##### Table of Contents









UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549




---

FORM 10-K

|                                                |  |                                                                                             
|----------------------------------------------- |  | --------------------------------------------------------------------------------------------
|(Mark One)                                     
|                                               
|x                                               |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|                                               
|For the fiscal year ended March 31,
    2004   
|                                               
|OR                                             
|                                               
|                                                |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|                                               
|For the transition period
    from           to

Commission File Number: 0-29637

SELECTICA, INC.

(Exact name of registrant as specified in its
charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Delaware                                                           |  | 77-0432030                              
|(State or other jurisdiction
    of incorporation or organization) |  | (I.R.S. Employer
    Identification No.)
|                                                                  
|3 West Plumeria Drive, San Jose,
    California                    |  | 95134-2111                              
|(Address of principal executive
    offices)                       |  | (Zip Code)                              

Registrants telephone number, including
area code: (408) 570-9700

Securities registered pursuant to
Section 12(b) of the Act: None

Securities registered pursuant to
Section 12(g) of the Act: Common Stock, $0.0001 par
value

Indicate by check mark whether the registrant:
(1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the
past
90 days.     Yes x     No o

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any
amendment to this
Form 10-K. x

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Rule 12b-2 of the
Act).     Yes x     No o

The aggregate market value of voting stock held
by non-affiliates of the registrant was $118,810,392 based upon
the closing price on the NASDAQ on the last business day of the
registrants most recently completed second fiscal quarter
(September 30, 2003).

The number of shares outstanding of the
registrants common stock as of May 31, 2004 was
32,613,521.

Documents Incorporated by Reference

Part III  Portions of the
registrants definitive Proxy Statement to be issued in
conjunction with the registrants 2004 Annual Meeting of
Stockholders, which is expected to be filed not later than
120 days after the registrants fiscal year ended
March 31, 2004. Except as expressly incorporated by
reference, the registrants Proxy Statement shall not be
deemed to be a part of this report on Form 10-K.



---






---










SELECTICA, INC.

FORM 10-K ANNUAL REPORT

FOR THE FISCAL YEAR ENDED


MARCH 31, 2004


TABLE OF CONTENTS

|             |  |                                                                                                                       |  |  |    | 
|------------ |  | --------------------------------------------------------------------------------------------------------------------- |  |  | -- | 
|PART I       |  |                                                                                                                       |  |  |    | 
|Item 1.      |  | Business                                                                                                              |  |  | 2  | 
|Item 2.      |  | Properties                                                                                                            |  |  | 11 | 
|Item 3.      |  | Legal Proceedings                                                                                                     |  |  | 12 | 
|Item 4.      |  | Submission of Matters to a
    Vote of Security Holders                                                               |  |  | 14 | 
|            
|PART II      |  |                                                                                                                       |  |  |    | 
|Item 5.      |  | Market for Registrants
    Common Equity, Related Stockholder Matters, and Issuer Purchases
    of Equity Securities |  |  | 28 | 
|Item 6.      |  | Selected Consolidated
    Financial Data                                                                              |  |  | 29 | 
|Item 7.      |  | Managements Discussion
    and Analysis of Financial Condition and Results of Operations                             |  |  | 30 | 
|Item 7A.     |  | Quantitative and Qualitative
    Disclosures About Market Risk                                                        |  |  | 43 | 
|Item 8.      |  | Consolidated Financial
    Statements and Supplementary Data                                                          |  |  | 45 | 
|Item 9.      |  | Changes in and Disagreements
    with Accountants on Accounting and Financial Disclosure                              |  |  | 47 | 
|Item 9A.     |  | Controls and Procedures                                                                                               |  |  | 47 | 
|            
|PART III     |  |                                                                                                                       |  |  |    | 
|Item 10.     |  | Directors and Executive
    Officers of the Registrant                                                                |  |  | 47 | 
|Item 11.     |  | Executive Compensation                                                                                                |  |  | 48 | 
|Item 12.     |  | Security Ownership of
    Certain Beneficial Owners and Management and Related Stockholder
    Matters                |  |  | 48 | 
|Item 13.     |  | Certain Relationships and
    Related Transactions                                                                    |  |  | 48 | 
|Item 14.     |  | Principal Accountant Fees
    and Services                                                                            |  |  | 48 | 
|            
|PART IV      |  |                                                                                                                       |  |  |    | 
|Item 15.     |  | Exhibits, Consolidated
    Financial Statement Schedules, and Reports on Form 8-K                                     |  |  | 49 | 
|Signatures   |  |                                                                                                                       |  | 
|EXHIBIT 23.1
|EXHIBIT 31.1
|EXHIBIT 31.2
|EXHIBIT 32.1
|EXHIBIT 32.2



1



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In addition to historical information, this
Annual Report on Form 10-K 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
Consolidated Financial Condition and Results of Operations
and Risk Factors. You should carefully review the
risks described in other documents the Company files from time
to time with the Securities and Exchange Commission, including
the quarterly reports on Form 10-Q to be filed by the
Company in 2004. 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 annual report on Form 10-K. The Company
undertakes no obligation to release publicly any updates to the
forward-looking statements included herein after the date of
this document.




PART I






|        |         
|------- | --------
|Item 1. | Business

BUSINESS OVERVIEW

Selectica, Inc. (Selectica) is a leading provider
of software that enables enterprises to utilize the Internet as
a platform for selling complex products and services. Our
software products facilitate our customers efforts to
correctly configure, price, and quote offerings for their
products and services across multiple distribution channels. Our
applications have also been deployed to manage complex product
features and business rules in enterprises, thereby bridging a
gap that presently exists between customer relationship
management (CRM) software and enterprise resource
management (ERP) software. As a result, our products help
our customers improve profitability by reducing process costs,
optimizing pricing, eliminating 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 enterprise resource planning, or ERP, systems. This allows
for an easy-to-install application and reduced deployment time.
Across a wide range of industries, Selecticas products
have demonstrated an ability to increase productivity, improve
order accuracy, boost return on investment and establish and
maintain a competitive advantage. Selecticas customers
represent manufacturing and service leaders including: ABB,
Applied Bio Systems, Bell Canada, Cisco, Dell, General Electric,
Firemans Fund Insurance Company, Hitachi, Juniper
Networks, Rockwell Automation, and Tellabs.

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.

The Internet has also evolved as a platform for
the deployment of business applications. Historically, companies
seeking to improve their operations have implemented
applications such as ERP or CRM software based on client-server
architectures that require a significant part of the application
to be loaded on every users computer. This in turn
required that the end users of software use a highly capable
desktop or laptop computer. 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

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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. To date, many electronic commerce
web sites have been 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

A gap exists between the core functionality of
CRM and ERP software packages. CRM software typically manages
sales campaigns, tracks the obtaining 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.
The gap between these two basic packages is comprised of the
various business functions 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
customer identified through CRM system to a product the
enterprise can deliver through its ERP system. We call this the
Opportunity to Order gap. This Opportunity to
Order makes it difficult for enterprises to identify
optimal proposals for sales opportunities, configure potential
solutions and provide accurate quotes for the proposed
solutions. The accuracy of a quote is itself a multifaceted item
which requires enforcing existing business rules such as maximum
discounts, margin requirements and ensuring that items that are
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 business rules to
optimize the solutions offered to its customers.



| |                                  
| | ---------------------------------
| | Limitations of Existing Solutions

Until recently, 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.

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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:



| |   |                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | have not been engineered for the Internet
    platform and, as a result, are not easily deployed across a
    broad range of Internet-enabled devices;
|
| |  | require significant custom programming for
    deployment and maintenance;                                                                            
|
| |  | provide a limited interactive experience; or                                                                                                          
|
| |  | employ application architectures that limit their
    scalability and reliability.                                                                    

We believe that there is a significant
opportunity for software that leverages the Internet platform to
enable companies to efficiently sell complex products and
services. Furthermore, there is a demonstrated need to fill the
opportunity to order gap that exists between current ERP and CRM
solutions.

Selectica Solutions

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.

Selecticas products are also 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 identified
prospects needs, to 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 certain parameters. These business rules 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.

Some of the major design benefits of our
applications are described below:



| |                                                         
| | --------------------------------------------------------
| | Allows 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.



| |                    
| | -------------------
| | Shorten Sales Cycle

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:



| |   |                                                                                                                                                                                       
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | providing comprehensive product information to
    the customer or sales person at the point of sale without
    requiring interaction with product experts; and                      
|
| |  | automating the pricing and configuration of
    complex products and services, thereby providing sales
    professionals and their customers with accurate, real-time
    information.

4



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| |                           
| | --------------------------
| | Ensures Accuracy of Quotes

Our software automates the delivery of quotes to
customers. Only quotes that comply with all of the business
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
currently permit the entering of inaccurate orders into their
systems. Because these ERP systems are often linked directly to
manufacturing, this can cause the beginning of the production of
a product 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 sales people having to give
concessions or write-offs to compensate for cancelled or delayed
orders. All of these benefits can significantly enhance
profitable 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 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 both
provides scalability and allows 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 specified 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 the company.



| |                           
| | --------------------------
| | 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.

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Selectica Products

The following table provides a list of our
products and a brief description of the features and benefits to
our customers.

|                                            |  |                                                                                                                                                     |  |                                                                                                                                                                                         
|------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Product                                     |  | Features                                                                                                                                            |  | Benefits                                                                                                                                                                                
|                                            |  |                                                                                                                                                     |  |                                                                                                                                                                                         
|1. Selectica Configuration Platform         |  | Configuration engine                                                                                                                                |  | Enables customized, one-to-one selling using the
    Internet platform                                                                                                                  
|                                            |  | Highly scalable Internet-architecture                                                                                                               |  | Designed to support millions of simultaneous
    users by simply installing more servers                                                                                                
|                                            |  | Java-based                                                                                                                                          |  | Platform independence                                                                                                                                                                   
|                                            |  | Supports open standard integration interfaces                                                                                                       |  | Integrates with other web-based applications and
    legacy systems                                                                                                                     
|                                            |  | Dynamic information update                                                                                                                          |  | Ability to update product information without
    stopping selling process                                                                                                              
|                                            |  | Easy-to-use, dynamically generated interface                                                                                                        |  | Maximizes sales force productivity by reducing
    sales training time                                                                                                                  
|                                            |  | Supports devices with limited processing power                                                                                                      |  | Ability to be deployed on a broad range of devices                                                                                                                                      
|                                            |  | HTML-based client                                                                                                                                   |  | Designed to run on any device with a standard web
    browser                                                                                                                           
|2. Selectica Pricer                         |  | Allows users to manage sophisticated pricing
    logic across the enterprise                                                                        |  | Accelerates the introduction of new pricing
    schemes                                                                                                                                 
|3. Selectica Mobile                         |  | Complete stand-alone selling system that runs on
    laptop computers                                                                               |  | Enables mobile users to access our solution with
    the same user interface as a connected system                                                                                      
|                                            |  | Automatically synchronizes KnowledgeBases and
    quotes                                                                                            |  | Enables updated product and pricing information
    and orders                                                                                                                          
|                                            |  | Provides comprehensive functionality on mobile
    platforms using the same unmatched performance and reliability
    as the Selectica Configurator |  | Reduces time and inconsistency                                                                                                                                                          
|4. Selectica Application Data Manager (ADM) |  | Enables rapid updates of product, pricing and
    service data; anytime (24x7 accessibility), anywhere                                              |  | Improved responsiveness to changing market
    conditions                                                                                                                               
|                                            |  | Easy-to-use interface provides a consolidated
    view of corporate data repositories                                                               |  | Enables users to maintain and manage product and
    service information with the ability to add, modify and delete
    product, pricing and service information without IT intervention
|5. Selectica Quoter                         |  | Central server and storage facility for customer
    orders, configurations and pricing information                                                 |  | Enables users to generate, save and revise quotes
    online.                                                                                                                           
|                                            |  | Provides easy access from remote devices to quote
    archives                                                                                      |  | Enables accurate quotes and orders                                                                                                                                                      

6



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|                                                              |  |                                                                                                                                                                                                                                                                      |  |                                                                                                                                                                                               
|------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Product                                                       |  | Features                                                                                                                                                                                                                                                             |  | Benefits                                                                                                                                                                                      
|                                                              |  |                                                                                                                                                                                                                                                                      |  |                                                                                                                                                                                               
|6. Selectica Studio                                           |  | Models, tests and debugs applications using a
    single tool                                                                                                                                                                                                        |  | Simplifies development process                                                                                                                                                                
|                                                              |  | Graphical KnowledgeBase and user interface
    development tools                                                                                                                                                                                                     |  | Enables application deployment and maintenance by
    non-technical personnel                                                                                                                 
|7. Selectica Analyst                                          |  | Analyzes business data by collecting data from
    Selectica applications servers and transforms it to facilitate
    fine- grained marketing analysis                                                                                                               |  | Enables enterprises to measure, monitor and
    increase the effectiveness of their Selectica application and
    universally share reports                                                   
|8. Selectica Repository                                       |  | Database that stores KnowledgeBase in readable,
    format which can be easily queried.                                                                                                                                                                              |  | Provides distributed team development of
    KnowledgeBases for easy development and maintenance                                                                                              
|9. Selectica Connector                                        |  | Out-of-the box integration to other enterprises
    applications including Oracle and IBM WebSphere.                                                                                                                                                                 |  | Enables easy integration and reduces costs and
    deployment time                                                                                                                            
|10. Selectica KDE (KnowledgeBase Development
    Environment) |  | Create and maintain automated KnowledgeBases                                                                                                                                                                                                                         |  | Maintain the consistency of KnowledgeBases Full
    automated environment via a command line interface will
    eliminate need for user interface                                             
|11. Selectica Deal Optimization                               |  | Recommends calculated concessions to
    customers that include product substitution, bundle, cross-sell,
    and up-sell opportunities. Automatically escalates deals to the
    appropriate manager. Captures competitive, market segment and
    win/loss data. |  | Discern deal attractiveness based on revenue,
    margin, inventory or other predetermined business rules.
    Provides insight into lost transactions and maximizing future
    transactions.
|12. Selectica Solution Advisor                                |  | Packaged guided selling solution. Intuitive
    web-based development environment.                                                                                                                                                                                   |  | Enables enterprises to rapidly create
    applications that help customers find the products that best fit
    their needs. Out-of-box functionality without customization.                   

To further capitalize on the opportunity to order
gap, we intend to begin marketing new products in the fall of
2004. We intend for these products to be largely comprised of
our existing applications with additional features and
functionality to make use and integration simpler for our
customers. We intend to market these programs as our Enterprise
Productivity Suite of applications. Our release schedule is
subject to change and may be delayed by any number of factors,
including delays in development, unfavorable or changing market
conditions or customer input, and we may decide to package these
products differently or not to release these products at all.

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:



| |   |                                 
| | - | --------------------------------
| |  | declarative constraint engine;  
|
| |  | integrated modeling environment;

7



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| |   |                                    
| | - | -----------------------------------
| |  | multi-threaded server; and         
|
| |  | 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:



| |   |                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------
| |  | easily create and update KnowledgeBases
    containing product attributes;                              
|
| |  | create HTML-based graphical user interface, or
    GUI, applications;                                   
|
| |  | test the application interactively as the
    application is being built and conduct batch order checks;
|
| |  | verify the semantics of the
    KnowledgeBase; and                                                      
|
| |  | 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, employing a thin-client
architecture, 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.

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COMPETITION

The market for software products that utilize the
Internet as a business platform is intensely competitive, and we
expect competition to remain fierce. We encounter competition
from a number of different sources, including in-house and
customized Internet-development companies, companies focused on
configuration and other enterprise software companies seeking to
extend their solutions.

Our principal competitors include Oracle
Corporation, SAP, Siebel Systems and Trilogy 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.

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:



| |   |                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a longer operating history;                                                                                                                                                                                         
|
| |  | a preferred vendor status with our customers;                                                                                                                                                                       
|
| |  | more extensive name recognition and marketing
    power;                                                                                                                                                            
|
| |  | 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
|
| |  | in the case where we attempt to bridge gaps
    between ERP and CRM 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 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, 2004, our sales team
consisted of 32 persons, with sales and field support personnel
in California, Georgia, Illinois, Indiana, Massachusetts,
Pennsylvania, Texas, Canada, India, Japan, 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,
2004, we had 12 marketing personnel located in San Jose, CA.

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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 106 people as of March 31, 2004.
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 generally been priced
as a percentage of product license fees. Customers under
maintenance contracts receive technical product support and
product upgrades 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, 2004, we had
approximately 132 full-time engineers and technical writing
specialists that primarily work on product development,
documentation, quality assurance and testing.

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.

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.

10



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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:



| |   |                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | cease selling, incorporating or using products or
    services that incorporate the challenged intellectual property;                                                                               
|
| |  | obtain from the holder of the infringed
    intellectual property right a license to sell or use the
    relevant intellectual property, which license may not be
    available on reasonable terms;
|
| |  | redesign those products or services that
    incorporate such intellectual property; or                                                                                                             
|
| |  | pay money damages to the holder of the infringed
    intellectual property right.                                                                                                                   

In the event of a successful claim of
infringement against us and our failure or inability to license
the infringed intellectual property on reasonable terms or
license a substitute intellectual property or redesign our
product to avoid infringement, our business and operating
results would be significantly harmed. If we are forced to
abandon use of our trademark, we may be forced to change our
name and incur substantial expenses to build a new brand, which
would significantly harm our business and operating results. For
information about the complaint filed against the Company
alleging patent infringement, please see Item 3: Legal
Proceedings: Patent Infringement.

EMPLOYEES

At March 31, 2004, we had a total of 320
employees, of whom 140 were located in India and 180 located in
North America, United Kingdom, and Japan. Of the total, 132 were
in research and development, 106 were in consulting, 44 were
engaged in sales, marketing and business development and 38 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.

AVAILABLE INFORMATION

We file annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on
Form 8-K and 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. | 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.

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India.We own an
office in Pune and lease an office in Chennai primarily for
consulting and quality assurance purposes. These facilities
occupy approximately 22,000 and 25,000 square feet,
respectively. The lease for the office in Chennai extends
through May 2009.

We believe the office space in these facilities
will be adequate to meet our needs.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

Patent Infringement

On April 22, 2004, Trilogy Software Inc. and
Trilogy Development Group (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 the Company. The
complaint alleges that the Company has been and is 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 the Company from
infringing Trilogys patents in the future, and any other
relief to which Trilogy may be entitled. The Company is
currently evaluating the merits of this complaint and we may
incur substantial costs to defend against such claim.

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
Selectica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 the
Company with prejudice in return for the assignment by the
Company of claims that the Company might have against its
underwriters. No payment to the plaintiffs by the Company is

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required under the MOU. After further
negotiations, the essential terms of the MOU were formalized in
a Stipulation and Agreement of Settlement, which has been
executed on behalf of the Company. The settling parties
anticipate presenting the settlement papers to the Court on
June 14, 2004. There can be no assurance that the Court
will approve the settlement.


Shareholder Derivative Action

On April 16, 2002, a shareholder derivative
action was filed in the Superior Court of California,
Santa Clara County, against certain of our officers and
directors, against CSFB, as the underwriters of our IPO, and
against the Company as nominal defendant. The action was filed
by a shareholder purporting to assert on behalf of the Company
claims for breach of fiduciary duty, aiding and abetting and
conspiracy, negligence, unjust enrichment, and breach of
contract, related to the pricing of shares in the Companys
IPO. On June 6, 2002, the shareholder plaintiff filed an
amended complaint dropping the breach of contract claim against
CSFB and adding claims against CSFB for breach of an
agents duty to its principal and for violation of the
California Unfair Competition Law, based on alleged violations
of certain rules of the National Association of Securities
Dealers.

On November 25, 2002, following the removal
of the case to federal court and the subsequent remand of the
case back to the state court, the Company and the officer and
director defendants filed answers to the amended complaint,
preserving certain defenses including defenses based on
plaintiffs lack of standing to bring the suit. Also on
November 25, 2002, CSFB filed a motion to dismiss the case,
on the grounds that the plaintiff lacks standing. That motion
was heard on March 4, 2003, and on March 18, 2003 the
Court issued an Order sustaining the motion but granting
plaintiff 30 days to file an amended complaint.

On April 18, 2003, the plaintiff filed a
second amended complaint. This complaint adds new allegations as
to standing, and also alleges certain additional facts
supporting the various causes of action against the defendants.
Specifically, plaintiffs new complaint alleges that CSFB
offered and provided, and the individual defendants accepted,
improper gratuities in the form of allocations of
IPO stocks of other companies, in order to influence the
selection of CSFB as the underwriter of the Companys IPO.

On June 17, 2003, CSFB responded to this
second amended complaint by filing a demurrer (motion to
dismiss) on the grounds that the plaintiff lacks standing to
bring the action. Also on June 17, 2003, the Company and
the individual defendants responded to the second amended
complaint by joining CSFBs demurrer, while reserving other
objections. At a hearing on this matter on August 12, 2003,
the Court again granted CSFBs demurrer, with leave for
plaintiff to further amend his complaint, and granted plaintiff
permission to file a motion seeking to establish
plaintiffs standing pursuant to the so-called
contemporaneous ownership rule.

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. The
shareholder derivative litigation is also in its preliminary
stages. At a minimum, the class action litigation as well as the
shareholder derivative litigation could result in substantial
costs and divert our managements attention and resources,
which could seriously harm our business.

Settlement Agreement

In July 2002, the Company received a complaint
from a former employee over a commission matter. We defended
this matter vigorously and we were not able to estimate the
likelihood or an unfavorable result or the range of any
potential loss to the Company. In August 2003, this matter was
brought to arbitration and settled with the former employee for
the amount of $550,000, which was included as an expense to
sales and marketing.

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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. | Submission of Matters to a Vote of Security
    Holders

No matters were submitted to a vote of security
holders during the quarter ended March 31, 2004.

RISKS RELATED TO OUR BUSINESS

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 applicable to common stockholders of approximately
$8.8 million, $29.7 million, and $26.4 million
for the fiscal years ended March 31, 2004, 2003 and 2002,
respectively. We had an accumulated deficit of approximately
$158.0 million as of March 31, 2004. 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.

The unpredictability of our quarterly revenues
and results of operations makes it difficult to predict our
financial performance and may cause volatility or a decline in
the price of our common stock if we are unable to satisfy the
expectations of investors or the market.

In the past, our quarterly operating results have
varied significantly, and we expect these fluctuations to
continue. Future operating results may vary depending on a
number of factors, many of which are outside of our control.

Our quarterly revenues may fluctuate as a result
of our ability to recognize revenue in a given quarter. We enter
into arrangements for the sale of 1) licenses of 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 with Respect to Certain Transactions.
We recognize maintenance revenues over the term of the
maintenance contract as 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

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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 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 since 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 profit 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. 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 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.

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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 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.
Consulting services are recognized based on customer acceptance
in the form of customer-signed timesheets, cash received, or
customer-signed acceptance.

Because we rely on a limited number of customers,
the timing of customer acceptance or milestone achievement, or
the amount of services we provide to a single customer can
significantly affect our operating results. For example, on
these separate occasions, our services and license revenues
declined significantly in March 31, 2003, March 31,
2001 and June 30, 1999 due to the delays of milestone
achievement of services and customer acceptance under a
particular contract. See Managements Discussion and
Analysis of Financial Condition and Results of
Operations  Results of Operations. 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 continue to 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. If our bookings
decrease, it will cause our revenues to decline in future
periods which could significantly harm our business and
operating results.

If we do not hire a permanent Chief Executive
Officer, our business and operating results could be adversely
affected.

We currently have an interim Chief Executive
Officer. Although we have embarked on a search process to locate
a permanent Chief Executive Officer, there can be no guarantee
that such process will be successful. While the search is
on-going, our executive management team must take on additional
responsibilities for duties previously performed by the CEO. The
search for a new CEO may create uncertainty and instability both
within the Company and between the Company and its key customers
and prospects. Moreover, if and when a permanent Chief Executive
Officer is hired, the transition may cause further disruptions,
both internally and externally.

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 78%, 53% and 32% of our revenues for
the fiscal years ended

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March 31, 2004, 2003 and 2002, respectively,
and our ten largest customers accounted for 88%, 65%, and 50% of
our revenues for the fiscal years ended March 31, 2004,
2003 and 2002, respectively. Revenues from significant customers
as a percentage of total revenues are as follows:


|                                     |            |  |  |     | 
|------------------------------------ | ---------- |  |  | --- | 
|Fiscal Year ended March 31,
    2004 |            |  |  |    
|                                     | Customer A |  |  | 39% | 
|                                     | Customer B |  |  | 20% | 
|Fiscal Year ended March 31,
    2003 |            |  |  |    
|                                     | Customer B |  |  | 25% | 
|                                     | Customer C |  |  | 14% | 
|Fiscal Year ended March 31,
    2002 |            |  |  |    
|                                     | Customer C |  |  | 11% | 

We expect that we will continue to depend upon a
relatively small number of customers for a substantial portion
of our revenues for the foreseeable future. Contracts with our
customers can generally be terminated on short notice by the
customer. As a result, if we fail to successfully sell our
products and services to one or more customers in any particular
period, or a large customer purchases fewer of our products or
services, defers or cancels orders, or terminates its
relationship with us, our business and operating results would
be harmed.

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 configuration, pricing management and quoting
solutions, 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 justifies the expenses. A continuation of
stagnation in information technology spending due to economic
conditions or other factors could significantly harm our
business and operating results.

Our lengthy sales cycle makes it difficult for
us to forecast revenue and aggravates the variability of
quarterly fluctuations, which could cause our stock price to
decline.

The sales cycle of our products has historically
averaged between four and six months, and may sometimes be
significantly longer. We are generally required to provide a
significant level of education regarding the use and benefits of
our products, and potential customers tend to engage in
extensive internal reviews before making purchase decisions. In
addition, the purchase of our products typically involves a
significant commitment by our customers of capital and other
resources, and is therefore subject to delays that are beyond
our control, such as customers internal budgetary
procedures and the testing and acceptance of new technologies
that affect key operations. In addition, because we intend to
target large companies, our sales cycle can be lengthier due to
the decision process in large organizations. As a result of our
products long sales cycles, we face difficulty predicting
the quarter in which sales to expected customers may occur. If
anticipated sales from a specific customer for a particular
quarter are not realized in that quarter, our operating results
for that quarter could fall below the expectations of financial
analysts and investors, which could cause our stock price to
decline.

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 Software Inc.
and Trilogy Development Group (Trilogy) filed a
complaint in the United States District

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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 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s
patents in the future, and any other relief to which Trilogy may
be entitled. The Company is currently evaluating the merits of
this complaint and we may incur substantial costs to defend
against such claim.


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. . However, 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:



| |   |                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | cease selling, incorporating or using products or
    services that incorporate the challenged intellectual property;                                                                               
|
| |  | obtain from the holder of the infringed
    intellectual property right a license to sell or use the
    relevant intellectual property, which license may not be
    available on reasonable terms;
|
| |  | redesign those products or services that
    incorporate such intellectual property; and/or                                                                                                         
|
| |  | pay money damages to the holder of the infringed
    intellectual property right.                                                                                                                   

In the event of a successful claim of
infringement against us and our failure or inability to license
the infringed intellectual property on reasonable terms or
license a substitute intellectual property or redesign our
product to avoid infringement, our business and operating
results would be significantly harmed. If we are forced to
abandon use of our trademark, we may be forced to change our
name and incur substantial expenses to build a new brand, which
would significantly harm our business.

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 relative youth of the market 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, it
would significantly harm our business and operating results.

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Our limited operating history and the fact
that we operate in a new and evolving industry makes evaluating
our business prospects and results of operations
difficult.

We were founded in June 1996 and have a limited
operating history. We began marketing our products in early 1997
and released ACE 6.0 in March 2003. The revenue and income
potential of our business and market are uncertain. As a result
of our limited operating history, we have limited financial data
that you can use to evaluate our business. Our revenue is
dependent on our ability to enter into significant software
license transactions with new and existing customers. Our
success depends on gaining new customers and maintaining
relationships with our existing customers. You must consider our
prospects in light of the risks and difficulties we may
encounter as an early stage company in the new and rapidly
evolving market for configuration, pricing management and
quoting solutions.

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, Oracle
Corporation, SAP and Siebel Systems, all of which offer
integrated solutions for electronic commerce incorporating some
of the functionality of configuration, pricing management and
quoting solutions.

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:



| |   |                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a longer operating history;                                                                                                                                                                                      
|
| |  | preferred vendor status with our customers;                                                                                                                                                                      
|
| |  | more extensive name recognition and marketing
    power; and                                                                                                                                                     
|
| |  | significantly greater financial, technical,
    marketing and other resources, giving them the ability to
    respond more quickly to new or changing opportunities,
    technologies, and customer requirements.

Our competitors may also bundle their products in
a manner that may discourage users from purchasing our products.
Current and potential competitors may establish cooperative
relationships with each other or with third parties, or adopt
aggressive pricing policies to gain market share. Competitive
pressures may require us to reduce the prices of our products
and services. We may not be able to maintain or expand our sales
if competition increases and we are unable to respond
effectively.

If we do not keep pace with technological
change, including maintaining interoperability of our product
with the software and hardware platforms predominantly used by
our customers, our product may be rendered obsolete and our
business may fail.

Our industry is characterized by rapid
technological change, changes in customer requirements, frequent
new product and service introductions and enhancements and
emerging industry standards. In order to achieve broad customer
acceptance, our products must be compatible with major software
and hardware platforms used by our customers. Our products
currently operate on the Microsoft Windows NT, Sun Solaris,
IBM AIX, Linux, and Microsoft Windows 2000 Operating Systems. In
addition, our products are required to interoperate with
electronic commerce applications and databases. We must
continually modify and enhance our products to keep pace with
changes in these operating systems, applications and databases.
configuration, pricing management and quoting solutions
technology is complex and new products and product enhancements
can require long development and testing periods. If our
products were to be incompatible with a popular new operating
system, electronic commerce application or database, our
business would be significantly harmed. In addition, the
development of entirely new technologies to replace existing
software could

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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 management and quoting
solutions rely on defining a 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 attract and 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 have recently had a high rate or
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 new business
may be harmed.

If we are unable 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, there is additional
downward pressure on the pricing of services projects which
makes it increasingly difficult to improve operating margins.

Although services revenues, which are comprised
primarily of revenues from consulting fees, maintenance
contracts and training, are important to our business,
representing 58%, 71% and 65% of total revenues for the years
ended March 31, 2004, 2003, and 2002, respectively,
services revenues have lower gross margins than license
revenues. Gross margins for services revenues were 27%, 27%, and
6% for the years ended March 31, 2004, 2003, and 2002,
respectively, compared to gross margins for license revenues of
92%, 88%, and 94% for the respective periods.

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

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to provide these resources, we may lose sales or
incur customer dissatisfaction and our business and operating
results could be significantly harmed.


Our sale of intellectual property assets to
Accenture presents a number of new challenges to the
Company.

We recently sold the rights to intellectual
property assets targeted specifically for the health insurance
market segment to Accenture. This transaction requires us to
take on a number of responsibilities that we have not previously
undertaken. Our business relationship requires us to provide
support to users of our software products through a third party,
assist in the transition of existing eInsurance customers to a
new support and services arrangement and transition a number of
our employees to Accenture. If we fail to successfully
transition our existing customers or provide support for our new
partner, it could damage our reputation in the marketplace. If
we are unable to transition our employees, we may need to deploy
additional resources to assist in the success of our partner and
our customers. A failure in any of these undertakings could harm
our results of operations.

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, which could
result in lost revenues, a delay in market acceptance or
negative publicity, each which would significantly harm our
business and operating results.

The loss of any of our key personnel would
harm our competitiveness because of the time and effort that we
would have to expend to replace such personnel.

We believe that our success will depend on the
continued employment of our management team and key technical
personnel, none of whom, except Stephen Bennion, our Chief
Financial Officer and Interim President and Chief Executive
Officer, have an employment agreement with us. If one or more
members of our senior management team or key technical personnel
were unable or unwilling to continue in their present positions,
these individuals would be difficult to replace. Consequently,
our ability to manage day-to-day operations, including our
operations in Pune and Chennai, India, develop and deliver new
technologies, attract and retain customers, attract and retain
employees and generate revenues would be significantly harmed.

A substantial portion of our operations are
conducted by India-based personnel, and any change in the
political and economic conditions of India or in immigration
policies, 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,
2004, there were 140 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 internationally with India-based
employees. We presently rely on a number of visa programs to
enable these India-based employees to

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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.

Any acquisitions that we may make could
disrupt our business and harm our operating results.

We may acquire or make investments in
complementary companies, products or technologies. In the event
of any such investments, acquisitions or joint ventures, we
could:



| |   |                                                                                  
| | - | ---------------------------------------------------------------------------------
| |  | issue stock that would dilute our current
    stockholders percentage ownership;
|
| |  | incur debt;                                                                      
|
| |  | assume liabilities;                                                              
|
| |  | incur amortization expenses related to other
    intangible assets; or           
|
| |  | incur large and immediate write-offs.                                            

These investments, acquisitions or joint ventures
also involve numerous risks, including:



| |   |                                                                                                                                                        
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | problems combining the purchased operations,
    technologies or products with ours;                                                                   
|
| |  | unanticipated costs;                                                                                                                                   
|
| |  | diversion of managements attention from our
    core business;                                                                                        
|
| |  | adverse effects on existing business
    relationships with suppliers and customers;                                                                   
|
| |  | potential loss of key employees, particularly
    those of the acquired organizations; and                                                             
|
| |  | reliance to our disadvantage on the judgment and
    decisions of third parties and lack of control over the
    operations of a joint venture partner.

Any acquisition or joint venture may cause our
financial results to suffer as a result of these risks.

If we 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.

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Any reduction in expenses will place a
significant strain on our management systems and resources, and
if we fail to manage these changes, our business will be
harmed.

We may further reduce our operating expenses and
as a result, this would place increased demands on our
managerial, administrative, operational, financial and other
resources.

Our rapid growth required us to manage a large
number of relationships with customers, suppliers and employees,
as well as a large number of complex contracts. Additional cost
cutting measures would force us to handle these demands with a
smaller number of employees. In addition, the resignation of our
Chief Executive Office has put increased responsibility on a
smaller management team. 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.

Our future success depends on our proprietary
intellectual property, and if we are unable to protect our
intellectual property from potential competitors our business
may be significantly harmed.

We rely on a combination of trademark, trade
secret and copyright law and contractual restrictions to protect
the proprietary aspects of our technology. These legal
protections afford only limited protection for our technology.
We currently have six issued patents and four pending patents in
the U.S. In addition, we have one 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. 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 results of operations will be harmed by
charges associated with stock-based compensation, accelerated
vesting and modification of terms 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 charges related to
securities issuances in future periods, which will negatively
affect our operating results. Since inception we have recorded
approximately $12.0 million in net deferred compensation
charges. During the years ended March 31, 2004, 2003 and
2002, we amortized approximately $1.9, $2.1 million, and
$2.4 million of such charges which included the
compensation expenses related to option acceleration, option
modification, and variable accounting, respectively. We expect
to amortize approximately $125,000 compensation for the fiscal
year ending March 31, 2005 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.

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

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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 complaints and are involved in shareholder derivative
litigation. We also may be subject to other legal proceedings or
claims arising in the ordinary course of business, all of which
could result in substantial costs and divert management
attention and resources.



| |             
| | ------------
| | 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
Selectica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 the
Company with prejudice in return for the assignment by the
Company of claims that the Company might have against its
underwriters. 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, which has been executed on behalf of
the Company. The settling parties anticipate presenting the
settlement papers to the Court on June 14, 2004. There can
be no assurance that the Court will approve the settlement.



| |                              
| | -----------------------------
| | Shareholder Derivative Action

On April 16, 2002, a shareholder derivative
action was filed in the Superior Court of California,
Santa Clara County, against certain of our officers and
directors, against CSFB, as the underwriters of our IPO, and
against the Company as nominal defendant. The action was filed
by a shareholder purporting to assert on behalf of the Company
claims for breach of fiduciary duty, aiding and abetting and
conspiracy,

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negligence, unjust enrichment, and breach of
contract, related to the pricing of shares in the Companys
IPO. On June 6, 2002, the shareholder plaintiff filed an
amended complaint dropping the breach of contract claim against
CSFB and adding claims against CSFB for breach of an
agents duty to its principal and for violation of the
California Unfair Competition Law, based on alleged violations
of certain rules of the National Association of Securities
Dealers.


On November 25, 2002, following the removal
of the case to federal court and the subsequent remand of the
case back to the state court, the Company and the officer and
director defendants filed answers to the amended complaint,
preserving certain defenses including defenses based on
plaintiffs lack of standing to bring the suit. Also on
November 25, 2002, CSFB filed a motion to dismiss the case,
on the grounds that the plaintiff lacks standing. That motion
was heard on March 4, 2003, and on March 18, 2003 the
Court issued an Order sustaining the motion but granting
plaintiff 30 days to file an amended complaint.

On April 18, 2003, the plaintiff filed a
second amended complaint. This complaint adds new allegations as
to standing, and also alleges certain additional facts
supporting the various causes of action against the defendants.
Specifically, plaintiffs new complaint alleges that CSFB
offered and provided, and the individual defendants accepted,
improper gratuities in the form of allocations of
IPO stocks of other companies, in order to influence the
selection of CSFB as the underwriter of the Companys IPO.

On June 17, 2003, CSFB responded to this
second amended complaint by filing a demurrer (motion to
dismiss) on the grounds that the plaintiff lacks standing to
bring the action. Also on June 17, 2003, the Company and
the individual defendants responded to the second amended
complaint by joining CSFBs demurrer, while reserving other
objections. At a hearing on this matter on August 12, 2003,
the Court again granted CSFBs demurrer, with leave for
plaintiff to further amend his complaint, and granted plaintiff
permission to file a motion seeking to establish
plaintiffs standing pursuant to the so-called
contemporaneous ownership rule.

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. The
shareholder derivative litigation is also in its preliminary
stages. At a minimum, the class action litigation as well as the
shareholder derivative litigation could result in substantial
costs and divert our managements attention and resources,
which could seriously harm our business.

Other

The Company reported the results of its 2003
annual stockholders meeting in the Companys Form 10-Q
for the quarter ended September 30, 2003. The Company
subsequently discovered that the voting numbers reported in that
Form 10-Q with respect to the election of the Board
nominees was incorrect. The Company is currently investigating
the actual vote count and the procedures followed by the Company
in the election of its directors at its 2003 annual meeting of
stockholders. Although the investigation is at a preliminary
stage, the Company does not believe that the investigation will
affect the outcome of the election.

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:



| |   |                                                                                      
| | - | -------------------------------------------------------------------------------------
| |  | providing for a classified board of directors
    with staggered three-year terms;   
|
| |  | restricting the ability of stockholders to call
    special meetings of stockholders;

25



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| |   |                                                                                                                                                                                                       
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | prohibiting stockholder action by written consent;                                                                                                                                                    
|
| |  | 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
|
| |  | 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.

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.

Compliance with new regulations dealing with
corporate governance and public disclosure may result in
additional expenses and require significant management
attention.

Changing laws, regulations and standards relating
to corporate governance and public disclosure, including the
Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Stock
Market rules, are creating uncertainty for companies such as
ours. For example, new laws and regulations may require us to
change the composition of our board of directors, the
composition, the responsibility and manner of operation of
various board-level committees, and the type and volume of
information filed by us with governing bodies. We are committed
to complying with these requirements and maintaining high
standards of corporate governance and public disclosure. As a
result, we intend to invest in the necessary resources to comply
with evolving standards. This investment may result in increased
general and administrative expenses and a diversion of
management time and attention from revenue-generating activities
to compliance activities.

26



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##### Table of Contents



RISKS RELATED TO THE INDUSTRY

If use of the Internet does not continue to
develop and reliably support the demands placed on it by
electronic commerce, the market for our products and services
may be adversely affected, and we may not achieve anticipated
sales growth.

Growth in sales of our products and services
depends upon the continued and increased use of the Internet as
a medium for commerce and communication. Growth in the use of
the Internet is a recent phenomenon and may not continue. In
addition, the Internet infrastructure may not be able to support
the demands placed on it by increased usage and bandwidth
requirements. There have also been well-publicized security
breaches involving denial of service attacks on
major web sites. Concerns over these and other security breaches
may slow the adoption of electronic commerce by businesses,
while privacy concerns over inadequate security of information
distributed over the Internet may also slow the adoption of
electronic commerce by individual consumers. Other risks
associated with commercial use of the Internet could slow its
growth, including:



| |   |                                                                              
| | - | -----------------------------------------------------------------------------
| |  | inadequate reliability of the network
    infrastructure;                    
|
| |  | slow development of enabling technologies and
    complementary products; and
|
| |  | limited accessibility and ability to deliver
    quality service.            

In addition, the recent growth in the use of the
Internet has caused frequent periods of poor or slow
performance, requiring components of the Internet infrastructure
to be upgraded. Delays in the development or adoption of new
equipment and standards or protocols required to handle
increased levels of Internet activity, or increased government
regulation, could cause the Internet to lose its viability as a
commercial medium. If the Internet infrastructure does not
develop sufficiently to address these concerns, it may not
develop as a commercial marketplace, which is necessary for us
to increase sales.

Increasing government regulation of the
Internet could limit the market for our products and services,
or impose greater tax burdens on us or liability for
transmission of protected data.

As electronic commerce and the Internet continue
to evolve, federal, state and foreign governments may adopt laws
and regulations covering issues such as user privacy, taxation
of goods and services provided over the Internet, pricing,
content and quality of products and services. If enacted, these
laws and regulations could limit the market for electronic
commerce, and therefore the market for our products and
services. Although many of these regulations may not apply
directly to our business, we expect that laws regulating the
solicitation, collection or processing of personal or consumer
information could indirectly affect our business.

Laws or regulations concerning telecommunications
might also negatively impact us. Several telecommunications
companies have petitioned the Federal Communications Commission
to regulate Internet service providers and online service
providers in a manner similar to long distance telephone
carriers and to impose access fees on these companies. This type
of legislation could increase the cost of conducting business
over the Internet, which could limit the growth of electronic
commerce generally and have a negative impact on our business
and operating results.

27



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##### Table of Contents






PART II






|        |                                                                                                                          
|------- | -------------------------------------------------------------------------------------------------------------------------
|Item 5. | Market for the Registrants Common
    Equity, Related Stockholder Matters and Issuers 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.

|            |                |      |   |      |  |  |   |      | 
|----------- | -------------- | ---- | - | ---- |  |  | - | ---- | 
|            |                | High |   | Low 
|            |                |      |   |     
|Fiscal 2003 |                |      |   |      |  |  |   |     
|            | First Quarter  |      | $ | 4.05 |  |  | $ | 3.50 | 
|            | Second Quarter |      | $ | 4.35 |  |  | $ | 3.10 | 
|            | Third Quarter  |      | $ | 3.57 |  |  | $ | 2.30 | 
|            | Fourth Quarter |      | $ | 3.03 |  |  | $ | 2.57 | 
|Fiscal 2004 |                |      |   |      |  |  |   |     
|            | First Quarter  |      | $ | 3.34 |  |  | $ | 2.69 | 
|            | Second Quarter |      | $ | 4.75 |  |  | $ | 3.09 | 
|            | Third Quarter  |      | $ | 5.44 |  |  | $ | 4.05 | 
|            | Fourth Quarter |      | $ | 5.55 |  |  | $ | 4.29 | 

As of May 31, 2004, there were approximately
185 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.

On March 15, 2000 Selectica completed the
initial public offering of its common stock. The shares of the
common stock sold in the offering were registered under the
Securities Act of 1933, as amended, on a Registration Statement
on Form S-1 (No. 333-92545). The Securities and
Exchange Commission declared the Registration Statement
effective on March 9, 2000.

The offering commenced on March 10, 2000 and
terminated on March 15, 2000 after we had sold all of the
4,600,000 shares of common stock registered under the
Registration Statement (including 450,000 shares sold by
Selectica and 150,000 sold by one of our stockholders in
connection with the exercise of the underwriters
over-allotment option). The managing underwriters in the
offering were Credit Suisse First Boston, Thomas Weisel Partners
LLC, U.S. Bancorp Piper Jaffray and E*Offering. The initial
public offering price was $30.00 per share for an aggregate
initial public offering of approximately $138.0 million.
There has been no change in the disclosure contained in the
Companys report on Form 10-K filed June 28, 2001
regarding the use of proceeds generated by the Companys
initial public offering of its common stock.

In October 2003, we issued 8,665 shares of
common stock pursuant to the exercise of a warrant with an
aggregate exercise price of $3.53. In January 2004, we issued
23,005 shares of common stock pursuant to the exercise of a
warrant with an aggregate exercise price of $3.53.

28



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##### Table of Contents



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.






|        |                                         
|------- | ----------------------------------------
|Item 6. | Selected Consolidated Financial
    Data

|                                                                                                    |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |        |        | 
|--------------------------------------------------------------------------------------------------- | -------------------------- | ------------------------------------- | ------- | ------ | ------ | ---- | ------- | ------ | ------ | ---- | ------- | ------ | ------ | - | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                                                                    |                            |                                      
|                                                                                                    |                            | Years Ended March 31,                
|                                                                                                    |                            |                                      
|                                                                                                    |                            | 2004                                  |         | 2003   |        | 2002 |         | 2001   |        | 2000
|                                                                                                    |                            |                                       |         |        |        |      |         |        |        |     
|                                                                                                    |                            |                                      
|                                                                                                    |                            | (in thousands, except per share data)
|Consolidated Statement of Operations
    Data:                                                      |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Revenues:                                                                                           |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                                                                                    | License                    |                                       | $       | 16,935 |        |      | $       | 10,218 |        |      | $       | 16,683 |        |   | $       | 23,933 |        |   | $       | 9,181  |       
|                                                                                                    | Services                   |                                       |         | 23,089 |        |      |         | 25,350 |        |      |         | 30,511 |        |   |         | 31,367 |        |   |         | 7,390  |       
|                                                                                                    |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                                                                                    |                            | Total revenues                        |         |        | 40,024 |      |         |        | 35,568 |      |         |        | 47,194 |   |         |        | 55,300 |   |         |        | 16,571 | 
|Cost of revenues:                                                                                   |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                                                                                    | License                    |                                       |         | 1,410  |        |      |         | 1,185  |        |      |         | 1,023  |        |   |         | 1,457  |        |   |         | 4,520  |       
|                                                                                                    | Services                   |                                       |         | 16,827 |        |      |         | 18,518 |        |      |         | 28,660 |        |   |         | 28,678 |        |   |         | 15,169 |       
|                                                                                                    |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                                                                                    |                            | Total cost of revenues                |         |        | 18,237 |      |         |        | 19,703 |      |         |        | 29,683 |   |         |        | 30,135 |   |         |        | 19,689 | 
|                                                                                                    |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Gross profit (loss)                                                                                 |                            |                                       | 21,787  |        |        |      | 15,865  |        |        |      | 17,511  |        |        |   | 25,165  |        |        |   | (3,118  | )     
|Operating expenses:                                                                                 |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                                                                                    | Research and development   |                                       |         | 13,474 |        |      |         | 13,202 |        |      |         | 15,343 |        |   |         | 21,849 |        |   |         | 7,347  |       
|                                                                                                    | Sales and marketing        |                                       |         | 14,491 |        |      |         | 19,368 |        |      |         | 25,215 |        |   |         | 50,686 |        |   |         | 17,026 |       
|                                                                                                    | General and administrative |                                       |         | 5,385  |        |      |         | 6,068  |        |      |         | 8,922  |        |   |         | 14,876 |        |   |         | 4,554  |       
|                                                                                                    |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|                                                                                                    |                            | Total operating expenses              |         |        | 33,350 |      |         |        | 38,638 |      |         |        | 49,480 |   |         |        | 87,411 |   |         |        | 28,927 | 
|                                                                                                    |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Loss from operations                                                                                |                            |                                       | (11,563 | )      |        |      | (22,773 | )      |        |      | (31,969 | )      |        |   | (62,246 | )      |        |   | (32,045 | )     
|Other income, net                                                                                   |                            |                                       | 1,092   |        |        |      |        |        |        |      |        |        |        |   |        |        |        |   |        |       
|Interest income                                                                                     |                            |                                       | 1,625   |        |        |      | 2,999   |        |        |      | 5,896   |        |        |   | 12,654  |        |        |   | 1,241   |       
|                                                                                                    |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Net loss before taxes                                                                               |                            |                                       | (8,846  | )      |        |      | (19,774 | )      |        |      | (26,073 | )      |        |   | (49,592 | )      |        |   | (30,804 | )     
|Provision for income taxes                                                                          |                            |                                       |        |        |        |      |        |        |        |      | 304     |        |        |   | 275     |        |        |   | 50      |       
|                                                                                                    |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Net loss before cumulative effect of an
    accounting change                                       |                            |                                       | (8,846  | )      |        |      | (19,774 | )      |        |      | (26,377 | )      |        |   | (49,867 | )      |        |   | (30,854 | )     
|Cumulative effect of an accounting change to
    adopt FAS 142                                      |                            |                                       |        |        |        |      | (9,974  | )      |        |      |        |        |        |   |        |        |        |   |        |       
|                                                                                                    |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Net loss                                                                                            |                            |                                       | (8,846  | )      |        |      | (29,748 | )      |        |      | (26,377 | )      |        |   | (49,867 | )      |        |   | (30,854 | )     
|Deemed dividend on Series E convertible
    preferred stock                                         |                            |                                       |        |        |        |      |        |        |        |      |        |        |        |   |        |        |        |   | 925     |       
|                                                                                                    |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Net loss applicable to common stockholders                                                          |                            | $                                     | (8,846  | )      |        | $    | (29,748 | )      |        | $    | (26,377 | )      |        | $ | (49,867 | )      |        | $ | (31,779 | )     
|                                                                                                    |                            |                                       |         |        |        |      |         |        |        |      |         |        |        |   |         |        |        |   |         |       
|Basic and diluted net loss per share applicable
    to common stockholders                          |                            | $                                     | (0.28   | )      |        | $    | (0.92   | )      |        | $    | (0.75   | )      |        | $ | (1.44   | )      |        | $ | (4.54   | )     
|Shares used in computing basic and diluted net
    loss per share applicable to common stockholders |                            |                                       | 31,165  |        |        |      | 32,219  |        |        |      | 35,090  |        |        |   | 34,580  |        |        |   | 6,999   |       

29



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##### Table of Contents



|                                 |  |                       |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |         | 
|-------------------------------- |  | --------------------- | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                 |  |                      
|                                 |  | Years Ended March 31,
|                                 |  |                      
|                                 |  | 2004                  |         | 2003 |  | 2002 |         | 2001 |  | 2000
|                                 |  |                       |         |      |  |      |         |      |  |     
|                                 |  |                      
|                                 |  | (in thousands)       
|Consolidated Balance Sheet Data: |  |                       |         |      |  |      |         |      |  |      |         |  |  |   |         |  |  |   |         | 
|Current assets                   |  | $                     | 102,663 |      |  | $    | 117,853 |      |  | $    | 133,456 |  |  | $ | 167,181 |  |  | $ | 229,252 | 
|Non current assets               |  |                       | 23,753  |      |  |      | 19,296  |      |  |      | 36,628  |  |  |   | 42,591  |  |  |   | 11,467  | 
|Current liabilities              |  |                       | 12,896  |      |  |      | 22,731  |      |  |      | 15,509  |  |  |   | 26,265  |  |  |   | 26,641  | 
|Non current liabilities          |  |                       | 1,482   |      |  |      | 1,338   |      |  |      | 1,223   |  |  |   | 969     |  |  |   |        | 
|Working capital                  |  |                       | 89,767  |      |  |      | 95,122  |      |  |      | 117,947 |  |  |   | 140,916 |  |  |   | 202,611 | 
|Total assets                     |  |                       | 126,416 |      |  |      | 137,149 |      |  |      | 170,084 |  |  |   | 209,772 |  |  |   | 240,719 | 
|Total stockholders equity       |  |                       | 112,038 |      |  |      | 113,080 |      |  |      | 153,352 |  |  |   | 182,538 |  |  |   | 214,078 | 

Certain reclassifications have been made to prior
years consolidated balance sheets and consolidated statements of
cash flow to conform to the current year presentation. As of
March 31, 2002, the Company reclassified approximately
$37.4 million from short-term investments to cash
equivalents and reduced accounts receivable and deferred revenue
by $3.9 million primarily related to maintenance contract
periods which have not commenced. As of March 31, 2001, the
Company reclassified approximately $17.1 million from
long-term investments to short term investments and cash
equivalents and reduced accounts receivable and deferred revenue
by approximately $10.0 million primarily related to
maintenance contract periods which have not commenced,
respectively. As of March 31, 2000, the Company reduced
accounts receivable and deferred revenue by approximately
$1.7 million primarily related to maintenance contract
periods that have not commenced.






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|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.

30



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##### Table of Contents



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, 2004, 2003, and 2002.

|                                                               |                            |                          |     |      |     |      |     |    |     |  |     |    |     | 
|-------------------------------------------------------------- | -------------------------- | ------------------------ | --- | ---- | --- | ---- | --- | -- | --- |  | --- | -- | --- | 
|                                                               |                            |                         
|                                                               |                            | Years Ended March 31,   
|                                                               |                            |                         
|                                                               |                            | 2004                     |     | 2003 |     | 2002
|                                                               |                            |                          |     |      |     |     
|As a Percentage of Total Revenues:                             |                            |                          |     |      |     |      |     |    |     |  |     |   
|Revenues:                                                      |                            |                          |     |      |     |      |     |    |     |  |     |   
|                                                               | License                    |                          |     | 42   | %   |      |     | 29 | %   |  |     | 35 | %  
|                                                               | Services                   |                          |     | 58   |     |      |     | 71 |     |  |     | 65 |    
|                                                               |                            |                          |     |      |     |      |     |    |     |  |     |   
|                                                               |                            | Total revenues           |     |      | 100 |      |     |    | 100 |  |     |    | 100 | 
|Cost of revenues:                                              |                            |                          |     |      |     |      |     |    |     |  |     |   
|                                                               | License                    |                          |     | 4    |     |      |     | 3  |     |  |     | 2  |    
|                                                               | Services                   |                          |     | 42   |     |      |     | 52 |     |  |     | 61 |    
|                                                               |                            |                          |     |      |     |      |     |    |     |  |     |   
|                                                               |                            | Total cost of revenues   |     |      | 46  |      |     |    | 55  |  |     |    | 63  | 
|                                                               |                            |                          |     |      |     |      |     |    |     |  |     |   
|                                                               |                            | Gross profit             |     |      | 54  |      |     |    | 45  |  |     |    | 37  | 
|Operating expenses:                                            |                            |                          |     |      |     |      |     |    |     |  |     |   
|                                                               | Research and development   |                          |     | 34   |     |      |     | 37 |     |  |     | 33 |    
|                                                               | Sales and marketing        |                          |     | 36   |     |      |     | 55 |     |  |     | 53 |    
|                                                               | General and administrative |                          |     | 13   |     |      |     | 17 |     |  |     | 19 |    
|                                                               |                            |                          |     |      |     |      |     |    |     |  |     |   
|                                                               |                            | Total operating expenses |     |      | 83  |      |     |    | 109 |  |     |    | 105 | 
|                                                               |                            |                          |     |      |     |      |     |    |     |  |     |   
|Loss from operations                                           |                            |                          | (29 | )    |     |      | (64 | )  |     |  | (68 | ) 
|Other income, net                                              |                            |                          | 3   |      |     |      |    |    |     |  |    |   
|Interest income                                                |                            |                          | 4   |      |     |      | 8   |    |     |  | 12  |   
|                                                               |                            |                          |     |      |     |      |     |    |     |  |     |   
|Loss before provision for income taxes                         |                            |                          | (22 | )    |     |      | (56 | )  |     |  | (56 | ) 
|Provision for income taxes                                     |                            |                          |    |      |     |      |    |    |     |  | 1   |   
|                                                               |                            |                          |     |      |     |      |     |    |     |  |     |   
|Loss before cumulative effect of an accounting
    change      |                            |                          | (22 | )    |     |      | (56 | )  |     |  | (57 | ) 
|Cumulative effect of an accounting change to
    adopt FAS 142 |                            |                          | 0   |      |     |      | (28 | )  |     |  |    |   
|                                                               |                            |                          |     |      |     |      |     |    |     |  |     |   
|Net loss                                                       |                            |                          | (22 | )%   |     |      | (84 | )% |     |  | (57 | )%
|                                                               |                            |                          |     |      |     |      |     |    |     |  |     |   

Overview

Selectica is a leading provider of software that
enables enterprises to utilize the Internet as a platform for
selling complex product and services. Our software products
facilitate our customers efforts to correctly configure,
price, and quote offerings across multiple distribution
channels. Our applications have also been deployed to bridge the
gap between customer relationship management
(CRM) applications and other business applications with
respect to the management of complex product features and
business rules. As a result, we help our customers improve
profitability by reducing process costs, optimizing pricing,
eliminating rework and concessions, and avoiding high-risk
business. 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 enterprise resource planning, or ERP,
systems. This allows for an easy-to-install application and
reduced deployment time. Across a wide range of industries,
Selecticas products have demonstrated an ability to
increase productivity, improve order accuracy, boost return on
investment and establish and maintain a competitive advantage.
Selecticas customers represent manufacturing and service
leaders including: ABB, Applied Bio Systems, Bell Canada, Cisco,
Dell, General Electric, Firemans Fund Insurance
Company, Hitachi, Juniper Networks, Rockwell Automation and
Tellabs.

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Summary of Operating Results for
2004

For the year ended March 31, 2004, our
revenue was approximately $40.0 million with license
revenues representing 42% and services revenues representing 58%
of total revenues. In addition, approximately 60% of our annual
revenue came from two customers. License margin for the year was
92% and services margin was 27%. Total operating expenses were
$33.4 million. During the year, we also recognized
approximately $1.1 million in other income relating to the
sale of our rights to intellectual property assets targeted
specifically for the health insurance market segment to
Accenture. Net loss for the year was approximately
$8.8 million or $.28 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. In fiscal 2004, approximately 76% of
our license revenues and associated services revenue from
initial implementations came from contracts that were booked in
previous fiscal years. In addition, we have some bookings, which
are related to follow-on services to our existing customers.
These bookings are usually recognized as revenue more quickly
than initial implementations and represented approximately 37%
of total revenue for the year. During the first half of fiscal
2004, bookings consisted of only follow-on services. During the
latter half of fiscal 2004, we saw less follow-on services
bookings and more new customer bookings, which contributed to an
overall increase in total bookings. We believe that the success
in the increase of new customer and total bookings during the
latter half of fiscal 2004 is directly related to the focus
around new customer bookings by sales and executive management.

We also continue to believe that the economy has
had an impact on the enterprise software industry. Over the past
four fiscal years, we have witnessed decreased spending in
enterprise software and increased sales cycles. The increased
sales cycles are primarily due to increased scrutiny around the
technology and the analysis on the return on investment
(ROI) by potential business owners, finance
managers, IT groups, and executive levels of management. In
addition, because ROI has become such a key element in the
decision making process for some of our new customers, we may
agree to certain sales terms which cause a delay in revenue
recognition.



| |                   
| | ------------------
| | Expense Management

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. Total annual expense levels
for normal operations in fiscal 2003, which exclude non-cash
charges and restructuring charges, were approximately
$54.8 million. The decrease in annual expenses was
primarily due to significant headcount reductions, closure of
some of our foreign offices, and reduction in spending in all
areas.

Outlook for 2005

Because of the weak bookings experienced in the
first half of fiscal 2004 and the timing difference with respect
to when revenue is recognized, management believes that reported
revenue will be impacted over the next two quarters. As a
result, managements focus is primarily on new bookings as
opposed to revenue. Revenue will only increase through an
increased level of bookings with related terms which do not
delay revenue recognition.

On the expense side, we may make larger
investments in the area of sales and marketing to reposition the
Company in the opportunity to order space. If we make such
investments, we plan to reduce other areas accordingly to
maintain current operating expense levels.

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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:



| |         
| | --------
| | Revenues

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 with Respect to Certain Transactions. We
recognize maintenance revenues over the term of the maintenance
contract as 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, under the subscription method, 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 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,

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(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 since 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 profit 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. 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 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.

To date we have not entered into arrangements
solely for the license of our products and, therefore, we have
not demonstrated vendor-specific objective evidence for the fair
value of the license element.

Arrangements consisting of 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.
Consulting services are recognized based on customer acceptance
in the form of customer-signed timesheets, cash received, or
customer-signed acceptance.

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In all cases we classify revenues for these
arrangements as license revenues and services revenues based on
the estimates of fair value for each element as noted below:

|                                           |  |                       |     |      |  |      |     |   |  |  |     |  
|------------------------------------------ |  | --------------------- | --- | ---- |  | ---- | --- | - |  |  | --- | -
|                                           |  |                      
|                                           |  | Years Ended March 31,
|                                           |  |                      
|                                           |  | 2004                  |     | 2003 |  | 2002
|                                           |  |                       |     |      |  |     
|As a Percentage of Total Revenues:         |  |                       |     |      |  |      |     |   |  |  |     |  
|Contract Accounting                        |  |                       | 51  | %    |  |      | 80  | % |  |  | 84  | %
|Residual Method                            |  |                       | 3   |      |  |      | 2   |   |  |  | 3   |  
|Subscription Method (includes Maintenance) |  |                       | 46  |      |  |      | 18  |   |  |  | 13  |  
|                                           |  |                       |     |      |  |      |     |   |  |  |     |  
|Total Revenues                             |  |                       | 100 | %    |  |      | 100 | % |  |  | 100 | %
|                                           |  |                       |     |      |  |      |     |   |  |  |     |  

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. Amounts recognized as revenue in advance of
billing (typically under percentage-of-completion accounting)
are recorded as unbilled receivables.



| |                                
| | -------------------------------
| | 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. For all other
receivables, we record an allowance based on an assessment of
the aging of such receivables, our historical experience with
bad debts and the general economic environment.



| |                             
| | ----------------------------
| | 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.

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:

|                                     |            |  |  |     | 
|------------------------------------ | ---------- |  |  | --- | 
|Fiscal Year ended March 31,
    2004 |            |  |  |    
|                                     | Customer A |  |  | 39% | 
|                                     | Customer B |  |  | 20% | 
|Fiscal Year ended March 31,
    2003 |            |  |  |    
|                                     | Customer B |  |  | 25% | 
|                                     | Customer C |  |  | 14% | 
|Fiscal Year ended March 31,
    2002 |            |  |  |    
|                                     | Customer C |  |  | 11% | 

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. In addition, if the recent conflicts
between India and Pakistan resume, it could adversely affect our
operations in India.

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We have a limited operating history upon which we
may be evaluated. We have incurred significant losses since
inception and, as of March 31, 2004, we had an accumulated
deficit of approximately $158.0 million. We believe our
success depends on the growth of our customer base and the
development of the emerging configuration, pricing management
and quoting solutions market. Due to the slowing of the
U.S. economy, particularly in the area of technology
infrastructure investment, and in an effort to achieve
profitability, we underwent certain restructuring activities
during the second and third quarters of the fiscal year of 2003.
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 view of the rapidly changing nature of our
business and our limited operating history, we believe that
period-to-period comparisons of revenues and operating results
are not necessarily meaningful and should not be relied upon as
indications of future performance. Our limited operating history
makes it difficult to forecast future operating results. We do
not believe that any of our historical growth rates are
necessarily sustainable or indicative of future growth and we
cannot be certain that revenues will increase. This was
evidenced by the slight growth in the first quarter of fiscal
2002 with further declines in the remaining quarters of fiscal
year 2002 and throughout fiscal 2003, and the slight growth in
fiscal 2004.

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.

Equity Transactions

During the year ended March 31, 2001, the
Company repurchased 650,000 shares of common stock from
certain key employees (the Stock Repurchase). These
shares were originally issued in connection with the exercise of
stock options in exchange for full recourse promissory notes
with an aggregate value of $9.5 million. As compensation
for services rendered by these employees and in order to provide
an inducement for continued employment, the shares were
repurchased at prices greater than their fair market values at
the time of the repurchase. As a result, the Company recorded a
total compensation expense of approximately $1.2 million of
which approximately $156,000 was expensed to research and
development, approximately $291,000 was expensed in cost of
goods sold, approximately $291,000 was expensed in sales and
marketing, and approximately $447,000 was expensed in general
and administrative expense. During the year ended March 31,
2002, the Company repurchased 212,814 shares of common
stock with an aggregate value of approximately $924,000 from
those employees (the Stock Repurchase),
50,000 shares were repurchased at the prices greater than
their fair market values at the time of the repurchase. The
Company recorded a total compensation expense of approximately
$201,000 and classified it under general and administrative
expense.

As a result of the stock repurchase, the
remaining outstanding shares owned by those employees
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.
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. 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 options in
the future.

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In August 2001, the Board authorized the Company
to repurchase up to $30 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 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, 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.

The aggregate of the purchases since the
authorizations by the Board of Directors was approximately
6.2 million shares at the cost of approximately
$21.0 million including brokerage fees.

Results of Operations

Revenues

|         |                              |                                    |        |        |   |      |    |        |   |      |        |        |   |  |     |     |    |   |        |        |  
|-------- | ---------------------------- | ---------------------------------- | ------ | ------ | - | ---- | -- | ------ | - | ---- | ------ | ------ | - |  | --- | --- | -- | - | ------ | ------ | -
|         |                              | 2004                               |        | Change |   | 2003 |    | Change |   | 2002
|         |                              |                                    |        |        |   |      |    |        |   |     
|         |                              |                                   
|         |                              | (in thousands, except percentages)
|License  |                              | $                                  | 16,935 |        |   |      | 66 | %      |   | $    | 10,218 |        |   |  | (39 | )%  |    | $ | 16,683 |       
|         | Percentage of total revenues |                                    |        | 42     | % |      |    |        |   |      |        | 29     | % |  |     |     |    |   |        | 35     | %
|Services |                              | $                                  | 23,089 |        |   |      | (9 | )%     |   | $    | 25,350 |        |   |  | (17 | )%  |    | $ | 30,511 |       
|         | Percentage of total revenues |                                    |        | 58     | % |      |    |        |   |      |        | 71     | % |  |     |     |    |   |        | 65     | %
|         | Total revenues               |                                    | $      | 40,024 |   |      |    | 13     | % |      | $      | 35,568 |   |  |     | (25 | )% |   | $      | 47,194 |  

License.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 2003 license revenues decreased on an annual
basis by approximately $6.5 million compared to fiscal 2002
primarily due to the weakening economic environment, which
impacted the productivity of our sales force. Fiscal 2004
license revenues came primarily from three significant
customers, two of which were signed in fiscal 2003 and one in
fiscal 2002. Fiscal 2003 license revenues came primarily from
three significant customers, two of which were signed in fiscal
2001 and one in fiscal 2003. Fiscal 2002 license revenues came
primarily from eleven customers, two of which were signed in
fiscal year 2002, five of which were signed in fiscal 2001,
three of which were signed in fiscal year 2000, and one which
was signed in fiscal 1999.

In fiscal 2002, we also expensed approximately
$254,000 for a discount on the sale of common stock to a
customer against license revenues.

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,
training and out-of pocket reimbursement. Maintenance revenues
represented 35%, 25%, and 13% of total services revenues for the
years ended March 31, 2004, 2003, and 2002, respectively.
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 2003,
services revenues decreased on an annual basis by approximately
$5.2 million primarily due to fewer new implementations and
significantly fewer billings related to out-of-pocket
reimbursements, offset by an increase in maintenance revenues of
$2.4 million.

In fiscal 2004, services revenue was reduced by
approximately $21,000 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

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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 depending 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.

Cost of Revenues

|                          |                                 |                                    |        |        |   |      |    |        |  |      |        |    |   |  |     |    |  |   |        |    |  
|------------------------- | ------------------------------- | ---------------------------------- | ------ | ------ | - | ---- | -- | ------ |  | ---- | ------ | -- | - |  | --- | -- |  | - | ------ | -- | -
|                          |                                 | 2004                               |        | Change |   | 2003 |    | Change |  | 2002
|                          |                                 |                                    |        |        |   |      |    |        |  |     
|                          |                                 |                                   
|                          |                                 | (in thousands, except percentages)
|Cost of license revenues  |                                 | $                                  | 1,410  |        |   |      | 19 | %      |  | $    | 1,185  |    |   |  | 16  | %  |  | $ | 1,023  |   
|                          | Percentage of license revenues  |                                    |        | 8      | % |      |    |        |  |      |        | 12 | % |  |     |    |  |   |        | 6  | %
|Cost of services revenues |                                 | $                                  | 16,827 |        |   |      | (9 | )%     |  | $    | 18,518 |    |   |  | (35 | )% |  | $ | 28,660 |   
|                          | Percentage of services revenues |                                    |        | 73     | % |      |    |        |  |      |        | 73 | % |  |     |    |  |   |        | 94 | %

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, other data transmission costs.
We experienced an increase in costs during fiscal 2004 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. 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.

In fiscal 2003, we experienced a decline in cost
of services revenue of $10.1 million primarily due to our
restructuring efforts. In fiscal 2003, we also recorded
approximately $644,000 for deferred compensation related to
stock options, $259,000 for restructuring charges, $231,000 for
compensation expense related to option acceleration, and $2,000
for compensation expense related to variable accounting.

In fiscal 2002, we amortized approximately
$1.1 million of goodwill and other intangible assets
related to the Wakely Software acquisition, recorded expense of
approximately $799,000 for deferred compensation related to
stock options, $245,000 for restructuring costs related to the
severance and benefits paid to terminated employees and $20,000
for compensation expenses related to variable accounting.

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.

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Gross Margin

|                                |  |      |    |      |  |      |    |   |  |  |    |  
|------------------------------- |  | ---- | -- | ---- |  | ---- | -- | - |  |  | -- | -
|                                |  | 2004 |    | 2003 |  | 2002
|                                |  |      |    |      |  |     
|Gross margin, license revenues  |  |      | 92 | %    |  |      | 88 | % |  |  | 94 | %
|Gross margin, services revenues |  |      | 27 | %    |  |      | 27 | % |  |  | 6  | %
|Gross margin, total revenues    |  |      | 54 | %    |  |      | 45 | % |  |  | 37 | %

Gross Margin 
Licenses.Because we have certain
license costs that are fixed, gross margins fluctuate until we
have sufficient license revenues. 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, 2004, 2003, and 2002 have not fluctuated
significantly in absolute dollars. Due to lower license revenues
in fiscal 2003, we experienced lower gross margins for licenses.
In fiscal 2004 and 2002, we experienced similar levels of
license revenues and thus more consistent and higher gross
margins.

Gross Margin 
Services.Services revenues have
decreased from $30.5 million in fiscal 2002, to $25.4 in
fiscal 2003, to $23.1 million in fiscal 2004. While
services revenues have decreased, we have also been able to
decrease our costs significantly in order to maintain a higher
services margin. In fiscal 2004, we balanced expenses with
services revenues to maintain stronger services margins without
sacrificing overall customer satisfaction. In fiscal 2003, we
dramatically reduced our costs through restructuring and the
continual effort to shift more work to lower cost regions.

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

|                           |                              |                                    |        |        |   |      |     |        |  |      |        |    |   |  |     |    |  |   |        |    |  
|-------------------------- | ---------------------------- | ---------------------------------- | ------ | ------ | - | ---- | --- | ------ |  | ---- | ------ | -- | - |  | --- | -- |  | - | ------ | -- | -
|                           |                              | 2004                               |        | Change |   | 2003 |     | Change |  | 2002
|                           |                              |                                    |        |        |   |      |     |        |  |     
|                           |                              |                                   
|                           |                              | (in thousands, except percentages)
|Research and development   |                              | $                                  | 13,474 |        |   |      | 2   | %      |  | $    | 13,202 |    |   |  | (14 | )% |  | $ | 15,343 |   
|                           | Percentage of total revenues |                                    |        | 34     | % |      |     |        |  |      |        | 37 | % |  |     |    |  |   |        | 33 | %
|Sales and marketing        |                              | $                                  | 14,491 |        |   |      | (25 | )%     |  | $    | 19,368 |    |   |  | (23 | )% |  | $ | 25,215 |   
|                           | Percentage of total revenues |                                    |        | 36     | % |      |     |        |  |      |        | 55 | % |  |     |    |  |   |        | 53 | %
|General and administrative |                              | $                                  | 5,385  |        |   |      | (11 | )%     |  | $    | 6,068  |    |   |  | (32 | )% |  | $ | 8,922  |   
|                           | Percentage of total revenues |                                    |        | 13     | % |      |     |        |  |      |        | 17 | % |  |     |    |  |   |        | 19 | %

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 slight increase of
approximately $272,000 in fiscal 2004 compared to fiscal 2003
was primarily due to severance related charges. The decrease of
approximately $2.1 million in fiscal year 2003 compared to
fiscal 2002 was primarily due to the benefits of our
restructuring activities. 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. For fiscal 2003, we recorded expenses of
approximately $253,000 for deferred compensation related to
stock options and $142,000 for restructuring, principally
comprised of reductions in headcount. For fiscal 2002, we
recorded expenses of approximately $267,000 for deferred
compensation related to stock options, $1.3 million for the
development agreement entered into with a significant customer
and $287,000 for restructuring and $7,000 for compensation
expense

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related to option acceleration. We may reduce
expenses in research and development in absolute dollars over
the next year as necessary to balance total expenses.


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. The decrease of approximately $4.9 million in
fiscal 2004 compared to fiscal 2003 was primarily due to the
benefits of our restructuring activities. The decrease of
approximately $5.8 million in fiscal year 2003 compared to
fiscal 2002 was also 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. For
fiscal 2003, we recorded expenses of approximately $556,000 for
deferred compensation related to stock options, approximately
$390,000 for restructuring charges and approximately $17,000 for
compensation expense related to option acceleration. For fiscal
2002, we recorded expenses of approximately $729,000 for
deferred compensation related to stock options, approximately
$454,000 for restructuring charges and approximately $106,000 of
deferred compensation expense related to stock option
acceleration respectively. 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 decrease of approximately $683,000 in
fiscal 2004 compared to fiscal 2003 was primarily due to our
restructuring efforts including head count reductions. The
decrease of approximately $2.9 million in fiscal year 2003
compared to fiscal 2002 was also primarily due to our
restructuring efforts including head count 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. For fiscal 2002, we recorded expenses
of approximately $401,000 of deferred compensation related to
stock options, approximately $201,000 for the repurchase of
stock from certain executives, approximately $774,000 for
restructuring charges, and approximately $1.5 million for
the amortization of goodwill related to the Wakely Software
acquisition. 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, 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 heads
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
heads 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 heads in the areas of professional services,
research and development, sales, marketing, and general
administration and were completed by the fourth quarter of 2004.

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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.

Other Income, Net

In December 2003, pursuant to an asset purchase
agreement the Company sold its 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. The Company recognized
approximately $1.1 million in other income during the
quarter.

Interest Income

|                |  |                                    |       |        |  |      |     |        |  |      |       |  |  |  |     |    |  |   |       | 
|--------------- |  | ---------------------------------- | ----- | ------ |  | ---- | --- | ------ |  | ---- | ----- |  |  |  | --- | -- |  | - | ----- | 
|                |  | 2004                               |       | Change |  | 2003 |     | Change |  | 2002
|                |  |                                    |       |        |  |      |     |        |  |     
|                |  |                                   
|                |  | (in thousands, except percentages)
|Interest Income |  | $                                  | 1,625 |        |  |      | (46 | )%     |  | $    | 2,999 |  |  |  | (49 | )% |  | $ | 5,896 | 

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.

The decreases in fiscal 2004 and 2003 were due
primarily to lower interest rates.

Provision for Income Taxes

We have recorded a tax provision of $304,000 for
fiscal year 2002. We did not record a provision for fiscal 2003
and 2004. The provision for income taxes in fiscal 2002 consists
solely of foreign taxes.

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 intend to evaluate the realizability of
the deferred tax assets on a quarterly basis.

Recent Accounting Pronouncements

In November 2002, the EITF reached a consensus on
Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables (EITF No. 00-21). EITF No. 00-21
provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products,
services or rights to use assets. The provisions of EITF
No. 00-21 applies to revenue arrangements entered into
after June 15, 2003. The Company adopted EITF
No. 00-21 and the provisions of this guidance did not have
a significant impact on its results of operations and financial
condition.

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest
Entities (FIN 46), an interpretation of Accounting
Research Bulletin No. 51, Consolidated Financial
Statements. FIN 46 requires certain variable interest
entities (VIEs) to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity
do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity
to finance its activities without additional subordinated
financial support from other parties. FIN 46 is effective
for all new VIEs created or acquired after January 31,

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2003. For VIEs created or acquired prior to
February 1, 2003, the provisions of FIN 46 must be
applied for the first interim or annual period beginning after
March 15, 2004. As of March 31, 2004, we have not
invested in any new VIEs created after January 31, 2003. As
of result, FIN 46 will not have an impact on our results of
operations and financial condition.


Liquidity and Capital Resources

|                                                         |  |                                    |         |        |  |      |      |        |  |      |         |   |  |  |     |    |  |   |         |  
|-------------------------------------------------------- |  | ---------------------------------- | ------- | ------ |  | ---- | ---- | ------ |  | ---- | ------- | - |  |  | --- | -- |  | - | ------- | -
|                                                         |  | 2004                               |         | Change |  | 2003 |      | Change |  | 2002
|                                                         |  |                                    |         |        |  |      |      |        |  |     
|                                                         |  |                                   
|                                                         |  | (in thousands, except percentages)
|Cash, cash equivalents and short-term investments        |  | $                                  | 99,369  |        |  |      | (9   | )%     |  | $    | 109,217 |   |  |  | (13 | )% |  | $ | 126,057 |  
|Working capital                                          |  | $                                  | 89,767  |        |  |      | (6   | )%     |  | $    | 95,122  |   |  |  | (19 | )% |  | $ | 117,947 |  
|Net cash used for operating activities                   |  | $                                  | (10,167 | )      |  |      | 50   | %      |  | $    | (6,784  | ) |  |  | 63  | %  |  | $ | (18,413 | )
|Net cash provided by (used for) investing
    activities |  | $                                  | (19,298 | )      |  |      | (189 | )%     |  | $    | 21,613  |   |  |  | 131 | %  |  | $ | 9,352   |  
|Net cash provided by (used for) financing
    activities |  | $                                  | 5,821   |        |  |      | (146 | )%     |  | $    | (12,593 | ) |  |  | 132 | %  |  | $ | (5,422  | )

Our primary sources of liquidity consisted of
$99.4 million in cash, cash equivalents and short-term
investments as of March 31, 2004 compared to
$109.2 million in cash, cash equivalents and short-term
investments as of March 31, 2003. At March 31, 2002,
our sources of liquidity consisted of $126.1 million in
cash, cash equivalents and short-term investments. The decrease
from fiscal 2004 compared to 2003 primarily related to
approximately $10.2 million of cash used in operations, a
net $20.0 million used for long and short term investments,
$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. The decrease from fiscal 2002 compared to fiscal
2003 primarily related to approximately $6.8 million of
cash used in operations, $13.4 million for stock repurchase
in the open market, offset by approximately $679,000 of proceeds
from issuance of common stock.

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. In fiscal 2003, we experienced a
net decrease in working capital primarily due to the cash used
in operations, stock repurchases and capital expenditures, which
are mentioned above, and an increase of approximately
$8.4 million in deferred revenue. The increase of deferred
revenues was a result of an increase in cash received for
amounts billed in advance of revenue recognition for our
software products and services.

Historically, we have funded our operations with
proceeds from the sale of preferred stock, private placements,
and a public offering. 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 net cash used for operating
activities in fiscal 2002 was due primarily to the net loss
adjusted for non-cash expenses. In addition, we experienced a
net decrease in cash due to the reduction of all our
liabilities, offset primarily by our decreases in accounts
receivable and other assets.

The $19.3 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
$9.4 million of net cash provided by investing activities
in fiscal 2002 was due primarily to approximately
$9.4 million of net proceeds from the maturity of
short-term and long-term investments.

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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 and
$5.4 million of net cash used for financing activities in
fiscal 2003 and 2002, respectively, 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 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, 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.

The aggregate of the purchases since inception of
the repurchase program has been approximately 6.2 million
shares at the cost of approximately $21.0 million including
brokerage fees.

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
long-term investment of approximately $180,000 is related to a
facility lease agreement that has expiration date greater than
twelve months from March 31, 2004.

We had no significant commitments for capital
expenditures as of March 31, 2004. 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 31,2004 are adequate to fund our operations through
at least March 31, 2005.

We engage in global business operations and are
therefore exposed to foreign currency fluctuations. As of
March 31, 2004, the effects of the foreign currency
fluctuations in Europe and India were insignificant.

Our contractual obligations and commercial
commitments at March 31, 2004, are summarized as follows
(see also Note 6 and Note 8 of Notes to Consolidated
Financial Statements):

|                         |  |                        |        |           |  |       |       |       |  |         |       |  |  |   |       |  |  |   |   | 
|------------------------ |  | ---------------------- | ------ | --------- |  | ----- | ----- | ----- |  | ------- | ----- |  |  | - | ----- |  |  | - | - | 
|                         |  |                       
|                         |  | Payments Due By Period
|                         |  |                       
|                         |  |                        |        | Less Than |  | 1-3   |       | 4-5   |  | After 5
|Contractual Obligations: |  | Total                  |        | 1 Year    |  | Years |       | Years |  | Years  
|                         |  |                        |        |           |  |       |       |       |  |        
|                         |  |                       
|                         |  | (in thousands)        
|Operating Leases         |  | $                      | 15,139 |           |  | $     | 2,728 |       |  | $       | 7,661 |  |  | $ | 4,750 |  |  | $ |  | 






|         |                                                               
|-------- | --------------------------------------------------------------
|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.

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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 2004, a hypothetical 50 basis
point increase in interest rates would have resulted in a
reduction of approximately $241,000 (less than 0.30%) 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, 2004.

For fiscal 2003, a hypothetical 50 basis
point increase in interest rates would have resulted in a
reduction of approximately $85,000 (less than 0.10%) 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, 2003.

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, 2004:

|                        |  |             |        |      |  |       |        |   |  |   |        |  
|----------------------- |  | ----------- | ------ | ---- |  | ----- | ------ | - |  | - | ------ | -
|                        |  | 2005        |        | 2006 |  | Total
|                        |  |             |        |      |  |      
|                        |  |            
|                        |  | (thousands)
|Auction rate preferreds |  | $           | 27,850 |      |  | $     |       |   |  | $ | 27,850 |  
|Weighted Average yield  |  |             | 1.10   | %    |  |       |       |   |  |   | 1.10   | %
|Government agencies     |  |             | 25,563 |      |  |       | 18,558 |   |  |   | 44,121 |  
|Weighted Average yield  |  |             | 2.85   | %    |  |       | 1.91   | % |  |   | 2.42   | %
|Corporate notes & bonds |  |             | 14,418 |      |  |       | 847    |   |  |   | 15,265 |  
|Weighted Average yield  |  |             | 3.17   | %    |  |       | 1.38   | % |  |   | 3.03   | %
|Certificate of Deposit  |  |             | 189    |      |  |       |       |   |  |   | 189    |  
|Weighted Average yield  |  |             | 1.05   | %    |  |       |       |   |  |   | 1.05   | %
|                        |  |             |        |      |  |       |        |   |  |   |        |  
|Total investments       |  | $           | 68,020 |      |  | $     | 19,405 |   |  | $ | 87,425 |  
|                        |  |             |        |      |  |       |        |   |  |   |        |  

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|        |                                                             
|------- | ------------------------------------------------------------
|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.

|                                                                                                   |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |       |       | 
|-------------------------------------------------------------------------------------------------- | -------------------------- | ------------------------ | ------ | --------- | ------ | -------- | ------ | -------- | ----- | - | ------ | ----- | ----- | - | ------ | ----- | ----- | 
|                                                                                                   |                            |                         
|                                                                                                   |                            | Quarters Ended          
|                                                                                                   |                            |                         
|                                                                                                   |                            | June 30,                 |        | Sept. 30, |        | Dec. 31, |        | Mar. 31,
|                                                                                                   |                            | 2003                     |        | 2003      |        | 2003     |        | 2004    
|                                                                                                   |                            |                          |        |           |        |          |        |         
|                                                                                                   |                            |                         
|                                                                                                   |                            | (in thousands)          
|Consolidated Statement of Operations
    Data:                                                     |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|Revenues:                                                                                          |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|                                                                                                   | License                    |                          | $      | 4,704     |        |          | $      | 4,325    |       |   | $      | 4,796 |       |   | $      | 3,110 |      
|                                                                                                   | Services                   |                          |        | 7,083     |        |          |        | 5,591    |       |   |        | 5,189 |       |   |        | 5,226 |      
|                                                                                                   |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|                                                                                                   |                            | Total revenues           |        |           | 11,787 |          |        |          | 9,916 |   |        |       | 9,985 |   |        |       | 8,336 | 
|Cost of revenues:                                                                                  |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|                                                                                                   | License                    |                          |        | 264       |        |          |        | 327      |       |   |        | 289   |       |   |        | 530   |      
|                                                                                                   | Services                   |                          |        | 5,354     |        |          |        | 3,932    |       |   |        | 4,109 |       |   |        | 3,432 |      
|                                                                                                   |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|                                                                                                   |                            | Total cost of revenues   |        |           | 5,618  |          |        |          | 4,259 |   |        |       | 4,398 |   |        |       | 3,962 | 
|                                                                                                   |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|                                                                                                   |                            | Gross profit             |        |           | 6,169  |          |        |          | 5,657 |   |        |       | 5,587 |   |        |       | 4,374 | 
|Operating expenses:                                                                                |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|                                                                                                   | Research and development   |                          |        | 3,223     |        |          |        | 3,573    |       |   |        | 3,149 |       |   |        | 3,529 |      
|                                                                                                   | Sales and marketing        |                          |        | 3,994     |        |          |        | 4,164    |       |   |        | 3,044 |       |   |        | 3,289 |      
|                                                                                                   | General and administrative |                          |        | 1,299     |        |          |        | 1,453    |       |   |        | 1,327 |       |   |        | 1,306 |      
|                                                                                                   |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|                                                                                                   |                            | Total operating expenses |        |           | 8,516  |          |        |          | 9,190 |   |        |       | 7,520 |   |        |       | 8,124 | 
|                                                                                                   |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|Loss from operations                                                                               |                            |                          | (2,347 | )         |        |          | (3,533 | )        |       |   | (1,933 | )     |       |   | (3,750 | )    
|Other income, net                                                                                  |                            |                          |       |           |        |          |       |          |       |   | 1,092  |       |       |   |       |      
|Interest income                                                                                    |                            |                          | 499    |           |        |          | 334    |          |       |   | 388    |       |       |   | 404    |      
|                                                                                                   |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|Net loss before taxes                                                                              |                            |                          | (1,848 | )         |        |          | (3,199 | )        |       |   | (453   | )     |       |   | (3,346 | )    
|Provision for income taxes                                                                         |                            |                          |       |           |        |          |       |          |       |   |       |       |       |   |       |      
|                                                                                                   |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|Loss before cumulative effect of an accounting
    change                                          |                            |                          | (1,848 | )         |        |          | (3,199 | )        |       |   | (453   | )     |       |   | (3,346 | )    
|Cumulative effect of an accounting change to
    adopt
    SFAS 142                                |                            |                          |       |           |        |          |       |          |       |   |       |       |       |   |       |      
|                                                                                                   |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|Net loss                                                                                           |                            | $                        | (1,848 | )         |        | $        | (3,199 | )        |       | $ | (453   | )     |       | $ | (3,346 | )    
|                                                                                                   |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|Basic and diluted, net loss per share                                                              |                            | $                        | (0.06  | )         |        | $        | (0.10  | )        |       | $ | (0.01  | )     |       | $ | (0.10  | )    
|                                                                                                   |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      
|Weighted-average shares of common stock used in
    computing basic and diluted net loss per share |                            |                          | 30,635 |           |        |          | 30,915 |          |       |   | 31,235 |       |       |   | 31,879 |      
|                                                                                                   |                            |                          |        |           |        |          |        |          |       |   |        |       |       |   |        |      

45



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|                                                                                                   |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |       |       | 
|-------------------------------------------------------------------------------------------------- | -------------------------- | ------------------------ | ------- | --------- | ------ | -------- | ------ | -------- | ------ | - | ------ | ----- | ----- | - | ------ | ----- | ----- | 
|                                                                                                   |                            |                         
|                                                                                                   |                            | Quarters Ended          
|                                                                                                   |                            |                         
|                                                                                                   |                            | June 30,                 |         | Sept. 30, |        | Dec. 31, |        | Mar. 31,
|                                                                                                   |                            | 2002                     |         | 2002      |        | 2002     |        | 2003    
|                                                                                                   |                            |                          |         |           |        |          |        |         
|                                                                                                   |                            |                         
|                                                                                                   |                            | (in thousands)          
|Consolidated Statement of Operations
    Data:                                                     |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|Revenues:                                                                                          |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|                                                                                                   | License                    |                          | $       | 2,387     |        |          | $      | 3,225    |        |   | $      | 2,691 |       |   | $      | 1,915 |      
|                                                                                                   | Services                   |                          |         | 7,248     |        |          |        | 6,186    |        |   |        | 7,278 |       |   |        | 4,638 |      
|                                                                                                   |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|                                                                                                   |                            | Total revenues           |         |           | 9,635  |          |        |          | 9,411  |   |        |       | 9,969 |   |        |       | 6,553 | 
|Cost of revenues:                                                                                  |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|                                                                                                   | License                    |                          |         | 231       |        |          |        | 296      |        |   |        | 194   |       |   |        | 464   |      
|                                                                                                   | Services                   |                          |         | 5,342     |        |          |        | 4,671    |        |   |        | 4,366 |       |   |        | 4,139 |      
|                                                                                                   |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|                                                                                                   |                            | Total cost of revenues   |         |           | 5,573  |          |        |          | 4,967  |   |        |       | 4,560 |   |        |       | 4,603 | 
|                                                                                                   |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|                                                                                                   |                            | Gross profit             |         |           | 4,062  |          |        |          | 4,444  |   |        |       | 5,409 |   |        |       | 1,950 | 
|Operating expenses:                                                                                |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|                                                                                                   | Research and development   |                          |         | 3,566     |        |          |        | 3,379    |        |   |        | 3,018 |       |   |        | 3,239 |      
|                                                                                                   | Sales and marketing        |                          |         | 5,509     |        |          |        | 4,859    |        |   |        | 4,575 |       |   |        | 4,424 |      
|                                                                                                   | General and administrative |                          |         | 1,447     |        |          |        | 2,163    |        |   |        | 1,252 |       |   |        | 1,206 |      
|                                                                                                   |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|                                                                                                   |                            | Total operating expenses |         |           | 10,522 |          |        |          | 10,401 |   |        |       | 8,845 |   |        |       | 8,869 | 
|                                                                                                   |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|Loss from operations                                                                               |                            |                          | (6,460  | )         |        |          | (5,957 | )        |        |   | (3,436 | )     |       |   | (6,919 | )    
|Interest income                                                                                    |                            |                          | 917     |           |        |          | 762    |          |        |   | 760    |       |       |   | 560    |      
|                                                                                                   |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|Net loss before taxes                                                                              |                            |                          | (5,543  | )         |        |          | (5,195 | )        |        |   | (2,676 | )     |       |   | (6,359 | )    
|Provision for income taxes                                                                         |                            |                          |        |           |        |          |       |          |        |   |       |       |       |   |       |      
|                                                                                                   |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|Loss before cumulative effect of an accounting
    change                                          |                            |                          | (5,543  | )         |        |          | (5,195 | )        |        |   | (2,676 | )     |       |   | (6,359 | )    
|Cumulative effect of an accounting change to
    adopt SFAS 142                                    |                            |                          | (9,974  | )         |        |          |       |          |        |   |       |       |       |   |       |      
|                                                                                                   |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|Net loss                                                                                           |                            | $                        | (15,517 | )         |        | $        | (5,195 | )        |        | $ | (2,676 | )     |       | $ | (6,359 | )    
|                                                                                                   |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|Basic and diluted, net loss per share                                                              |                            | $                        | (0.46   | )         |        | $        | (0.16  | )        |        | $ | (0.08  | )     |       | $ | (0.21  | )    
|                                                                                                   |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      
|Weighted-average shares of common stock used in
    computing basic and diluted net loss per share |                            |                          | 33,700  |           |        |          | 32,694 |          |        |   | 31,609 |       |       |   | 30,873 |      
|                                                                                                   |                            |                          |         |           |        |          |        |          |        |   |        |       |       |   |        |      

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.

46



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##### Table of Contents



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. | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure

There is no disclosure to report pursuant to
Item 9.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

(a) Evaluation of disclosure controls and
procedures. As of the end of the period covered by this
report, an evaluation was performed under the supervision and
with the participation of the Companys management,
including the Chief Executive Officer (Interim) and Chief
Financial Officer and the VP of Finance, of the effectiveness of
the design and operation of the Companys disclosure
controls and procedures (as defined in
Rules 13a-15(e) and 15d-15((e) under the Securities
Exchange Act of 1934). Based on the evaluation, the
Companys management, including the Chief Executive Officer
(Interim) and Chief Financial Officer and the VP of Finance,
concluded that the Companys disclosure controls and
procedures were effective as of March 31, 2004.

(b) Changes in internal controls over
financial reporting. There have been no significant changes
in the Companys internal controls over financial reporting
or in other factors that could significantly affect internal
controls subsequent to their evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.




PART III






|         |                                                       
|-------- | ------------------------------------------------------
|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 2004 Annual Meeting of
Stockholders. Such information is incorporated herein by
reference.

The Company reported the results of its 2003
annual stockholders meeting in the Companys Form 10-Q
for the quarter ended September 30, 2003. The Company
subsequently discovered that the voting numbers reported in that
Form 10-Q with respect to the election of the Board
nominees was incorrect. The Company is currently investigating
the actual vote count and the procedures followed by the Company
in the election of its directors at its 2003 annual meeting of
stockholders. Although the investigation is at a preliminary
stage, the Company does not believe that the investigation will
affect the outcome of the election.

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 2004 Annual
Meeting of Stockholders. Such information is incorporated herein
by reference.

Audit Committee Financial Expert

Information with respect to the Companys
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 2004 Annual
Meeting of Stockholders. Such information is hereby incorporated
by reference.

47



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##### Table of Contents



Identification of the Audit
Committee

Information with respect to the Companys
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 2004 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 2004 Annual
Meeting of Stockholders. Such information is hereby incorporated
by reference.

Code of Ethics

Information concerning the Companys 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 2004 Annual Meeting of
Stockholders. Such information is hereby incorporated by
reference. The Code of Ethics for Chief Executive Officer and
Senior Financial Officers and Code of Business Conduct can also
be found on our website, www.selectica.com/about/conduct.htm.






|         |                       
|-------- | ----------------------
|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 2004 Annual Meeting of Stockholders. Such information
is incorporated herein by reference.






|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|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 2004 Annual
Meeting of Stockholders. Such information is incorporated herein
by reference.






|         |                                                   
|-------- | --------------------------------------------------
|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
2004 Annual Meeting of Stockholders. Such information is
incorporated herein by reference.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

Information concerning the fees and services of
the Companys 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 2004 Annual
Meeting of Stockholders. Such information is hereby incorporated
by reference.

48



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##### Table of Contents






PART IV






|         |                                                                                  
|-------- | ---------------------------------------------------------------------------------
|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,
    2004 and 2003                                        
|
| |  | Consolidated Statement of Operations for the
    years ended March 31, 2004, 2003, and 2002          
|
| |  | Consolidated Statement of Stockholders
    Equity for the years ended March 31, 2004, 2003, and 2002
|
| |  | Consolidated Statements of Cash Flows for the
    years ended March 31, 2004, 2003, and 2002         
|
| |  | 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:

|        |          |             |  |                                                                                                                                                                       
|------- | -------- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |          |            
|No.     |          | Description
|        |          |            
|        | 3.1(1)   |             |  | The Second Amended and Restated Certificate of
    Incorporation.                                                                                                     
|        | 3.2(6)   |             |  | Certificate of Designation of Series A
    Junior or Participating Preferred Stock.                                                                                   
|        | 3.3(6)   |             |  | Amended and Restated Bylaws.                                                                                                                                          
|        | 4.1(1)   |             |  | Reference is made to Exhibits 3.1, 3.2 and
    3.3.                                                                                                                   
|        | 4.2(1)   |             |  | Form of Registrants Common Stock
    certificate.                                                                                                                    
|        | 4.3(1)   |             |  | Amended and Restated Investor Rights Agreement
    dated June 16, 1999.                                                                                               
|        | 4.4(2)   |             |  | Rights Agreement between Registrant and
    U.S. Stock Transfer Corporation, as Rights Agent, dated
    February 4, 2003.                                             
|        | 10.1(1)  |             |  | Form of Indemnification Agreement.                                                                                                                                    
|        | 10.2(1)  |             |  | 1996 Stock Plan.                                                                                                                                                      
|        | 10.3(6)  |             |  | 1999 Employee Stock Purchase Plan.                                                                                                                                    
|        | 10.4(6)  |             |  | 1999 Equity Incentive Plan, as amended and
    restated December 11, 2002.                                                                                            
|        | 10.5(1)  |             |  | Lease between John Arrillaga Survivors Trust and
    the Richard T. Perry Separate Property Trust as Landlord and the
    Registrant as Tenant, dated October 1, 1999.
|        | 10.6(1)  |             |  | Major Account License Agreement between the
    Registrant and Fujitsu Network Communications, Inc., dated
    November 4, 1998.                                      
|        | 10.7(1)  |             |  | Agreement for Web Site Design and Development
    Service between the Registrant and BMW of North America, Inc.,
    dated July 15, 1998.                             
|        | 10.8(1)  |             |  | Major Account License Agreement between the
    Registrant and the Firemans Fund Insurance Company,
    dated June 24, 1999.                                         
|        | 10.9(1)  |             |  | Major Account License Agreement between the
    Registrant and Aspect Telecommunications, dated May 17,
    1999.                                                     
|        | 10.10(1) |             |  | A Consulting Engagement Proposal from the
    Registrant to 3Com, dated July 29, 1999.                                                                                
|        | 10.11(1) |             |  | A Consulting Engagement Proposal from the
    Registrant to 3Com, dated August 10, 1999.                                                                              
|        | 10.12(3) |             |  | Employment Agreement between the Registrant and
    Dr. Sanjay Mittal, dated as of January 1, 2003.                                                                   

49



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##### Table of Contents



|        |          |             |  |                                                                                                                                                                                                                                                                               
|------- | -------- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |          |            
|No.     |          | Description
|        |          |            
|        | 10.13(3) |             |  | Employment Agreement between the Registrant and
    Stephen Bennion dated as of January 1, 2003.                                                                                                                                                                              
|        | 10.14(1) |             |  | Major Account License Agreement between the
    Registrant and Samsung SDS Co., Ltd., dated January 12,
    2000; amendment #1 to Major Account License Agreement
    between the Registrant and Samsung SDS Co., Ltd., dated
    February 10, 2000.                          
|        | 10.15(1) |             |  | International Value Added Reseller Agreement
    between the Registrant and Samsung SDS Co., Ltd., dated
    January 12, 2000; Amendment #1 to International Value
    Added Reseller Agreement between the Registrant and Samsung SDS
    Co., Ltd., dated February 29, 2000.
|        | 10.16(1) |             |  | Stock Purchase Agreement between the Registrant
    and Samsung SDS Co., Ltd., dated January 31, 2000;
    Amendment #1 to the Stock Purchase Agreement between the
    Registrant and Samsung SDS Co., Ltd., dated February 8,
    2000.                                     
|        | 10.17(1) |             |  | Lease between John Arrillaga Survivors Trust and
    Richard T. Perry Separate Property Trust as Landlord and the
    Registrant as Tenant, dated October 1, 1999.                                                                                                            
|        | 10.18(1) |             |  | Stock Purchase Agreement between the Registrant
    and Dell USA, L.P., dated February 14, 2000.                                                                                                                                                                              
|        | 10.19(4) |             |  | Offer to exchange outstanding options, dated
    April 27, 2001.                                                                                                                                                                                                              
|        | 10.20(5) |             |  | Offer to exchange outstanding options dated
    February 19, 2003.                                                                                                                                                                                                            
|        | 10.21(6) |             |  | Warrant to Purchase Common Stock issued to Sales.
    Technologies Limited, dated April 4, 2001.                                                                                                                                                                              
|        | 10.22(6) |             |  | Licensed Works Agreement between the Registrant
    and International Business Machines Corporation, dated
    December 11, 2002.                                                                                                                                             
|        | 10.23(6) |             |  | Licensed Works Agreement Statement of Work
    between the Registrant and International Business Machines
    Corporation, dated December 11, 2002.                                                                                                                           
|        | 10.24(6) |             |  | Professional Services Agreement between the
    Registrant and GE Medical Services, dated June 28, 2002.                                                                                                                                                                      
|        | 10.25(6) |             |  | Major Account License Agreement between the
    Registrant and GE Medical Systems, dated June 28, 2002.                                                                                                                                                                       
|        | 10.26(6) |             |  | Amendment #1 to Major Account License
    Agreement between the Registrant and GE Medical Systems.                                                                                                                                                                            
|        | 10.27(6) |             |  | Amendment #2 to Major Account License
    Agreement between the Registrant and GE Medical Systems, dated
    October 8, 2002.                                                                                                                                                 
|        | 10.28(6) |             |  | Amendment #3 to Major Account License
    Agreement between the Registrant and GE Medical Systems, dated
    March 31, 2003.                                                                                                                                                  
|        | 10.29(6) |             |  | Addendum #1 to Professional Services
    Agreement between Registrant and GE Medical Services, dated
    August 27, 2002.                                                                                                                                                     
|        | 10.30(6) |             |  | Amendment #2 to Professional Services
    Agreement between Registrant and GE Medical Services, dated
    March 3, 2003.                                                                                                                                                      
|        | 10.31(7) |             |  | Settlement Agreement and General Release between
    Registrant and David Choi, dated August 13, 2003.                                                                                                                                                                        
|        | 10.32(7) |             |  | Letter Agreement between Registrant and Sanjay
    Mittal, Dated September 22, 2003.                                                                                                                                                                                          
|        | 21.1(6)  |             |  | Subsidiaries.                                                                                                                                                                                                                                                                 
|        | 23.1     |             |  | Consent of Independent Registered Public
    Accounting Firm.                                                                                                                                                                                                                 
|        | 31.1     |             |  | Certification Pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                  
|        | 31.2     |             |  | Certification Pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                  
|        | 32.1     |             |  | Certification Pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                  
|        | 31.2     |             |  | Certification Pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                  

50



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---

|    |                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------
|(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 Schedule TO filed by the
    Company on April 27, 2001.                                          
|   
|(5) | Previously filed in Schedule TO filed by the
    Company on February 19, 2003.                                       
|   
|(6) | Previously filed in the Companys report on
    Form 10-K filed on June 30, 2003.                                    
|   
|(7) | Previously filed in the Companys report on
    Form 10-Q filed on November 11, 2003.                                

(b) Reports on Form 8-K:

On January 9, 2004, the Registrant filed a
Current Report on Form 8-K under Item 5, Item 7
and Item 12 to report that on January 6, 2004 the
Registrant issued a press release announcing that David Achim
had been appointed Senior Vice President of Worldwide Sales and
that Mr. Achim replaced Patrick McCarthy, who was leaving
the Registrant in mid-January to take a hiatus in his career
while attending to family issues. A copy of the press release
was filed as an exhibit to the Current Report.

On January 22, 2004, the Registrant filed a
Current Report on Form 8-K under Item 7 and
Item 12 to report that on January 22, 2004 the
Registrant issued a press release announcing its financial
results for the third quarter ending December 31, 2003,
providing guidance for the fourth quarter ending March 31,
2004 and announcing that in connection with the issuance of the
press release, the Company was holding a press conference to
discuss the press release. A copy of the press release was filed
as an exhibit to the Current Report.

(c) Exhibits.

See (a)(3) above.

(d) Financial Statement Schedule.

See (a)(2) above.

51



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##### Table of Contents



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

|                                                                                                     |  |  |      | 
|---------------------------------------------------------------------------------------------------- |  |  | ---- | 
|Consolidated Balance Sheets as of March 31,
    2004 and 2003                                        |  |  | F-2  | 
|Consolidated Statements of Operations 
    Years ended March 31, 2004, 2003, and 2002               |  |  | F-3  | 
|Consolidated Statements of Stockholders
    Equity  Years ended March 31, 2004, 2003, and
    2002 |  |  | F-4  | 
|Consolidated Statements of Cash Flows 
    Years ended March 31, 2004, 2003, and 2002               |  |  | F-5  | 
|Notes to Consolidated Financial Statements                                                           |  |  | F-6  | 
|Report of Independent Registered Public
    Accounting Firm                                          |  |  | F-33 | 

F-1



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##### Table of Contents



SELECTICA, INC.

CONSOLIDATED BALANCE SHEETS

|                                                                                                 |                                                                                                                                         |                   |          |         |  |   |          |         | 
|------------------------------------------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------------------------------- | ----------------- | -------- | ------- |  | - | -------- | ------- | 
|                                                                                                 |                                                                                                                                         |                  
|                                                                                                 |                                                                                                                                         | March 31,        
|                                                                                                 |                                                                                                                                         |                  
|                                                                                                 |                                                                                                                                         | 2004              |          | 2003   
|                                                                                                 |                                                                                                                                         |                   |          |        
|                                                                                                 |                                                                                                                                         |                  
|                                                                                                 |                                                                                                                                         | (in thousands,   
|                                                                                                 |                                                                                                                                         | except par value)
|Assets                                                                                           |                                                                                                                                         |                   |          |         |  |   |          |        
|Current assets:                                                                                  |                                                                                                                                         |                   |          |         |  |   |          |        
|                                                                                                 | Cash and cash equivalents                                                                                                               |                   | $        | 31,349  |  |   | $        | 54,993  | 
|                                                                                                 | Short-term investments                                                                                                                  |                   |          | 68,020  |  |   |          | 54,224  | 
|                                                                                                 | Accounts receivable, net of allowance for
    doubtful accounts of $115 and $741, respectively                                          |                   |          | 697     |  |   |          | 3,485   | 
|                                                                                                 | Prepaid expenses and other current assets                                                                                               |                   |          | 2,597   |  |   |          | 3,863   | 
|                                                                                                 | Investments, restricted  short term                                                                                                    |                   |          |        |  |   |          | 1,288   | 
|                                                                                                 |                                                                                                                                         |                   |          |         |  |   |          |        
|                                                                                                 | Total current assets                                                                                                                    |                   |          | 102,663 |  |   |          | 117,853 | 
|Property and equipment, net                                                                      |                                                                                                                                         |                   | 3,620    |         |  |   | 5,274    |        
|Other assets                                                                                     |                                                                                                                                         |                   | 548      |         |  |   | 710      |        
|Long term investments                                                                            |                                                                                                                                         |                   | 19,405   |         |  |   | 13,134   |        
|Investments, restricted  long term                                                              |                                                                                                                                         |                   | 180      |         |  |   | 178      |        
|                                                                                                 |                                                                                                                                         |                   |          |         |  |   |          |        
|Total assets                                                                                     |                                                                                                                                         | $                 | 126,416  |         |  | $ | 137,149  |        
|                                                                                                 |                                                                                                                                         |                   |          |         |  |   |          |        
|                                                                                                
|Liabilities and Stockholders
    Equity                                                         |                                                                                                                                         |                   |          |         |  |   |          |        
|Current liabilities:                                                                             |                                                                                                                                         |                   |          |         |  |   |          |        
|                                                                                                 | Accounts payable                                                                                                                        |                   | $        | 644     |  |   | $        | 936     | 
|                                                                                                 | Accrued payroll and related liabilities                                                                                                 |                   |          | 1,726   |  |   |          | 1,932   | 
|                                                                                                 | Other accrued liabilities                                                                                                               |                   |          | 2,769   |  |   |          | 3,377   | 
|                                                                                                 | Deferred revenues                                                                                                                       |                   |          | 7,757   |  |   |          | 16,486  | 
|                                                                                                 |                                                                                                                                         |                   |          |         |  |   |          |        
|Total current liabilities                                                                        |                                                                                                                                         |                   | 12,896   |         |  |   | 22,731   |        
|Other long term liabilities                                                                      |                                                                                                                                         |                   | 1,482    |         |  |   | 1,338    |        
|Commitments and contingencies                                                                    |                                                                                                                                         |                   |          |         |  |   |          |        
|Stockholders equity:                                                                            |                                                                                                                                         |                   |          |         |  |   |          |        
|Preferred stock, $0.0001 par value:                                                              |                                                                                                                                         |                   |          |         |  |   |          |        
|                                                                                                 | Authorized: 25,000 shares at March 31,
    2004 and 2003; None issued and outstanding                                                   |                   |          |        |  |   |          |        | 
|Common stock, $0.0001 par value:                                                                 |                                                                                                                                         |                   |          |         |  |   |          |        
|                                                                                                 | Authorized: 150,000 shares at March 31,
    2004 and 2003 Issued: 39,482 and 37,371 shares at
    March 31, 2004 and 2003, respectively |                   |          |         |  |   |          |         | 
|                                                                                                 | Outstanding: 33,246 and 31,519 shares at
    March 31, 2004 and 2003, respectively                                                      |                   |          | 4       |  |   |          | 4       | 
|Additional paid-in capital                                                                       |                                                                                                                                         |                   | 291,055  |         |  |   | 284,454  |        
|Deferred compensation                                                                            |                                                                                                                                         |                   | (158     | )       |  |   | (1,869   | )      
|Stockholder notes receivable                                                                     |                                                                                                                                         |                   |         |         |  |   | (730     | )      
|Accumulated deficit                                                                              |                                                                                                                                         |                   | (157,960 | )       |  |   | (149,114 | )      
|Accumulated other comprehensive income                                                           |                                                                                                                                         |                   | 47       |         |  |   | 7        |        
|Treasury stock at cost 
    6,236 shares and 5,852 at March 31, 2004 and 2003,
    respectively |                                                                                                                                         |                   | (20,950  | )       |  |   | (19,672  | )      
|                                                                                                 |                                                                                                                                         |                   |          |         |  |   |          |        
|Total stockholders equity                                                                       |                                                                                                                                         |                   | 112,038  |         |  |   | 113,080  |        
|                                                                                                 |                                                                                                                                         |                   |          |         |  |   |          |        
|Total liabilities and stockholders equity                                                       |                                                                                                                                         | $                 | 126,416  |         |  | $ | 137,149  |        
|                                                                                                 |                                                                                                                                         |                   |          |         |  |   |          |        

See accompanying notes.

F-2



---



##### Table of Contents



SELECTICA, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                                                                                   |                            |                                          |         |        |        |      |         |        |        |   |         |        |        | 
|-------------------------------------------------------------------------------------------------- | -------------------------- | ---------------------------------------- | ------- | ------ | ------ | ---- | ------- | ------ | ------ | - | ------- | ------ | ------ | 
|                                                                                                   |                            |                                         
|                                                                                                   |                            | Years Ended March 31,                   
|                                                                                                   |                            |                                         
|                                                                                                   |                            | 2004                                     |         | 2003   |        | 2002
|                                                                                                   |                            |                                          |         |        |        |     
|                                                                                                   |                            |                                         
|                                                                                                   |                            | (in thousands, except per share amounts)
|Revenues:                                                                                          |                            |                                          |         |        |        |      |         |        |        |   |         |       
|                                                                                                   | License                    |                                          | $       | 16,935 |        |      | $       | 10,218 |        |   | $       | 16,683 |       
|                                                                                                   | Services                   |                                          |         | 23,089 |        |      |         | 25,350 |        |   |         | 30,511 |       
|                                                                                                   |                            |                                          |         |        |        |      |         |        |        |   |         |       
|                                                                                                   |                            | Total revenues                           |         |        | 40,024 |      |         |        | 35,568 |   |         |        | 47,194 | 
|Cost of revenues:                                                                                  |                            |                                          |         |        |        |      |         |        |        |   |         |       
|                                                                                                   | License                    |                                          |         | 1,410  |        |      |         | 1,185  |        |   |         | 1,023  |       
|                                                                                                   | Services                   |                                          |         | 16,827 |        |      |         | 18,518 |        |   |         | 28,660 |       
|                                                                                                   |                            |                                          |         |        |        |      |         |        |        |   |         |       
|                                                                                                   |                            | Total cost of revenues                   |         |        | 18,237 |      |         |        | 19,703 |   |         |        | 29,683 | 
|                                                                                                   |                            |                                          |         |        |        |      |         |        |        |   |         |       
|Gross profit                                                                                       |                            |                                          | 21,787  |        |        |      | 15,865  |        |        |   | 17,511  |       
|                                                                                                   | Research and development   |                                          |         | 13,474 |        |      |         | 13,202 |        |   |         | 15,343 |       
|                                                                                                   | Sales and marketing        |                                          |         | 14,491 |        |      |         | 19,368 |        |   |         | 25,215 |       
|                                                                                                   | General and administrative |                                          |         | 5,385  |        |      |         | 6,068  |        |   |         | 8,922  |       
|                                                                                                   |                            |                                          |         |        |        |      |         |        |        |   |         |       
|Total operating expenses                                                                           |                            |                                          | 33,350  |        |        |      | 38,638  |        |        |   | 49,480  |       
|                                                                                                   |                            |                                          |         |        |        |      |         |        |        |   |         |       
|Loss from operations                                                                               |                            |                                          | (11,563 | )      |        |      | (22,773 | )      |        |   | (31,969 | )     
|Other income, net                                                                                  |                            |                                          | 1,092   |        |        |      |        |        |        |   |        |       
|Interest income                                                                                    |                            |                                          | 1,625   |        |        |      | 2,999   |        |        |   | 5,896   |       
|                                                                                                   |                            |                                          |         |        |        |      |         |        |        |   |         |       
|Loss before provision for income taxes                                                             |                            |                                          | (8,846  | )      |        |      | (19,774 | )      |        |   | (26,073 | )     
|Provision for income taxes                                                                         |                            |                                          |        |        |        |      |        |        |        |   | 304     |       
|                                                                                                   |                            |                                          |         |        |        |      |         |        |        |   |         |       
|Loss before cumulative effect of an accounting
    change to adopt FAS 142                         |                            |                                          | (8,846  | )      |        |      | (19,774 | )      |        |   | (26,377 | )     
|Cumulative effect of an accounting change to
    adopt FAS 142                                     |                            |                                          |        |        |        |      | (9,974  | )      |        |   |        |       
|                                                                                                   |                            |                                          |         |        |        |      |         |        |        |   |         |       
|Net loss                                                                                           |                            | $                                        | (8,846  | )      |        | $    | (29,748 | )      |        | $ | (26,377 | )     
|                                                                                                   |                            |                                          |         |        |        |      |         |        |        |   |         |       
|Basic and diluted loss per share:                                                                  |                            |                                          |         |        |        |      |         |        |        |   |         |       
|Loss before cumulative effect of an accounting
    change to adopt FAS 142                         |                            | $                                        | (0.28   | )      |        | $    | (0.61   | )      |        | $ | (0.75   | )     
|Cumulative effect of an accounting change to
    adopt FAS 142                                     |                            |                                          |        |        |        |      | (0.31   | )      |        |   |        |       
|                                                                                                   |                            |                                          |         |        |        |      |         |        |        |   |         |       
|Basic and diluted net loss per share                                                               |                            | $                                        | (0.28   | )      |        | $    | (0.92   | )      |        | $ | (0.75   | )     
|                                                                                                   |                            |                                          |         |        |        |      |         |        |        |   |         |       
|Weighted-average shares of common stock used in
    computing basic and diluted net loss per share |                            |                                          | 31,165  |        |        |      | 32,219  |        |        |   | 35,090  |       

See accompanying notes.

F-3



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##### Table of Contents



SELECTICA, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

|                                                                                                       |                          |                          |                          |            |  |          |   |              |  |            |         |   |  |   |        |   |  |   |        |   |  |  | 
|------------------------------------------------------------------------------------------------------ | ------------------------ | ------------------------ | ------------------------ | ---------- |  | -------- | - | ------------ |  | ---------- | ------- | - |  | - | ------ | - |  | - | ------ | - |  |  | 
|                                                                                                       |                          |                          |                          |            |  |          |   |             
|                                                                                                       |                          | Common Stock             |                          | Additional |  |          |   | Stockholder 
|                                                                                                       |                          |                          |                          | Paid-In    |  | Deferred |   | Notes       
|                                                                                                       |                          | Shares                   |                          | Amount     |  | Capital  |   | Compensation |  | Receivable
|                                                                                                       |                          |                          |                          |            |  |          |   |              |  |           
|                                                                                                       |                          |                         
|                                                                                                       |                          | (in thousands)          
|Balance at March 31, 2001                                                                              |                          |                          | 37,032                   |            |  |          | 4 |              |  |            | 285,179 |   |  |   | (7,970 | ) |  |   | (1,915 | )
|                                                                                                      
|Repurchase of common stock                                                                             |                          |                          |                         |            |  |          |  |              |  |            |        |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Repurchase of common stock issued to certain
    executives                                            |                          |                          | (213                     | )          |  |          |  |              |  |            | (924    | ) |  |   |       |   |  |   | 924    |  
|                                                                                                      
|Fair value of warrants issued in connection with
    development agreement                             |                          |                          |                         |            |  |          |  |              |  |            | 227     |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Compensation expense related to variable
    accounting of exercised options                           |                          |                          |                         |            |  |          |  |              |  |            | 53      |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Compensation expense related to acceleration of
    stock options for certain terminated employees     |                          |                          |                         |            |  |          |  |              |  |            | 125     |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Shares issued in connection with ESPP                                                                  |                          |                          | 163                      |            |  |          |  |              |  |            | 527     |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Net deferred compensation related to options
    granted at less than FMV                              |                          |                          |                         |            |  |          |  |              |  |            | (1,736  | ) |  |   | 3,938  |   |  |   |       |  
|                                                                                                      
|Net deferred compensation related to repurchase
    of shares Issued in exchange for shareholder notes |                          |                          |                         |            |  |          |  |              |  |            | 201     |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Repayment of shareholders notes receivable                                                            |                          |                          |                         |            |  |          |  |              |  |            |        |   |  |   |       |   |  |   | 111    |  
|                                                                                                      
|Exercise of stock options by employees, net of
    repurchase                                          |                          |                          | 54                       |            |  |          |  |              |  |            | 189     |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Issuance of common stock for services                                                                  |                          |                          | 3                        |            |  |          |  |              |  |            | 6       |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Comprehensive loss:                                                                                    |                          |                          |                          |            |  |          |   |              |  |            |         |   |  |   |        |   |  |   |        |  
|                                                                                                      
|                                                                                                       | Other comprehensive loss |                          |                          |           |  |          |   |             |  |            |         |  |  |   |        |  |  |   |        |  | 
|                                                                                                      
|                                                                                                       | Net loss                 |                          |                          |           |  |          |   |             |  |            |         |  |  |   |        |  |  |   |        |  | 
|                                                                                                       |                          |                          |                          |            |  |          |   |              |  |            |         |   |  |   |        |   |  |   |        |  
|                                                                                                      
|                                                                                                       |                          |                          | Total Comprehensive loss |            |  |          |   |              |  |            |         |   |  |   |        |   |  |   |        |   |  |  | 
|Balance at March 31, 2002                                                                              |                          |                          | 37,039                   |            |  |          | 4 |              |  |            | 283,847 |   |  |   | (4,032 | ) |  |   | (880   | )
|                                                                                                      
|Repurchase of common stock                                                                             |                          |                          |                         |            |  |          |  |              |  |            |        |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Exercise of stock options by employees, net of
    repurchase                                          |                          |                          | 177                      |            |  |          |  |              |  |            | 309     |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Issuance of common stock for services                                                                  |                          |                          | 18                       |            |  |          |  |              |  |            | 48      |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Net option cancellation                                                                                |                          |                          |                         |            |  |          |  |              |  |            | (376    | ) |  |   | 376    |   |  |   |       |  
|                                                                                                      
|Shares issued in connection with ESPP                                                                  |                          |                          | 137                      |            |  |          |  |              |  |            | 370     |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Compensation expense related to acceleration of
    stock options for certain terminated employees     |                          |                          |                         |            |  |          |  |              |  |            | 249     |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Compensation expense related to variable
    accounting of exercised options                           |                          |                          |                         |            |  |          |  |              |  |            | 7       |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Net deferred compensation related to options
    granted at less than FMV                              |                          |                          |                         |            |  |          |  |              |  |            |        |   |  |   | 1,787  |   |  |   |       |  
|                                                                                                      
|Repayment of shareholders notes receivable                                                            |                          |                          |                         |            |  |          |  |              |  |            |        |   |  |   |       |   |  |   | 150    |  
|                                                                                                      
|Comprehensive loss:                                                                                    |                          |                          |                          |            |  |          |   |              |  |            |         |   |  |   |        |   |  |   |        |  
|                                                                                                      
|                                                                                                       | Other comprehensive loss |                          |                          |           |  |          |   |             |  |            |         |  |  |   |        |  |  |   |        |  | 
|                                                                                                      
|                                                                                                       | Net loss                 |                          |                          |           |  |          |   |             |  |            |         |  |  |   |        |  |  |   |        |  | 
|                                                                                                       |                          |                          |                          |            |  |          |   |              |  |            |         |   |  |   |        |   |  |   |        |  
|                                                                                                      
|                                                                                                       |                          | Total Comprehensive loss |                          |            |  |          |   |              |  |            |         |   |  |   |        |   |  |   |        |   |  | 
|Balance at March 31, 2003                                                                              |                          |                          | 37,371                   |            |  | $        | 4 |              |  | $          | 284,454 |   |  | $ | (1,869 | ) |  | $ | (730   | )
|                                                                                                      
|Repurchase of common stock                                                                             |                          |                          |                         |            |  |          |  |              |  |            |        |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Exercise of stock options by employees, net of
    repurchase                                          |                          |                          | 1,984                    |            |  |          |  |              |  |            | 6,163   |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Issuance of common stock for services                                                                  |                          |                          | 2                        |            |  |          |  |              |  |            | 9       |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Net option cancellation                                                                                |                          |                          |                         |            |  |          |  |              |  |            | (604    | ) |  |   | 604    |   |  |   |       |  
|                                                                                                      
|Shares issued in connection with ESPP                                                                  |                          |                          | 94                       |            |  |          |  |              |  |            | 206     |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Compensation expense related to acceleration of
    stock options for certain terminated employees     |                          |                          |                         |            |  |          |  |              |  |            | 234     |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Compensation expense related to variable
    accounting of exercised options                           |                          |                          |                         |            |  |          |  |              |  |            | 149     |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Net deferred compensation related to options
    granted at less than FMV                              |                          |                          |                         |            |  |          |  |              |  |            |        |   |  |   | 1,107  |   |  |   |       |  
|                                                                                                      
|Compensation expense related to modification of
    stock options                                      |                          |                          |                         |            |  |          |  |              |  |            | 444     |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Exercise of warrant                                                                                    |                          |                          | 31                       |            |  |          |  |              |  |            |        |   |  |   |       |   |  |   |       |  
|                                                                                                      
|Repayment of shareholders notes receivable                                                            |                          |                          |                         |            |  |          |  |              |  |            |        |   |  |   |       |   |  |   | 730    |  
|                                                                                                      
|Comprehensive loss:                                                                                    |                          |                          |                          |            |  |          |   |              |  |            |         |   |  |   |        |   |  |   |        |  
|                                                                                                      
|                                                                                                       | Other comprehensive loss |                          |                          |           |  |          |   |             |  |            |         |  |  |   |        |  |  |   |        |  | 
|                                                                                                      
|                                                                                                       | Net loss                 |                          |                          |           |  |          |   |             |  |            |         |  |  |   |        |  |  |   |        |  | 
|                                                                                                       |                          |                          |                          |            |  |          |   |              |  |            |         |   |  |   |        |   |  |   |        |  
|                                                                                                      
|Balance at March 31, 2004                                                                              |                          |                          | 39,482                   |            |  | $        | 4 |              |  | $          | 291,055 |   |  | $ | (158   | ) |  | $ | 0      |  
|                                                                                                       |                          |                          |                          |            |  |          |   |              |  |            |         |   |  |   |        |   |  |   |        |  

[Additional columns below]

[Continued from above table, first column(s) repeated]

|                                                                                                       |                          |                          |                          |               |   |                |     |               |   |               |        |      |  |   |         |   |  |   |         |         |   |   |        |         |         |         |  
|------------------------------------------------------------------------------------------------------ | ------------------------ | ------------------------ | ------------------------ | ------------- | - | -------------- | --- | ------------- | - | ------------- | ------ | ---- |  | - | ------- | - |  | - | ------- | ------- | - | - | ------ | ------- | ------- | ------- | -
|                                                                                                       |                          |                          |                          | Accumulated   |   |                |     |               |   |               |        |     
|                                                                                                       |                          |                          |                          | Other         |   |                |     |               |   |              
|                                                                                                       |                          |                          |                          | Comprehensive |   | Treasury Stock |     | Total         |   |              
|                                                                                                       |                          | Accumulated              |                          | Income        |   |                |     | Stockholders |   | Comprehensive
|                                                                                                       |                          | Deficit                  |                          | (Loss)        |   | Shares         |     | Amount        |   | Equity        |        | Loss
|                                                                                                       |                          |                          |                          |               |   |                |     |               |   |               |        |     
|                                                                                                       |                          |                         
|                                                                                                       |                          | (in thousands)          
|Balance at March 31, 2001                                                                              |                          |                          | (92,989                  | )             |   |                | 229 |               |   |               |       |      |  |   |        |   |  |   | 182,538 |         |   |   |        |        
|Repurchase of common stock                                                                             |                          |                          |                         |               |   |                |    |               |   |               | (1,800 | )    |  |   | (6,250  | ) |  |   | (6,250  | )       |   |   |        |        
|Repurchase of common stock issued to certain
    executives                                            |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   |        |         |   |   |        |        
|Fair value of warrants issued in connection with
    development agreement                             |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 227     |         |   |   |        |        
|Compensation expense related to variable
    accounting of exercised options                           |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 53      |         |   |   |        |        
|Compensation expense related to acceleration of
    stock options for certain terminated employees     |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 125     |         |   |   |        |        
|Shares issued in connection with ESPP                                                                  |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 527     |         |   |   |        |        
|Net deferred compensation related to options
    granted at less than FMV                              |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 2,202   |         |   |   |        |        
|Net deferred compensation related to repurchase
    of shares Issued in exchange for shareholder notes |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 201     |         |   |   |        |        
|Repayment of shareholders notes receivable                                                            |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 111     |         |   |   |        |        
|Exercise of stock options by employees, net of
    repurchase                                          |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 189     |         |   |   |        |        
|Issuance of common stock for services                                                                  |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 6       |         |   |   |        |        
|Comprehensive loss:                                                                                    |                          |                          |                          |               |   |                |     |               |   |               |        |      |  |   |         |   |  |   |         |         |   |   |        |        
|                                                                                                       | Other comprehensive loss |                          |                          |              |   |                |     | (200          | ) |               |        |     |  |   |         |  |  |   |         | (200    | ) |   | $      | (200    | )      
|                                                                                                       | Net loss                 |                          |                          | (26,377       | ) |                |     |              |   |               |        |     |  |   |         |  |  |   |         | (26,377 | ) |   |        | (26,377 | )      
|                                                                                                       |                          |                          |                          |               |   |                |     |               |   |               |        |      |  |   |         |   |  |   |         |         |   |   |        |        
|                                                                                                       |                          |                          | Total Comprehensive loss |               |   |                |     |               |   |               |        |      |  |   |         |   |  |   |         |         |   |   |        |         | $       | (26,577 | )
|                                                                                                       |                          |                          |                          |               |   |                |     |               |   |               |        |      |  |   |         |   |  |   |         |         |   |   |        |        
|Balance at March 31, 2002                                                                              |                          |                          | (119,366                 | )             |   |                | 29  |               |   |               | (1,800 | )    |  |   | (6,250  | ) |  |   | 153,352 |         |   |   |        |        
|Repurchase of common stock                                                                             |                          |                          |                         |               |   |                |    |               |   |               | (4,052 | )    |  |   | (13,422 | ) |  |   | (13,422 | )       |   |   |        |        
|Exercise of stock options by employees, net of
    repurchase                                          |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 309     |         |   |   |        |        
|Issuance of common stock for services                                                                  |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 48      |         |   |   |        |        
|Net option cancellation                                                                                |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   |        |         |   |   |        |        
|Shares issued in connection with ESPP                                                                  |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 370     |         |   |   |        |        
|Compensation expense related to acceleration of
    stock options for certain terminated employees     |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 249     |         |   |   |        |        
|Compensation expense related to variable
    accounting of exercised options                           |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 7       |         |   |   |        |        
|Net deferred compensation related to options
    granted at less than FMV                              |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 1,787   |         |   |   |        |        
|Repayment of shareholders notes receivable                                                            |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 150     |         |   |   |        |        
|Comprehensive loss:                                                                                    |                          |                          |                          |               |   |                |     |               |   |               |        |      |  |   |         |   |  |   |         |         |   |   |        |        
|                                                                                                       | Other comprehensive loss |                          |                          |              |   |                |     | (22           | ) |               |        |     |  |   |         |  |  |   |         | (22     | ) |   | $      | (22     | )      
|                                                                                                       | Net loss                 |                          |                          | (29,748       | ) |                |     |              |   |               |        |     |  |   |         |  |  |   |         | (29,748 | ) |   |        | (29,748 | )      
|                                                                                                       |                          |                          |                          |               |   |                |     |               |   |               |        |      |  |   |         |   |  |   |         |         |   |   |        |        
|                                                                                                       |                          | Total Comprehensive loss |                          |               |   |                |     |               |   |               |        |      |  |   |         |   |  |   |         |         |   |   |        | $       | (29,770 | )      
|                                                                                                       |                          |                          |                          |               |   |                |     |               |   |               |        |      |  |   |         |   |  |   |         |         |   |   |        |        
|Balance at March 31, 2003                                                                              |                          | $                        | (149,114                 | )             |   | $              | 7   |               |   |               | (5,852 | )    |  | $ | (19,672 | ) |  | $ | 113,080 |         |   |   |        |        
|Repurchase of common stock                                                                             |                          |                          |                         |               |   |                |    |               |   |               | (384   | )    |  |   | (1,278  | ) |  |   | (1,278  | )       |   |   |        |        
|Exercise of stock options by employees, net of
    repurchase                                          |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 6,163   |         |   |   |        |        
|Issuance of common stock for services                                                                  |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 9       |         |   |   |        |        
|Net option cancellation                                                                                |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   |        |         |   |   |        |        
|Shares issued in connection with ESPP                                                                  |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 206     |         |   |   |        |        
|Compensation expense related to acceleration of
    stock options for certain terminated employees     |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 234     |         |   |   |        |        
|Compensation expense related to variable
    accounting of exercised options                           |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 149     |         |   |   |        |        
|Net deferred compensation related to options
    granted at less than FMV                              |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 1,107   |         |   |   |        |        
|Compensation expense related to modification of
    stock options                                      |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 444     |         |   |   |        |        
|Exercise of warrant                                                                                    |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   |        |         |   |   |        |        
|Repayment of shareholders notes receivable                                                            |                          |                          |                         |               |   |                |    |               |   |               |       |      |  |   |        |   |  |   | 730     |         |   |   |        |        
|Comprehensive loss:                                                                                    |                          |                          |                          |               |   |                |     |               |   |               |        |      |  |   |         |   |  |   |         |         |   |   |        |        
|                                                                                                       | Other comprehensive loss |                          |                          |              |   |                |     | 40            |   |               |        |     |  |   |         |  |  |   |         | 40      |   |   |        | 40      |        
|                                                                                                       | Net loss                 |                          |                          | (8,846        | ) |                |     |              |   |               |        |     |  |   |         |  |  |   |         | (8,846  | ) |   |        | (8,846  | )      
|                                                                                                       |                          |                          |                          |               |   |                |     |               |   |               |        |      |  |   |         |   |  |   |         |         |   |   |        |        
|Balance at March 31, 2004                                                                              |                          | $                        | (157,960                 | )             |   | $              | 47  |               |   |               | (6,236 | )    |  | $ | (20,950 | ) |  | $ | 112,038 |         |   | $ | (8,806 | )      
|                                                                                                       |                          |                          |                          |               |   |                |     |               |   |               |        |      |  |   |         |   |  |   |         |         |   |   |        |        

See accompanying notes.

F-4



---



##### Table of Contents



SELECTICA, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                                |                                                                                          |                                           |          |       |        |      |          |       |       |   |         |       |        |  
|------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------- | ----------------------------------------- | -------- | ----- | ------ | ---- | -------- | ----- | ----- | - | ------- | ----- | ------ | -
|                                                                                |                                                                                          |                                          
|                                                                                |                                                                                          | Years Ended March 31,                    
|                                                                                |                                                                                          |                                          
|                                                                                |                                                                                          | 2004                                      |          | 2003  |        | 2002
|                                                                                |                                                                                          |                                           |          |       |        |     
|                                                                                |                                                                                          |                                          
|                                                                                |                                                                                          | (in thousands)                           
|Operating activities:                                                           |                                                                                          |                                           |          |       |        |      |          |       |       |   |         |      
|Net loss                                                                        |                                                                                          | $                                         | (8,846   | )     |        | $    | (29,748  | )     |       | $ | (26,377 | )    
|Adjustments to reconcile net loss to net cash
    used in operating activities: |                                                                                          |                                           |          |       |        |      |          |       |       |   |         |      
|                                                                                | Depreciation                                                                             |                                           |          | 2,104 |        |      |          | 3,505 |       |   |         | 4,154 |       
|                                                                                | Gain and Loss on disposition of property and
    equipment                               |                                           |          | 107   |        |      |          | (5    | )     |   |         | 32    |       
|                                                                                | Amortization of goodwill                                                                 |                                           |          |      |        |      |          |      |       |   |         | 2,663 |       
|                                                                                | Amortization of deferred compensation                                                    |                                           |          | 1,107 |        |      |          | 1,787 |       |   |         | 2,202 |       
|                                                                                | Amortization of discount on the sale of common
    stock to a customer                   |                                           |          |      |        |      |          |      |       |   |         | 254   |       
|                                                                                | Amortization of warrants in connection with
    licenses and services agreement          |                                           |          |      |        |      |          |      |       |   |         | 375   |       
|                                                                                | Amortization of development agreement                                                    |                                           |          |      |        |      |          |      |       |   |         | 1,277 |       
|                                                                                | Cumulative effect of an accounting change to
    adopt FAS 142                           |                                           |          |      |        |      |          | 9,974 |       |   |         |      |       
|                                                                                | Issuance of common stock in exchange for services                                        |                                           |          | 9     |        |      |          | 48    |       |   |         | 6     |       
|                                                                                | Compensation expenses related to variable
    accounting of exercised options            |                                           |          | 149   |        |      |          | 7     |       |   |         | 53    |       
|                                                                                | Compensation expenses related to repurchase of
    shares in excess of fair market value |                                           |          |      |        |      |          |      |       |   |         | 201   |       
|                                                                                | Accelerated vesting of stock options to employees                                        |                                           |          | 234   |        |      |          | 249   |       |   |         | 125   |       
|                                                                                | Compensation expenses related to modification of
    options                             |                                           |          | 444   |        |      |          |      |       |   |         |      |       
|                                                                                | Changes in assets and liabilities:                                                       |                                           |          |       |        |      |          |       |       |   |         |       |       
|                                                                                |                                                                                          | Accounts receivable                       |          |       | 2,788  |      |          |       | 254   |   |         |       | 5,179  |  
|                                                                                |                                                                                          | Prepaid expenses and other current assets |          |       | 1,266  |      |          |       | (203  | ) |         |       | 1,371  |  
|                                                                                |                                                                                          | Other assets                              |          |       | 162    |      |          |       | 11    |   |         |       | 1,203  |  
|                                                                                |                                                                                          | Accounts payable                          |          |       | (292   | )    |          |       | (389  | ) |         |       | (1,885 | )
|                                                                                |                                                                                          | Accrued payroll and related liabilities   |          |       | (206   | )    |          |       | (785  | ) |         |       | (2,286 | )
|                                                                                |                                                                                          | Other accrued and long term liabilities   |          |       | (464   | )    |          |       | 114   |   |         |       | (2,085 | )
|                                                                                |                                                                                          | Deferred revenue                          |          |       | (8,729 | )    |          |       | 8,397 |   |         |       | (4,875 | )
|                                                                                |                                                                                          |                                           |          |       |        |      |          |       |       |   |         |      
|Net cash used for operating activities                                          |                                                                                          |                                           | (10,167  | )     |        |      | (6,784   | )     |       |   | (18,413 | )    
|Investing activities                                                            |                                                                                          |                                           |          |       |        |      |          |       |       |   |         |      
|Purchase of capital assets                                                      |                                                                                          |                                           | (573     | )     |        |      | (1,454   | )     |       |   | (74     | )    
|Proceeds from disposition of property and
    equipment                         |                                                                                          |                                           | 16       |       |        |      | 5        |       |       |   | 32      |      
|Proceeds from restricted investments                                            |                                                                                          |                                           | 1,286    |       |        |      |         |       |       |   |        |      
|Purchase of short-term investments                                              |                                                                                          |                                           | (108,490 | )     |        |      | (108,494 | )     |       |   | (93,946 | )    
|Purchase of long-term investments                                               |                                                                                          |                                           | (74,971  | )     |        |      | (70,299  | )     |       |   | (47,420 | )    
|Proceeds from maturities of short-term investments                              |                                                                                          |                                           | 126,834  |       |        |      | 136,204  |       |       |   | 142,695 |      
|Proceeds from maturities of long-term investments                               |                                                                                          |                                           | 36,600   |       |        |      | 65,651   |       |       |   | 8,065   |      
|                                                                                |                                                                                          |                                           |          |       |        |      |          |       |       |   |         |      
|Net cash provided by (used for) investing
    activities                        |                                                                                          |                                           | (19,298  | )     |        |      | 21,613   |       |       |   | 9,352   |      
|Financing activities                                                            |                                                                                          |                                           |          |       |        |      |          |       |       |   |         |      
|Purchase of treasury stock                                                      |                                                                                          |                                           | (1,278   | )     |        |      | (13,422  | )     |       |   | (6,250  | )    
|Proceeds from stockholder notes receivable                                      |                                                                                          |                                           | 730      |       |        |      | 150      |       |       |   | 111     |      
|Proceeds from issuance of common stock                                          |                                                                                          |                                           | 6,369    |       |        |      | 679      |       |       |   | 717     |      
|                                                                                |                                                                                          |                                           |          |       |        |      |          |       |       |   |         |      
|Net cash provided by (used for) financing
    activities                        |                                                                                          |                                           | 5,821    |       |        |      | (12,593  | )     |       |   | (5,422  | )    
|                                                                                |                                                                                          |                                           |          |       |        |      |          |       |       |   |         |      
|Net increase (decrease) in cash and cash
    equivalents                        |                                                                                          |                                           | (23,644  | )     |        |      | 2,236    |       |       |   | (14,483 | )    
|Cash and cash equivalents at beginning of the
    period                        |                                                                                          |                                           | 54,993   |       |        |      | 52,757   |       |       |   | 67,240  |      
|                                                                                |                                                                                          |                                           |          |       |        |      |          |       |       |   |         |      
|Cash and cash equivalents at end of the period                                  |                                                                                          | $                                         | 31,349   |       |        | $    | 54,993   |       |       | $ | 52,757  |      
|                                                                                |                                                                                          |                                           |          |       |        |      |          |       |       |   |         |      
|Supplemental disclosure of non-cash financing
    activities                    |                                                                                          |                                           |          |       |        |      |          |       |       |   |         |      
|Deferred compensation related to cancelled stock
    options                    |                                                                                          | $                                         | 574      |       |        | $    | 376      |       |       | $ | 1,736   |      
|Fair value of warrants issued in connection with
    development agreement      |                                                                                          | $                                         |         |       |        | $    |         |       |       | $ | 227     |      
|Repurchase of stock in exchange for cancellation
    of notes                   |                                                                                          | $                                         |         |       |        | $    |         |       |       | $ | 924     |      
|Change in unrealized gain (loss) on available for
    sales securities          |                                                                                          | $                                         | 40       |       |        | $    | (22      | )     |       | $ | (200    | )    

See accompanying notes.

F-5



---



##### Table of Contents



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
the 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, 2004, 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, 2004 and 2003. The
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.

F-6



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##### Table of Contents



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.



| |                                                            
| | -----------------------------------------------------------
| | 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, 2004, 2003, and 2002:

|            |  |                |       |            |  |             |     |          |  |           |     |  |  |   |     |  |  |   |       | 
|----------- |  | -------------- | ----- | ---------- |  | ----------- | --- | -------- |  | --------- | --- |  |  | - | --- |  |  | - | ----- | 
|            |  | Balance at     |       | Charged to |  |             |     | Benefit  |  | Balance  
|            |  | Beginning      |       | Costs and  |  | Amounts     |     | Included |  | at End of
|Fiscal Year |  | of Period      |       | Expenses   |  | Written Off |     | Revenue  |  | Period   
|            |  |                |       |            |  |             |     |          |  |          
|            |  |               
|            |  | (in thousands)
|2004        |  | $              | 741   |            |  | $           |    |          |  | $         | 241 |  |  | $ | 385 |  |  | $ | 115   | 
|2003        |  | $              | 1,194 |            |  | $           |    |          |  | $         | 453 |  |  | $ |    |  |  | $ | 741   | 
|2002        |  | $              | 1,051 |            |  | $           | 667 |          |  | $         | 524 |  |  | $ |    |  |  | $ | 1,194 | 

The Company evaluates the collectibility of our
accounts receivable based on a combination of factors. When the
Company believes a collectibility issue exists with respect to a
specific receivable, it records an allowance to reduce that
receivable to the amount that it believes to be collectible. For
all other receivables, the Company records an allowance based on
an assessment of the aging of such receivables, its historical
experience with bad debts and the general economic environment.

Historically, the Company had recorded the offset
for the allowance for doubtful accounts as bad debt expense as a
cost to general and administrative expenses or as an offset to
service revenues. As receivables have declined, the reduction in
the allowance for doubtful accounts has resulted in a benefit to
general and administrative expense and revenue during fiscal
2004. Going forward, the Company intends to offset any changes
to the allowance account to services revenues.



| |                       
| | ----------------------
| | 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.

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 with Respect to Certain Transactions.
The Company recognizes maintenance revenues over the term of the
maintenance contract as vendor-specific objective evidence of
fair value for maintenance

F-7



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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, under the subscription method, 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 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 since 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 profit 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. To date, when the Company has
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 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 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.

F-8



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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 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.
Consulting services are recognized based on customer acceptance
in the form of customer-signed timesheets, cash received, or
customer-signed acceptance.

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. Amounts recognized as revenue in advance of
billing (typically under percentage-of-completion accounting)
are recorded as unbilled receivables.



| |                        
| | -----------------------
| | Customer Concentrations

A limited number of customers have historically
accounted for a substantial portion of the Companys
revenues.

Customers who accounted for at least 10% of total
revenues were as follows:

|           |  |           |    |      |  |      |    |   |  |  |    |  
|---------- |  | --------- | -- | ---- |  | ---- | -- | - |  |  | -- | -
|           |  |          
|           |  | March 31,
|           |  |          
|           |  | 2004      |    | 2003 |  | 2002
|           |  |           |    |      |  |     
|Customer A |  |           | 39 | %    |  |      | *  |   |  |  | *  |  
|Customer B |  |           | 20 | %    |  |      | 25 | % |  |  | *  |  
|Customer C |  |           | *  |      |  |      | 14 | % |  |  | 11 | %



---



|  |                                               
|- | ----------------------------------------------
|* | Revenues were less than 10% of total revenues.

F-9



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Customers who accounted for at least 10% of gross
accounts receivable were as follows:

|           |  |           |    |      |  |  |    |  
|---------- |  | --------- | -- | ---- |  |  | -- | -
|           |  |          
|           |  | March 31,
|           |  |          
|           |  | 2004      |    | 2003
|           |  |           |    |     
|Customer A |  |           | 47 | %    |  |  | *  |  
|Customer B |  |           | 18 | %    |  |  | *  |  
|Customer C |  |           | 12 | %    |  |  | *  |  
|Customer D |  |           | *  |      |  |  | 20 | %
|Customer E |  |           | *  |      |  |  | 13 | %
|Customer F |  |           | *  |      |  |  | 12 | %



---



|  |                                                                     
|- | --------------------------------------------------------------------
|* | 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, 2004 and 2003. 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, 2004.



| |                    
| | -------------------
| | Advertising Expense

The cost of advertising is expensed as incurred.
Advertising expense for the years ended March 31, 2004,
2003 and 2002 was approximately $34,000, $175,000, and
$509,000 million, respectively.



| |                  
| | -----------------
| | 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

F-10



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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 gains on available for sale securities of
approximately $47,000 and approximately $7,000 at March 31,
2004 and 2003, respectively. We recorded approximately $81,000
in realized losses, approximately $145,000 in realized gains,
and approximately $18,000 in realized gains in the years ended
March 31, 2004, 2003, and 2002, 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, 2004, 2003, and 2002 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, 2004, 2003, and 2002 with the following weighted
average assumptions:

|                              |  |           |        |      |  |      |        |  |  |  |        | 
|----------------------------- |  | --------- | ------ | ---- |  | ---- | ------ |  |  |  | ------ | 
|                              |  |          
|                              |  | March 31,
|                              |  |          
|                              |  | 2004      |        | 2003 |  | 2002
|                              |  |           |        |      |  |     
|Risk-free interest rate       |  |           | 2.89%  |      |  |      | 2.75%  |  |  |  | 4.61%  | 
|Dividend yield                |  |           | 0.00%  |      |  |      | 0.00%  |  |  |  | 0.00%  | 
|Expected volatility           |  |           | 42.77% |      |  |      | 75.15% |  |  |  | 88.22% | 
|Expected option life in years |  |           | 3.86   |      |  |      | 4.00   |  |  |  | 3.99   | 

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, 2004, 2003 and 2002
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, 2004, 2003 and 2002 with the following weighted
average assumptions:

|                              |  |           |       |      |  |      |       |   |  |  |       |  
|----------------------------- |  | --------- | ----- | ---- |  | ---- | ----- | - |  |  | ----- | -
|                              |  |          
|                              |  | March 31,
|                              |  |          
|                              |  | 2004      |       | 2003 |  | 2002
|                              |  |           |       |      |  |     
|Risk-free interest rate       |  |           | 1.33  | %    |  |      | 2.29  | % |  |  | 4.91  | %
|Dividend yield                |  |           | 0.00  | %    |  |      | 0.00  | % |  |  | 0.00  | %
|Expected volatility           |  |           | 41.28 | %    |  |      | 66.67 | % |  |  | 90.77 | %
|Expected option life in years |  |           | 1.25  |      |  |      | 1.25  |   |  |  | 1.25  |  

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. Because
the Companys employee stock options have characteristics
significantly different from those of traded options and because
changes in the subjective input assumptions can materially
affect the fair value estimate, in managements opinion, the

F-11



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock
options.

|                                                                                                            |  |      |         |      |  |      |         |   |  |   |         |  
|----------------------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                                                                                            |  | 2004 |         | 2003 |  | 2002
|                                                                                                            |  |      |         |      |  |     
|Net loss, as reported                                                                                       |  | $    | (8,846  | )    |  | $    | (29,748 | ) |  | $ | (26,377 | )
|Add: Stock based employee compensation expense
    included in reported net loss                            |  |      | 1,107   |      |  |      | 1,787   |   |  |   | 2,202   |  
|Deduct: Total stock based employee compensation
    determined under fair value based method for all awards |  |      | 17,111  |      |  |      | 23,533  |   |  |   | 21,040  |  
|                                                                                                            |  |      |         |      |  |      |         |   |  |   |         |  
|Pro forma net loss                                                                                          |  | $    | (24,850 | )    |  | $    | (51,494 | ) |  | $ | (45,215 | )
|                                                                                                            |  |      |         |      |  |      |         |   |  |   |         |  
|Basic and diluted net loss per share, as reported                                                           |  | $    | (0.28   | )    |  | $    | (0.92   | ) |  | $ | (.75    | )
|                                                                                                            |  |      |         |      |  |      |         |   |  |   |         |  
|Basic and diluted pro forma net loss per share                                                              |  | $    | (.80    | )    |  | $    | (1.60   | ) |  | $ | (1.29   | )
|                                                                                                            |  |      |         |      |  |      |         |   |  |   |         |  



| |                    
| | -------------------
| | 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 operating
decision maker or group 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.

Export revenues are attributable to countries
based on the location of the customers. 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 fiscal year
ended March 31, 2002, sales to international locations were
derived primarily from Canada, Korea, Mexico, Sweden, and the
United Kingdom.

|                       |  |                       |      |      |  |      |      |  |  |  |      | 
|---------------------- |  | --------------------- | ---- | ---- |  | ---- | ---- |  |  |  | ---- | 
|                       |  |                      
|                       |  | Years Ended March 31,
|                       |  |                      
|                       |  | 2004                  |      | 2003 |  | 2002
|                       |  |                       |      |      |  |     
|International revenues |  |                       | 10%  |      |  |      | 24%  |  |  |  | 20%  | 
|Domestic revenues      |  |                       | 90%  |      |  |      | 76%  |  |  |  | 80%  | 
|                       |  |                       |      |      |  |      |      |  |  |  |      | 
|Total Revenues         |  |                       | 100% |      |  |      | 100% |  |  |  | 100% | 
|                       |  |                       |      |      |  |      |      |  |  |  |      | 

There were no sales to a specific international
location, which accounted for at least 10% of the total revenue.

For the years ended March 31, 2004 and 2003,
the Company held long-lived assets outside of the United States
with a net book value of approximately $1.5 and $1.7 of million
of which approximately $1.4 million and $1.6 million
were in India, respectively.



| |                     
| | --------------------
| | 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, we recognized approximately $849,000 of
license revenue and approximately $964,000 of services revenue
from the cancelled contract.

F-12



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                          
| | -------------------------
| | 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 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. The Company recognized approximately
$1.1 million in other income for the quarter ended
December 31, 2003.



| |                       
| | ----------------------
| | 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, 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 has
agreed to have him continue as Chief Technical Advisor
(CTA). Pursuant to this arrangement, Dr. Mittal
will receive $20,000 per month for his services and this
arrangement will continue until either party terminates the CTA
service. During the year ended March 31, 2004, the Company
recorded approximately $135,000 as outside services expense in
research and development. In the event that
Dr. Mittals role as CTA terminates, subject to
certain conditions, he will be entitled to receive a lump-sum
severance payment of $412,500. The Company believes that the
payment is estimatable and probable, and therefore, has accrued
for this amount. This amount was recorded in September 2003, as
compensation expense of which approximately $93,000 was included
in cost of goods sold, approximately $231,000 was included in
research and development, approximately $52,000 as sales and
marketing expense and approximately $37,000 was included in
general and administrative expense.



| |                              
| | -----------------------------
| | New Accounting Pronouncements

In November 2002, the EITF reached a consensus on
Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables (EITF No. 00-21). EITF No. 00-21
provides guidance on how to account for arrangements that
involve the delivery or performance of multiple products,
services or rights to use assets. The provisions of EITF
No. 00-21 applies to revenue arrangements entered into
after June 15, 2003. The Company adopted EITF
No. 00-21 and the provisions of this guidance did not have
a significant impact on its results of operations and financial
condition.

In January 2003, the FASB issued Interpretation
No. 46, Consolidation of Variable Interest
Entities (FIN 46), an interpretation of Accounting
Research Bulletin No. 51, Consolidated Financial
Statements. FIN 46 requires certain variable interest
entities (VIEs) to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity
do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity
to finance its activities without additional subordinated
financial support from other parties. FIN 46 is effective
for all new VIEs created or acquired after January 31,
2003. For VIEs created or acquired prior to February 1,
2003, the provisions of FIN 46 must be applied for the
first interim or annual period beginning after March 15,
2004. As of March 31, 2004, the Company has not invested in
any new VIEs created after January 31, 2003. As of result,
FIN 46 will not have an impact on the Companys
results of operations and financial condition.

F-13



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|   |                                           
|-- | ------------------------------------------
|3. | Cash, Cash Equivalents and
    Investments

Cash, cash equivalents, short term and long term
investments consisted of the following:

|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |        | 
|---------------------------- | ----------------------- | -------------- | ------ | ------ |  | ---- | -- | ------ |  | - | --- | --- | - | - | ------ | ------ | 
|                             |                         |               
|                             |                         | Unrealized    
|                             |                         |               
|                             |                         | Cost           |        | Gain   |  | Loss |    | Market
|                             |                         |                |        |        |  |      |    |       
|                             |                         |               
|                             |                         | (in thousands)
|March 31, 2004:              |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|Cash and cash equivalents:   |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|                             | Cash                    |                | $      | 27,550 |  |      | $  |       |  |   | $   |    |   |   | $      | 27,550 | 
|                             | Money market fund       |                |        | 2,800  |  |      |    |       |  |   |     |    |   |   |        | 2,800  | 
|                             | Commercial paper        |                |        | 999    |  |      |    |       |  |   |     |    |   |   |        | 999    | 
|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|                             |                         | $              | 31,349 |        |  | $    |   |        |  | $ |    |     |   | $ | 31,349 |       
|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|Short-term investments:      |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|(due in less than 12 months) |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|                             | Auction rate securities |                | $      | 27,850 |  |      | $  |       |  |   | $   |    |   |   | $      | 27,850 | 
|                             | Government agencies     |                |        | 25,536 |  |      |    | 27     |  |   |     |    |   |   |        | 25,563 | 
|                             | Corporate notes & bonds |                |        | 14,411 |  |      |    | 7      |  |   |     |    |   |   |        | 14,418 | 
|                             | Certificate of deposit  |                |        | 189    |  |      |    |       |  |   |     |    |   |   |        | 189    | 
|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|                             |                         | $              | 67,986 |        |  | $    | 34 |        |  | $ |    |     |   | $ | 68,020 |       
|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|Long-term investments:       |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|(due in 12 to 18 months)     |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|                             | Government agencies     |                | $      | 18,543 |  |      | $  | 15     |  |   | $   |    |   |   | $      | 18,558 | 
|                             | Corporate notes & bonds |                |        | 849    |  |      |    |       |  |   |     | (2  | ) |   |        | 847    | 
|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|                             |                         | $              | 19,392 |        |  | $    | 15 |        |  | $ | (2  | )   |   | $ | 19,405 |       
|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|March 31, 2003:              |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|Cash and cash equivalents:   |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|                             | Cash                    |                | $      | 35,896 |  |      | $  |       |  |   | $   |    |   |   | $      | 35,896 | 
|                             | Money market fund       |                |        | 14,226 |  |      |    |       |  |   |     |    |   |   |        | 14,226 | 
|                             | Commercial paper        |                |        | 4,871  |  |      |    |       |  |   |     |    |   |   |        | 4,871  | 
|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|                             |                         | $              | 54,993 |        |  | $    |   |        |  | $ |    |     |   | $ | 54,993 |       
|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|Short-term investments:      |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|(due in less than 12 months) |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|                             | Auction rate securities |                | $      | 44,102 |  |      | $  |       |  |   | $   | (2  | ) |   | $      | 44,100 | 
|                             | Government agencies     |                |        | 3,367  |  |      |    | 16     |  |   |     |    |   |   |        | 3,383  | 
|                             | Corporate notes & bonds |                |        | 3,734  |  |      |    | 7      |  |   |     |    |   |   |        | 3,741  | 
|                             | Municipal bonds         |                |        | 3,000  |  |      |    |       |  |   |     |    |   |   |        | 3,000  | 
|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|                             |                         | $              | 54,203 |        |  | $    | 23 |        |  | $ | (2  | )   |   | $ | 54,224 |       
|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|Long-term investments:       |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|(due in 12 to 18 months)     |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|                             | Government agencies     |                | $      | 8,232  |  |      | $  | 30     |  |   | $   |    |   |   | $      | 8,262  | 
|                             | Asset-Backed securities |                |        | 3,856  |  |      |    |       |  |   |     | (51 | ) |   |        | 3,805  | 
|                             | Corporate notes & bonds |                |        | 1,060  |  |      |    | 7      |  |   |     |    |   |   |        | 1,067  | 
|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       
|                             |                         | $              | 13,148 |        |  | $    | 37 |        |  | $ | (51 | )   |   | $ | 13,134 |       
|                             |                         |                |        |        |  |      |    |        |  |   |     |     |   |   |        |       

F-14



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

As of March 31, 2004, the Company has only
one active operating lease that requires security deposit to be
maintained at financial institutions for the term of the lease.
The security deposit of approximately $180,000 is classified as
a restricted long-term investment and held in commercial paper.

During the year ended March 31, 2003, three
operating leases expired. The total security deposits of
approximately $180,000 were held and maintained at financial
institutions according to the lease terms. These deposits were
held in commercial paper and classified as restricted short-term
investments. In addition, in connections with the acquisition of
Wakely Software, Inc., the Company set up an escrow fund of
approximately $1.0 million primarily made up of mutual
funds and classified as a restricted short-term investment. The
full amount of $1.0 million was paid to the founder of
Wakely Software, Inc. in August 2003 per the escrow
agreement. The interest earned on the investment was used in
operations.

Net unrealized holding gains on
available-for-sale securities as of March 31, 2004 and 2003
were approximately $47,000 and $7,000, respectively.



|   |                       
|-- | ----------------------
|4. | Property and Equipment

Property and equipment, at cost, consist of the
following:

|                               |                                   |                |         |       |  |   |         |       | 
|------------------------------ | --------------------------------- | -------------- | ------- | ----- |  | - | ------- | ----- | 
|                               |                                   |               
|                               |                                   | March 31,     
|                               |                                   |               
|                               |                                   | 2004           |         | 2003 
|                               |                                   |                |         |      
|                               |                                   |               
|                               |                                   | (in thousands)
|Computers and software         |                                   | $              | 9,768   |       |  | $ | 9,758   |      
|Furniture and equipment        |                                   |                | 3,162   |       |  |   | 3,289   |      
|Leasehold improvements         |                                   |                | 2,615   |       |  |   | 2,575   |      
|Land and building              |                                   |                | 1,109   |       |  |   | 1,028   |      
|                               |                                   |                |         |       |  |   |         |      
|                               |                                   |                | 16,654  |       |  |   | 16,650  |      
|Less: accumulated depreciation |                                   |                | (13,034 | )     |  |   | (11,376 | )    
|                               |                                   |                |         |       |  |   |         |      
|                               | Total property and equipment, net |                | $       | 3,620 |  |   | $       | 5,274 | 
|                               |                                   |                |         |       |  |   |         |      



|   |                             
|-- | ----------------------------
|5. | Stockholder Notes Receivable

During the year ended March 31, 2000, in
consideration for the issuance of the Companys common
stock, various key employees executed promissory notes in the
principal amount of approximately $12.7 million. The notes
bear interest at rates from 6.02% to 6.56% per annum, and
are due and payable in four years from the date of issuance. The
notes are full recourse, and in addition, each of the employees
has pledged the common stock, 2.0 million shares of common
stock in aggregate as of March 31, 2000, as collateral to
secure the obligations under the notes.

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.

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,

F-15



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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. During the year ended March 31,
2002, the Company recorded a total compensation expense of
approximately $53,000 of which approximately $20,000 was
recorded as cost of goods sold and approximately $33,000 was
recorded as general and administrative expense.



|   |                            
|-- | ---------------------------
|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, 2004, are as follows:

|           |                               |                |       |           |  |       |    |    |  |  |       |        | 
|---------- | ----------------------------- | -------------- | ----- | --------- |  | ----- | -- | -- |  |  | ----- | ------ | 
|           |                               | Offices        |       | Equipment |  | Total
|           |                               |                |       |           |  |      
|           |                               |               
|           |                               | (in thousands)
|2005       |                               |                | 2,728 |           |  |       | 30 |    |  |  | 2,758 |       
|2006       |                               |                | 2,485 |           |  |       | 23 |    |  |  | 2,508 |       
|2007       |                               |                | 2,536 |           |  |       | 13 |    |  |  | 2,549 |       
|2008       |                               |                | 2,640 |           |  |       | 13 |    |  |  | 2,653 |       
|2009       |                               |                | 2,745 |           |  |       |   |    |  |  | 2,745 |       
|Thereafter |                               |                | 2,005 |           |  |       |   |    |  |  | 2,005 |       
|           |                               |                |       |           |  |       |    |    |  |  |       |       
|           | Total future minimum payments |                | $     | 15,139    |  |       | $  | 79 |  |  | $     | 15,218 | 
|           |                               |                |       |           |  |       |    |    |  |  |       |       

Rental expenses for office space and equipment
were approximately $3.0 million, $3.8 million, and
$5.1 million for the years ended March 31, 2004, 2003
and 2002, 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 currently believes that the ultimate amount of
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. However, the ultimate outcome of any
litigation is uncertain, and either unfavorable or favorable
outcomes could have a material negative impact. Regardless of
outcome, litigation can have an adverse impact on the Company
because of defense costs, diversion of management resources and
other factors.



| |             
| | ------------
| | 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

F-16



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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 Selectica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 the
Company with prejudice in return for the assignment by the
Company of claims that the Company might have against its
underwriters. 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, which has been executed on behalf of
the Company. The settling parties anticipate presenting the
settlement papers to the Court on June 14, 2004. There can
be no assurance that the Court will approve the settlement.



| |                              
| | -----------------------------
| | Shareholder Derivative Action

On April 16, 2002, a shareholder derivative
action was filed in the Superior Court of California,
Santa Clara County, against certain of our officers and
directors, against CSFB, as the underwriters of our IPO, and
against the Company as nominal defendant. The action was filed
by a shareholder purporting to assert on behalf of the Company
claims for breach of fiduciary duty, aiding and abetting and
conspiracy, negligence, unjust enrichment, and breach of
contract, related to the pricing of shares in the Companys
IPO. On June 6, 2002, the shareholder plaintiff filed an
amended complaint dropping the breach of contract claim against
CSFB and adding claims against CSFB for breach of an
agents duty to its principal and for violation of the
California Unfair Competition Law, based on alleged violations
of certain rules of the National Association of Securities
Dealers.

On November 25, 2002, following the removal
of the case to federal court and the subsequent remand of the
case back to the state court, the Company and the officer and
director defendants filed answers to the amended complaint,
preserving certain defenses including defenses based on
plaintiffs lack of standing to bring the suit. Also on
November 25, 2002, CSFB filed a motion to dismiss the case,
on the grounds that the plaintiff lacks standing. That motion
was heard on March 4, 2003, and on March 18, 2003 the
Court issued an Order sustaining the motion but granting
plaintiff 30 days to file an amended complaint.

On April 18, 2003, the plaintiff filed a
second amended complaint. This complaint adds new allegations as
to standing, and also alleges certain additional facts
supporting the various causes of action against the defendants.
Specifically, plaintiffs new complaint alleges that CSFB
offered and provided, and the individual defendants accepted,
improper gratuities in the form of allocations of
IPO stocks of other companies, in order to influence the
selection of CSFB as the underwriter of the Companys IPO.

On June 17, 2003, CSFB responded to this
second amended complaint by filing a demurrer (motion to
dismiss) on the grounds that the plaintiff lacks standing to
bring the action. Also on June 17, 2003, the

F-17



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Company and the individual defendants responded
to the second amended complaint by joining CSFBs demurrer,
while reserving other objections. At a hearing on this matter on
August 12, 2003, the Court again granted CSFBs
demurrer, with leave for plaintiff to further amend his
complaint, and granted plaintiff permission to file a motion
seeking to establish plaintiffs standing pursuant to the
so-called contemporaneous ownership rule.

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. The
shareholder derivative litigation is also in its preliminary
stages. At a minimum, the class action litigation as well as the
shareholder derivative litigation could result in substantial
costs and divert our managements attention and resources,
which could seriously harm our business.



| |                     
| | --------------------
| | Settlement Agreement

In July 2002, the Company received a complaint
from a former employee over a commission matter. Since then, we
have been defending this matter vigorously and were not able to
estimate the likelihood or an unfavorable result or the range of
any potential loss to the Company. In August 2003, this matter
was brought to arbitration and settled with the former employee
for the amount of $550,000, which is included as an expense to
sales and marketing.



| |      
| | -----
| | 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.



|   |                  
|-- | -----------------
|8. | Letters of Credit

As of March 31, 2004 and 2003, the Company
has letters of credit totaling approximately $150,000 and
$466,000, respectively, with a bank which serve as collateral
for the Companys obligations to third parties for lease
payments. As of March 31, 2004 and 2003, no amounts were
drawn under these letters 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 be subject to annual impairment tests.
SFAS 142 also requires that goodwill be tested for
impairment at the reporting unit level at adoption and at least
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

F-18



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

utilizing various valuation techniques including
discounted cash flow and comparative market analysis.
Thereafter, given the indication of a potential impairment, we
performed step two of the test. We 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, we 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.

Prior to April 1, 2002, Goodwill was
amortized on a straight-line basis over the estimated useful
life, generally five years. The carrying values of goodwill was
reviewed if facts and circumstances suggested that they may be
impaired. If this review indicates that carrying values of
goodwill will not be recoverable based on projected undiscounted
future cash flows, carrying values are reduced to estimated fair
values by first reducing goodwill and second by reducing
long-term assets and other intangibles. During fiscal year 2002
the applicable accounting policy for reviewing goodwill for
impairment was an undiscounted cash flow basis, a method allowed
by SFAS 121. When analyzed using undiscounted cash flows
prescribed by SFAS 121, the Company did not have an
impairment of any intangibles assets at March 31, 2002.

In accordance with SFAS 142 adopted on
April 1, 2002, we stopped the periodic amortization of
goodwill. The following table shows the reconciliation of
reported net loss adjusted for the adoption of SFAS 142 for
the year ended March 31, 2002. (in thousands, except per
share data):

|                                          |  |           |         |  
|----------------------------------------- |  | --------- | ------- | -
|                                          |  | March 31,
|                                          |  | 2002     
|                                          |  |          
|Reported net loss                         |  | $         | (26,377 | )
|Add back: Goodwill amortization           |  |           | 2,663   |  
|                                          |  |           |         |  
|Adjusted net loss                         |  | $         | (23,714 | )
|                                          |  |           |         |  
|Basic and diluted net loss per
    share: |  |           |         |  
|Reported net loss                         |  | $         | (0.75   | )
|Add back: Goodwill amortization           |  |           | 0.07    |  
|                                          |  |           |         |  
|Adjusted net loss per share               |  | $         | (0.68   | )
|                                          |  |           |         |  



|    |                     
|--- | --------------------
|10. | Stockholders Equity



| |                                              
| | ---------------------------------------------
| | Common Stock Reserved for Future
    Issuance

At March 31, 2004, common stock reserved for
future issuance was as follows:

|                             |                            |                                                 |       |       |        | 
|---------------------------- | -------------------------- | ----------------------------------------------- | ----- | ----- | ------ | 
|                             |                            | (in thousands)                                 
|Stock option plans:          |                            |                                                 |       |      
|                             | Outstanding                |                                                 |       | 7,014 |       
|                             | Reserved for future grants |                                                 |       | 6,746 |       
|Employee Stock Purchase Plan |                            |                                                 | 1,905 |      
|                             |                            |                                                 |       |      
|                             |                            | Total common stock reserved for future issuance |       |       | 15,665 | 
|                             |                            |                                                 |       |      

F-19



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                
| | ---------------
| | 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, 2004
and 2003.

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. The accompanying consolidated financial statements
have been retroactively restated to give effect to the
reincorporation.



| |         
| | --------
| | Warrants

In September 1999, the Company entered into a
development agreement with an investor whereby the investor and
the Company will work to port the current suite of products to
additional platforms. In connection with the development
agreement, the Company issued warrants to
purchase 57,000 shares of Series E convertible
preferred stock at $4.382 per share. The warrants were
issued in December 1999 and were exercised on March 9,
2000. The Company determined the fair value of the warrants
using the Black-Scholes valuation model assuming a fair value of
the Companys Series E convertible preferred stock of
$19.00, risk free interest rate of 5.5%, dividend yield of 0%,
volatility factor of 80% and a life of 22 months. The fair
value of approximately $381,000 was amortized over the remaining
life of the development agreement. The amortization expense of
approximately $104,000 was recorded as research and development
expenses during the years ended March 31, 2002. The fair
value was fully amortized during the year ended March 31,
2002

In November 1999, the Company entered into a
license agreement and one year maintenance contract in the
amount of approximately $3.0 million with a customer and in
connection with the agreement committed to the issuance of a
warrant to purchase 800,000 shares of common stock. In
January 2000 the warrant was issued with an exercise price of
$13.00 and was net exercised on July 25, 2000. The value of
the warrants was estimated to be approximately
$16.4 million and was based upon a Black-Scholes valuation
model with the following assumptions: risk free interest rate of
5.5%, dividend yield of 0%, volatility of 80%, expected life of
2 years, exercise price of $13.00 and fair value of $30.00.
Service revenues were reduced by approximately $375,000 during
the year ended March 31, 2002. The fair value was fully
amortized during the year ended March 31, 2002.

In connection with a development agreement
entered into in April 2001, the Company issued a warrant to
purchase 100,000 shares of the Companys common
stock. The Company determined the fair value of the warrant
using the Black-Scholes valuation model assuming a fair value of
the Companys common stock at $3.53 per share, risk
free interest rate of 6%, dividend yield of 0%, volatility
factor of 99% and expected life of 3 years. The value of
the warrant was estimated to be approximately $227,000 and was
fully amortized and recorded as research and development
expenses during the year ended March 31, 2002. In October
2003 and January 2004, 33,333 shares and
66,666 shares, respectively were net exercised.



| |                          
| | -------------------------
| | 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. All services were complete at
the date of grant and the value of the services was based upon
the then fair value of the common stock. 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.

F-20



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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. During
fiscal year 2002, the Company issued 2,500 shares of common
stock at a weighted average fair value of $2.59, in exchange for
marketing services and recorded a compensation expense of
approximately $6,000.



| |                 
| | ----------------
| | Stock Repurchase

In August 2001, the Board of Directors 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. This program expired in April 2003.

In May 2003, the Board approved an additional
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, 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.

The aggregate of the purchases since the
authorizations by the Board of Directors was approximately
6.2 million shares at the cost of approximately
$21.0 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.



| |             
| | ------------
| | 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 will 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.

F-21



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                   
| | ------------------
| | Stock Option Plans



| |                                                  
| | -------------------------------------------------
| | Stock Option Plans  Approved by
    Stockholders



| |                
| | ---------------
| | 1996 Stock Plan

The Companys 1996 Stock Plan (the
1996 Plan) was adopted by the Board of Directors on
August 26, 1996. The 1996 Plan permits the grant of
incentive stock options, nonstatutory stock options and
restricted shares. 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. Incentive stock options are granted at
an exercise price of not less than 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.
Vesting and exercise provisions are determined by the Board of
Directors at the time 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.
Options can be exercised at any time and stock issued under the
1996 Plan may be subject to repurchase by the Company. This
right to repurchase generally lapses over four years from the
vesting commencement date of the option.

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 Board of
Directors 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 services. The Board of Directors may modify,
extend or assume outstanding options. The Board of Directors 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 change in control occurs, an option or other award
under the 1996 Plan will become fully exercisable and fully
vested if the option or award is not assumed by the surviving
corporation or its parent or if the surviving corporation or its
parent does not substitute its own options for the options
granted under the 1996 Plan. 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 outstanding options and other
awards under the 1996 Plan shall be assumed or substituted with
its own options by the surviving corporation or its parent,
shall be continued by the Company if it is the surviving
corporation or shall be cancelled for a cash payment. The Board
of Directors may amend or terminate the 1996 Plan at any time.



| |                           
| | --------------------------
| | 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

F-22



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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.

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.

F-23



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                                  
| | ---------------------------------
| | 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 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 right 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.

F-24



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                       
| | ----------------------
| | 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 options and shares of
restricted stock. 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 and consultants, who are not
officers or members of the Board of Directors, are eligible to
participate in the Supplemental 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
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.



| |           
| | ----------
| | 1996A Plan

The Company adopted the 1996 Stock Plan as
amended and restated March 28, 2001 (the 1996A
Plan). A total of approximately 8.1 million shares of
common stock have been reserved under the 1996A Plan. With
limited restrictions, if shares awarded under the 1996A Plan are
forfeited, those shares will again become available for new
awards under the 1996A Plan. The 1996A Plan permits the grant of
options, stock

F-25



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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 1996A
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 1996A Plan have a
maximum term of ten years.

The Compensation Committee of the Board of
Directors administers the 1996A Plan and has complete discretion
to make all decisions relating to the interpretation and
operation of the 1996A 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 1996A 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 Directors may amend or terminate the
1996A Plan at any time. The 1996A Plan will continue in effect
indefinitely unless the Board of Directors decides to terminate
the plan earlier.

F-26



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Activity under all stock option plans is as
follows:

|                          |                             |                |       |                     |   |                |       |                |   |   |                 |                 |  |   |       |       | 
|------------------------- | --------------------------- | -------------- | ----- | ------------------- | - | -------------- | ----- | -------------- | - | - | --------------- | --------------- |  | - | ----- | ----- | 
|                          |                             |                |       |                    
|                          |                             |                |       | Options Outstanding
|                          |                             |                |       |                    
|                          |                             | Shares         |       |                     |   | Weighted-     
|                          |                             | Available for  |       | Number of           |   |                |       | Average       
|                          |                             | Grant          |       | Shares              |   | Exercise Price |       | Exercise Price
|                          |                             |                |       |                     |   |                |       |               
|                          |                             |               
|                          |                             | (in thousands)
|Balance at March 31, 2001 |                             |                | 1,938 |                     |   |                | 4,534 |                |   | $ | 0.030  $74.688 |                 |  | $ | 21.13 |      
|                          | Increase in shares reserved |                |       | 6,325               |   |                |       |               |   |   |                 |                 |  |   |       |       | 
|                          | Options granted             |                |       | (6,719              | ) |                |       | 6,717          |   |   | $               | 1.750  $61.683 |  |   | $     | 3.64  | 
|                          | Options exercised           |                |       |                    |   |                |       | (113           | ) |   | $               | 0.100  $4.380  |  |   | $     | 2.14  | 
|                          | Options canceled            |                |       | 1,405               |   |                |       | (2,131         | ) |   | $               | 0.030  $74.688 |  |   | $     | 20.58 | 
|                          |                             |                |       |                     |   |                |       |                |   |   |                 |                 |  |   |       |      
|Balance at March 31, 2002 |                             |                | 2,949 |                     |   |                | 9,007 |                |   | $ | 0.100  $74.688 |                 |  | $ | 8.45  |      
|                          | Increase in shares reserved |                |       | 3,308               |   |                |       |               |   |   |                 |                 |  |   |       |       | 
|                          | Options granted             |                |       | (2,623              | ) |                |       | 2,623          |   |   | $               | 1.990  $4.350  |  |   | $     | 2.73  | 
|                          | Options exercised           |                |       |                    |   |                |       | (187           | ) |   | $               | 0.100  $3.920  |  |   | $     | 1.80  | 
|                          | Options canceled            |                |       | 2,080               |   |                |       | (2,893         | ) |   | $               | 0.300  $74.688 |  |   | $     | 13.50 | 
|                          |                             |                |       |                     |   |                |       |                |   |   |                 |                 |  |   |       |      
|Balance at March 31, 2003 |                             |                | 5,714 |                     |   |                | 8,550 |                |   | $ | 0.200  $63.484 |                 |  | $ | 5.13  |      
|                          | Increase in shares reserved |                |       | 1,571               |   |                |       |               |   |   |                 |                 |  |   |       |       | 
|                          | Options granted             |                |       | (2,289              | ) |                |       | 2,289          |   |   | $               | 2.35  $5.30    |  |   | $     | 4.46  | 
|                          | Options exercised           |                |       |                    |   |                |       | (1,984         | ) |   | $               | 0.200  $4.38   |  |   | $     | 3.11  | 
|                          | Options canceled            |                |       | 1,750               |   |                |       | (1,841         | ) |   | $               | 1.25  $63.48   |  |   | $     | 6.82  | 
|                          |                             |                |       |                     |   |                |       |                |   |   |                 |                 |  |   |       |      
|Balance at March 31, 2004 |                             |                | 6,746 |                     |   |                | 7,014 |                |   | $ | 0.200  $63.48  |                 |  | $ | 5.62  |      
|                          |                             |                |       |                     |   |                |       |                |   |   |                 |                 |  |   |       |      

|                |                    |                     |  |                |         |                 |  |                |      |           |  |   |                   |  |  |  |       |  |  |   |         | 
|--------------- | ------------------ | ------------------- |  | -------------- | ------- | --------------- |  | -------------- | ---- | --------- |  | - | ----------------- |  |  |  | ----- |  |  | - | ------- | 
|                |                    |                     |  |               
|                |                    | Options Outstanding |  | Options Vested
|                |                    |                     |  |               
|                |                    |                     |  | Weighted-      |         |                 |  |               
|                |                    | Number of           |  | Average        |         |                 |  |                |      | Weighted-
|                |                    | Outstanding         |  | Remaining      |         |                 |  | Options        |      | Average  
|Range of        |                    | Shares as of        |  | Contractual    |         | Range of        |  | Vested at      |      | Exercise 
|Exercise Prices |                    | March 31, 2004      |  | Life           |         | Exercise Prices |  | March 31, 2004 |      | Price    
|                |                    |                     |  |                |         |                 |  |                |      |          
|                |                    | (in thousands)      |  |                |         |                 |  | (in thousands) |      |          
|                | $0.2000  $ 2.560  |                     |  |                | 0 1,930 |                 |  |                | 8.11 |           |  | $ | 0.2000  $ 2.5600 |  |  |  | 1,151 |  |  | $ | 2.4214  | 
|                | $2.5800  $ 3.890  |                     |  |                | 0 1,158 |                 |  |                | 7.52 |           |  | $ | 2.5800  $ 3.8900 |  |  |  | 797   |  |  | $ | 3.3790  | 
|                | $3.9100  $ 4.160  |                     |  |                | 0 1,307 |                 |  |                | 7.30 |           |  | $ | 3.9100  $ 4.1600 |  |  |  | 891   |  |  | $ | 4.1509  | 
|                | $4.1990  $ 4.770  |                     |  |                | 0 1,274 |                 |  |                | 9.38 |           |  | $ | 4.1990  $ 4.7700 |  |  |  | 787   |  |  | $ | 4.2484  | 
|                | $4.9400  $63.4844 |                     |  |                | 1,345   |                 |  |                | 6.65 |           |  | $ | 4.9400  $63.4844 |  |  |  | 582   |  |  | $ | 19.1417 | 
|                |                    |                     |  |                |         |                 |  |                |      |           |  |   |                   |  |  |  |       |  |  |   |         | 
|                | $0.2000  $63.4844 |                     |  |                | 7,014   |                 |  |                | 7.81 |           |  | $ | 0.2000  $63.4844 |  |  |  | 4,207 |  |  | $ | 5.6203  | 
|                |                    |                     |  |                |         |                 |  |                |      |           |  |   |                   |  |  |  |       |  |  |   |         | 

F-27



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Equity Compensation Plan Information

|                                                      |  |                         |       |                    |  |                      |       |   |  |  |       |    
|----------------------------------------------------- |  | ----------------------- | ----- | ------------------ |  | -------------------- | ----- | - |  |  | ----- | ---
|                                                      |  |                         |       |                    |  | Number of Securities
|                                                      |  | Number of Securities    |       | Weighted-Average   |  | Remaining Available 
|                                                      |  | to be Issued upon       |       | Exercise Price of  |  | for Future Issuance 
|                                                      |  | Exercise of Outstanding |       | Outstanding        |  | Under Equity        
|                                                      |  | Options, and Rights     |       | Options and Rights |  | Compensation Plans  
|                                                      |  |                         |       |                    |  |                     
|Plans Approved by Stockholders                        |  |                         |       |                    |  |                      |       |   |  |  |       |    
|1996 Stock Plan                                       |  |                         | 423   |                    |  | $                    | 8.33  | 8 |  |  |      |    
|1999 Equity Incentive Plan                            |  |                         | 3,614 |                    |  | $                    | 5.23  | 1 |  |  | 5,992 | (1)
|1999 Employee Stock Purchase Plan                     |  |                         |      |                    |  | $                    | 6.92  | 9 |  |  | 1,905 | (2)
|Plans Not Required to be Approved by
    Stockholders |  |                         |       |                    |  |                      |       |   |  |  |       |    
|Officer Option Agreement                              |  |                         | 50    |                    |  | $                    | 25.50 |   |  |  |      |    
|2001 Supplemental Plan                                |  |                         | 1,715 |                    |  | $                    | 3.84  | 7 |  |  | 264   |    
|1996A Plan                                            |  |                         | 1,212 |                    |  | $                    | 3.77  | 6 |  |  | 490   |    
|                                                      |  |                         |       |                    |  |                      |       |   |  |  |       |    
|Total                                                 |  |                         | 7,014 |                    |  |                      |       |   |  |  | 8,651 |    
|                                                      |  |                         |       |                    |  |                      |       |   |  |  |       |    



---



|    |                                                                                                                                                                                                                  
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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.   
|   
|(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 are
subject to repurchase. At March 31, 2004, no shares were
subject to repurchase under the 1996 Stock Plan.



|    |                                                        
|--- | -------------------------------------------------------
|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:

|                                                                                   |  |                                          |        |      |  |      |         |   |  |   |         |  
|---------------------------------------------------------------------------------- |  | ---------------------------------------- | ------ | ---- |  | ---- | ------- | - |  | - | ------- | -
|                                                                                   |  |                                         
|                                                                                   |  | Years Ended March 31,                   
|                                                                                   |  |                                         
|                                                                                   |  | 2004                                     |        | 2003 |  | 2002
|                                                                                   |  |                                          |        |      |  |     
|                                                                                   |  |                                         
|                                                                                   |  | (in thousands, except per share amounts)
|Net loss                                                                           |  | $                                        | (8,846 | )    |  | $    | (29,748 | ) |  | $ | (26,377 | )
|                                                                                   |  |                                          |        |      |  |      |         |   |  |   |         |  
|Basic and diluted:                                                                 |  |                                          |        |      |  |      |         |   |  |   |         |  
|Weighted-average shares of common stock
    outstanding                            |  |                                          | 31,177 |      |  |      | 32,331  |   |  |   | 35,531  |  
|Less weighted-average shares subject to repurchase                                 |  |                                          | (12    | )    |  |      | (112    | ) |  |   | (441    | )
|                                                                                   |  |                                          |        |      |  |      |         |   |  |   |         |  
|Weighted-average shares used in computing basic
    and diluted net loss per share |  |                                          | 31,165 |      |  |      | 32,219  |   |  |   | 35,090  |  
|                                                                                   |  |                                          |        |      |  |      |         |   |  |   |         |  
|Basic and diluted net loss per share                                               |  | $                                        | (0.28  | )    |  | $    | (0.92   | ) |  | $ | (0.75   | )
|                                                                                   |  |                                          |        |      |  |      |         |   |  |   |         |  

F-28



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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:

|                                                                                                                                                                                                                                     |  |                       |       |      |  |      |       |  |  |  |       | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | --------------------- | ----- | ---- |  | ---- | ----- |  |  |  | ----- | 
|                                                                                                                                                                                                                                     |  |                      
|                                                                                                                                                                                                                                     |  | Years Ended March 31,
|                                                                                                                                                                                                                                     |  |                      
|                                                                                                                                                                                                                                     |  | 2004                  |       | 2003 |  | 2002
|                                                                                                                                                                                                                                     |  |                       |       |      |  |     
|                                                                                                                                                                                                                                     |  |                      
|                                                                                                                                                                                                                                     |  | (in thousands)       
|Options excluded due to the exercise price
    exceeding the average fair market value of the Companys
    common stock during the period                                                                                           |  |                       | 589   |      |  |      | 3,798 |  |  |  | 3,705 | 
|Options excluded for which the exercise price was
    less than the average fair market value of the Companys
    common stock during the period but were excluded as inclusion
    would decrease the Companys net loss per share |  |                       | 6,425 |      |  |      | 4,752 |  |  |  | 5,302 | 
|Common shares excluded resulting from common
    stock subject to repurchase                                                                                                                                                         |  |                       |      |      |  |      | 43    |  |  |  | 198   | 
|                                                                                                                                                                                                                                     |  |                       |       |      |  |      |       |  |  |  |       | 
|Total common stock equivalents excluded from
    diluted net loss per common share                                                                                                                                                   |  |                       | 7,014 |      |  |      | 8,593 |  |  |  | 9,205 | 
|                                                                                                                                                                                                                                     |  |                       |       |      |  |      |       |  |  |  |       | 



|    |             
|--- | ------------
|12. | Income Taxes

The provision for income taxes is based upon
income (loss) before income taxes as follows (in thousands):

|                              |                    |           |        |        |   |      |         |         |   |   |         |         |  
|----------------------------- | ------------------ | --------- | ------ | ------ | - | ---- | ------- | ------- | - | - | ------- | ------- | -
|                              |                    |          
|                              |                    | March 31,
|                              |                    |          
|                              |                    | 2004      |        | 2003   |   | 2002
|                              |                    |           |        |        |   |     
|Domestic Pre-Tax Loss         |                    | $         | (7,380 | )      |   | $    | (20,358 | )       |   | $ | (22,586 | )      
|Foreign Pre-Tax Income/(Loss) |                    |           | (1,466 | )      |   |      | 584     |         |   |   | (3,487  | )      
|                              |                    |           |        |        |   |      |         |         |   |   |         |        
|                              | Total Pre-Tax Loss |           | $      | (8,846 | ) |      | $       | (19,774 | ) |   | $       | (26,073 | )
|                              |                    |           |        |        |   |      |         |         |   |   |         |        

|                                     |  |                       |        |      |  |      |        |   |  |   |        |  
|------------------------------------ |  | --------------------- | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                                     |  |                      
|                                     |  | Years Ended March 31,
|                                     |  |                      
|                                     |  | 2004                  |        | 2003 |  | 2002
|                                     |  |                       |        |      |  |     
|Computed federal tax                 |  | $                     | (3,096 | )    |  | $    | (9,822 | ) |  | $ | (9,126 | )
|Computed state tax                   |  |                       | 50     |      |  |      | 50     |   |  |   |       |  
|Computed foreign tax                 |  |                       | 240    |      |  |      | 169    |   |  |   | 304    |  
|Losses not benefited                 |  |                       | 3,315  |      |  |      | 6,367  |   |  |   | 7,043  |  
|Deferred compensation expense        |  |                       | 511    |      |  |      | 724    |   |  |   | 944    |  
|Nondeductible acquisition expenses   |  |                       |       |      |  |      | 3,276  |   |  |   | 1,139  |  
|Change in tax reserve                |  |                       | (240   | )    |  |      | (169   | ) |  |   |       |  
|Non-deductible expenses              |  |                       | 29     |      |  |      | 31     |   |  |   |       |  
|Pre-tax foreign loss                 |  |                       | (454   | )    |  |      | (173   | ) |  |   |       |  
|Research and development tax credits |  |                       | (355   | )    |  |      | (453   | ) |  |   |       |  
|                                     |  |                       |        |      |  |      |        |   |  |   |        |  
|Provision for income tax             |  | $                     |       |      |  | $    |       |   |  | $ | 304    |  
|                                     |  |                       |        |      |  |      |        |   |  |   |        |  

F-29



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

|                         |  |                       |   |      |  |      |   |  |  |   |     | 
|------------------------ |  | --------------------- | - | ---- |  | ---- | - |  |  | - | --- | 
|                         |  |                      
|                         |  | Years Ended March 31,
|                         |  |                      
|                         |  | 2004                  |   | 2003 |  | 2002
|                         |  |                       |   |      |  |     
|US current tax expense   |  | $                     |  |      |  | $    |  |  |  | $ |    | 
|Deferred tax             |  |                       |  |      |  |      |  |  |  |   |    | 
|Foreign tax expense      |  |                       |  |      |  |      |  |  |  |   | 304 | 
|                         |  |                       |   |      |  |      |   |  |  |   |     | 
|Provision for income tax |  | $                     |  |      |  | $    |  |  |  | $ | 304 | 
|                         |  |                       |   |      |  |      |   |  |  |   |     | 

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):

|                                 |                         |           |         |      |  |      |         |   |  |   |         |   | 
|-------------------------------- | ----------------------- | --------- | ------- | ---- |  | ---- | ------- | - |  | - | ------- | - | 
|                                 |                         |          
|                                 |                         | March 31,
|                                 |                         |          
|                                 |                         | 2004      |         | 2003 |  | 2002
|                                 |                         |           |         |      |  |     
|Deferred tax assets:             |                         |           |         |      |  |      |         |   |  |   |         |  
|Net operating loss carryforwards |                         | $         | 47,043  |      |  | $    | 38,181  |   |  | $ | 31,610  |  
|Tax credit carryforwards         |                         |           | 4,766   |      |  |      | 4,065   |   |  |   | 1,419   |  
|Deferred revenue                 |                         |           | 618     |      |  |      | 5,766   |   |  |   | 3,705   |  
|Other                            |                         |           | 4,316   |      |  |      | 4,576   |   |  |   | 294     |  
|                                 |                         |           |         |      |  |      |         |   |  |   |         |  
|Total net deferred tax assets    |                         |           | 56,743  |      |  |      | 52,588  |   |  |   | 37,028  |  
|Valuation allowance              |                         |           | (56,743 | )    |  |      | (52,588 | ) |  |   | (37,028 | )
|                                 |                         |           |         |      |  |      |         |   |  |   |         |  
|                                 | Net deferred tax assets |           | $       |     |  |      | $       |  |  |   | $       |  | 
|                                 |                         |           |         |      |  |      |         |   |  |   |         |  

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
$4.2 million, $15.6 million, and $8.2 million
during 2004, 2003, and 2002, respectively.

As of March 31, 2004, the Company had
federal and state net operating loss carryforwards of
approximately $126.9 million and approximately
$45.8 million, respectively. As of March 31, 2004, the
Company also had federal and state research and development tax
credit carryforwards of approximately $2.6 million and
$3.3 million, respectively. The federal net operating loss
and credit carryforwards expire at various dates beginning in
2012 through 2024, if not utilized. The state net operating loss
carryforwards expire at various dates beginning in 2005 through
2016, if not utilized. The state tax credit carryforwards have
no expiration date.

Selecticas subsidiary in India (Selectica
India Private Ltd.), has a 10-year tax holiday, which commenced
from the fiscal year 1999. The subsidiary 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.

F-30



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|    |             
|--- | ------------
|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, 2004, 2003 and 2002. 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 heads 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 heads 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 heads 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. The savings
for salaries and benefits on an annual basis for 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 savings for salaries and
benefits on an annual basis was 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.

F-31



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##### Table of Contents



SELECTICA, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

As of March 31, 2004 we did not have a
balance in the reserve for restructuring. As of March 31,
2003, the balance of the reserve for restructuring was
approximately $264,000, which was included in Other Accrued
Liabilities in the accompanying consolidated balance sheet. The
activity in the accrued restructuring balances related to all of
the plans described above was as follows:

Include subtotals for each year-end.

|                                                                        |  |                |        |  
|----------------------------------------------------------------------- |  | -------------- | ------ | -
|                                                                        |  | (in thousands)
|Charge for the year ended March 31,
    2001  Plan 1                   |  | $              | 667    |  
|Payments for the year ended March 31,
    2001  Plan 1                 |  |                | (317   | )
|                                                                        |  |                |        |  
|Accrual balance, March 31, 2001                                         |  |                | 350    |  
|Charge for the year ended March 31,
    2002  Plan 2                   |  |                | 1,759  |  
|Payments for the year ended March 31,
    2002  Plan 1                 |  |                | (350   | )
|Payments for the year ended March 31,
    2002  Plan 2                 |  |                | (1,577 | )
|                                                                        |  |                |        |  
|Accrual balance, March 31, 2002                                         |  |                | 182    |  
|Charge for the year ended March 31,
    2003  Plan 3                   |  |                | 1,760  |  
|Payments for the year ended March 31,
    2003  Plan 2                 |  |                | (182   | )
|Stock based compensation for the year ended
    March 21, 2003  Plan 3 |  |                | (249   | )
|Payments for the year ended March 31,
    2003  Plan 3                 |  |                | (1,247 | )
|                                                                        |  |                |        |  
|Accrual balance, March 31, 2003                                         |  |                | 264    |  
|Payments for the year ended March 31,
    2004  Plan 3                 |  |                | (198   | )
|Write back of expense for the year ended
    March 31, 2004  Plan 3    |  |                | (66    | )
|                                                                        |  |                |        |  
|Accrual balance, March 31, 2004                                         |  | $              |       |  
|                                                                        |  |                |        |  



|    |                 
|--- | ----------------
|15. | Subsequent Event

On April 22, 2004, Trilogy Software Inc. and
Trilogy Development Group (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 the Company. The
complaint alleges that the Company has been and is 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 the Company from
infringing Trilogys patents in the future, and any other
relief to which Trilogy may be entitled. The Company is
currently evaluating the merits of this complaint.

F-32



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##### Table of Contents



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, 2004 and
2003, and the related consolidated statements of operations,
stockholders equity, and cash flows for each of the three
years in the period ended March 31, 2004. 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, 2004 and 2003, and the consolidated results of
their operations and their cash flows for each of the three
years in the period ended March 31, 2004, 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.



| |                      
| | ---------------------
| | /s/ ERNST & YOUNG LLP

San Jose, California 
 April 22, 2004

F-33



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##### Table of Contents






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 14th day of
June 14, 2004.



| |                                      
| | -------------------------------------
| | SELECTICA, INC.                      
| | Registrant                           
|
| | /s/ STEPHEN BENNION                  
| |                                      
| | Stephen Bennion                      
| | President and Chief Executive Officer
| | (Interim) and Chief Financial 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.

|                                                                  |  |                                                     |  |               |  | 
|----------------------------------------------------------------- |  | --------------------------------------------------- |  | ------------- |  | 
|                                                                  |  |                                                     |  |              
|Signature                                                         |  | Title                                               |  | Date         
|                                                                  |  |                                                     |  |              
|Principal Executive Officer:                                      |  |                                                     |  |              
|/s/ STEPHEN BENNIONStephen Bennion                                |  | President and Chief Executive Officer
    (Interim) |  | June 14, 2004
|                                                                 
|Principal Financial Officer and Principal
    Accounting Officer: |  |                                                     |  |              
|/s/ STEPHEN BENNIONStephen Bennion                                |  | Chief Financial Officer                             |  | June 14, 2004
|                                                                 
|Directors:                                                        |  |                                                     |  |              
|/s/ JAMIE ARNOLDJamie Arnold                                      |  | Director                                            |  | June 14, 2004
|                                                                 
|/s/ JOHN FISHERJohn Fisher                                        |  | Director                                            |  | June 14, 2004
|                                                                 
|/s/ MICHAEL LYONSMichael Lyons                                    |  | Director                                            |  | June 14, 2004
|                                                                 
|/s/ THOMAS NEUSTAETTERThomas Neustaetter                          |  | Director                                            |  | June 14, 2004



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##### Table of Contents



EXHIBIT INDEX

|        |    |             |  |                                                                                                                                                                                                                                                                               
|------- | -- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|No.     |    | Description
|        |    |            
|        | 3  | .1(1)       |  | The Second Amended and Restated Certificate of
    Incorporation.                                                                                                                                                                                                             
|        | 3  | .2(6)       |  | Certificate of Designation of Series A
    Junior or Participating Preferred Stock.                                                                                                                                                                                           
|        | 3  | .3(6)       |  | Amended and Restated Bylaws.                                                                                                                                                                                                                                                  
|        | 4  | .1(1)       |  | Reference is made to Exhibits 3.1, 3.2 and
    3.3.                                                                                                                                                                                                                           
|        | 4  | .2(1)       |  | Form of Registrants Common Stock
    certificate.                                                                                                                                                                                                                            
|        | 4  | .3(1)       |  | Amended and Restated Investor Rights Agreement
    dated June 16, 1999.                                                                                                                                                                                                       
|        | 4  | .4(2)       |  | Rights Agreement between Registrant and
    U.S. Stock Transfer Corporation, as Rights Agent, dated
    February 4, 2003.                                                                                                                                                     
|        | 10 | .1(1)       |  | Form of Indemnification Agreement.                                                                                                                                                                                                                                            
|        | 10 | .2(1)       |  | 1996 Stock Plan.                                                                                                                                                                                                                                                              
|        | 10 | .3(6)       |  | 1999 Employee Stock Purchase Plan.                                                                                                                                                                                                                                            
|        | 10 | .4(6)       |  | 1999 Equity Incentive Plan, as amended and
    restated December 11, 2002.                                                                                                                                                                                                    
|        | 10 | .5(1)       |  | Lease between John Arrillaga Survivors Trust and
    the Richard T. Perry Separate Property Trust as Landlord and the
    Registrant as Tenant, dated October 1, 1999.                                                                                                        
|        | 10 | .6(1)       |  | Major Account License Agreement between the
    Registrant and Fujitsu Network Communications, Inc., dated
    November 4, 1998.                                                                                                                                              
|        | 10 | .7(1)       |  | Agreement for Web Site Design and Development
    Service between the Registrant and BMW of North America, Inc.,
    dated July 15, 1998.                                                                                                                                     
|        | 10 | .8(1)       |  | Major Account License Agreement between the
    Registrant and the Firemans Fund Insurance Company,
    dated June 24, 1999.                                                                                                                                                 
|        | 10 | .9(1)       |  | Major Account License Agreement between the
    Registrant and Aspect Telecommunications, dated May 17,
    1999.                                                                                                                                                             
|        | 10 | .10(1)      |  | A Consulting Engagement Proposal from the
    Registrant to 3Com, dated July 29, 1999.                                                                                                                                                                                        
|        | 10 | .11(1)      |  | A Consulting Engagement Proposal from the
    Registrant to 3Com, dated August 10, 1999.                                                                                                                                                                                      
|        | 10 | .12(3)      |  | Employment Agreement between the Registrant and
    Dr. Sanjay Mittal, dated as of January 1, 2003.                                                                                                                                                                           
|        | 10 | .13(3)      |  | Employment Agreement between the Registrant and
    Stephen Bennion dated as of January 1, 2003.                                                                                                                                                                              
|        | 10 | .14(1)      |  | Major Account License Agreement between the
    Registrant and Samsung SDS Co., Ltd., dated January 12,
    2000; amendment #1 to Major Account License Agreement
    between the Registrant and Samsung SDS Co., Ltd., dated
    February 10, 2000.                          
|        | 10 | .15(1)      |  | International Value Added Reseller Agreement
    between the Registrant and Samsung SDS Co., Ltd., dated
    January 12, 2000; Amendment #1 to International Value
    Added Reseller Agreement between the Registrant and Samsung SDS
    Co., Ltd., dated February 29, 2000.
|        | 10 | .16(1)      |  | Stock Purchase Agreement between the Registrant
    and Samsung SDS Co., Ltd., dated January 31, 2000;
    Amendment #1 to the Stock Purchase Agreement between the
    Registrant and Samsung SDS Co., Ltd., dated February 8,
    2000.                                     
|        | 10 | .17(1)      |  | Lease between John Arrillaga Survivors Trust and
    Richard T. Perry Separate Property Trust as Landlord and the
    Registrant as Tenant, dated October 1, 1999.                                                                                                            
|        | 10 | .18(1)      |  | Stock Purchase Agreement between the Registrant
    and Dell USA, L.P., dated February 14, 2000.                                                                                                                                                                              
|        | 10 | .19(4)      |  | Offer to exchange outstanding options, dated
    April 27, 2001.                                                                                                                                                                                                              
|        | 10 | .20(5)      |  | Offer to exchange outstanding options dated
    February 19, 2003.                                                                                                                                                                                                            
|        | 10 | .21(6)      |  | Warrant to Purchase Common Stock issued to Sales.
    Technologies Limited, dated April 4, 2001.                                                                                                                                                                              
|        | 10 | .22(6)      |  | Licensed Works Agreement between the Registrant
    and International Business Machines Corporation, dated
    December 11, 2002.                                                                                                                                             



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##### Table of Contents



|        |    |             |  |                                                                                                                                                    
|------- | -- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |    |            
|No.     |    | Description
|        |    |            
|        | 10 | .23(6)      |  | Licensed Works Agreement Statement of Work
    between the Registrant and International Business Machines
    Corporation, dated December 11, 2002.
|        | 10 | .24(6)      |  | Professional Services Agreement between the
    Registrant and GE Medical Services, dated June 28, 2002.                                           
|        | 10 | .25(6)      |  | Major Account License Agreement between the
    Registrant and GE Medical Systems, dated June 28, 2002.                                            
|        | 10 | .26(6)      |  | Amendment #1 to Major Account License
    Agreement between the Registrant and GE Medical Systems.                                                 
|        | 10 | .27(6)      |  | Amendment #2 to Major Account License
    Agreement between the Registrant and GE Medical Systems, dated
    October 8, 2002.                      
|        | 10 | .28(6)      |  | Amendment #3 to Major Account License
    Agreement between the Registrant and GE Medical Systems, dated
    March 31, 2003.                       
|        | 10 | .29(6)      |  | Addendum #1 to Professional Services
    Agreement between Registrant and GE Medical Services, dated
    August 27, 2002.                          
|        | 10 | .30(6)      |  | Amendment #2 to Professional Services
    Agreement between Registrant and GE Medical Services, dated
    March 3, 2003.                           
|        | 10 | .31(7)      |  | Settlement Agreement and General Release between
    Registrant and David Choi, dated August 13, 2003.                                             
|        | 10 | .32(7)      |  | Letter Agreement between Registrant and Sanjay
    Mittal, Dated September 22, 2003.                                                               
|        | 21 | .1(6)       |  | Subsidiaries.                                                                                                                                      
|        | 23 | .1          |  | Consent of Independent Registered Public
    Accounting Firm                                                                                       
|        | 31 | .1          |  | Certification Pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.                                                                       
|        | 31 | .2          |  | Certification Pursuant to Section 302 of the
    Sarbanes-Oxley Act of 2002.                                                                       
|        | 32 | .1          |  | Certification Pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                                       
|        | 31 | .2          |  | Certification Pursuant to Section 906 of the
    Sarbanes-Oxley Act of 2002.                                                                       



---



|    |                                                                                                                      
|--- | ---------------------------------------------------------------------------------------------------------------------
|(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 Schedule TO filed by the
    Company on April 27, 2001.                                          
|   
|(5) | Previously filed in Schedule TO filed by the
    Company on February 19, 2003.                                       
|   
|(6) | Previously filed in the Companys report on
    Form 10-K filed on June 30, 2003.                                    
|   
|(7) | Previously filed in the Companys report on
    Form 10-Q filed on November 11, 2003.