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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended September 30, 2001
Commission File Number 0-26130
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SELECTICA, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0432030
(State of Incorporation) (IRS Employer Identification No.)
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 34,887,522 shares of Common Stock, $0.0001 par value, as of
October 31, 2001.
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FORM 10-Q
SELECTICA, INC.
INDEX
Page
----
PART I FINANCIAL INFORMATION
ITEM 1: Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets as of September 30, 2001 and March 31, 2001
(Unaudited)........................................................................... 3
Condensed Consolidated Statements of Operations for the three months ended September 30,
2001 and 2000 and six months ended September 30, 2001 and 2000 (Unaudited)............ 4
Condensed Consolidated Statements of Cash Flows for the six months ended September 30,
2001 and 2000 (Unaudited)............................................................. 5
Notes to Condensed Consolidated Financial Statements (Unaudited)........................ 6
ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations... 12
ITEM 3: Quantitative and Qualitative Disclosure about Market Risk............................... 31
PART II OTHER INFORMATION
ITEM 6: Exhibits and Reports on Form 8-K........................................................ 33
Signatures...................................................................................... 34
2
SELECTICA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
(Unaudited)
September 30, March 31,
2001 2001*
------------- ---------
ASSETS
Current assets:
Cash and cash equivalents....................................................... $ 52,778 $ 73,306
Short-term investments.......................................................... 53,167 63,848
Accounts receivable, net of allowance for doubtful accounts of $988 and $1,051,
respectively.................................................................. 7,572 18,965
Prepaid expenses and other current assets....................................... 3,068 4,009
--------- --------
Total current assets........................................................ 116,585 160,128
Property and equipment, net........................................................ 9,340 11,469
Goodwill, net of amortization of $3,149 and $1,815, respectively................... 11,303 12,637
Other assets....................................................................... 808 1,311
Long-term investments.............................................................. 51,638 31,144
Investments, restricted............................................................ 2,089 2,079
Development agreements, net of amortization of $4,205 and $3,117, respectively..... 189 1,051
--------- --------
Total assets................................................................ $ 191,952 $219,819
--------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................................ $ 1,279 $ 3,210
Accrued payroll and related liabilities......................................... 2,927 5,003
Other accrued liabilities....................................................... 4,473 5,717
Deferred revenues............................................................... 14,362 22,382
--------- --------
Total current liabilities.......................................................... 23,041 36,312
Other long term liabilities........................................................ 1,109 969
Commitments and contingencies......................................................
Stockholders' equity:
Preferred stock................................................................. -- --
Common stock.................................................................... 4 4
Additional paid-in capital...................................................... 284,516 285,179
Deferred compensation........................................................... (5,632) (7,970)
Stockholder notes receivable.................................................... (1,617) (1,915)
Accumulated deficit............................................................. (107,057) (92,989)
Accumulated other comprehensive loss............................................ 601 229
Treasury stock.................................................................. (3,013) --
--------- --------
Total stockholders' equity.................................................. 167,802 182,538
--------- --------
Total liabilities and stockholders' equity.................................. $ 191,952 $219,819
========= ========
- --------
* Amounts derived from audited financial statements at the date indicated
See accompanying notes.
3
SELECTICA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended Six Months Ended
September 30, September 30,
----------------- ------------------
2001 2000 2001 2000
------- -------- -------- --------
Revenues:
License..................................................... $ 3,953 $ 6,281 $ 10,038 $ 9,955
Services.................................................... 5,735 6,966 13,795 10,873
------- -------- -------- --------
Total revenues.......................................... 9,688 13,247 23,833 20,828
Cost of revenues:..............................................
License..................................................... 178 277 513 508
Services.................................................... 6,218 5,792 13,466 11,019
------- -------- -------- --------
Total cost of revenues.................................. 6,396 6,069 13,979 11,527
------- -------- -------- --------
Gross profit................................................... 3,292 7,178 9,854 9,301
Operating expenses:............................................
Research and development.................................... 3,721 6,954 8,145 11,336
Sales and marketing......................................... 5,999 12,844 14,322 25,567
General and administrative.................................. 1,907 3,554 5,069 5,507
------- -------- -------- --------
Total operating expenses................................ 11,627 23,352 27,536 42,410
------- -------- -------- --------
Loss from operations........................................... (8,335) (16,174) (17,682) (33,109)
Other income, net:.............................................
Interest income, net........................................ 1,766 3,353 3,768 6,695
------- -------- -------- --------
Loss before provision for income taxes......................... (6,569) (12,821) (13,914) (26,414)
Provision for income taxes..................................... 79 125 154 125
------- -------- -------- --------
Net loss....................................................... $(6,648) $(12,946) $(14,068) $(26,539)
======= ======== ======== ========
Basic and diluted net loss per share........................ $ (0.19) $ (0.38) $ (0.40) $ (0.79)
======= ======== ======== ========
Weighted-average shares of common stock used in computing basic
and diluted, net loss per share.............................. 35,574 34,135 35,547 33,754
======= ======== ======== ========
See accompanying notes.
4
SELECTICA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six Months Ended
September 30,
-------------------
2001 2000
-------- ---------
Operating Activities
Net loss..................................................................... $(14,068) $ (26,539)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation.............................................................. 2,113 1,145
Loss on disposal of fixed assets.......................................... 32 --
Amortization of private placement discount................................ 254 1,628
Amortization of warrants in connection with license and service agreement. 250 5,202
Amortization of goodwill.................................................. 1,334 390
In-process research and development....................................... -- 1,870
Amortization of development agreement..................................... 1,088 1,055
Amortization of deferred compensation..................................... 1,186 1,744
Accelerated vesting of stock options to employees......................... 125 475
Changes in assets and liabilities:
Accounts receivable................................................... 11,393 (8,022)
Prepaid expenses and other current assets............................. 941 (524)
Other assets.......................................................... 493 (2,263)
Accounts payable...................................................... (1,931) (1,584)
Accrued payroll and related liabilities............................... (2,076) 3,021
Other accrued and long-term liabilities............................... (1,104) (97)
Deferred revenues..................................................... (8,524) 2,899
-------- ---------
Net cash used in operating activities........................................ (8,494) (19,600)
Investing Activities
Capital expenditures...................................................... (45) (4,378)
Acquisition of Wakely..................................................... -- (4,755)
Proceeds from sales of fixed assets....................................... 29 --
Purchase of short term investments........................................ (19,204) (71,357)
Proceeds from sales and maturities of short term investment............... 71,031 --
Purchase of long term investments......................................... (27,498) (30,219)
Proceeds from sales and maturities of long term investment................ 7,286 --
-------- ---------
Net cash provided by (used in) in investing activities....................... 31,599 (110,709)
Financing Activities
Net proceeds from initial public offering................................. -- (129)
Repurchase of common stock................................................ (3,013) --
Proceeds from shareholder notes receivable................................ 298 --
Proceeds from issuance of common stock.................................... 138 238
-------- ---------
Net cash (used in) provided by financing activities.......................... (2,577) 109
-------- ---------
Net decrease in cash and cash equivalents.................................... (20,528) (130,200)
Cash and cash equivalents at beginning of the period......................... 73,306 215,825
-------- ---------
Cash and cash equivalents at end of the period............................... $ 52,778 $ 85,625
======== =========
Supplemental Cash Flow Information
Deferred compensation related to stock options............................... $ 1,152 $ 408
Warrants issued in connection with development agreement..................... $ 226 $ --
See accompanying notes.
5
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Summary of Significant Accounting Policies
Basis of Presentation
The condensed consolidated balance sheet as of September 30, 2001, the
condensed consolidated statements of operations and cash flows for the six
months ended September 30, 2001 and 2000, and the condensed consolidated
statements of operations for the three months ended September 30, 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 September 30, 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 has 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 the 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 financial statements 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:
Three Months Ended Six Months Ended
September 30, September 30,
----------------- ---------------
2001 2000 2001 2000
---- ---- ---- ----
Fireman's Fund............................ 11% * * *
Dell...................................... * 20% * 18%
Samsung SDS............................... * 19% * 23%
Cisco Systems............................. * 12% * *
- --------
* Revenues were less than 10%.
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 September 30, 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 2001. 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 test goodwill for impairment using the current method, which uses an
undiscounted cash flow test.
6
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes methods for derivative financial instruments and hedging activities
related to those instruments, as well as other hedging activities. We have
implemented SFAS No. 133 beginning April 01, 2001. For the six months ended
September 30, 2001, we did not hold any derivative instruments and did not
engage in hedging activities, the adoption of SFAS No. 133 had no material
impact on our financial position, results of operations or cash flows.
2. Cash Equivalents and Investments
Cash Equivalents
All cash equivalents as of September 30, 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:
September 30, March 31
2001 2001
------------- --------
(In Thousands)
Cash Equivalents:
Commercial papers...................... $ 8,738 $15,741
Money market........................... 31,974 31,366
Government agency notes................ -- 8,947
Corporate notes........................ -- 6,066
------- -------
Total.................................. $40,712 $62,120
======= =======
Investments
All investments as of September 30, 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:
September 30, March 31,
2001 2001
------------- ---------
(In Thousands)
Short-term Investments:
Auction rate preferreds................ $20,980 $ --
Government agencies.................... 23,737 40,893
Corporate notes & bonds................ 7,223 18,369
Commercial paper....................... -- 4,494
Municipal bonds........................ 1,045 --
------- -------
Short-term investments at cost...... 52,985 63,756
Unrealized gains....................... 182 92
------- -------
Fair value.......................... $53,167 $63,848
======= =======
September 30, March 31,
2001 2001
------------- ---------
(In Thousands)
Long-term Investments:
Corporate notes & bonds................ $27,561 $20,981
Government agencies.................... 23,658 10,026
------- -------
Long-term investments at cost....... 51,219 31,007
Unrealized gains....................... 419 137
------- -------
Fair value.......................... $51,638 $31,144
======= =======
7
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
As of September 30, 2001, the Company has four operating leases that require
security deposits to be maintained at financial institutions for the term of
the leases. The total security deposits of the leases in the amount of
approximately $589,000 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 and classified as a restricted long-term investment. The escrow
fund in amounts of $500,000 and $1.0 million will be paid in approximately 18
months and 36 months from the date of acquisition, respectively. The interest
earned on the investment can be used in operations.
Unrealized holding gains on available-for-sale securities as of September
30, 2001 and March 31, 2001 were approximately $601,000 and $229,000,
respectively.
3. Stockholders' Equity
Warrants
In September 1999, the Company entered into a development agreement with an
investor whereby the investor and the Company will work to port the current
suite of ACE products to additional platforms. In connection with the
development agreement, the Company issued warrants to purchase 57,000 shares of
Series E convertible preferred stock at $4.382 per share. The warrants were
issued in December 1999 and were exercised on March 9, 2000. The Company
determined the fair value of the warrants using the Black-Scholes valuation
model assuming a fair value of the Company's Series E convertible preferred
stock of $19.00, risk free interest rate of 5.5%, volatility factor of 80% and
a life of 22 months. The fair value of approximately $381,000 is being
amortized over the remaining life of the development agreement. The Company
amortized approximately $52,000 and $104,000 related to the fair value of the
warrants in the three and six months ended September 30, 2001. The fair value
of the warrants was fully amortized as of September 30, 2001.
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 six months ended September 30, 2001, the total amortization of the charges
related to this agreement was $125,000 and $250,000, respectively. As of
September 30, 2001, the remaining balance of the fair value of the warrants was
$125,000 which balance will be fully amortized by 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 next
three years. For the three and six months ended September 30, 2001, the Company
has amortized approximately $19,000 and $38,000 related to the fair value of
the warrant.
8
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Deferred Compensation
During the six months ending September 30, 2001, options worth approximately
$453,000 were granted to employees with exercise prices that were less than
fair value, respectively. Such compensation will be amortized over the vesting
period of the options, typically four years. For the six months ended September
30, 2001 and 2000, the Company amortized approximately $1.2 million and $1.7
million of deferred compensation, respectively. For the three months ended
September 30, 2001 and 2000, the Company amortized approximately $553,000 and
$895,000 of deferred compensation, respectively.
Accelerated Options
During the six months ended September 30, 2001, in association with employee
termination agreements, the Company accelerated the vesting of options to
purchase 38,659 shares of unvested common stock. For the six months ended
September 30, 2001 and 2000, the Company recorded approximately $125,000 and
$475,000 of related compensation expense. For the three months ended September
30, 2001 and 2000, there was no compensation expense recorded by the Company
with regard to the acceleration of options.
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.
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 quarter ended September 30, 2001, the Company repurchased 927,600
shares of its common stock at an average price of $3.25 in the open market at a
cost of approximately $3.0 million. 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.
4. Income Taxes
The Company has recorded a tax provision of $79,000 and $154,000 for the
three and six-month periods ended September 30, 2001, respectively, compared to
$125,000 and $125,000 for the same periods a year ago. The provision for income
taxes is intended primarily 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
9
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 6,798,379 and 5,289,124 shares of common stock
were excluded from the computations for the three and six-month periods ended
September 30, 2001 as their effect is antidilutive, compared to 426,728 and
4,126,479 for the same periods a year ago.
6. Comprehensive Loss
The components of comprehensive loss, net of related income tax, for the
three and six months ended September 30, 2001 and 2000 are as follows:
Three Months Ended Six Months Ended
September 30, September 30,
----------------- ------------------
2001 2000 2001 2000
------- -------- -------- --------
(In thousands)
Net loss......................................... $(6,648) $(12,946) $(14,068) $(26,539)
Change in unrealized gain on securities.......... 247 341 373 107
------- -------- -------- --------
Comprehensive loss............................... $(6,401) $(12,605) $(13,695) $(26,432)
======= ======== ======== ========
Accumulated other comprehensive gain was approximately $601,000 and $229,000
as of September 30, 2001 and March 31, 2001, and represents net unrealized gain
on securities.
7. Litigation
On June 5, 2001, a number of 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. We believe that the claims
against us are without merit and intend to defend against the complaints
vigorously. To date, there have been no significant developments in the
litigation. We believe that the resolution of such matter will not have a
material impact to our financial position, results of operations or cash flows.
8. Restructuring
For the six months ended September 30, 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
10
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
administrative expense. The restructuring charges were primarily for the
severance and benefits paid to the terminated employees. During the six months
ended September 30, 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. The
restructuring activities are expected to complete in December 2001. For the six
months ended September 30, 2001 and the year ended March 31, 2001, the reserve
for the restructuring was $221,000 and $350,000, respectively, which was
included in current liabilities and is summarized as follows:
Severance and Benefits:
FY 2001 Restructuring Charges.............................. $ 667,000
Cash Charges............................................... (317,000)
-----------
Reserve balance, March 31, 2001............................ 350,000
FY 2002 Restructuring Charges 04/01/01 to 09/30/01......... 1,440,000
Cash Charges for 04/01/01 to 09/30/01...................... (1,569,000)
-----------
Reserve balance, September 30, 2001........................ $ 221,000
===========
9. Subsequent Events
As of October 31, 2001, the Company has repurchased 1,362,600 shares of its
common shares at an average price of $3.31 in the open market at a cost of
approximately $4.5 million.
11
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 Internet 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 Internet 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 Internet 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
12
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, (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 six months ended September 30, 2001, we recognized 74% of license
and services revenues under the percentage-of-completion method, 16% under the
completed contract method and 10% under the residual method. For the six months
ended September 30, 2000, we recognized 42% of license and services revenues
under the residual method, 41% under the percentage-of-completion method and
17% under the completed contract method. For the three months ended September
30, 2001, we recognized 72% of license and services revenues under the
percentage-of-completion method, 27% under the completed contract method and 1%
under the residual method. For the three months end September 30, 2000, we
recognized 45% of license and services revenues under the
percentage-of-completion method, 40% under the residual method and 15% under
the completed contract method.
13
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
September 30, 2001, March 31, 2001 and June 30, 1999 due to the delay of
milestone achievement of services under a particular contract.
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 six months ended September 30, 2001, we did not have
any customers which accounted for over 10% of our revenues. For the six months
ended September 30, 2000, revenue from Samsung SDS and Dell accounted for 23%
and 18% of our revenues, respectively. For the three months ended, September
30, 2001, revenue from Fireman's Fund accounted for 11% of our revenues.For the
three months ended September 30, 2000, revenue from Dell, Samsung SDS, and
Cisco accounted for 20%, 19%, and 12%, respectively.
We have a limited operating history upon which we may be evaluated. We have
incurred significant losses since inception and, as of September 30, 2001, we
had an accumulated deficit of approximately $107.1 million. We believe our
success depends on the continued growth of our customer base and the
development of the emerging Interactive Selling System market. However, 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 and second 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 September 30, 2001, we have
amortized approximately $38,000 related to the fair value of the warrant.
During the quarter ended September 30, 2001, the Company repurchased 927,600
shares of its common stock at an average price of $3.25 in the open market at a
cost of approximately $3.0 million. This program was
14
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.
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 six months ended September 30, 2001 and 2000.
Three Months Ended Six Months Ended
September 30 September 30,
---------------- --------------
2001 2000 2001 2000
---- ---- ---- ----
As a Percentage of Total Revenues:
Revenues:
License....................................... 41% 47% 42% 48%
Services...................................... 59 53 58 52
--- ---- --- ----
Total revenues............................ 100 100 100 100
Cost of revenues:
License....................................... 2 2 2 2
Services...................................... 64 44 57 53
--- ---- --- ----
Total cost of revenues.................... 66 46 59 55
--- ---- --- ----
Gross profit (loss)....................... 34 54 41 45
Operating expenses:
Research and development...................... 38 52 34 54
Sales and marketing........................... 62 97 60 123
General and administrative.................... 20 27 21 26
--- ---- --- ----
Total operating expenses.................. 120 176 116 203
--- ---- --- ----
Loss from operations............................. (86) (122) (75) (158)
Interest and other income (expense), net......... 18 25 16 32
--- ---- --- ----
Net loss before taxes............................ (68) (97) (59) (126)
Provision for income taxes....................... 1 1 1 1
--- ---- --- ----
Net loss......................................... (69)% (98)% (60)% (127)%
=== ==== === ====
Three and Six Months Ended September 30, 2001 and 2000
Revenues
Total revenues were approximately $9.7 million and $23.8 million in the
three and six months ended September 30, 2001 compared to approximately $13.2
million and $20.8 million, respectively, for the same periods a year ago. 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 $4.0 million and $10.0
million in the three and six months ended September 30, 2001 compared to
approximately $6.3 million and $10.0 million, respectively, in the same period
a year ago. For the six months ended September 30, 2001, license revenue was
comparable to the same period a year ago. For the three months ended September
30, 2001, revenue decreased approximately $2.3 million compared to the three
months ended September 30, 2000. This 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 six months
ended September 30, 2000, we amortized approximately $1.4 million against the
15
license revenues in association with the fair value of the warrant issued to a
significant customer in connection with a license and service agreement. For
the three months ended September 30, 2000, we amortized approximately $733,000
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.
Services. Services revenues totaled approximately $5.7 million and $13.8
million in the three and six months ended September 30, 2001, compared to
approximately $7.0 million and $10.9 million, respectively, to the same periods
a year ago. Our services revenues are comprised of fees from consulting,
maintenance and training services. The increase of approximately $2.9 million
in services revenues for the six months ended September 30, 2001 compared to
the same period a year ago was due primarily to the increase in maintenance and
maintenance renewals, consulting, and training services associated with our
increased installed base. However, a decrease of approximately $1.3 million for
the three months ended September 30, 2001 compared to the same period ended
September 30, 2000 was the result of the slowdown in economy which caused a
significant decrease in technology spending. During the six months ended
September 30, 2001 and 2000, revenues were also reduced by amortization of
approximately $250,000 and $3.8 million, respectively, the fair value of the
warrant issued to a significant customer in connection with a license and
service agreement. During three months ended September 30, 2001 and 2000,
revenues were reduced by amortization of approximately $125,000 and $1.7
million, respectively, the fair value of the warrant as noted. 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 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. Cost of license was approximately $178,000 and $513,000 and
represents 5% of license revenues in the three and six months ended September
30, 2001, as compared to approximately $277,000 and $508,000 or 4% and 5% of
license revenues, respectively, for the same periods a year ago. We expect cost
of license revenues to maintain a relatively consistent level as a percentage
of license revenues.
Cost of Services Revenue, Cost of services revenue is comprised mainly of
salaries and related expenses of our services organization. For the three and
six months ended September 30, 2001, cost of services revenues totaled
approximately $6.2 million and $13.5 million up from approximately $5.8 million
and $11.0 million, respectively, compared to the same periods a year ago. Cost
of services revenues represented 108% and 98% of services revenues in the three
months and six months ended September 30, 2001 compared to 83% and 101%,
respectively, for the same period a year ago. The increase in cost of services
was primarily due to an increase in the number of consulting and technical
support personnel necessary to support both the expansion of our installed base
of customers and new implementations. In addition, during the six months ending
September 30, 2001, we amortized approximately $414,000 for deferred
compensation, $189,000 for restructuring costs related to the severance and
benefits paid to terminated employees and $562,000 for goodwill in connection
with the Wakely Software acquisition. During the six months ended September 30,
2000, we amortized approximately $358,000 for deferred compensation. During the
three months ended September 30, 2001, we amortized approximately $220,000 for
the deferred compensation and approximately $281,000 for goodwill in connection
with the Wakely Software acquisition. For the three months ended September 30,
2000, we amortized approximately $176,000 for deferred compensation and
approximately $13,000 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 six months ended September 30, 2001, we experienced
overall gross margins of 34% and 41% compared to overall gross margins of 54%
and 45%, 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
16
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.
Gross Margin -- Licenses. Gross margin for license revenues was
approximately 95% for the three and six months ended September 30, 2001 and 96%
and 95%, respectively, for the same periods a year ago.
Gross Margin -- Services. Gross margin for services was approximately
negative 8% and 2% for the three and six months ended September 30, 2001 and
17% and negative 1%, 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 $3.7 million and $8.1 million for the three and six months ended
September 30, 2001 down from approximately $7.0 million and $11.3 million,
respectively, compared to the same periods a year ago. The decrease was
primarily due to our restructuring. During the six months ended September 30,
2001, we amortized approximately $137,000 for deferred compensation, $1.1
million for the development agreement entered into with a significant customer
and $287,000 for restructuring charges. During the six months ended September
30, 2000, we amortized approximately $173,000 for deferred compensation, $1.1
million for the development agreement entered into with a significant 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
September 30, 2001, we amortized approximately $67,000 for deferred
compensation and $544,000 for the development agreement entered into with a
significant customer. During the three months ended September 30, 2000, we
amortized approximately $87,000 for deferred compensation, $526,000 for the
development agreement entered into with a significant customer and one-time
$1.9 million charge for in process research and development in relation to the
Wakely Software acquisition.
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 $6.0 million and $14.3
million in the three and six months ended September 30, 2001 down from
approximately $12.8 million and $25.6 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 six months ended
September 30, 2001, we amortized approximately $422,000 for deferred
compensation, $359,000 for restructuring charges and $106,000 for acceleration
of stock option vesting. During the six months ended September 30, 2000, we
amortized $981,000 for deferred compensation and $431,000 for acceleration of
stock option vesting. During the three months ended September 30, 2001 and
2000, we amortized approximately $160,000 and $517,000 for deferred
compensation, respectively.
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 $1.9 million and $5.1 million in
the three and six months ended September 30, 2001, down from approximately $3.6
million and $5.5 million, respectively, compared to the same periods a year
ago. The decrease was primarily due to our restructuring plan. During the six
months ended September 30, 2001, we amortized approximately $213,000 for
deferred compensation, $12,000 for acceleration of stock option vesting,
$605,000 for restructuring charges, and $766,000 for the amortization of
goodwill in connection with the Wakely Software acquisition. For the six months
ended September 30, 2000, we amortized approximately $232,000 for deferred
compensation, $44,000 for acceleration of stock option vesting and $255,000
from the amortization
17
of goodwill in connection with the Wakely Software acquisition. During the
three months ended September 30, 2001, we amortized approximately $106,000 for
deferred compensation, $49,000 for restructuring charges and $383,000 for the
amortization of goodwill in connection with the Wakely Software acquisition.
During the three months ended September 30, 2000, we amortized approximately
$116,000 for deferred compensation and $255,000 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 $1.8 million and $3.8 million for the three and six
months ended September 30, 2001 compared with interest income of approximately
$3.4 million and $6.7 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 our expansion and the
operation of our business during the fiscal year of 2001.
Provision for Income Taxes
For the three months and six months ended September 30, 2001, we have
recorded a tax provision of approximately $75,000 and $154,000 compared to none
and $125,000, 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 September 30, 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 2001. 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 test goodwill for impairment using the current method, which uses an
undiscounted cash flow test.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes methods for derivative financial instruments and hedging activities
related to those instruments, as well as other hedging activities. We have
implemented SFAS No. 133 beginning April 01, 2001. For the six months ended
September 30, 2001, we did not hold any derivative instruments and did not
engage in hedging activities, the adoption of SFAS No. 133 had no material
impact on our financial position, results of operations or cash flows.
18
Consolidated Balance Sheet Data
Cash, cash equivalents, short-term and long-term investments were
approximately $157.6 million at September 30, 2001 compared to approximately
$168.3 million at March 31, 2001. The decrease primarily relates to cash used
in operations during the six months ended September 30, 2001 of approximately
$7.7 million and $3.0 million of stock repurchase in the open market. Accounts
receivable was approximately $7.6 million at September 30, 2001 compared to
approximately $19.0 million at March 31, 2001. The decrease of approximately
$11.4 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 were approximately $3.0 million at September 30, 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 $189,000 at September 30, 2001 and
approximately $1.1 million at March 31, 2001. The decrease was due to the
amortization for the six months ended September 30, 2001.
Current liabilities were approximately $23.0 million at September 30, 2001
and approximately $36.3 million at March 31, 2001. The decrease of
approximately $13.3 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 $8.0 million in the current
period.
Liquidity and Capital Resources
As of September 30, 2001, cash, cash equivalents and short-term investments
totaled approximately $105.9 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 six months ended September 30, 2001 was approximately $9.0 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 six months ended September 30,
2001 was approximately $12 million and consisted primarily of the net proceeds
from the sales of short-term and long-term investments.
Cash used for financing activities for the six months ended September 30,
2001 was approximately $2.6 million and consisted primarily 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 in next 12 months.
19
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 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
September 30, 2001, March 31, 2001 and June 30, 1999 due to the delay of
milestone achievement of services under a particular
20
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 $14.1 million for the six months ended September 30,
2001 an accumulated deficit of approximately $107.1 million as of September 30,
2001. We intend to reduce 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. 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.
21
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 4.5, the
newest version of our software, in October 2000. 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, would impede 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.
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.
22
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.
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 36% of our
revenues for the six months ended September 30, 2001 and 55% for the fiscal
year ended March 31, 2001, respectively, and our ten largest customers
accounted for 58% of our revenues for the six months ended September 30, 2001
and 67% for the fiscal year ended March 31, 2001, respectively. There was no
significant customer who accounted for more than 10% of total revenues for the
six months ended September 30, 2001. Revenues from significant customers as a
percentage of total revenues for the year ended March 31, 2001 are as follows:
Fiscal Year ended March 31, 2001
Samsung, SDS............................................... 17%
Dell....................................................... 16%
Cisco...................................................... 14%
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
23
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.
On June 5, 2001, a number of 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. 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 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.
24
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 58% and 52% of total revenues for the six months ended
September 30, 2001 and 2000 respectively, services revenues have lower gross
margins than license revenues. Gross margins for services revenues were 2% and
negative 1% for the six months ended September 30, 2001 and 2000, respectively,
compared to gross margins for license revenues of 95% for the six months ended
September 30, 2001 and for the six months ended September 30, 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.
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 Pune,
India, develop and deliver new technologies, attract and retain customers,
attract and retain other employees and generate revenues would be significantly
harmed.
25
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 September 30, 2001, there were 252 persons employed in India. We are
dependent on our India-based operations for these aspects of our business and
we intend to 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 executive officers or the members of our
Board of Directors.
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.
26
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.
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;
27
. 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.
Restrictions on export of encrypted technology could cause us to incur delays
in international product sales, which would adversely impact the expansion and
growth of our business.
Our software utilizes encryption technology, the export of which is
regulated by the United States government. If our export authority is revoked
or modified, if our software is unlawfully exported or if the United States
adopts new legislation restricting export of software and encryption
technology, we may experience delay or reduction in shipment of our products
internationally. Current or future export regulations could limit our ability
to distribute our products outside of the United States. While we take
precautions against unlawful exportation of our software, we cannot effectively
control the unauthorized distribution of software across the Internet.
28
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;
. 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 recently 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 September 30, 2001, we
expanded from 68 to 558 employees, including 31 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 $8.6 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 six
months ended September 30, 2001, the total amortization of the deferred
compensation expenses was approximately $1.2 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
29
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 six months ended September 30, 2001, the total
amortization of charges related to this agreement was approximately $250,000
against the revenue. The remaining balance of the fair value of the warrants
was approximately $125,000 and will be fully amortized by the quarter ended
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 September 30, 2001, we have amortized approximately $38,000 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 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.
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.
30
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 $571,000
(less than 0.4%) 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 September 30, 2001.
31
PART II OTHER INFORMATION
Item 1. Legal Proceedings
On June 5, 2001, a number of 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 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.
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 Sales Technologies Limited 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
32
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.
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.
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
33
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: November 13, 2001
SELECTICA, INC.
By: /s/ STEPHEN R. BENNION
__________________________________
Stephen R. Bennion
Chief Financial Officer and Secretary
34