Item 1.
Business
BUSINESS OVERVIEW
Selectica develops, markets, sells and supports software that helps companies with multiple product lines and channels of distribution to effectively configure, price and quote their products and services. We recently expanded our product family to include contract management and compliance solutions through a technology acquisition. Our products enable customers to increase revenue and profit margins and reduce costs through seamless, web-enabled automation of the “quote to contract” business processes, which reside between legacy CRM and ERP systems. Our software offers sophisticated methods to navigate product content and knowledge to drive education and qualification of potential customers, and is used by both business-to-business and business-to-consumer companies. Our products help our customers improve profitability by reducing process costs, optimizing pricing and eliminating or substantially reducing rework and concessions. Businesses that deploy our products are able to empower business managers to quickly and easily modify product, service and price information enterprise-wide to ensure proper margins and to stay ahead of changing market conditions. Our product architecture has been designed specifically for the Internet and provides scalability, reliability, flexibility and ease of use. Additionally, our products have been developed with an open architecture that leverages data in existing applications, such as ERP systems. This allows for an easier-to-install application and reduced deployment time. Over the past number of years, our solutions have been successfully implemented at a number of companies such as IBM, Cisco Systems, Dell, Rockwell and GE Healthcare.
Industry Background
The Internet as a Technology Platform
Advances in computing and communications technology have enabled businesses to utilize the Internet as a technology platform to automate and improve business processes in two ways. In the area broadly referred to as electronic commerce, the Internet serves as a platform to enable businesses and other organizations to interact with their customer, replacing other forms of communications such as fax, phone and person to person. At the outset, electronic commerce transactions were simple purchases of products such as books, compact discs, stocks and toys. Since then, the Internet has become a platform for selling an increasingly complex variety of products and services. With the emergence of the Internet platform, companies have more broadly and cost-effectively deployed business applications to customers, partners and employees and made the most current application and information immediately available using a web browser on less sophisticated Internet-enabled computing devices, such as cell phones or personal digital assistants.
Complexity in Electronic Commerce
Complexity in the selling process manifests itself in numerous ways. One type is product complexity, where the product has many possible features, with factors interacting with one another and with other factors to influence the performance or manufacturability of that item. Examples of complex products include networking and telecommunications equipment, automobiles, and computers. A second type of complexity is “needs” complexity, in which the product or service itself may be relatively simple, such as an insurance policy or a printer, but the factors that go into evaluating a specific customer’s needs and matching those needs with the optimal product or service may be complex. A third type of complexity comes from flexible or customized pricing and discount programs, including those based on the features of the product.
The completion of a complex sales transaction depends on a seller’s ability to identify and satisfy the full range of a buyer’s needs. In traditional sales, companies rely on trained salespeople to interact with customers, address customer needs, explain product features, and ultimately complete the sale. Historically, many electronic commerce web sites provided static collections of non-interactive content, and have had limited capability for assisting and guiding customers or sales personnel through a complex purchasing decision. The Internet affords businesses the ability to centralize and simplify complex selling processes and deploy a platform for aggregating, bundling, and pricing complex products and services across all sales channels.
The Opportunity to Order Gap
Companies seeking to improve their process for selling products and services have typically implemented customer relationship management (CRM) software and have sought to improve provisioning of their products and services by implementing enterprise resource planning (ERP) software. Historically, a significant gap has existed between the core functionality of CRM software and ERP software. CRM software typically manages sales campaigns, tracks collection and qualification of prospective customers and monitors the pipeline of existing sales opportunities. ERP software typically fulfills orders, in some instances automatically interacting with the supply chain, invoices customers and tracks accounts receivables and payments. In between the functionally of these two basic packages is a variety of back office business functions and processes which occur from the time a sales opportunity has been defined in the CRM software to the time when an order is placed into the ERP system. Currently, most enterprises do not have an effective method of connecting a customer identified through its CRM system to a product the enterprise can deliver through its ERP system. This is referred to as the “Opportunity to Order” gap, and typically consists of the processes required to efficiently and accurately configure, price and quote a product or service for a potential customer and correctly deliver the order specifications for fulfillment and billing. Without a comprehensive Opportunity to Order solution, companies resort to methods for building and pricing customer quotes through a combination of spreadsheets and teams of sales representatives and engineers searching through product catalogs. Depending on the complexity of the products and variables, this can result in a significant error rate in customer quotes. These errors are typically the result of invalid or outdated configuration, pricing and/or quotation information, and often require expensive and timely customer service intervention before the order can be processed. The ability to accurately quote product and service offerings requires enterprises to enforce business rules such as maximum discounts, margin requirements and ensure that items quoted are available in the required time period. An ineffective system for matching customer needs to available products and services slows the sales cycle and may lead to customers having a poor experience. In addition, an inefficient system makes it difficult for a company to enforce its pricing and other rules for selling products or services to optimize the solutions offered to its customers.
Limitations of Existing Solutions
Businesses have generally attempted to address the challenges of complexity in the selling process by building in-house solutions. These solutions often require significant up-front development costs and lengthy deployment periods. Furthermore, due to the rapid pace of change in products and business processes, companies often find it difficult and expensive to maintain these systems and integrate new functionality and technologies. As a result, businesses have sought to implement third-party packaged applications. With
respect to the opportunity to order gap, CRM and ERP providers have attempted to extend the functionality of their products or offer complementary modules that fill portions of the opportunity to order gap.
The current commercially available software, both from CRM and ERP vendors and from other companies with solutions that are designed to help companies address the challenges of complexity in the selling process, may have one or more of the following limitations. In general, the applications:
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have not been engineered for the Internet platform and, as a result, are not easily deployed across a broad range of Internet-enabled channels and/or devices;
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require significant custom programming for deployment and maintenance;
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provide a limited interactive experience; or
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employ application architectures that limit their scalability and reliability.
We believe there is a significant opportunity for software that leverages the Internet platform to enable companies to efficiently sell complex products and services and bridge the Opportunity to Order gap that exists between current CRM and ERP solutions.
Selectica Solutions
Selectica’s products are used by enterprises to bridge the Opportunity to Order gap between CRM and ERP solutions. Selectica’s software enables sales professionals to suggest solutions based on an identified prospect’s needs, configure proposed solutions based on customer requests and provide accurate quotes for complex products and services. Selectica’s products enable enterprises to extend their business rules to the sales channel by restricting the sales force from presenting quotes that do not fall within parameters determined by the enterprise. These business parameters run the spectrum from the manufacturability of a product to the required margins on any given product or service. Selectica’s products enable these business rules to be easily modified and then provide instant transmission of the updated rules throughout the organization.
Selectica’s applications are designed to enable enterprises to easily develop and rapidly deploy an Internet sales channel that interactively assists their customers, partners and employees through the selection, configuration, pricing, quoting and fulfillment processes. Our software 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, such as personal digital assistants (PDAs) and cellular phones, while offering customers, partners and employees an interface customized to meet their specific needs. Our products are built using Java technology and utilizes a unique business logic engine (KnowledgeBase), repository, and a multi-threaded architecture. This design enables the core of our solutions, the Configurator server, to reduce the amount of memory used to support new user sessions and to deploy a cost-effective, robust and highly scalable, Internet-enhanced sales channel.
Some of the major design benefits of our applications are described below:
Enables Selling Process to Support Key Business Goals
Our software helps companies ensure that all orders conform to specific criteria. For example, if a company had a minimum gross margin requirement for a given product, our solution could ensure that the features and options chosen will result in a product that meets the company’s margin objectives.
Shortens Sales Cycles
Generally, in a traditional sales environment for complex products and services, prospective buyers repeatedly interact with a seller’s sales force to determine an appropriate configuration and pricing. Our
software is designed to enable companies to reduce the time required to convert interested prospects into customers in several ways, including:
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providing comprehensive product information to the customer or sales person at the point of sale without requiring interaction with product experts; and
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automating the pricing and configuration of complex products and services, thereby providing sales professionals and their customers with accurate, real-time information.
Ensures Accuracy of Quotes
Our software automates the delivery of quotes to customers. Only quotes that comply with all of the pricing and other rules applicable to a particular product or service can be generated by our products. This procedure makes certain that all quotes accurately reflect the business rules with respect to the quoted product or service. The benefits of accurate quotes include limiting the problem of informing a disappointed customer that the company cannot live up to its quote and eliminating the need for quotes to be reviewed by internal compliance teams within the organization. Many ERP systems permit users to enter inaccurate orders into their systems. Because these ERP systems are often linked directly to manufacturing, this can result in products which either cannot or should not be assembled. Accurate quotes enable enterprises to avoid costly order rework by ensuring that only accurate orders are placed into the ERP systems. This also prevents or reduces concessions or write-offs by the sales force to compensate for cancelled or delayed orders. All of these benefits can significantly enhance profitability and customer satisfaction.
Provides Comprehensive Solution
Our products provide the functionality for Internet platform selling in a single comprehensive solution. Our products have been developed with an open architecture that leverages data in existing enterprise applications, such as CRM and ERP systems, to provide an application that is both easy to develop and deploy.
Opportunity for Increased Sales
We enable sellers of complex products and services to reach and sell to additional customers by enabling them to use the Internet as an effective sales channel. Our applications are designed for the Internet platform and allow companies to sell over a broad range of Internet-enabled devices, including those with limited processing power, such as personal digital assistants or mobile phones.
Opportunity for Greater Revenue per Customer
Enterprises can use our solutions to perform real-time analysis and optimization to identify cross-selling and up-selling opportunities. For example, a prospective buyer of a computer may be prompted to consider additional features such as increased memory, or complementary products such as a printer, based on specific selections made. In addition, by enabling companies to build an easy-to-use selling channel that is always available to their customers, we provide companies with the opportunity to capture a greater percentage of their customers’ business.
Improves Efficiency of the Indirect Sales Channel
Using our products, companies can enable their channel partners, such as distributors and resellers, to access their selling tools and product information. This allows distributors and resellers to effectively sell complex products and services with less support from the company. It also improves order accuracy, which results in greater efficiency and increased customer satisfaction.
Enhances Customer Relations
Our software enables a seller of complex products and services to present each customer with different options based upon the customer’s specific needs. This customization of the selling process actively engages
the customer in the decision-making process. Selectica’s platform also ensures that customers arrive at a product configuration that meets the business and manufacturing guidelines of that customer.
Reduced Costs of Ownership
An effective selling system requires the user to build a KnowledgeBase that captures all product configurations and selling rules. Our configuration platform allows users to build, tailor and maintain their KnowledgeBase without custom programming. It also reduces the need for expensive technical specialists and programmers to maintain and enhance their business applications.
Selectica Products
We offer software for sales configuration management. We also sell complementary development tools that come pre-packaged with our software, or are available separately. We also develop libraries to accelerate deployment of configuration and pricing engines by our services teams, partners and systems integrators.
Our products are written with Java and Java components sold in binary form delivered on CD-ROMs or over the Internet. Our software engines and applications are designed to be flexible and can be deployed on a wide range of hardware and software platforms, including the popular MS Windows, Linux and several Unix platforms. These applications take advantage of the cutting edge developments around Java 2 Enterprise Edition (J2EE) and other complementary technologies in application servers, user interface and data management technologies.
We currently have four products that represent the core of our Sales Configurator and pricing management software offering:
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Selectica Configurator is a procedural based configuration based engine. Development tools allow for modeling pricing and other rules on product and service offerings and the engine manages the execution of these stored rules.
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Selectica Pricer engine is used to automate pricing and quoting processes. Price management tools enable definition of complex pricing rules and allow modeling of pricing scenarios. The pricing engine executes the pricing rules to determine the price dynamically based on the supplied rule factors.
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Selectica Solutions Advisor is an application built on the core Selectica Configurator engine and is used by businesses to guide their customers to find the right product online. Selectica Solutions Advisor comes with a user friendly data management module to capture the “sales rules” associated with guiding users to the right products based on their needs and a front-end interactive selling application that captures users needs and guides them to a ranked list of applicable product offers.
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Our EPS-M Application platform that uses some of the core SCMS engines is a vertical specific application for the manufacturing industry.
We recently introduced the Enterprise Productivity Suite for Manufacturing (EPS-M). This process-focused solution is an application focused on manufacturing and enables businesses to quickly launch new products or brands by allowing them to connect rules for complex products and services data rules with price information. This product enables the customer to create, capture and share product knowledge across the enterprise. The Selectica Configurator and Pricer engines are the base technologies for the application platform and manufacturing business process workflows are built into the application to allow product managers to manage product and service data and pricing in a configuration repository.
The following table provides a full list of our products and a brief description of the features and benefits to our customers:
On May 3, 2005, we acquired certain business assets of Determine Software, Inc. (Determine) for approximately $799,000 in cash. Determine is a provider of enterprise contract management software. Determine’s solutions include: the ability to aggregate and analyze enterprise-wide contract information, automate and accelerate contract related business processes, enforce contract and relationship compliance (Sarbanes-Oxley) and automate the contract process from request to signature. The addition of Determine’s software capabilities and customers will allow us to extend our offerings to include contract management solutions.
With this acquisition, we will have solutions to manage the contract lifecycle, from request to signature to execution. Additionally, we will be able to offer a suite of software designed for revenue centric processes for enterprises engaged in both buy side and sell side transactions. The Determine products are part of our
solutions that will link CRM and ERP applications by enabling the configuration, pricing and quoting of complex bundled products and solutions.
Selectica’s Technology
We have developed an innovative architecture for creating a personalized, intuitive, interactive and scalable application that includes selection, configuration, pricing, quoting and fulfillment processes. The four key technological advantages of our products are:
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declarative constraint engine;
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integrated modeling environment;
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multi-threaded server; and
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scalable, thin-client architecture.
Declarative Constraint Engine
Many existing configurators are custom programs that were written specifically for the product or family of products being configured. This means both the configuration logic and the data describing product attributes are combined in a single computer program that requires significant reprogramming to reflect simple product changes. In contrast, our applications utilize a constraint-based engine that is separate from the data describing the product attributes. This allows businesses to easily create and modify the KnowledgeBase to reflect product changes utilizing our integrated modeling environment, thereby eliminating the need for expensive programming teams.
Our engine, written in Java, is easily deployed on various operating platforms. The use of Java allows us to support a range of deployment environments, ranging from Java applications in a notebook computer to server generated browser-readable pages, with the same engine and the same KnowledgeBase.
Integrated Modeling Environment
We have developed an integrated modeling environment that allows our customers to easily create a sophisticated system without any programming. Our programs utilize drag-and-drop tools that enable sales and marketing personnel, rather than expensive programmers, to maintain and enhance their customized solution. Using these drag-and-drop tools, businesses can:
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easily create and update KnowledgeBases containing product attributes;
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create HTML-based graphical user interface (GUI) applications;
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test the application interactively as the application is being built and conduct batch order checks;
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verify the semantics of the KnowledgeBase; and
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create flexible models from individual models.
Multi-threaded Server
We have highly scalable server architecture for deploying our customers’ applications. The n-tier architecture, an architecture that enables multiple servers to run at the same time, allows us to support a range of configurations from a single Configurator server to several Configurator servers managed via a single manager running on an HTTP server or another server. Our Manager product can manage a single server running Configurator or multiple servers all running Configurator. Our multi-threaded technologies enhance the performance for each buyer session because each session state is preserved as the buyer makes subsequent selections. Furthermore, Configurator can support a large number of concurrent user sessions because the engine uses a small amount of memory for each incremental user session.
Scalable Thin-client Architecture
Our software employs a thin-client architecture and supports an Internet computing model enabling users to access our software with any industry-standard browser. This enables access to our applications for users on a broad range of Internet-enabled devices. Our Configurator servers use our engine to process user requests from an HTML session, using the KnowledgeBase and legacy data as needed. This approach can enforce rules, eliminate incorrect choices and make calculations or suggest choices by generating the next HTML screen dynamically. Our servers can also be accessed by custom applications using our thin-client application programming interfaces. Our Configurator can communicate with our Selectica Quoter or one or more database servers from other vendors, and other enterprise resources, including legacy resources using our Connector products.
EPS-M Technology
EPS-M is built on the same core technology and based on leading best practices from our installed base of customer implementations. The EPS-M solution is based on a modular J2EE (Java 2 Enterprise Edition) architecture and is built on a unified data model that integrates configuration, quoting and pricing based on our third generation rules-based engine and workflow automation. The EPS-M development environment is powered by our data management utility, which provides catalog creation, product modeling, and business logic and rules management capabilities.
EPS-M runs on all popular J2EE application servers like IBM Websphere, BEA Weblogic and JBoss. EPS-M is certified to run on popular operating systems like Unix, Solaris, AIX, Linux and Microsoft Windows.
It uses object-relational technologies to manage a system of record on industry leading databases like Oracle, DB2 and MS SQL Server. EPS-M is also certified with 3rd party JCA (Java Connector Architecture) adapters for seamless connectivity with ERP systems like SAP and Oracle Applications.
Service Business
We offer comprehensive consulting, training and implementation services and ongoing customer support and maintenance, which support our software applications. Generally, we charge our customers for these services on a time and materials basis, with training services billed upon delivery. Customer support and maintenance typically is charged as a percentage of license fees and can be renewed annually at the election of our customers based on available support offerings. Our in-house services organization also educates third-party system integrators on the use of our software to assist them in providing services to our customers. As of March 31, 2005, our services organization consisted of 84 employees.
Consulting Services
Through our Professional Services organization, we globally deploy professionals who specialize in the design, implementation, deployment, upgrade and migration services for our SCMS technology and EPS-M applications software. We assist our customers to consolidate their sales information technology operations, integrate disparate sales and marketing systems to our systems and increase the security of their data assets. We focus on implementing software with a number of consulting accelerators, such as preconfigured business flows, which are designed to increase the pace at which our customers achieve value from our applications. Our services organization is aligned with our targeted industries to optimize our ability to support our customers’ needs. We also provide our customers with education and training. Our training services include providing user documentation and training at our corporate offices in San Jose, California, in several regional offices and at the customer site. Customers can access Web-based training and computer-based training our from their own offices.
Customer Support and Maintenance
We provide our customers with software updates, new releases, and corrections as part of our support services. We offer help desk support through our Global Support Center (GSC), which provides technical and product error reporting and resolution support. Customers can access the GSC by various methods, including online interactive support. We enable customers to monitor the progress of their requests for assistance and offer a wide variety of up-to-date Selectica-specific product knowledge, including release planning, application descriptions, publications and training course dates, with intuitive search capabilities on our company-wide intranet, a portion of which is accessible by our partners and customers.
Competition
We compete with a number of private and public companies in our individual product lines. Our principal competitors include Oracle Corporation, SAP, Siebel Systems and stand alone point applications such as Firepond, Trilogy Software (Trilogy) and Comergent Technologies, all of which offer integrated solutions for incorporating some of the functionality of our solutions. Our competitors may intensify their efforts in our market. In addition, other enterprise software companies may offer competitive products in the future.
We also face significant competition from internally developed systems. Information technology, or IT, departments of potential customers have developed or may develop systems that provide for some or all of the functionality of our products. We expect that internally developed application integration and process automation efforts will continue to be a principal source of competition for the foreseeable future. In particular, it can be difficult to license our products to a potential customer whose internal development group has already invested substantially in, and made progress towards completion of, the systems that our products are intended to replace.
Many of our competitors have greater resources and broader alliance and customer relationships than we do. In addition, many of our competitors have extensive knowledge of our industry. Current and potential competitors have established, or may establish, cooperative relationships among themselves or with third parties to offer a single solution and increase the ability of their products to address customer needs. Furthermore, our competitors may combine with each other and other companies may enter our markets by acquiring or entering into strategic relationships with our competitors.
The software industry is intensely competitive and rapidly evolving. Total cost of ownership, performance, functionality, ease of use, product reliability, security and quality of technical support are the key competitive factors that face us in each of the markets in which we compete. We believe that the principal competitive factors affecting our market include:
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vertical domain expertise;
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product functionality and features;
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product architecture and technology;
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incumbency of vendors;
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availability of global support;
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relationship with system integrators;
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coverage of direct sales force;
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ease and speed of product implementation;
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vendor and product reputation;
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financial condition of similar vendors;
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ability of products to support large numbers of concurrent users;
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price of the solution;
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flexibility in delivering the solution (premise, hosted and on-demand);
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hosted and on-demand solutions;
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customer referenceability;
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measurable value (top and bottom line) to the customer; and
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implementation complexity and time requirement.
We believe that our primary competitive advantages are our technology expertise, the breadth and depth of our product’s functionality and features, measurable value, breadth of delivery options and our product architecture. We may not be able to compete as effectively against current and potential competitors if those competitors have greater financial, sales, marketing, professional services, technical support, training capabilities and other resources.
Competitors vary in size and in the scope and breadth of the products and services offered. Although we believe we have advantages over our competitors as described above, some of our competitors and potential competitors have significant advantages over us, including:
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a longer operating history;
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a preferred vendor status with our customers;
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more extensive name recognition and marketing power;
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significantly greater financial, technical, marketing and other resources, giving them the ability to respond more quickly to new or changing opportunities, technologies and customer requirements; and
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in the case where we attempt to bridge gaps between CRM and ERP solutions, an existing relationship with our target customers.
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 or maintain 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.
OPERATIONS
Sales and Marketing
Our sales and marketing objective is to achieve broad penetration through targeted sales and increased brand name recognition. As of March 31, 2005, our sales team consisted of 17 persons, with sales and field support personnel in California, Georgia, Illinois, Indiana, Massachusetts, Minnesota, North Carolina, Texas, Canada, and the United Kingdom.
We sell our products and services primarily through a direct sales force supported by telesales, system engineering and integration support. We believe that the integration of these support networks assists in both the establishment and enhancement of customer relationships. We have developed programs to attract and retain high quality, motivated sales representatives that have the necessary technical skills and consultative sales experience.
Our marketing department is engaged in a wide variety of activities, such as awareness and lead generation programs, product management, public relations, advertising, speaking programs, seminars, sales collateral creation and production, direct mail, and event hosting. As of March 31, 2005, we had 8 marketing personnel located in California and Washington.
Professional Services
Consulting Services
We maintain a highly qualified and experienced professional services organization to deliver configuration, pricing management, and quoting solutions. Our professional services organization offers a broad range of services through its consulting and customer education. These services include product education, presales prototype development, training seminars, product implementation, application development, customization, integration and a full range of education and technical support. This organization is also responsible for training our partners to provide professional services and technical support to our customers. The professional services organization consisted of 84 people as of March 31, 2005. Because significant portions of our implementations can be performed away from the customer’s site, we have the flexibility of being able to provide services from either our U.S. or India-based operations.
Customer Support
In addition to consulting services, we offer various levels of product maintenance to our customers. We have generally provided maintenance services under an annual, renewable contract and our services have been priced as a percentage of product license fees. Customers under maintenance contracts receive technical product support and product upgrades, corrections, and enhancements as they are released throughout the life of the maintenance contracts.
Research and Development
To date we have invested substantial resources in research and development. At March 31, 2005, we had approximately 125 full-time engineers and technical writing specialists that primarily work on product development, documentation, quality assurance and testing. For the fiscal years ended March 31, 2005, 2004, and 2003, we incurred appropriately $12.4 million, $13.5 million, and $13.2 million, respectively, on research and development.
We expect that most of our new products and enhancements to existing products will be developed internally. However, we will evaluate on an ongoing basis externally developed technologies for integration into our suite of products. Enhancements to our existing products are released periodically to add new features, improve functionality and incorporate feedback and suggestions from our current customer base. These updates are usually provided as part of separate maintenance agreement sold with the product license.
International Operations
As of March 31, 2005, we had offices in three countries, the U.S., India, and a small office in the U.K All of our international operations are conducted through wholly owned subsidiaries. Revenues from our international operations were 33%, 10%, and 24% of our total revenues for the fiscal years ended March 31, 2005, 2004 and 2003, respectively.
Intellectual Property and Other Proprietary Rights
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 have six issued patents and four pending patents in the U.S. In addition, we have one trademark registered in U.S., one trademark registered and one pending in South Korea, two trademarks registered in Canada and one trademark registered in European Community. Our trademark and patent applications might not result in the issuance of any trademarks or patents. Our patents or any future issued patents or trademarks might be invalidated or circumvented or otherwise fail to provide us any meaningful protection. We seek to protect the source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to license agreements, which impose certain restrictions on the licensee’s ability to utilize the software. We also seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to
execute confidentiality agreements. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of many countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets and to determine the validity and scope of the proprietary rights of others. Our failure to adequately protect our intellectual property could have a material adverse effect on our business and operating results.
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. From time to time, we receive correspondence from patent holders recommending that we license their patents. After reviewing these patents, we have informed these patent holders that it would not be necessary to license these patents. However, we may be required to license such patents or we may incur legal fees to defend our position that such patent 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:
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cease selling, incorporating or using products or services that incorporate the challenged intellectual property;
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obtain from the holder of the infringed intellectual property right a license to sell or use the relevant intellectual property, which license may not be available on reasonable terms;
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redesign those products or services that incorporate such intellectual property; or
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pay money damages to the holder of the infringed intellectual property right.
In the event of a successful claim of infringement against us and our failure or inability to license the infringed intellectual property on 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.
On April 22, 2004, Trilogy and Trilogy Development Group (collectively, Trilogy Group) filed a complaint in the United States District Court for the Eastern District of Texas Marshall Division (which has subsequently been served), alleging patent infringement against the Company. For information about this complaint filed against the Company alleging patent infringement, please see Item 3: Legal Proceedings: Patent Infringement.
Employees
At March 31, 2005, we had a total of 270 employees, of whom 139 were located in India and 131 located in North America, United Kingdom, and Japan. Of the total, 125 were in research and development, 84 were in consulting, 25 were engaged in sales, marketing and business development and 36 were in administration and finance. None of our employees are represented by a labor union and we consider our relations with our employees to be good.
Acquisitions
On May 3, 2005, we acquired certain business assets of Determine for approximately $799,000 in cash. Determine is a provider of enterprise contract management software. Determine’s solutions include: the ability to aggregate and analyze enterprise-wide contract information, automate and accelerate contract related business processes, enforce contract and relationship compliance (Sarbanes-Oxley) and automate the contract process from request to signature. The addition of Determine’s software capabilities and customers will allow us to extend our offerings to include contract management solutions.
With this acquisition, we will now have solutions to manage every aspect of the contract lifecycle, from request to signature. Additionally, we will be able to offer a suite of software designed for revenue centric processes for enterprises engaged in both buy side and sell side transactions. The Determine products are part of our solutions that will link CRM and ERP applications by enabling the configuration, pricing and quoting of complex bundled products and solutions.
AVAILABLE INFORMATION
We file annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy and information statements and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended. The public may read and copy these materials at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the public reference room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website (www.sec.gov) that contains reports, proxy and information statements and other information regarding Selectica, Inc. and other companies that file materials with the SEC electronically. You may also obtain copies of reports filed with the SEC, free of charge, on our website at www.selectica.com.
Item 2.
Item 2.
Properties
Facilities
United States. Our principal administrative, sales, marketing, consulting, and research and development facility occupies approximately 80,000 square feet of office space in San Jose, California. The lease extends through November 2009.
India. We own an office in Pune, which is used primarily for development, consulting and quality assurance purposes. This facility occupies approximately 22,000 square feet.
United Kingdom. We lease, on a month to month basis, a small office in Bracknell, used for professional services.
We believe the office space in these facilities will be adequate to meet our needs.
Item 3.
Item 3.
Legal Proceedings
Patent Infringement
On April 22, 2004, Trilogy filed a complaint in the United States District Court for the Eastern District of Texas Marshall Division (which has subsequently been served), alleging patent infringement against us. The complaint alleges that we have been and are willfully infringing, directly and indirectly, on Trilogy patents relating to the making, using, licensing, selling, offering for sale, or importing products including configuration and pricing software and related consulting services. The complaint seeks money damages, costs, attorneys’ fees, penalties for willful infringement, an injunction to prevent us from infringing Trilogy’s patents in the future, and any other relief to which Trilogy may be entitled. We intend to vigorously defend against Trilogy’s claims and may incur substantial costs in such defense. While we cannot predict the outcome of this litigation, we believe the claims are without merit.
On September 2, 2004, we filed counterclaims in the Eastern District of Texas Marshall Division action against Trilogy for infringement of our U.S. Patent Nos. 6,405,308, 6,675,294, 5,878,400 and 6,553,350 for willfully infringing, directly and indirectly, by making, using, licensing, selling, offering for sale, or importing products including configuration and ordering software. We seek money damages, costs, attorneys’ fees, penalties for willful infringement, an injunction to prevent Trilogy from infringing our patents in the future, and any other relief to which we may be entitled. We may incur substantial costs in pursuing its claims against Trilogy. Discovery has just begun in this action. The Court has set a trial date for January 2006 in this action.
Class Action
Between June 5, 2001 and June 22, 2001, four securities class action complaints were filed against us, certain of our officers and directors, and Credit Suisse First Boston Corporation (“CSFB”), as the underwriters of our March 13, 2000 initial public offering (“IPO”), in the United States District Court for the Southern District of New York. On August 9, 2001, these actions were consolidated before a single judge along with cases brought against numerous other issuers, their officers and directors and their underwriters, that make similar allegations involving the allocation of shares in the IPOs of those issuers. The consolidation was for purposes of pretrial motions and discovery only. On April 19, 2002, plaintiffs filed a consolidated amended complaint asserting essentially the same claims as the original complaints.
The amended complaint alleges that the officer and director defendants, CSFB and Selectica, Inc. violated federal securities laws by making material false and misleading statements in the prospectus incorporated in our registration statement on Form S-1 filed with the SEC in March 2000 in connection with our IPO. Specifically, the complaint alleges, among other things, that CSFB solicited and received excessive and undisclosed commissions from several investors in exchange for which CSFB allocated to those investors material portions of the restricted number of shares of common stock issued in our IPO. The complaint further alleges that CSFB entered into agreements with its customers in which it agreed to allocate the common stock sold in our IPO to certain customers in exchange for which such customers agreed to purchase additional shares of our common stock in the after-market at pre-determined prices. The complaint also alleges that the underwriters offered to provide positive market analyst coverage for us after the IPO, which had the effect of manipulating the market for the Company’s stock.
On July 15, 2002, the Company and the officer and director defendants, along with other issuers and their related officer and director defendants, filed a joint motion to dismiss based on common issues. Opposition and reply papers were filed and the Court heard oral argument. Prior to the ruling on the motion to dismiss, on October 8, 2002, the individual officers and directors entered into a stipulation of dismissal and tolling agreement with plaintiffs. As part of that agreement, plaintiffs dismissed the case without prejudice against the individual defendants. The Court ordered the dismissal of the officers and directors without prejudice on October 9, 2002. The Court rendered its decision on the motion to dismiss on February 19, 2003, denying dismissal of the Company.
On June 25, 2003, a Special Committee of the Board of Directors of the Company approved a Memorandum of Understanding (the “MOU”) reflecting a settlement in which the plaintiffs agreed to dismiss the case against us with prejudice in return for the assignment by us of certain claims that we might have against its underwriters. The same offer of settlement was made to all the issuer defendants involved in the litigation. No payment to the plaintiffs by us is required under the MOU. After further negotiations, the essential terms of the MOU were formalized in a Stipulation and Agreement of Settlement (“Settlement”), which has been executed on behalf of us. The settling parties presented the proposed Settlement papers to the Court on June 14, 2004 and filed formal motions seeking preliminary approval on June 25, 2004. The underwriter defendants, who are not parties to the proposed Settlement, filed a brief objecting to its terms on July 14, 2004. On February 15, 2005, the Court granted preliminary approval of the settlement conditioned on the agreement of the parties to narrow one of a number of the provisions intended to protect the issuers against possible future claims by the underwriters. We re-approved the Settlement with the proposed modifications that were outlined by the Court in its February 15, 2005 Order granting preliminary approval. Approval of any settlement involves a three-step process in the district court: (i) a preliminary approval, (ii) determination of the appropriate notice of the settlement to be provided to the settlement class, and (iii) a final fairness hearing. At a hearing on April 13, 2005, the Court set January 6, 2006 as the date for the final fairness hearing. There are still discussions regarding the form of the notice for the final hearing, which will be sent out in September 2005. There can be no assurance that the Court will approve the settlement.
In the meantime, the plaintiffs and underwriters have continued to litigate the consolidated action. The litigation is proceeding through the class certification phase by focusing on six cases chosen by the plaintiffs and underwriters (“focus cases”). The Company is not a focus case. On October 13, 2004, the Court certified
classes in each of the six focus cases. The underwriter defendants have sought review of that decision. Along with the other non-focus case issuer defendants, we have not participated in the class certification phase.
The plaintiffs’ money damage claims include prejudgment and post-judgement interest, attorneys’ and experts’ witness fees and other costs, as well as other relief to which the plaintiffs may be entitled should they prevail. We believe that the securities class action allegations against us and our officers and directors are without merit and, if settlement of the action is not finalized, we intend to contest the allegations vigorously. However, the patent infringement litigation is in its preliminary stages, and we cannot predict its outcome. The litigation process is inherently uncertain. If the outcome of the litigation is adverse to us and if, in addition, we are required to pay significant monetary damages, then our business would be significantly harmed. At a minimum, the class action litigation could result in substantial costs and divert our management’s attention and resources, which could seriously harm our business.
Other
In the future we may subject to other lawsuits. Any litigation, even if not successful against us, could result in substantial costs and divert management’s and other resources away from the operations of our business.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter ended March 31, 2005.
RISK FACTORS
Set forth below and elsewhere in this annual report and in the other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this annual report. Prospective and existing investors are strongly urged to carefully consider the various cautionary statements and risks set forth in this annual report and our other public filings.
We have a history of losses and expect to continue to incur net losses in the near-term.
We have experienced operating losses in each quarterly and annual period since inception. We incurred net losses of approximately $14.7 million, $8.8 million, and $29.7 million for the fiscal years ended March 31, 2005, 2004, and 2003, respectively. We had an accumulated deficit of approximately $172.6 million as of March 31, 2005. We plan to reduce research and development, sales and marketing, and general and administrative expenses in absolute dollars over the next year as necessary to balance expense levels with projected revenues. We will need to generate significant increases in our revenues to achieve and maintain profitability. If our revenue fails to grow or grows more slowly than we anticipate or our operating expenses exceed our expectations, our losses will significantly increase which would significantly harm our business and operating results.
Our quarterly revenues and operating results are inherently unpredictable and subject to fluctuations, and as a result, we may fail to meet the expectations of security analysts and investors, which could cause volatility or adversely affect the trading price of our common stock.
We enter into arrangements for the sale of: (1) licenses of software products and related maintenance contracts; (2) bundled license, maintenance, and services; and (3) services. In instances where maintenance is bundled with a license of software products, such maintenance term is typically one year.
For each arrangement, we determine whether evidence of an arrangement exists, delivery has occurred, the fees are fixed or determinable, and collection is probable. If any of these criteria are not met, revenue recognition is deferred until such time as all of the criteria are met.
Our quarterly revenues may also fluctuate due our ability to perform services, achieve specific milestones and obtain formal customer acceptance of specific elements of the overall completion of a project. As we provide such services and products, the timing of delivery and acceptance, changed conditions with the customers and projects could result in changes to the timing of our revenue recognition, and thus, our operating results.
Likewise, if our customers do not renew maintenance services or purchase additional products, our operating results could suffer. Historically, we have derived and expect to continue to derive a significant portion of our total revenue from existing customers who purchase additional products or renew maintenance agreements. Our customers may not renew such maintenance agreements or expand the use of our products. In addition, as we introduce new products, our current customers may not require of desire the features of our new products. If our customers do not renew their maintenance agreements with us or choose not to purchase additional products, our operating results could suffer.
Because we rely on a limited number of customers, the timing of customer acceptance or milestone achievement, or the amount of services we provide to a single customer can significantly affect our operating results or the failure to replace a significant customer. For example, our services and license revenues declined significantly in the quarter ending on March 31, 2003, due to milestone achievement delays of services and customer acceptance under a particular contract. Because expenses are relatively fixed in the near term, any shortfall from anticipated revenues could cause our quarterly operating results to fall below anticipated levels.
We may also experience seasonality in revenues. For example, our quarterly results may fluctuate based upon our customers’ calendar year budgeting cycles. These seasonal variations may lead to fluctuations in our quarterly revenues and operating results.
Based upon the foregoing, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and that such comparisons should not be relied upon as indications of future performance. In some future quarter, our operating results may be below the expectations of public market analysts and investors, which could cause volatility or a decline in the price of our common stock.
If our bookings do not improve, our results of operations could be significantly harmed.
In any given period our revenues are dependent on customer contracts booked during earlier periods. Because we typically recognize revenue in periods after contracts are entered into, a decline in the number of contracts booked during any particular period or the value of such contracts would cause a decrease in revenue in future periods. The number and value of our bookings has been lower than management expectations. Our failure to increase bookings in the previous quarters was a significant factor in the decline of our revenues in more recent quarters. If our bookings remain at current levels or if the value of such bookings decreases further, it will cause our revenues to decline in future periods and could significantly harm our business and operating results.
The loss of any of our key personnel or the failure of our new management team to integrate with our current team would harm our competitiveness because of the time and effort that we would have to expend to replace such personnel.
We believe that our success will depend on the continued employment of our management team and key technical personnel, including Vincent Ostrosky, our President and Chief Executive Officer, and Stephen Bennion, our Chief Financial Officer, who have employment agreements with us. If our Chief Executive Officer, who was hired in October 2004, does not successfully integrate with our employees, partners and customers, it could significantly harm our business and operating results.
If one or more members of our senior management team or key technical personnel were unable or unwilling to continue in their present positions, these individuals would be difficult to replace and our ability to manage day-to-day operations, including our operations in Pune, India, develop and deliver new technologies, attract and retain customers, attract and retain other employees and generate revenues would be significantly harmed.
Any mergers, acquisitions or joint ventures that we may make could disrupt our business and harm our operating results.
On December 3, 2004, we announced that it entered into a definitive merger agreement with I-many, Inc., under which we agreed, subject to certain conditions, to pay $1.55 per share in cash for all outstanding shares of I-many common stock, for a total transaction value of $70 million. The transaction was not approved by the I-many stockholders, and the merger agreement was terminated in March 2005. In May 2005, we entered into an agreement to purchase certain assets and products of Determine for cash. The transaction closed in the first quarter of fiscal 2006.
The attempt to acquire and merge I-many required a significant amount of management time, as well as significant consulting, legal and accounting expense which negatively affected our operating results. We may engage in acquisitions of other companies, products or technologies, such as the recent acquisition of Determine. If we fail to integrate successfully any future acquisitions (or technologies associated with such), the revenue and operating results of the combined companies could decline. The process of integrating an acquired business may result in unforeseen difficulties and expenditures. If we fail to complete any acquisitions of any other companies, it may also result in unforeseen difficulties and expenditures. Acquisitions may involve a number of other potential risks to our business and include, but are not limited to the following:
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potential adverse effects on our operating results, including unanticipated costs and liabilities, unforeseen accounting charges or fluctuations from failure to accurately forecast the financial impact of an acquisition.
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use of cash;
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issuance of stock that would dilute our current stockholders’ percentage ownership;
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incurring debt;
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assumption of liabilities;
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amortization expenses related to other intangible assets;
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incurring large and immediate write-offs; or
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incurring legal and professional fees.
These mergers or joint ventures also involve numerous risks, including:
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problems combining the purchased operations, technologies or products with ours;
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unanticipated costs;
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diversion of managements’ attention from our core business;
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adverse effects on existing business relationships with suppliers and customers; and
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potential loss of key employees, particularly those of the acquired organizations.
Any mergers or joint ventures may cause our financial results to suffer as a result of these risks. Where mergers, acquisitions or joint ventures are intended to enhance revenue and operating results, such revenue opportunities may not materialize, or the cost of integration and reorganization of the new operations may cost more than anticipated.
Any unsolicited proposals for the purchase of our Company could disrupt business and harm our operating results.
In January 2005, Trilogy, a privately held company, conditionally proposed to purchase all of our outstanding common stock for $4.00 per share. This unsolicited proposal assumed that the I-many merger was not completed. On February 2, 2005, following consultation with our legal and financial advisors, we issued a press release announcing that our Board of Directors determined that Trilogy’s proposal was not in our best interests or those of our stockholders. For reasons unrelated to Trilogy’s proposal, I-many and Selectica
terminated the I-many merger on March 31, 2005. On April 11, 2005, Trilogy filed a Statement of Beneficial Ownership on Schedule 13D with the Securities and Exchange Commission reporting that it owned 6.9% of our outstanding common stock as of that date. As described further in this report, Trilogy is also engaged in a patent infringement lawsuit against us.
Uncertainty regarding Trilogy’s intentions toward us may cause disruption in our business, which could result in a material adverse effect on our financial condition and operating results. Additionally, as a consequence of the uncertainty surrounding our future, our key employees may be distracted and could seek other employment opportunities. If key employees leave, there could be a material adverse effect on our business and results of operations. Uncertainty surrounding Trilogy’s intentions and Trilogy’s patent infringement lawsuit against us could also be disruptive to our relations with our existing and potential customers as the proposal and/or the patent litigation may be viewed negatively by some customers. Responding to any proposals from Trilogy and patent lawsuit has consumed, and may continue to consume, attention from our management and employees, and may require us to incur significant costs which could adversely affect our financial and operating results.
If our new product marketing strategy is unsuccessful, it could significantly harm our business and operating results.
We have recently revised our product marketing focus. We had previously positioned our company as a seller of Internet Selling Solutions, however, we now emphasize our products’ ability to bridge the gap that exists between CRM and other business applications, which we refer to as the Opportunity to Order Gap. We have brought new products such as EPS-M to market, which are specifically tailored to address this gap in a specific industry. If the market for products that address the Opportunity to Order Gap is smaller than we anticipated or if our products fail to gain widespread acceptance in this market, our results of operations would be adversely affected. In addition, if there is a delay in bringing our new products to market, it would delay our ability to derive revenues from such products and our business and operating results could be significantly harmed.
We have relied and expect to continue to rely on a limited number of customers for a substantial portion of our revenues, and the loss of any of these customers would significantly harm our business and operating results.
Our business and financial condition is dependent on a limited number of customers. Our five largest customers accounted for approximately 67%, 78% and 53% of our revenues for the fiscal years ended March 31, 2005, 2004, and 2003, respectively, and our ten largest customers accounted for 84%, 88%, and 65% of our revenues for the fiscal years ended March 31, 2005, 2004, and 2003, respectively. Revenues from significant customers greater than 10% of total revenues are as follows:
We expect that we will continue to depend upon a relatively small number of customers for a substantial portion of our revenues for the foreseeable future. As a result, if we fail to successfully sell our products and services to one or more customers in any particular period or a large customer purchases fewer of our products
or services, defers or cancels orders, or terminates its relationship with us, our business and operating results would be harmed.
Our lengthy sales cycle makes it difficult for us to forecast revenue and exacerbates the variability of quarterly fluctuations, which could cause our stock price to decline.
The sales cycle of our products has historically averaged between nine to twelve months, and may sometimes be significantly longer. We are generally required to provide a significant level of education regarding the use and benefits of our products, and potential customers tend to engage in extensive internal reviews before making purchase decisions. In addition, the purchase of our products typically involves a significant commitment by our customers of capital and other resources, and is therefore subject to delays that are beyond our control, such as customers’ internal budgetary procedures and the testing and acceptance of new technologies that affect key operations. In addition, because we target large companies, our sales cycle can be lengthier due to the decision process in large organizations. As a result of our products’ long sales cycles, we face difficulty predicting the quarter in which sales to expected customers may occur. If anticipated sales from a specific customer for a particular quarter are not realized in that quarter, our operating results for that quarter could fall below the expectations of financial analysts and investors, which could cause our stock price to decline.
We are currently subject to intellectual property litigation, and could be subject to additional such litigation in the future, in connection with which 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. On April 22, 2004, Trilogy filed a complaint in the United States District Court for the Eastern District of Texas Marshall Division (which has subsequently been served), alleging patent infringement against us. The complaint alleges that we have been and are willfully infringing, directly and indirectly, on Trilogy patents relating to the making, using, licensing, selling, offering for sale, or importing products including configuration and pricing software and related consulting services. The complaint seeks money damages, costs, attorneys’ fees, penalties for willful infringement, an injunction to prevent us from infringing Trilogy’s patents in the future, and any other relief to which Trilogy may be entitled. We intend to vigorously defend against Trilogy’s claims and may incur substantial costs in such defense. While we cannot predict the outcome of this litigation, we believe the claims are without merit
On September 2, 2004, we filed counterclaims in the Eastern District of Texas Marshall Division action against Trilogy for infringement of our U.S. Patent Nos. 6,405,308, 6,675,294, 5,878,400 and 6,553,350 for willfully infringing, directly and indirectly, by making, using, licensing, selling, offering for sale, or importing products including configuration and ordering software. We seek money damages, costs, attorneys’ fees, penalties for willful infringement, an injunction to prevent Trilogy from infringing our patents in the future, and any other relief to which we may be entitled. We may incur substantial costs in pursuing its claims against Trilogy. Discovery has just begun in this action. The Court has set a trial date for January 2006 in this action.
In addition, from time to time, we receive correspondence from patent holders recommending that we license their patents. After reviewing these patents, we have informed these patent holders that it would not be necessary to license these patents. However, we may be required to license such patents or incur legal fees to defend our position that such licenses are not necessary, and there can be no assurance that we would be able to obtain a license to use such patents on commercially reasonable terms, or at all.
Any intellectual property litigation, including the litigation with Trilogy, or any threat of such litigation could force us to do one or more of the following:
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cease selling, incorporating or using products or services that incorporate the challenged intellectual property;
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obtain from the holder of the infringed intellectual property right a license to sublicense or use the relevant intellectual property, which license may not be available on reasonable terms;
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redesign those products or services that incorporate such intellectual property; and/or
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pay money damages to the holder of the infringed intellectual property right.
In the event of a successful claim of infringement against us and our failure or inability to license the infringed intellectual property on 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.
Any reduction in expenses will place a significant strain on our management systems and resources if we fail to manage these changes, our business will be harmed.
We have reduced our headcount and operations in the last two years and we may further reduce our operating expenses. As a result, this would place increased demands on our managerial, administrative, operational, financial and other resources.
Additional cost cutting measures would force us to handle our current customer base and operations with a smaller number of employees. If we are unable to initiate procedures and controls to support our future operations in an efficient and timely manner, or if we are unable to otherwise manage these changes effectively, our business would be harmed.
Developments in the market for configuration, pricing management and quoting solutions may harm our operating results, which could cause a decline in the price of our common stock.
The market for configuration, pricing management and quoting solutions, which has only recently begun to develop, is evolving rapidly. Because this market is relatively 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 rapid change in the marketplace poses a number of concerns. 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. The decrease in technology infrastructure spending may reduce the size of the market for configuration, pricing management and quoting solutions. Our potential customers may decide to purchase more complete solutions offered by larger competitors instead of individual applications. If the market for configuration, pricing management and quoting solutions is slow to develop, or if our customers purchase more fully integrated products, our business and operating results would be significantly harmed.
We face intense competition, which could reduce our sales, prevent us from achieving or maintaining profitability and inhibit our future growth.
The market for software and services that enable electronic commerce is intensely competitive and rapidly changing. We expect competition to persist and intensify, which could result in price reductions, reduced gross margins and loss of market share. Our principal competitors include large publicly-traded companies such as Oracle Corporation, SAP and Siebel Systems as well as privately held companies such as Comergent Technologies, Firepond, and Trilogy, all of which offer integrated solutions for electronic commerce incorporating some of the functionality of our configuration, pricing and quoting software, as well as private companies such as Comergent Technologies.
Our competitors may intensify their efforts in our market. In addition, other enterprise software companies may offer competitive products in the future. Competitors vary in size and in the scope and breadth of the products and services offered. Although we believe we have advantages over our competitors including the comprehensiveness of our solution, our use of Java technology and our multi-threaded architecture, some of our competitors and potential competitors have significant advantages over us, including:
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a longer operating history;
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preferred vendor status with our customers;
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more extensive name recognition and marketing power; and
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significantly greater financial, technical, marketing and other resources, giving them the ability to respond more quickly to new or changing opportunities, technologies, and customer requirements.
Our competitors may also bundle their products in a manner that may discourage users from purchasing our products. Current and potential competitors may establish cooperative relationships with each other or with third parties, or adopt aggressive pricing policies to gain market share. Competitive pressures may require us to reduce the prices of our products and services. We may not be able to maintain or expand our sales if competition increases, and we are unable to respond effectively.
A decline in general economic conditions or a decrease in information technology spending could harm our results of operations.
A change in economic conditions could lead to revised budgetary constraints regarding information technology spending for our customers. We have had potential customers select our software, but decide to delay or not to implement any configuration system. Many companies have decided to reduce their expenditures for information technology by either delaying non-mission critical projects or abandoning them until their levels of business justify the expenses. Stagnation in information technology spending due to economic conditions or other factors could significantly harm our business and operating results.
If we do not keep pace with technological change, including maintaining interoperability of our products with the software and hardware platforms predominantly used by our customers, our products may be rendered obsolete, and our business may fail.
Our industry is characterized by rapid technological change, changes in customer requirements, frequent new product and service introductions and enhancements and emerging industry standards. In order to achieve broad customer acceptance, our products must be compatible with major software and hardware platforms used by our customers. Our products currently operate on the Microsoft Windows NT, Sun Solaris, IBM AIX, J2EE, Linux and Microsoft Windows 2000 Operating Systems. In addition, our products are required to interoperate with electronic commerce applications and databases. We must continually modify and enhance our products to keep pace with changes in these operating systems, applications and databases. Our configuration, pricing and quoting products are complex, and new products and product enhancements can require long development and testing periods. If our products were to be incompatible with a popular new operating system, electronic commerce application or database, our business would be significantly harmed. In addition, the development of entirely new technologies to replace existing software could lead to new competitive products that have better performance or lower prices than our products and could render our products obsolete and unmarketable.
Our failure to meet customer expectations on deployment of our products could result in negative publicity and reduced sales, both of which would significantly harm our business and operating results.
In the past, our customers have experienced difficulties or delays in completing implementation of our products. We may experience similar difficulties or delays in the future. Our configuration, pricing and quoting products rely on defining a repository of information called the KnowledgeBase 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 KnowledgeBase can be more time consuming than we or our customers anticipate. If
our customers do not devote the resources necessary to create the KnowledgeBase, the deployment of our products can be delayed. Deploying our products can also involve time-consuming integration with our customers’ legacy systems, such as existing databases and enterprise resource planning software. Failing to meet customer expectations on deployment of our products could result in a loss of customers and negative publicity regarding us and our products, which could adversely affect our ability to attract new customers. In addition, time-consuming deployments may also increase the amount of professional services we must allocate to each customer, thereby increasing our costs and adversely affecting our business and operating results.
If we are unable to maintain our direct sales force, sales of our products and services may not meet our expectations, and our business and operating results will be significantly harmed.
We depend on our direct sales force for all of our current sales, and our future growth depends on the ability of our direct sales force to develop customer relationships and increase sales to a level that will allow us to reach and maintain profitability. If we are unable to retain qualified sales personnel or if newly hired personnel fail to develop the necessary skills or to reach productivity when anticipated, we may not be able to increase sales of our products and services, and our results of operation could be significantly harmed. We continue to have a high rate of turnover in our executive sales positions. If our sales management fails to successfully integrate into the Company or improve the performance of the sales personnel, our business may be harmed.
If we are unable to manage our professional services organization, we will be unable to provide our customers with technical support for our products, which could significantly harm our business and operating results.
We need to better manage our professional services organization to assist our customers with implementation and maintenance of our products. Because 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. In addition, because of market conditions, the pricing of professional services projects has made it difficult to improve operating margins.
Services revenues, which generated 71%, 58%, and 71% of our revenues during the years ended March 31, 2005, 2004, and 2003, respectively, are comprised primarily of revenues from consulting fees, maintenance contracts and training, are important to our business. Services revenues have lower gross margins than license revenues. During the years ended March 31, 2005, 2004, and 2003, respectively, gross margins percentages for services revenues and license revenues for the respective periods are as follows:
We intend to charge for our professional services on a time and materials rather than a fixed-fee basis. However in current market conditions, many customers insist on services provided on a fixed-fee basis. To the extent that customers are unwilling to utilize third-party consultants or require us to provide professional services on a fixed fee basis, our cost of services revenues could increase and could cause us to recognize a loss on a specific contract, either of which would adversely affect our operating results. In addition, if we are unable to provide these professional services, we may lose sales or incur customer dissatisfaction, and our business and operating results could be significantly harmed.
If new versions and releases of our products contain errors or defects, we could suffer losses and negative publicity, which would adversely affect our business and operating results.
Complex software products such as ours often contain errors or defects, including errors relating to security, particularly when first introduced or when new versions or enhancements are released. In the past, we have discovered defects in our products and provided product updates to our customers to address such defects. Our products and other future products may contain defects or errors, that could result in lost revenues, a delay in market acceptance or negative publicity, each which would significantly harm our business and operating results.
A substantial portion of our operations are conducted by India-based personnel, and any change in the political and economic conditions of India or in immigration policies that adversely affects our ability to conduct our operations in India could significantly harm our business.
We conduct development, quality assurance and professional services operations in India. As of March 31, 2005, there were 139 persons employed in India. We are dependent on our India-based operations for these aspects of our business. As a result, we are directly influenced by the political and economic conditions affecting India. Operating expenses incurred by our operations in India are denominated in Indian currency, and accordingly, we are exposed to adverse movements in currency exchange rates. This, as well as any other political or economic problems or changes in India, could have a negative impact on our India-based operations, resulting in significant harm to our business and operating results. Furthermore, the intellectual property laws of India may not adequately protect our proprietary rights. We believe that it is particularly difficult to find quality management personnel in India, and we may not be able to timely replace our current India-based management team if any of them were to leave our Company.
Our training program for some of our India-based employees includes an internship at our San Jose, California headquarters. Additionally, we provide services to some of our customers with India-based employees. We presently rely on a number of visa programs to enable these India-based employees to travel and work internationally. Any change in the immigration policies of India or the countries to which these employees travel and work could cause disruption or force the termination of these programs, which would harm our business.
Demand for our products and services will decline significantly if our software cannot support and manage a substantial number of users.
Our strategy requires that our products be highly scalable. To date, only a limited number of our customers have deployed our products on a large scale. If our customers cannot successfully implement large-scale deployments, or if they determine that we cannot accommodate large-scale deployments, our business and operating results would be significantly harmed.
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. 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. Competition for such personnel has markedly intensified in India, where we have a large portion of our workforce. Many multinational corporations have expanded their operations into India, and there is an increased demand for individuals with relevant technology experience.
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 patent, trademark, trade secret and copyright law and contractual restrictions to protect the proprietary aspects of our technology. These legal protections afford only limited protection for our technology. We currently hold nine patents in U.S. In addition, we have two trademarks registered in U.S., one trademark registered and one pending in South Korea, two trademarks registered in Canada and one trademark registered in European Community, and we have also applied to register another two trademarks in the United States. Our trademark applications might not result in the issuance of any trademarks. Our patents or any future issued trademarks might be invalidated or circumvented or otherwise fail to provide us any meaningful protection. We seek to protect the source code for our software, documentation and other written materials under trade secret and copyright laws. We license our software pursuant to license agreements, which impose certain restrictions on the licensee’s ability to utilize the software. We also seek to avoid disclosure of our intellectual property by requiring employees and consultants with access to our proprietary information to execute confidentiality agreements. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of many countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Litigation may be necessary in the future to enforce our intellectual property rights, to protect our trade secrets and to determine the validity and scope of the proprietary rights of others. Our failure to adequately protect our intellectual property could have a material adverse effect on our business and operating results.
Our results of operations will be reduced by charges associated with stock-based compensation, accelerated vesting associated with stock options issued to employees, charges associated with other securities issued by us, and charges related to variable accounting.
We have in the past and expect in the future to incur a significant amount of amortization of deferred compensation charges related to securities issuances in future periods, which will negatively affect our operating results. Since inception we have recorded approximately $12.1 million in net deferred compensation charges. During the years ended March 31, 2005, 2004, and 2003, we amortized approximately $131,000, $1.9, and $2.1 million of such charges which included the compensation expenses related to option acceleration, option modification, and variable accounting, respectively. We expect to amortize approximately $183,000 compensation for the fiscal year ending March 31, 2006 and we may incur additional charges in the future in connection with grants of stock-based compensation at less than fair value and for charges related to variable plan accounting.
The Company will adopt the provisions of FASB 123R using a modified prospective application effective April 1, 2006. This new pronouncement from the FASB provides for certain changes to the method for valuing stock-based compensation among other changes, FASB 123R will apply to new awards and to awards that are outstanding which are subsequently modified or cancelled. Compensation expense cost calculated under FASB 123R could negatively impact our operating results in the future. The Company is in the process of determining how the new method of valuing stock-based compensation as prescribed under FASB 123R will be applied to stock based awards after the effective date and how much impact the recognition of compensation expense related to such awards will have on its operating results.
Failure to improve and maintain relationships with systems integrators and consulting firms, which assist us with the sale and installation of our products, would impede the acceptance of our products and the growth of our revenues.
Our strategy has been to rely in part upon systems integrators and consulting firms to recommend our products to their customers and to install and deploy our products. To date, we have had limited success in utilizing these firms as a sales channel or as a provider of professional services. To increase our revenues and implementation capabilities, we must continue to develop and expand our relationships with these systems integrators and consulting firms. If these systems integrators and consulting firms are unwilling to install and deploy our products, we may not have the resources to provide adequate implementation services to our customers, and our business and operating results could be significantly harmed.
We are the target of several securities class action and patent infringement complaints, which could result in substantial costs and divert management attention and resources.
Patent Infringement
On April 22, 2004, Trilogy Group filed a complaint in the United States District Court for the Eastern District of Texas Marshall Division (which has subsequently been served), alleging patent infringement against us. The complaint alleges that we have been and are willfully infringing, directly and indirectly, on Trilogy Group patents relating to the making, using, licensing, selling, offering for sale, or importing products including configuration and pricing software and related consulting services. The complaint seeks money damages, costs, attorneys’ fees, penalties for willful infringement, an injunction to prevent us from infringing Trilogy Group’s patents in the future, and any other relief to which Trilogy Group may be entitled. We intend to vigorously defend against Trilogy Group’s claims and may incur substantial costs in such defense. While we cannot predict the outcome of this litigation, we believe the claims are without merit
On September 2, 2004, we filed counterclaims in the Eastern District of Texas Marshall Division action against Trilogy Group for infringement of our U.S. Patent Nos. 6,405,308, 6,675,294, 5,878,400 and 6,553,350 for willfully infringing, directly and indirectly, by making, using, licensing, selling, offering for sale, or importing products including configuration and ordering software. We seek money damages, costs, attorneys’ fees, penalties for willful infringement, an injunction to prevent Trilogy Group from infringing our patents in the future, and any other relief to which we may be entitled. We may incur substantial costs in pursuing its claims against Trilogy Group. Discovery has just begun in this action. The Court has set a trial date for January 2006 in this action.
In addition, from time to time, we receive correspondence from patent holders recommending that we license their patents. After reviewing these patents, we have informed these patent holders that it would not be necessary to license these patents. However, we may be required to license such patents or incur legal fees to defend our position that such licenses are not necessary, and there can be no assurance that we would be able to obtain a license to use such patents on commercially reasonable terms, or at all.
Any intellectual property litigation, including the litigation with Trilogy Group, or any threat of such litigation could force us to do one or more of the following:
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cease selling, incorporating or using products or services that incorporate the challenged intellectual property;
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obtain from the holder of the infringed intellectual property right a license to sublicense or use the relevant intellectual property, which license may not be available on reasonable terms;
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redesign those products or services that incorporate such intellectual property; and/or
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pay money damages to the holder of the infringed intellectual property right.
In the event of a successful claim of infringement against us and our failure or inability to license the infringed intellectual property on 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.
Class Action
Between June 5, 2001 and June 22, 2001, four securities class action complaints were filed against us, certain of our officers and directors, and CSFB, as the underwriters of our March 13, 2000 IPO, in the United States District Court for the Southern District of New York. On August 9, 2001, these actions were consolidated before a single judge along with cases brought against numerous other issuers, their officers and directors and their underwriters, that make similar allegations involving the allocation of shares in the IPOs of those issuers. The consolidation was for purposes of pretrial motions and discovery only. On April 19, 2002, plaintiffs filed a consolidated amended complaint asserting essentially the same claims as the original complaints.
The amended complaint alleges that the Company, the officer and director defendants and CSFB violated federal securities laws by making material false and misleading statements in the prospectus incorporated in our registration statement on Form S-1 filed with the SEC in March 2000 in connection with our IPO. Specifically, the complaint alleges, among other things, that CSFB solicited and received excessive and undisclosed commissions from several investors in exchange for which CSFB allocated to those investors material portions of the restricted number of shares of common stock issued in our IPO. The complaint further alleges that CSFB entered into agreements with its customers in which it agreed to allocate the common stock sold in our IPO to certain customers in exchange for which such customers agreed to purchase additional shares of our common stock in the after-market at pre-determined prices. The complaint also alleges that the underwriters offered to provide positive market analyst coverage for us after the IPO, which had the effect of manipulating the market for our stock.
On July 15, 2002, the Company and the officer and director defendants, along with other issuers and their related officer and director defendants, filed a joint motion to dismiss based on common issues. Opposition and reply papers were filed and the Court heard oral argument. Prior to the ruling on the motion to dismiss, on October 8, 2002, the individual officers and directors entered into a stipulation of dismissal and tolling agreement with plaintiffs. As part of that agreement, plaintiffs dismissed the case without prejudice against the individual defendants. The Court ordered the dismissal of the officers and directors without prejudice on October 9, 2002. The Court rendered its decision on the motion to dismiss on February 19, 2003, denying dismissal of the Company.
On June 25, 2003, a Special Committee of the Board of Directors approved a Memorandum of Understanding (the “MOU”) reflecting a settlement in which the plaintiffs agreed to dismiss the case against the Company with prejudice in return for the assignment by the Company of certain claims that the Company might have against its underwriters. The same offer of settlement was made to all issuer defendants involved in the litigation. No payment to the plaintiffs by the Company is required under the MOU. After further negotiations, the essential terms of the MOU were formalized in a Stipulation and Agreement of Settlement (“Settlement”), which has been executed on behalf of the Company. The settling parties presented the proposed Settlement papers to the Court on June 14, 2004 and filed formal motions seeking preliminary approval on June 25, 2004. The underwriter defendants, who are not parties to the proposed Settlement, filed a brief objecting to its terms on July 14, 2004. On February 15, 2005, the Court granted preliminary approval of the settlement conditioned on the agreement of the parties to narrow one of a number of the provisions intended to protect the issuers against possible future claims by the underwriters. We re-approved the Settlement with the proposed modifications that were outlined by the Court in its February 15, 2005 Order granting preliminary approval. Approval of any settlement involves a three-step process in the district court: (i) a preliminary approval, (ii) determination of the appropriate notice of the settlement to be provided to the settlement class, and (iii) a final fairness hearing. At a hearing on April 13, 2005, the Court set January 6, 2006 as the date for the final fairness hearing. There are still discussions regarding the form of the notice for the final hearing, which will be sent out in September 2005. There can be no assurance that the Court will approve the settlement.
In the meantime, the plaintiffs and underwriters have continued to litigate the consolidated action. The litigation is proceeding through the class certification phase by focusing on six cases chosen by the plaintiffs and underwriters (“focus cases”). Selectica is not a focus case. On October 13, 2004, the Court certified classes in each of the six focus cases. The underwriter defendants have sought review of that decision. Selectica, along with the other non-focus case issuer defendants, has not participated in the class certification phase.
The plaintiffs’ money damage claims include prejudgment and post-judgment interest, attorneys’ and experts’ witness fees and other costs, as well as other relief to which the plaintiffs may be entitled should they prevail. The Company believes that the securities class action allegations against the Company and our officers and directors are without merit and, if settlement of the action is not finalized, the Company intends to contest the allegations vigorously. However, the litigation is in its preliminary stages, and the Company cannot predict its outcome. The litigation process is inherently uncertain. If the outcome of the litigation is adverse to the Company and if, in addition, the Company is required to pay significant monetary damages, the Company’s business would be significantly harmed. At a minimum, the class action litigation could result in substantial costs and divert our management’s attention and resources, which could seriously harm our business.
In the future we may be subject to other lawsuits. Any litigation, even if not successful against us, could result in substantial costs and divert management’s and other resources away from the operations of our business.
Anti-takeover defenses that we have in place could prevent or frustrate attempts by stockholders to change our board of directors or the direction of the company.
Provisions of our amended and restated certificate of incorporation and amended and restated bylaws, Delaware law and the stockholder rights plan adopted by the Company on February 4, 2003 may make it more difficult for or prevent a third party from acquiring control of us without approval of our directors. These provisions include:
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providing for a classified board of directors with staggered three-year terms;
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restricting the ability of stockholders to call special meetings of stockholders;
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prohibiting stockholder action by written consent;
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establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings; and
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granting our board of directors the ability to designate the terms of and issue new series of preferred stock without stockholder approval.
These provisions may have the effect of entrenching our board of directors and may deprive or limit your strategic opportunities to sell your shares.
If we are unable to successfully address the material weaknesses in our disclosure controls and procedures, including our internal control over financial reporting, our ability to report our financial results on a timely and accurate basis may be adversely affected.
We have evaluated our “disclosure controls and procedures” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as well as our internal control over financial reporting as required by Section 404 of the Sarbanes-Oxley Act of 2002. Our independent registered public accounting firm has performed a similar evaluation of our internal control over financial reporting. Effective controls are necessary for us to provide reliable financial reports and help identify and deter fraud. If we cannot provide reliable financial reports or prevent fraud, our operating results could be harmed. As of March 31, 2005, we concluded that we had deficiencies in our internal control over financial reporting that constitute three material weaknesses, as further described in Item 8, Report of Management on Internal Control over Financial Reporting. Our independent registered public accounting firm reached the same conclusion. We are
implementing corrective actions, which we believe will remediate each of these deficiencies. However, we cannot be certain that these measures will result in adequate controls over our financial processes and reporting in the future. If these actions are not successful in addressing these material weaknesses, our ability to report our financial results on a timely and accurate basis may be adversely affected. In addition, if we cannot establish effective internal control over financial reporting and disclosure controls and procedures, investors may lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.
Compliance with new regulations dealing with corporate governance and public disclosure may result in additional expenses and require significant management attention.
The Sarbanes-Oxley Act of 2002, as well as new rules implemented by the Securities Exchange Commission and the NASDAQ National Market has required changes in corporate governance practices of public companies. These new rules are increasing our legal and financial compliance costs and causing some management and accounting activities to become more time-consuming and costly. This includes increased levels of documentation, monitoring internal controls, and increased manpower and use of consultants to comply. We have and will continue to expend significant efforts and resources to comply with these rules and regulations and have implemented a comprehensive program of compliance with these requirements and high standards of corporate governance and public disclosure.
These new rules may also make it more difficult and more expensive us to obtain director and officer liability insurance, and may make us accept reduced coverage or incur substantially higher costs for such coverage. The new rules and regulations may also make it more difficult for us to attract and retain qualified executive officers and members of our board of directors, particularly to serve on our audit committee.
Restrictions on export of encrypted technology could cause us to incur delays in international product sales, which would adversely impact the expansion and growth of our business.
Our software utilizes encryption technology, the export of which is regulated by the United States government. If our export authority is revoked or modified, if our software is unlawfully exported or if the United States adopts new legislation restricting export of software and encryption technology, we may experience delay or reduction in shipment of our products internationally. Current or future export regulations could limit our ability to distribute our products outside of the United States. While we take precautions against unlawful exportation of our software, we cannot effectively control the unauthorized distribution of software across the Internet.
Unauthorized break-ins or other assaults on our computer systems could harm our business.
Our servers are vulnerable to physical or electronic break-ins and similar disruptions, which could lead to loss of data or public release of proprietary information. In addition, unauthorized persons may improperly access our data. We have experienced an unauthorized break-in by a “hacker” who has stated that he could, in the future, damage our systems or take confidential information. These and other types of attacks could harm us. Actions of this sort may be very expensive to remedy and could adversely affect results of operations.
Changes to accounting standards and financial reporting requirements, may affect our financial results.
We are required to follow accounting standards and financial reporting set by governing bodies in the U.S. and other countries where we do business. From time to time, these governing bodies implement new and revised laws and regulations. These new and revised accounting standards, financial reporting and tax laws may require changes to accounting principles used in preparing our financial statements. These changes may have a material impact on our business and financial results. For example, a change in accounting rules can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change became effective. As a result, changes to existing rules or reconsideration of current practices caused by such changes may adversely affect our reported financial results or the way we conduct our business.
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 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:
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inadequate reliability of the network infrastructure;
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slow development of enabling technologies and complementary products; and
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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.
PART II
Item 5.
Item 5.
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer’s Purchases of Equity Securities
Our common stock is traded over the counter on the Nasdaq National Market under the symbol “SLTC.” Our common stock began trading in March 2000.
The following table sets forth, for the period indicated, the high and low closing prices per share of the common stock as reported on the Nasdaq National Market.
As of May 31, 2005, there were approximately 170 holders of record of our common stock. Brokers and other institutions hold many of such shares on behalf of stockholders.
The trading price of the Company’s Common Stock could be subject to wide fluctuations in response to quarterly variations in operating results, announcements of technological innovations or new products by the Company or its competitors, changes in financial estimates or purchase recommendations by securities analysts and other events or factors. In addition, the stock market has experienced volatility that has affected the market prices of equity securities of many high technology companies and that often has been unrelated to the operating performance of such companies. These broad market fluctuations may adversely affect the market price of the Company’s Common Stock.
Dividend Policy
We have never declared or paid any cash dividends on our capital stock. We currently anticipate that we will retain future earnings, if any, to fund the development and growth of our business. Therefore, we do not expect to pay any cash dividends in the foreseeable future.
Equity Compensation Plan Information
The following table sets forth as of March 31, 2005 certain information regarding our equity compensation plans.
(1)
These plans permit the grant of options, stock appreciation rights, shares of restricted stock and stock units.
(2)
On each January 1, starting in 2001, the number of shares reserved for issuance under our 1999 Equity Incentive Plan will be automatically increased by the lesser of 5% of the then outstanding shares of
common stock or 1.8 million shares. On each May 1, starting in 2001, the number of shares reserved for issuance under our 1999 Employee Stock Purchase Plan will be automatically increased by the lesser of 2% of the then outstanding shares of common stock or 1.0 million shares.
Stock Option Plans - Not Required to be Approved by Stockholders
Officer Option Agreement
On January 19, 2005, the Company entered into a stock option agreement with the Company’s Chief Executive officer, Vincent Ostrosky that granted him a nonstatutory stock option for 990,000 shares of the Company’s common stock at an exercise price per share of $3.40 (660,000 options were also granted to Mr. Ostrosky from the 1999 Equity Incentive Plan to comprise the total number of options under his employment agreement with the Company). The option vests 1/48th upon the completion of each month of service after the vesting commencement date of October 21, 2004. The exercise price of the option may be paid with: cash, outstanding shares of common stock, or the cashless exercise method through a designated broker. If a change in control occurs, the shares subject to the option will become vested in an additional number of shares equal to 50% of the then unvested shares subject to the option. In the event that an Involuntary Termination occurs within 24 months following a change in control, the option will become vested in all of the unvested shares subject to the option. A change in control includes: a merger or consolidation after which the then-current stockholders own less than 50% of the surviving corporation or a sale of all or substantially all of the assets. If a merger or other reorganization occurs, the agreement of merger or reorganization may provide that the surviving corporation or its parent shall substitute its own option for the option, the option shall be continued by the Company if it is the surviving corporation or the option shall be cancelled for a cash payment. The option expires 10 years after the option grant date but will expire earlier if there is a termination of service of the optionee.
2001 Supplemental Plan
The Company adopted the 2001 Supplemental Plan (the “Supplemental Plan”) on April 4, 2001, and the Supplemental Plan did not require stockholder approval. A total of approximately 2.5 million shares of common stock have been reserved for issuance under the Supplemental Plan. With limited restrictions, if shares awarded under the Supplemental Plan are forfeited, those shares will again become available for new awards under the Supplemental Plan. The Supplemental Plan permits the grant of non-statutory options and shares of restricted stock. Employees and consultants, who are not officers or members of the Board of Directors, are eligible to participate in the Supplemental Plan. Options are granted at an exercise price of not less than 85% of the fair market value per share on the date of grant. Options generally vest with respect to 25% of the shares one year after the options’ vesting commencement date and the remainder vest in equal monthly installments over the following 36 months. Options granted under the Supplemental Plan have a maximum term of ten years.
The Compensation Committee of the Board of Directors administers the Supplemental Plan and has complete discretion to make all decisions relating to the interpretation and operation of the Supplemental Plan. The Compensation Committee has the discretion to determine which eligible persons are to receive an award, and to determine the type, number, vesting requirements and other features and conditions of each award. The exercise price of options may be paid with: cash, outstanding shares of common stock, the cashless exercise method through a designated broker, a pledge of shares to a broker or a promissory note. The purchase price for newly issued restricted shares may be paid with: cash, a promissory note or the rendering of past or future services. The Compensation Committee may reprice options and may modify, extend or assume outstanding options. The Compensation Committee may accept the cancellation of outstanding options in return for the grant of new options. The new option may have the same or a different number of shares and the same or a different exercise price. If a merger or other reorganization occurs, the agreement of merger or reorganization shall provide that outstanding options and other awards under the Supplemental Plan shall be assumed or substituted with comparable awards by the surviving corporation or its parent or subsidiary, shall be continued by the Company if it is the surviving corporation, shall have accelerated vesting and then expire early or shall be cancelled for a cash payment. If a change in control occurs, awards will become fully
exercisable and fully vested if the awards do not remain outstanding, are not assumed by the surviving corporation or its parent or subsidiary and if the surviving corporation or its parent or subsidiary does not substitute its own awards that have substantially the same terms for the awards granted under the Supplemental Plan. If a change in control occurs and a plan participant is involuntarily terminated within 12 months following this change in control, then the vesting of awards held by the participant will accelerate, as if the participant provided another 12 months of service. A change in control includes: a merger or consolidation after which the then-current stockholders own less than 50% of the surviving corporation, a sale of all or substantially all of the assets, a proxy contest that results in replacement of more than one-half of the directors over a 24-month period or an acquisition of 50% or more of the outstanding stock by a person other than a person related to the Company, including a corporation owned by the stockholders. The Board of Directors may amend or terminate the Supplemental Plan at any time. The Supplemental Plan will continue in effect indefinitely unless the Board of Directors decides to terminate the plan earlier.
For the three months ended March 31, 2005, there were no purchases of equity securities by us and/or our affiliated purchasers.
Item 6.
Item 6.
Selected Consolidated Financial Data
Item 7.
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
In addition to historical information, this quarterly report contains forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Management’s Discussion and Analysis” and “Risks Related to Our Business.” Actual results could differ materially. Important factors that could cause actual results to differ materially include, but are not limited to, the level of demand for Selectica’s products and services; the intensity of competition; Selectica’s ability to effectively manage product transitions and to continue to expand and improve internal infrastructure; and risks associated with potential acquisitions. For a more detailed discussion of the risks relating to Selectica’s business, readers should refer to the section later in this report entitled “Risks Related to Our Business.” Readers are cautioned not to place undue reliance on the forward-looking statements, including statements regarding the Company’s expectations, beliefs, intentions or strategies regarding the future, which speak only as of the date of this quarterly report. Selectica assumes no obligation to update these forward-looking statements.
The following table sets forth the percentage of total revenues for certain items in the Company’s Consolidated Statements of Operations data for the years ended March 31, 2005, 2004, and 2003.
Overview
We develop, market, sell and support software that helps companies with multiple product lines and channels of distribution to effectively configure, price, quote and manage the contracting process for their products and services. Our products enable customers to increase revenue and profit margins and reduce costs through seamless, web-enabled automation of the “quote to contract” business processes which reside between legacy CRM and ERP systems. Over the past number of years, Selectica solutions have been successfully implemented at a number of companies such as IBM, Cisco Systems, Dell, Rockwell and GE Healthcare. However, these types of large system sales have declined significantly over the past several quarters due, we believe, to reduced IT spending, reluctance of customers to undertake large, custom project implementations our target customers’ growing preference for smaller scale, more focused system implementations, and increased competition from suite vendors such as Oracle, SAP and Siebel and point application software vendors like Comergent Technologies, Firepond and Trilogy.
In response to this development over the past year, we developed and introduced a “next generation” product family branded as EPS-M, which utilizes state-of-the-art technology and the power of our configuration, and pricing engines in a less expensive, more application focused offering. We have also been focused on expanding our product footprint and value proposition by extending into the growing contract management and compliance market. We began to achieve this objective shortly after the close of fiscal 2005 with the acquisition of certain of the assets of Determine. The products acquired also extend our business model by permitting us to offer an on-demand/hosted software-as-a-service solution for our customers. This on-demand/hosted solution will initially focus around contract management. We intend to integrate contract management and compliance functionality into our EPS-M product during the first half of fiscal 2006. With these new products, we are seeking to attract a middle market customer segment interested in using application software to manage complex product and service offering data, pricing management, contract management, compliance and speed new product or brand launches. Concurrent with the development, marketing and sales of these new products, we will continue to sell and support our existing platform products.
Also in response to these business developments, we have worked to reduce our operating costs through the reduction of personnel and other costs. These cost reductions are described further below. During fiscal 2005, we faced significant challenges as bookings of platform products underperformed expectations for the reasons described above and sales of the new EPS-M product family did not begin as projected. We expect our new bookings to continue to be challenged for at least the next two quarters as we transition to these new products, enter new markets and retool our sales force to sell our new products in new markets.
In addition, we spent significant time and expense during fiscal 2005 pursuing the acquisition of I-many, Inc., a provider of contract management and compliance software. Although management and the Board of Directors of I-many supported the transaction, a number of I-many’s stockholders were not satisfied with the agreed upon price and did not approve the transaction. As a result, the proposed merger agreement was terminated. As described above, we were able to enter the contract management and compliance market
through our recent acquisition of certain assets of Determine. Additionally, Trilogy, a competitor, announced in January 2005, a conditional unsolicited offer to acquire us. As previously disclosed, our Board of Directors carefully considered the Trilogy offer and rejected it. At the same time, Trilogy and Selectica have each filed patent infringement complaints against the other. This activity by Trilogy has caused diversion of our management’s attention and has caused us to incur significant legal expense. Further, our management believes that Trilogy’s actions have negatively impacted and may continue to negatively impact our business by slowing or preventing new bookings.
During fiscal 2005, we made key changes to our management team. Mr. Vince Ostrosky joined us in October 2004 as Chairman and Chief Executive Officer. Mr. Ostrosky is an industry veteran with significant experience in the CRM and supply chain markets.
Summary of Operating Results for 2005
For the year ended March 31, 2005, our revenues were approximately $31.1 million with license revenues representing 29% and services revenues representing 71% of total revenues. In addition, approximately 60% of our annual revenue came from four customers. License margin for the year was 91% and services margin was 43%. Total operating expenses were $34.6 million. The operating expenses increased significantly due to the attempted merger with I-many, Inc., patent litigation costs, consulting and audit costs associated with compliance with Sarbanes-Oxley, recruitment of a new CEO, and continued restructuring charges. Net loss for the year was approximately $14.7 million or $.45 per share.
Key Performance Indicators
Bookings and Revenue
Due to the nature and scope of our product implementations, we typically recognize revenue from contracts signed during a particular quarter (“bookings) over several quarters or fiscal years. Please see also our discussion of bookings in the “Overview” section of this Item 7 above.
Expense Management
Total annual expense levels for normal operations in fiscal 2005, which exclude non-cash charges and restructuring charges, were approximately $43.4 million. Total annual expense levels in fiscal 2004 for normal operations, which exclude non-cash charges, legal settlements, and severance agreement with the former CEO, were approximately $47.9 million. These decrease in annual expenses were due to significant headcount reductions, closure of some of our foreign offices, and reduction in spending in all areas. These reductions were offset by approximately $1.6 million of legal, consulting and investment banking fees incurred for the unsuccessful merger with I-many, Inc., approximately $1.1 million accounting, audit and legal fees associated with compliance with Sarbanes-Oxley, and approximately $600,000 of severance and related benefits associated with staff reductions and office closures.
In January 2005, we reduced our headcount by 34 employees. This reduction represents an annual savings in personal expenses of approximately $3.4 million. We made an additional reduction in staff of 42 employees in May 2005. This second reduction represented an additional annual savings in personnel expenses of approximately $3.9 million. These reductions along with cost reductions associated with costs of benefits, travel, office expense, and other support expenses, are expected to have aggregate cost savings of approximately $8.0 million in fiscal 2006.
Outlook for 2006
Revenue is expected to be flat or decline during fiscal 2006. The Company has changed its business model, which will require establishing a new and larger customer base, and a mix of products and services associated with the model. On our current business model, our backlog of projects with deferred revenue continues to decline due to weak bookings during fiscal 2005. Efforts are focused on increasing bookings during the year to resume growth beyond fiscal 2006. We currently anticipate that the acquisition of
Determine’s assets will contribute approximately $1.5 million in bookings during fiscal 2006, however, revenue recognized on such bookings will depend on the specific terms and conditions. We anticipate that the majority of customers for our contract management solutions will choose an ASP hosted solution with payments typically made monthly or quarterly. Therefore, contract management products are expected to generate a new revenue stream that will build over time. This will extend the time necessary to achieve breakeven, which we do not anticipate until the end of fiscal 2007.
Additionally, management will continue to review the Company’s cost structure to minimize expenses and use of cash as it implements its planned business model changes. Although it is not assured, this activity may result in additional restructuring charges for severance and other benefits, and excess leased facilities that could result in significant one-time charges during fiscal 2006.
Critical Accounting Policies and Estimates
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States. These accounting principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. Our management is also required to make certain judgments that affect the reported amounts of revenues and expenses during the reporting period. We periodically evaluate our estimates including those relating to revenue recognition, allowance for doubtful accounts, litigation and other contingencies. The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our consolidated financial statements. We evaluate our estimates and judgments on an on-going basis. We base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances. Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may vary from what we anticipate and different assumptions or estimates about the future could change our reported results. We believe the following accounting policies are the most critical to us, in that they are important to the portrayal of our financial statements and they require our most difficult, subjective or complex judgments in the preparation of our consolidated financial statements:
Revenue Recognition
We enter into arrangements for the sale of 1) licenses of software products and related maintenance contracts; 2) bundled license, maintenance, and services; and 3) consulting services. In instances where maintenance is bundled with a license of software products, such maintenance term is typically one year.
For each arrangement, we determine whether evidence of an arrangement exists, delivery has occurred, the fees are fixed or determinable, and collection is probable. If any of these criteria are not met, revenue recognition is deferred until such time as all of the criteria are met.
Arrangements consisting of license and maintenance only. 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 prescribed by Statement of Position 98-9 “Modification of SOP No. 97-2 Software Revenue Recognition, with Respect to Certain Transactions.” We recognize maintenance revenues over the term of the maintenance contract because vendor-specific objective evidence of fair value for maintenance exists. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If vendor specific objective evidence does not exist to allocate the total fee to all undelivered elements of the arrangement, revenue is deferred until the earlier of the time at which (1) such evidence does exist for the undelivered elements, or (2) all elements are delivered. If unspecified future products are given over a specified term, we recognize license revenue ratably over the applicable period. We recognize license fees from resellers as revenue when the above criteria have been met and the reseller has sold the subject licenses through to the end-user.
Arrangements consisting of license, maintenance and other services. Services revenues can consist of maintenance, training and/or consulting services. Consulting services include a range of services including installation of off-the-shelf software, customization of the software for the customer’s specific application, data conversion and building of interfaces to allow the 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 the software requires the building of interfaces to the customer’s existing applications or customization of the software for specific applications. As a result, judgment 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 the likelihood of 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 under the percentage of completion contract method in accordance with the provisions of SOP 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts.” We follow the percentage of completion method if reasonably dependable estimates of progress toward completion of a contract can be made. We estimate the percentage of completion on contracts utilizing hours and costs incurred to date as a percentage of the total estimated hours and costs to complete the project. Recognized revenues and profits are subject to revisions as the contract progresses to completion. Revisions in profit estimates are charged to income in the period in which the facts that give rise to the revision become known. We also account for certain arrangements under the completed contract method when we do not have the ability to reasonably estimate progress toward completion. To date, when we have been primarily responsible for the implementation of the software, services have been considered essential to the functionality of the software products, and therefore license and services revenues have been recognized pursuant to SOP 81-1.
For those contracts that include contract milestones or acceptance criteria, we recognize revenue as such milestones are achieved or as such acceptance occurs.
For those contracts with unspecified future products and services which are not essential to the functionality of the other elements of the arrangement, license revenue is recognized by the subscription method over the length of time that the unspecified future product is available to the customer.
In some instances the acceptance criteria in the contract require 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 services qualify for separate accounting, we use vendor-specific objective evidence of fair value for 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 previously noted, 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 of fair value in multiple element arrangements.
In accordance with Statement of Position 97-2, “Software Revenue Recognition,” vendor-specific objective evidence of fair value of maintenance is determined by reference to the price the customer will be required to pay when it is sold separately (that is, the renewal rate). Each license agreement offers additional maintenance renewal periods at a stated price. Maintenance contracts are typically one year in duration.
Arrangements consisting of consulting services. Consulting services consists of a range of services including installation of off-the-shelf software, customization of the software for the customer’s specific application, data conversion and building of interfaces to allow the software to operate in customized environments. Consulting services may be recognized based on customer acceptance in the form of customer-signed timesheets, invoices, cash received, or customer-signed acceptance as defined in the master service agreement.
The following table shows how our revenue has been recognized:
Customer billing occurs in accordance with contract terms. Customer advances and amounts billed to customers in excess of revenue recognized are recorded as deferred revenues. The majority of our contracts have been accounted for on completed contract method upon achievement of milestones or final acceptance from the customer.
Short Term Investments
The Company monitors its investments for impairment on a quarterly basis and determines whether a decline in fair value is other-than-temporary by considering factors such as current economic and market conditions, the credit rating of the issuers, the length of time an investment has been below our carrying value and our ability and intent to hold the investment to maturity. If a decline in fair value, caused by factors other than changes in interest rates, is determined to be other-than-temporary, an adjustment is recorded and charged to operations.
Allowance for Doubtful Accounts
We evaluate the collectibility of our accounts receivable based on a combination of factors. When we believe a collectibility issue exists with respect to a specific receivable, we record an allowance to reduce that receivable to the amount that we believe to be collectible. In making the evaluations, we will consider the collection history with the customer, its credit rating, communications with the customer as to reasons for the delay in payment, disputes or claims filed by the customer, warranty claims, non-responsiveness of customers to collection calls, feedback from the responsible sales contact. In addition, we will also consider general economic conditions, the age of the receivable and the quality of the collection efforts.
Contingencies and Litigation
We are subject to various proceedings, lawsuits and claims relating to product, technology, labor, shareholder and other matters. We are required to assess the likelihood of any adverse outcomes and the potential range of probable losses in these matters. The amount of loss accrual, if any, is determined after careful analysis of each matter, and is subject to adjustment if warranted by new developments or revised strategies.
Related Party Transaction and Severance Agreement
In connection with the resignation of Dr. Sanjay Mittal, Chief Executive Officer, the Company agreed to have him continue as Chief Technical Advisor (“CTA”). Pursuant to this arrangement, Dr. Mittal received $20,000 per month for his services and this arrangement would continue until either party terminates the CTA service. During the year ended March 31, 2005, the Company recorded approximately $220,000 as outside services expenses in general and administration. In March 2005, Dr. Mittal’s role as CTA was terminated and he received a lump-sum severance payment of $412,500 in addition to the amount paid for outside services. Since the Company believed the payment was estimatable and probable, and therefore, accrued for this amount in September 2003, as compensation expense of which approximately $93,000 was included in the cost of goods sold, approximately $231,000 was included in research and development, approximately $52,000 as a sales and marketing expense and approximately $37,000 was included as a general and administrative expense.
Factors Affecting Operating Results
A small number of customers account for a significant portion of our total revenues. We expect that our revenue will continue to depend upon a limited number of customers. If we were to lose a customer, it would have a significant impact upon future revenue. Customers who accounted for at least 10% of total revenues were as follows:
To date, we have foreign activities in India, Canada and some European and Asian countries because we believe international markets represent a significant growth opportunity. We anticipate that our exposure to foreign currency fluctuations will continue since we have not adopted a hedging program to protect us from risks associated with foreign currency fluctuations.
We have incurred significant losses since inception and, as of March 31, 2005, we had an accumulated deficit of approximately $172.6 million. We believe our success depends on the growth of our customer base and the development of the emerging configuration, pricing management, quoting solutions and the contract management and compliance market. In the early 2000’s, we underwent certain restructuring activities and again during the fourth quarter of the fiscal year of 2005, and the first quarter of fiscal year 2006, in an effort to achieve profitability. As a result of these restructuring activities, we reduced our headcount by 38 individuals globally or approximately 7% of our workforce as of March 31, 2003. In addition, we reduced our headcount by 34 individuals globally or approximately 10% of our workforce as of December 31, 2004, and by 42 individuals globally or approximately 16% of our workforce as of April 30, 2005.
In view of the rapidly changing nature of our business, we believe that period-to-period comparisons of revenues and operating results are not necessarily meaningful and should not be relied upon as indications of future performance. Our operating history has been volatile and makes it difficult to forecast future operating results. This was evidenced by the decline in revenue in fiscal 2005, the slight growth in fiscal 2004, and decline in fiscal 2003.
Because our services tend to be specific to each customer and how that customer will use our products, and because each customer sets different acceptance criteria, it is difficult for us to accurately forecast the
amount of revenue that will be recognized on any particular customer contract during any quarter or fiscal year. As a result, we base our revenue estimates, and our determination of associated expense levels, on our analysis of the likely revenue recognition events under each contract during a particular period. Although the value of customer contracts signed during any particular quarter or fiscal year is not an accurate indicator of revenues that will be recognized during any particular quarter or fiscal year, in general, if the value of customer contracts signed in any particular quarter or fiscal year is lower than expected, revenue recognized in future quarters and fiscal years will likely be negatively effected.
Results of Operations
Revenues
License. Fiscal 2005 license revenue decreased on an annual basis by approximately $7.8 million. This was due to a decreasing number of new licenses, delays in deployment and customer acceptance where license fees were dependent on completion of service projects. License revenues also decreased in fiscal 2005 because of recognition of revenue on a significant contract in fiscal 2004, as described below. This contract accounted for approximately a $9.5 million decrease in license revenues offset by other contracts where license revenue was recognized upon comparison to fiscal 2004. Fiscal year 2004 license revenues increased on an annual basis by approximately $6.7 million compared to fiscal 2003 primarily due to one significant contract that was signed in December 2002. The license revenue for this contract was recognized on a subscription basis for the twelve months ending in December 2003, due to the right to unspecified future products. Fiscal 2005 license revenues and Fiscal 2004 license revenues came primarily from three significant customers, two of which were signed in fiscal 2003 and one in fiscal 2002.
Due to the shift in our strategy and business model, we expect license revenues to continue to decrease in future periods as a percentage of total revenues and in absolute dollars. The level of revenues is also dependent on the number and size of new license contracts. Fluctuations in revenue may also occur due to timing of revenue recognition, based and achievement of milestones, customer acceptance, changes in scope or renegotiated terms and additional services.
Services. Services revenues are comprised of fees from consulting, maintenance, training and out-of pocket reimbursement. Maintenance revenues represented 35%, 35%, and 25% of total services revenues for the years ended March 31, 2005, 2004, and 2003, respectively. During fiscal 2005, services revenue decreased by approximately $1.1 million compared to fiscal 2004. This decrease is also attributable to a decrease in the number of new licenses and the services associated with them. During fiscal 2004, services revenues decreased on an annual basis by approximately $2.3 million compared to fiscal 2003. In 2004, we experienced less services revenues, compared to fiscal 2003, from our installed base as customers expanded their Selectica platforms, offset by an increase in maintenance revenues of approximately $1.8 million.
In fiscal 2005, service revenue was not reduced by the cost of professional services from any value added reseller because there were no such costs. The number of customers with maintenance contracts declined, and maintenance revenues decreased by approximately $421,000. The balance of this decrease was due to higher service revenues on one significant contract in 2004. In fiscal 2004, services revenue was reduced by approximately $21,000 to related to the cost of professional services from a value added reseller and increased approximately $385,000 due to a reduction in the allowance for bad debt which was originally recorded against revenue. In fiscal 2003, services revenue was reduced by approximately $158,000 related to the cost of professional services from a value added reseller and decreased approximately $126,000 due to a reduction in the allowance for bad debt which was originally recorded against revenue.
We expect services revenues to continue to fluctuate in future periods as a percentage of total revenues and in absolute dollars. This will depend on the number and size of new software implementations and follow-on services to our existing customers. We expect maintenance revenue to fluctuate in absolute dollars and as a percentage of services revenues with respect to the number of maintenance renewals, and number and size of new license contracts. In addition, maintenance renewals are extremely dependent upon customer satisfaction and the level of need to make changes or upgrade versions of our software by our customers. Fluctuations in revenue are also due to timing of revenue recognition, based and achievement of milestones, customer acceptance, changes in scope or renegotiated terms, and additional services.
Cost of Revenues
Cost of License Revenues. Cost of license revenues consists of royalty fees associated with third-party software, 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. During fiscal 2005, these costs decreased along with the decrease in license revenues. We experienced an increase in costs during fiscal 2004 compared to fiscal 2003 due to the write-off of approximately $268,000 of prepaid royalties associated with third party products. These amounts were expensed primarily due to delays in the timing and changing priorities of new product releases. Excluding this write-off, costs of license revenues for fiscal 2004 were consistent with the prior year. In addition, costs of licenses have a component of fixed costs that are not dependent upon sales volume. We expect cost of license revenues to maintain a relatively consistent level in absolute dollars.
Cost of Services Revenues. Cost of services revenues is comprised mainly of salaries and related expenses of our services organization plus certain allocated expenses. In fiscal 2005, we experienced a decrease of approximately $4.4 million in cost of services revenue due to restructuring efforts initiated in fiscal 2004 as well as fiscal 2005. The latter related to a reduction in force of 22 professional services staff and further deployment of service work to India, which reduced costs by approximately $2.5 million. This included reducing the number of India employees working in the U.S. office and the per diem costs associated with housing them in the U.S. There were also reductions in third party consulting costs of approximately $280,000, and deferred project costs of approximately $341,000. Deferred compensation costs were reduced by approximately $433,000. The balance of the reductions were attributable to lower facilities and depreciation expenses.
We experienced a decline of $1.7 million in costs of services revenues during fiscal 2004 primarily due to of our restructuring efforts, the increase in utilization rates of individuals, and the continual efforts to shift work to lower cost regions, primarily India, in the consulting and technical support functions. The decline in costs of revenues during fiscal 2004 were partially offset by the recognition of deferred costs related to deferred revenue contracts and severance benefits paid to terminated employees not associated with restructuring during the year. In fiscal 2004, we recorded approximately $437,000 for deferred compensation related to stock options, approximately $89,000 for stock option modification charges, approximately $37,000 for compensation expense related to option acceleration, $39,000 for restructuring costs related to the severance and benefits paid to terminated employees, and approximately $93,000 related to the lump-sum severance payment to the Chief Technical Advisor (“CTA”), respectively. The decrease in cost of service revenues in fiscal 2004 compared to fiscal 2003 was also comprised of approximately $2.3 million in reduced outside consultant fees and $1.5 million in reduced travel expenses. These reductions were offset by increases in facilities and overhead support costs by shifting more of the work internally.
We expect cost of services revenues to fluctuate as a percentage of service revenues and we plan to reduce our investment in cost of services revenues in absolute dollars over the next year as necessary to balance expense levels with projected revenues.
Gross Margin
Gross Margin - Licenses. Because we have certain license costs that are fixed, gross margins fluctuate until we have sufficient license revenues. License margins may also fluctuate due to embedded third-party software. When license software products are sold with royalty bearing software, margins are lower than when license software without such third party products are sold. Accordingly, margins will vary based on gross license revenue and product mix.
Cost of licenses for the fiscal years ending March 31, 2005, 2004, and 2003 have not fluctuated significantly as a percentage and in absolute dollars. Due to lower license revenues in fiscal 2003, we experienced lower gross margins for licenses. In fiscal 2005 and 2004, we experienced similar levels of gross margins. The decrease in license gross margin in fiscal 2005 compared to fiscal 2004 was due to recognition license revenue on a large license in fiscal 2004, which had been deferred deferred from fiscal 2003. In fiscal 2005, license gross margin also decreased due to a decrease in the number of new licenses and completion of new deployments. Gross margin on license revenue increased in fiscal 2004 compared to fiscal 2003 because of the significant revenue recognized on one significant contract signed in late 2002.
Gross Margin - Services. While services revenues decreased by $1.1 million in fiscal 2005 to $22.0 million, gross margin improved to 43% from 27% in fiscal 2005. This was attributable to cost reductions in professional service staff and related costs. Services revenues have decreased from $25.4 in fiscal 2003 to $23.1 million in fiscal 2004, and to $22.0 million in fiscal 2005. While services revenues have decreased, we have also been able to decrease our costs significantly in order to maintain a higher services margin. This was attributable to reductions in professional services staff in 2004 whose cost reductions were more fully reflected in 2005. This is in addition to a reduction in professional staff in January 2005. The improvement was also due to completion of a number of lower margin contracts in fiscal 2004. In addition, there was a significant service implementation in fiscal 2005 for which we performed significant services and expensed in fiscal 2004 in advance of the contract signing. This created higher margins in fiscal 2005 on that particular contract.
In fiscal 2004, we balanced expenses with services revenues to maintain stronger services margins without sacrificing overall customer satisfaction.
We expect that our overall gross margins will continue to fluctuate due to the timing of services and license revenue recognition and will continue to be adversely affected by lower margins associated with services revenues. The impact on our gross margin will depend on the mix of services we provide, whether the services are performed by our in-house staff or third party consultants, and the overall utilization rates of our professional services organization.
Expenses
Research and Development. Research and development expenses consist mainly of salaries and related costs of our engineering, quality assurance, technical publications efforts, and certain allocated expenses. The decrease in research and development expenses of approximately $1.1 million in fiscal 2005 compared to fiscal 2004 was attributable to a reduction in force of 20 personnel and the related costs for facilities, overhead and benefits. Headcount reductions lowered salaries and benefits by approximately $2.0 million. The slight increase of approximately $272,000 in fiscal 2004 compared to fiscal 2003 was primarily due to severance related charges. During fiscal 2004, we expensed approximately $231,000 related to the lump-sum severance payment to the CTA, approximately $166,000 for deferred compensation related to stock options, approximately $138,000 for stock option modification charges, approximately $74,000 for compensation expense related to option acceleration, and $199,000 for costs related to the severance and benefits paid to terminated employees. We may reduce expenses in research and development in absolute dollars over the next year as necessary to balance total expenses. There were no non-cash stock compensation charges to research and development in fiscal 2005.
Sales and Marketing. Sales and marketing expenses consist mainly of salaries and related costs for our sales and marketing organization, sales commissions, expenses for trade shows, public relations, collateral sales materials, advertising and certain allocated expenses. In fiscal 2005, sales and marketing expenses decreased by approximately $2.6 million when compared to fiscal 2004. The decrease was primarily attributable to reductions of 8 staff with salaries and benefits of approximately $900,000 and reductions in commissions and bonuses of approximately $1.5 million. Commissions and bonuses were lower due to a decrease in revenues and bookings targets for 2005 when compared to fiscal 2004. There were also decreases of approximately $89,000 in facilities and office support expenses (legal, office supplies, travel, depreciation) and an approximately $352,000 reduction in marketing and promotional expenses. Non-cash stock compensation charges also decreased from fiscal 2005 compared to fiscal 2004, by approximately $522,000. These decreases were offset by approximately $272,000 of increases in non-billable project expenses, and approximately $711,000 of restructuring charges, including severance charges of approximately $373,000, for the Vice President of Business Development and other terminated sales employees.
The decrease of approximately $4.9 million in fiscal 2004 compared to fiscal 2003 was primarily due to the benefits of our restructuring activities. For fiscal 2004, we recorded expenses of approximately $348,000 for deferred compensation related to stock options, $909,000 for costs related to the severance and benefits paid to terminated employees, approximately $3,000 for compensation related to variable accounting, approximately $217,000 for stock option modification charges, approximately $250,000 related to an employee bonus associated with the Wakely Software acquisition, approximately $52,000 related to the lump-sum severance payment to the CTA, and approximately $93,000 for compensation expense related to option acceleration. The decrease in fiscal 2004 expenses compared to fiscal 2003 was attributable to decreases in salaries and benefits from headcount reductions of approximately $2.0 million, approximately $415,000 in travel expenses, $796,000 in reductions in marketing programs and promotions, $840,000 in facilities and overhead costs, and $408,000 in non-cash compensation charges and others.
We may increase our sales and marketing expenses in absolute dollars over the next year as necessary to reposition the company in the opportunity to order space.
General and Administrative. General and administrative expenses consist mainly of personnel and related costs for general corporate functions, including finance, accounting, legal, human resources, bad debt expense and certain allocated expenses. The increase of approximately $5.0 million in fiscal 2005 compared to fiscal 2004 was primarily due to increases in legal fees associated with patent litigation (approximately $1.9 million), accounting and audit fees associated with compliance with Sarbanes-Oxley (approximately $1.1 million), the hiring of a new CEO and the related recruiting and benefit costs (approximately $437,000), and severance benefits to the VP Finance (approximately $143,000). We also incurred approximately $1.6 million of legal and consulting fees associated with the unsuccessful merger with I-many, Inc. The increase due to Sarbanes-Oxley included approximately $660,000 of audit fees and accounting consulting fees of approximately $399,000. These increase were offset by reductions in facilities and depreciation costs of approximately $208,000 and $335,000, respectively. In addition, non-cash compensation charges decreased by
approximately $312,000 in fiscal 2005, because there were no such expenses during the current fiscal year compared to fiscal 2004.
The decrease of approximately $683,000 in fiscal 2004 compared to fiscal 2003 was primarily due to our restructuring efforts including headcount reductions. In fiscal 2004, we amortized approximately $166,000 for deferred compensation related to stock options, recorded approximately $146,000 for compensation related to variable accounting and expensed approximately $37,000 related to the lump-sum severance payment to the CTA. For fiscal 2003, we recorded expenses of approximately $332,000 for deferred compensation expense relations to stock options, approximately $720,000 for restructuring, principally comprised of reductions in headcount, and approximately $5,000 of compensation expense related to variable accounting. In addition, we reduced the allowance for doubtful accounts by approximately $450,000 primarily due to lower bad debt exposure from lower levels of accounts receivable, originally recorded against general and administrative expenses.
The decrease in general and administrative expenses in fiscal 2004 compared to fiscal 2003 was attributable to decreases in facilities costs of approximately $530,000 due to the closure of several offices, and approximately $792,000 related to restructuring charges and deferred compensation charges due to variable accounting. These decreases were offset by increases in employee benefits of approximately $345,000 and legal fees associated with the class action litigation of approximately $288,000.
We may reduce general and administrative expenses in absolute dollars over the next year as necessary to balance total expenses.
Restructuring. In the quarter ended March 31, 2001, we began restructuring worldwide operations to reduce costs and improve efficiencies in response to a slower economic environment. The restructuring costs were accounted for under EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit and Activity,” and were charged to operations when the criteria in EITF 94-3 were met. The first plan (“Plan 1”) was initiated in the quarter ended March 31, 2001 and was comprised of severance and related benefits of $667,000 for the reduction of 30 staff in the areas of professional services, research and development, sales, marketing, and general administration. The second plan (“Plan 2”) was initiated and completed in the quarter ended June 30, 2001 and was comprised of severance and related benefits of $1.8 million for the reduction of 41 staff in the areas of professional services, research and development, sales, marketing, and general administration. The third plan (“Plan 3”) was initiated in July 2002 and was comprised of severance and related benefits of $1.7M for the reduction of 38 staff in the areas of professional services, research and development, sales, marketing, and general administration and were completed by the fourth quarter of 2004.
Plan 1 reduced headcount by 6, 3, 11, and 10 for professional services, research and development, sales and marketing, and general administration, respectively. The anticipated savings for salaries and benefits on an annual basis was approximately $3.3 million. Plan 2 further reduced headcount by 5, 18, 17, and 1 for professional services, research and development, sales and marketing and general administration, respectively. The anticipated savings for salaries and benefits on an annual basis is approximately $4.4 million. Plan 3 reduced headcount by 9, 7, 17, and 5 for professional services, research and development, sales and marketing, and general administration, respectively. The savings for salaries and benefits on an annual basis was approximately $3.5 million.
In January of 2005, we implemented another reduction of 34 staff. This reduction was in response to a decline in bookings and the need to further balance expenses due to the Company’s change in strategy. The reduced headcounts were 5, 20, 8, 1 for professional services, research and development, sales and marketing, and general and administrative areas, respectively. These reductions were offset by related severance costs of $868,000 and the use of outside services and consultants to assume certain tasks and ongoing projects. The severance and employee benefits were substantially paid off by the end of the fiscal year. The savings from this reduction was approximately $3.4 million annually.
In May 2005, we further reduced staff by a total of 42 people, broken down to 11, 8, 12, and 11 for professional services, research and development, sales and marketing, and general and administrative, respectively. The approximate savings from this reduction was $3.9 million annually.
Other Income, Net
In December 2003, pursuant to an asset purchase agreement we sold our rights to intellectual property targeted specifically for a portion of the health insurance market segment to Accenture Global Services, GmbH for $1.4 million. As part of the transaction, six employees accepted employment with Accenture prior to the closing, and we entered into a non-compete clause for five years in the market segment. The transaction expenses associated with the sale were approximately $300,000 including approximately $250,000 in bonuses and approximately $30,000 for compensation related to acceleration of stock option vesting. We recognized approximately $1.1 million in other income during the quarter. In fiscal 2005, a penalty reserve of $95,000 associated with this sale expired without claims and the amount was released to operations.
Interest Income
Interest income consists primarily of interest earned on cash balances, short-term and long-term investments, and stockholders’ notes receivable. In August of 2003, all notes receivable from certain key employees were paid in full along with calculated interest.
Interest income increased in 2005 due to investment of $20 million in higher rate instruments from cash equivalent accounts. This reinvestment accounted for the increase in interest income of $266,000. The decrease in fiscal 2004 was due primarily to lower interest rates and lower cash balances.
Provision for Income Taxes
We recorded a tax benefit of $117,000 for fiscal 2005. We did not record a provision for fiscal 2003 and 2004. This tax benefit is the result of a reduction in U.S. tax reserves of approximately $235,000 offset by foreign and state income tax provisions of approximately $118,000. This overall benefit is based on our current estimates of taxes due in foreign jurisdictions and nominal income tax amounts for U.S. federal and state taxes, due to our significant U.S. net operating loss carryforwards.
The 2005, 2004 and 2003 tax provisions vary from the expected benefit at the U.S. federal statutory rate due to the recording of valuation allowances against our U.S. operating loss and the effects of different tax rates in our foreign jurisdictions. Given our history of operating losses and our ability to achieve profitable operations, it is difficult to accurately forecast how results will be affected by the realization of net operating loss carryforwards.
FASB Statement No. 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based upon the weight of available evidence, which includes our historical operating performance and the reported cumulative net losses in all prior years, we have provided a full valuation allowance against our net deferred tax assets. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis.
Recent Accounting Pronouncements
In December 2004, the FASB issued Statement No. 123 R, “Share-Based Payment”, as an amendment to FASB No. 123. FASB 123 R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period (usually the vesting period). No compensation cost is recognized for equity instruments for which employees do not render the requisite service. Employee share purchase plans will not result in recognition of compensation cost if certain conditions are met; those conditions are much the same as the related conditions in FASB No. 123. FASB 123 R will be effective for us as of the first quarter of fiscal 2006, beginning April 1, 2006. The Company is in the process of determining how the new method of valuing stock-based compensation as prescribed under FASB 123 R will
be applied to stock based awards after the effective date and the impact the recognition of compensation expense related to such awards will have on its operating results.
Liquidity and Capital Resources
Our primary sources of liquidity consisted of approximately $93.3 million in cash, cash equivalents and short-term investments as of March 31, 2005 compared to approximately $97.3 million in cash, cash equivalents and short-term investments as of March 31, 2004.
In fiscal 2005, we funded our operations through the sale of long and short-term investments. Net cash used in operating activities of approximately $19.2 million included an operating loss of approximately $14.7 million. Adjustments for non-cash expenses for depreciation of approximately $1.3 million were offset by increases in accounts receivable of approximately $2.1 million, a decrease in deferred revenue of approximately $5.0 million, and reductions in accrued severance liabilities and sales taxes.
The $19.2 million of cash provided by investing activities in fiscal 2005 was primarily due to proceeds from the sale of approximately $20.0 million of short and long-term investments offset by purchases of capital equipment of approximately $880,000. Net cash provided by financing activities were approximately $561,000 attributable to proceeds of approximately $1.4 million from the exercise of stock options and employee stock purchases in fiscal 2005. This was offset by approximately $798,000 repurchases of common stock during the year.
In fiscal 2005, we had a slight increase in working capital primarily due to sales of long-term investments offset by cash used in operations, a decrease in deferred revenue, purchase of capital equipment, and common stock repurchases. In fiscal 2004, we experienced a net decrease in working capital primarily due to the cash used in operations, stock repurchases, capital expenditures, and greater long-term investments offset by a decrease in liabilities, primarily related to deferred revenue
Sources of liquidity consisted of approximately $97.3 million in cash, cash equivalents and short-term investments as of March 31, 2004 compared to approximately $109.2 million in cash, cash equivalents and short-term investments as of March 31, 2003. The decrease from fiscal 2004 compared to 2003 primarily related to approximately $10.2 million of cash used in operations, a net approximately $22.6 million used for long and short term investments, approximately $573,000 for capital expenditures, $1.3 million for stock repurchase in the open market, offset by approximately $6.4 million of proceeds from issuance of common stock and approximately $730,000 from proceeds from stockholders notes receivable.
Net cash used for operating activities during fiscal 2004 reflects net loss of approximately $8.8 million. The net cash used for operating activities in fiscal 2004 was primarily due to net loss adjusted for non-cash expenses, the decrease of accounts receivable, prepaid expenses and other current assets offset by a decrease in deferred revenue. The net cash used for operating activities in fiscal 2003 was due primarily to the net loss adjusted for non-cash expenses and the cumulative effect of an accounting change to adopt FAS 142. In addition, we experienced a net increase in cash due to the reduction of accounts receivable and increase in deferred revenues, offset by the decrease of accounts payable and payroll related liabilities.
The $21.9 million of net cash used by investing activities in fiscal 2004 was due primarily to the net purchase of approximately $20.0 million of short and long-term investments. The $21.6 million of net cash
provided by investing activities in fiscal 2003 was due primarily to approximately $23.1 million of net proceeds from the maturity of short-term and long-term investments offset by approximately $1.5 million for capital expenditures.
The $5.8 million of net cash provided by financing activities in fiscal 2004 was primarily from the proceeds from issuance of common stock offset by the cash used to repurchase our common stock. The $12.6 million of net cash used for financing activities in fiscal 2003 was primarily the result of the cash used to repurchase our common stock.
In August 2001, the Board authorized the Company to repurchase up to $30.0 million worth of stock in the open market subject to certain criteria as determined by the Board. In May 2003, the Board approved an additional stock buyback program to repurchase up to $30 million worth of stock in the open market subject to certain criteria as determined by the Board.
During the year ended March 31, 2005, we repurchased approximately 201,500 shares of its common stock at an average price of $3.96 in the open market at a cost of approximately $798,000 including brokerage fees. During the year ended March 31, 2004, we repurchased 383,600 shares of its common stock at an average price of $3.33 in the open market at a cost of approximately $1.3 million including brokerage fees.
We have repurchased approximately 6.4 million shares at a cost of approximately $22.0 million including brokerage fees since inception of the repurchase program.
From time to time, we are required to obtain letters of credit that serve as collateral for our obligations to third parties under facility lease agreements. These letters of credit are secured by investments and are recorded as restricted long-term investments in the balance sheet. We currently have one letter of credit for $150,000 and have not drawn down on this letter of credit to date. The restricted short-term investment of approximately $182,000 is related to a facility lease agreement that has expiration date less than twelve months from March 31, 2005.
We had no significant commitments for capital expenditures as of March 31, 2005. We expect to fund our future capital expenditures, liquidity and strategic operating programs from a combination of available cash balances and internally generated funds. We have no outside debt, and do not have any plans to enter into borrowing arrangements. Our cash, cash equivalents, and short-term investment balances as of March 31,2005 are adequate to fund our operations through at least March 31, 2006.
We currently anticipate that the acquisition of Determine’s assets will contribute approximately $1.5 million in bookings during fiscal 2006, however, revenue recognized on such bookings will depend on the mix of contracts with licenses and professional services versus an ASP hosted solution with payments typically made monthly or quarterly. We anticipate that Determine’s cash flow will break even during fiscal 2006 and operate at breakeven for the same period.
We do not anticipate any significant capital expenditures, payments due on long-term obligations, or other contractual obligations. However, management is continuing to review the Company’s cost structure to minimize expenses and use of cash as it implements its planned business model changes. This activity may result in additional restructuring charges or severance and other benefits. Additionally, abandonment of excess leased facilities could result in significant one-time charges and use of cash, although such charges and use of cash are not assured.
Our contractual obligations and commercial commitments at March 31, 2005, are summarized as follows
We engage in global business operations and are therefore exposed to foreign currency fluctuations. As of March 31, 2005, the effects of the foreign currency fluctuations in Europe and India were insignificant.
Item 7A:
Item 7A:
Quantitative and Qualitative Disclosures About Market Risk
The following discusses our exposure to market risk related to changes in foreign currency exchange rates and interest rates. This discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results could vary materially as a result of a number of factors including those set forth in the Risk Factors section of this report.
Foreign Currency Exchange Rate Risk
We develop products in the United States and India and sell them worldwide. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since our sales are currently priced in U.S. dollars and are translated to local currency amounts, a strengthening of the dollar could make our products less competitive in foreign markets.
Our exposure to fluctuation in the relative value of other currencies has been limited because substantially all of our assets are denominated in U.S. dollars. The impact to our financial statements has therefore not been material. To date, we have not entered into any foreign exchange hedges or other derivative financial instruments. We will continue to evaluate our exposure to foreign currency exchange rate risk on a regular basis.
Interest Rate Risk
We established policies and business practices regarding our investment portfolio to preserve principal while obtaining reasonable rates of return without significantly increasing risk. This is accomplished by investing in widely diversified short-term and long-term investments, consisting primarily of investment grade securities. Our interest income is sensitive to changes in the general level of U.S. interest rates.
For fiscal 2005, a hypothetical 50 basis point increase in interest rates would have resulted in a reduction of approximately $170,000 (less than 0.17%) in the fair value of our cash equivalents and investments. This potential change is based upon a sensitivity analysis performed on our financial positions at March 31, 2005.
Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted because of a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations because of changes in interest rates or we may suffer losses in principal if forced to sell securities that have seen a decline in market value because of changes in interest rates. Our investments are made in accordance with an investment policy approved by the Board of Directors. In general, our investment policy requires that our securities purchases be rated A1/P1, AA/ Aa3 or better. No securities may have a maturity that exceeds 18 months and the average duration of our investment portfolio may not exceed 9 months. At any time, no more than 15% of the investment portfolio may be insured by a single insurer and no more than 25% of investments may be invested in any one industry other than the US government bonds, commercial paper and money market funds.
The following summarizes short-term and long-term investments at fair value, weighted average yields and expected maturity dates as of March 31, 2005:
Item 8.
Item 8.
Consolidated Financial Statements and Supplementary Data
Annual Financial Statements
Our financial statements required by this item are submitted as a separate section of the Form 10-K. See Item 15(a) for a listing of financial statements provided in the section titled “Financial Statements.”
Quarterly Results of Operations (Unaudited)
The following table sets forth, for the periods presented, selected data from our consolidated statements of operations. The data has been derived from our unaudited consolidated financial statements, and, in the opinion of our management, include all adjustments, consisting only of normal recurring adjustments, that are necessary for a fair presentation of the results of operations for these periods. This unaudited information should be read in conjunction with the consolidated financial statements and notes included elsewhere in this annual report. The operating results in any quarter are not necessarily indicative of the results that may be expected for any future period. We have incurred losses in each quarter since inception and expect to continue to incur losses for the foreseeable future.
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.
In the short term, we expect our quarterly revenues to be significantly dependent on the sale of a small number of relatively large orders for our products and services. In addition, our products and services generally have a long sales cycle. As a result, our quarterly revenues may fluctuate significantly if we are unable to complete one or more substantial sales in any given quarter. In many cases, we recognize revenues from licenses and services on a percentage-of-completion or subscription basis. Deployment of our products requires a substantial commitment of resources by our customers or their consultants over an extended period of time. The time required to complete a deployment may vary from customer to customer and may be protracted due to unforeseen circumstances. Our ability to recognize these revenues thus may be delayed if we are unable to meet milestones on a timely basis. Because operating expenses are relatively fixed in the near term, any shortfall in anticipated revenues could cause our quarterly operating results to fall below anticipated levels.
We may also experience seasonality in revenues and our revenues are impacted by current economic trends. For example, our quarterly results may fluctuate based upon our customers’ budgeting cycles as well as changes to such budgets based upon current economic trends. These seasonal variations and purchasing trends 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.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There is no disclosure to report pursuant to Item 9.
Item 9A.
Item 9A.
Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2005. Based on this evaluation, our chief executive officer and chief financial officer concluded that as of March 31, 2005, our disclosure controls and procedures were not effective because of the material weakness described below.
Report of Management on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). The Company’s internal control system is designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the reliability of financial reporting and the preparation of published financial statements in accordance with generally accepted accounting principles. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
A material weakness is a control deficiency or combination of control deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Based on management’s assessment of our internal control over financial reporting as of March 31, 2005, we have identified the following five material weaknesses.
First, management identified a material weakness for insufficient controls over the Quote to Collect process related to the review, approval, and accounting for the Allowance for Doubtful Accounts. The Company had incorrectly included a general reserve provision in the Allowance for Doubtful Accounts as of December 31, 2004. Also, the Company had incorrectly recorded a receivable as uncollectible as of March 31, 2005, for which payment was subsequently received after March 31, 2005 but prior to the completion of the quarterly close process. As a result of this material weakness, Accounts Receivable and Services Revenue were incorrectly stated. Adjustments were recorded to increase Accounts Receivable and Services Revenue as of December 31, 2004 and as of March 31, 2005, prior to the issuance of our financial statements for the respective dates.
Second, management identified a material weakness for insufficient controls for the Treasury process related to the classification of Cash Equivalents and Investments. The Company had incorrectly classified Cash Equivalents and Investments in its India subsidiary. As a result of this material weakness, Cash Equivalents, Short Term and Long Term Investments were not classified in accordance with generally accepted accounting principles. An adjustment was recorded to reduce Cash Equivalents and increase Short Term and Long Term Investments as of March 31, 2005.
Third, management identified the following deficiencies in its revenue recognition process, which constitute a material weakness in the aggregate.
a) Insufficient controls over the monitoring of deferred revenue accounts for the purpose of determining when revenue should be recognized. The Company failed to reverse deferred revenue when all criteria for revenue recognition had occurred.
b) Insufficient controls for the identification of services to be provided to customers at no charge. The Company inappropriately recorded revenue related to a service provided to a customer that was provided for no charge.
Fourth, management identified the following deficiencies in its payroll process, which constitute a material weakness in the aggregate.
a) Insufficient controls over the recording of expenses related to the benefits of terminated employees. The Company had failed to record the expenses related to the benefits extended when employees were involuntarily terminated as part of a reduction in force program. These inadequate controls resulted in an adjustment as of March 31, 2005 to increase Accrued Payroll and Related Liabilities, and increase Sales and Marketing expense.
b) Insufficient controls over the recording of expenses related to the acceleration of stock options for a former executive. The error arose because of a lack of in-depth review of the appropriate accounting treatment for this transaction. These inadequate controls resulted in an adjustment as of March 31, 2005 to decrease Additional Paid In Capital and Sales and Marketing expense.
Fifth, management identified the following deficiencies in our financial statement close process, which constitute a material weakness in the aggregate.
a) Insufficient controls over the monitoring of the terms of employment agreements and bonus programs and determining the appropriate accounting treatment for related accrued bonuses in accordance with employment agreements and bonus programs. These inadequate controls resulted in adjustments as of December 31, 2004 and March 31, 2005 to decrease Accrued Payroll and Related Liabilities, and decrease General and Administrative expense. These adjustments were recorded prior to the issuance of the respective financial statements.
b) Insufficient controls over the monitoring of accrued liabilities recorded upon the sale of the e-insurance business to Accenture in December 2003. The Company had incorrectly not reversed the accrual when the related obligation expired on December 31, 2004. The error arose because of a lack of in-depth review of the account reconciliation. These inadequate controls resulted in an adjustment as of December 31, 2004 to decrease Accrued Liabilities and decrease General and Administrative expense. The adjustment was recorded prior to the issuance of the December 31, 2004 financial statements.
Because of the five material weaknesses described in the preceding paragraphs, the Company has concluded that its internal control over financial reporting was not effective as of March 31, 2005.
Our independent registered public accounting firm, Ernst & Young LLP, has issued an attestation report on management’s assessment of the Company’s internal control over financial reporting, which is included herein.
Completed and Planned Remediation
In June 2005, our management discussed the material weaknesses described above with our audit committee. The Company is implementing corrective actions that we believe will remediate each of these material weaknesses, however a material weakness may not be considered fully remediated until the instituted controls are operational for a period of time and have been tested by management.
In the first quarter of 2006, we plan to develop a process where the Vice President of Finance will review and approve cash and investment reconciliations and determine that classifications are correct for all Cash and Investments Accounts.
In the first quarter of 2006, we plan to develop a checklist to determine that the proper accounting for employment contracts, which include terms, milestones or “clawback” provisions. The checklist will include activities such as extension of COBRA payments, bonuses, accelerated option vesting, etc. The checklist will be reviewed and approved on a monthly basis by the Vice President of Finance and CFO.
In the first quarter of 2006, we plan to include a Chief Financial Officer (CFO) review and approval for all transactions, which are deemed non-routine and non-systematic by the Vice President of Finance.
In the first quarter of 2006, we plan to include a CFO review and approval of the Allowance for Doubtful Accounts.
Date: June 24, 2005
/s/ VINCENT G. OSTROSKY
Vincent G. Ostrosky
President and Chief Executive Officer
/s/ STEPHEN BENNION
Stephen Bennion
Chief Financial Officer
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Board of Directors and Shareholders of
Selectica, Inc.
We have audited management’s assessment, included in the accompanying “Report of Management on Internal Control Over Financial Reporting,” that Selectica, Inc. did not maintain effective internal control over financial reporting as of March 31, 2005, because of the effect of the five material weaknesses included in management’s assessment and described below, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Selectica’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following five material weaknesses have been identified and included in management’s assessment.
First, the Company identified a material weakness for insufficient controls over the Quote to Collect process related to the review, approval, and accounting for the Allowance for Doubtful Accounts. The Company had incorrectly included a general reserve provision in the Allowance for Doubtful Accounts as of December 31, 2004. Also, the Company had incorrectly recorded a receivable as uncollectible as of March 31, 2005, for which payment was subsequently received after March 31, 2005 but prior to the completion of the quarterly close process. As a result of this material weakness, Accounts Receivable and Services Revenue were incorrectly stated. Adjustments were recorded to increase Accounts Receivable and Services Revenue as of December 31, 2004 and as of March 31, 2005, prior to the issuance of our financial statements for the respective dates.
Second, the Company identified a material weakness for insufficient controls for the Treasury process related to the classification of Cash Equivalents and Investments. The Company had incorrectly classified Cash Equivalents and Investments in its India subsidiary. As a result of this material weakness, Cash Equivalents, Short Term and Long Term Investments were not classified for in accordance with generally accepted accounting principles. An adjustment was recorded to reduce Cash Equivalents and increase Short Term and Long Term Investments as of March 31, 2005.
Third, the Company identified the following deficiencies in its revenue recognition process, which constitute a material weakness in the aggregate.
a) Insufficient controls over the monitoring of deferred revenue accounts for the purpose of determining when revenue should be recognized. The Company failed to reverse deferred revenue when all criteria for revenue recognition had occurred.
b) Insufficient controls for the identification of services to be provided to customers at no charge. The Company inappropriately recorded revenue related to a service provided to a customer that was provided for no charge.
Fourth, the Company identified the following deficiencies in our payroll process, which constitute a material weakness in the aggregate.
a) Insufficient controls over the recording of expenses related to the benefits of terminated employees. The Company had failed to record the expenses related to the benefits extended when employees were involuntarily terminated as part of a reduction in force program. These inadequate controls resulted in an adjustment as of March 31, 2005 to increase Accrued Payroll and Related Liabilities and increase Sales and Marketing expense.
b) Insufficient controls over the recording of expenses related to the acceleration of stock options for a former executive. The error arose because of a lack of in-depth review of the appropriate accounting treatment for this transaction. These inadequate controls resulted in an adjustment as of March 31, 2005 to decrease Additional Paid In Capital and Sales and Marketing expense.
Fifth, the Company identified the following deficiencies in our financial statement close process, which constitute a material weakness in the aggregate.
a) Insufficient controls over the monitoring of the terms of employment agreements and bonus programs and determining the appropriate accounting treatment for related accrued bonuses in accordance with employment agreements and bonus programs. These inadequate controls resulted in adjustments as of December 31, 2004 and March 31, 2005 to decrease Accrued Payroll and Related Liabilities, and decrease General and Administrative expense. These adjustments were recorded prior to the issuance of the respective financial statements.
b) Insufficient controls over the monitoring of accrued liabilities recorded upon the sale of the e-insurance business to Accenture in December 2003. The Company had incorrectly not reversed the accrual when the related obligation expired on December 31, 2004. The error arose because of a lack of in-depth review of the account reconciliation. These inadequate controls resulted in an adjustment as of December 31, 2004 to decrease Accrued Liabilities and decrease General and Administrative expense. The adjustment was recorded prior to the issuance of the December 31, 2004 financial statements.
These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2005 financial statements, and this report does not affect our report dated June 24, 2005 on those financial statements.
In our opinion, management’s assessment that Selectica, Inc. did not maintain effective internal control over financial reporting as of March 31, 2005, is fairly stated, in all material respects, based on the COSO control criteria. Also, in our opinion, because of the effect of the material weaknesses described above on the
achievement of the objectives of the control criteria, Selectica, Inc. has not maintained effective internal control over financial reporting as of March 31, 2005, based on the COSO control criteria.
Walnut Creek, California
June 24, 2005
Item 9B.
Item 9B. Other Information
There is no disclosure to report pursuant to Item 9B.
PART III
Item 10.
Item 10.
Directors and Executive Officers of the Registrant
Directors
Information with respect to directors may be found in the section caption “Election of Directors” appearing in the definitive proxy statement to be delivered to stockholders in connection with the 2005 Annual Meeting of Stockholders. Such information is incorporated herein by reference.
Executive Officers
Information with respect to executive officers may be found in the section caption “Executive Officers” appearing in the definitive proxy statement to be delivered to stockholders in connection with the 2005 Annual Meeting of Stockholders. Such information is incorporated herein by reference.
Audit Committee Financial Expert
Information with respect to our audit committee financial expert may be found in the section “Report of the Audit Committee of the Board of Directors” appearing in the definitive proxy statement to be delivered to stockholders in connection with the 2005 Annual Meeting of Stockholders. Such information is hereby incorporated by reference.
Identification of the Audit Committee
Information with respect to our audit committee may be found in the section “Report of the Audit Committee of the Board of Directors” appearing in the definitive proxy statement to be delivered to stockholders in connection with the 2005 Annual Meeting of Stockholders. Such information is hereby incorporated by reference.
Section 16(a) Beneficial Ownership Reporting Compliance
Information concerning compliance with beneficial ownership reporting requirements may be found in the section “Compliance with Section 16(a) of the Exchange Act” appearing in the definitive proxy statement to be delivered to stockholders in connection with the 2005 Annual Meeting of Stockholders. Such information is hereby incorporated by reference.
Code of Ethics
Information concerning our Code of Ethics for Chief Executive Officer and Senior Financial Officers and Code of Business Conduct may be found in the section “Code of Ethics for Chief Executive Officer and Senior Financial Officers and Code of Business Conduct” appearing in the definitive proxy statement to be delivered to stockholders in connection with the 2005 Annual Meeting of Stockholders. Such information is hereby incorporated by reference.
Item 11.
Item 11.
Executive Compensation
Information with respect to executive officers and directors may be found in the section caption “Executive Compensation” appearing in the definitive proxy statement to be delivered to stockholders in connection with the 2005 Annual Meeting of Stockholders. Such information is incorporated herein by reference.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information with respect to this item may be found in the section caption “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” appearing in the definitive proxy statement to be delivered to stockholders in connection with the 2005 Annual Meeting of Stockholders. Such information is incorporated herein by reference.
Item 13.
Item 13.
Certain Relationships and Related Transactions
Information with respect to this item may be found in the section caption “Certain Relationships and Related Transactions” appearing in the definitive proxy statement to be delivered to stockholders in connection with the 2005 Annual Meeting of Stockholders. Such information is incorporated herein by reference.
Item 14.
Item 14.
Principal Accountant Fees and Services
Information concerning the fees and services of our principal accountants may be found in the section “Report of the Audit Committee of the Board of Directors” appearing in the definitive proxy statement to be delivered to stockholders in connection with the 2005 Annual Meeting of Stockholders. Such information is hereby incorporated by reference.
PART IV
Item 15.
Item 15.
Exhibits, Consolidated Financial Statement Schedules, and Reports on Form 8-K
(a) The following documents are filed as part of this report:
(1) Financial Statements:
The following are included in Item 8 and are filed as part of this Annual Report on Form 10-K.
•
Consolidated Balance Sheets as of March 31, 2005 and 2004
•
Consolidated Statement of Operations for the years ended March 31, 2005, 2004, and 2003
•
Consolidated Statement of Stockholders’ Equity for the years ended March 31, 2005, 2004, and 2003
•
Consolidated Statements of Cash Flows for the years ended March 31, 2005, 2004, and 2003
•
Notes to Consolidated Financial Statements
•
Report of Independent Registered Public Accounting Firm
(2) Financial Statement Schedules:
Financial Statement Schedules have been omitted because the information required to be set forth therein is not applicable or is included in the Financial Statements or notes thereto.
(3) Exhibits:
(1)
Previously filed in the Company’s Registration Statement (No. 333-92545) declared effective on March 9, 2000.
(2)
Previously filed in the Company’s report on Form 8-K filed on February 6, 2003.
(3)
Previously filed in the Company’s report on Form 10-Q filed on February 14, 2003.
(4)
Previously filed in the Company’s report on Form 10-K filed on June 30, 2003.
(5)
Previously filed in the Company’s report on Form 10-Q filed on November 11, 2003.
(6)
Previously filed in the Company’s report on Form 8-K filed on October 21, 2004.
(b) Exhibits.
See (a)(3) above.
(c) Financial Statement Schedule.
See (a)(2) above.
FINANCIAL STATEMENTS
As required under Item 8. Financial Statements and Supplementary Data, the consolidated financial statements of the Company are provided in this separate section. The consolidated financial statements included in this section are as follows
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
SELECTICA, INC.
CONSOLIDATED BALANCE SHEETS
See accompanying notes.
SELECTICA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes.
SELECTICA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
See accompanying notes.
SELECTICA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes.
SELECTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1.
Organization and Operations
Selectica, Inc. (the Company or Selectica) was incorporated in the State of California on June 6, 1996 and subsequently reincorporated in the State of Delaware on January 19, 2000. The Company was organized to provide configuration, pricing management and quoting solutions for automating customers’ opportunity to order process.
2.
Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include all accounts of the Company and those of its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles in the United States 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.
Foreign Currency Transactions
Foreign currency transactions at foreign operations are measured using the U.S. dollar as the functional currency. Accordingly, monetary accounts (principally cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities) are remeasured into U.S. dollar using the foreign exchange rate at the balance sheet date. Operational accounts and non-monetary balance sheet accounts are remeasured at the rate in effect at the date of a transaction. The effects of foreign currency remeasurement are reported in current operations and were immaterial for all periods presented.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash, cash equivalents, short-term investments, long-term investments, restricted investments, and accounts receivable. The Company places its short-term, long-term and restricted investments in high-credit quality financial institutions. The Company is exposed to credit risk in the event of default by these institutions to the extent of the amount recorded on the balance sheet. As of March 31, 2005, the Company has invested in short-term and long-term investments including commercial paper, corporate notes/bonds, and government agency notes/bonds. Restricted investments include corporate bonds and term deposits. Accounts receivable are derived from revenue earned from customers primarily located in the United States. The Company performs ongoing credit evaluations of its customers’ financial condition and generally does not require collateral. The Company maintains reserves for potential credit losses, and historically, such losses have been immaterial.
Cash Equivalents and Investments
Cash equivalents consist of short-term, highly liquid financial instruments, principally money market funds, commercial paper, corporate notes and government agency notes with insignificant interest rate risk that are readily convertible to cash and have maturities of three months or less from the date of purchase. The fair value, based on quoted market prices, of cash equivalents is substantially equal to their carrying value at March 31, 2005 and 2004. Company considers all investment securities with maturities of more than 3 months but less than one year to be short-term investments. Investments with maturities of more than one year are considered to be long-term investments.
SELECTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company classifies investments as available-for-sale at the time of purchase and periodically reevaluates such designation. Unrealized gains or losses on available-for-sale securities are included in accumulated other comprehensive income or loss in stockholders’ equity until their disposition. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale securities are included in interest income. The cost of securities sold is based on the specific-identification method. For the years ended March 31, 2005 and 2004, the Company reported its investments at fair market value. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, both of which are included in interest income.
The Company monitors its investments for impairment on a quarterly basis and determines whether a decline in fair value is other-than-temporary by considering factors such as current economic and market conditions, the credit rating of the issuers, the length of time an investment has been below the Company’s carrying value, and the Company’s ability and intent to hold the investment to maturity. If a decline in fair value, caused by factors other than changes in interest rates, is determined to be other-than-temporary, and adjustment is recorded and charged to operations.
Accounts Receivable and Allowance for Doubtful Accounts
The following describes activity in the accounts receivable allowance for doubtful accounts for the years ended March 31, 2005, 2004, and 2003:
The Company evaluates the collectibility of its accounts receivable based on a combination of factors. When the Company believes a collectibility issue exists with respect to a specific receivable, the Company records an allowance to reduce that receivable to the amount that it believes to be collectible. In making the evaluations, the Company will consider the collection history with the customer, its credit rating, communications with the customer as to reasons for the delay in payment, disputes or claims filed by the customer, warranty claims, non-responsiveness of customers to collection calls, feedback from the responsible sales contact. In addition, the Company will also consider general economic conditions, the age of the receivable and the quality of the collection efforts.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using the straight-line method based on estimated useful lives. The estimated useful lives for computer software and equipment is three years, furniture and fixtures is five years, and leasehold improvements is the shorter of the applicable lease term or estimated useful life. The estimated life for the building is 25 years and land is not depreciated.
Revenue Recognition
The Company enters into arrangements for the sale of 1) licenses of software products and related maintenance contracts; 2) bundled license, maintenance, and services; and 3) consulting services. In instances where maintenance is bundled with a license of software products, such maintenance term is typically one year.
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For each arrangement, the Company determines whether evidence of an arrangement exists, delivery has occurred, the fees are fixed or determinable, and collection is probable. If any of these criteria are not met, revenue recognition is deferred until such time as all of the criteria are met.
Arrangements consisting of license and maintenance only. For those contracts that consist solely of license and maintenance, the Company recognizes license revenues based upon the residual method after all elements other than maintenance have been delivered as prescribed by Statement of Position 98-9 “Modification of SOP No. 97-2 Software Revenue Recognition, with Respect to Certain Transactions.” The Company recognizes maintenance revenues over the term of the maintenance contract because vendor-specific objective evidence of fair value for maintenance exists. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If vendor specific objective evidence does not exist to allocate the total fee to all undelivered elements of the arrangement, revenue is deferred until the earlier of the time at which (1) such evidence does exist for the undelivered elements, or (2) all elements are delivered. If unspecified future products are given over a specified term, the Company recognizes license revenue ratably over the applicable period. The Company recognizes license fees from resellers as revenue when the above criteria have been met and the reseller has sold the subject licenses through to the end-user.
Arrangements consisting of license, maintenance and other services. Services revenues can consist of maintenance, training and/or consulting services. Consulting services include a range of services including installation of off-the-shelf software, customization of the software for the customer’s specific application, data conversion and building of interfaces to allow the software to operate in customized environments.
In all cases, the Company assesses whether the service element of the arrangement is essential to the functionality of the other elements of the arrangement. In this determination the Company focuses 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 the software requires the building of interfaces to the customer’s existing applications or customization of the software for specific applications. As a result, judgment is required in the determination of whether such services constitute “complex” interfaces. In making this determination the Company considers 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. The Company also considers the likelihood of refunds, forfeitures and concessions when determining the significance of such services.
In those instances where the Company determines that the service elements are essential to the other elements of the arrangement, the Company accounts for the entire arrangement under the percentage of completion contract method in accordance with the provisions of SOP 81-1, “Accounting for Performance of Construction Type and Certain Production Type Contracts.” The Company follows the percentage of completion method if reasonably dependable estimates of progress toward completion of a contract can be made. The Company estimates the percentage of completion on contracts utilizing hours and costs incurred to date as a percentage of the total estimated hours and costs to complete the project. Recognized revenues and profits are subject to revisions as the contract progresses to completion. Revisions in profit estimates are charged to income in the period in which the facts that give rise to the revision become known. The Company also accounts for certain arrangements under the completed contract method, when the terms of acceptance and warranty commitments preclude revenue recognition until all uncertainties expire. To date, when the Company has been primarily responsible for the implementation of the software, services have been
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considered essential to the functionality of the software products, and therefore license and services revenues have been recognized pursuant to SOP 81-1.
For those contracts that include contract milestones or acceptance criteria, the Company recognizes revenue as such milestones are achieved or as such acceptance occurs.
For those contracts with unspecified future products and services which are not essential to the functionality of the other elements of the arrangement, license revenue is recognized by the subscription method over the length of time that the unspecified future product is available to the customer.
In some instances the acceptance criteria in the contract require acceptance after all services are complete and all other elements have been delivered. In these instances the Company recognizes revenue based upon the completed contract method after such acceptance has occurred.
For those arrangements for which the Company has concluded that the service element is not essential to the other elements of the arrangement, the Company determines whether the services are available from other vendors, do not involve a significant degree of risk or unique acceptance criteria, and whether the Company has sufficient experience in providing the service to be able to separately account for the service. When services qualify for separate accounting, the Company uses vendor-specific objective evidence of fair value for 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 previously noted, the Company enters 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 of fair value in multiple element arrangements.
In accordance with Statement of Position 97-2, “Software Revenue Recognition,” vendor-specific objective evidence of fair value of maintenance is determined by reference to the price the customer will be required to pay when it is sold separately (that is, the renewal rate). Each license agreement offers additional maintenance renewal periods at a stated price. Maintenance contracts are typically one year in duration.
Arrangements consisting of consulting services. Consulting services consist of a range of services including installation of off-the-shelf software, customization of the software for the customer’s specific application, data conversion and building of interfaces to allow the software to operate in customized environments. Consulting services may be recognized based on customer acceptance in the form of customer-signed timesheets, invoices, cash received, or customer-signed acceptance as defined in the master service agreement.
Customer Concentrations
A limited number of customers have historically accounted for a substantial portion of the Company’s revenues.
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Customers who accounted for at least 10% of total revenues were as follows:
*
Revenues were less than 10% of total revenues.
Customers who accounted for at least 10% of gross accounts receivable were as follows:
*
Customer account was less than 10% of gross accounts receivable.
Warranties and Indemnifications
The Company generally provides a warranty for its software product to its customers and accounts for its warranties under SFAS No. 5, “Accounting for Contingencies”. The Company’s products are generally warranted to perform substantially in accordance with the functional specifications set forth in the associated product documentation for a period of 90 days. In the event there is a failure of such warranties, the Company generally is obligated to correct the product to conform to the product documentation or, if the Company is unable to do so, the customer is entitled to seek a refund of the purchase price of the product or service. The Company has not provided for a warranty accrual as of March 31, 2005 and 2004. To date, the Company has not refunded any amounts in relation to the warranty.
The Company generally agrees to indemnify its customers against legal claims that the Company’s software infringe certain third-party intellectual property rights and accounts for its indemnification under SFAS 5. In the event of such a claim, the Company is obligated to defend its customer against the claim and to either settle the claim at the Company’s expense or pay damages that the customer is legally required to pay to the third-party claimant. In addition, in the event of the infringement, the Company agrees to modify or replace the infringing product, or, if those options are not reasonably possible, to refund the cost of the software. To date, the Company has not been required to make any payment resulting from infringement claims asserted against our customers. As such, the Company has not provided for an indemnification accrual as of March 31, 2005 and 2004.
Advertising Expense
The cost of advertising is expensed as incurred. Advertising expense for the years ended March 31, 2005, 2004 and 2003 was approximately $18,000, $34,000, and $175,000, respectively.
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Development Costs
Software development costs incurred prior to the establishment of technological feasibility are included in research and development expenses. The Company defines establishment of technological feasibility as the completion of a working model. Software development costs incurred subsequent to the establishment of technological feasibility through the period of general market availability of the products are capitalized, if material, after consideration of various factors, including net realizable value. To date, software development costs that are eligible for capitalization have not been material and have been expensed.
Accumulated Other Comprehensive Income or Loss
Statement of Financial Accounting No. 130, “Reporting Comprehensive Income” (SFAS 130), establishes standards for reporting and displaying comprehensive net income or loss and its components in stockholders’ equity. However, it has no impact on our net loss as presented in our financial statements. Accumulated other comprehensive income or loss is comprised of net unrealized losses on available for sale securities of approximately $448,000 and approximately $47,000 at March 31, 2005 and 2004, respectively. The Company recorded approximately $3,000 in realized losses, approximately $81,000 in realized losses, and approximately $145,000 in realized gains in the years ended March 31, 2005, 2004, and 2003, respectively.
Stock-Based Compensation
The Company accounts for employee stock-based compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), and complies with the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123) and SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (SFAS 148). Under APB 25, compensation expense for fixed stock options is based on the difference between the fair market value of the Company’s stock and the exercise price of the option on the date of grant (Intrinsic Value Method), if any.
Pro Forma Disclosure of the Effect of Stock-Based Compensation
The Company uses the intrinsic value method in accounting for its employee stock options because, as discussed below, the alternative fair value accounting method requires use of option valuation models that were not developed for use in valuing employee stock options. Under the intrinsic value method, when the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, there is no compensation expense recognized.
Pro forma information regarding net loss as if the Company had accounted for its employee stock purchase during the fiscal years ended March 31, 2005, 2004, and 2003 under the fair value method was estimated at the date of grant using the Black-Scholes option-pricing model for the year ended March 31, 2005, 2004, and 2003 with the following weighted average assumptions:
Pro forma information regarding net loss as if the Company had accounted for its employee stock options granted during the fiscal years ended March 31, 2005, 2004 and 2003 under the fair value method was
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estimated at the date of grant using the Black-Scholes option-pricing model for the year ended March 31, 2005, 2004 and 2003 with the following weighted average assumptions:
The option valuation models were developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected life of the option.
Segment Information
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief executive officer in deciding how to allocate resources and in assessing performance. The Company operates in one segment, configuration, pricing management and quoting solutions for electronic commerce. The Company primarily markets its products in the United States.
International revenues are attributable to countries based on the location of the customers. For the fiscal year ended March 31, 2005, sales to international locations were derived primarily from Canada, France, India, Japan, New Zealand, Sweden, and the United Kingdom. For the fiscal year ended March 31, 2004, sales to international locations were derived primarily from Australia, Canada, Germany, India, Japan, New Zealand, and the United Kingdom. For the fiscal year ended March 31, 2003, sales to international locations were derived primarily from Canada, Germany, India, Japan, Mexico, New Zealand, Sweden, and the United Kingdom.
For the year ended March 31, 2005, there were revenues from one specific international customer, which accounted for 12% of the total revenue. For the years ended March 31, 2004 and 2003, there were no sales to a specific international customers that, which accounted for at least 10% of the total revenue.
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For the years ended March 31, 2005 and 2004, the Company held long-lived assets outside of the United States with a net book of approximately $1.2 million and approximately $1.4 million respectively, which were in India.
Contract termination
During the year ended March 31, 2004, the Company terminated a license and services contract in connection with the sale of certain intellectual property assets to Accenture. Pursuant to our agreement with that customer, the Company will retain all payments that the Company has received or is entitled to collect for items and services earned before the cancellation occurred. As a result of this termination, the Company recognized revenue in the amount of cash received, for licenses and for implementation services. For the year ending March 31, 2004, the Company recognized approximately $849,000 of license revenue and approximately $964,000 of services revenue from the cancelled contract.
Sale of eInsurance Assets
In December 2003, pursuant to an asset purchase agreement the Company sold its suite of intellectual property assets targeted specifically for the health insurance market segment to Accenture Global Services, GmbH for $1.4 million. As part of the transaction, six employees accepted employment with Accenture prior to the closing, and the Company entered into a non-compete clause for five years in the market segment. The transaction expenses associated with the sale were approximately $300,000. The Company recognized approximately $1.1 million in other income for the year ended March 31, 2004.
Concurrent Transaction
The Company, from time to time, purchases professional services from a value added reseller. The Company records the cost of the professional services purchased as a reduction of license or services revenue recorded from the reseller. For the year ending March 31, 2005, the Company recognized approximately $515,000 in license and service royalty revenue, which is net of approximately $264,000 professional services purchased by the Company. For the year ending March 31, 2004, the Company recognized approximately $871,000 in license and service royalty revenue, which is net of approximately $69,000 professional services purchased by the Company. For the year ending March 31, 2003, the Company recognized approximately $441,000 as license and service revenue that is net of approximately $179,000 professional services purchased by the Company.
Related Party Transaction and Severance Agreement
In connection with the resignation of Dr. Sanjay Mittal, Chief Executive Officer, the Company agreed to have him continue as Chief Technical Advisor (“CTA”). Pursuant to this arrangement, Dr. Mittal received $20,000 per month for his services and this arrangement would continue until either party terminates the CTA service. During the year ended March 31, 2005, the Company recorded approximately $220,000 as outside services expenses in general and administration. In March 2005, Dr. Mittal’s role as CTA was terminated and he received a lump-sum severance payment of $412,500 in addition to the amount paid for outside services. Since the Company believed the payment was estimatable and probable, and therefore, accrued for this amount in September 2003, as compensation expense of which approximately $93,000 was included in the cost of goods sold, approximately $231,000 was included in research and development, approximately $52,000 as a sales and marketing expense and approximately $37,000 was included as a general and administrative expense.
New Accounting Pronouncements
In December 2004, the FASB issued Statement No. 123 R, “Share-Based Payment”, as an amendment to FASB No. 123. FASB 123 R requires a public entity to measure the cost of employee services received in
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exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period (usually the vesting period). No compensation cost is recognized for equity instruments for which employees do not render the requisite service. Employee share purchase plans will not result in recognition of compensation cost if certain conditions are met; those conditions are much the same as the related conditions in FASB No. 123. The Company will adopt the provisions of FASB 123 R using a modified prospective application effective April 1, 2006. This new pronouncement from the FASB provides for certain changes to the method for valuing stock-based compensation among other changes, FASB 123 R will apply to new awards and to awards that are outstanding which are subsequently modified or cancelled. The Company is in the process of determining how the new method of valuing stock-based compensation as prescribed under FASB 123 R will be applied to stock-based awards after the effective date and the impact the recognition of compensation expense related to such awards will have on its operating results.
Reclassifications
Certain reclassifications have been made to prior year balances in order to conform them to the current year’s presentation.
We have reclassified certain amounts in the consolidated statement of cash flows for the year ended March 31, 2004 and in the consolidated balance sheets for the year ended March 31, 2004 to conform to the current presentation. Certificates of deposits of approximately $555,000 and approximately $2.1 million have been reclassified from cash equivalent to short-term investments and long-term investments, respectively for the year ended March 31, 2004. Due to this reclassification, net cash used in investing activities increased by approximately $2.6 million for the year ended March 31, 2004.
3.
Cash, Cash Equivalents and Investments
Cash, cash equivalents, short term and long term investments consisted of the following:
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The Company has only one active operating lease that requires a security deposit to be maintained at financial institutions for the term of the lease. As of March 31, 2005, this security deposit of approximately $182,000 is classified as a restricted short-term investment and held in commercial paper. The deposit will mature in September 2005. As of March 31, 2004, this security deposit of approximately $180,000 is classified as a restricted long-term investment and held in commercial paper.
Net unrealized holding losses and gains on available-for-sale securities as of March 31, 2005 and 2004 were approximately $448,000 and approximately $47,000, respectively. The Company realized losses from investments of approximately $3,000 for the year ended March 31, 2005 and approximately $81,000 in 2004. The Company realized gains of approximately $144,000 in 2003.
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4.
Property and Equipment
Property and equipment, at cost, consist of the following:
5.
Stockholder Notes Receivable
During the year ended March 31, 2003 and 2002, approximately $150,000 and $111,000 of the notes receivable were repaid by the various key employees. In addition, unvested stock worth an aggregate of approximately $924,000, originally issued in exchange for full recourse notes, were repurchased by the Company in fiscal year 2002. As a result of the repurchase, the remaining outstanding shares which were exercised with full recourse promissory notes representing 166,772 shares and approximately $384,000 in total outstanding notes, were deemed to be compensatory as of January 4, 2002 and became subject to variable accounting. In August of 2003, these notes receivable from certain key employees were paid in full along with calculated interest and the Company will not be required to revalue these shares in the future.
6.
Operating Lease Commitments
The Company leases office space and office equipment under operating lease agreements that expire at various dates through 2010. Aggregate future minimum annual payments under these lease agreements, which have non-cancelable lease terms, as of March 31, 2005, are as follows:
Rental expenses for office space and equipment were approximately $2.8 million, $3.0 million, and $3.8 million for the years ended March 31, 2005, 2004 and 2003, respectively.
7.
Litigation
The Company is subject to certain routine legal proceedings, as well as demands, claims and threatened litigation, that arise in the normal course of our business. The Company believes that the ultimate amount of
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liability, if any, for any pending claims of any type, except for the items mentioned below, (either alone or combined) will not materially affect our financial position, results of operations or liquidity.
Patent Infringement
On April 22, 2004, Trilogy Group filed a complaint in the United States District Court for the Eastern District of Texas Marshall Division (which has subsequently been served), alleging patent infringement against the Company. The complaint alleges that the Company has been and is willfully infringing, directly and indirectly, on Trilogy Group patents relating to the making, using, licensing, selling, offering for sale, or importing products including configuration and pricing software and related consulting services. The complaint seeks money damages, costs, attorneys’ fees, penalties for willful infringement, an injunction to prevent the Company from infringing Trilogy Group’s patents in the future, and any other relief to which Trilogy Group may be entitled. The Company intends to vigorously defend against Trilogy Group’s claims and may incur substantial costs in such defense. The Company believes the claims are without merit.
On September 2, 2004, the Company filed counterclaims in the Eastern District of Texas Marshall Division action against Trilogy Group for infringement of the Company’s U.S. Patent Nos. 6,405,308, 6,675,294, 5,878,400 and 6,553,350 for willfully infringing, directly and indirectly, by making, using, licensing, selling, offering for sale, or importing products including configuration and ordering software. The Company seeks money damages, costs, attorneys’ fees, penalties for willful infringement, an injunction to prevent Trilogy Group from infringing the Company’s patents in the future, and any other relief to which Trilogy Group may be entitled. Discovery has just begun in this action. The Court has set a trial date for January 2006 in this action.
Class Action
Between June 5, 2001 and June 22, 2001, four securities class action complaints were filed against the Company, certain of our officers and directors, and Credit Suisse First Boston Corporation (“CSFB”), as the underwriters of our March 13, 2000 initial public offering (“IPO”), in the United States District Court for the Southern District of New York. On August 9, 2001, these actions were consolidated before a single judge along with cases brought against numerous other issuers, their officers and directors and their underwriters, that make similar allegations involving the allocation of shares in the IPOs of those issuers. The consolidation was for purposes of pretrial motions and discovery only. On April 19, 2002, plaintiffs filed a consolidated amended complaint asserting essentially the same claims as the original complaints.
The amended complaint alleges that the Company, the officer and director defendants and CSFB violated federal securities laws by making material false and misleading statements in the prospectus incorporated in our registration statement on Form S-1 filed with the SEC in March 2000 in connection with our IPO. Specifically, the complaint alleges, among other things, that CSFB solicited and received excessive and undisclosed commissions from several investors in exchange for which CSFB allocated to those investors material portions of the restricted number of shares of common stock issued in our IPO. The complaint further alleges that CSFB entered into agreements with its customers in which it agreed to allocate the common stock sold in our IPO to certain customers in exchange for which such customers agreed to purchase additional shares of our common stock in the after-market at pre-determined prices. The complaint also alleges that the underwriters offered to provide positive market analyst coverage for the Company after the IPO, which had the effect of manipulating the market for the Company’s stock.
On July 15, 2002, the Company and the officer and director defendants, along with other issuers and their related officer and director defendants, filed a joint motion to dismiss based on common issues. Opposition and reply papers were filed and the Court heard oral argument. Prior to the ruling on the motion to dismiss, on October 8, 2002, the individual officers and directors entered into a stipulation of dismissal and tolling agreement with plaintiffs. As part of that agreement, plaintiffs dismissed the case without prejudice against
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the individual defendants. The Court ordered the dismissal of the officers and directors without prejudice on October 9, 2002. The Court rendered its decision on the motion to dismiss on February 19, 2003, denying dismissal of the Company.
On June 25, 2003, a Special Committee of the Board of Directors approved a Memorandum of Understanding “MOU” reflecting a settlement in which the plaintiffs agreed to dismiss the case against the Company with prejudice in return for the assignment by the Company of certain claims that the Company might have against its underwriters. The same offer of settlement was made to all the issuer defendants involved in the litigation. No payment to the plaintiffs by the Company is required under the MOU. After further negotiations, the essential terms of the MOU were formalized in a Stipulation and Agreement of Settlement (“Settlement”), which has been executed on behalf of the Company. The settling parties presented the proposed Settlement papers to the Court on June 14, 2004 and filed formal motions seeking preliminary approval on June 25, 2004. The underwriter defendants, who are not parties to the proposed Settlement, filed a brief objecting to its terms on July 14, 2004. On February 15, 2005, the Court granted preliminary approval of the settlement conditioned on the agreement of the parties to narrow one of a number of the provisions intended to protect the issuers against possible future claims by the underwriters. The Company re-approved the Settlement with the proposed modifications that were outlined by the Court in its February 15, 2005 Order granting preliminary approval. Approval of any settlement involves a three-step process in the district court: (i) a preliminary approval, (ii) determination of the appropriate notice of the settlement to be provided to the settlement class, and (iii) a final fairness hearing. At a hearing on April 13, 2005, the Court set January 6, 2006 as the date for the final fairness hearing. There are still discussions regarding the form of the notice for the final hearing, which will be sent out in September 2005. There can be no assurance that the Court will approve the settlement.
In the meantime, the plaintiffs and underwriters have continued to litigate the consolidated action. The litigation is proceeding through the class certification phase by focusing on six cases chosen by the plaintiffs and underwriters (“focus cases”). The Company is not a focus case. On October 13, 2004, the Court certified classes in each of the six focus cases. The underwriter defendants have sought review of that decision. The Company, along with the other non-focus case issuer defendants, has not participated in the class certification phase.
The plaintiffs’ money damage claims include prejudgment and post-judgment interest, attorneys’ and experts’ witness fees and other costs, as well as other relief to which the plaintiffs may be entitled should they prevail. The Company believes that the securities class action allegations against the Company and our officers and directors are without merit and, if settlement of the action is not finalized, the Company intends to contest the allegations vigorously.
8.
Letters of Credit
As of March 31, 2005 and 2004, the Company has a letter of credit totaling approximately $150,000, with a bank which serve as collateral for the Company’s obligations to third parties for lease payments. As of March 31, 2005 and 2004, no amounts were drawn under this letter of credit.
9.
Goodwill
Goodwill represents the excess of the purchase price of acquired companies over estimated fair values of tangible and intangible net assets acquired.
In June 2001, the FASB issued SFAS 142, “Goodwill and Other Intangible Assets” (SFAS 142), effective for fiscal years beginning after December 15, 2001. Under SFAS 142, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. SFAS 142 also requires that goodwill be tested for impairment at the reporting unit level upon adoption and at least
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annually thereafter, utilizing a two-step methodology. The initial step requires us to determine the fair value of each reporting unit and compare it to the carrying value, including goodwill, of such unit. If the fair value exceeds the carrying value, no impairment loss would be recognized. However, if the carrying value of the reporting unit exceeded its fair value, the goodwill of this unit may be impaired. The amount, if any, of the impairment would then be measured in the second step.
In April 2002, the Company performed, under SFAS 142, the first of the required impairment tests of goodwill. That test indicated that the carrying values exceeded their estimated fair values, as determined utilizing various valuation techniques including discounted cash flow and comparative market analysis. Thereafter, given the indication of a potential impairment, the Company performed step two of the test. The Company compared the implied fair value of the affected reporting unit’s goodwill to its carrying value to measure the amount of impairment. The fair value of goodwill was determined by allocating the reporting unit’s fair value to all of its assets and liabilities in a manner similar to a purchase price allocation. Based on this analysis, the Company measured and recognized an impairment loss for the remaining balance of goodwill of approximately $10.0 million for the three months ended June 30, 2002. This loss was recorded as a cumulative effect of an accounting change in the period.
10.
Stockholders’ Equity
Common Stock Reserved for Future Issuance
At March 31, 2005, common stock reserved for future issuance was as follows:
Preferred Stock
The Company’s Certificate of Incorporation was amended to authorize 25 million shares of preferred stock at a par value of $0.0001 per share upon reincorporation in Delaware in January 2000. There was no preferred stock issued and outstanding at March 31, 2005 and 2004.
The Board of Directors has the authority, without action by the stockholders, to designate and issue the preferred stock in one or more series and to fix the rights, preferences, privileges, and related restrictions, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series or the designation of the series.
Stock Issued for Services
Under the terms of the Company’s 1996 Stock Plan, from time to time the Company issues shares of common stock in exchange for services.
During 2005, the Company awarded 15,000 shares of restricted stock to the new CEO and recorded a deferred compensation charge of approximately $51,000. In addition, the Company granted severance awards to certain terminated employees which modified the terms of their stock options and resulted in the Company recording approximately $137,000 stock compensation charge.
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During fiscal year 2004, the Company issued 2,000 shares of common stock at a weighted average value of $4.32 in exchange for services provided by the professional services organization and recorded a compensation expense of approximately $9,000. During fiscal year 2003, the Company issued 18,000 shares of common stock at a weighted average value of $2.67 in exchange for sales and marketing services and recorded a compensation expense of approximately $48,000.
Deferred Compensation
The Company recorded deferred stock compensation expenses in connection with certain stock options to employees representing the difference between the fair market value of the stock at the grant date and the exercise price, as prescribed in APB 25. Deferred compensation amounts are included as a reduction in stockholders’ equity. Deferred compensation related to these grants are being amortized by charges to operations over its vesting periods.
During the year ended March 31, 2005, the Company recorded total compensation expense of approximately $131,000, which was included in the cost of sales. During the year ended March 31, 2004, the Company recorded total compensation expense of approximately $149,000 of which approximately $3,000 was included in sales and marketing expense and approximately $146,000 was included in general and administrative expense. During the year ended March 31, 2003, the Company recorded a total compensation expense of approximately $7,000 of which approximately $2,000 was recorded as cost of goods sold and $5,000 as general and administrative expense.
Stock Repurchase
In May 2003, the Board of Directors approved a stock buyback program to repurchase up to $30.0 million worth of stock in the open market subject to certain criteria as determined by the Board.
During the year ended March 31, 2005, the Company repurchased approximately 201,500 shares of its common stock at an average price of $3.96 in the open market at a cost of approximately $798,000 including brokerage fees. During the year ended March 31, 2004, the Company repurchased 383,600 shares of its common stock at an average price of $3.33 in the open market at a cost of approximately $1.3 million including brokerage fees. During the year ended March 31, 2003, the Company repurchased approximately 4.1 million shares of its common stock at an average price of $3.26 in the open market at a cost of approximately $13.4 million including brokerage fees.
Dividend Distribution of Preferred Stock Purchase Rights
On February 4, 2003, the Board of Directors declared a dividend distribution of one preferred share purchase right on each outstanding share of its common stock. Each right will initially entitle stockholders to buy one one-thousandth of a share of newly created Series A Junior Participating Preferred Stock of the Company, at an initial exercise price of $18.00, in the event the rights become exercisable. In general, the rights will become exercisable if a person or group becomes the beneficial owner of 15% or more of the outstanding common stock of the Company or announces a tender offer for 15% or more of the outstanding common stock. The Board of Directors will in general be entitled to redeem the rights at $0.0001 per right at any time before either of these events occur. In the event that the rights become exercisable, each right will entitle its holder to purchase, at the rights exercise price, a number of common stock or equivalent securities having a market value at that time of twice the rights exercise price. Rights held by the triggering person will become void and will not be exercisable to purchase shares at the reduced purchase price. The rights expire in ten years.
SELECTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Tender Offer
On February 19, 2003, the Company commenced an option exchange program in which its employees were offered the opportunity to exchange stock options with exercise prices of $4.17 and above for new stock options. Participants in the exchange program were to receive new options to purchase one hundred percent (100%) of the number of share of our common stock subject to the options that were cancelled. On March 19, 2003, approximately 1.1 million stock options were cancelled at a weighted exercise price of $19.18. The exchange offer was not available to executive officers and members of our Board of Directors. Approximately 933,000 new options were granted on September 22, 2003 at the market price of $4.24 per share.
Stock Option Plans - Approved by Stockholders
1996 Plan
The Company adopted the 1996 Stock Plan as amended and restated March 28, 2001 (the “1996 Plan”). A total of approximately 8.1 million shares of common stock have been reserved under the 1996 Plan. With limited restrictions, if shares awarded under the 1996 Plan are forfeited, those shares will again become available for new awards under the 1996 Plan. The 1996 Plan permits the grant of options, stock appreciation rights, shares of restricted stock, and stock units. The types of options include incentive stock options that qualify for favorable tax treatment for the optionee under Section 422 of the Internal Revenue Code of 1986 and nonstatutory stock options not designed to qualify for favorable tax treatment. Employees, non-employee members of the board and consultants are eligible to participate in the 1996 Plan. Incentive stock options are granted at an exercise price of not less than 100% of the fair market value per share of the common stock on the date of grant, and nonstatutory stock options are granted at an exercise price of not less than 85% of the fair market value per share on the date of grant. Options generally vest with respect to 25% of the shares one year after the options’ vesting commencement date and the remainder vest in equal monthly installments over the following 36 months. Options granted under the 1996 Plan have a maximum term of ten years.
The Compensation Committee of the Board of Directors administers the 1996 Plan and has complete discretion to make all decisions relating to the interpretation and operation of the 1996 Plan. The Compensation Committee has the discretion to determine which eligible persons are to receive an award, and to determine the type, number, vesting requirements and other features and conditions of each award. The exercise price of options may be paid with: cash, outstanding shares of common stock, the cashless exercise method through a designated broker, a pledge of shares to a broker or a promissory note. The purchase price for newly issued restricted shares may be paid with: cash, a promissory note or the rendering of past or future services. The Compensation Committee may reprice options and may modify, extend or assume outstanding options and stock appreciation rights. The Compensation Committee may accept the cancellation of outstanding options or stock appreciation rights in return for the grant of new options or stock appreciation rights. The new option or right may have the same or a different number of shares and the same or a different exercise price. If a merger or other reorganization occurs, the agreement of merger or reorganization shall provide that outstanding options and other awards under the 1996 Plan shall be assumed or substituted with comparable awards by the surviving corporation or its parent or subsidiary, shall be continued by the Company if it is the surviving corporation, shall have accelerated vesting and then expire early or shall be cancelled for a cash payment. If a change in control occurs and a plan participant is involuntarily terminated within 12 months following this change in control, then the vesting of awards held by the participant will accelerate, as if the participant provided another 12 months of service. A change in control includes: a merger or consolidation after which the then-current stockholders own less than 50% of the surviving corporation, a sale of all or substantially all of the assets, a proxy contest that results in replacement of more than one-half of the directors over a 24-month period or an acquisition of 50% or more of the outstanding stock by a person other than a person related to the Company, including a corporation owned by the stockholders. The Board of
SELECTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Directors may amend or terminate the 1996 Plan at any time. The 1996 Plan will continue in effect indefinitely unless the Board of Directors decides to terminate the plan earlier.
1999 Equity Incentive Plan
The Company adopted the 1999 Equity Incentive Plan (the “1999 Plan”) on November 18, 1999. A total of 2.2 million shares of common stock were initially reserved for issuance under the 1999 Plan. On each January 1, starting in 2001, the number of shares reserved for issuance will be automatically increased by the lesser of 5% of the then outstanding shares of common stock or 1.8 million. With limited restrictions, if shares awarded under the 1999 Plan are forfeited, those shares will again become available for new awards under the 1999 Plan. The 1999 Plan permits the grant of options, stock appreciation rights, shares of restricted stock, and stock units. The types of options include incentive stock options that qualify for favorable tax treatment for the optionee under Section 422 of the Internal Revenue Code of 1986 and nonstatutory stock options not designed to qualify for favorable tax treatment. Employees, non-employee members of the Board of Directors and consultants are eligible to participate in the 1999 Plan. Each eligible participant is limited to being granted options or stock appreciation rights covering no more than 330,000 shares per fiscal year, except in the first year of employment where the limit is 660,000 shares. Incentive stock options are granted at an exercise price of not less than 100% of the fair market value per share of the common stock on the date of grant, and nonstatutory stock options are granted at an exercise price of not less than 85% of the fair market value per share on the date of grant. Options generally vest with respect to 25% of the shares one year after the options’ vesting commencement date and the remainder vest in equal monthly installments over the following 36 months. Options granted under the 1999 Plan have a maximum term of ten years.
The Compensation Committee of the Board of Directors administers the 1999 Plan and has complete discretion to make all decisions relating to the interpretation and operation of the 1999 Plan. The Compensation Committee has the discretion to determine which eligible persons are to receive an award, and to determine the type, number, vesting requirements and other features and conditions of each award. The exercise price of options may be paid with: cash, outstanding shares of common stock, the cashless exercise method through a designated broker, a pledge of shares to a broker or a promissory note. The purchase price for newly issued restricted shares may be paid with: cash, a promissory note or the rendering of past or future services. The Compensation Committee may reprice options and may modify, extend or assume outstanding options and stock appreciation rights. The Compensation Committee may accept the cancellation of outstanding options or stock appreciation rights in return for the grant of new options or stock appreciation rights. The new option or right may have the same or a different number of shares and the same or a different exercise price. If a merger or other reorganization occurs, the agreement of merger or reorganization shall provide that outstanding options and other awards under the 1999 Plan shall be assumed or substituted with comparable awards by the surviving corporation or its parent or subsidiary, shall be continued by the Company if it is the surviving corporation, shall have accelerated vesting and then expire early or shall be cancelled for a cash payment. If a change in control occurs, awards will become fully exercisable and fully vested if the awards do not remain outstanding, are not assumed by the surviving corporation or its parent or subsidiary and if the surviving corporation or its parent or subsidiary does not substitute its own awards that have substantially the same terms for the awards granted under the 1999 Plan. If a change in control occurs and a plan participant is involuntarily terminated within 12 months following this change in control, then the vesting of awards held by the participant will accelerate, as if the participant provided another 12 months of service. A change in control includes: a merger or consolidation after which the then-current stockholders own less than 50% of the surviving corporation, a sale of all or substantially all of the assets, a proxy contest that results in replacement of more than one-half of the directors over a 24-month period or an acquisition of 50% or more of the outstanding stock by a person other than a person related to the Company, including a corporation owned by the stockholders. The Board of Directors may amend or terminate the 1999 Plan at any time.
SELECTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Each individual who first joins the board of directors as a non-employee director after December 11, 2002 will receive at that time an option for 50,000 shares of common stock. This option becomes vested as to 25% of the option shares upon the completion of 12 months of service and as to 1/48 of the option shares upon the completion of each month of service thereafter. In addition, at each of the Company’s annual stockholders’ meetings, beginning in 2003, each non-employee director who will continue to be a director after that meeting will automatically be granted at that meeting an option for 12,500 shares of common stock. However, any non-employee director who receives an option for 50,000 shares under this plan will first become eligible to receive the annual option for 12,500 shares at the annual meeting that occurs during the calendar year following the year in which he or she received the option for 50,000 shares. The option for 12,500 shares becomes vested upon the completion of 12 months of service from the grant date. If there is a change in control, or a termination as a result of death, disability or retirement after reaching age 65, the options granted to non-employee directors will become fully vested. If the Board of Directors amends the plan, stockholder approval of the amendment will be sought only if required by applicable law. The 1999 Plan will continue in effect indefinitely unless the Board of Directors decides to terminate the plan earlier.
1999 Employee Stock Purchase Plan
On November 18, 1999, the Company’s Board of Directors approved the adoption of the 1999 Employee Stock Purchase Plan (the “Purchase Plan”) and the Company’s stockholders have approved of the Purchase Plan. A total of 1.0 million shares of common stock were initially reserved for issuance under the Purchase Plan. On each May 1, starting in 2001, the number of shares reserved for issuance will be automatically increased by the lesser of 2% of the then outstanding shares of common stock or 1.0 million shares.
The Compensation Committee of the Board of Directors administers this plan. The Purchase Plan is intended to qualify under Section 423 of the Internal Revenue Code. The Purchase Plan permits eligible employees to purchase common stock through payroll deductions, which may not exceed 15% of an employee’s cash compensation, at a purchase price equal to the lower of 85% of the fair market value of the Company’s common stock at the beginning of each offering period or at the end of each purchase period. Employees who work more than five months per year and more than twenty hours per week are eligible to participate in the Purchase Plan. Stockholders who own more than 5% of the Company’s outstanding common stock are excluded from participating in the Purchase Plan. Each eligible employee cannot purchase more than 1,250 shares per purchase date (2,500 shares per year) and, generally, cannot purchase more than $25,000 of stock per calendar year. Eligible employees may begin participating in the Purchase Plan at the start of an offering period. Each offering period lasts 24 months and consists of four consecutive purchase periods of six months duration. Two overlapping offering periods will start on May 1 and November 1 of each calendar year. The first offering period started on March 9, 2000 and ended on April 30, 2002. Employees may end their participation in the Purchase Plan at any time. Participation ends automatically upon termination of employment. If a change in control occurs, the Purchase Plan will end and shares will be purchased with the payroll deductions accumulated to date by participating employees, unless this plan is assumed by the surviving corporation or its parent. The Board of Directors may amend or terminate the Purchase Plan at any time. If not terminated earlier, the Purchase Plan has a term of twenty years. If the Board of Directors increases the number of shares of common stock reserved for issuance under the Purchase Plan, other than any share increase resulting from the formula described in the previous paragraph, it must seek the approval of the Company’s stockholders.
Stock Option Plans - Not Required to be Approved by Stockholders
Officer Option Agreement
On March 9, 2000, the Company entered into a stock option agreement with an optionee that granted the optionee a nonstatutory stock option for 50,000 shares of the Company’s common stock at an exercise price
SELECTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
per share of $25.50. The option is immediately exercisable but any shares that remain unvested at service termination is subject to the Company’s repurchase right. 1/48th of the shares subject to the option vest (and the corresponding repurchase lapses) upon the completion of each month of service after the vesting commencement date of March 9, 2000. The exercise price of the option may be paid with: cash, outstanding shares of common stock, the cashless exercise method through a designated broker, a pledge of shares to a broker or a promissory note. If a change in control occurs, the shares subject to the option will become fully vested if the Company’s repurchase right is not assigned to the entity employing the optionee after the change in control or to its parent or subsidiary. A change in control includes: a merger or consolidation after which the then-current stockholders own less than 50% of the surviving corporation or a sale of all or substantially all of the assets. If a merger or other reorganization occurs, the agreement of merger or reorganization may provide that the surviving corporation or its parent shall substitute its own option for the option, the option shall be continued by the Company if it is the surviving corporation or the option shall be cancelled for a cash payment. The option expires 10 years after the option grant date but will expire earlier if there is a termination of service of the optionee.
On January 19, 2005, the Company entered into a stock option agreement with the Company’s Chief Executive officer, Vincent Ostrosky, that granted him a nonstatutory stock option for 990,000 shares of the Company’s common stock at an exercise price per share of $3.40 (660,000 options were also granted to Mr. Ostrosky from the 1999 Equity Incentive Plan to comprise the total number of options under his employment agreement with the Company). The option vests 1/48th upon the completion of each month of service after the vesting commencement date of October 21, 2004. The exercise price of the option may be paid with: cash, outstanding shares of common stock, or the cashless exercise method through a designated broker. If a change in control occurs, the shares subject to the option will become vested in an additional number of shares equal to 50% of the then unvested shares subject to the option. In the event that an Involuntary Termination occurs within 24 months following a change in control, the option will become vested in all of the unvested shares subject to the option. A change in control includes: a merger or consolidation after which the then-current stockholders own less than 50% of the surviving corporation or a sale of all or substantially all of the assets. If a merger or other reorganization occurs, the agreement of merger or reorganization may provide that the surviving corporation or its parent shall substitute its own option for the option, the option shall be continued by the Company if it is the surviving corporation or the option shall be cancelled for a cash payment. The option expires 10 years after the option grant date but will expire earlier if there is a termination of service of the optionee.
2001 Supplemental Plan
The Company adopted the 2001 Supplemental Plan (the “Supplemental Plan”) on April 4, 2001, and the Supplemental Plan did not require stockholder approval. A total of approximately 2.5 million shares of common stock have been reserved for issuance under the Supplemental Plan. With limited restrictions, if shares awarded under the Supplemental Plan are forfeited, those shares will again become available for new awards under the Supplemental Plan. The Supplemental Plan permits the grant of non-statutory options and shares of restricted stock. Employees and consultants, who are not officers or members of the Board of Directors, are eligible to participate in the Supplemental Plan. Options are granted at an exercise price of not less than 85% of the fair market value per share on the date of grant. Options generally vest with respect to 25% of the shares one year after the options’ vesting commencement date and the remainder vest in equal monthly installments over the following 36 months. Options granted under the Supplemental Plan have a maximum term of ten years.
The Compensation Committee of the Board of Directors administers the Supplemental Plan and has complete discretion to make all decisions relating to the interpretation and operation of the Supplemental Plan. The Compensation Committee has the discretion to determine which eligible persons are to receive an award, and to determine the type, number, vesting requirements and other features and conditions of each
SELECTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
award. The exercise price of options may be paid with: cash, outstanding shares of common stock, the cashless exercise method through a designated broker, a pledge of shares to a broker or a promissory note. The purchase price for newly issued restricted shares may be paid with: cash, a promissory note or the rendering of past or future services. The Compensation Committee may reprice options and may modify, extend or assume outstanding options. The Compensation Committee may accept the cancellation of outstanding options in return for the grant of new options. The new option may have the same or a different number of shares and the same or a different exercise price. If a merger or other reorganization occurs, the agreement of merger or reorganization shall provide that outstanding options and other awards under the Supplemental Plan shall be assumed or substituted with comparable awards by the surviving corporation or its parent or subsidiary, shall be continued by the Company if it is the surviving corporation, shall have accelerated vesting and then expire early or shall be cancelled for a cash payment. If a change in control occurs, awards will become fully exercisable and fully vested if the awards do not remain outstanding, are not assumed by the surviving corporation or its parent or subsidiary and if the surviving corporation or its parent or subsidiary does not substitute its own awards that have substantially the same terms for the awards granted under the Supplemental Plan. If a change in control occurs and a plan participant is involuntarily terminated within 12 months following this change in control, then the vesting of awards held by the participant will accelerate, as if the participant provided another 12 months of service. A change in control includes: a merger or consolidation after which the then-current stockholders own less than 50% of the surviving corporation, a sale of all or substantially all of the assets, a proxy contest that results in replacement of more than one-half of the directors over a 24-month period or an acquisition of 50% or more of the outstanding stock by a person other than a person related to the Company, including a corporation owned by the stockholders. The Board of Directors may amend or terminate the Supplemental Plan at any time. The Supplemental Plan will continue in effect indefinitely unless the Board of Directors decides to terminate the plan earlier.
Activity under all stock option plans is as follows:
SELECTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The weighted average, grant date fair value of options granted during the year, except when the exercise prices of some options differ from the market price of the stock on the grant date is as follows:
Equity Compensation Plan Information
(1)
On each January 1, starting in 2001, the number of shares reserved for issuance will be automatically increased by the lesser of 5% of the then outstanding shares of common stock or 1.8 million shares.
(2)
On each May 1, starting in 2001, the number of shares reserved for issuance will be automatically increased by the lesser of 2% of the then outstanding shares of common stock or 1.0 million shares.
All vested shares granted under all Plans are exercisable, however, shares exercised but not vested under the 1996 Stock Plan are subject to repurchase. At March 31, 2005, no shares were subject to repurchase under the 1996 Stock Plan.
SELECTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
11.
Computation of Basic and Diluted Net Loss Per Share
Basic and diluted net loss per common share is presented in conformity with Statement of Financial Accounting Standards No. 128, “Earnings Per Share” (FAS 128), for all periods presented. In accordance with FAS 128, basic and diluted net loss per share have been computed using the weighted-average number of shares of common stock outstanding during the period, less shares subject to repurchase.
The following table presents the computation of basic and diluted net loss per share:
The Company excludes potentially dilutive securities from its diluted net loss per share computation when their effect would be antidilutive to net loss per share amounts. The following common stock equivalents were excluded from the net loss per share computation:
12.
Income Taxes
The provision for income taxes is based upon income (loss) before income taxes as follows (in thousands):
SELECTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Financial Accounting Standards Board Statement No. 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based on the weight of available evidence, which includes the Company’s historical operation performance and the reported cumulative net losses in all prior years, the Company has provided a full valuation allowance against its net deferred tax assets.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax assets are as follows (in thousands):
Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance increased by approximately $9.8 million, $4.2 million, and $15.6 million during 2005, 2004, and 2003 respectively.
As of March 31, 2005, the Company had federal, state and foreign net operating loss carryforwards of approximately $143.4 million, approximately $48.5 million and approximately $10.6 million, respectively. As of March 31, 2005, the Company also had federal and state research and development tax credit carryforwards of approximately $2.9 million and $3.9 million, respectively. The federal net operating loss and credit
SELECTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
carryforwards expire at various dates through 2025, if not utilized. The state net operating loss carryforwards expire at various dates through 2016, if not utilized. The state tax credit carryforwards have no expiration date. Of the foreign net operating loss carryforwards, approximately $8.6 million relate to the U.K. and approximately $2.0 million relate to Canada. The U.K. net operating loss carryforwards have no expiration date and may be carried forward indefinitely, subject to certain restrictions. The Canadian net operating loss carryforwards expire at various dates through 2015, if not utilized.
Selectica’s subsidiary in India (Selectica India Private Ltd.), has a 10-year tax holiday, which commenced from the fiscal year 1999. Selectica India Private Ltd. will be exempt from taxation on income generated during this period.
Utilization of the Company’s net operating loss may be subject to substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code and similar state provisions. Such an annual limitation could result in the expiration of the net operating losses and credits before utilization.
13.
Benefit Plan
Effective February 1998, the Company adopted a tax-deferred savings plan, the Selectica 401(k) Plan (the 401(k) Plan), for the benefit of qualified employees. The 401(k) Plan is designed to provide employees with an accumulation of funds at retirement. Qualified employees may elect to make contributions to the 401(k) Plan on a monthly basis. The 401(k) Plan does not require the Company to make any contributions. No contributions were made by the Company for the years ended March 31, 2005, 2004, and 2003. Administrative expenses relating to the 401(k) Plan are insignificant.
14.
Restructuring
In the quarter ended March 31, 2001, the Company began restructuring worldwide operations to reduce costs and improve efficiencies in response to a slower economic environment. The restructuring costs were accounted for under EITF No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit and Activity,” and were charged to operations when the criteria in EITF 94-3 were met. The first plan (“Plan 1”) was initiated in the quarter ended March 31, 2001 and was comprised of severance and related benefits of $667,000 for the reduction of 30 staff in the areas of professional services, research and development, sales, marketing, and general administration. The second plan (“Plan 2”) was initiated and completed in the quarter ended June 30, 2001 and was comprised of severance and related benefits of $1.8 million for the reduction of 41 staff in the areas of professional services, research and development, sales, marketing, and general administration. The third plan (“Plan 3”) was initiated in July 2002 and was comprised of severance and related benefits of $1.7 million for the reduction of 38 staff in the areas of professional services, research and development, sales, marketing, and general administration and was completed in the fourth quarter of 2004.
Plan 1 reduced headcount by 6, 3, 11, and 10 for professional services, research and development, sales and marketing, and general administration, respectively. Plan 2 further reduced headcount by 5, 18, 17, and 1 for professional services, research and development, sales and marketing, and general administration, respectively. Plan 3 reduced headcount by 9, 7, 17, and 5 for professional services, research and development, sales and marketing, and general administration, respectively
In January 2005, the Company had made further reductions in headcount of 34 staff of Plan 4. The Company made these reductions in an effort to reduce costs in response to continued decline in bookings and economic conditions. The headcount reductions were 5 in professional services, 20 in research and development, 8 in sales and marketing, and 1 in general administration. These headcount reductions resulted in severance and other benefits of approximately $929,000.
SELECTICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The activity in the accrued restructuring balances related to all of the plans described above was as follows:
Include subtotals for each year-end.
15.
Subsequent Events
On May 3, 2005, the Company acquired certain business assets of Determine Software, Inc. (Determine) for approximately $799,000 in cash. Determine is a provider of enterprise contract management software.
The Company made a reduction in staff of 42 employees in May 2005. Additional headcount reductions consisted of 11 in professional services, 8 in research and development, 12 in sales and marketing and 11 in general administration and finance. These headcount reductions resulted in severance and other benefits of approximately $3.9 million.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Selectica, Inc.
We have audited the accompanying consolidated balance sheets of Selectica, Inc. as of March 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended March 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Selectica Inc. at March 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 2005, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 10 to the consolidated financial statements, effective April 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.”
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Selectica, Inc’s. internal control over financial reporting as of March 31, 2005, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated June 24, 2005 expressed an unqualified opinion on management’s assessment of the effectiveness of internal control over financial reporting and an adverse opinion on the effectiveness of internal control over financial reporting.
/s/ Ernst & Young LLP
Walnut Creek, California
June 24, 2005
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Jose, State of California, on the 29th day of June 2005.
SELECTICA, INC.
Registrant
/s/ Vincent G. Ostrosky
Vincent G. Ostrosky
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
(1)
Previously filed in the Company’s Registration Statement (No. 333-92545) declared effective on March 9, 2000.
(2)
Previously filed in the Company’s report on Form 8-K filed on February 6, 2003.
(3)
Previously filed in the Company’s report on Form 10-Q filed on February 14, 2003.
(4)
Previously filed in the Company’s report on Form 10-K filed on June 30, 2003.
(5)
Previously filed in the Company’s report on Form 10-Q filed on November 11, 2003.
(6)
Previously filed in the Company’s report on Form 8-K filed on October 21, 2004.