1
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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 DECEMBER 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER 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 36,989,961 shares of Common Stock, $0.0001 par value, as of
January 31, 2001.
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2
FORM 10-Q
SELECTICA INC.
INDEX
PAGE
----
PART I FINANCIAL INFORMATION
Item 1: Financial Statements
Condensed Consolidated Balance Sheets as of December 31,
2000 and March 31, 2000..................................... 1
Condensed Consolidated Statements of Operations for the
three months ended December 31, 2000 and 1999 and nine
months ended December 31, 2000 and 1999..................... 2
Condensed Consolidated Statements of Cash Flows for the nine
months ended December 31, 2000 and 1999..................... 3
Notes to Condensed Consolidated Financial Statements........ 4
Item 2: Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 9
Item 3: Quantitative and Qualitative Disclosure about Market Risk... 27
PART II OTHER INFORMATION
Item 6: Exhibits and Reports on Form 8-K............................ 29
Signatures........................................................... 30
i
3
SELECTICA, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
(UNAUDITED)
ASSETS
DECEMBER 31, MARCH 31,
2000 2000*
------------ ---------
Current assets:
Cash and cash equivalents................................. $ 52,826 $215,818
Short-term investments.................................... 95,978 --
Accounts receivable, net of allowance for doubtful
accounts of $1,147 and $415, respectively.............. 19,906 5,749
Prepaid expenses and other current assets................. 3,503 9,418
-------- --------
Total current assets.............................. 172,213 230,985
Property and equipment, net................................. 10,341 6,127
Goodwill, net of amortization of $1,146 and $116,
respectively.............................................. 13,307 30
Other assets................................................ 2,390 2,054
Long-term investments....................................... 29,856 --
Investments, restricted..................................... 1,950 100
Development agreement, net of amortization of $2,592 and
$1,011,
respectively.............................................. 1,575 3,156
-------- --------
Total assets...................................... $231,632 $242,452
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 4,073 $ 4,258
Accrued payroll and related liabilities................... 4,482 1,879
Other accrued liabilities................................. 4,617 3,755
Deferred revenues......................................... 21,475 18,482
-------- --------
Total current liabilities......................... 34,647 28,374
Other long term liabilities............................... 885 --
Commitments and contingencies
Stockholders' equity:
Common stock.............................................. 4 3
Additional paid-in capital................................ 290,989 281,773
Deferred compensation..................................... (9,703) (11,860)
Stockholder notes receivable.............................. (7,830) (12,716)
Accumulated deficit....................................... (77,580) (43,122)
Accumulated other comprehensive gain...................... 220 --
-------- --------
Total stockholders' equity........................ 196,100 214,078
-------- --------
Total liabilities and stockholders' equity........ $231,632 $242,452
======== ========
- ---------------
* Amounts derived from audited financial statements
See accompanying notes.
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SELECTICA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------ -------------------
2000 1999 2000 1999*
-------- ------- -------- --------
Revenues:
License.............................................. $ 8,659 $ 2,348 $ 18,614 $ 5,181
Services............................................. 10,950 2,157 21,823 3,959
-------- ------- -------- --------
Total revenues............................... 19,609 4,505 40,437 9,140
Cost of revenues:
License.............................................. 414 117 922 259
Services............................................. 7,836 1,954 18,855 5,240
-------- ------- -------- --------
Total cost of revenues....................... 8,250 2,071 19,777 5,499
-------- ------- -------- --------
Gross profit........................................... 11,359 2,434 20,660 3,641
Operating expenses:
Research and development............................. 5,131 1,892 16,467 4,132
Sales and marketing.................................. 13,004 4,408 38,571 9,271
General and administrative........................... 4,432 1,197 9,939 2,924
-------- ------- -------- --------
Total operating expenses..................... 22,567 7,497 64,977 16,327
-------- ------- -------- --------
Loss from operations................................... (11,208) (5,063) (44,317) (12,686)
Other income, net:
Interest income, net................................. 3,364 221 10,059 319
-------- ------- -------- --------
Loss before provision for income taxes................. (7,844) (4,842) (34,258) (12,367)
Provision for income taxes............................. 75 -- 200 50
-------- ------- -------- --------
Net loss............................................... (7,919) (4,842) (34,458) (12,417)
-------- ------- -------- --------
Deemed dividend on Series E preferred stock.......... -- 925 -- 925
Net loss applicable to common stockholders............. $ (7,919) $(5,767) $(34,458) $(13,342)
======== ======= ======== ========
Basic and diluted, net loss per share applicable to
common stockholders.................................. $ (0.23) $ (0.23) $ (1.01) $ (0.59)
======== ======= ======== ========
Weighted-average shares of common stock used in
computing basic and diluted, net loss per share
applicable to common stockholders.................... 35,101 25,104 34,249 22,455
======== ======= ======== ========
- ---------------
* Amounts derived from audited financial statements at the date indicated
See accompanying notes.
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5
SELECTICA, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
DECEMBER 31,
---------------------
2000 1999
--------- --------
OPERATING ACTIVITIES
Net loss.................................................... $ (34,458) $(12,417)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 1,971 731
Amortization of private placement discount................ 2,722 --
Amortization of warrants in connection with license and
service agreement....................................... 5,936 --
Issuance of common stock in exchange for services......... -- 371
Compensation expense related to repurchase of shares over
fair market value....................................... 873 --
Accrued interest on convertible notes converted to
convertible preferred stock............................. -- 7
Amortization of goodwill.................................. 1,028 --
In-process research and development....................... 1,870 --
Amortization of development agreement..................... 1,581 472
Amortization of deferred compensation..................... 2,576 590
Accelerated vesting of stock options to employees......... 527 66
Warrants issued in conjunction with debt financing........ -- 35
Changes in assets and liabilities:
Accounts receivable, net................................ (13,647) (1,640)
Prepaid expenses and other current assets............... (21) (435)
Other assets............................................ (2,147) (1,263)
Accounts payable........................................ (261) (70)
Accrued payroll and related liabilities................. 2,169 699
Other accrued and long-term liabilities................. 617 1,710
Deferred revenues....................................... 271 2,976
--------- --------
Net cash used in operating activities....................... (28,393) (8,168)
INVESTING ACTIVITIES
Capital expenditures...................................... (6,063) (3,350)
Acquisition of Wakely Software, Inc....................... (4,755) --
Acquisition of certain assets and liabilities of
LoanMarket Resources, LLC............................... (216) --
Net purchase of short term investments.................... (95,915) --
Net purchase of long term investments..................... (29,699) --
Acquisition of Selectica, India........................... -- (150)
--------- --------
Net cash used in investing activities....................... (136,648) (3,500)
FINANCING ACTIVITIES
Proceeds from issuance of convertible notes............... -- 1,000
Cost of financing......................................... (1,209) --
Proceeds from stockholder notes receivable................ 386 --
Exercise of warrants in exchange for preferred stock...... -- 23
Net proceeds from issuance of convertible preferred
stock................................................... -- 24,913
Repurchase of common stock................................ -- (456)
Proceeds from issuance of common stock.................... 2,865 312
--------- --------
Net cash provided by financing activities................... 2,042 25,792
--------- --------
Net increase (decrease) in cash and cash equivalents........ (162,999) 14,124
Cash and cash equivalents at beginning of the period........ 215,825 --
--------- --------
Cash and cash equivalents at end of the period.............. $ 52,826 $ 14,124
========= ========
SUPPLEMENTAL CASH FLOW INFORMATION
Deferred compensation related to stock options............ $ 1,111 $ 6,345
Cash paid for interest.................................... $ -- $ 53
Convertible notes payable and accrued interest converted
to convertible preferred stock.......................... $ -- $ 944
Warrants issued in conjunction with convertible notes
payable................................................. $ -- $ 50
Warrants issued in conjunction with convertible preferred
stock financing......................................... $ -- $ 616
Warrants issued in connection with development
agreement............................................... $ -- $ 381
Issuance of stock in exchange for notes................... $ -- $ 7,016
Repurchase of stock in exchange for cancellation of
notes................................................... $ 4,500 $ --
See accompanying notes.
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SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The condensed consolidated balance sheet as of December 31, 2000, the
condensed consolidated statements of operations and cash flows for the nine
months ended December 31, 2000, and the condensed consolidated statements of
operations for the three months ended December 31, 2000 and 1999 have been
prepared by the Company and are unaudited. In the opinion of management, all
necessary adjustments, including normal recurring adjustments, have been made to
present fairly the financial position, results of operations, and cash flows at
December 31, 2000 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, 2000 and the condensed consolidated
statements of operations and cash flows for the nine months ended December 31,
1999 have been derived from audited consolidated financial statements at that
date.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted. These consolidated financial statements should
be read in conjunction with the audited consolidated financial statements and
notes included in this prospectus and the Company's Annual Report on Form 10-K
for the year ended March 31, 2000.
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 NINE MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
------------- -------------
2000 1999 2000 1999
---- ---- ---- ----
Cisco Systems......................................... 18% * 13% *
Dell.................................................. 14% * 16% *
Highmark Blue Cross Blue Shield....................... 12% * * *
Samsung SDS........................................... 12% * 18% *
Fireman's Fund Insurance.............................. * 28% * 14%
Fujitsu Network Corporation........................... * 16% * *
Aspect Communications................................. * * * 15%
3Com Corporation...................................... * * * 14%
- ---------------
* Revenues were less than 10%.
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7
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
2. INVESTMENTS
All investments as of December 31, 2000 are classified as
available-for-sale securities. The Company did not hold any investments as of
March 31, 2000. The following is a summary of the aggregate cost, gross
unrealized gains, and estimated fair value of the Company's short-term and
long-term investments:
DECEMBER 31,
2000
---------------
(IN THOUSANDS)
SHORT-TERM INVESTMENTS:
Commercial Paper..................................... $22,535
Corporate notes and bonds............................ 32,994
Government agencies.................................. 40,386
-------
Short-term investments at cost....................... 95,915
Unrealized gain...................................... 63
-------
Fair value........................................ $95,978
=======
DECEMBER 31,
2000
---------------
(IN THOUSANDS)
LONG-TERM INVESTMENTS:
Corporate notes and bonds............................ $14,708
Government agencies.................................. 14,991
-------
Short-term investments at cost.................... 29,699
Unrealized gains..................................... 157
-------
Fair value........................................ $29,856
=======
Unrealized holding gains and losses on available-for-sale securities at
March 31, 2000 and gross realized gains and losses on sales of
available-for-sale securities during the three and nine months ended December
31, 2000 and 1999 were not significant.
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 $381,000 is being amortized over the
remaining life of the development agreement. As December 31, 2000, total
amortization of this warrant was approximately $225,000.
In November 1999, the Company entered into a license agreement and one year
maintenance contract in the amount of $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 warrants was estimated to be $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
5
8
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
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 a $9.7
million loss on the contract in the year ended March 31, 2000. The Company
amortized against revenue $733,000 and $5.9 million related to the fair value of
the warrants in the three and nine months ended December 31, 2000, respectively.
Deferred Compensation
The Company granted 250,850 and 643,665 options to employees with exercise
price that were less than fair value and recorded net deferred compensation of
approximately $703,000 and $1.2 million, for the three and nine months ended
December 31, 2000, respectively. Such compensation will be amortized over the
vesting period of the options, typically four years. For the nine months ended
December 31, 2000 and 1999, the Company amortized approximately $2.6 million and
$590,000, respectively.
Accelerated Options
During the nine months ended December 31, 2000, in association with
employee termination agreements, the Company accelerated vesting on options to
purchase 24,807 shares of common stock and recorded approximately $527,000 of
related compensation expense.
Stock Repurchase
On December 29, 2000, the Company elected to repurchase 150,000 shares of
common stock at cost from certain key employees (the "Stock Repurchase").These
shares were originally issued in exchange for full recourse promissory notes
with an aggregate value of $4.5 million. As compensation for services rendered
by these employees and in order to provide an inducement for continued
employment, we repurchased these shares at a repurchase price which was greater
than the fair value of the stock at the time of the repurchase. As a result we
recorded a total compensation expense of approximately $873,000 of which
$291,000 was expensed in cost of goods sold, $291,000 was expensed in sales and
marketing, and $291,000 was expensed in general and administrative expense.
4. INCOME TAXES
The Company has recorded a tax provision of $200,000 and $50,000 for the
nine months ended December 31, 2000 and 1999 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 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 and warrants to purchase 4,896,675 and 2,455,102 shares of common stock
were excluded from the nine months ended December 31, 2000 and 1999 computation
as their effect is antidilutive.
6
9
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
The following table presents the computation of basic and diluted net loss
per share
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------ --------------------
2000 1999 2000 1999
------- ------- -------- --------
(IN THOUSANDS)
Net loss applicable to common
stockholders............................ $(7,919) $(5,767) $(34,458) $(13,342)
======= ======= ======== ========
Basic and diluted:
Weighted-average shares of common stock
outstanding.......................... 36,894 26,894 36,454 23,791
Less weighted-average shares subject to
repurchase........................... (1,793) (1,790) (2,205) (1,336)
------- ------- -------- --------
Weighted-average shares used in
computing basic and diluted, net loss
per share applicable to common
stockholders......................... 35,101 25,104 34,249 22,455
======= ======= ======== ========
Basic and diluted, net loss per share
applicable to common stockholders.... $ (.23) $ (.23) $ (1.01) $ (.59)
======= ======= ======== ========
6. COMPREHENSIVE LOSS
The components of comprehensive loss are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------ --------------------
2000 1999 2000 1999
------- ------- -------- --------
(IN THOUSANDS)
Net loss applicable to common
stockholders............................ $(7,919) $(5,767) $(34,458) $(13,342)
Change in unrealized gain on securities... 113 -- 220 --
------- ------- -------- --------
Comprehensive loss........................ $(7,806) $(5,767) $(34,238) $(13,342)
======= ======= ======== ========
Accumulated other comprehensive loss as of December 31, 2000, represents
net unrealized gain on securities. There were no elements of accumulated other
comprehensive income at March 31, 2000.
7. ACQUISITIONS
In August 2000, the Company acquired Wakely Software, Inc. ("Wakely"), a
provider of rating software and actuarial services for the insurance industry.
The purchase price for privately-held Wakely was approximately $13.7 million,
consisting of approximately $4.4 million in cash and approximately for 175,000
shares of the Company's common stock that was paid at closing. Wakely had an
accumulated deficit of $961,000 at the date of acquisition. 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 seven years. We also
expensed $1.9 million of in-process research and development at the time of
acquisition.
Based upon an independent valuation, it was determined that there was an
allocation between developed and in-process research and development. This
allocation was based on whether or not technological feasibility was achieved
and whether there was an alternative future use for the technology. SFAS 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed," sets guidelines for establishing technological feasibility.
Technological feasibility can be achieved through the existence of either a
detailed program design or a completed working model. As of the respective dates
for the acquisition discussed above, we concluded that the purchased in-process
research and developments had no alternative future use and expensed it
according to the provisions of SFAS 86.
7
10
SELECTICA, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (CONTINUED)
In November 2000, the Company acquired certain assets and liabilities of
LoanMarket Resources, LLC ("LoanMarket"), a provider of real-time, mortgage,
home equity, and unsecured lending software solutions. The purchase price for
these assets and liabilities from the privately-held LoanMarket was
approximately $1.5 million, consisting of approximately $403,000 in cash, 35,000
shares of the Company's common stock that was paid at closing and assumed
liabilities of approximately $155,000. The Company allocated $1.5 million to
intangible assets and will amortize this amount over a period of three years,
the expected future life of the assets.
8
11
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 contract; (2) bundled license, maintenance, and
services; and (3) services on a time and material basis. In instances where
maintenance is bundled with a license of our software products, such maintenance
term is typically one year.
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 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 and recognize maintenance revenues
over the term of the maintenance contract as vendor specific objective evidence
of fair value for maintenance does exist.
Services can consist of maintenance, training and/or consulting services.
Consulting services include a range of services including installation of our
off-the-shelf software, customization of our software for the customer's
specific application, data conversion and building of interfaces to allow our
software to operate in customized environments.
In all cases, we assess whether the service element of the arrangement is
essential to the functionality of the other elements of the arrangement. In this
determination we focus on whether the software is off-the-shelf software,
whether the services include significant alterations to the features and
functionality of the software, whether the services involve the building of
complex interfaces, the timing of payments and the existence of milestones.
Often the installation of our software requires the building of interfaces to
the customer's existing applications or customization of the software for
specific applications. As a result, judgement is required in the determination
of whether such services constitute "complex" interfaces. In making this
determination we consider the following: (1) the relative fair value of the
services compared to the software, (2) the amount of time and effort subsequent
to delivery of the software until the interfaces or other modifications are
completed, (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 contract milestones or acceptance criteria we recognize
revenue as such milestones are achieved or as such acceptance occurs.
9
12
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 for the fair value of the services and the
maintenance to 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 upon time and material 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), which is
based on the price established by management having the relevant authority. Each
license agreement offers additional maintenance renewal periods at a stated
price. Maintenance contracts are typically one year in duration. To date we have
had four maintenance contracts come up for renewal for which the customer
elected to renew such maintenance contracts. We believe that given the nature of
our products as selling solutions for the Internet, our customers view
maintenance of those products as important to their business and will continue
to need upgrades and support of licensed products. As a result, we believe
renewals will occur in the future as more contracts come up for renewal.
To date we have not entered into arrangements solely for license of our
products and, therefore, we have not demonstrated vendor specific objective
evidence for the fair value of the license element.
In all cases we classify revenues for these arrangements as license
revenues and services revenues based on the estimates of fair value for each
element.
For the nine months ended December 31, 2000, we recognized 39%of license
and services revenues using the percentage-of-completion method, 34% using the
residual method, and 26% using the completed contract method. For the nine
months ended December 31, 1999, we recognized 40% of license and services
revenues using completed contract method, 29% using the percentage of completion
method, and 23% using the residual method. For the three months ended December
31, 2000, we recognized 40% of license and services revenues using the
percentage of completion method, 34% using the completed contract method, and
26% using the residual method. For the three months ended December 31, 1999, we
recognized 46% of license and services revenues using the residual method, 29%
of license and services revenues using the percentage of completion method and
24% under the completed contract method.
Because we rely on a limited number of customers, the timing of customer
acceptance or milestone achievement, or the amount of services we provide to a
single customer can significantly affect our operating results. For example, our
services revenues declined significantly in the quarter ended June 30, 1999 due
to the completion of services under a contract with BMW of North America, one of
our significant customers. Our license and services revenues increased
significantly in the quarters ended September 30, 1999 and December 31, 1999
generally due to the addition of two new customers in each respective quarter.
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.
10
13
Factors Affecting Operating Results
A relatively small number of customers account for a significant portion of
our total revenues. For the nine months ended December 31, 2000, revenue from
Samsung SDS, Dell, and Cisco accounted for 18%, 16%, and 13% of our revenues,
respectively. For the nine months ended December 31, 1999, revenue from Aspect
Communications, 3Com, and Fireman's Fund Insurance accounted for 15%, 14%, and
14% of our revenues, respectively. For the three months ended December 31, 2000,
revenue from Cisco, Dell, Highmark Blue Cross Blue Shield, and Samsung SDS
accounted for 18%, 14%, 12% and 12%, respectively. For the three months ended
December 31, 1999, revenue from Fireman's Fund Insurance and Fujitsu Network
Corporation accounted for 28% and 16% of our revenues, respectively. We expect
that revenues from a limited number of customers will continue to account for a
large percentage of total revenues in future quarters.
To date, our revenues have been predominantly attributable to sales in the
United States. We plan to expand our international operations significantly,
because we believe international markets represent a significant growth
opportunity. Consequently, we expect that international revenues will increase
as a percentage of total revenues in the future. The expansion of our
international operations will be subject to a variety of risks that could
significantly harm our business and operating results. As our international
sales and operations expand, we anticipate that our exposure to foreign currency
fluctuations will increase because we have not adopted a hedging program to
protect us from risks associated with foreign currency fluctuations.
We have a limited operating history upon which we may be evaluated. We have
incurred significant losses since inception and, as of December 31, 2000, we had
an accumulated deficit of approximately $77.6 million. We believe our success
depends on the continued growth of our customer base and the development of the
emerging Internet selling system market. Accordingly, we intend to continue to
invest heavily in sales and marketing and research and development. Furthermore,
we expect to continue to incur substantial operating losses for the foreseeable
future.
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. 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
During October 1999, we issued, 1,505,702 shares of Series E Preferred
Stock to various investors, including parties related to us, for gross proceeds
of $6,597,986. Of this amount, $23,000 related to the exercise of warrants to
purchase 5,250 shares of Series E Preferred Stock issued in connection with the
convertible debt financing in May 1999. We issued 1,500,452 of these shares at
$4.382 per share while the deemed fair value of such preferred stock at that
date was approximately $7.70. As a result, in the third quarter of fiscal 2000
we recorded $5.0 million of charges related to the difference between the actual
issuance price of the preferred stock and its deemed fair value. Of this amount,
$266,000 was accounted for as compensation expense, $925,000 was accounted for
as a dividend to stockholders in the third quarter of fiscal 2000 and the
remaining amount will be amortized over an approximate two-year period in
connection with a development agreement entered into in September 1999 with
Intel, one of the investors. As of December 31, 2000 approximately $2.4 million
had been amortized.
Under the terms of the development agreement with Intel, we will work with
Intel to port the current suite of ACE products to additional platforms. In
connection with the development agreement, we issued warrants to purchase 57,000
shares of Series E convertible Preferred Stock. The warrants were issued in
December 1999 and were valued using the Black-Scholes valuation model. The value
of the warrants is approximately $381,000 and this amount will be expensed over
the remaining life of the development agreement, which will be approximately two
years. As of December 31, 2000, approximately $225,000 had been amortized.
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On January 7, 2000, in connection with a license agreement entered into in
November 1999 and one year maintenance agreement of $3.0 million, we issued a
warrant to purchase 800,000 shares of common stock to one of our customers, for
$800,000. The warrant is fully vested, has a life of two years, and an exercise
price per share of $13. The value of the warrant is approximately $16.4 million
and was determined based upon a Black-Scholes valuation model. The value of the
warrant, less the warrant purchase price of $800,000, is greater than the
revenues associated with the license and maintenance agreement, and accordingly,
we recorded a loss of approximately $9.7 million in the fourth quarter of fiscal
2000.
Between April 1, 2000 and December 31, 2000, an aggregate of 2,269,330
options to purchase common stock were granted at a weighted average price of
$32.61. We have recorded deferred compensation related to these options of
approximately $1.6 million representing the difference between the exercise
price of the options granted and the deemed fair value of our common stock at
the date of grant.
RESULTS OF OPERATIONS
The following table sets forth the percentage of total revenues for certain
items in the Company's condensed consolidated statements of operations data for
the three and nine months ended December 31, 2000 and 1999.
THREE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
------------ ------------
2000 1999 2000 1999
---- ---- ---- ----
AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
License............................................. 44% 52% 46% 57%
Services............................................ 56 48 54 43
--- ---- ---- ----
Total revenues.............................. 100 100 100 100
Cost of revenues:
License............................................. 2 3 2 3
Services............................................ 40 43 47 56
Services -- related party........................... -- -- -- 1
--- ---- ---- ----
Total cost of revenues...................... 42 46 49 60
--- ---- ---- ----
Gross profit (loss)......................... 58 54 51 40
Operating expenses:
Research and development............................ 26 42 41 45
Sales and marketing................................. 66 98 95 101
General and administrative.......................... 23 26 25 32
--- ---- ---- ----
Total operating expenses.................... 115 166 161 178
--- ---- ---- ----
Loss from operations.................................. (57) (112) (110) (138)
Interest and other income (expense), net.............. 17 5 25 3
--- ---- ---- ----
Net loss before taxes................................. (40) (107) (85) (135)
Provision for income taxes............................ -- -- -- 1
--- ---- ---- ----
Net loss.............................................. (40) (107) (85) (136)
--- ---- ---- ----
Deemed dividend on Series E preferred shares.......... -- 21 -- 10
--- ---- ---- ----
Net loss applicable to common stockholders............ (40)% (128)% (85)% (146)%
=== ==== ==== ====
THREE AND NINE MONTHS ENDED DECEMBER 31, 2000 AND 1999
Revenues
Total revenues were $19.6 and $40.4 million in the three and nine months
ended December 31, 2000 up from $4.5 million and $9.1 million, respectively,
compared to the same periods a year ago. We believe that the future percentage
increase in revenues will be significantly less than what has been achieved in
prior periods.
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License. License revenues totaled $8.7 million and $18.6 million in the
three and nine months ended December 31, 2000 up from $2.3 million and $5.2
million, respectively, compared to the same periods a year ago. The net increase
in license revenues was due to the addition of new customers as a result of
expanded marketing activities, growth in our sales force, and greater demand for
and the acceptance of our ACE suite of products. The increase was also offset by
$2.1 million due to the amortization of the fair value of the warrant issued to
a significant customer in connection with a license and service agreement. As of
December 31, 2000, we have fully amortized the amount associated with the fair
value of this warrant. We intend to generate additional license revenues from
our existing customers and anticipate that revenues will increase in absolute
dollars in future periods, although it will fluctuate as a percentage of total
revenues as our customers and size of transactions change.
Services. Services revenues totaled $11.0 million and $21.8 million in the
three and nine months ended December 31, 2000, up from $2.2 million and $4.0
million, respectively, compared to the same periods a year ago. Our services
revenues are comprised of fees from consulting, maintenance and training
services. Services revenues from Wakely were immaterial from the date of
acquisition to December 31, 2000. The increase in services revenues was due
primarily to the increase in maintenance and maintenance renewals, consulting,
and training services associated with our increased installed base. During the
nine months ended December 31, 2000, revenues were also reduced by amortization
of $3.8 million, the fair value of the warrant issued to a significant customer
in connection with a license and service agreement as noted above. As of
December 31, 2000, we have fully amortized the amount associated with the fair
value of this warrant. We expect services revenues to continue to increase in
terms of absolute dollars in future periods as the number of consulting projects
and maintenance contracts increases with the addition of new customers.
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 revenues represented 5% and 5% of license
revenues in the three and nine months ended December 31, 2000, and in the same
periods a year ago. As we enter into more independent software vendor agreements
we expect cost of license to increase in absolute dollars and to fluctuate as a
percentage of license revenues.
Cost of Services Revenues, including Related Party. Cost of services
revenue is comprised mainly of salaries and related expenses of our services
organization. Cost of services revenues totaled $7.8 million and $18.9 million
in the three and nine months ended December 31, 2000 up from $2.0 million and
$5.2 million, respectively, compared to the same periods a year ago. Cost of
services revenues from Wakely was approximately $758,000 from the date of
acquisition to December 31, 2000. Cost of services revenue, including related
party, represented 72% and 86% of services revenues in the three and nine months
ended December 31, 2000 compared to 91% and 132%, respectively, for the same
periods a year ago. The increase in costs of services is 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. We amortized approximately $548,000 for deferred compensation
and approximately $291,000 for the stock repurchase for the nine months ended
December 31, 2000. We anticipate that cost of services revenues will increase in
absolute dollars in future periods as our number of customers increases. We
expect cost of services revenues to fluctuate as a percentage of service
revenue.
Gross Margin
For the three and nine months ended December 31, 2000, we experienced
overall gross margins of 58% and 51% compared to overall gross margins of 54%
and 40%, respectively, in the same periods a year ago. We expect that our
overall gross margins will continue to fluctuate due to the timing of services
and license revenue recognition and will continue to be adversely affected by
lower margins associated with services revenues. The amount of impact on our
gross margin will depend on the mix of services we provide, whether the services
are performed by our in-house staff or third party consultants, and the overall
utilization rates of our professional services organization.
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Gross Margin -- Licenses. Gross margin for license revenues was
approximately 95% and 95% for the three and nine months ended December 31, 2000
and in the same periods a year ago. During the nine months ended December 31,
2000, revenues were reduced by $2.1 million representing amortization of the
fair value of the warrant issued to a significant customer in connection with a
license and service agreement. As of December 31, 2000, we have fully amortized
the amount associated with the fair value of this warrant.
Gross Margin -- Services. Gross margin for services was approximately 28%
and 14% for the three and nine months ended December 31, 2000 and 9% and
negative 32%, respectively, for the same periods a year ago. The gross margin
for the nine months ended December 31, 2000 included amortization of $3.8
million, the fair value of the warrant issued to a significant customer in
connection with a license and service agreement. As of December 31, 2000, we
have fully amortized the amount associated with the fair value of this warrant.
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. The impact on our gross
profit will depend on the mix of services we provide, whether the services are
performed by our in-house staff or third party consultants, whether the services
are being performed on a fixed fee basis and the overall utilization rates of
our professional services organization. We anticipate that cost of services
revenues will increase in absolute dollars in future periods as our number of
customers increases and that 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 $5.1 million
and $16.5 million for the three and nine months ended December 31, 2000 and $1.9
million and $4.1 million, respectively, compared to the same periods a year ago.
Research and development expenses from Wakely was approximately $230,000 from
the date of acquisition to December 31, 2000. The increase was primarily due to
an increase in the number of research and development personnel to support the
development of ACE 4.0, ACE 4.5, quality assurance, and technical publications
operations. We amortized approximately $260,000 for deferred compensation and
approximately $1.6 million for the development agreement entered into with
Intel. Research and development expenses also included $1.9 million for the one-
time charge for in process research and development in relation to the Wakely
acquisition for the nine months ended December 31, 2000. We expect that research
and development expenses will increase in absolute dollars in future periods.
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 $13.0 million and $38.6 million in the
three and nine months ended December 31, 2000 up from $4.4 and $9.3 million,
respectively, for the same periods a year ago. Sales and marketing expense from
Wakely was approximately $473,000 from the date acquisition to December 31,
2000. The increases were primarily due to the hiring of additional sales and
marketing personnel and expenses incurred in connection with trade show and
additional marketing programs. We amortized approximately $1.4 million for
deferred compensation, $483,000 for acceleration of stock option vesting, and
approximately $291,000 for the stock repurchase for the nine months ended
December 31, 2000. We expect that sales and marketing expenses will increase in
absolute dollars over the next year as we increase spending on advertising and
marketing programs and establish sales offices in additional domestic and
international locations.
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 $4.4 million and $9.9 million in the three and
nine months ended December 31, 2000, up from $1.2 million and $2.9 million,
respectively, compared to the same periods a year ago. General and
administrative expense from Wakely was approximately $428,000 from the date of
acquisition to December 31, 2000. The increase was primarily due to a higher
number of personnel and additional legal and accounting costs incurred in
connection with business activities. We amortized approximately $345,000 for
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deferred compensation, $44,000 for acceleration of stock option vesting, and
approximately $291,000 for the stock repurchase during the nine months ended
December 31, 2000. In addition, we incurred approximately $639,000 from the
amortization of goodwill in connection with the Wakely acquisition and
anticipate incurring $383,000 in quarterly amortization for the next seven
years. We expect that general and administrative expenses will increase in
absolute dollars over the next fiscal year as we hire additional general and
administrative personnel to support our expanding business activities.
Interest and Other Income, Net
Interest and other income, net primarily consists of interest earned on
cash balances and stockholders notes receivable, offset by interest expense
related to convertible debt issued in the three months ended June 30, 1999 and
converted in the same quarter. Interest and other income, net totaled $3.4
million and $10.1 million for the three and nine months ended December 31, 2000
compared with interest income of $221,000 and $319,000, respectively, for the
comparable periods in the prior year. The increase in net interest income for
the three and nine months ended December 31, 2000 resulted primarily from
interest income on our initial public offering and private placement net
proceeds of $193.1 million, which was completed on March 10, 2000.
Provision for Income Taxes
We have recorded a tax provision of $200,000 and $50,000 for the nine
months ended December 31, 2000 and 1999, respectively. The provision for income
taxes consists primarily of state income taxes and foreign taxes.
CONSOLIDATED BALANCE SHEET DATA
Cash, cash equivalents, short and long term investments were approximately
$178.7 million at December 31, 2000 compared to $215.8 million at March 31,
2000. The decrease primarily relates to cash used in operations during the nine
months ended December 31, 2000 of $28.4 million, the Wakely acquisition of $4.8
million, capital expenditures of $6.1 million and investments in short and
long-term commercial paper of $125.6 million at December 31, 2000. Accounts
receivable was approximately $19.9 million at December 31, 2000 compared to $5.7
million at March 31, 2000. The increase of $14.2 million is a direct result of
increased deferred revenues related to advanced billings, maintenance, and
increased license and services revenues from new customers. Prepaid expenses
were approximately $3.5 million at December 31, 2000 compared to $9.4 million at
March 31, 2000. The decrease of $5.9 million is primarily due to the
amortization of the fair value of a warrant issued to a customer in connection
with a license agreement. Property and equipment, net was $10.3 million at
December 31, 2000 and $6.1 million at March 31, 2000. The $4.2 million increase
primarily relates to capital additions of $6.1 million related to leasehold
improvements to our new facility in San Jose as well as computers and networking
equipment related to our headcount growth offset by accumulated depreciation of
$2.0 million. Goodwill, net was $13.3 million at December 31, 2000 and $30,000
at March 31, 2000. This increase in net goodwill primarily relates to $13.1
million in relation to the acquisition of Wakely and $1.1 million with respect
to the acquisition of certain assets of LoanMarket offset by amortization of
$1.0 million. Investments, restricted was $2.0 million at December 31, 2000 and
$100,000 at March 31, 2000. The $1.8 million increase primarily relates to $1.5
million in escrow as a result of the Wakely acquisition.
Accrued payroll and related liabilities was approximately $4.5 million at
December 31, 2000 compared to $1.9 million at March 31, 2000. The $2.6 million
increase primarily relates to employee contributions withheld related to our
Employee Stock Purchase Plan which began on March 8, 2000 and for which the
second purchase cycle ends on April 30, 2001. Deferred revenues were $21.5
million at December 31, 2000 compared to $18.5 million at March 31, 2000. The
$3.0 million increase was primarily due to cash advances and amounts billed in
advance for performing services or delivering product.
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LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2000, cash, cash equivalents and short term investments
totaled $148.8 million, compared to $215.8 million at March 31, 2000. We
currently have no significant capital commitments other than obligations under
operating leases.
We have funded our operations with proceeds from the private sale of common
and preferred stock, and public offering. Cash used by operating activities for
the nine months ended December 31, 2000 was $28.3 million and was primarily a
result of our net loss adjusted for noncash items, increases in accounts
receivable, and other assets offset by the increases in accrued payroll.
Cash used for investing activities for the nine months ended December 31,
2000 was $136.6 million and consisted primarily of the acquisition of Wakely,
long-term and short-term investments as well as capital expenditures.
Cash provided by financing activities for the nine months ended December
31, 2000 was $2.0 million and was a result of the issuance of common stock
during the nine months ended December 31, 2000 offset by fees related to our
private placement in March 2000.
We expect to experience growth in our operating expenses in absolute
dollars for the foreseeable future in order to execute our business plan. As a
result, we anticipate that operating expenses and planned capital expenditures
will constitute a material use of our cash resources. Our capital requirements
depend on numerous factors, including developing, marketing, selling and
supporting our products, the timing and extent of establishing international
operations, and other factors. We expect to devote substantial resources to hire
additional research and development personnel to support the development of new
products and new versions of existing products. Sales and marketing expenses are
expected to increase in absolute dollars as we hire additional sales and
marketing personnel, increase spending on advertising and marketing programs,
and establish sales offices in additional domestic and international locations.
General and administrative expenses are expected to increase in absolute dollars
to support the expansion of our business as we hire additional general and
administrative personnel.
RECENT ACCOUNTING PRONOUNCEMENTS
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. Because we do
not currently hold any derivative instruments and do not engage in hedging
activities, we expect that the adoption of SFAS No. 133 will not have a material
impact on our financial position, results of operations or cash flows. We will
be required to implement SFAS No. 133 for the year ending March 31, 2002.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements." SAB
101 provides guidance on the recognition, presentation, and disclosure of
revenue in financial statements. SAB 101 is effective for years beginning after
December 15, 1999 and is required to be reported beginning in the quarter ended
March 31, 2001. SAB 101 is not expected to have a significant effect on the
Company's consolidated results of operations, financial position, or cash flows.
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RISK FACTORS
RISKS RELATED TO OUR BUSINESS
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 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 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 have vendor
specific objective evidence of fair value for the service.
In addition, because we rely on a limited number of customers, the timing
of milestone achievement or customer acceptance by, the amount of services we
provide to, or the recognition of significant license revenues upon shipment to
a single customer can significantly affect our operating results. For example,
our services revenues declined significantly in the quarter ended June 30, 1999
due to completion of a services contract with BMW of North America, one of our
significant customers. Our license and service revenues increased significantly
in the quarters ended September 30, 1999, December 31, 1999 and March 31, 2000
generally due to the addition of two new customers. See "Management's Discussion
and Analysis." We intend to significantly increase our operating expenses for
the foreseeable future. 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.
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We may also experience seasonality in revenues. For example, our quarterly
results may fluctuate based upon our customers' calendar year budgeting cycles
and changes in information technology spending patterns. 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 FOR THE
FORESEEABLE FUTURE.
We have experienced operating losses in each quarterly and annual period
since inception. We incurred net losses applicable to common stockholders of
$7.5 million for the fiscal year ended March 31, 1999, $31.8 million for the
fiscal year ended March 31, 2000 and $34.5 million for the nine months ended
December 31, 2000. As of December 31, 2000, we had an accumulated deficit of
$77.6 million. We expect to significantly increase our research and development,
sales and marketing, and general and administrative expenses, and consequently
our losses may increase in the future. In order to accommodate our increase in
employees, we have leased a larger facility, and we will incur increased capital
equipment costs. We will need to generate significant increases in our revenues
to achieve and maintain profitability. If our revenue fails to grow or grows
more slowly than we anticipate or our operating expenses exceed our
expectations, our losses will significantly increase which would significantly
harm our business and operating results.
A DECLINE 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 Internet 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 INTERNET 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 Internet 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 Internet selling system software to develop, or a delay in the
development of this market, would significantly harm our business and operating
results.
OUR LIMITED OPERATING HISTORY AND THE FACT THAT WE OPERATE IN A NEW INDUSTRY
MAKES EVALUATING OUR BUSINESS PROSPECTS AND RESULTS OF OPERATIONS DIFFICULT.
We were founded in June 1996 and have a limited operating history. We began
marketing our ACE suite of products in early 1997, released ACE 4.0 in November
1999, and released ACE 4.5 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
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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 Internet 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 Internet 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 Oracle
Corporation, Siebel Systems, I2, SAP, Trilogy Software, FirePond, Calico
Commerce and BAAN, all of which offer integrated solutions for electronic
commerce incorporating some of the functionality of an Internet 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. Many of our competitors and potential competitors have a
number of significant advantages over us, including:
- a longer operating history;
- preferred vendor status with our customers;
- more extensive name recognition and marketing power; and
- significantly greater financial, technical, marketing and other
resources, giving them the ability to respond more quickly to new or
changing opportunities, technologies and customer requirements.
Our competitors may also bundle their products in a manner that may
discourage users from purchasing our products. Current and potential competitors
may establish cooperative relationships with each other or with third parties,
or adopt aggressive pricing policies to gain market share. Competitive pressures
may require us to reduce the prices of our products and services. We may not be
able to maintain or expand our sales if competition increases and we are unable
to respond effectively.
OUR LENGTHY SALES CYCLE MAKES IT DIFFICULT FOR US TO FORECAST REVENUE AND
AGGRAVATES THE VARIABILITY OF QUARTERLY FLUCTUATIONS, WHICH COULD CAUSE OUR
STOCK PRICE TO DECLINE.
The sales cycle of our products has historically averaged between four and
six months, and may sometimes be significantly longer. We are generally required
to provide a significant level of education regarding the use and benefits of
our products, and potential customers tend to engage in extensive internal
reviews before making purchase decisions. In addition, the purchase of our
products typically involves a significant commitment by our customers of capital
and other resources, and is therefore subject to delays that are beyond our
control, such as customers' internal budgetary procedures and the testing and
acceptance of new technologies that affect key operations. In addition, because
we intend to target large companies, our sales cycle can be lengthier due to the
decision process in large organizations. As a result of our products' long sales
cycles, we face difficulty predicting the quarter in which sales to expected
customers may occur. If anticipated sales from a specific customer for a
particular quarter are not realized in that quarter, our operating results for
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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 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. Internet 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 57% of our
revenues for the nine months ended December 31, 2000 and our ten largest
customers accounted for 72% of our revenues for the nine months ended December
31, 2000. Our five largest customers accounted for approximately 53% of our
revenues for the fiscal year ended March 31, 2000, and our ten largest customers
accounted for 76% of our revenues for the fiscal year ended March 31, 2000.
We expect that we will continue to depend upon a relatively small number of
customers for a substantial portion of our revenues for the foreseeable future.
Contracts with our customers can generally be terminated on short notice by the
customer. As a result, if we fail to successfully sell our products and services
to one or more customers in any particular period, or a large customer purchases
less of our products or services, defers or cancels orders, or terminates its
relationship with us, our business and operating results would be harmed.
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 Internet 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.
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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.
There is a shortage of the sales personnel we need, such as sales
engineers, and competition for qualified personnel is intense. In addition, it
will take time for new sales personnel to achieve full productivity. If we are
unable to hire or 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 expand our sales organization and increase sales of our
products and services.
IF WE ARE UNABLE TO GROW AND MANAGE OUR PROFESSIONAL SERVICES ORGANIZATION, WE
WILL BE UNABLE TO PROVIDE OUR CUSTOMERS WITH TECHNICAL SUPPORT FOR OUR PRODUCTS,
WHICH COULD SIGNIFICANTLY HARM OUR BUSINESS AND OPERATING RESULTS.
As we increase licensing of our software products, we must grow our
professional services organization to assist our customers with implementation
and maintenance of our products. Because these professional services have been
expensive to provide, we must improve the management of our professional
services organizations to improve our results of operations. Improving the
efficiency of our consulting services is dependent upon attracting and retaining
experienced project managers. Competition for these project managers is intense,
particularly in the Silicon Valley and in India where the majority of our
professional services organization is based, and we may not be able to hire
qualified individuals to fill these positions.
Although services revenues, which are primarily comprised of revenues from
consulting fees, maintenance contracts and training, are important to our
business, representing 54% and 43% of total revenues for the nine months ended
December 31, 2000 and for the year ended March 31, 2000, respectively, services
revenues have lower gross margins than license revenues. Gross margins for
services revenues were 14% and negative 113% for the nine months ended December
31, 2000 and for the year ended March 31, 2000, respectively, compared to gross
margins for license revenues of 95% and 51% for the respective periods. As a
result, a continued increase in the percentage of total net revenues represented
by services revenues or an unexpected decrease in license revenues could have a
detrimental impact on our overall gross margins and our operating results.
We anticipate that customers will increasingly utilize third-party
consultants to install and deploy our products. Additionally, for all new
contracts we 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.
A SUBSTANTIAL PORTION OF OUR OPERATIONS ARE CONDUCTED BY INDIA-BASED PERSONNEL,
AND ANY CHANGE IN THE POLITICAL AND ECONOMIC CONDITIONS OF INDIA OR IN
IMMIGRATION POLICIES, WHICH WOULD ADVERSELY AFFECT OUR ABILITY TO CONDUCT OUR
OPERATIONS IN INDIA, COULD SIGNIFICANTLY HARM OUR BUSINESS.
We conduct quality assurance and professional services operations in India.
As of December 31, 2000, there were 356 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
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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.
OUR OPERATING RESULTS ARE SIGNIFICANTLY DEPENDENT UPON THE SALE OF OUR ACE SUITE
OF PRODUCTS, INCLUDING ACE 4.5 AND ACE SME RELEASED IN OCTOBER 2000.
We expect that we will continue to depend on revenue from new and enhanced
versions of ACE for the foreseeable future, and if companies do not adopt or
expand their use of ACE, our business and operating results would be
significantly harmed. ACE 4.5, the most recent release of our core product, and
ACE SME, a version designed specifically for the requirements and resources of
small to medium-sized enterprises, were introduced in October 2000. Since these
new products have been only recently introduced, customers may discover errors
or other problems with the product, which may adversely affect its acceptance.
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. ACE 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.
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 December 31, 2000, we
expanded from 68 to 751 employees, including 29 employees from the acquisition
of Wakely. We have also significantly expanded our operations in the U.S. and
internationally and we plan to continue to expand the geographic scope of our
operations.
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.
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.
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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. An important component of our
employee compensation is stock options. Because of the decline in our stock
price, some of our employees hold options with an exercise price substantially
below the current market price. This could adversely affect our ability to
attract and retain employees.
IF WE BECOME SUBJECT TO PRODUCT LIABILITY LITIGATION, IT COULD BE COSTLY AND
TIME CONSUMING TO DEFEND AND COULD DISTRACT US FROM FOCUSING ON OUR BUSINESS AND
OPERATIONS.
Since our products are company-wide, mission-critical computer applications
with a potentially strong impact on our customers' sales, errors, defects or
other performance problems could result in financial or other damages to our
customers. Although our license agreements generally contain provisions designed
to limit our exposure to product liability claims, existing or future laws or
unfavorable judicial decisions could negate such limitation of liability
provisions. Product liability litigation, even if it were unsuccessful, would be
time consuming and costly to defend.
OUR FUTURE SUCCESS DEPENDS ON OUR PROPRIETARY INTELLECTUAL PROPERTY, AND IF WE
ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY FROM POTENTIAL COMPETITORS OUR
BUSINESS MAY BE SIGNIFICANTLY HARMED.
We rely on a combination of trademark, trade secret and copyright law and
contractual restrictions to protect the proprietary aspects of our technology.
These legal protections afford only limited protection for our technology. We
currently hold one patent. We also currently have two pending U.S. patent
applications. In addition, we have three trademarks and have applied to register
two of the trademarks in the United States. Our trademark and patent
applications might not result in the issuance of any trademarks or patents. If
any patent or trademark is issued, it 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.
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These investments, acquisitions or joint ventures also involve numerous
risks, including:
- problems combining the purchased operations, technologies or products
with ours;
- unanticipated costs;
- diversion of managements' attention from our core business;
- adverse effects on existing business relationships with suppliers and
customers;
- potential loss of key employees, particularly those of the acquired
organizations; and
- reliance to our disadvantage on the judgment and decisions of third
parties and lack of control over the operations of a joint venture
partner.
Any acquisition or joint venture may cause our financial results to suffer
as a result of these risks.
IF WE ARE SUBJECT TO INTELLECTUAL PROPERTY LITIGATION, WE MAY INCUR SUBSTANTIAL
COSTS, WHICH WOULD HARM OUR OPERATING RESULTS.
Our success and ability to compete are dependent on our ability to operate
without infringing upon the proprietary rights of others. Any intellectual
property litigation could result in substantial costs and diversion of resources
and could significantly harm our business and operating results. In the past, we
received correspondence from two patent holders recommending that we license
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.
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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 RESULTS OF OPERATIONS WILL BE HARMED BY CHARGES ASSOCIATED WITH OUR PAYMENT
OF STOCK-BASED COMPENSATION AND CHARGES ASSOCIATED WITH OTHER SECURITIES
ISSUANCE BY US.
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 $14.3 million in net deferred compensation charges. During the year
ended March 31, 2000 and the nine months ended December 31, 2000 we amortized
$1.3 million and $2.6 million of such charges, respectively. We expect to
amortize approximately $3.4 million of stock-based compensation for the fiscal
year ending March 31, 2001 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 $16.4 million. In the quarter ended March 31, 2000, we
recorded a charge of $9.7 million related to the loss on the license and
software maintenance contract, of which $4.1 million was charged to cost of
license revenues and $5.6 million was charged to costs of services revenues, in
relation to the issuance of these warrants. During the nine months ended
December 31, 2000, revenues were reduced by amortization of $5.9 million in
connection with this license and services agreement. As of December 31, 2000, we
have fully amortized the amount associated with the fair value of this 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 seven
years. We also expensed $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 7 of Notes to condensed
financial statements for the nine months ended December 31, 2000.
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.
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IF WE FAIL TO IMPROVE OUR ACCOUNTING AND FINANCIAL CONTROL SYSTEMS OR ACCURATELY
MANAGE THE PROGRESS OF OUR CUSTOMER CONTRACTS, OUR OPERATING RESULTS WILL BE
SIGNIFICANTLY HARMED.
In the past, we have had difficulty managing our accounting and financial
reporting systems and the volume and complexity of our customer contracts. We
need to improve our financial and accounting controls, improve our reporting and
approval procedures, expand and train key personnel within our finance and
management organizations, implement more robust information systems, and
accurately record and track our customer contracts. If we fail to improve our
financial systems, procedures and controls or if we fail to effectively manage
our customer contracts, 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.
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.
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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 $320,000
(less than 0.18%) in the fair value of our available-for-sale securities. This
potential change is based upon a sensitivity analysis performed on our financial
positions at December 31, 2000.
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PART II OTHER INFORMATION
ITEM 1.
None
ITEM 2.
(a) Modification of Constituent Instruments
Not applicable
(b) Change in Rights
Not applicable
(c) Issuances of Securities
On November 9, 2000, we issued 35,000 shares of our common stock in
connection with the acquisition of certain assets and liabilities of LoanMarket
Resources, LLC. The issuance of the shares of common stock 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 $138.0 million. We paid a total of
$11.3 million in underwriting discounts, commissions, and other expenses related
to the offering. None of the costs and expenses related to the offering were
paid directly or indirectly to any director, officer, general partner of
Selectica or their associates, persons owning 10 percent or more of any class of
equity securities of Selectica or an affiliate of Selectica.
After deducting the underwriting discounts and commissions and the offering
expenses the estimated net proceeds to Selectica from the offering were
approximately $122.2 million. The net offering proceeds have been used for
general corporate purposes, to provide working capital to develop products and
to expand the Company's operations. Funds that have not been used have been
invested in certificate of deposits and other investment grade securities. We
also may use a portion of the net proceeds to acquire or invest in businesses,
technologies, products or services.
ITEM 3.
None
ITEM 4.
None
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ITEM 5.
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
None
B. Reports on Form 8-K
None
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereto duly authorized.
Date: February 8, 2000 SELECTICA, INC.
By: /s/ STEPHEN R. BENNION
------------------------------------
Stephen R. Bennion
Chief Financial Officer and
Secretary
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