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SELECTICA INC - 10-Q - : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) 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 of Financial Condition and Results of Operations" as well as in the "Risk Factors" in Item 1A to Part 1 to the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2011 (the "Form 10-K"). They include the following: the level of demand for Selectica's products and services; the intensity of competition; Selectica's ability to effectively manage product transitions and to continue to expand and improve internal infrastructure; risks associated with potential acquisitions; and adverse financial, customer and employee consequences that might result to us if litigation were to be resolved in an adverse manner to us. For a more detailed discussion of the risks relating to our business, readers should refer to 1A to Part 1 in the Form 10-K entitled "Risk Factors." Readers are cautioned not to place undue reliance on the forward-looking statements, including statements regarding our expectations, beliefs, intentions or strategies regarding the future, which speak only as of the date of this quarterly report. We assume no obligation to update these forward-looking statements. Overview We provide Contract Management (CM) and Sales Configuration (SCS) software solutions that allow enterprises to efficiently manage business processes. Our solutions include software, on demand hosting, professional services and expertise. Our CM products enable customers to create, manage and analyze contracts in a single, easy to use repository and are offered as an on-premise or hosted solution. Our software enables any and all corporate departments (e.g. Sales, Services, Procurement, Finance, IT and others) to model their specific contracting processes using our application and to manage the lifecycle of the department's relationships with the counterparty from creation through closure. Our SCS products enable customers to increase revenues and reduce costs through seamless, web-enabled automation of the "quote to contract" business processes, which reside between legacy Customer Relationship Management (CRM) and Enterprise Resource Planning (ERP) systems. These products are built using Java technology and utilize a unique business logic engine, repository, and a multi-threaded architecture. This design reduces the amount of memory used to support new user sessions and to deploy a cost-effective, robust and highly scalable, Internet-enhanced sales channel. Quarterly Financial Overview For the three months ended June 30, 2011, our revenues were approximately $3.8 million with license revenues representing 2% and services revenues representing 98% of total revenues. In addition, approximately 32% of our quarterly revenues came from three customers. License margins for the quarter were 49% and services margins were 66%. Net loss for the quarter was approximately $0.6 million or $(0.21) per share. For the three months ended June 30, 2010, our revenues were approximately $3.7 million with license revenues representing 22% and services revenues representing 78% of total revenues. In addition, approximately 33% of our quarterly revenues came from three customers. License margins for the quarter were 82% and services margins were 59%. Net loss for the quarter was approximately $0.4 million or $(0.16) per share. 16 -------------------------------------------------------------------------------- Critical Accounting Policies and Estimates There have been no material changes to any of our critical accounting policies and estimates as disclosed in our Annual Report on Form 10-K for the year ended March 31, 2011. Factors Affecting Operating Results A small number of customers account for a significant portion of our total revenues. We expect that our revenues will continue to depend upon a limited number of customers. If we were to lose a large customer, it would have a significant impact upon future revenues. Customers who accounted for at least 10% of total revenues were as follows: Three Months Ended June 30, 2011 2010 Customer A 15 % 15 % Customer B * 10 % * Less than 10% of total revenues. We have incurred significant losses since inception and, as of June 30, 2011, we had an accumulated deficit of approximately $256 million. We believe our success depends on the growth of our customer base and the development of the emerging contract management and compliance markets and the stability of our sales configuration customer base. 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 results have historically been dependent on a few significant customer transactions which make predicting future performance difficult. 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 affected. 17 -------------------------------------------------------------------------------- Results of Operations: Revenues Three Months Ended June 30, 2011 2010 Change (in thousands, except percentages) License $ 92 $ 836 $ (744) Percentage of total revenues 2 % 22 % (89) % Services $ 3,662 $ 2,897 $ 765 Percentage of total revenues 98 % 78 % 26 % Total revenues $ 3,754 $ 3,733 $ 21 License. License revenues consist of revenue from licensing our software products. For the three months ending June 30, 2011, license revenues decreased $0.7 million compared to the three months ending June 30, 2010 due to fewer license transactions in our CM product. We expect license revenues to continue to fluctuate in future periods as a percentage of total revenues and in absolute dollars depending on the number and size of new license contracts. Services. Services revenues are comprised of fees from consulting, maintenance, hosting, training, subscription revenues and out-of-pocket reimbursements. During the three months ended June 30, 2011, services revenues increased $0.8 million compared to the three months ended June 30, 2010 primarily due to a higher level of consulting services delivered to our CM customers. In addition, we recognized higher maintenance revenues from a larger number of CM customers. Maintenance revenues represented 45% and 54% of total services revenues for the three months ended June 30, 2011 and 2010, respectively. We expect services revenues to continue to fluctuate in future periods as a percentage of total revenues and in absolute dollars. This will depend on the number and size of new software implementations and follow-on services to our existing customers. We expect maintenance revenues to fluctuate in absolute dollars and as a percentage of services revenues based on the number of maintenance renewals, and number and size of new contracts. In addition, maintenance renewals are extremely dependent upon customer satisfaction and the level of need to make changes or upgrade versions of our software by our customers. Fluctuations in services revenues are also due to timing of revenue recognition, achievement of milestones, customer acceptance, changes in scope, and additional services. Cost of revenues Three Months Ended June 30, 2011 2010 Change (in thousands, except percentages) Cost of license revenues $ 47 $ 150 $ (103 ) Percentage of license revenues 51 % 18 % (69) % Cost of services revenues $ 1,246 $ 1,195 $ 51 Percentage of services revenues 34 % 41 % 4 % Cost of License Revenues. Cost of license revenues consists primarily of a fixed allocation of our research and development costs, and costs of purchased third party licenses sold to customers as part of a bundled arrangement. During the three months ended June 30, 2011, cost of license revenues decreased by $0.1 million compared to the three months ended June 30, 2010 primarily due to the delivery of third party licenses sold to a customer in the prior year. We expect cost of license revenues to maintain a consistent level in absolute dollars in fiscal 2012. Cost of Services Revenues. Cost of services revenues is comprised mainly of salaries and related expenses of our services organization, our data center costs, plus certain allocated expenses. During the three months ended June 30, 2011, these costs remained flat compared to the same period in 2010. We expect cost of services revenues to fluctuate as a percentage of service revenues in fiscal year 2012. 18 -------------------------------------------------------------------------------- Gross Margins Gross margin percentages for services revenues and license revenues for the respective periods are as follows: Three Months Ended June 30, 2011 2010 License 49 % 82 % Services 66 % 59 % Gross Margin - Licenses. Because we have certain license costs that are fixed, margins will vary based on gross license revenue, the nature of the license agreements and product mix. Gross margin decreased to 49% for the three months ended June 30, 2011 compared to 82% for the three months ended June 30, 2010. This was primarily due to a $0.7 million decrease in license revenues year over year resulting from fewer license transactions in our CM product. Gross Margin - Services. During the three months ended June 30, 2011, gross margin from services increased to 66% compared to 59% for the three months ended June 30, 2010. This increase was largely due to a higher level of consulting services delivered to our CM customers. In addition, we recognized higher maintenance revenues from a larger number of CM customers compared to the same period in 2010. We expect that our overall gross margins will continue to fluctuate due to the timing of services and license revenue recognition and will continue to be adversely affected by lower margins associated with services revenues. The impact on our gross margin will depend on the mix of services we provide, whether the services are performed by our in-house staff or third party consultants, and the overall utilization rates of our professional services organization. Operating Expenses Research and Development Expenses Three Months Ended June 30, 2011 2010 Change (in thousands, except percentages) Research and development $ 896 $ 764 $ 132 Percentage of total revenues 24 % 20 % 17 % Research and development expenses consist primarily of salaries and related costs of our engineering, quality assurance, technical publication efforts and certain allocated expenses. Research and development expenses increased $0.1 million during the three months ending June 30, 2011 compared to the same period in 2010. These increases are primarily due to ongoing investments into our Ukraine research and operations center. We expect research and development expenditures to increase modestly in absolute dollars over the next year as we continue to invest in research in development as evidenced by the Ukraine research and operations center opened in fiscal 2011. This facility represents a significant investment for us as we look to execute on our global expansion strategy. 19 -------------------------------------------------------------------------------- Sales and Marketing Three Months Ended June 30, 2011 2010 Change (in thousands, except percentages) Sales and marketing $ 1,180 $ 1,038 $ 142 Percentage of total revenues 31 % 28 % 14 % Sales and marketing expenses consist primarily of salaries and related costs for our sales and marketing organization, sales commissions, expenses for travel and entertainment, trade shows, public relations, collateral sales materials, advertising and certain allocated expenses. For the three months ended June 30, 2011, sales and marketing expenses increased $0.1 million compared to the same period in 2010. The increase is primarily due to our 2011 annual Fusion conference, as well as headcount additions within our marketing department, resulting in higher compensation expenses. We expect modest increases in sales and marketing expenses in fiscal 2012 in absolute dollars and as a percentage of total revenues. General and Administrative Three Months Ended June 30, 2011 2010 Change (in thousands, except percentages) General and administrative $ 929 $ 971 $ (42 ) Percentage of total revenues 25 % 26 % (4 )% 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. General and administrative expenses remained flat compared to the same period in 2010. We expect modest increases in general and administrative expenses in fiscal 2012 in absolute dollars and as a percentage of total revenues. Interest and Other Income (Expense), Net Interest and other income (expense), net consists primarily of interest earned on cash balances and short-term investments, interest expense on our note payable to Versata, foreign currency fluctuations, and other miscellaneous expenditures. During the three months ended June 30, 2011 and 2010, interest and other income (expense), net remained flat totaling $52,000 and $57,000, respectively. 20 -------------------------------------------------------------------------------- Provision for Income Taxes During the three months ended June 30, 2011, we did not record an income tax provision, and during the three months ended June 30, 2010, we recorded an income tax provision of approximately $4,000. The June 30, 2011 and June 30, 2010 amounts relate to nominal state minimum and franchise taxes. Liquidity and Capital Resources June 30, March 31, 2011 2011 (in thousands) Cash, cash equivalents and short-term investments $ 16,835 $ 17,021 Working capital $ 13,610 $ 14,275 Three Months Ended June 30, 2011 2010 (in thousands) Net cash provided by operating activities $ 21 $ 418 Net cash used in investing activities $ (7 ) $ (22 ) Net cash used in financing activities $ (200 ) $ (325 ) Our primary sources of liquidity consisted of approximately $16.8 million in cash, cash equivalents and short-term investments as of June 30, 2011 compared to approximately $17.0 million in cash, cash equivalents and short-term investments as of March 31, 2011. Net cash provided by operating activities was not significant for the three months ended June 30, 2011. Net cash provided by operating activities was $0.4 million for the three months ended June 30, 2010, resulting primarily from improved operating results, a $1.1 million decrease in accounts receivable, net resulting from strong cash collection efforts during the quarter, and a $0.2 million increase in accounts payable. These increases were partially offset by a $0.9 million decrease in deferred revenues. Net cash used in investing activities was not significant for the three months ended June 30, 2011 and 2010, respectively. As a result of current adverse financial market conditions, investments in some financial instruments may pose risks arising from liquidity and credit concerns. Although we believe our current investment portfolio has very little risk of impairment, we cannot predict future market conditions or market liquidity and can provide no assurance that our investment portfolio will remain unimpaired. Net cash used in financing activities was $0.2 million for the three months ended June 30, 2011, resulting from our $0.2 million payment on our note payable to Versata. Net cash used in financing activities was $0.3 million for the three months ended June 30, 2010, resulting from $0.1 million in costs to defend our Rights Agreement, as well as our $0.2 million payment on our note payable to Versata. We expect to incur significant operating costs for the foreseeable future. We expect to fund our operating costs, as well as our future capital expenditures and liquidity needs, from a combination of available cash balances and internally generated funds. We have no outside debt other than our note payable to Versata, and do not have any plans to enter into borrowing arrangements. As a result, our net cash flows will depend heavily on the level of future sales, changes in deferred revenues, our ability to manage costs and ongoing legal proceedings. We believe our cash, cash equivalents, and short-term investment balances as of June 30, 2011 are adequate to fund our operations through at least June 30, 2012. However, given the significant changes in our business and results of operations in the last 12 months, the fluctuation in cash and investment balances may be greater than presently anticipated. After the next 12 months, we may find it necessary to obtain additional funds. In the event additional funds are required, we may not be able to obtain additional financing on favorable terms or at all. Contractual Obligations We had no significant commitments for capital expenditures as of June 30, 2011. We do not anticipate any significant capital expenditures, payments due on long-term obligations other than our note payable to Versata, or other contractual obligations. However, management is continuing to review our cost structure to minimize expenses and use of cash as we implement our planned business model changes. This activity may result in additional restructuring charges or severance and other benefits. 21 -------------------------------------------------------------------------------- Our contractual obligations and commercial commitments at June 30, 2011, are summarized as follows: Payments Due By Period Less Than 1-3 4-5 After 5 Contractual Obligations: Total 1 Year Years Years Years (in thousands) Operating leases $ 805 $ 174 $ 501 $ 130 $ - Versata note 4,130 786 2,078 1,266 - Total $ 4,935 $ 960 $ 2,579 $ 1,396 $ - |