Determine 10Q 2007 Q3 Quarterly report

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 December 31, 2006

¨	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 95110

(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, and 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 x Non-accelerated filer ¨

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 September 15, 2007 was 28,407,299.

FORM 10-Q

SELECTICA, INC.

INDEX


PART I FINANCIAL INFORMATION

ITEM 1:	Financial Statements (unaudited)

	Condensed Consolidated Balance Sheets as of December 31, 2006 and March 31, 2006	4

	Condensed Consolidated Statements of Operations for the three and nine months ended December 31, 2006 and 2005	5

	Condensed Consolidated Statements of Cash Flows for the nine months ended December 31, 2006 and 2005	6

	Notes to Condensed Consolidated Financial Statements	7

ITEM 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22

ITEM 3:	Quantitative and Qualitative Disclosures about Market Risk	34

ITEM 4	Controls and Procedures	36

PART II OTHER INFORMATION

ITEM 1:	Legal Proceedings	37

ITEM 1A:	Risk Factors	38

ITEM 2:	Unregistered Sales of Equity Securities and Use of Proceeds	51

ITEM 3:	Defaults Upon Senior Securities	52

ITEM 4:	Submission of Matters to a Vote of Security Holders	52

ITEM 5:	Other Information	52

ITEM 6:	Exhibits	52

Signatures		53

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 2006. 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 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.

EXPLANATORY NOTE REGARDING RESTATEMENT OF OUR CONSOLIDATED FINANCIAL STATEMENTS

In this Form 10-Q for the three and nine months ended December 31, 2006, we are restating our consolidated balance sheet as of March 31, 2006. The restatement includes adjustments arising from an internal review of our historical financial statements, as well as the determinations of a Special Committee of our Board of Directors, assisted by independent legal counsel and independent forensic and technical specialists, formed in October, 2006 to conduct an internal investigation into our historical stock option granting practices that concluded that our historical measurement dates could not be relied upon. This restatement is more fully described in Note 3, “Restatement of Consolidated Financial Statements,” to Consolidated Financial Statements and in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” In our Form 10-K for the year ended March 31, 2007 filed with the Securities and Exchange Commission (“2007 Form 10-K”) on October 2, 2007, we are restating our consolidated balance sheet as of March 31, 2006 and March 31, 2005 and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of our fiscal years ended March 31, 2006 and March 31, 2005.

Financial information included in the reports on Form 10-K, Form 10-Q and Form 8-K filed by us prior to July 12, 2007, and the related opinions of its independent registered public accounting firms, and all earnings press releases and similar communications issued by us prior to July 12, 2007 should not be relied upon and are superseded in their entirety by this 2007 Form 10-Q and other reports on Form 10-K and Form 8-K filed by us with the Securities and Exchange Commission on or after July 12, 2007.

Except for the sections that address the restatement, or as otherwise specifically noted in this 2007 Form 10-Q, all of the information in this 2007 Form 10-Q is as of December 31, 2006 and does not reflect events occurring after that date. Accordingly, this 2007 Form 10-Q should be read in conjunction with our periodic filings made with the SEC, including any amendments to those filings, as well as any Current Reports filed on Form 8-K.

PART I: FINANCIAL INFORMATION

ITEM 1:

FINANCIAL STATEMENTS

SELECTICA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS)


	December 31, 2006 (unaudited)			March 31, 2006 *
	December 31, 2006 (unaudited)			March 31, 2006 *
				(Restated)(1)
Assets
Current assets:
Cash and cash equivalents	$	20,440		$	12,628
Short-term investments		37,642			61,377
Accounts receivable, net of allowance for doubtful accounts of $108 and $167, respectively		2,743			3,243
Prepaid expenses and other current assets		859			2,259

Total current assets		61,684			79,507
Property and equipment, net		1,767			2,407
Intangible assets		360			516
Other assets		647			511
Long-term investments		2,226			2,929

Total assets	$	66,684		$	85,870

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	932		$	1,651
Accrued payroll and related liabilities		1,036			1,431
Other accrued liabilities		4,852			2,467
Deferred revenues		1,765			2,052

Total current liabilities		8,585			7,601

Other long term liabilities		3,516			1,090

Contingencies (see Note 10)
Stockholders’ equity:
Common stock		3			4
Additional paid-in capital		299,221			299,107
Accumulated deficit		(212,028	)		(195,944	)
Deferred compensation		0			(1,072	)
Accumulated other comprehensive loss		(28	)		(107	)
Treasury stock		(32,585	)		(24,809	)

Total stockholders’ equity		54,583			77,179

Total liabilities and stockholders’ equity	$	66,684		$	85,870

(1)	See Note 3, “Restatement of Consolidated Financial Statements” of the Notes to Consolidated Financial Statements.

See accompanying notes.

*	Derived from audited consolidated financial statements

SELECTICA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

(UNAUDITED)


	Three Months Ended December 31,						Nine Months Ended December 31,
	2006			2005			2006			2005
Revenues:
License	$	439		$	520		$	1,200		$	3,593
Services		3,221			4,737			10,672			14,822

Total revenues		3,660			5,257			11,872			18,415
Cost of revenues:
License		82			164			1,062			502
Services		1,571			2,259			6,014			6,787

Total cost of revenues		1,653			2,423			7,076			7,289

Gross profit		2,007			2,834			4,796			11,126
Operating expenses:
Research and development		1,681			1,951			5,933			6,740
Sales and marketing		1,435			1,597			5,057			5,032
General and administrative		1,716			2,394			6,171			8,793
Restructuring		5,784			824			5,784			824
Professional fees related to stock option investigation		482			—			482			—
Litigation settlement		—			7,500			—			7,500

Total operating expenses		11,099			14,266			23,427			28,889

Loss from operations		(9,092	)		(11,432	)		(18,631	)		(17,763	)
Interest and other income, net		1,033			647			2,633			1,832

Loss before provision for income taxes		(8,059	)		(10,785	)		(15,998	)		(15,931	)
Provision for income taxes		22			26			86			74

Net loss	$	(8,081	)	$	(10,811	)	$	(16,084	)	$	(16,005	)

Basic and diluted net loss per share	$	(0.27	)	$	(0.33	)	$	(0.54	)	$	(0.48	)

Weighted-average shares of common stock used in computing basic and diluted net loss per share		29,832			32,958			30,608			32,894

See accompanying notes.

SELECTICA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)


	Nine Months Ended December 30,
	2006			2005
Operating activities
Net loss	$	(16,084	)	$	(16,005	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		516			680
Amortization		156			207
Loss (gain) on disposition of property and equipment		1,064			(37	)
Stock based compensation expense		1,009			217
Compensation expenses related to modification of options		—			(16	)
Changes in assets and liabilities:
Accounts receivable (net)		500			448
Prepaid expenses and other current assets		1,400			178
Other assets		(136	)		(29	)
Accounts payable		(719	)		338
Accrued payroll and related liabilities		(395	)		(641	)
Other accrued liabilities and long term liabilities		4,810			7,636
Deferred revenues		(287	)		(479	)

Net cash used in operating activities		(8,166	)		(7,504	)

Investing activities
Purchase of capital assets		(976	)		(27	)
Proceeds from restricted investments					182
Purchase of short-term investments		(36,330	)		(43,003	)
Purchase of long term investments					(7,885	)
Proceeds from maturities of short-term investments		60,144			37,411
Proceeds from maturities of long-term investments		703			8,604
Cash paid for acquisition		—			(801	)
Proceeds from disposal of fixed assets		36			—

Net cash provided by (used in) investing activities		23,577			(5,519	)

Financing activities
Purchase of treasury stock		(7,776	)		(336	)
Proceeds from issuance of common stock		177			552

Net cash provided by (used in) financing activities		(7,599	)		216

Net increase (decrease) in cash and cash equivalents		7,812			(12,807	)
Cash and cash equivalents at beginning of the period		12,628			29,360

Cash and cash equivalents at end of the period	$	20,440		$	16,165

See accompanying notes.

SELECTICA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Basis of Presentation

The condensed consolidated balance sheet as of December 31, 2006, the condensed consolidated statements of operations for the three and nine months ended December 31, 2006 and 2005, and the condensed consolidated statement of cash flows for the nine months ended December 31, 2006 and 2005 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 December 31, 2006, and the results of operations for the three and nine months ended December 31, 2006 and 2005 and cash flows for the nine months ended December 31, 2006 and 2005. Interim results are not necessarily indicative of the results for a full fiscal year. The consolidated balance sheet as of March 31, 2006 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, 2006.

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, 2006.

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 December 31,				Nine Months Ended December 31,
	2006		2005		2006		2005
			Restated				Restated
Customer A	11	%	24	%	11	%	25	%
Customer B	26	%	22	%	29	%	22	%
Customer C	*		20	%	*		*
Customer D	*		*		11	%	*
Customer E	10	%	*		*		*

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

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


	December 31, 2006		March 31, 2006
Customer A	41	%	24	%
Customer B	14	%	*
Customer C	*		24	%
Customer D	*		11	%
Customer E	12	%	*

*	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 losses on available for sale securities of approximately $28,000 and $107,000, respectively, at December 31, 2006 and March 31, 2006.

The components of comprehensive loss, net of related income tax, for the three and nine months ended December 31, 2006 and 2005 are as follows:


	Three Months Ended December 31,						Nine Months Ended December 31,
	2006			2005			2006			2005
				Restated						Restated
	(In thousands)
Net loss	$	(8,081	)	$	(10,811	)	$	(16,084	)	$	(16,005	)
Change in unrealized gain on securities		(9	)		61			79			297

Comprehensive loss	$	(8,090	)	$	(10,750	)	$	(16,005	)	$	(15,708	)

Stock-Based Compensation

Beginning April 1, 2006, the Company adopted the provisions of, and accounts for stock-based compensation in accordance with, (“SFAS”) No. 123 (revised 2004) “Share-Based Payment” (“SFAS No. 123R”) and Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) No. 107. The Company elected the modified-prospective method, under which prior periods are not revised for comparative purposes. The Company currently uses the Black-Scholes option-pricing model to determine the fair value of stock options and employee stock purchase plan rights and compensation cost is recognized as expense over the requisite service period.

The Company previously applied Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations and provided the required pro forma disclosures of SFAS No. 123, “Accounting for Stock-Based Compensation” as amended by SFAS No. 148. See Note 8.

Segment Information

International revenues are attributable to countries based on the location of the customers. For the three and nine months ended December 31, 2006, sales to international locations were derived primarily from the United Kingdom, Canada and India. For the three and nine months ended December 31, 2005, sales to international locations were derived primarily from Canada, India, Japan, New Zealand, Sweden and the United Kingdom.


	Three Months Ended December 31,				Nine Months Ended December 31,
	2006		2005		2006		2005
			Restated				Restated
International revenues	18	%	12	%	14	%	16	%
Domestic revenues	82	%	88	%	86	%	84	%

Total revenues	100	%	100	%	100	%	100	%

For the three months ended December 31, 2006 sales to one international customer accounted for 10% of total revenue. For the nine months ended December 31, 2006, there was one sale to any international customer that accounted for 10% of the total revenue. For the nine months ended December 31, 2005, sales to one specific international customer accounted for 12% of total revenue.

As of December 31, 2006 and March 31, 2006, the Company held long-lived assets outside of the United States with a net book value of approximately $1.0 million, which were primarily in India.

3. Restatement of Consolidated Financial Statements

Restatement of Previously Issued Financial Statements

Financial information included in the reports on Form 10-K, Form 10-Q and Form 8-K filed by us prior to July 12, 2007, and the related opinions of its independent registered public accounting firms, and all earnings press releases and similar communications issued by us prior to July 12, 2007 should not be relied upon and are superseded in their entirety by this 2007 Form 10-Q and other reports on Form 10-Q and Form 8-K filed by us with the Securities and Exchange Commission on or after July 12, 2007.

Background relating to Special Committee Investigation

In October 2006, Selectica’s Board of Directors formed a Special Committee to conduct a voluntary investigation of its historical stock option grants. The Special Committee retained independent legal counsel, and forensic accounting experts to assist with the investigation. The scope of the Special Committee investigation included all stock option grants dating from the eve of the Company’s initial public offering (“IPO”), which occurred on March 10, 2000, through the end of 2006 (the “Review Period”). During the Review Period, the Company issued approximately 22 million option shares and restricted stock. The Company made 2,424 grants on 164 grant dates.

Based on the Special Committee’s investigation, which the Company’s Board of Directors has adopted, we have determined that the actual measurement dates for financial accounting purposes of certain stock options granted primarily during fiscal years 2001-2005 differ from the recorded grant dates of such awards and that new measurement dates for financial accounting purposes apply to the affected awards which result in additional non-cash stock-based compensation expense.

The Special Committee found, among other things, that the Company lacks contemporaneous evidence supporting a significant number of the recorded option grants. Further, the Company appears to have incorrectly measured the effective dates for a number of its option grants based on a variety of factors, including delays in the approval of awards, retrospective selection of some grant dates, the absence of clear and definitive documentation regarding grant dates, modifications of or additions to previously awarded grants, and other issues relating to unreliable processes. The affected grants include grants to employees, officers and former directors.

Because of the time required to complete our internal investigation and determine the appropriate accounting treatment, we have been delinquent in filing our Quarterly Reports on Form 10-Q for the three month periods ended September 30, 2006 and December 31, 2006. Those reports have been filed concurrently with this 2007 Form 10-Q.

Remedial measures

In light of the findings of the Special Committee, the Company has adopted remedial measures as indicated below and intends to adopt and implement further remedial measures at the earliest practicable date, including, among other things, the following:

Effective January 30, 2007, the Company has adopted a new stock option grant policy intended to eliminate many of the procedural issues that precipitated the Special Committee investigation. Among

other things, the policy now provides that all stock option awards to officers and other employees will be granted by the Compensation Committee, and all stock option awards will be granted at meetings at which minutes shall be taken. Unanimous Written Consents (UWCs) will no longer be used to grant stock option awards.

The Special Committee has been conducting a “best practices” review of the Company’s existing stock option controls, processes, policies and procedures with the assistance of its auditors, as well as independent and corporate counsel. The Committee will soon propose improvements to the controls, processes, policies and procedures intended to strengthen the Company’s options granting practices.

Effective August 24, 2007, Mr. Bennion is no longer the Company’s Chief Executive Officer or a member of the Board of Directors. However, in light of Mr. Bennion’s significant, ongoing contributions to the Company, knowledge of the industry and relationships with key providers and customers of the Company, the Board believed that Mr. Bennion could continue to provide substantial value to the Company’s stockholders. Accordingly, Mr. Bennion was offered and accepted a new role as Vice President and General Manager of the Configuration, Pricing and Quoting Business Unit. Mr. Bennion’s new position does not involve accounting or financial reporting responsibilities.

The Company has undertaken to improve training and education for all directors, officers and other relevant personnel. These improvements are designed to ensure that everyone involved in the granting and administration of stock options fully understands the terms of the stock option plans, the relevant accounting requirements under Generally Accepted Accounting Principles for stock options and other share-based compensation, as well as recent revisions to the grant approval and documentation process. Going forward, such training will be held annually and as needed for the education of newly-hired personnel.

The Audit Committee will review the Company’s compliance with all controls and procedures regarding equity compensation, including the Company’s stock option policies and procedure, at least annually, to determine whether additional revisions, training, or oversight is required.

Accounting Considerations—Stock-Based Compensation

We accounted for employee, officer and director stock option grants as fixed grants under APB 25, using a measurement date of the recorded grant date. We issued most grants with an exercise price equal to the fair market value of our common stock on the recorded grant date, and therefore originally recorded no stock-based compensation expense. In cases where stock option grants were issued at less than fair market value, we amortized the discount over the vesting period of the option adjusting for terminations.

As a result of the findings of the investigation conducted by the Audit Committee and our own further review of our stock option granting practices, we determined that, although fixed accounting under APB 25 was appropriate, the measurement dates for certain stock option grants differed from the recorded grant dates for such grants. In some instances, we were only able to locate sufficient evidence to identify the measurement date described in APB 25, the first date on which both the number of shares that an individual employee was entitled to receive and the exercise price were known, within a range of possible dates. As a result, we developed a methodology to establish the revised measurement date as our estimate of the first date on which both the number of shares that an individual employee was entitled to receive and the exercise price were known with finality. Using the methodology described below, we concluded that it was appropriate to revise the measurement dates for these grants based upon our findings, and we refer to these revised measurement dates as the Deemed Measurement Dates.

We calculated stock-based compensation expense under APB 25 based upon the intrinsic value as of the Deemed Measurement Dates of stock option awards determined to be fixed under APB 25 and the vesting provisions of the underlying options. We calculated the intrinsic value on the Deemed Measurement Date as the closing price of our common stock on such date as reported on the Nasdaq National Market, now the Nasdaq Global Market, less the exercise price per share of common stock as stated in the underlying stock option agreement, multiplied by the number of shares subject to such stock option award. We recognized these amounts as compensation expense over the vesting period of the underlying options (generally four years).

We determined the Deemed Measurement Dates for all stock option grants to be either the Approval Date or the Communication Date for the stock option grant. The Approval Date was used in each case that it was reliably determined that a Board meeting occurred on such a date, and the Communication Date was used in those cases where the Approval Date could not be determined or was determined to be unreliable.

The Approval Date for the stock option was the date set forth in executed minutes or a fully-executed consent of the board of directors, compensation committee, provided that (1) documentary evidence existed that the allocation of shares had been finalized on such date, and (2) the Communication Date for the stock option was within 30 days of the Approval Date.

The Communication Date for the stock option was the date we determined the key terms of the option (both the number of shares and the exercise price) to be initially communicated to the optionee. In the absence of specific documentary evidence of initial communication, we generally determined the Communication Date to be the date the employee record was added to the stock option database application (Record Add Date).

We determined that variable accounting under APB 25, which is required in situations when the terms of option grants are modified subsequent to the date that all granting actions are complete, was not applicable for any of the grants during the Review Period.

The methodology described above, and the determination of which stock option grants should be considered Outliers, as described above, involves judgment. We believe that the judgments applied are consistent with the provisions of the appropriate accounting pronouncements and the letter from the Office of the Chief Accountant of the SEC to the Financial Executives International and the American Institute of Certified Public Accountants dated September 19, 2006.

Impact of the Restatement Adjustments on the Consolidated Financial Statements

The following table presents the impact of the financial statement restatement adjustments on beginning accumulated deficit and the Company’s previously reported consolidated statements of income for the periods indicated:


	Net Loss December 31						Accumulated Deficit
	Three Months 2005			Nine Months 2005			April, 1, 2004
	(in thousands)
As previously reported:	$	(10,780	)	$	(15,930	)	$	(157,960	)
Adjustment stock compensation expense (benefit)		(31	)		(75	)		(4,220	)
Adjustment payroll taxes, interest and penalties		—			—			(1,137	)

As restated	$	(10,811	)	$	(16,005	)	$	(163,317	)

The following table presents the impact of the individual restatement adjustments, which is explained in further detail in note 3 above:


	Three Months Ended June 30, 2006			Years Ended March 31
	Three Months Ended June 30, 2006			2006		2005		2004		2003		2002		2001		2000
	(in thousands)
Stock based compensation expense	$	(17	)	$	82	$	370	$	564	$	1,170	$	1,781	$	702	$	92
Payroll taxes, interest and penalties									1,137

Total adjustment to net loss due to stock based compensation	$	(17	)	$	82	$	370	$	1,701	$	1,170	$	1,781	$	702	$	92

Stock-Based Compensation—These adjustments are from the Company’s determination that the initially recorded measurement dates of option grants could not be relied upon, based upon the Special Committee’s investigation and the Company’s subsequent reviews and analyses. For substantially all such option grants, there was correspondence or other evidence that indicated that not all required corporate approvals had been obtained as of the initially recorded measurement date. The Company adopted a methodology to remeasure these option grants to a revised measurement date, as previously described and accounted for these grants as fixed awards under Accounting Principles Board Opinion (APB) No. 25 Accounting for Stock Issued to Employees, or APB 25.

Payroll taxes and interest—During the year ended March 31, 2005, in connection with certain stock based compensation adjustments, the Company determined that certain stock options were exercised without the imposition of income tax withholding and employment taxes. As of September 25, 2007, the Company has recorded a net liability of approximately $1,137,000 for the accrued, but unpaid payroll tax, interest, and penalty expense. Such costs were recorded in the periods in which the underlying stock options were exercised. In subsequent periods, should the Company confirm that such income associated with the exercise of stock options was appropriately reported on the recipient’s personal income tax return, such expenses will be in material part reversed, with the reduction in the related functional expense category in the Company’s consolidated statements of operations.

Income tax benefit (provision)—Because of the potential impact of the measurement date changes on the qualified status of Affected ISOs, the Company has determined that all Affected ISOs might not be qualified as ISOs under IRS regulations, and therefore should be accounted for as if they were Nonstatutory Stock Options under the IRC, or NSOs, for income tax accounting purposes. However, the Company recorded no income tax benefit associated with stock-based compensation and related charges because of valuation allowances provided against the resulting deferred tax assets, as the Company believes that sufficient doubt exists that it will be able to realize the value of those assets.

The following table presents the impact of the financial statement restatement adjustments on the Company’s previously reported consolidated statements of operations (unaudited, in thousands, except per share data):


	As Previously Reported
	Three months ended December 31, 2005			Nine months ended December 31, 2005
Net Revenues		5,257			18,415
Gross profit		2,838			11,134

Loss from operations		(11,401	)		(17,688	)
Net loss		(10,780	)		(15,930	)

Basic and diluted, net loss per share	$	(0.33	)	$	(0.48	)


	Adjustments
	Three months ended December 31, 2005			Nine months ended December 31, 2005
Net Revenues	$	—		$	—
Gross profit		(4	)		(11	)

Loss from operations		(31	)		(75	)
Net loss		(31	)		(75	)

Basic and diluted, net loss per share	$	(0.00	)	$	(0.00	)


	As Restated
	Three months ended December 31, 2005			Nine months ended December 31, 2005
Net Revenues		5,257			18,415
Gross profit		2,834			11,126

Loss from operations		(11,432	)		(17,763	)
Net loss		(10,811	)		(16,005	)

Basic and diluted, net loss per share	$	(0.33	)	$	(0.48	)

The following table presents the impact of the financial statement restatement adjustments on the Company’s previously reported consolidated balance sheet items (unaudited, in thousands):



	As Previously Reported March 31, 2006			Adjustments			As Restated
Other accrued liabilities		1,330			1,137			2,467
Total current liabilities		6,464			1,137			7,601
Additional paid-in capital		293,383			5,724			299,107
Deferred stock-based compensation		(20	)		(1,052	)		(1,072	)
Accumulated deficit		(190,136	)		(5,808	)		(195,944	)
Total stockholders’ equity	$	78,315		$	(1,137	)	$	77,179

4. Concurrent Transaction

In May 2006, the Company entered into a swap 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”. As of December 31, 2006, the Company had received the two servers, and placed them into service in September. The Company does not plan to resell the servers. Azul went live on Fastraq and started using Selectica services in September 2006.

The Company 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 prorata 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. For the nine months ended December 31, 2006, the Company recognized approximately $20,000 of revenue from the value-added reseller and did not purchase any professional services from the value-added reseller. For the nine months ended December 31, 2005, the Company recognized approximately $585,000 of revenue from the value-added reseller and did not purchase any professional services from the value-added reseller.

5. Related Party Transaction

In connection with the resignation of Dr. Sanjay Mittal, as Chief Executive Officer in September 2003, 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 the Company’s patent litigation, which was settled in February 2006. As a result, his consulting services agreement terminated. Dr. Mittal was paid $10,000 and $25,000 fees for consulting services for the three and nine months ended December 31, 2006 and $11,700 and $21,450 for the three and nine months ended December 31, 2005. Dr. Mittal was a member of the Board of Directors until July 21, 2006.

On July 21, 2006, Dr. Sanjay Mittal resigned as a member of the Board of Directors. Also on July 21, 2006, the Company entered into a new consulting agreement with Dr. Mittal. Under the terms of the consulting agreement, Dr. Mittal will serve as a consultant to the Company for a period of at least 12 months, subject to earlier termination under certain specified circumstances, and will receive $500 per hour for services rendered, with a minimum payment of 10 hours per calendar month.

6. 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 December 31, 2006, approximately $14.2 million remained 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 and nine months ended December 31, 2006, the Company repurchased 1,906,800 and 3,636,561 shares, respectively, of its common stock. During the three and nine months ended December 31, 2005, the Company repurchased 125,839 shares of its common stock.

7. Income Taxes

The Company recorded a provision for income taxes of approximately $22,000 and $86,000 for the three and nine months ended December 31, 2006, respectively. The Company recorded a provision for income taxes of approximately $26,000 and $74,000 for the three and nine months ended December 31, 2005, respectively. The provision relates to state franchise taxes in the U.S. and foreign taxes on interest income in India.

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.

8. 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.

Prior to the Adoption of SFAS No. 123R

Prior to the adoption of SFAS No. 123R, the Company provided the pro forma disclosures required under SFAS No. 123, as amended by SFAS No. 148.

The pro-forma information for the three and nine months ended December 31, 2005 was as follows (in thousands, except per share data):


	Three Months Ended December 31, 2005			Nine Months Ended December 31, 2005
Net loss, as reported (restated)	$	(10,811	)	$	(16,005	)
Add: Stock-based employee compensation expense included in reported net loss		47			193
Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards		(583	)		(2,052	)

Net loss, pro forma	$	(11,347	)	$	(17,864	)

Basic and diluted net loss per share, as reported (restated)	$	(0.33	)	$	(0.48	)

Basic and diluted net loss per share, pro forma	$	(0.34	)	$	(0.55	)

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, 2006.

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.

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 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 using the following weighted average assumptions:


	Three Months Ended December 31,						Nine Months Ended December 31,
	2006			2005			2006			2005
Risk-free interest rate		4.70	%		4.38	%		4.65	%		3.78	%
Dividend yield		—			—			—			—
Expected volatility		35.60	%		60.94	%		38.07	%		64.48	%
Expected option life in years		3.82			3.98			3.48			3.87
Weighted average fair value at grant date	$	0.70		$	1.37		$	0.76		$	1.60

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


	Three Months Ended December 31,						Nine Months Ended December 31,
	2006			2005			2006			2005
Risk-free interest rate		4.70	%		4.38	%		4.88	%		3.97	%
Dividend yield		—
Expected volatility		35.60	%		60.94	%		38.89	%		62.22	%
Expected option life in years		1.25			1.25			1.25			1.25
Weighted average fair value at grant date	$	0.64		$	1.24		$	0.76		$	1.30

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


			Options Outstanding
	Shares available for grant		Number of shares		Weighted-average exercise price per share
	(in thousands)
Outstanding at September 30, 2006	9,352		5,703		$	3.43
Grants	(918	)	694		$	2.28
Options exercised	0		(5	)	$	1.50
Options cancelled	2,304		(2,304	)	$	3.00
Plan Shares Expired	(922	)	0		$	2.99

Outstanding at December 31, 2006	9,816		4,088		$	3.48

The intrinsic value is calculated as the difference between the market value as of December 31, 2006 and the exercise price of the shares. The market value of the Company’s common stock as of December 31, 2006 was $1.77 as reported by the NASDAQ National Market. The aggregate intrinsic value of stock options outstanding at December 31, 2006 was $10,085 and none was related to exercisable options.

The following table summarizes values for the indicated periods:


	Three Months ending December 31, 2006		Six Months ending December 31, 2006
	(in thousands)
Weighted Average grant date fair value	$	489	$	1,233
Intrinsic value of options exercised	$	5	$	40
Fair value of shares vesting during the period	$	—	$	258

The options outstanding and exercisable at December 31, 2006 were in the following exercise price ranges:


	Options Outstanding		Options Vested
Range of Exercise Prices	Number of Shares	Weighted- Average Remaining Contractual Life (Years)	Number of Shares	Weighted- Average Exercise Price
$ 1.68 — $ 2.44	827,270	8.12	404,238	$	2.34
$ 2.45 — $ 2.56	1,088,937	7.65	412,145		2.55
$ 2.65 — $ 3.40	1,191,539	5.26	682,840		3.17
$ 3.44 — $ 4.94	837,710	2.05	776,712		4.14
$ 5.30 — $ 63.48	142,580	3.52	132,163	��	17.44

$ 1.68 — $ 63.48	4,088,036	5.76	2,408,098	$	4.02

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


	Three Months Ended December 31,		Nine Months Ended December 31,
	2006	2005	2006	2005
Weighted average options with strike price below FMV	130,000	1,590,572	180,000	1,590,572
Weighted average options with strike price at FMV	0	200,000	0	200,000
Weighted average options with strike price above FMV	3,958,036	5,449,351	3,908,036	5,449,351

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 nine months ended December 31, 2006 was $27,431 and $62,272, respectively. The compensation cost in connection with the ESPP for the three and nine months ended December 31, 2005 was $40,071 and $107,451, respectively. During the three and nine months ended December 31, 2006, there were 12,369 shares and 30,658 shares issued, respectively, under the ESPP at a weighted average purchase price of $1.66 and $2.05 per share, respectively. During the three and nine months ended December 31, 2005, there were 25,273 and 61,633 shares, respectively, issued under the ESPP at a weighted average purchase price of $2.56 and $2.68 per share, respectively. At December 31, 2006, 3,004,844 shares were available for purchase under the ESPP.

Impact of the Adoption of SFAS No. 123R

The Company elected to adopt the modified prospective application method as provided by SFAS No. 123R under which prior periods are not revised for comparative purposes. The effect of recording stock-based compensation for the three and nine months ended December 31, 2006 was as follows:


	Three Months Ended December 31, 2006		Nine Months Ended December 31, 2006
	(in thousands)
Stock-based compensation expense by caption:
Cost of revenues	$	19	$	149
Research and development		4		156
Selling and marketing		25		136
General and administrative		77		571

Impact on net loss	$	125	$	1,012

As of December 30, 2006 the company updated the estimated employee contributions to the employee stock purchase plan, resulting in a reduction of the purchase plan stock expense. For the nine months ended December 31, 2006 the company recognized approximately $62,000 of employee stock purchase expense. During this period the company should have recognized approximately $35,000 of expense, resulting in an overcharge of approximately $27,000.

As of December 31, 2006, the Company had an unrecorded deferred stock-based compensation balance related to stock options of approximately $702,232 before estimated forfeitures, which will be recognized over an estimated weighted average amortization period of 5.4 years. In the Company’s pro forma disclosures 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.

During the three and nine months ended December 31, 2006, the Company granted 687,500 and 1,671,500 stock options with an estimated total grant-date fair value of $532,251 and $1,329,281, respectively. Of these amounts, the Company estimated that the stock-based compensation for the awards not expected to vest were $106,450 and $265,856, respectively.

9. 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.

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 December 31,		Nine Months Ended December 31,
	2006	2005	2006	2005
	(In thousands)
Options excluded due to the exercise price exceeding the average fair market value of the Company’s common stock during the period	3,958	5,449	3,908	5,449
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	130	1,790	180	1,790

Total common stock equivalents excluded from diluted net loss per common share	4,088	7,239	4,088	7,239

10. Litigation

The Company is subject to certain routine legal proceedings, as well as demands, claims and threatened litigation, that arise in the normal course of its business. The Company believes that the ultimate amount of liability, if any, for any pending claims of any type, except for the items described in the Company’s Annual Report on Form 10-K for the year ended March 31, 2006, (either alone or combined) will not materially affect its financial position, results of operations or liquidity.

11. Acquisition

In May 2005, the Company entered into an agreement to purchase certain assets and products of Determine Software, Inc. (“Determine”) for approximately $892,000. The transaction closed in the first quarter of fiscal 2006 and has been accounted for in accordance with SFAS 141 “Business Combinations”. Determine was a provider of enterprise contract management software. Determine’s solutions include: the ability to aggregate and analyze enterprise-wide contract information, automate and accelerate contract related business processes, enforce contract and relationship-wide contract and relationship compliance. The addition of Determine’s software capabilities and customers will allow the Company to extend its offerings to include contract management solutions. The Company allocated the purchase price of the acquisition to tangible and intangible assets acquired based on several factors, including valuations, estimates and assumptions.

The total purchase price is allocated as follows (in thousands of dollars):


	Amount		Amortization life
	(in thousands)		(years)
Accounts Receivable	$	74	—
Fixed Assets		17	2
Intangible assets:
Developed technology		367	3
Customer relationship		338	4
Customer backlog		96	1

Total purchase price	$	892

The results of Determine’s operations effective May 3, 2005 have been included in the condensed consolidated financial statements.

As of December 31, 2006, the intangible assets associated with Determine are included in Other Assets as follows:


	Amount
	(in thousands)
Cost	$	801
Accumulated amortization		(441	)

Net	$	360

These intangible assets are being amortized on a straight-line basis over their estimated future lives as follows:


	Nine months Ended		Fiscal Years Ended March 31,
	2007		2008		2009		2010
	(in thousands)
Amortization by fiscal year	$	155	$	207	$	95	$	7

Amortization for the three and nine months ended December 31, 2006, was approximately $52,000 and $155,000 for each respective period. Amortization for the three and nine months ended December 31, 2005, was approximately $78,000 and $207,000 for each respective period.

12. Restructuring

On December 31, 2006 the company relocated the corporate headquarters to a smaller facility. As a result of the relocation the company incurred a one time charge of approximately $5.8 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 $600,000. In addition, during the quarter 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. All charges for this reduction in staff have been accounted for in accordance with SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.”

On August 9, 2006 the company entered into a separation agreement with Vincent Ostrosky. Under the separation agreement Mr. Ostrosky received a lump sum severance payment equal to 12 months of his base salary or $400,000. All amounts associated with this reduction have been paid as December 31, 2006. In May 2005, the Company reduced headcount by 42 employees. Headcount reduction consisted of 11 in general and administrative, 12 in sales and marketing, 8 in research and development and 11 in professional service. These reductions resulted in charges of approximately $688,000 during the quarter ended June 30, 2005, consisting principally of severance payments and benefits, of which $115,000 was included in cost of revenues, $131,000 included in research and development expense, $126,000 included in sales and marketing expense, and $316,000 included in general and administrative expense. The charges for this reduction in staff have been accounted for in accordance with SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.”

13.

Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 requires the use of a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. The Company is required to adopt FIN 48 for fiscal years beginning after December 15, 2006. The cumulative effect of initially adopting FIN 48 will be recorded as an adjustment to opening retained earnings in the year of adoption and will be presented separately. Only tax positions that meet the more likely than not recognition threshold at the effective date may be recognized upon adoption of FIN 48. The Company does not believe this new standard will have a material impact on its future results of operations or financial position.

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.

EXPLANATORY NOTE REGARDING RESTATEMENT OF OUR CONSOLIDATED FINANCIAL STATEMENTS

Financial information included in the reports on Form 10-K, Form 10-Q and Form 8-K filed by us prior to July 12, 2007, and the related opinions of its independent registered public accounting firms, and all earnings press releases and similar communications issued by us prior to July 12, 2007 should not be relied upon and are superseded in their entirety by this 2007 Form 10-K and other reports on Form 10-Q and Form 8-K filed by us with the Securities and Exchange Commission on or after July 12, 2007.

Background relating to Special Committee Investigation

In October 2006, Selectica’s Board of Directors formed a Special Committee to conduct a voluntary investigation of its historical stock option grants. The Special Committee retained independent legal counsel and forensic accounting experts to assist with the investigation. The scope of the Special Committee investigation included all stock option grants dating from the eve of the Company’s initial public offering (“IPO”), which occurred on March 10, 2000, through the end of 2006 (the “Review Period”). During the Review Period, the Company issued approximately 22 million option shares and restricted stock. The Company made 2,424 grants on 164 grant dates.

Remedial measures

Effective January 30, 2007, the Company has adopted a new stock option grant policy intended to eliminate many of the procedural issues that precipitated the Special Committee investigation. Among other things, the policy now provides that all stock option awards to officers and other employees will be granted by the Compensation Committee, and all stock option awards will be granted at meetings at which minutes shall be taken. Unanimous Written Consents (UWCs) will no longer be used to grant stock option awards.

Effective August 24, 2007, Mr. Bennion is no longer the Company’s Chief Executive Officer or a member of the Board of Directors. However, in light of Mr. Bennion’s significant, ongoing contributions to the Company, knowledge of the industry and relationships with key providers and customers of the Company, the Board believed that Mr. Bennion could continue to provide substantial value to the Company’s shareholders. Accordingly, Mr. Bennion was offered and accepted a new role as Vice President and General Manager of the Configuration, Pricing and Quoting Business Unit. Mr. Bennion’s new position does not involve accounting or financial reporting responsibilities.

10.

Accounting Considerations—Stock-Based Compensation

instances, we were only able to locate sufficient evidence to identify the measurement date described in APB 25, the first date on which both the number of shares that an individual employee was entitled to receive and the exercise price were known, within a range of possible dates. As a result, we developed a methodology to establish the revised measurement date as our estimate of the first date on which both the number of shares that an individual employee was entitled to receive and the exercise price were known with finality. Using the methodology described below, we concluded that it was appropriate to revise the measurement dates for these grants based upon our findings, and we refer to these revised measurement dates as the Deemed Measurement Dates.

Impact of the Restatement Adjustments on the Consolidated Financial Statements


	Net Loss December 31						Accumulated Deficit
	Three Months 2005			Nine Months 2005			April 1, 2004
	(in thousands, except per share amounts)
As previously reported:	$	(10,780	)	$	(15,930	)	$	(157,960	)
Adjustment stock compensation expense (benefit)		(31	)		(75	)		(4,220	)
Adjustment payroll taxes, interest and penalties		—			—			(1,137	)

As restated	$	(10,811	)	$	(16,005	)	$	(163,317	)

The following table presents the impact of the individual restatement adjustments, which is explained in further detail in note 3 above:


	Three Months Ended June 30, 2006			Years Ended March 31
	Three Months Ended June 30, 2006			2006		2005		2004		2003		2002		2001		2000
	(in thousands)
Stock based compensation expense	$	(17	)	$	82	$	370	$	564	$	1,170	$	1,781	$	702	$	92
Payroll taxes, interest and penalties									1,137

Total adjustment to net loss due to stock based compensation	$	(17	)	$	82	$	370	$	1,701	$	1,170	$	1,781	$	702	$	92

Overview

We are a leading provider of configuration, price and quotation (CPQ) 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 lifecycle management (CLM) market, beginning with the acquisition of certain assets of Determine Software in May 2005. Our CLM 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 CLM products to account for an increasing percentage of overall sales in the future.

Also in response to these business developments, we reduced our operating costs through the reduction of personnel and other costs. During fiscal 2006 and the first half of fiscal 2007, sales of our legacy CPQ software declined rapidly and were only partially offset by growth in bookings and sales of our CLM products. We expect sales of our CPQ products to remain flat and sales of our CLM products to account for an increasing percentage of overall sales for the remainder of fiscal 2007. We plan to further streamline our operations by vacating our corporate headquarters and reducing headcount during the second half of fiscal 2007. With these actions, we estimate our breakeven level will be reduced to below $5.0 million in quarterly revenues by the end of fiscal 2007. Based on our expectation that new bookings will improve, combined with our ongoing cost reduction initiatives, we expect to achieve profitability in the fourth quarter of fiscal year 2007.

On August 9, 2006, we announced that our board of directors had named Stephen Bennion as our new Chairman and Chief Executive Officer. Mr. Bennion had served as our Chief Financial Officer since 1999. Mr. Bennion replaced Vince Ostrosky. Mr. Ostrosky will continue to serve on our board of directors. On September 28, 2006, we announced that our board of directors had named Bill Roeschlein as our new Chief Financial Officer.

Quarterly Financial Overview

For the three and nine months ended December 31, 2006, our revenues were approximately $3.7 million and $11.9 million, respectively, with license revenues representing 12% and 10%, respectively, and services revenues representing 88% and 90%, respectively, of total revenues. Approximately 47% of our quarterly revenue came from 3 customers and approximately 51% of our nine months of revenue came from 3 customers. License margins for the quarter were 81% and services margins were 49%. License margins for the nine months ended were 11% and services margins were 43%. While we anticipate entering into more time and material based services contracts, we still have some existing contracts, which have fixed fee terms and may lower services margins in the future. Net loss for the three and nine months was approximately $8.5 million and $16.4 million, respectively, or $0.28 and $0.54, respectively, per share.

Overall bookings for the three and nine months ended December 31, 2006 decreased in comparison to three and nine months ended December 31, 2005. Booking declines in our CPQ business were only partially offset by increased bookings in our CLM business. We will need to continue to increase our level of overall bookings on a quarterly basis in order to increase our reported revenues. We may continue to reduce quarterly operating expense levels depending on the level of bookings achieved.

Additionally, as part of our continuing expense reduction efforts, we relocated our corporate headquarters to a lower cost facility in the San Jose area. Accordingly, we recorded a one-time charge of approximately $5.8 million in the third quarter of fiscal 2007 related to these relocation efforts.

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, 2006 except FAS123R as discussed in the financial statement footnotes.

The following table shows how our revenues have been recognized:


	Three Months Ended December 31,				Nine Months Ended December 31,
As a Percentage of Total Revenues:	2006		2005		2006		2005
Contract accounting	52	%	74	%	59	%	68	%
Residual method	—		—		—		—
Subscription method (includes maintenance)	48	%	29	%	41	%	32	%

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, as Chief Executive Officer in September 2003, we 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 our patent litigation, which was settled in February 2006. As a result, his consulting services agreement terminated. Dr. Mittal was not paid any fees for consulting services for the three and nine months ended December 31, 2006 and December 31, 2005. Dr. Mittal was a member of the Board of Directors until July 21, 2006.

On July 21, 2006, Dr. Sanjay Mittal resigned as a member of the Board of Directors. Also on July 21, 2006, we entered into a new consulting agreement with Dr. Mittal. Under the terms of the consulting agreement, Dr. Mittal will serve as a consultant to us for a period of at least 12 months, subject to earlier termination under certain specified circumstances, and will receive $500 per hour for services rendered, with a minimum payment of 10 hours per calendar month.

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 December 31,				Nine Months Ended December 31,
	2006		2005		2006		2005
Customer A	11	%	24	%	11	%	25	%
Customer B	26	%	22	%	29	%	22	%
Customer C	*		20	%	*		*
Customer D	*		*		11	%	*
Customer E	10	%	*		*		*

*	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 December 31, 2006, we had an accumulated deficit of approximately $212 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 2006 and 2005 and plan further restructuring activities in the second half of this fiscal year.

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 2006 and 2005.

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 December 31,									Nine Months Ended December 31,
	2006			2005			Change			2006			2005			Change
	(in thousands, except percentages)
License	$	439		$	520		$	(81	)	$	1,200		$	3,593		$	(2,393	)
Percentage of total revenues		12	%		10	%		(16	)%		10	%		20	%		(67	)%
Services		3,221			4,737			(1,516	)		10,672			14,822			(4,150	)
Percentage of total revenues		88	%		90	%		(32	)%		90	%		80	%		(28	)%
Total revenues	$	3,660		$	5,257		$	(1,597	)	$	11,872		$	18,415		$	(6,543	)

License.For the three and nine months ending December 31, 2006, license revenues decreased by approximately $81,000 and $2.4 million, respectively, compared to the three and nine months ending December 31, 2005.

Our inability to increase bookings in the previous quarters was a significant factor in the decline of our revenues this quarter. Our license bookings have generally declined since the third quarter of fiscal 2005. 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 three and nine months ending December 31, 2006, services revenues decreased compared to the same periods ending December 31, 2005. The decrease primarily related to fewer service opportunities provided by new license agreements as bookings of license agreements has 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 69% and 43% of total services revenues for the three months ended December 31, 2006 and December 31, 2005, respectively. Maintenance revenues represented 54% and 40% of total services revenues for the nine months ended December 31, 2006 and December 31, 2005, 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 December 31,									Nine Months Ended December 31,
	2006			2005			Change			2006			2005			Change
	(in thousands, except percentages)
Cost of license revenues	$	82		$	164		$	(82	)	$	1,062		$	502		$	560

Percentage of license revenues		19	%		32	%		(50	)%		89	%		14	%		112	%
Cost of services revenues	$	1,571		$	2,259		$	(688	)	$	6,014		$	6,787		$	(773	)

Percentage of services revenues		49	%		48	%		(30	)%		56	%		46	%		(11	)%

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. The increase in cost of license revenue was due to a $600,000 write off of prepaid royalties related to Sales Tech. The royalties were prepaid with the expectation the party would sell our product overseas. However, during Q2 we determined based on discussions with the party, there does not appear to be a future benefit. 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 nine months ended December 31, 2006, these costs decreased 30% while cost of service revenue decreased 11% compared to the same periods in 2005 primarily due to a decrease in salaries and facilities expenses offset by an increase of approximately $190,000 of consulting expense. Additionally, there was approximately $52K in severance charges in the three months ended December 31, 2006. Restructuring and severances costs resulted in a charge of $116,000 in the three months ended June 30, 2005.

Our cost of revenues included charges of $19,000 and $149,000 related to stock compensation expense in the three and nine months ended December 31, 2006, respectively. Our cost of revenues included charges of $7,000 and $22,000 related to stock compensation expense in the three and nine months ended December 31, 2005, respectively. On April 1, 2006, we adopted SFAS 123R, which accounted for this increase.

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 December 31,				Nine Months Ended December 31,
	2006		2005		2006		2005
License	81	%	68	%	11	%	86	%
Services	51	%	52	%	44	%	54	%

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. Significantly lower license revenues and a $600,000 royalty write off in Q2, failed to offset the fixed license costs and we experienced lower license gross margins during the three and nine months ended December 31, 2006 compared to the three and nine months ending December 31, 2005.

Gross Margin—Services. During the three and nine months ended December 31, 2006, revenues from services decreased by approximately $1.5 and $4.2 million and gross margin decreased to 51% and 44%. While services revenues decreased, we were unable to decrease our costs correspondingly in order to maintain the services margin compared to the three and nine months ended December 31, 2005.

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 December 31,									Nine Months Ended December 31,
	2006			2005			Change			2006			2005			Change
	(in thousands, except percentages)
Research and development	$	1,681		$	1,951		$	(270	)	$	5,933		$	6,740		$	(807	)

Percentage of total revenues		46	%		37	%		(14	)%		50	%		37	%		(12	)%

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 $269,000 and $807,000 in research and development expenses during the three and nine months ending December 31, 2006 compared to the three and nine months ended December 31, 2005 was primarily attributable to a staff reduction and decreases in costs for facilities, overhead and benefits. Restructuring and severances costs resulted in a charge of $165,000 in the three months ended December 31, 2006 and $131,000 in the three months ended December 31,

2005. Headcount reductions lowered salaries and benefits by approximately $500,000. We amortized $31,000 and $93,000 in the three and nine months ended December 31, 2006, respectively, of Determine intangible assets for development technology amortization. We amortized $31,000 and $82,000 in the three and nine months ended December 31, 2005, respectively, of Determine intangible assets for customer relationships. The decrease in research and development expenses was offset by charges of $4,000 and $156,000 related to stock compensation expense in the three and nine months ended December 31, 2006. Stock compensation expense of $8,000 and $29,000 was incurred in the three and nine months ended December 31, 2005. In the three and nine months ended December 31, 2006, we adopted SFAS 123R, which accounted for the increases.

We may reduce expenses in research and development in absolute dollars over the current year as necessary to balance total expenses.

Sales and Marketing


	Three Months Ended December 31,									Nine Months Ended December 31,
	2006			2005			Change			2006			2005			Change
	(in thousands, except percentages)
Sales and marketing	$	1,435		$	1,597		$	(162	)	$	5,057		$	5,032		$	25

Percentage of total revenues		39	%		30	%		(10	)%		43	%		27	%		0	%

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. For the three months ended December 31, 2006, sales and marketing expenses decreased $162,000 when compared to the same periods in 2005. Restructuring and severances costs resulted in charges of $48,000 in the three months ended December 31, 2006 and $126,000 in the three months ended December 31, 2005. Additionally, we incurred amortization of intangible assets of $21,000 and $63,000, respectively, in the three and nine months ended December 31, 2006, and charges of $25,000 and $136,000, respectively, related to stock compensation expense in the three and nine months ended December 31, 2006 as we adopted SFAS 123R. Stock compensation expense of $5,000 and $18,000 was incurred in the three and nine months ended December 31, 2005.

We may increase our sales and marketing expenses in absolute dollars over the next year as necessary to continue the business expansion.

General and Administrative


	Three Months Ended December 31,									Nine Months Ended December 31,
	2006			2005			Change			2006			2005			Change
	(in thousands, except percentages)
General and administrative	$	1,716		$	2,394		$	(678	)	$	6,171		$	8,793		$	(2,622	)

Percentage of total revenues		47	%		46	%		(30	)%		51	%		48	%		(30	)%

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 $678,000 in general and administrative expense during the three months ended December 31, 2006 was due to a $7.5 million settlement of the patent lawsuit with Trilogy in the nine months ended December 2005 offset by estimated restructuring chares of relocating the corporate headquarters of approximately $5.8 million. The decrease of $4.7 million during the nine months ending December 31, 2006 compared to the nine months ended December 31, 2005, was due primarily to decreases of approximately $1.1 million in legal and professional fees associated with patent litigation, which was settled in February 2006. Restructuring and severances costs resulted in a charge of $120,000 in the three months ended December 31, 2006 and $316,000 in the nine months ended December 31, 2005. In addition, the company entered into a separation agreement with the prior CEO who received a lump sum severance payment equal to 12 months of his base salary or $400,000. We incurred

charges of $77,000 and $571,000, respectively, related to stock compensation expense in the three and nine months ended December 31, 2006. We incurred charges of $26,000 and $124,000 respectively, related to stock compensation expense in the three and nine months ended December 31, 2005. In the three and nine months ended December 31, 2006, we adopted SFAS 123R, which accounted for this increase.

The decline in overall operating expenses reflects the impact of our efforts to reduce our cost structure, particularly general and administrative expenses. We may reduce general and administrative expenses in absolute dollars over the next year as necessary to balance total expenses.

Restructuring

On December 31, 2006 the company relocated the corporate headquarters to a smaller facility. As a result of the relocation the company incurred a one time administrative charge of approximately $6.0 million, consisting principally of net present value of remaining lease payments estimated at $5.4 million in addition to a remaining net book value of leasehold improvements on the old facility of approximately $600,000. In addition, during the quarter 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. All charges for the company relocation and reduction in staff have been accounted for in accordance with SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.” All severance and employee benefits have been paid as of December 31, 2006.

In May 2005, we implemented a reduction of 42 employees. This was accounted for under Summary of Statement No. 146 (“SFAS 146”), “Accounting for Costs Associated with Exit or Disposal Activities”, which replaced EITF 94-3 on January 1, 2003. The reduced headcounts were 11, 8, 12, and 11 for professional services, research and development, sales and marketing, and general and administrative, respectively. These reductions were offset by related severance costs of approximately $688,000 included in operating expenses, and the use of outside services and consultants to assume certain tasks and ongoing projects.

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 nine months ended December 31, 2006, interest income totaled approximately $1.0 million and $2.6 million, respectively. Interest income consists primarily of interest earned on cash balances and short-term and long-term investments. During the three and nine months ended December 31, 2005, interest income totaled approximately $647,000 and $1.8 million, respectively. The increase was due primarily to higher interest rates on our cash and investment balances.

Provision for Income Taxes

During the three and nine months ended December 31, 2006, we recorded income tax provisions of approximately $22,000 and $86,000, respectively. During the three and nine months ended December 31, 2005, we recorded income tax provisions of approximately $26,000 and $74,000, 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.

Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 requires the use of a two-step approach for recognizing and measuring tax benefits taken or expected to be taken in a tax return and disclosures regarding uncertainties in income tax positions. We are required to adopt FIN 48 effective January 1, 2007. The cumulative effect of initially adopting FIN 48 will be recorded as an adjustment to opening retained earnings in the year of adoption and will be presented separately. Only tax positions that meet the more likely than not recognition threshold at the effective date may be recognized upon adoption of FIN 48. We do not believe this new standard will have a material impact on our future results of operations or financial position.

Liquidity and Capital Resources


	December 31, 2006		March 31, 2006		Change
	(in thousands, except percentages)
Cash, cash equivalents and short-term investments	$	58,082	$	74,005	(22	)%
Working capital	$	53,099	$	71,906	(26	)%


	Nine Months Ended December 31,
	2006			2005
	(in thousands)
Net cash used in operating activities	$	(8,166	)	$	(7,504	)
Net cash provided by (used in) investing activities	$	23,577		$	(5,519	)
Net cash provided by (used in) financing activities	$	(7,599	)	$	216

Our primary sources of liquidity consisted of approximately $58.1 million in cash, cash equivalents and short-term investments as of December 31, 2006 compared to approximately $74.0 million in cash, cash equivalents and short-term investments as of March 31, 2006. During the nine months ending December 31, 2006, the decrease in cash and cash equivalents was primarily related to approximately $8.2 million of cash used in operations and approximately $7.8 million of cash used to repurchase our stock, offset by net sales of short and long-term investments of approximately $23.6 million. During the nine months ending December 31, 2005, the decrease in cash and cash equivalents was primarily related to approximately $7.4 million of cash used in operations and approximately $5.7 million net purchases of short and long-term investments and $892,000 of Determine acquisition costs, offset by the issuance of common stock of approximately $608,000. We experienced a net decrease in working capital at December 31, 2006 as compared to March 31, 2006 primarily due to the cash used in operations and the cost of repurchasing our stock.

The net cash provided by investing activities for the nine months ending December 31, 2006 was due primarily to approximately $23.6 million of net maturity of available-for-sale investments as compared to approximately $5.6 million of net purchases of available-for-sale investments for the nine months ending December 31, 2005. During the nine months ending December 31, 2005, we acquired the assets of Determine Software, Inc. for approximately $892,000.

The net cash used in financing activities for the nine months ended December 31, 2006, was primarily due to the cost of stock repurchased by us for approximately $7.8 million, offset by issuance of common stock through the exercise of options and employee stock purchase plans for approximately $0.2 million. The net cash provided by financing activities for the nine months ending December 31, 2005 was due primarily to the proceeds from the issuance of common stock through the exercise of options and employee stock purchase plans for approximately $608,000.

We had no significant commitments for capital expenditures as of December 31, 2006. 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. Our cash, cash equivalents, and short-term investment balances as of December 31, 2006 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. Additionally, abandonment of excess leased facilities could result in significant one-time charges and use of cash, although such charges and use of cash are not assured. As part of our continuing expense reduction efforts, we will be relocating our corporate headquarters to a lower cost facility in the San Jose area. As a result, we recorded a one-time charge of approximately $5.4 million in the third quarter of fiscal 2007 related to this relocation effort.

Our contractual obligations and commercial commitments at December 31, 2006, 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	$	8,418	$	2,881	$	5,537	—	—

We engage in global business operations and are therefore exposed to foreign currency fluctuations. As of December 31, 2006, the effects of the foreign currency fluctuations in Europe and India were insignificant.

During Q4 FY06 we adopted a new stock repurchase program, which authorized us to purchase up to approximately $25.0 million worth of shares. As of December 31, 2006, approximately $13.9 million remains available to be used under this program.

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.

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 nine months ending December 31, 2006, a hypothetical 50 basis point increase in interest rates would have resulted in a reduction of approximately $70,000 (less than 0.12%) 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 December 31, 2006. During the nine months ending December 31, 2005, a hypothetical 50 basis point increase in interest rates would have resulted in a reduction of approximately $83,000 (less than 0.09%) 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 December 31, 2006 and December 31, 2005.

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 December 31, 2006 through the fiscal years ending:


	2007			2008			2009			2010			Total
	(in thousands, except percentages)
Investment CD	$	221		$	3,780		$	1		$	18		$	4,020
Weighted Average yield		4.32	%		6.50	%		5.75	%		6.50	%		6.38	%
Commercial Paper	$	5,732		$	11,725								$	17,457
Weighted Average yield		5.25	%		5.26	%								5.26	%
Auction rate securities	$	4,850											$	4,850
Weighted Average yield		5.19	%											5.19	%
Corporate notes & bonds	$	500		$	4,011		$	979					$	5,490
Weighted Average yield		5.11	%		5.33	%		5.25	%					5.30	%
Government agencies	$	3,148		$	4,903								$	8,051
Weighted Average yield		4.68	%		5.11	%								4.94	%

Total investments	$	14,451		$	24,419		$	980		$	18		$	39,868

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.

(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 June 2006, 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.

In fiscal year 2007, we are committed to hiring a sufficient number of technically qualified employees and/or consultants to ensure that all significant accounting issues, both routine and non-routine, are identified, researched and properly concluded upon. This will include preparation and review of the financial statements and related required supporting documentation.

Because of the insufficient controls described in the preceding paragraphs, we concluded that our internal controls over financial reporting were not effective as of December 31, 2006. While management implemented new controls in the last fiscal year, we maintained our assessment as of December 31, 2006 to allow 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. 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 nine months ended December 31, 2006, 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

Class Action

During 2001, a number of securities class action complaints were filed against us, certain of our officers and directors, and certain of the underwriters of our March 13, 2000 initial public offering (“IPO”). On August 9, 2001, these actions were consolidated before a single judge along with cases brought against numerous other issuers, their officers and directors and their underwriters that make similar allegations involving the allocation of shares in the IPOs of those issuers. The consolidation was for purposes of pretrial motions and discovery only. On April 19, 2002, plaintiffs filed a consolidated amended complaint asserting essentially the same claims as the original complaints.

The amended complaint alleges that the officer and director defendants, the underwriter’s defendants and Selectica, Inc. violated federal securities laws by making material false and misleading statements in the prospectus incorporated in our registration statement on Form S-1 filed with the SEC in March 2000 in connection with our IPO. Specifically, the complaint alleges, among other things, that the underwriters solicited and received excessive and undisclosed commissions from several investors in exchange for which the underwriters allocated to those investors material portions of the restricted number of shares of common stock issued in our IPO. The complaint further alleges that the underwriters entered into agreements with its customers in which it agreed to allocate the common stock sold in our IPO to certain customers in exchange for which such customers agreed to purchase additional shares of our common stock in the after-market at pre-determined prices. The complaint also alleges that the underwriters offered to provide positive market analyst coverage for us after the IPO, which had the effect of manipulating the market for our stock.

During the course of pre-trial proceedings, the plaintiffs dismissed their claims against the individual defendants without prejudice in return for the individual defendants’ execution of a tolling agreement. A motion to dismiss filed by us was denied by the Court on November 19, 2003.

On June 25, 2003, our Special Committee of the Board of Directors approved a Memorandum of Understanding (the “MOU”) reflecting a settlement in which the plaintiffs agreed to dismiss the case against us with prejudice in return for our assignment of certain claims that we might have against its underwriters. The same offer of settlement was made to all the issuer defendants involved in the litigation. No payment to the plaintiffs by us is required under the MOU. After further negotiations, the essential terms of the MOU were formalized in a Stipulation and Agreement of Settlement (“Settlement”), which has been executed on behalf of us.

The settling parties presented the proposed Settlement papers to the Court and filed formal motions seeking preliminary approval. The underwriter defendants, who are not parties to the proposed Settlement, filed objections to the Settlement. On February 15, 2005, the Court granted preliminary approval of the Settlement conditioned on the agreement of the parties to narrow one of a number of the provisions intended to protect the issuers against possible future claims by the underwriters. We re-approved the Settlement with the proposed modifications that were outlined by the Court in its February 15, 2005 Order granting preliminary approval. Approval of any settlement involves a three-step process in the district court: (i) a preliminary approval, (ii) determination of the appropriate notice of the settlement to be provided to the settlement class, and (iii) a final fairness hearing.

On August 31, 2005, the Court entered a preliminary order approving the modifications to the Settlement and certifying the settlement classes. The Court also ordered that the mailing of the notices of pendency and proposed settlement of the class actions be completed by January 15, 2006. The deadline for class members to request exclusion from the settlement classes was March 24, 2006.

As part of the Settlement, the settling issuers were required to assign to the plaintiffs certain claims they had against their underwriters (“Assigned Claims”). To preserve these claims while the proposed Settlement was pending the Court’s final approval, the settling issuers sought tolling agreements from the underwriters. In the event that an underwriting defendant would not enter a tolling agreement, under the terms of the proposed Settlement agreement, the settling issuer conditionally assigned the claims to a litigation trustee. Before the expiration of any relevant statutes of limitations, the litigation trustee filed lawsuits against the various issuers’ respective underwriters alleging the Assigned Claims. All of our underwriters entered into tolling agreements. On February 24, 2006, the Court dismissed, with prejudice, the Assigned Claims brought by the litigation trustee against the other issuers’ underwriters that had not entered into tolling agreements on statute of limitations grounds. After the Court’s ruling, three of our underwriters terminated their tolling agreements. Accordingly, we conditionally assigned their Assigned Claims to the litigation trustee. Because the Assigned Claims were part of the consideration contemplated under the Settlement, it is unclear how the Court’s February 24, 2006 decision will impact the Settlement and the Court’s final approval of it.

On April 24, 2006, the Court held a hearing in connection with a motion for final approval of a proposed Settlement. The Court did not rule on the fairness of the Settlement at the hearing. It is uncertain when the Court will issue a ruling. Despite the preliminary approval of the Settlement, there can be no assurance that the Court will provide final approval of the Settlement.

In the meantime, the plaintiffs and underwriters have continued to litigate the consolidated action. The litigation is proceeding through the class certification phase by focusing on six cases chosen by the plaintiffs and underwriters (“focus cases”). We are not a focus case. On October 13, 2004, the Court certified classes in each of the six focus cases. The underwriter defendants have appealed that decision. On June 6, 2006, the Court heard oral argument from the underwriters and the plaintiffs on the appeal. After the argument, the Court indicated that it would reserve its decision. It is uncertain when the Court of Appeals will rule on the appeal.

The plaintiffs’ money damage claims include prejudgment and post-judgment interest, attorneys’ and experts’ witness fees and other costs, as well as other relief to which the plaintiffs may be entitled should they prevail. We believe that the securities class action allegations against us and our officers and directors are without merit and, if settlement of the action is not finalized, we intend to contest the allegations vigorously. However, the class action litigation is in its preliminary stages, and we cannot predict its outcome.

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, 2006, actual results could differ materially from those projected in any forward-looking statements.

The matters related to the review of our historical stock option granting practices and the restatement of our financial statements may result in additional litigation, regulatory proceedings and government enforcement actions, which could harm our business, financial condition, results of operations and cash flows.

Our historical stock option granting practices and the restatement of our financial statements have exposed us to greater risks associated with litigation, regulatory proceedings and government enforcement actions. For more information regarding our current litigation and related inquiries, please see Part II, Item 1- “Legal Proceedings” as well as the other risk factors related to litigation set forth in this section. We have provided the results of our internal review and investigation of our stock option practices to the Securities and Exchange Commission, or SEC, and we have responded to informal requests for documents and additional information from the SEC. We intend to continue to cooperate with the SEC and any other governmental agency which may become involved in this matter. We cannot give any assurance regarding the outcomes from litigation, regulatory proceedings or government enforcement actions relating to our past stock option practices. The resolution of these matters will be time consuming, expensive, and may distract management from the conduct of our business. Furthermore, if we are subject to adverse findings in litigation, regulatory proceedings or government enforcement actions, we could be required to pay damages or penalties or have other remedies imposed, which could harm our business, financial condition, results of operations and cash flows.

While we believe that we have made appropriate judgments in determining the correct measurement dates for our stock option grants, the SEC may disagree with the manner in which we accounted for and reported, or not reported, the corresponding financial impact. Accordingly, there is a risk that we may have to further restate our prior financial statements, amend prior filings with the SEC, or take other actions not currently contemplated.

In November 2006, we received a Staff Determination letter from The NASDAQ Global Market (“NASDAQ”) stating that, as a result of the failure to timely file quarterly report on Form 10-Q for the quarter ended September 30, 2006 (the “Second Quarter Form 10-Q”), we were not in compliance with the filing requirements for continued listing as set forth in Marketplace Rule 4310(c)(14) and were therefore subject to delisting from NASDAQ. In February 2007, the NASDAQ Listing Qualifications Panel granted our request for continued listing, provided that we file a response with NASDAQ to specific requests for information from NASDAQ related to our stock option granting practices review as well as the Second Quarter Form 10-Q, the Third Quarter Form 10-Q and any required restatements with the SEC on or before May 9, 2007. In March 2007, we received a notice from the NASDAQ Listing and Hearings Review Council (the “Review Council”), which advised us that any delisting determination by the NASDAQ Listing Qualifications Panel had been stayed pending further review by the Review Council. The Review Council notified us in July 2007 that we were granted an exception to demonstrate compliance with all of the NASDAQ Stock Market continued listing requirements until their next meeting on October 5, 2007. On September 5, 2007, we filed with NASDAQ a response to specific requests for information from NASDAQ related to our stock option granting practices review. In addition, immediately before the filing of this 2007 Form 10-K, we filed our Second Quarter Form 10-Q and the Third Quarter Form 10-Q with the SEC. We consider that the filing of these materials has remedied our non-compliance with Marketplace Rule 4310(c)(14), subject to NASDAQ’s affirmative completion of its compliance protocols and its notification to us accordingly. However, if NASDAQ disagrees with our position or if the SEC disagrees with the manner in which we have accounted for and reported, or not reported, the financial impact of past stock option grants, there could be further delays in filing subsequent SEC reports or other actions that might result in the delisting of our common stock from the NASDAQ Global Market.

We have a history of losses and expect to continue to incur net losses in the near-term.

We have experienced operating losses in each quarterly and annual period since inception. We incurred net losses of approximately $8.0 million and $10.8 million for the three months ended December 31, 2006 and December 31, 2005, respectively. We incurred net losses of approximately $16 million for each of the nine months ended December 31, 2006 and December 31, 2005. We have an accumulated deficit of approximately $212 million as of December 31, 2006. We plan to reduce our investment in research and development, sales and marketing, and general and administrative expenses in absolute dollars over the next year as necessary to balance expense levels with projected revenues. We will need to generate significant increases in our revenues to achieve and maintain profitability. If our revenue fails to grow or grows more slowly than we anticipate or our operating expenses exceed our expectations, our losses will significantly increase which would significantly harm our business and operating results.

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 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 as a seller of Configuration, Price and Quotation (CPQ) software, however, we are now investing most of our internal resources into 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.

We are the target of several securities class action complaints and have been subject to patent infringement complaints and could be again, all of which could result in substantial costs and divert management attention and resources.

Patent Infringement

On April 22, 2004, Trilogy Group (“Trilogy”) filed a complaint in the United States District Court for the Eastern District of Texas Marshall Division alleging patent infringement against us. On September 2, 2004, we filed counterclaims in the Eastern District of Texas Marshall Division action against Trilogy for infringement of our U.S.

Patent Nos. 6,405,308, 6,675,294, 5,878,400 and 6,553,350 for willfully infringing, directly and indirectly, by making, using, licensing, selling, offering for sale, or importing products including configuration and ordering software.

In January 2006, we reached a settlement with Trilogy resolving the patent dispute. Both parties agreed to grant each other cross-licenses to the asserted patents for the life of the patents, entered into mutual releases and dismissed with prejudice all outstanding patent infringement claims against each other. Under the terms of the settlement, we paid a one-time sum of $7.5 million to Trilogy on February 16, 2006.

In addition, from time to time, we have received (and may receive in the future) correspondence from patent holders (including our competitors) recommending that we license their patents. We review and evaluate these patents (in light of the allegations from the patent holders). To date, we have informed these patent holders that it would not be necessary to license these patents. However, we may be required to license such patents or incur legal fees to defend our position that such licenses are not necessary (as was the case in the Trilogy litigation), and there can be no assurance that we would be able to obtain a license to use such patents on commercially reasonable terms, or at all.

Any intellectual property litigation, such as the litigation with Trilogy, or any threat of such litigation could force us to do one or more of the following:

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cease selling, incorporating or using products or services that incorporate the challenged intellectual property;

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obtain from the holder of the infringed intellectual property right a license to sublicense or use the relevant intellectual property, which license may not be available on commercially reasonable terms or at all;

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redesign those products or services that incorporate such intellectual property; and/or

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pay money damages to the holder of the infringed intellectual property right.

In the event of a successful claim of infringement against us and our failure or inability to license the infringed intellectual property on commercially reasonable terms (or at all) or license a substitute intellectual property or redesign our product to avoid infringement, our business and operating results would be significantly harmed. If we are forced to abandon use of our trademark, we may be forced to change our name and incur substantial expenses to build a new brand, which would significantly harm our business.

Class Action

During 2001, a number of securities class action complaints were filed in the United States District Court for the Southern District of New York against us, certain of its officers and directors, and certain of the underwriters of ours March 13, 2000 initial public offering (“IPO”). On August 9, 2001, these actions were consolidated before a single judge along with cases brought against numerous other issuers, their officers and directors and their underwriters that make similar allegations involving the allocation of shares in the IPOs of those issuers. The consolidation was for purposes of pretrial motions and discovery only. On April 19, 2002, plaintiffs filed a consolidated amended complaint asserting essentially the same claims as the original complaints.

On June 25, 2003, a Special Committee of our Board of Directors approved a Memorandum of Understanding (the “MOU”) reflecting a settlement in which the plaintiffs agreed to dismiss the case against us with prejudice in return for our assignment of certain claims that we might have against its underwriters. The same offer of settlement was made to all the issuer defendants involved in the litigation. No payment to the plaintiffs by us is required under the MOU. After further negotiations, the essential terms of the MOU were formalized in a Stipulation and Agreement of Settlement (“Settlement”), which has been executed on behalf of us.

As part of the Settlement, the settling issuers were required to assign to the plaintiffs certain claims they had against their underwriters (“Assigned Claims”). To preserve these claims while the proposed Settlement was pending the Court’s final approval, the settling issuers sought tolling agreements from the underwriters. In the event that an underwriting defendant would not enter a tolling agreement, under the terms of the proposed Settlement agreement, the settling issuer conditionally assigned the claims to a litigation trustee. Before the expiration of any relevant statutes of limitations, the litigation trustee filed lawsuits against the various issuers’ respective underwriters alleging the Assigned Claims. All of our underwriters entered into tolling agreements. On February 24, 2006, the Court dismissed, with prejudice, the Assigned Claims brought by the litigation trustee against the other issuers’ underwriters that had not entered into tolling agreements on statute of limitations grounds. After the Court’s ruling, two of our underwriters terminated their tolling agreements. Accordingly, we conditionally assigned their Assigned Claims to the litigation trustee. Because the Assigned Claims were part of the consideration contemplated under the Settlement, it is unclear how the Court’s February 24, 2006 decision will impact the Settlement and the Court’s final approval of it.

In the meantime, the plaintiffs and underwriters have continued to litigate the consolidated action. The litigation is proceeding through the class certification phase by focusing on six cases chosen by the plaintiffs and underwriters (“focus cases”). We are not a focus case. On October 13, 2004, the Court certified classes in each of the six focus cases. The underwriter defendants have appealed that decision to the United States Court of Appeals for the Second Circuit. On June 6, 2006, the Court heard oral argument from the underwriters and the plaintiffs on the appeal. After the argument, the Court indicated that it would reserve its decision. It is uncertain when the Court of Appeals will rule on the appeal.

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.

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:

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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;

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use of cash;

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

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incurring debt;

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assumption of liabilities;

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amortization expenses related to other intangible assets;

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incurring large and immediate write-offs;

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incurring legal and professional fees;

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

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diversion of managements’ attention from our core business;

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

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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 annual 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 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.

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 three largest customers accounted for approximately 51% and 48% of our revenues for the nine months ended December 31, 2006 and December 31, 2005, respectively. Revenues from significant customers greater than 10% of total revenues are as follows:


	Three Months Ended December 31,				��	Nine Months Ended December 31,
	2006		2005			2006		2005
Customer A	11	%	25	%		11	%	26	%
Customer B	26	%	23	%		29	%	22	%
Customer C	*		15	%		*		*
Customer D	*		*			11	%	*
Customer E	10	%	*			*		*

*	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.

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:

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a longer operating history;

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preferred vendor status with our customers;

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more extensive name recognition and marketing power; and

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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.

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.

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 88% and 90% of our revenues during the three months ended December 31, 2006 and December 31, 2005, respectively, are comprised primarily of revenues from consulting fees, maintenance contracts and training and are important to our business. Services revenues have lower gross margins than license revenues. Services revenues generated 90% and 80% of our revenues during the nine months ended December 31, 2006 and December 31, 2005, respectively. During the three and nine months ended December 31, 2006 and December 31, 2005, respectively, gross margins percentages for services revenues and license revenues are as follows:


	Three Months Ended December 31,				Nine Months Ended December 31,
	2006		2005		2006		2005
License	81	%	68	%	11	%	86	%
Services	49	%	52	%	43	%	54	%

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 December 31, 2006 we employed 76 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.

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. During the three months ended December 31, 2006 and December 31, 2005, we recognized approximately $398,000 and $15,000, respectively, of such charges, which included the compensation expenses related to our recent adoption of SFAS 123R, as well as deferred compensation, option acceleration, option modification, and variable accounting. During the nine months ended December 31, 2006 and December 31, 2005, we recognized approximately $1.3 million and $117,000, respectively.

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. Upon adoption, compensation expense cost calculated under SFAS 123R will 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.

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 have evaluated our “disclosure controls and procedures” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as well as our internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002. Our independent registered public accounting firm has performed a similar evaluation of our internal control over financial reporting. Effective controls are necessary for us to provide reliable financial reports and help identify and deter fraud. If we cannot provide reliable financial reports or prevent fraud, our operating results could be harmed. As of March 31, 2006, we concluded that we had deficiencies in our internal controls over financial reporting that constituted a material weakness, as further described in Item 9A, Report of Management on Internal Control over Financial Reporting. Our independent registered public accounting firm reached the same conclusion. As of December 31, 2006, we concluded we continue to have deficiencies. If we cannot establish and maintain effective internal controls over financial reporting, investors may lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.

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.

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.

The following table presents information with respect to purchases of our common stock made during the three months ended December 31, 2006 by us or any “affiliated purchaser” of ours as defined in Rule 10b-18(a)(3) under the Exchange Act.


Period	(a) Total Number of Shares Purchased	(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1) (2)	(d) Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs
October 1, 2006 – October 31, 2006	175,705	$	2.43	175,705	$	16,994,266
November 1, 2006 – November 31, 2006	863,317	$	1.77	863,317	$	15,430,947
December 1, 2006 – December 31, 2006	824,692	$	1.73	824,692	$	13,973,482

Total	1,863,714	$	1.81	1,863,714	$	13,973,482

(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.

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: October 1, 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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