- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
---------------------
<Table>
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
</Table>
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2001
COMMISSION FILE NUMBER 0-29637
---------------------
SELECTICA, INC.
(Exact name of registrant as specified in its charter)
<Table>
DELAWARE 77-0432030
(State of Incorporation) (IRS Employer Identification No.)
</Table>
3 WEST PLUMERIA DRIVE, SAN JOSE, CA 95134
(Address of Principal Executive Offices)
(408) 570-9700
(Registrant's Telephone Number, Including Area Code)
Indicate by a check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports); and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Approximately 34,879,732 shares of Common Stock, $0.0001 par value, as of
January 31, 2002.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
FORM 10-Q
SELECTICA INC.
INDEX
<Table>
<Caption>
PAGE
----
PART I FINANCIAL INFORMATION
ITEM 1: Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of December 31,
2001 (Unaudited) and March 31, 2001......................... 2
Condensed Consolidated Statements of Operations for the
three months ended December 31, 2001 and 2000 and nine
months ended December 31, 2001 and 2000 (Unaudited)......... 3
Condensed Consolidated Statements of Cash Flows for the nine
months ended December 31, 2001 and 2000 (Unaudited)......... 4
Notes to Condensed Consolidated Financial Statements
(Unaudited)................................................. 5
ITEM 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 11
ITEM 3: Quantitative and Qualitative Disclosure about Market Risk... 29
PART II OTHER INFORMATION
ITEM 6: Exhibits and Reports on Form 8-K............................ 31
Signatures........................................................... 32
</Table>
1
SELECTICA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<Table>
<Caption>
DECEMBER 31, MARCH 31,
2001 2001*
------------ ---------
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 69,477 $ 73,306
Short-term investments.................................... 44,644 63,848
Accounts receivable, net of allowance for doubtful
accounts of $744 and $1,051, respectively.............. 7,881 18,965
Prepaid expenses and other current assets................. 2,776 4,009
--------- --------
Total current assets...................................... 124,778 160,128
Property and equipment, net................................. 8,358 11,469
Goodwill, net of amortization of $3,814 and $1,815,
respectively.............................................. 10,638 12,637
Other assets................................................ 791 1,311
Long-term investments....................................... 39,520 31,144
Investments, restricted..................................... 1,454 2,079
Development agreements, net of amortization of $4,224 and
$3,117, respectively...................................... 170 1,051
--------- --------
Total assets................................................ $ 185,709 $219,819
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,230 $ 3,210
Accrued payroll and related liabilities................... 2,682 5,003
Other accrued liabilities................................. 5,128 5,717
Deferred revenues......................................... 14,142 22,382
--------- --------
Total current liabilities................................... 23,182 36,312
Other long term liabilities................................. 1,178 969
Commitments and contingencies Stockholders' equity:
Common stock.............................................. 4 4
Additional paid-in capital................................ 284,762 285,179
Deferred compensation..................................... (5,000) (7,970)
Stockholder notes receivable.............................. (1,617) (1,915)
Accumulated deficit....................................... (112,590) (92,989)
Accumulated other comprehensive income.................... 380 229
Treasury stock............................................ (4,590) --
--------- --------
Total stockholders' equity................................ 161,349 182,538
--------- --------
Total liabilities and stockholders' equity.................. $ 185,709 $219,819
========= ========
</Table>
- ---------------
* Amounts derived from audited financial statements at the date indicated
See accompanying notes.
2
SELECTICA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------ -------------------
2001 2000 2001 2000
------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Revenues:
License........................................... $ 2,860 $ 8,659 $ 12,898 $ 18,614
Services.......................................... 7,485 10,950 21,280 21,823
------- -------- -------- --------
Total revenues............................ 10,345 19,609 34,178 40,437
Cost of revenues:
License........................................... 229 414 742 922
Services.......................................... 5,848 7,836 19,314 18,855
------- -------- -------- --------
Total cost of revenues.................... 6,077 8,250 20,056 19,777
------- -------- -------- --------
Gross profit........................................ 4,268 11,359 14,122 20,660
Operating expenses:
Research and development.......................... 3,494 5,131 11,639 16,467
Sales and marketing............................... 5,753 13,004 20,075 38,571
General and administrative........................ 1,743 4,432 6,812 9,939
------- -------- -------- --------
Total operating expenses.................. 10,990 22,567 38,526 64,977
------- -------- -------- --------
Loss from operations................................ (6,722) (11,208) (24,404) (44,317)
Other income, net:
Interest income, net.............................. 1,264 3,364 5,032 10,059
------- -------- -------- --------
Loss before provision for income taxes.............. (5,458) (7,844) (19,372) (34,258)
Provision for income taxes.......................... 75 75 229 200
------- -------- -------- --------
Net loss............................................ $(5,533) $ (7,919) $(19,601) $(34,458)
======= ======== ======== ========
Basic and diluted, net loss per share............... $ (0.16) $ (0.23) $ (0.56) $ (1.01)
======= ======== ======== ========
Weighted-average shares of common stock used in
computing basic and diluted, net loss per share
applicable to common stockholders................. 34,697 35,101 35,258 34,249
======= ======== ======== ========
</Table>
See accompanying notes.
3
SELECTICA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<Table>
<Caption>
NINE MONTHS ENDED
DECEMBER 31,
--------------------
2001 2000
-------- ---------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net loss.................................................... $(19,601) $ (34,458)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 3,200 1,971
Loss on disposal of fixed assets.......................... 32 --
Amortization of private placement discount................ 254 2,722
Amortization of warrants in connection with license and
service agreement...................................... 375 5,936
Compensation expense related to repurchase of shares over
fair market value...................................... -- 873
Amortization of goodwill.................................. 1,999 1,028
In-process research and development....................... -- 1,870
Amortization of development agreement..................... 1,107 1,581
Amortization of deferred compensation..................... 1,717 2,576
Accelerated vesting of stock options to employees......... 125 527
Changes in assets and liabilities:
Accounts receivable, net............................... 11,084 (13,647)
Prepaid expenses and other current assets.............. 1,733 (21)
Other assets........................................... 1,145 (2,147)
Accounts payable....................................... (1,980) (261)
Accrued payroll and related liabilities................ (2,321) 2,169
Other accrued and long-term liabilities................ (380) 617
Deferred revenues...................................... (8,869) 271
-------- ---------
Net cash used in operating activities....................... (10,380) (28,393)
INVESTING ACTIVITIES
Purchase of fixed assets.................................. (153) (6,063)
Proceeds from sales of fixed assets....................... 32 --
Acquisition of Wakely Software, Inc....................... -- (4,755)
Acquisition of certain assets and liabilities of
LoanMarket Resources, LLC.............................. -- (216)
Purchase of short term investments........................ (68,075) (95,915)
Proceeds from sales and maturities of short-term
investments............................................ 86,787 --
Purchase of long term investments......................... (39,368) (29,699)
Proceeds from sales and maturities of long-term
investments............................................ 31,135 --
-------- ---------
Net cash provided by (used in) investing activities......... 10,358 (136,648)
FINANCING ACTIVITIES
Cost of financing......................................... -- (1,209)
Cost of stock repurchase.................................. (4,590) --
Proceeds from stockholder notes receivable................ 298 386
Net proceeds from issuance of common stock................ 485 2,865
-------- ---------
Net cash provided by (used in) financing activities......... (3,807) 2,042
-------- ---------
Net decrease in cash and cash equivalents................... (3,829) (162,999)
Cash and cash equivalents at beginning of the period........ 73,306 215,825
-------- ---------
Cash and cash equivalents at end of the period.............. $ 69,477 $ 52,826
======== =========
SUPPLEMENTAL CASH FLOW INFORMATION
Deferred compensation related to stock options............ $ 1,152 $ 1,111
Warrants issued in connection with development
agreement.............................................. $ 226 $ --
Repurchase of stock in exchange for cancellation of
notes.................................................. $ -- $ 4,500
</Table>
See accompanying notes.
4
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The condensed consolidated balance sheet as of December 31, 2001, the
condensed consolidated statements of operations and cash flows for the nine
months ended December 31, 2001 and 2000, the condensed consolidated statements
of operations for the three months ended December 31, 2001 and 2000 have been
prepared by the Company and are unaudited. In the opinion of management, all
necessary adjustments, including normal recurring adjustments, have been made to
present fairly the financial position, results of operations, and cash flows at
December 31, 2001 and for all periods presented. Interim results are not
necessarily indicative of the results for a full fiscal year. The condensed
consolidated balance sheet as of March 31, 2001 have been derived from audited
consolidated financial statements at that date.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These consolidated financial statements should
be read in conjunction with the audited consolidated financial statements and
notes included in this prospectus and the Company's Annual Report on Form 10-K
for the year ended March 31, 2001.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the condensed consolidated
balance sheet as of December 31, 2001, the condensed consolidated statements of
operations and cash flows for the nine months ended December 31, 2001 and 2000,
the condensed consolidated statements of operations for the three months ended
December 31, 2001 and 2000 and accompanying notes. Actual results could differ
from those estimates.
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:
<Table>
<Caption>
THREE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----
Cisco Systems............................................ * 18% * 13%
Dell..................................................... * 14% * 16%
Highmark Blue Cross Blue Shield.......................... * 12% * *
Samsung SDS.............................................. * 12% * 18%
</Table>
- ---------------
* Revenues were less than 10%.
There were no customers who accounted for at least 10% of total revenues
for the three and nine months ended December 31, 2001.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and SFAS
No. 142, "Goodwill and Other Intangible Assets." These standards become
effective for fiscal years beginning after December 15, 2001. Beginning in the
first quarter of fiscal 2003, goodwill will no longer be amortized but will be
subject to annual impairment
5
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS -- (CONTINUED)
tests. All other intangible assets will continue to be amortized over their
estimated useful lives. Based on acquisitions completed as of December 31, 2001,
application of the non-amortization provisions of these rules is expected to
result in a decrease in net loss of approximately $2.7 million per year.
The new rules also require business combinations after June 30, 2001 to be
accounted for using the purchase method of accounting and goodwill acquired
after June 30, 2001 will not be amortized. Goodwill existing at June 30, 2001,
will continue to be amortized through the end of fiscal 2002. During fiscal
2003, the Company will test goodwill for impairment under the new rules,
applying a fair-value-based test. Through the end of fiscal 2002, the Company
will continue to review goodwill impairment under Statement of Financial
Accounting Standards No. 121 "Accounting for Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed of" (SFAS 121). Goodwill will continue to
be amortized through to March 31, 2002. As of December 31, 2001, the Company's
balance of goodwill was $10.6 million.
2. CASH EQUIVALENTS AND INVESTMENTS
CASH EQUIVALENTS
All cash equivalents as of December 31, 2001 and March 31, 2001 are
classified as available-for-sale securities and included under the caption "cash
and cash equivalents." The following is a summary of the aggregate cost, gross
unrealized losses, and estimated fair value of the Company's cash equivalents:
<Table>
<Caption>
DECEMBER 31, MARCH 31,
2001 2001
------------ ---------
(IN THOUSANDS)
CASH EQUIVALENTS:
Commercial papers........................................... $19,276 $15,741
Money market................................................ 36,011 31,366
Government agency notes..................................... -- 8,947
Corporate notes............................................. -- 6,066
------- -------
Total....................................................... $55,287 $62,120
======= =======
</Table>
INVESTMENTS
All investments as of December 31, 2001 and March 31, 2001 are classified
as available-for-sale securities. The following is a summary of the aggregate
cost, gross unrealized losses, and estimated fair value of the Company's
short-term investments:
<Table>
<Caption>
DECEMBER 31, MARCH 31,
2001 2001
------------ ---------
(IN THOUSANDS)
SHORT-TERM INVESTMENTS:
Auction rate preferreds................................... $20,720 $ --
Government agencies....................................... 20,739 40,893
Corporate notes & bonds................................... -- 18,369
Commercial paper.......................................... -- 4,494
Municipal bonds........................................... 3,085 --
------- -------
Short-term investments at cost......................... 44,544 63,756
Unrealized gains.......................................... 100 92
------- -------
Fair value............................................. $44,644 $63,848
======= =======
</Table>
6
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
DECEMBER 31, MARCH 31,
2001 2001
------------ ---------
(IN THOUSANDS)
LONG-TERM INVESTMENTS:
Corporate notes & bonds................................... $23,430 $20,981
Government agencies....................................... 15,810 10,026
------- -------
Available for sale securities at cost.................. 39,240 31,007
Unrealized gains.......................................... 280 137
------- -------
Fair value............................................. $39,520 $31,144
======= =======
</Table>
As of December 31, 2001, the Company has three operating leases that
require security deposits to be maintained at financial institutions for the
term of the leases. The total security deposit of the leases in the amount of
approximately $454,000 is classified as a restricted long-term investment and is
held in commercial paper. In addition, due to the acquisition of Wakely
Software, Inc., the total escrow fund of approximately $1.5 million is held in
corporate bonds, of which $500,000 is classified as an other current asset, and
will be paid to the founder of Wakely Software, Inc. on February 8, 2002 per the
escrow agreement. The balance of $1.0 million is classified as a restricted
long-term investment and will be paid in August 2003. The interest earned on the
investment can be used in operations.
Unrealized holding gains on available-for-sale securities as of December
31, 2001 and March 31, 2001 were approximately $380,000 and $229,000,
respectively.
3. STOCKHOLDERS' EQUITY
WARRANTS
In November 1999, the Company entered into a license agreement and one year
maintenance contract in the amount of approximately $3.0 million with a customer
and in connection with the agreement committed to the issuance of a warrant to
purchase 800,000 shares of common stock. In January 2000 the warrant was issued
with an exercise price of $13.00 and was net exercised on July 25, 2000. The
value of the warrant was estimated to be approximately $16.4 million and was
based upon a Black-Scholes valuation model with the following assumptions: risk
free interest rate of 5.5%, dividend yield of 0%, volatility of 80%, expected
life of 2 years, exercise price of $13.00 and fair value of $30.00. As the
warrant value less the warrant purchase price of $800,000, exceeds the related
license and maintenance revenue under the agreement and subsequent services
agreements, the Company recorded an approximate $9.7 million loss on the
contract in the year ended March 31, 2000, of which approximately $4.1 million
was charged to costs of license revenues and approximately $5.6 million was
charged to cost of services revenues. For the fiscal year of 2001, the Company
amortized approximately $5.5 million related to the fair value of the warrants
against the license revenue. For the three and nine months ended December 31,
2001, the total amortization of the charges to the cost of service revenue
related to this agreement was approximately $125,000 and $375,000, respectively.
For the three and nine months ended December 31, 2000, the total amortization of
the charges to the cost of service revenue related to this agreement was
approximately $733,000 and $5.9 million, respectively. The fair value of the
warrants was fully amortized in the quarter ended December 31, 2001.
In connection with a development agreement entered into in April 2001, the
Company issued a warrant to purchase 100,000 shares of the Company's common
stock. The Company determined the fair value of the warrant using the
Black-Scholes valuation model assuming a fair value of the Company's common
stock at $3.53 per share, risk free interest rate of 6%, dividend yield of 0%,
volatility factor of 99% and expected life of 3 years. The value of the warrant
was estimated to be approximately $227,000 and will be amortized over the
7
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS -- (CONTINUED)
next three years. For the three and nine months ended December 31, 2001, the
Company has amortized approximately $19,000 and $57,000 related to the fair
value of the warrant.
DEFERRED COMPENSATION
The Company granted 2,750 and 728,900 options to employees with exercise
price that were less than fair value and recorded net deferred compensation of
approximately $2,000 and $455,000, for three and nine months ended December 31,
2001, respectively. Such compensation will be amortized over the vesting period
of the options, typically four years. For the nine months ended December 31,
2001 and 2000, the Company amortized approximately $1.7 million and $2.6 million
of deferred compensation, respectively. For the three months ended December 31,
2001 and 2000, the Company amortized approximately $532,000 and $831,000 of
deferred compensation, respectively.
ACCELERATED OPTIONS
During the nine months ended December 31, 2001 and 2000, in association
with employee termination agreements, the Company accelerated the vesting of
options to purchase 38,659 and 24,807 shares of unvested common stock,
respectively. For the nine months ended December 31, 2001 and 2000, the Company
recorded approximately $125,000 and $527,000 of related compensation expense.
For the three months ended December 31, 2001, the Company recorded no
compensation expense regard to the acceleration of options. For the three months
ended December 31, 2000, the Company recorded approximately $52,000 of related
compensation expense.
STOCK OPTIONS
On April 27, 2001, the Company commenced an option exchange program in
which its employees were offered the opportunity to exchange stock options with
exercise prices of $8.50 and above for new stock options. Participants in the
exchange program will receive new options to purchase one hundred and twenty
percent (120%) of the number of shares of its common stock subject to the
options that were exchanged and canceled. The new options will be granted more
than six months and one day from May 28, 2001, the date the old options were
cancelled. The exercise price of the new options will be the closing market
price on the NASDAQ Stock Market on the grant date of the new options. The
exchange offer was not available to executive officers or the members of our
Board of Directors. On December 3, 2001, the option exchange program was
completed. There were 340,000 stock options cancelled in exchange for the
issuance of 408,000 new stock options at the grant price of $3.92 per share.
In addition, on May 30, 2001, the Company granted additional options to
purchase an aggregate of approximately 4 million shares of its common stock to
all its employees that did not participate in the option exchange offer. The
Company will amortize approximately $350,000 in deferred compensation expense
associated with these grants over four years.
STOCK REPURCHASE
During the nine months ended December 31, 2001, the Company repurchased
1,382,600 shares of its common stock at an average price of $3.20 in the open
market at a cost of approximately $4.6 million including brokerage fees. This
program was authorized by the Board of Directors in August 2001 to allow the
Company to repurchase up to $30 million worth of stock in the open market
subject to certain criteria as determined by the Board.
8
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS -- (CONTINUED)
4. INCOME TAXES
For the nine months ended December 31, 2001 and 2000, the Company has
recorded a tax provision of $229,000 and $200,000. For the three months ended
December 31, 2001 and 2000, the Company has recorded a tax provision of $75,000
and $75,000. They were primarily accrued for state and foreign taxes.
5. EARNINGS PER SHARE
The Company calculates earnings per share in accordance with Financial
Accounting Standards Board No. 128, Earnings per Share. The diluted net loss per
share is equivalent to the basic net loss per share because the Company has
experienced losses since inception and thus no potential common shares from the
exercise of stock options, conversion of convertible preferred stock, or
exercise of warrants have been included in the net loss per share calculation.
Options to purchase 5,771,846 and 5,446,796 shares of common stock were excluded
from the computations for the three and nine-month periods ended December 31,
2001 as their effect is antidilutive, compared to 1,664,453 and 4,896,675 for
the three and nine-month periods ended December 31, 2000.
6. COMPREHENSIVE LOSS
The components of comprehensive loss are as follows:
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------- -------------------
2001 2000 2001 2000
-------- -------- -------- --------
(IN THOUSANDS)
Net loss............................................. $(5,533) $(7,919) $(19,601) $(34,458)
Change in unrealized gain on securities.............. (222) 113 151 220
------- ------- -------- --------
Comprehensive loss................................... $(5,755) $(7,806) $(19,450) $(34,238)
======= ======= ======== ========
</Table>
Accumulated other comprehensive gain was approximately $380,000 and
$229,000 as of December 31, 2001 and March 31, 2001, and represents net
unrealized gain on securities.
7. LITIGATION
Between June 5, 2001 and June 22, 2001, four securities class action
complaints were filed against the Company, the underwriters of the Company's
initial public offering, and certain of the Company's executives in the United
States District Court for the Southern District of New York. The complaints
allege that the underwriters of the Company's initial public offering, Selectica
and the other named defendants 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. The
complaints allege, among other things, that Credit Suisse First Boston solicited
and received excessive and undisclosed commissions from several investors in
exchange for which Credit Suisse First Boston allocated to these investors
material portions of the restricted number of shares of common stock issued in
connection with the Company's initial public offering. The complaints further
allege that Credit Suisse First Boston entered into agreements with its
customers in which Credit Suisse First Boston agreed to allocate the common
stock sold in the Company's initial public offering to certain customers in
exchange for which such customers agreed to purchase additional shares of the
Company's common stock in the after-market at pre-determined prices.
On August 9, 2001, these actions were consolidated before a single judge
along with cases brought against numerous other issuers and their underwriters
that make similar allegations involving the IPO's of those issuers. The
consolidation was for purposes of pretrial motions and discovery only. We
believe that the claims against us are without merit and intend to defend
against the complaints vigorously.
9
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS -- (CONTINUED)
8. RESTRUCTURING
For the nine months ended December 31, 2001, the Company has recorded
restructuring charges of approximately $1.4 million, which were the result of a
plan established to align the Company's global workforce with existing and
anticipated market requirements and necessitated by the Company's improved
operating efficiencies. Approximately $189,000 of restructuring costs was
accounted as cost of services revenues, $287,000 as research and development
expense, $359,000 as sales and marketing expense and $605,000 as general and
administrative expense. The restructuring charges were primarily for the
severance and benefits paid to the terminated employees. During the nine months
ended December 31, 2001, the Company terminated 160 employees (or 21% of its
workforce) globally, in the areas of administration, marketing, business
development, engineering, sales, consulting and services support. The Company
estimates that annual salary and fringe benefits savings of approximately $8.0
million will be recognized in fiscal 2002 as a result of these activities. For
the nine months ended December 31, 2001 and the year ended March 31, 2001, the
reserve for the restructuring was $111,000 and $350,000, respectively, which was
included in current liabilities and is summarized as follows:
SEVERANCE AND BENEFITS:
<Table>
FY 2001 Restructuring Charges............................... $ 667,000
Cash Charges................................................ (317,000)
-----------
Reserve balance, March 31, 2001............................. 350,000
FY 2002 Restructuring Charges April 01, 2001 to December 31,
2001...................................................... 1,440,000
Cash Charges for April 01, 2001 to December 31, 2001........ (1,679,000)
-----------
Reserve balance, December 31, 2001.......................... $ 111,000
===========
</Table>
9. SUBSEQUENT EVENTS
As of February 12, 2002, the Company has repurchased 92,000 shares of its
common shares at an average price of $3.90 in the open market at a cost of
approximately $363,000 including brokerage fees.
10
MANAGEMENT'S DISCUSSION AND ANALYSIS
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" and
"Risks Related to Our Business." 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; and risks associated with potential acquisitions. For a more
detailed discussion of the risks relating to Selectica's business, readers
should refer to the section later in this report entitled "Risks Related to Our
Business." 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 quarterly report and Selectica assumes no
obligation to update these forward-looking statements.
OVERVIEW
Selectica is a leading provider of Interactive selling system software and
services that enable companies to efficiently sell complex products and services
over intranets, extranets and the Internet. Our ACE suite of software products
is a comprehensive Interactive selling system solution that gives sellers the
ability to manage the sales process in order to facilitate the conversion of
prospective buyers into customers. Our Interactive selling system solution
allows companies to use the Internet platform to deploy a selling application to
many points of contact, including personal computers, in-store kiosks and mobile
devices, while offering customers, partners and employees an interface
customized to their specific needs.
REVENUES
We enter into arrangements for the sale of (1) licenses of our software
products and related maintenance contracts; (2) bundled licenses, maintenance
contracts, and services; and (3) services on a time and materials basis. In
instances where maintenance contracts are bundled with a license of our software
products, such maintenance contracts are typically for a one-year term.
For each arrangement, we determine whether evidence of an arrangement
exists, delivery has occurred, the fee is 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.
For those arrangements that consist of a license and a maintenance
contract, we recognize license revenues based upon the residual method after all
elements other than maintenance have been delivered and we recognize maintenance
revenues over the term of the maintenance contract as vendor-specific objective
evidence of fair value for maintenance is determined.
Services can consist of maintenance, training and/or consulting services.
Consulting services include a range of services including installation of our
off-the-shelf software, customization of our software for the customer's
specific application, data conversion and building of interfaces to allow our
software to operate in customized environments.
In all cases, we assess whether the service element of the arrangement is
essential to the functionality of the other elements of the arrangement. In this
determination we focus on whether the software is off-the-shelf software,
whether the services include significant alterations to the features and
functionality of the software, whether the services involve the building of
complex interfaces, the timing of payments and the existence of milestones.
Often the installation of our software requires the building of interfaces to
the customer's existing applications or customization of the software for
specific applications. As a result, judgement is required in the determination
of whether such services constitute "complex" interfaces. In making this
determination we consider the following: (1) the relative fair value of the
services compared to the software, (2) the amount of time and effort subsequent
to delivery of the software until the interfaces or other modifications are
completed,
11
(3) the degree of technical difficulty in building of the interface and
uniqueness of the application, (4) the degree of involvement of customer
personnel, and (5) any contractual cancellation, acceptance, or termination
provisions for failure to complete the interfaces. We also consider refunds,
forfeitures and concessions when determining the significance of such services.
In those instances where we determine that the service elements are
essential to the other elements of the arrangement, we account for the entire
arrangement using contract accounting.
For those arrangements accounted for using contract accounting that do not
include contractual milestones or other acceptance criteria we utilize the
percentage of completion method based upon input measures of hours. For those
contracts that include contractual milestones or acceptance criteria we
recognize revenue as such milestones are achieved or as such acceptance occurs.
In some instances the acceptance criteria in the contract requires
acceptance after all services are complete and all other elements have been
delivered. In these instances we recognize revenue based upon the completed
contract method after such acceptance has occurred.
For those arrangements for which we have concluded that the service element
is not essential to the other elements of the arrangement we determine whether
the services are available from other vendors, do not involve a significant
degree of risk or unique acceptance criteria, and whether we have sufficient
experience in providing the service to be able to separately account for the
service. When the service qualifies for separate accounting, we use
vendor-specific objective evidence to determine the fair value of the services
and the maintenance. In such instances, we account for the arrangement using the
residual method, regardless of any separate prices stated within the contract
for each element.
Vendor-specific objective evidence of fair value of services is based upon
hourly rates. As noted above, we enter into contracts for services alone and
such contracts are based on a time and materials basis. Such hourly rates are
used to assess the vendor-specific objective evidence in multiple element
arrangements.
In accordance with paragraph 10 of Statement of Position 97-2, Software
Revenue Recognition, vendor-specific objective evidence of fair value of
maintenance is determined by reference to the price the customer will be
required to pay when it is sold separately (that is, the renewal rate). Each
license agreement offers additional maintenance renewal periods at a stated
price. Maintenance contracts are typically one year in duration.
To date we have not entered into arrangements solely for the license of our
products and, therefore, we have not demonstrated vendor-specific objective
evidence for the fair value of the license element.
In all cases we classify revenues for these arrangements as license
revenues and services revenues based on the estimates of fair value for each
element.
For the nine months ended December 31, 2001, we recognized 67% of license
and services revenues under the percentage-of-completion method, 26% under the
completed contract method and 7% under the residual method. For the nine months
ended December 31, 2000, we recognized 40% of license and services revenues
under percentage-of-completion method, 34% under the residual method and 26%
under the completed contract method. For the three months ended December 31,
2001, we recognized 52% of license and services revenues under the
percentage-of-completion method, 47% under the completed contract method and 1%
under the residual method. For the three months end December 31, 2000, we
recognized 40% of license and services revenues under the
percentage-of-completion method, 34% under the completed contract method and 26%
under the residual method.
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. For example, our
license and services revenues declined significantly in the quarters ended
December 31, 2001, September 30, 2001, March 31, 2001 and June 30, 1999 due to
the delay of milestone achievement of services under a particular contract.
12
Customer billing occurs in accordance with contract terms. Customer
advances and amounts billed to customers in excess of revenue recognized are
recorded as deferred revenue. Amounts recognized as revenue in advance of
billing (typically under percentage-of-completion accounting) are recorded as
unbilled receivables.
FACTORS AFFECTING OPERATING RESULTS
A relatively small number of customers accounted for a significant portion
of our total revenues. For the three and nine months ended December 31, 2001, we
did not have any customers who accounted for over 10% of our revenues. For the
nine months ended December 31, 2000, revenue from Samsung SDS, Dell, and Cisco
accounted for 18%, 16%, and 13% of our revenues, respectively. For the three
months ended December 31, 2000, revenue from Cisco, Dell, Highmark Blue Cross
Blue Shield, and Samsung SDS accounted for 18%, 14%, 12% and 12% of our
revenues, respectively.
We have a limited operating history upon which we may be evaluated. We have
incurred significant losses since inception and, as of December 31, 2001, we had
an accumulated deficit of approximately $112.6 million. We believe our success
depends on the continued growth of our customer base and the development of the
emerging Interactive Selling System market. Due to the slowing of the U.S.
economy, particularly in the area of technology infrastructure investment, and
in an effort to achieve profitability, we underwent restructuring activities
from March 2001 throughout the second quarter of fiscal year 2002. During the
restructuring activities in March 2001, we reduced our headcount, primarily in
India, by 158 individuals or approximately 20% of our workforce. As a result of
the restructuring activities in March 2001, we reduced our annual operating
expenses by approximately $3.7 million, principally from reduced salaries and
associated expenses. During the restructuring activities for the six months
ended September 30, 2001, we further reduced our headcount by 160 individuals
globally or approximately 21% of our workforce compared to March 31, 2001. These
restructuring activities resulted in an annual reduction of expenses by $8.0
million.
In view of the rapidly changing nature of our business and our limited
operating history, 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 limited operating history makes it
difficult to forecast future operating results. Additionally, despite our recent
revenue growth, we do not believe that historical growth rates are necessarily
sustainable or indicative of future growth and we cannot be certain that
revenues will increase. This was evidenced by the results of the fourth quarter
of fiscal 2001, first, second and third quarter of fiscal 2002. Even if we were
to achieve profitability in any period, we may not be able to sustain or
increase profitability on a quarterly or annual basis.
EQUITY TRANSACTIONS
In connection with a development agreement entered into in April 2001, we
issued a warrant to purchase 100,000 shares of our common stock. We determined
the fair value of the warrant using the Black-Scholes valuation model assuming a
fair value of our common stock at $3.53 per share, risk free interest rate of
6%, dividend yield of 0%, volatility factor of 99% and expected life of 3 years.
The value of the warrant was estimated to be approximately $227,000 and would be
amortized over the next three years. As of December 31, 2001, we have amortized
approximately $57,000 related to the fair value of the warrant.
During the quarter ended December 31, 2001, the Company repurchased 455,000
shares of its common stock at an average price of $3.39 in the open market at a
cost of approximately $1.6 million including brokerage fees. During the nine
months ended December 31, 2001, the Company repurchased a total of 1,382,600
shares of its common stock at an average price of $3.20 in the open market at a
cost of approximately $4.6 million including brokerage fees. This program was
authorized by the Board of Directors in August 2001 to allow the Company to
repurchase up to $30 million worth of stock in the open market subject to
certain criteria as determined by the Board.
13
RESULTS OF OPERATIONS
The following table sets forth the percentage of total revenues for certain
items in the Company's condensed consolidated statements of operations data for
the three and nine months ended December 31, 2001 and 2000.
<Table>
<Caption>
THREE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
------------ ------------
2001 2000 2001 2000
---- ---- ---- ----
AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
License................................................... 28% 44% 38% 46%
Services.................................................. 72 56 62 54
--- --- --- ----
Total revenues.................................... 100 100 100 100
Cost of revenues:
License................................................... 2 2 2 2
Services.................................................. 57 40 57 47
--- --- --- ----
Total cost of revenues............................ 59 42 59 49
--- --- --- ----
Gross profit (loss)............................... 41 58 41 51
Operating expenses:
Research and development.................................. 34 26 34 41
Sales and marketing....................................... 56 66 59 95
General and administrative................................ 17 23 20 25
--- --- --- ----
Total operating expenses.......................... 107 115 113 161
--- --- --- ----
Loss from operations........................................ (66) (57) (72) (110)
Interest and other income (expense), net.................... 12 17 15 25
--- --- --- ----
Net loss before taxes....................................... (54) (40) (57) (85)
Provision for income taxes.................................. 1 -- 1 --
--- --- --- ----
Net loss.................................................... (55)% (40)% (58)% (85)%
=== === === ====
</Table>
THREE AND NINE MONTHS ENDED DECEMBER 31, 2001 AND 2000
REVENUES
Total revenues were approximately $10.3 million and $34.2 million in the
three and nine months ended December 31, 2001 compared to approximately $19.6
million and $40.4 million, respectively, for the same periods a year ago. For
the three months ended December 31, 2001 and 2000, services revenues represented
72% and 56% of total revenues, respectively. This fluctuation was primarily due
to the increased demand for services associated with enhancing and expanding
existing customer installations. We believe that the future revenues will
continue to fluctuate due to the changing number and size of the new customers,
number of consulting projects and maintenance contracts, and environment in the
current economy.
License. License revenues totaled approximately $2.9 million and $12.9
million in the three and nine months ended December 31, 2001 compared to
approximately $8.7 million and $18.6 million, respectively, in the same period a
year ago. The net decrease in license revenues was primarily due to a decline in
sales productivity arising from the weakening macroeconomic environment. The
slowdown in the economy has caused a significant decrease in technology spending
as well as extended the decision cycles of many potential customers. For the
three and nine months ended December 31, 2000, we amortized approximately
$733,000
14
and $2.2 million against the license revenues in association with the fair value
of the warrant issued to a significant customer in connection with a license and
service agreement, respectively.
Services. Services revenues totaled approximately $7.5 million and $21.3
million in the three and nine months ended December 31, 2001, compared to
approximately $11.0 million and $21.8 million, respectively, to the same periods
a year ago. Our services revenues are comprised of fees from consulting,
maintenance and training services. The total amount of services revenues for the
nine months ended December 31, 2001 was comparable to the same period a year
ago. The net decrease of $3.5 million in the three- month periods ended December
31, 2001 and 2000 was the result of the slowdown in economy which caused a
significant decrease in technology spending. During the nine months ended
December 31, 2001 and 2000, revenues were also reduced by amortization of
approximately $375,000 and $3.8 million, respectively, representing the fair
value of the warrant issued to a significant customer in connection with a
license and service agreement. During three months ended December 31, 2001 and
2000, revenues were reduced by amortization of approximately $125,000 and
$733,000, respectively, representing the fair value of the warrant issued to a
significant customer in connection with a license and service agreement. We
expect services revenues to continue to fluctuate in future periods as a
percentage of total revenues.
COST OF REVENUES
Cost of License Revenues. Cost of license revenues totaled approximately
$229,000 and $742,000 or represented 8% and 6% of license revenues in the three
and nine months ended December 31, 2001, compared to approximately $414,000 and
$922,000 or represented 5% and 5% of license revenues, respectively, to the same
periods a year ago. It consists of the costs of the product media, duplication,
packaging and delivery of our software products to our customers, which may
include documentation, shipping and other data transmission costs. We expect
cost of license revenues to maintain a relatively consistent level as a
percentage of license revenues.
Cost of Services Revenues. Cost of services revenue totaled approximately
$5.8 million and $19.3 million or represented 78% and 91% of services revenues
in the three and nine months ended December 31, 2001, compared to approximately
$7.8 million and $18.9 million or represented 72% and 86% of services revenues,
respectively, to the same periods a year ago. It is comprised mainly of salaries
and related expenses of our services organization. For the three months ended
December 31, 2001, the net decrease of $2.0 million in cost of services was
primarily due to the involvement of the personnel in India in consulting and
technical support areas, compared to the same period a year ago. During the nine
months ended December 31, 2001, we amortized approximately $622,000 for deferred
compensation, $189,000 for restructuring costs related to the severance and
benefits paid to terminated employees and $843,000 for goodwill in connection
with the Wakely Software acquisition. During the nine months ended December 31,
2000, we amortized approximately $548,000 for deferred compensation, $291,000
for the stock repurchase from certain key employees and $197,000 for goodwill in
connection with the Wakely Software acquisition. During the three months ended
December 31, 2001, we amortized approximately $208,000 for the deferred
compensation and $281,000 for goodwill in connection with the Wakely Software
acquisition. For the three months ended December 31, 2000, we amortized
approximately $189,000 for deferred compensation, $291,000 for the stock
repurchase from certain key employees and $184,000 for goodwill in connection
with the Wakely Software acquisition. We expect cost of services revenues to
fluctuate as a percentage of service revenues.
GROSS MARGIN
For the three and nine months ended December 31, 2001, we experienced
overall gross margins of 41% and 41% compared to overall gross margins of 58%
and 51%, respectively, for the same periods a year ago. 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 amount of 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.
15
Gross Margin -- Licenses. Gross margin for license revenues was 92% and
94% for the three and nine months ended December 31, 2001, compared to 95% and
95%, respectively, for the same periods a year ago.
Gross Margin -- Services. Gross margin for services was 22% and 9% for the
three and nine months ended December 31, 2001, compared to 28% and 14%,
respectively, for the same periods a year ago. We expect that our overall gross
margins will continue to fluctuate due to the timing of services revenue
recognition and will continue to be adversely affected by the lower margins on
our service contracts. We anticipate that the cost of services revenues will
fluctuate as a percentage of service revenue.
OPERATING EXPENSES
Research and Development. Our research and development costs primarily
consist of salaries and related costs of our engineering, quality assurance, and
technical publications efforts. Research and development costs were
approximately $3.5 million and $11.6 million for the three and nine months ended
December 31, 2001 down from approximately $5.1 million and $16.5 million,
respectively, compared to the same periods a year ago. The decrease was
primarily due to our restructuring. During the nine months ended December 31,
2001, we amortized approximately $201,000 for deferred compensation, $1.1
million for the development agreement entered into with a significant customer
and $287,000 for restructuring charges. During the nine months ended December
31, 2000, we amortized approximately $260,000 for deferred compensation, $1.6
million for the development agreement entered into with a customer, and one-time
$1.9 million charge for in process research and development in relation to the
Wakely Software acquisition. During the three months ended December 31, 2001, we
amortized approximately $65,000 for deferred compensation and $19,000 for the
development agreement entered into with a customer. During the three months
ended December 31, 2000, we amortized approximately $87,000 for deferred
compensation, $526,000 for the development agreement entered into with a
customer.
Sales and Marketing. Our sales and marketing expenses primarily consist of
salaries and related costs for our sales and marketing organization and
marketing programs, including trade shows, sales materials, and advertising.
Sales and marketing expenses totaled approximately $5.8 million and $20.1
million in the three and nine months ended December 31, 2001 down from
approximately $13.0 million and $38.6 million, respectively, for the same
periods a year ago. The decreases were primarily due to our restructuring and a
reduction in spending on marketing programs. During the nine months ended
December 31, 2001, we amortized approximately $576,000 for deferred
compensation, $359,000 for restructuring charges and $106,000 for acceleration
of stock option vesting. During the nine months ended December 31, 2000, we
amortized approximately $1.4 million for deferred compensation, $483,000 for
acceleration of stock option vesting and $291,000 for the stock repurchase from
certain key employees. During the three months ended December 31, 2001, we
amortized approximately $154,000 for deferred compensation. For the three months
ended December 31, 2000, we amortized approximately $494,000 for deferred
compensation and $291,000 for stock repurchase.
General and Administrative. Our general and administrative expenses
consist primarily of personnel and related costs for general corporate
functions, including finance, accounting, legal, human resources and facilities
as well as information system expenses not allocated to other departments.
General and administrative expenses totaled approximately $1.7 million and $6.8
million in the three and nine months ended December 31, 2001, down from
approximately $4.4 million and $9.9 million, respectively, compared to the same
periods a year ago. The decrease was primarily due to our restructuring plan.
During the nine months ended December 31, 2001, we amortized approximately
$318,000 for deferred compensation, $605,000 for restructuring charges, and $1.2
million for the amortization of goodwill in connection with the Wakely Software
acquisition. For the nine months ended December 31, 2000, we amortized
approximately $345,000 for deferred compensation, $44,000 for acceleration of
stock option vesting, $291,000 for the stock repurchase and $639,000 from the
amortization of goodwill in connection with the Wakely Software acquisition.
During the three months ended December 31, 2001, we amortized approximately
$105,000 for deferred compensation and $383,000 for the amortization of goodwill
in connection with the Wakely Software acquisition. During the three months
ended December 31, 2000, we amortized approximately $113,000 for deferred
compensation,
16
$291,000 for stock repurchase from certain key employees and $447,000 for the
amortization of goodwill in connection with the Wakely Software acquisition.
INTEREST AND OTHER INCOME, NET
Interest and other income, net primarily consists of interest earned on
cash balances and stockholders notes receivable. Interest and other income, net
totaled approximately $1.3 million and $5.0 million for the three and nine
months ended December 31, 2001 compared with interest income of approximately
$3.4 million and $10.1 million, respectively, for the comparable periods in the
prior year. The decrease was primarily due to the lower interest rate and the
reduction of the cash balance which was used for the operation of our business
during the fiscal year of 2002.
PROVISION FOR INCOME TAXES
For the three months and nine months ended December 31, 2001, we have
recorded a tax provision of approximately $75,000 and $229,000, compared to
$75,000 and $200,000, respectively, for the same period a year ago. The
provision for income taxes consists primarily of state income taxes and foreign
taxes.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 141, "Business Combinations," and SFAS
No. 142, "Goodwill and Other Intangible Assets." These standards become
effective for fiscal years beginning after December 15, 2001. Beginning in the
first quarter of fiscal 2003, goodwill will no longer be amortized but will be
subject to annual impairment tests. All other intangible assets will continue to
be amortized over their estimated useful lives. Based on acquisitions completed
as of December 31, 2001, application of the non-amortization provisions of these
rules is expected to result in a decrease in net loss of approximately $2.7
million per year.
The new rules also require business combinations after June 30, 2001 to be
accounted for using the purchase method of accounting and goodwill acquired
after June 30, 2001 will not be amortized. Goodwill existing at June 30, 2001,
will continue to be amortized through the end of fiscal 2002. During fiscal
2003, the Company will test goodwill for impairment under the new rules,
applying a fair-value-based test. Through the end of fiscal 2002, the Company
will continue to review goodwill impairment under Statement of Financial
Accounting Standards No. 121 "Accounting for Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed of" (SFAS 121). Goodwill will continue to
be amortized through to March 31, 2002. As of December 31, 2001, the Company's
balance of goodwill was $10.6 million.
CONSOLIDATED BALANCE SHEET DATA
Cash, cash equivalents, short-term and long-term investments were
approximately $153.6 million at December 31, 2001 compared to approximately
$168.3 million at March 31, 2001. The decrease was primarily related to cash
used in operations during the nine months ended December 31, 2001 of
approximately $10.4 million and $4.6 million of stock repurchase in the open
market. Accounts receivable, net was approximately $7.9 million at December 31,
2001 compared to approximately $19.0 million at March 31, 2001. The decrease of
approximately $11.1 million was mainly due to payments received from customers
and lower revenues in the current quarter as compared to the fourth quarter of
fiscal 2001. Prepaid expenses and other current assets were approximately $2.8
million at December 31, 2001 compared to approximately $4.0 million at March 31,
2001. The decrease was primarily due to the monthly amortization of prepaid
insurance and lower prepaid commission directly associated with lowered
revenues. Development agreement, net was approximately $170,000 at December 31,
2001 and approximately $1.1 million at March 31, 2001. The decrease was due to
the amortization for the nine months ended December 31, 2001.
Current liabilities were approximately $23.2 million at December 31, 2001
and approximately $36.3 million at March 31, 2001. The decrease of approximately
$13.1 million was primarily due to the decrease of our marketing activities,
accrued payroll expenses and overall general spending. In addition, deferred
revenue was reduced by approximately $8.2 million in the current period.
17
The total stockholders' equity was approximately $161.3 million at December
31, 2001 and approximately $182.5 million at March 31, 2001. The net decrease of
approximately $21.2 million was primarily due to approximately $19.6 million of
net loss by the Company and $4.6 million of stock repurchase in the open market
offset by approximately $1.7 million of amortization of deferred compensation.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2001, cash, cash equivalents and short-term investments
totaled approximately $114.1 million, compared to approximately $137.2 million
at March 31, 2001. We currently have no significant capital commitments other
than obligations under operating leases.
We have funded our operations with proceeds from the private sale of common
and preferred stock, and public offering. Cash used by operating activities for
the nine months ended December 31, 2001 was approximately $10.4 million and was
primarily as a result of our net loss adjusted for noncash items, decrease in
accounts receivable and deferred revenues.
Cash provided by investing activities for the nine months ended December
31, 2001 was approximately $10.4 million and consisted primarily of the net
proceeds from the sales of short-term and long-term investments.
Cash used in financing activities for the nine months ended December 31,
2001 was approximately $3.8 million and consisted primarily of the stock
repurchase program.
We believe that our existing cash and cash equivalents and our anticipated
cash flows from operations will be sufficient to meet our working capital and
operating resource expenditure requirements for at least the next 12 months.
RISKS RELATED TO OUR BUSINESS
In addition to other information in this Form 10-Q, the following risk
factors should be carefully considered in evaluating Selectica and its business
because such factors currently may have a significant impact on Selectica's
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 Selectica's other Securities and Exchange Commission filings including our
Form 10-K for our fiscal year ended March 31, 2001, actual results could differ
materially from those projected in any forward-looking statements.
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.
In the past, our quarterly operating results have varied significantly, and
we expect these fluctuations to continue. Future operating results may vary
depending on a number of factors, many of which are outside of our control.
Our quarterly revenues may fluctuate as a result of our ability to
recognize revenue in a given quarter. We enter into arrangements for the sale of
(1) licenses of our software products and related maintenance contract; (2)
bundled license, maintenance, and services; and (3) services on a time and
material basis. For each arrangement, we determine whether evidence of an
arrangement exists, delivery has occurred, the fee is 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.
Additionally, because we rely on a limited number of customers for our revenue,
the loss or delay of one prospective customer may seriously significantly harm
our operating results.
For those contracts that consist solely of license and maintenance we
recognize license revenues based upon the residual method after all elements
other than maintenance have been delivered as we have vendor specific objective
evidence of fair value of maintenance we recognize maintenance revenues over the
term of the maintenance contract. For those contracts that bundle the license
with maintenance, training, and/or
18
consulting services, we assess whether the service element of the arrangement is
essential to the functionality of the other elements of the arrangement. In
those instances where we determine that the service elements are essential to
the other elements of the arrangement, we account for the entire arrangement
using contract accounting.
For those arrangements accounted for using contract accounting that do not
include contractual milestones or other acceptance criteria we utilize the
percentage of completion method based upon input measures of hours. For those
contracts that include contract milestones or acceptance criteria we recognize
revenue as such milestones are achieved or as such acceptance occurs.
In some instances the acceptance criteria in the contract requires
acceptance after all services are complete and all other elements have been
delivered. In these instances we recognize revenue based upon the completed
contract method after such acceptance has occurred.
For those arrangements for which we have concluded that the service element
is not essential to the other elements of the arrangements we determine whether
the services are available from other vendors, do not involve a significant
degree of risk or unique acceptance criteria, and whether we have sufficient
experience in providing the service to be able to separately account for the
service. When the service qualifies for separate accounting we use
vendor-specific objective evidence of fair value for the service.
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. For example, our
services and license revenues declined significantly in the quarters ended
December 31, 2001, September 30, 2001, March 31, 2001 and June 30, 1999 due to
the delay of milestone achievement of services under a particular contract. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Quarterly Results of Operations." Because these 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.
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 applicable to common stockholders of
approximately $49.9 million, $31.8 million and $7.5 million for the fiscal years
ended March 31, 2001, 2000 and 1999, respectively. We have incurred net losses
of approximately $19.6 million for the nine months ended December 31, 2001 and
an accumulated deficit of approximately $112.6 million as of December 31, 2001.
We have reduced our research and development, sales and marketing, and general
and administrative expenses, and consequently expect our losses to be reduced in
the future. We will need to generate significant increases in our revenues to
achieve 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.
A DECLINE IN GENERAL ECONOMIC CONDITIONS OR A DECREASE IN INFORMATION TECHNOLOGY
SPENDING COULD HARM OUR RESULTS OF OPERATIONS.
The change in economic conditions may lead to revised budgetary constraints
regarding information technology spending for our customers. For example, a
potential customer which had selected our Interactive Selling System from a
number of competitors recently decided not to implement any configuration
system.
19
That company had decided to reduce its expenditures for information technology.
A general slowdown in information technology spending due to economic conditions
or other factors could significantly harm our business and operating results.
IF THE MARKET FOR INTERACTIVE SELLING SYSTEM SOFTWARE DOES NOT DEVELOP AS WE
ANTICIPATE, OUR OPERATING RESULTS WILL BE SIGNIFICANTLY HARMED, WHICH COULD
CAUSE A DECLINE IN THE PRICE OF OUR COMMON STOCK.
The market for Interactive Selling System software, which has only recently
begun to develop, is evolving rapidly and likely will have an increased number
of competitors. Because this market is new, it is difficult to assess its
competitive environment, growth rate and potential size. 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 acceptance and growth of the Internet as a business platform may not
continue to develop at historical rates and a sufficiently broad base of
companies may not adopt Internet platform-based business applications, either of
which could significantly harm our business and operating results. The failure
of the market for Interactive Selling System software to develop, or a delay in
the development of this market, would significantly harm our business and
operating results.
OUR LIMITED OPERATING HISTORY AND THE FACT THAT WE OPERATE IN A NEW INDUSTRY
MAKES EVALUATING OUR BUSINESS PROSPECTS AND RESULTS OF OPERATIONS DIFFICULT.
We were founded in June 1996 and have a limited operating history. We began
marketing our ACE suite of products in early 1997 and released ACE 5.0, the
newest version of our software, in August 2001. Our business model is still
emerging, and the revenue and income potential of our business and market are
unproven. As a result of our limited operating history, we have limited
financial data that you can use to evaluate our business. You must consider our
prospects in light of the risks and difficulties we may encounter as an early
stage company in the new and rapidly evolving market for Interactive Selling
Systems.
FAILURE TO ESTABLISH AND MAINTAIN RELATIONSHIPS WITH SYSTEMS INTEGRATORS AND
CONSULTING FIRMS, WHICH ASSIST US WITH THE SALE AND INSTALLATION OF OUR
PRODUCTS, MAY LIMIT ACCEPTANCE OF OUR PRODUCTS AND THE GROWTH OF OUR REVENUES.
We rely in part upon systems integrators and consulting firms to recommend
our products to their customers and to install and deploy our products. To
increase our revenues and implementation capabilities, we must develop and
expand our relationships with these systems integrators and consulting firms. If
systems integrators and consulting firms develop, market or recommend
competitive Interactive Selling Systems, our revenues may decline. In addition,
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.
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
new, 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 FirePond,
Trilogy Software, Oracle Corporation, SAP, I2, and Siebel Systems, all of which
offer integrated solutions for electronic commerce incorporating some of the
functionality of an Interactive Selling System. These competitors may intensify
their efforts in our market. In addition, other enterprise software companies
may offer competitive products in the future.
20
Competitors vary in size and in the scope and breadth of the products and
services offered. Some of our competitors and potential competitors have a
number of significant advantages over us, including:
- a longer operating history;
- preferred vendor status with our customers;
- more extensive name recognition and marketing power; and
- significantly greater financial, technical, marketing and other
resources, giving them the ability to respond more quickly to new or
changing opportunities, technologies, and customer requirements.
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.
OUR LENGTHY SALES CYCLE MAKES IT DIFFICULT FOR US TO FORECAST REVENUE AND
AGGRAVATES THE VARIABILITY OF QUARTERLY FLUCTUATIONS, WHICH COULD CAUSE OUR
STOCK PRICE TO DECLINE.
The sales cycle of our products has historically averaged between four and
six 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 intend to 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.
IF WE DO NOT KEEP PACE WITH TECHNOLOGICAL CHANGE, INCLUDING MAINTAINING
INTEROPERABILITY OF OUR PRODUCT WITH THE SOFTWARE AND HARDWARE PLATFORMS
PREDOMINANTLY USED BY OUR CUSTOMERS, OUR PRODUCT 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, 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. Interactive Selling System technology is 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.
21
WE HAVE RELIED AND EXPECT TO CONTINUE TO RELY ON A LIMITED NUMBER OF CUSTOMERS
FOR A SIGNIFICANT PORTION OF OUR REVENUES, AND THE LOSS OF ANY OF THESE
CUSTOMERS COULD SIGNIFICANTLY HARM OUR BUSINESS AND OPERATING RESULTS.
Our business and financial condition is dependent on a limited number of
customers. Our five largest customers accounted for approximately 32% of our
revenues for the nine months ended December 31, 2001 and 55% for the fiscal year
ended March 31, 2001, respectively, and our ten largest customers accounted for
51% of our revenues for the nine months ended December 31, 2001 and 67% for the
fiscal year ended March 31, 2001, respectively. Revenues from significant
customers as a percentage of total revenues for the year ended March 31, 2001
are as follows:
<Table>
FISCAL YEAR ENDED MARCH 31, 2001
Samsung, SDS................................................ 17%
Dell........................................................ 16%
Cisco....................................................... 14%
</Table>
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.
Contracts with our customers can generally be terminated on short notice by the
customer. 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
less of our products or services, defers or cancels orders, or terminates its
relationship with us, our business and operating results would be harmed.
WE ARE THE TARGET OF SEVERAL SECURITIES CLASS ACTION COMPLAINTS AND ARE AT RISK
OF SECURITIES CLASS ACTION LITIGATION, WHICH COULD RESULT IN SUBSTANTIAL COSTS
AND DIVERT MANAGEMENT ATTENTION AND RESOURCES.
Between June 5, 2001 and June 22, 2001, four securities class action
complaints were filed against us, the underwriters of our initial public
offering, and certain of our executives in the United States District Court for
the Southern District of New York. The complaints allege that the underwriters
of our initial public offering, Selectica and the other named defendants
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. The complaints allege, among other
things, that Credit Suisse First Boston solicited and received excessive and
undisclosed commissions from several investors in exchange for which Credit
Suisse First Boston allocated to these investors material portions of the
restricted number of shares of common stock issued in connection with our
initial public offering. The complaints further allege that Credit Suisse First
Boston entered into agreements with its customers in which Credit Suisse First
Boston agreed to allocate the common stock sold in our initial public offering
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.
On August 9, 2001, these actions were consolidated before a single judge
along with cases brought against numerous other issuers and their underwriters
that make similar allegations involving the IPO's of those issuers. The
consolidation was for purposes of pretrial motions and discovery only.
We believe that the claims against us are without merit and intend to
defend against the complaints vigorously. Securities class action litigation
could result in substantial costs and divert our management's attention and
resources, which could seriously harm our business.
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, our customers have experienced difficulties or delays in
completing implementation of our products. We may experience similar
difficulties or delays in the future. Our Interactive Selling System solution
relies on defining a knowledge base that must contain all of the information
about the products and services being configured. We have found that extracting
the information necessary to construct a knowledge base can be more time
consuming than we or our customers anticipate. If our customers do not devote
the resources necessary to create the knowledge base, the deployment of our
products can be delayed. Deploying
22
our ACE products can also involve time-consuming integration with our customers'
legacy systems, such as existing databases and enterprise resource planning
software. 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 AND EXPAND 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 all of our current sales and our
future growth depends 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.
IF WE ARE UNABLE TO GROW AND 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.
As we increase licensing of our software products, we must grow our
professional services organization to assist our customers with implementation
and maintenance of our products. Because these professional services have been
expensive to provide, we must improve the management of our professional
services organizations to improve our results of operations. Improving the
efficiency of our consulting services is dependent upon attracting and retaining
experienced project managers. Competition for these project managers is intense,
particularly in the Silicon Valley and in India where the majority of our
professional services organization is based, and we may not be able to hire
qualified individuals to fill these positions.
Although services revenues, which are primarily comprised of revenues from
consulting fees, maintenance contracts and training, are important to our
business, representing 62% and 54% of total revenues for the nine months ended
December 31, 2001 and 2000 respectively, services revenues have lower gross
margins than license revenues. Gross margins for services revenues were 9% and
14% for the nine months ended December 31, 2001 and 2000, respectively, compared
to gross margins for license revenues of 94% and 95% for the nine months ended
December 31, 2001 and 2000.
We anticipate that customers will increasingly utilize third-party
consultants to implement and deploy our products. Additionally, in the future we
intend to charge for our professional services on a time and materials rather
than 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
resources, 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 ACE products and other future products may contain defects or
errors, which could result in lost revenues, a delay in market acceptance or
negative publicity, which would significantly harm our business and operating
results.
23
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
senior management team and key technical personnel, none of whom, except Rajen
Jaswa, our President and Chief Executive Officer, and Dr. Sanjay Mittal, our
Chief Technical Officer and Vice President of Engineering, has an employment
agreement with us. 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. Consequently, our
ability to manage day-to-day operations, including our operations in India,
develop and deliver new technologies, attract and retain customers, attract and
retain other employees and generate revenues would be significantly harmed.
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, WHICH WOULD ADVERSELY AFFECT OUR ABILITY TO CONDUCT OUR
OPERATIONS IN INDIA, COULD SIGNIFICANTLY HARM OUR BUSINESS.
We conduct quality assurance and professional services operations in India.
As of December 31, 2001, there were 246 persons employed in India. We are
dependent on our India-based operations for these aspects of our business and we
may grow our operations in India. 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 internationally 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.
BECAUSE COMPETITION FOR QUALIFIED PERSONNEL IS INTENSE IN OUR INDUSTRY AND IN
OUR GEOGRAPHIC REGION, WE MAY NOT BE ABLE TO RECRUIT OR RETAIN PERSONNEL, WHICH
COULD IMPACT THE DEVELOPMENT OR SALES OF OUR PRODUCTS.
Our success depends on our ability to attract and retain qualified
management, engineering, sales and marketing and professional services
personnel. Competition for these types of personnel is intense, especially in
the Silicon Valley. We do not have employment agreements with most of our key
personnel. If we are unable to retain our existing key personnel, or attract and
train additional qualified personnel, our growth may be limited due to our lack
of capacity to develop and market our products.
Options to purchase our common stock are an important component of our
employee compensation. Because of the decline in our stock price, some of our
employees hold options with an exercise price substantially above the current
market price. This could adversely affect our ability to attract and retain
employees. On April 27, 2001, we commenced an option exchange program in which
our employees were offered the opportunity to exchange stock options with
exercise prices of $8.50 and above for new stock options. Participants in the
exchange program will receive new options to purchase one hundred and twenty
percent (120%) of the number of shares of our common stock subject to the
options that were exchanged and canceled. The new options will be granted more
than six months and one day from May 28, 2001, the date the old options were
cancelled. The exercise price of the new options will be the closing market
price on the NASDAQ Stock Market on the grant date of the new options. The
exchange offer was not available to
24
executive officers or the members of our Board of Directors. On December 3,
2001, the option exchange program was completed. There were 340,000 stock
options cancelled in exchange for the issuance of 408,000 new stock options at
the grant price of $3.92 per share.
In addition, on May 30, 2001, we granted additional options to purchase an
aggregate of approximately 4 million shares of our common stock to all our
employees that did not participate in the option exchange offer. We will
amortize approximately $350,000 in deferred compensation expense associated with
these grants over the next four years. Although these programs have been
designed to improve employee retention by creating additional incentives for our
employees, they may not have the desired impact. This could adversely affect our
ability to retain employees.
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.
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 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 two patents. We, also, currently have one pending U.S. patent
application. In addition, we have one trademarks registered in the U.S. and one
trademark registered in South Korea and have applied to register a total of
eight trademarks in the United States, Canada, Europe, India and Korea. Our
trademark and patent applications might not result in the issuance of any
trademarks or patents. Our patent or any future issued patents or trademarks
might be invalidated or circumvented or otherwise fail to provide us any
meaningful protection. We seek to protect source code for our software,
documentation and other written materials under trade secret and copyright laws.
We license our software pursuant to signed 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 significantly harm
our business and operating results.
ANY ACQUISITIONS THAT WE MAY MAKE COULD DISRUPT OUR BUSINESS AND HARM OUR
OPERATING RESULTS.
We may acquire or make investments in complementary companies, products or
technologies. In the event of any such investments, acquisitions or joint
ventures, we could:
- issue stock that would dilute our current stockholders' percentage
ownership;
- incur debt;
- assume liabilities;
- incur amortization expenses related to goodwill and other intangible
assets; or
- incur large and immediate write-offs.
25
These investments, acquisitions or joint ventures also involve numerous
risks, including:
- problems combining the purchased operations, technologies or products
with ours;
- unanticipated costs;
- diversion of managements' attention from our core business;
- adverse effects on existing business relationships with suppliers and
customers;
- potential loss of key employees, particularly those of the acquired
organizations; and
- reliance to our disadvantage on the judgment and decisions of third
parties and lack of control over the operations of a joint venture
partner.
Any acquisition or joint venture may cause our financial results to suffer
as a result of these risks.
IF WE ARE SUBJECT TO INTELLECTUAL PROPERTY LITIGATION, WE MAY INCUR SUBSTANTIAL
COSTS, WHICH WOULD HARM OUR OPERATING RESULTS.
Our success and ability to compete are dependent on our ability to operate
without infringing upon the proprietary rights of others. Any intellectual
property litigation could result in substantial costs and diversion of resources
and could significantly harm our business and operating results. In the past, we
received correspondence from two patent holders recommending that we licensed
their respective patents. After review of these patents, we informed these
patent holders that in our opinion, it would not be necessary to license these
patents. However, we may be required to license either or both patents or incur
legal fees to defend our position that such licenses are not necessary. We
cannot assure you that if required to do so, we would be able to obtain a
license to use either patent on commercially reasonable terms, or at all.
Any threat of intellectual property litigation could force us to do one or
more of the following:
- cease selling, incorporating or using products or services that
incorporate the challenged intellectual property;
- obtain from the holder of the infringed intellectual property right a
license to sell or use the relevant intellectual property, which license
may not be available on reasonable terms;
- redesign those products or services that incorporate such intellectual
property; or
- 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
reasonable terms 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 and operating results.
IF WE ARE UNABLE TO EXPAND OUR OPERATIONS INTERNATIONALLY OR ARE UNABLE TO
MANAGE THE GREATER COLLECTIONS, MANAGEMENT, HIRING, LEGAL, REGULATORY, AND
CURRENCY RISKS FROM THESE INTERNATIONAL OPERATIONS, OUR BUSINESS AND OPERATING
RESULTS WILL BE HARMED.
We intend to expand our operations internationally. This expansion may be
more difficult or take longer than we anticipate, and we may not be able to
successfully market, sell or deliver our products internationally. If successful
in our international expansion, we will be subject to a number of risks
associated with international operations, including:
- longer accounts receivable collection cycles;
- expenses associated with localizing products for foreign markets;
- difficulties in managing operations across disparate geographic areas;
26
- difficulties in hiring qualified local personnel;
- difficulties associated with enforcing agreements and collecting
receivables through foreign legal systems;
- unexpected changes in regulatory requirements that impose multiple
conflicting tax laws and regulations; and
- fluctuations in foreign exchange rates and the possible lack of financial
stability in foreign countries that prevent overseas sales growth.
OUR RAPID GROWTH PLACES A SIGNIFICANT STRAIN ON OUR MANAGEMENT SYSTEMS AND
RESOURCES, AND IF WE FAIL TO MANAGE THIS GROWTH, OUR BUSINESS WILL BE HARMED.
We have experienced a period of rapid growth and expansion, which places
significant demands on our managerial, administrative, operational, financial
and other resources. From December 31, 1998 to December 31, 2001, we expanded
from 68 to 542 employees, including 30 employees from the acquisition of Wakely
Software.
We will be required to manage an increasing number of relationships with
customers, suppliers and employees, and an increasing number of complex
contracts. 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 growth effectively, our business would be harmed.
OUR RESULTS OF OPERATIONS WILL BE HARMED BY CHARGES ASSOCIATED WITH OUR PAYMENT
OF STOCK-BASED COMPENSATION, CHARGES ASSOCIATED WITH OTHER SECURITIES ISSUANCE
BY US, AND CHARGES RELATED TO ACQUISITIONS.
We have in the past and expect in the future to incur a significant amount
of amortization of charges related to securities issuances in future periods,
which will negatively affect our operating results. Since inception we have
recorded approximately $9.7 million in net deferred compensation charges. During
the years ended March 31, 2001 and 2000, we amortized approximately $4.3 million
and approximately $1.3 million of such charges, respectively. For nine months
ended December 31, 2001, the total amortization of the deferred compensation
expenses was approximately $1.7 million. We expect to amortize approximately
$2.6 million of stock-based compensation for the fiscal year ending March 31,
2002 and we may incur additional charges in the future in connection with grants
of stock-based compensation at less than fair value.
In January 2000, in connection with a license and maintenance agreement, we
issued a warrant to purchase 800,000 shares of common stock for $800,000. The
fair value of the warrant was approximately $16.4 million. In the quarter ended
March 31, 2000, we recorded a charge of approximately $9.7 million related to
the loss on the license and software maintenance contract, of which
approximately $4.1 million was charged to cost of license revenues and
approximately $5.6 million was charged to costs of services revenues, in
relation to the issuance of these warrants. During the year ended March 31,
2001, revenues were reduced by amortization of approximately $5.5 million in
connection with this license and services agreement. For the nine months ended
December 31, 2001, the total amortization of charges related to this agreement
was approximately $375,000 against the revenue. The fair value of the warrants
was fully amortized as of December 31, 2001.
In connection with a development agreement entered into in April 2001, we
issued a warrant to purchase 100,000 shares of our common stock. We determined
the fair value of the warrant using the Black-Scholes valuation model assuming a
fair value of our common stock at $3.53 per share, risk free interest rate of
6%, dividend yield of 0%, volatility factor of 99% and expected life of 3 years.
The value of the warrant was estimated to be approximately $227,000. As of
December 31, 2001, we have amortized approximately $57,000 related to the fair
value of the warrant.
We accounted for the acquisition of Wakely as a purchase for accounting
purposes and allocated approximately $13.1 million to identified intangible
assets and goodwill. These assets are being amortized over
27
a period of three to five years. We also expensed approximately $1.9 million of
in-process research and development at the time of acquisition. See Note 10 of
the Notes to consolidated financial statements for the year ended March 31, 2000
and Note 9 of Notes to condensed financial statements for the year ended March
31, 2001.
OUR OPERATING RESULTS COULD BE ADVERSELY AFFECTED BY GOODWILL IMPAIRMENT.
We will continue to review goodwill impairment under Statement of Financial
Accounting Standards No. 121 "Accounting for Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed of" (SFAS 121), through March 31, 2002.
Goodwill will continue to be amortized through to March 31, 2002. As of December
31, 2001, the net unamortized goodwill balance was $10.6 million. If a goodwill
impairment charge under SFAS No. 121 is required, it could adversely affect our
financial results.
Beginning April 1, 2002 we will test goodwill for impairment under
Statement of Financial Accounting Standard No. 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets" (SFAS 144). SFAS 144 provides a
single model for accounting and reporting the impairment and disposal of
long-lived assets. The statement also sets new criteria for the classification
of assets held-for-sale and changes the reporting of discontinued operations. We
will assess the impact of SFAS 144 on its financial statements upon adoption in
fiscal 2003.
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 ACE 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.
RISKS RELATED TO THE INDUSTRY
IF USE OF THE INTERNET DOES NOT CONTINUE TO DEVELOP AND RELIABLY SUPPORT THE
DEMANDS PLACED ON IT BY ELECTRONIC COMMERCE, THE MARKET FOR OUR PRODUCTS AND
SERVICES MAY BE ADVERSELY AFFECTED, AND WE MAY NOT ACHIEVE ANTICIPATED SALES
GROWTH.
Growth in sales of our products and services depends upon the continued and
increased use of the Internet as a medium for commerce and communication. Growth
in the use of the Internet is a recent phenomenon and may not continue. In
addition, the Internet infrastructure may not be able to support the demands
placed on it by increased usage and bandwidth requirements. There have also been
recent well-publicized security breaches involving "denial of service" attacks
on major web sites. Concerns over these and other security breaches may slow the
adoption of electronic commerce by businesses, while privacy concerns over
inadequate security of information distributed over the Internet may also slow
the adoption of electronic commerce by individual consumers. Other risks
associated with commercial use of the Internet could slow its growth, including:
- inadequate reliability of the network infrastructure;
- slow development of enabling technologies and complementary products; and
- limited accessibility and ability to deliver quality service.
In addition, the recent growth in the use of the Internet has caused
frequent periods of poor or slow performance, requiring components of the
Internet infrastructure to be upgraded. Delays in the development or adoption of
new equipment and standards or protocols required to handle increased levels of
Internet activity, or increased government regulation, could cause the Internet
to lose its viability as a commercial medium. If the Internet infrastructure
does not develop sufficiently to address these concerns, it may not develop as a
commercial marketplace, which is necessary for us to increase sales.
28
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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET 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. Interest income is sensitive to changes in
the general level of U.S. interest rates, particularly since our investments are
in short-term instruments calculated at variable rates.
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 investments, consisting primarily of investment
grade securities, substantially all of which mature within the next twelve
months or have characteristics of short-term investments. A hypothetical 50
basis point increase in interest rates would result in an approximate $258,000
(less than 0.19%) in the fair value of our available-for-sale securities. This
potential change is based upon a sensitivity analysis performed on our financial
positions at December 31, 2001.
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 25% in any one industry other than the US government,
commercial paper and money market funds.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Between June 5, 2001 and June 22, 2001, four securities class action
complaints were filed against the Company, the Company's underwriters of the
Company's IPO, and certain executives in the United States District Court for
the Southern District of New York. The complaints allege that the underwriters
of the Company's IPO, the Company, and the other named defendants violated
federal securities laws by making material false and misleading statements in
the prospectus incorporated in the Company's registration
29
statement on Form S-1 filed with the SEC in March, 2000. The complaints allege,
among other things, that the lead underwriters solicited and received excessive
and undisclosed commissions from several investors in exchange for which the
lead underwriters allocated to these investors material portions of the
restricted number of shares of common stock issued in connection with the
Company's initial public offering. The complaints further allege that the lead
underwriters entered into agreements with their customers in which the lead
underwriters agreed to allocate the Company's common stock in its initial public
offering in exchange for which such customers agreed to purchase additional
shares of its common stock in the after-market at pre-determined prices.
On August 9, 2001, these actions were consolidated before a single judge
along with cases brought against numerous other issuers and their underwriters
that make similar allegations involving the IPO's of those issuers. The
consolidation was for purposes of pretrial motions and discovery only.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Modification of Constituent Instruments
Not applicable
(b) Change in Rights
Not applicable
(c) Issuances of Securities
In April 2001, the Company issued a warrant to purchase 100,000 shares of
the Company's common stock. The issuance of the warrant was exempt from the
registration requirements of the Securities Act of 1933, as amended, pursuant to
Section 4(2) thereof. The Company relied on the following criteria to make such
exemption available: the number of offerees, the size and manner of the
offering, the sophistication of the offeree and the availability of material
information.
(d) Use of Proceeds
On March 15, 2000 Selectica completed the initial public offering of its
common stock. The shares of the common stock sold in the offering were
registered under the Securities Act of 1933, as amended, on a Registration
Statement on Form S-1 (No. 333-92545). The Securities and Exchange Commission
declared the Registration Statement effective on March 9, 2000.
The offering commenced on March 10, 2000 and terminated on March 15, 2000
after we had sold all of the 4,600,000 shares of common stock registered under
the Registration Statement (including 450,000 shares sold by Selectica and
150,000 sold by one of our stockholders in connection with the exercise of the
underwriters' over-allotment option). The managing underwriters in the offering
were Credit Suisse First Boston, Thomas Weisel Partners LLC, U.S. Bancorp Piper
Jaffray and E*Offering. The initial public offering price was $30.00 per share
for an aggregate initial public offering of approximately $138.0 million. We
paid a total of approximately $11.3 million in underwriting discounts,
commissions, and other expenses related to the offering. None of the costs and
expenses related to the offering were paid directly or indirectly to any
director, officer, general partner of Selectica or their associates, persons
owning 10 percent or more of any class of equity securities of Selectica or an
affiliate of Selectica.
After deducting the underwriting discounts and commissions and the offering
expenses the estimated net proceeds to Selectica from the offering were
approximately $122.2 million. The net offering proceeds have been used for
general corporate purposes, to provide working capital to develop products and
to expand the Company's operations. Funds that have not been used have been
invested in certificate of deposits and other investment grade securities. We
also may use a portion of the net proceeds to acquire or invest in businesses,
technologies, products or services.
30
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
On April 27, 2001, we commenced an option exchange program in which our
employees were offered the opportunity to exchange stock options with exercise
prices of $8.50 and above for new stock options. Participants in the exchange
program will receive new options to purchase one hundred and twenty percent
(120%) of the number of shares of our common stock subject to the options that
were exchanged and canceled. The new options will be granted more than six
months and one day from May 28, 2001, the date the old options were cancelled.
The exercise price of the new options will be the closing market price on the
NASDAQ Stock Market on the grant date of the new options. The exchange offer was
not available to executive officers and the members of our Board of Directors.
On December 3, 2001, the option exchange program was completed. There were
340,000 stock options cancelled in exchange for the issuance of 408,000 new
stock options at the grant price of $3.92 per share.
In addition, on May 30, 2001, we granted additional options to purchase an
aggregate of approximately 4 million shares of our common stock to all our
employees that did not participate in the option exchange offer. We will
amortize approximately $350,000 in deferred compensation expense associated with
these grants over the next four years.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
None
B. Reports on Form 8-K
None
31
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereto duly authorized.
Date: February 14, 2002
SELECTICA, INC.
By: /s/ STEPHEN R. BENNION
------------------------------------
Stephen R. Bennion
Chief Financial Officer and
Secretary
32