and $1.7 million in general and administrative expense during the three and six months ending September 30, 2007 over the same period in 2006 is primarily due to lower facilities costs. We continue efforts to reduce our cost structure, particularly general and administrative expenses.

Interest and Other Income, Net

Interest income consists primarily of interest earned on cash balances and short-term and long-term investments. During the three and six months ended September 30, 2007 interest income totaled approximately $0.8 million and $1.9 million respectively. Interest income has remained relatively consistent with prior year as a result of drawing invested cash balances offset by higher interest rates.

Provision for Income Taxes

During the three and six months ended September 30, 2007 we recorded income tax provisions of approximately $38,000 and $244,000 compared to $35,000 and $64,000 for the same periods in 2006, respectively. These amounts related to taxes due in foreign jurisdictions and nominal tax amounts for federal and states taxes in the U.S.

FASB Statement No. 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based upon the weight of available evidence, which includes our historical operating performance and the reported cumulative net losses in all prior years, we have provided a full valuation allowance against our net deferred tax assets. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis.

 

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Liquidity and Capital Resources

 

     September 30,
2007
   March 31,
2007
   Change  
     (in thousands, except percentages)  

Cash, cash equivalents and short-term investments

   $ 51,832    $ 57,450    (10 )%

Working capital

   $ 34,771    $ 49,243    (29 )%

 

     Six Months Ended
September 30,
 
     2007     2006  
     (in thousands)  

Net cash used in operating activities

   $ (6,576 )   $ (4,695 )

Net cash provided by investing activities

   $ (7,640 )   $ 13,056  

Net cash used in financing activities

     —       $ (4,249 )

Our primary sources of liquidity consisted of approximately $52.4 million in cash, cash equivalents and short-term investments as of September 30, 2007 compared to approximately $57.5 million in cash, cash equivalents and short-term investments as of March 31, 2007. During the six months ending September 30, 2007, the decrease in cash and cash equivalents was primarily related to approximately $6.7 million of cash used in operations in addition to net purchases of short and long-term investments of approximately $7.6 million. During the six months ending September 30, 2006, the increase in cash and cash equivalents was primarily related to approximately $4.7 million of cash used in operations, approximately $4.4 million of cash used to repurchase our stock offset by cash provided by purchases of short and long-term investments of approximately $13.1 million. We experienced a net decrease in working capital at September 30, 2007 as compared to March 31, 2007 primarily due to the cash used in operations.

We had no significant commitments for capital expenditures as of September 30, 2007. We expect to fund our future capital expenditures, liquidity and strategic operating programs from a combination of available cash balances and internally generated funds. We have no outside debt and do not have any plans to enter into borrowing arrangements. We believe our cash, cash equivalents, and short-term investment balances as of September 30, 2007 are adequate to fund our operations through at least the next twelve months.

We do not anticipate any significant capital expenditures, payments due on long-term obligations, or other contractual obligations. However, management is continuing to review our cost structure to minimize expenses and use of cash as we implement our planned business model changes. This activity may result in additional restructuring charges or severance and other benefits.

Our contractual obligations and commercial commitments at September 30, 2007, are summarized as follows:

 

     Payments Due By Period     

Contractual Obligations:

   Total    

Less Than

1 Year

   

1-3

Years

   

4-5

Years

  

After 5

Years

     (in thousands)

Operating Leases

   $ 6,252     $ 2,898     $ 3,354     $ —      $ —  

Sublease Income

   $ (1,397 )   $ (300 )   $ (1,097 )   $ —      $ —  

Net Lease Payments

   $ 4,855     $ 2,598     $ 2,257     $ —      $ —  

We engage in global business operations and are therefore exposed to foreign currency fluctuations. As of September 30, 2007, the effects of the foreign currency fluctuations in Europe and India were insignificant.

We have adopted a new stock repurchase program, which authorizes us to pay up to approximately $25.0 million. Approximately $13.9 million remains available to be used under this program at September 30, 2007.

 

ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discusses our exposure to market risk related to changes in foreign currency exchange rates and interest rates. This discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results could vary materially as a result of a number of factors including those set forth in the Part II Item 1A entitled “Risk Factors” of this quarterly report on Form 10-Q.

Foreign Currency Exchange Rate Risk

We develop products in the United States and India and sell them worldwide. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since our sales are currently priced in U.S. dollars and are translated to local currency amounts, a strengthening of the dollar could make our products less competitive in foreign markets.

 

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Our exposure to fluctuation in the relative value of other currencies has been limited because substantially all of our assets are denominated in U.S. dollars. The impact to our financial statements has therefore not been material. To date, we have not entered into any foreign exchange hedges or other derivative financial instruments. We will continue to evaluate our exposure to foreign currency exchange rate risk on a regular basis.

Interest Rate Risk

We established policies and business practices regarding our investment portfolio to preserve principal while obtaining reasonable rates of return without significantly increasing risk. This is accomplished by investing in widely diversified short-term and long-term investments, consisting primarily of investment grade securities. Our interest income is sensitive to changes in the general level of U.S. interest rates.

During the three months ending September 30, 2007, a hypothetical 50 basis point increase in interest rates would have resulted in a reduction of approximately $42,000 (less than 0.1%) in the fair market value of our cash equivalents and investments. This potential change is based upon a sensitivity analysis performed on our financial positions at September 30, 2007. During the three months ending September 30, 2006, a hypothetical 50 basis point increase in interest rates would have resulted in a reduction of approximately $61,000 (less than 0.1%) in the fair market value of our cash equivalents and investments. This potential change is based upon a sensitivity analysis performed on our financial positions at September 30, 2006.

Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted because of a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations because of changes in interest rates or we may suffer losses in principal if forced to sell securities that have seen a decline in market value because of changes in interest rates. Our investments are made in accordance with an investment policy approved by the Board of Directors. In general, our investment policy requires that our securities purchases be rated A1/P1, AA/Aa3 or better. No securities may have a maturity that exceeds 18 months and the average duration of our investment portfolio may not exceed 9 months. At any time, no more than 15% of the investment portfolio may be insured by a single insurer and no more than 25% of investments may be invested in any one industry other than the US government bonds, commercial paper and money market funds.

The following summarizes short-term and long-term investments at fair value, weighted average yields and expected maturity dates as of September 30, 2007 through the fiscal years ending:

 

     2008     2009     2010    2011    Total  
     (in thousands, except percentages)  

Investment CD

   $ 5,458     $ 1,554     —      —      $ 7,012  

Weighted Average yield

     8.48 %     8.56 %   —      —        8.50 %

Commercial Paper

     22,510       —       —      —        22,510  

Weighted Average yield

     5.49 %     —       —      —        5.49 %

Auction rate securities

     —         —       —      —        0  

Weighted Average yield

     —         —       —      —        —    

Corporate notes & bonds

     1,417       2,452     —      —        3,869  

Weighted Average yield

     5.19 %     5.13 %   —      —        5.19 %

Government agencies

     2,492       —       —      —        2,492  

Weighted Average yield

     5.25 %     —       —      —        5.27 %
                        

Total investments

   $ 31,877     $ 4,006     —      —      $ 35,883  
                              

 

ITEM 4: CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures. Our Chief Executive Officer and our Chief Financial Officer, after evaluating the effectiveness of our “disclosure controls and procedures” (as defined in the Securities Exchange Act of 1934 (Exchange Act) Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this quarterly report, have concluded that our disclosure controls and procedures are not effective because of the material weaknesses described below.

 

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(b) Changes in Internal Control over Financial Reporting. As previously disclosed in Item 9A of our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on October 2, 2007, for the fiscal year ended March 31, 2007, we determined that the following material weakness existed in our internal control over financial reporting related to controls maintained by us:

We had insufficient controls over the External Reporting process related to the preparation, review and approval of the annual and the interim financial statements. Specifically, we had insufficient: a) review within the accounting and finance departments; b) preparation and review of footnote disclosures accompanying our financial statements; and c) technical accounting resources. As of March 31, 2006, we did not have sufficient personnel and technical accounting expertise within our accounting function to sufficiently address complex transactions and/or accounting and financial reporting issues that arise from time to time in the course of our operations. Although these deficiencies did not result in errors in the financial statements, there is however, more than a remote likelihood that a material misstatement of our annual or interim financial statements would not have been prevented or detected.

Planned Remediation

In August 2007, our management discussed the material weaknesses described above with our audit committee. We are implementing corrective actions that we believe will remediate the material weakness, however a material weakness may not be considered fully remediated until the instituted controls are operational for a period of time and have been tested by management.

Because of the insufficient controls described in the preceding paragraphs, we concluded that our internal controls over financial reporting were not effective as of September 30, 2007. While management implemented new controls in the last fiscal year, we maintained our assessment as of September 30, 2007 because we did not have sufficient time to monitor our new controls and determine whether the new controls are effective and that our remediation plans are sufficient. We will continue to assess the effectiveness of our internal controls, including the controls implemented to correct the five material weaknesses identified in fiscal 2005 and the material weakness identified in fiscal 2006 and fiscal 2007. Except for the remediation process implemented by management, there has been no change in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during the quarter ended September 30, 2007, which materially affected, or is reasonably likely to affect, our internal controls over financial reporting.

(c) Limitations on Effectiveness of Controls

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or our internal controls over the financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. The design of a control system reflects the fact that there are resource constraints, and the benefit of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within have been detected. These inherent limitations include the realities that judgment in decision-making can be faulty and that simple error or mistakes can occur. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving it stated goals under all future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

PART II: OTHER INFORMATION

 

ITEM 1: LEGAL PROCEEDINGS

Patent Infringement

On October 20, 2006, Versata Software, Inc., formerly known as Trilogy Software Inc., and a related party (collectively, “Versata”) filed a complaint against the Company in the United States District Court for the Eastern District of Texas, Marshall Division, alleging that the Company has been and is willfully infringing, directly and indirectly, U.S. Patent Nos. 5,515,524; 5,708,798 and 6,002,854 (collectively, the “Versata Patents”) by making, using, licensing, selling, offering for sale, or importing configuration software and related services. On October 9, 2007 Selectica Inc. and Versata Software Inc.reached a settlement of a patent lawsuit. Selectica paid Versata $10 million on October 9, 2007 and agreed to pay an additional amount of not more than $7.5 million in quarterly payments. The quarterly payments are based on 10% of revenues from the Company’s Configuration, Pricing or Quoting (CPQ or Sales Execution Segment) products and services and a 50% revenue share of CPQ revenue from new Company CPQ customers that are currently Versata customers and to whom Versata makes an introduction to Selectica. The Company agreed that its quarterly payments will be the greater of the sum calculated by the percentages of CPQ revenues or $200,000. Both parties entered into mutual releases releasing any and all claims that they may have against the other occurring before the settlement date.

 

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Other

In the future we may be subject to other lawsuits, including claims relating to intellectual property matters or securities laws. Any litigation, even if not successful against us, could result in substantial costs and divert management’s and other resources away from the operations of our business. If successful against us, we could be liable for large damage awards and, in the case of patent litigation, subject to injunctions that significant harm our business.

 

ITEM 1A: RISK FACTORS

In addition to other information in this Form 10-Q, the following risk factors should be carefully considered in evaluating our business because such factors currently may have a significant impact on our business, operating results and financial condition. As a result of the risk factors set forth below and elsewhere in this Form 10-Q, and the risks discussed in our other Securities and Exchange Commission filings including our Form 10-K for our fiscal year ended March 31, 2007, actual results could differ materially from those projected in any forward-looking statements.

We have relied and expect to continue to rely on a limited number of customers for a substantial portion of our revenues, and the loss of any of these customers would significantly harm our business and operating results.

Our business and financial condition is dependent on a limited number of customers. Our five largest customers accounted for approximately 58% and 54% of our revenues for the six months ended September 30, 2007 and September 30, 2006, respectively. Revenues from significant customers greater than 10% of total revenues are as follows:

 

    

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
     2007     2006     2007     2006  

Customer A

   45 %   40 %   28 %   31 %

Customer B

   *     *     10 %   *  

Customer C

   11 %   13 %   10 %   12 %

Customer D

   *     16 %   *     11 %

* Customer account was less than 10% of total revenues.

We expect that we will continue to depend upon a relatively small number of customers for a substantial portion of our revenues for the foreseeable future. As a result, if we fail to successfully sell our products and services to one or more customers in any particular period or a large customer purchases fewer of our products or services, defers or cancels orders, or terminates its relationship with us, our business and operating results would be harmed.

The unpredictability of our quarterly revenues and results of operations makes it difficult to predict our financial performance and may cause volatility or a decline in the price of our common stock if we are unable to satisfy the expectations of investors or the market.

We enter into arrangements for the sale of: (1) licenses of software products and related maintenance contracts; (2) bundled license, maintenance, and services; (3) services; and (4) subscription for on-demand services. In instances where maintenance is bundled with a license of software products, such maintenance term is typically one year.

For each arrangement, we determine whether evidence of an arrangement exists, delivery has occurred, the fees are fixed or determinable, and collection is probable. If any of these criteria are not met, revenue recognition is deferred until such time as all of the criteria are met.

Our quarterly revenues may also fluctuate due to our ability to perform services, achieve specific milestones and obtain formal customer acceptance of specific elements of the overall completion of a project. As we provide such services and products, the timing of delivery and acceptance, changed conditions with the customers and projects could result in changes to the timing of our revenue recognition, and thus, our operating results.

Likewise, if our customers do not renew maintenance services or purchase additional products, our operating results could suffer. Historically, we have derived and expect to continue to derive a significant portion of our total revenue from existing customers who purchase additional products or renew maintenance agreements. Our customers may not renew such

 

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maintenance agreements or expand the use of our products. In addition, as we introduce new products, our current customers may not require or desire the features of our new products. If our customers do not renew their subscriptions or maintenance agreements with us or choose not to purchase additional products, our operating results could suffer.

Because we rely on a limited number of customers, the timing of customer acceptance or milestone achievement, or the amount of services we provide to a single customer can significantly affect our operating results or the failure to replace a significant customer. Because expenses are relatively fixed in the near term, any shortfall from anticipated revenues could cause our quarterly operating results to fall below anticipated levels.

We may also experience seasonality in revenues. For example, our quarterly results may fluctuate based upon our customers’ calendar year budgeting cycles. These seasonal variations may lead to fluctuations in our quarterly revenues and operating results.

Based upon the foregoing, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and that such comparisons should not be relied upon as indications of future performance. In some future quarter, our operating results may be below the expectations of public market analysts and investors, which could cause volatility or a decline in the price of our common stock.

If our new product marketing strategy is unsuccessful, it could significantly harm our business and operating results.

We have recently revised our product marketing focus. We had previously positioned our company primarily as a seller of Configuration, Price and Quotation (CPQ) software, however, we are now investing a significant portion of our internal resources into a second offering, our contract lifecycle management products. If the market for these products is smaller than we anticipated or if our products fail to gain widespread acceptance in this market, our results of operations would be adversely affected. In addition, if there is a delay in bringing our new products to market, it would delay our ability to derive revenues from such products and our business and operating results could be significantly harmed.

If our bookings do not improve, our results of operations could be significantly harmed.

In any given period our revenues are dependent on customer contracts entered into, “booked” during earlier periods. Because we typically recognize revenue in periods after contracts are booked, a decline in the number of contracts booked during any particular period or the value of such contracts would cause a decrease in revenue in future periods. The number and value of our bookings has been lower than management expectations. Our inability to increase bookings in the previous quarters was a significant factor in the decline of our revenues in more recent quarters. If our bookings remain at current levels or if the value of such bookings decreases further, it will cause our revenues to decline in future periods and could significantly harm our business and operating results.

Our future success depends on our proprietary intellectual property, and if we are unable to protect our intellectual property from potential competitors, our business may be significantly harmed.

We rely on a combination of patent, trademark, trade secret and copyright law and contractual restrictions to protect the proprietary aspects of our technology. These legal protections afford only limited protection for our technology. We currently hold six patents in the United States. In addition, we have two trademarks registered in the United States, one trademark registered and one pending in South Korea, two trademarks registered in Canada and one trademark registered in European Community, and we have also applied to register another two trademarks in the United States. Our trademark applications might not result in the issuance of any trademarks. Our patents or any future issued trademarks might be invalidated or circumvented or otherwise fail to provide us any meaningful protection. We seek to protect the source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to license agreements, which impose certain restrictions on the licensee’s ability to utilize the software. We also seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of many countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets and to determine the validity and scope of the proprietary rights of others. Our failure to adequately protect our intellectual property could have a material adverse effect on our business and operating results.

 

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The loss of any of our key personnel would harm our competitiveness because of the time and effort that we would have to expend to replace such personnel.

We believe that our success will depend on the continued employment of our management team and key technical personnel. Moreover, some of the individuals on our management team have been in their current positions for a relatively short period of time. For example, our Chief Financial Officer and Vice President of Engineering joined us in September 2006. Our future success will depend to a significant extent on the ability of our management team to work effectively together. There can be no assurance that our management team will be able to integrate and work together effectively.

If one or more members of our senior management team or key technical personnel were unable or unwilling to continue in their present positions, these individuals would be difficult to replace and our ability to manage day-to-day operations, including our operations in Pune, India, develop and deliver new technologies, attract and retain customers, attract and retain other employees and generate revenues would be significantly harmed.

Any mergers, acquisitions or joint ventures that we may make could disrupt our business and harm our operating results.

On December 3, 2004, we announced that we entered into a definitive merger agreement with I-many, Inc., under which we agreed, subject to certain conditions, to pay $1.55 per share in cash for all outstanding shares of I-many common stock, for a total transaction value of $70 million. The transaction was not approved by the I-many stockholders, and the merger agreement was terminated in March 2005. In May 2005, we entered into an agreement to purchase certain assets and products of Determine for cash. The transaction closed in the first quarter of fiscal 2006.

The attempt to acquire and merge I-many required a significant amount of management time, as well as significant consulting, legal and accounting expense that negatively affected our operating results. We may engage in acquisitions of other companies, products or technologies, such as the acquisition of Determine. If we fail to integrate successfully any future acquisitions (or technologies associated with such), the revenue and operating results of the combined companies could decline. The process of integrating an acquired business may result in unforeseen difficulties and expenditures. If we fail to complete any acquisitions of any other companies, it may also result in unforeseen difficulties and expenditures. Acquisitions may involve a number of other potential risks to our business and include, but are not limited to the following:

 

   

potential adverse effects on our operating results, including unanticipated costs and liabilities, unforeseen accounting charges or fluctuations from failure to accurately forecast the financial impact of an acquisition;

 

   

use of cash;

 

   

issuance of stock that would dilute our current stockholders’ percentage ownership;

 

   

incurring debt;

 

   

assumption of liabilities;

 

   

amortization expenses related to other intangible assets;

 

   

incurring large and immediate write-offs;

 

   

incurring legal and professional fees;

 

   

problems combining the purchased operations, technologies or products with ours;

 

   

diversion of managements’ attention from our core business;

 

   

adverse effects on existing business relationships with suppliers and customers; and

 

   

potential loss of key employees, particularly those of the acquired organizations.

Any unsolicited proposals for the purchase of our Company could disrupt business and harm our operating results.

In January 2005, Trilogy, a privately held company, conditionally proposed to purchase all of our outstanding common stock for $4.00 per share. This unsolicited proposal assumed that the I-many merger was not completed. On February 2, 2005, following consultation with our legal and financial advisors, we issued a press release announcing that our Board of Directors determined that Trilogy’s proposal was not in our best interests or those of our stockholders. For reasons unrelated to Trilogy’s proposal, I-many and Selectica terminated the I-many merger on March 31, 2005. On April 11, 2005, Trilogy filed a Statement of Beneficial Ownership on Schedule 13D with the Securities and Exchange Commission reporting that it owned 6.9% of our outstanding common stock as of that date. As described further in this report, Trilogy was also engaged in a patent infringement lawsuit against us, which has been settled.

Uncertainty regarding Trilogy’s intentions toward us may cause disruption in our business, which could result in a material adverse effect on our financial condition and operating results. Additionally, as a consequence of the uncertainty surrounding our future, our key employees may be distracted and could seek other employment opportunities. If key employees leave, there could be a material adverse effect on our business and results of operations. Uncertainty surrounding

 

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Trilogy’s intentions and Trilogy’s patent infringement lawsuit against us could also be disruptive to our relations with our existing and potential customers as the proposal and/or the patent litigation may be viewed negatively by some customers. Responding to any proposals from Trilogy and the patent lawsuit has consumed, and may continue to consume, attention from our management and employees, and may require us to incur significant costs, which could adversely affect our financial and operating results.

Our lengthy sales cycle for our large enterprise sales execution systems makes it difficult for us to forecast revenue and exacerbates the variability of quarterly fluctuations, which could cause our stock price to decline.

The sales cycle of our large enterprise sales execution systems has historically averaged between nine to twelve months, and may sometimes be significantly longer. We are generally required to provide a significant level of education regarding the use and benefits of our products, and potential customers tend to engage in extensive internal reviews before making purchase decisions. In addition, the purchase of our products typically involves a significant commitment by our customers of capital and other resources, and is therefore subject to delays that are beyond our control, such as customers’ internal budgetary procedures and the testing and acceptance of new technologies that affect key operations. In addition, because we target large companies, our sales cycle can be lengthier due to the decision process in large organizations. As a result of our products’ long sales cycles, we face difficulty predicting the quarter in which sales to expected customers may occur. If anticipated sales from a specific customer for a particular quarter are not realized in that quarter, our operating results for that quarter could fall below the expectations of financial analysts and investors, which could cause our stock price to decline.

Developments in the market for enterprise software including configuration, pricing, contract management and quoting solutions may harm our operating results, which could cause a decline in the price of our common stock.

The market for enterprise software including configuration, pricing, contract management and quoting solutions is evolving rapidly. In view of changing market trends including vendor consolidation, the competitive environment gross rate and potential size of the market are difficult to assess. The growth of the market is dependent upon the willingness of businesses and consumers to purchase complex goods and services over the Internet and the acceptance of the Internet as a platform for business applications. In addition, companies that have already invested substantial resources in other methods of Internet selling may be reluctant or slow to adopt a new approach or application that may replace, limit or compete with their existing systems.

The rapid change in the marketplace poses a number of concerns. The decrease in technology infrastructure spending may reduce the size of the market for configuration, pricing management and quoting solutions. Our potential customers may decide to purchase more complete solutions offered by larger competitors instead of individual applications. If the market for configuration, pricing management, contract management and quoting solutions is slow to develop, or if our customers purchase more fully integrated products, our business and operating results would be significantly harmed.

We face intense competition, which could reduce our sales, prevent us from achieving or maintaining profitability and inhibit our future growth.

The market for software and services that enable electronic commerce is intensely competitive and rapidly changing. We expect competition to persist and intensify, which could result in price reductions, reduced gross margins and loss of market share. Our principal competitors include publicly-traded companies such as Oracle Corporation, Ariba, and I-Many as well as privately held companies such as Comergent Technologies, Firepond, Upside Software, Nextance, DiCarta/Emptoris and Trilogy, all of which offer integrated solutions for electronic commerce incorporating some of the functionality of our configuration, pricing, contract management and quoting software.

Our competitors may intensify their efforts in our market. In addition, other enterprise software companies may offer competitive products in the future. Competitors vary in size, in the scope and breadth of the products and services offered. Although we believe we have advantages over our competitors including the comprehensiveness of our solution, our use of Java technology and our multi-threaded architecture, some of our competitors and potential competitors have significant advantages over us, including:

 

   

a longer operating history;

 

   

preferred vendor status with our customers;

 

   

more extensive name recognition and marketing power; and

 

   

significantly greater financial, technical, marketing and other resources, giving them the ability to respond more quickly to new or changing opportunities, technologies, and customer requirements.

 

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Our competitors may also bundle their products in a manner that may discourage users from purchasing our products. Current and potential competitors may establish cooperative relationships with each other or with third parties, or adopt aggressive pricing policies to gain market share. Competitive pressures may require us to reduce the prices of our products and services. We may not be able to maintain or expand our sales if competition increases, and we are unable to respond effectively.

A decline in general economic conditions or a decrease in information technology spending could harm our results of operations.

A change in economic conditions could lead to revised budgetary constraints regarding information technology spending for our customers. We have had potential customers select our software, but decide to delay or not to implement any configuration system. Many companies have decided to reduce their expenditures for information technology by either delaying non-mission critical projects or abandoning them until their levels of business justify the expenses. Stagnation in information technology spending due to economic conditions or other factors could significantly harm our business and operating results.

If we do not keep pace with technological change, including maintaining interoperability of our products with the software and hardware platforms predominantly used by our customers, our products may be rendered obsolete, and our business may fail.

Our industry is characterized by rapid technological change, changes in customer requirements, frequent new product and service introductions and enhancements and emerging industry standards. In order to achieve broad customer acceptance, our products must be compatible with major software and hardware platforms used by our customers. Our products currently operate on the Microsoft Windows NT, Sun Solaris, IBM AIX, J2EE, Linux and Microsoft Windows 2000 Operating Systems. In addition, our products are required to interoperate with electronic commerce applications and databases. We must continually modify and enhance our products to keep pace with changes in these operating systems, applications and databases. Our configuration, pricing and quoting products are complex, and new products and product enhancements can require long development and testing periods. If our products were to be incompatible with a popular new operating system, electronic commerce application or database, our business would be significantly harmed. In addition, the development of entirely new technologies to replace existing software could lead to new competitive products that have better performance or lower prices than our products and could render our products obsolete and unmarketable.

Our failure to meet customer expectations on deployment of our products could result in negative publicity and reduced sales, both of which would significantly harm our business and operating results.

In the past, a small number of our customers have experienced difficulties or delays in completing implementation of our products. We may experience similar difficulties or delays in the future. Deploying our products typically involves integration with our customers’ legacy systems, such as existing databases and enterprise resource planning software as well adding their data to the system. Failing to meet customer expectations on deployment of our products could result in a loss of customers and negative publicity regarding us and our products, which could adversely affect our ability to attract new customers. In addition, time-consuming deployments may also increase the amount of professional services we must allocate to each customer, thereby increasing our costs and adversely affecting our business and operating results.

If we are unable to maintain our direct sales force, sales of our products and services may not meet our expectations, and our business and operating results will be significantly harmed.

We depend on our direct sales force for a significant portion of our current sales, and our future growth depends in part on the ability of our direct sales force to develop customer relationships and increase sales to a level that will allow us to reach and maintain profitability. If we are unable to retain qualified sales personnel or if newly hired personnel fail to develop the necessary skills or to reach productivity when anticipated, we may not be able to increase sales of our products and services, and our results of operation could be significantly harmed.

 

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If we are unable to manage our professional services organization, we will be unable to provide our customers with technical support for our products, which could significantly harm our business and operating results.

Services revenues, which generated 73% and 90% of our revenues during the three months ended September 30, 2007 and September 30, 2006, respectively, are comprised primarily of revenues from consulting fees, maintenance contracts and training and are important to our business. Service revenues generated 66% and 91% of our revenues during the six months ended September 30, 2007 and September 30, 2006 respectively. Services revenues have lower gross margins than license revenues. During the three and six months ended September 30, 2007 and September 30, 2006, respectively, gross margins percentages for license and services revenues are as follows:

 

    

Three Months Ended

September 30,

   

Six Months Ended

September 30,

 
     2007     2006     2007     2006  

License

   95 %   -195 %   96 %   -29 %

Services

   69 %   31 %   66 %   40 %

We intend to charge for our professional services on a time and materials rather than a fixed-fee basis. However, in current market conditions, many customers insist on services provided on a fixed-fee basis. To the extent that customers are unwilling to utilize third-party consultants or require us to provide professional services on a fixed-fee basis, our cost of services revenues could increase and could cause us to recognize a loss on a specific contract, either of which would adversely affect our operating results. In addition, if we are unable to provide these professional services, we may lose sales or incur customer dissatisfaction, and our business and operating results could be significantly harmed.

If new versions and releases of our products contain errors or defects, we could suffer losses and negative publicity, which would adversely affect our business and operating results.

Complex software products such as ours often contain errors or defects, including errors relating to security, particularly when first introduced or when new versions or enhancements are released. In the past, we have discovered defects in our products and provided product updates to our customers to address such defects. Our products and other future products may contain defects or errors that could result in lost revenues, a delay in market acceptance or negative publicity, each which would significantly harm our business and operating results.

A substantial portion of our operations are conducted by India-based personnel, and any change in the political and economic conditions of India or in immigration policies that adversely affects our ability to conduct our operations in India could significantly harm our business.

We conduct development, quality assurance and professional services operations in India. As of September 30, 2007 we employed 13 persons in India. We are dependent on our India-based operations for these aspects of our business. As a result, we are directly influenced by the political and economic conditions affecting India. Operating expenses incurred by our operations in India are denominated in Indian currency, and accordingly, we are exposed to adverse movements in currency exchange rates. This, as well as any other political or economic problems or changes in India, could have a negative impact on our India-based operations, resulting in significant harm to our business and operating results. Furthermore, the intellectual property laws of India may not adequately protect our proprietary rights. We believe that it is particularly difficult to find quality management personnel in India, and we may not be able to timely replace our current India-based management team if any of them were to leave our Company.

Our training program for some of our India-based employees includes an internship at our San Jose, California headquarters. Additionally, we provide services to some of our customers with India-based employees. We presently rely on a number of visa programs to enable these India-based employees to travel and work internationally. Any change in the immigration policies of India or the countries to which these employees travel and work could cause disruption or force the termination of these programs, which would harm our business.

Demand for our products and services will decline significantly if our software cannot support and manage a substantial number of users.

Our strategy requires that our products be highly scalable. To date, only a limited number of our customers have deployed our products on a large scale. If our customers cannot successfully implement large-scale deployments, or if they determine that we cannot accommodate large-scale deployments, our business and operating results would be significantly harmed.

 

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If we become subject to product liability litigation, it could be costly and time consuming to defend and could distract us from focusing on our business and operations.

Since our products are company-wide, mission-critical computer applications with a potentially strong impact on our customers’ sales, errors, defects or other performance problems could result in financial or other damages to our customers. Although our license agreements generally contain provisions designed to limit our exposure to product liability claims, existing or future laws or unfavorable judicial decisions could negate such limitation of liability provisions. Product liability litigation, even if it were unsuccessful, would be time consuming and costly to defend.

Any reduction in expenses will place a significant strain on our management systems and resources, and if we fail to manage these changes, our business will be harmed.

We may further reduce our operating expenses, and as a result, this would place increased demands on our managerial, administrative, operational, financial and other resources.

Our rapid growth required us to manage a large number of relationships with customers, suppliers and employees, as well as a large number of complex contracts. Additional cost cutting measures would force us to handle these demands with a smaller number of employees. If we are unable to initiate procedures and controls to support our future operations in an efficient and timely manner, or if we are unable to otherwise manage these changes effectively, our business would be harmed.

Our results of operations will be reduced by charges associated with stock-based compensation, accelerated vesting associated with stock options issued to employees, charges associated with other securities issued by us, and charges related to variable accounting.

We have in the past and expect in the future to incur a significant amount of charges related to securities issuances, which will negatively affect our operating results. We adopted the provisions of SFAS 123R using a modified prospective application effective April 1, 2006. We use the Black-Scholes model to determine the fair value of our share-based payments and recognize compensation cost on a straight-line basis over the vesting periods. This pronouncement from the FASB provides for certain changes to the method for valuing stock-based compensation. Among other changes, SFAS 123R applies to new awards and to awards that are outstanding which are subsequently modified or cancelled. Compensation expense cost calculated under SFAS 123R will continue to negatively impact our operating results.

Failure to improve and maintain relationships with systems integrators and consulting firms, which assist us with the sale and installation of our products, would impede the acceptance of our products and the growth of our revenues.

Our strategy has been to rely in part upon systems integrators and consulting firms to recommend our products to their customers and to install and deploy our products. To date, we have had limited success in utilizing these firms as a sales channel or as a provider of professional services. To increase our revenues and implementation capabilities, we must continue to develop and expand our relationships with these systems integrators and consulting firms. If these systems integrators and consulting firms are unwilling to install and deploy our products, we may not have the resources to provide adequate implementation services to our customers, and our business and operating results could be significantly harmed.

Our subscription-based products are hosted by a third-party provider.

Some of our Contract Management solutions are hosted by a third party data-center provider. Failure of the data center provider to maintain service levels as contracted, could result in customer dissatisfaction, customer losses and potential product warranty or performance liabilities.

Anti-takeover defenses that we have in place could prevent or frustrate attempts by stockholders to change our board of directors or the direction of the company.

Provisions of our amended and restated certificate of incorporation and amended and restated bylaws, Delaware law and the stockholder rights plan adopted by the company on February 4, 2003 may make it more difficult for or prevent a third party from acquiring control of the company without approval of our directors. These provisions include:

 

   

providing for a classified board of directors with staggered three-year terms;

 

   

restricting the ability of stockholders to call special meetings of stockholders;

 

   

prohibiting stockholder action by written consent;

 

   

establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings; and

 

   

granting our board of directors the ability to designate the terms of and issue new series of preferred stock without stockholder approval.

 

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These provisions may have the effect of entrenching our board of directors and may deprive or limit your strategic opportunities to sell your shares.

If we are unable to successfully address the material weaknesses in our disclosure controls and procedures, including our internal control over financial reporting, our ability to report our financial results on a timely and accurate basis may be adversely affected.

We conducted an evaluation, under the supervision and with the participation of our management including our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of March 31, 2007. Based upon that evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures are not effective to ensure that the information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and include controls and procedures designed to ensure that information required to be disclosed by us in such reports is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. As of September 30, 2007, we had inadequate policies, procedures and personnel to ensure that accurate, reliable interim and annual consolidated financial statements were prepared and reviewed on a timely basis. This significant deficiency is believed to be a material weakness and arose from a lack of review controls.

Compliance with new regulations dealing with corporate governance and public disclosure may result in additional expenses and require significant management attention.

The Sarbanes-Oxley Act of 2002, as well as new rules implemented by the Securities Exchange Commission and the NASDAQ National Market, has required changes in corporate governance practices of public companies. These rules are increasing our legal and financial compliance costs and causing some management and accounting activities to become more time-consuming and costly. This includes increased levels of documentation, monitoring internal controls, and increased manpower and use of consultants to comply. We have and will continue to expend significant efforts and resources to comply with these rules and regulations and have implemented a comprehensive program of compliance with these requirements and high standards of corporate governance and public disclosure.

These rules may also make it more difficult and more expensive us to obtain director and officer liability insurance, and may make us accept reduced coverage or incur substantially higher costs for such coverage. The rules and regulations may also make it more difficult for us to attract and retain qualified executive officers and members of our board of directors, particularly to serve on our audit committee.

Restrictions on export of encrypted technology could cause us to incur delays in international product sales, which would adversely impact the expansion and growth of our business.

Our software utilizes encryption technology, the export of which is regulated by the United States government. If our export authority is revoked or modified, if our software is unlawfully exported or if the United States adopts new legislation restricting export of software and encryption technology, we may experience delay or reduction in shipment of our products internationally. Current or future export regulations could limit our ability to distribute our products outside of the United States. While we take precautions against unlawful exportation of our software, we cannot effectively control the unauthorized distribution of software across the Internet.

Unauthorized break-ins or other assaults on our computer systems could harm our business.

Our servers are vulnerable to physical or electronic break-ins and similar disruptions, which could lead to loss of data or public release of proprietary information. In addition, unauthorized persons may improperly access our data. These and other types of attacks could harm us. Actions of this sort may be very expensive to remedy and could adversely affect results of operations.

Changes to accounting standards and financial reporting requirements or taxes, may affect our financial results.

We are required to follow accounting standards and financial reporting set by governing bodies in the U.S. and other countries where we do business. From time to time, these governing bodies implement new and revised laws and regulations. These new and revised accounting standards, financial reporting and tax laws may require changes to accounting principles used in preparing our financial statements. These changes may have a material impact on our business and financial results. For example, a change in accounting rules can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change became effective. As a result, changes to existing rules or reconsideration of current practices caused by such changes may adversely affect our reported financial results or the way we conduct our business.

 

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Increasing government regulation of the Internet could limit the market for our products and services, or impose greater tax burdens on us or liability for transmission of protected data.

As electronic commerce and the Internet continue to evolve, federal, state and foreign governments may adopt laws and regulations covering issues such as user privacy, taxation of goods and services provided over the Internet, pricing, content and quality of products and services. If enacted, these laws and regulations could limit the market for electronic commerce, and therefore the market for our products and services. Although many of these regulations may not apply directly to our business, we expect that laws regulating the solicitation, collection or processing of personal or consumer information could indirectly affect our business.

Laws or regulations concerning telecommunications might also negatively impact us. Several telecommunications companies have petitioned the Federal Communications Commission to regulate Internet service providers and online service providers in a manner similar to long distance telephone carriers and to impose access fees on these companies. This type of legislation could increase the cost of conducting business over the Internet, which could limit the growth of electronic commerce generally and have a negative impact on our business and operating results.

 

ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Items 2(a) and 2(b) are inapplicable.

(c) Issuer Purchases of Equity Securities.

Due to the voluntary stock option investigation there were no purchases of our common stock made during the three or six months ended September 30, 2007 by us or any “affiliated purchaser” of ours as defined in Rule 10b-18(a)(3) under the Exchange Act.

 

  (1) On November 9, 2005, Selectica announced that its Board of Directors had authorized a new $25 million stock repurchase program. The new repurchase plan resulted in shares of our stock being repurchased in the open market from time to time based on market conditions. This new program replaced the prior repurchase plan previously announced on May 6, 2003.

 

  (2) Shares have only been repurchased through publicly announced programs.

 

ITEM 3: DEFAULTS UPON SENIOR SECURITIES

Not applicable.

 

ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

 

ITEM 5: OTHER INFORMATION

Not applicable.

 

ITEM 6: EXHIBITS

 

Exhibit 31.1    Certification of Chairman and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1    Certification of Chairman and Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2    Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Date: November 13, 2007

 

SELECTICA, INC.
Registrant
/s/ ROBERT JURKOWSKI
Robert Jurkowski
Chairman and Chief Executive Officer
/s/ BILL ROESCHLEIN
Bill Roeschlein
Vice President and Chief Financial Officer

 

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