The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this Form 10-K. This discussion contains forward-looking statements reflecting our current expectations and estimates and assumptions concerning events and financial trends that may affect our future operating results or financial position. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed in the "Forward-Looking Statements" set forth above.

Overview

We provide contract management and sales configuration software solutions that allow enterprises to efficiently manage sell-side business processes. Our solutions include software, on demand hosting, professional services and expertise.

The Selectica Contract Lifecycle Management ("CLM" or "CM") solution is a contract authoring, analysis, repository and process automation product designed to enhance and automate the management of the entire contract lifecycle. It helps companies take control of their contract management processes by converting from paper-based to electronic repositories and by unlocking multiple layers of critical business data, making it available for the evaluation of risk, the exposure of lost revenue and the evaluation of supplier performance, and other purposes. The solution helps to improve the customer buying experience for sales organizations, improve the control of risk and decrease time spent drafting, monitoring and managing contracts for the corporate counsel's office and gain access to previously hidden discounts through the exposure and elimination of unfavorable agreements for procurement and sourcing organizations.

The Selectica Sales Configuration ("SCS") solution consolidates configuration, pricing and quoting functions into a single application platform enabling companies to streamline the opportunity-to-order process for manufacturers, service providers, and financial services companies. Our SCS solution provides a critical link between Customer Relationship Management (CRM) and Enterprise Resource Planning (ERP) systems that helps to simplify and automate the configuration, pricing, and quoting of complex products and services. By empowering customers, internal sales staff, and/or channel partners to generate error-free sales proposals for their unique requirements, we believe our SCS solution helps companies to close sales faster, accelerate revenue generation and enhance customer relationships.

Summary of Operating Results for Fiscal 2009

During the fiscal year ended March 31, 2009, our total revenues increased by 3%, or $0.4 million, to $16.4 million compared with total revenues of $16.0 million for the fiscal year ended March 31, 2008. The results for 2009 also reflected a shift of revenues from being primarily dependent on our SCS products to being primarily dependent on our CLM products. In fiscal 2009, CLM products and service revenues totaled $9.9 million or 60% of total revenues, representing an increase of $4.1 million or 72% over fiscal 2008, whereas our SCS products and service revenues totaled $6.5 million or 40% of total revenues, representing a decrease of $3.7 million or 36% over fiscal 2008. This resulted largely from increased license and professional service revenues for our CM products, reflecting the investments we made in fiscal 2009 to expand our CM business and the decline in license revenues for our SCS products.

During the fiscal year ended March 31, 2009, our net loss declined by 65% or $15.5 million, to $8.4 million compared to a net loss of $23.9 million for the fiscal year ended March 31, 2008. The most significant factors affecting the decline in our net loss are (i) a decline in charges from $16.3 million related to a litigation settlement in the fiscal year ended March 31, 2008, to $92,000 in the fiscal year ended March 31, 2009 (ii) a decline in professional fees related to our stock option investigation from $3.6 million in the fiscal year ended March 31, 2008 to $38,000 in the fiscal year ended March 31, 2009 and
(iii) a decline in gross margins in the

period ended March 31, 2009 due to the shift in mix between license revenues and service revenues offset by declines in costs for research and development, sales and marketing and restructuring. Service revenues typically have lower margins than license revenues and the shift towards service revenues in the year ended March 31, 2009 resulted in a decline of 8.9% (from 73.8% to 64.9%) in our overall gross margin from the year ended March 31, 2008.

Outlook for Fiscal 2010

We anticipate that our shift in focus from our SCS business to our CM business will continue in fiscal year 2010 and, specifically, that revenues from our CM business will continue to grow in fiscal year 2010, but at a lower rate of growth than in fiscal 2009, while revenues from our SCS business will remain flat or decline modestly. We believe that our success in fiscal year 2010 will depend critically on our ability to (i) manage the continuing shift from our SCS business to our CM business, (ii) increase our CM license revenue , (iii) manage our costs of professional services to increase our margins in that segment of our business, (iv) enhance our management team, (v) execute on our business plan despite a significant reduction in our workforce in the first quarter of fiscal 2010 and (vi) achieve targeted expense reductions. We believe that key risks in fiscal 2010 include (i) the impact of continuing adverse worldwide economic conditions on overall demand for our products, (ii) risks associated with the planned transition of our business, and (iii) the impact of our continuing litigation with Trilogy regarding our shareholder rights plan.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Our significant accounting policies are described in notes accompanying the consolidated financial statements. The preparation of the consolidated financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. Estimates are based on information available as of the date of the financial statements, and accordingly, actual results in future periods could differ from these estimates. Significant judgments and estimates used in the preparation of the consolidated financial statements apply critical accounting policies described in the notes to our consolidated financial statements.

We consider our recognition of revenue, calculation of liabilities and stock-based compensation to be the most critical judgments that are involved in the preparation of the consolidated financial statements.

Results of Operations

Revenues



                                         2009               2008           Change
                                           (in thousands, except percentages)
       License                        $     3,569        $     4,588      $ (1,019 )
       Percentage of total revenues            22 %               29 %          -
       Services                       $    12,876        $    11,415      $  1,461
       Percentage of total revenues            78 %               71 %          -
       Total revenues                 $    16,445        $    16,003      $    442

License. License revenues consist of revenue from licensing our software products. Fiscal 2009 license revenue decreased by $1.0 million from the prior year primarily due to the $1.9 million decline in license revenues from our sales configuration business as we increased our focus to our CM products, which produced an increase in CM license revenues of $0.9 million which did not offset the decline in SCS license revenues.

Services. Services revenues are comprised of fees from consulting, maintenance, training, subscription revenues and out-of pocket reimbursements. Services revenues for fiscal year 2009 increased $1.5 million, or 13%, from the prior year, primarily due to more consulting revenues provided by new and existing customer agreements in the CM business unit. Maintenance revenues were 44% and 49% of total service revenues for the twelve months ended March 31, 2009, and 2008, respectively.

We expect services revenues to continue to fluctuate in future periods as a percentage of total revenues and in absolute dollars. This will depend on new license revenue and 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, although renewed at a 100% rate from existing customers in fiscal 2009, are extremely dependent upon economic conditions, customer satisfaction and the level of need to make changes or upgrade versions of our software by our customers. Fluctuations in revenue are also due to timing of revenue recognition, achievement of milestones, customer acceptance, changes in scope or renegotiated terms, and additional services.

Factors Affecting Operating Results

A small number of customers in our SCS category 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:



                                         2009      2008
                            Customer A     18 %      25 %
                            Customer B      *        12 %

* Revenues were less than 10% of total revenues

We no longer have significant foreign activities. We anticipate that any exposure to foreign currency fluctuations will not be significant.

Cost of Revenues



                                              2009         2008        Change
           Cost of license revenues          $   206      $   255      $   (49 )
           Percentage of license revenues          6 %          6 %         -
           Cost of services revenues         $ 5,563      $ 3,946      $ 1,617
           Percentage of services revenues        43 %         35 %         -
           Total cost of revenues            $ 5,769      $ 4,201      $ 1,568

Cost of License Revenues. Cost of license revenues consists of a fixed allocation of our research and development costs. During the fiscal year 2009, license costs were $0.2 million. We expect cost of license revenues to maintain a relatively consistent level in absolute dollars in fiscal year 2010.

Cost of Services Revenues. Cost of services revenues is comprised mainly of salaries and related expenses of our services organization plus certain allocated corporate expenses. During fiscal 2009, these costs increased by approximately $1.6 million primarily due to the increase in investments in our CM professional services staff as well as an increase in the use of third-party consultants. This increase was partially offset by a decrease during fiscal 2009 of approximately $0.7 million from the SCS business unit due to a decrease of 10 headcount in SCS professional services.

We expect cost of service revenues to fluctuate as a percentage of service revenues.

Gross Margin



                                                   2009      2008
                 Gross margin, license revenues      94 %      94 %
                 Gross margin, services revenues     57 %      65 %
                 Gross margin, total revenues        65 %      74 %

Gross Margin-Gross margins represent gross profit as a percentage of revenue. Gross margins in fiscal 2009 and 2008 were affected by the factors discussed above under "Revenues" and "Cost of Revenues".

Gross Profit

Gross profit was $10.7 million, or 65% of revenues, in fiscal 2009 compared with $11.8 million, or 74% of revenues, in fiscal 2008. The decline in gross profit during fiscal year 2009 was due to the change in mix to a greater percentage of revenue being from services, which have lower margins, and an increase in our cost of services revenue due to the increase in investments in our CM professional services staff as well as an increase in the use of third-party consultants.

SCS gross profit was $4.9 million, or 75% of revenues, in fiscal 2009 compared with $7.9 million, or 77% of revenues, in fiscal 2008. The decrease was due to a $1.9 million reduction in license revenues and higher relative professional services revenues which operate at lower margins.

CM gross profit was $5.7 million, or 58% of revenues, in fiscal 2009 compared with $3.9 million, or 67% of revenues, in fiscal 2008. The increase in gross profit during fiscal year 2009 was due to increased license revenues while margins decreased due to the increase in development expenditures and investments in our CM professional services staff as well as an increase in the use of third-party consultants to complete historic fixed-price arrangements to assure customer satisfaction.

We expect that our overall gross margins will continue to fluctuate due to the timing of service and license revenue recognition and will continue to be adversely affected by lower margins associated with service 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. In addition, gross margins may be lower as a result of the shift and increased investment we have made to our CM business which, in the short term may have lower gross margins than our SCS business depending on the relationship of professional service revenues to license or subscription revenues.

Operating Expenses



                                             2009         2008        Change
           Total research and development   $ 4,218      $ 5,045      $  (827 )
           Percentage of total revenues          26 %         32 %         -

Research and Development. Research and development expenses consist mainly of salaries and related costs of our engineering, quality assurance, technical publications efforts, and certain allocated expenses. The decrease in research and development expenses of $0.8 million in fiscal 2009 compared to fiscal year 2008 was attributable primarily to reductions in headcount and decreases in costs for facilities, overhead and benefits. We expect research and development expenditures to increase modestly in absolute dollars over the next several years as we continue development in our CM products and integrate with tools provided by third parties.

                                            2009         2008        Change
            Sales and marketing            $ 6,307      $ 6,664      $  (357 )
            Percentage of total revenues        38 %         42 %         -

Sales and Marketing. Sales and marketing expenses consist primarily of salaries and related costs for our sales and marketing organization, sales commissions, expenses for travel and entertainment, trade shows, public relations, collateral sales materials, advertising and certain allocated expenses. In fiscal 2009, sales and marketing expenses decreased $0.4 million primarily due to decreases in expenditures in our SCS product line and the implementation of a new team in our CM product line which was fully in place only for the second half of fiscal 2009. We expect modest reductions in sales and marketing expenses in fiscal 2010 compared to fiscal 2009 both in absolute dollars and as a percentage of total revenues.

                                                            2009           2008          Change
General and administrative                                 $ 5,522       $  5,427       $      95
Percentage of total revenues                                    34 %           34 %            -
Professional fees related to stock option investigation    $    38       $  3,596       $  (3,558 )
Percentage of total revenues                                   0.2 %           22 %            -
Litigation settlement                                      $    92       $ 16,275       $ (16,183 )
Percentage of total revenues                                   0.6 %          101 %            -

General and Administrative, Professional fees related to stock option investigation, and litigation settlement. General and administrative expenses consist mainly of personnel and related costs for general corporate functions, including finance, accounting, legal, human resources, bad debt expense and certain allocated expenses. General and administrative expenses increased $0.1 million in fiscal 2009 compared with fiscal 2008 due to increased expenditures for outside contractors, and payments to our board members who assumed more active roles as a result of not having a full time CEO, offset partially by internal efficiencies. We incurred approximately $38,000 in professional fees related to the stock option investigation in fiscal 2009, compared to $3.6 million in fiscal year 2008 in professional fees related to the stock option investigation. We incurred approximately $92,000 in litigation settlement expenses related to the Versata lawsuit as the majority of those expenses were incurred in the prior year (See Footnote 8 to the Consolidated Financial Statements). We incurred approximately $16.3 million in legal settlement costs related to the Versata lawsuit in the prior year. We expect modest reductions in general and administrative expenses in fiscal 2010 compared to fiscal 2009 both in absolute dollars and as a percentage of total revenues.

Restructuring. Restructuring expenses consist primarily of personnel reductions and excess facility charges related to our cost realignment initiatives. The restructuring accrual and the related utilization for the fiscal year ended March 31, 2009 were (in thousands):

                                   Severance and          Excess
                                     Benefits           Facilities        Total
        Balance, March 31, 2008   $           126      $      2,705      $  2,831
        Additional accruals                   661              (143 )         518
        Amounts paid in cash                 (735 )          (1,812 )      (2,547 )
        Loan to sublessee                      -                463           463

        Balance, March 31, 2009   $            52      $      1,213      $  1,265

During fiscal year 2009, we reduced certain executive headcount and revised our excess facility accrual related to our corporate headquarters relocation in the amount of $0.7 million and $0.3 million, respectively. Based on a reduction of headcount in the first quarter of fiscal 2010, we expect to record restructuring charges of at least $500,000 in fiscal 2010.

Other income (expense), net

2009 2008 Change Other income (expense), net $ (2,122 ) $ 381 $ (2,503 )

Other income (expense), net consists primarily of expenses from the impact of foreign currency remeasurement, primarily from our Indian subsidiary (which was sold on March 31, 2009) as well as interest expense associated with our note payable to Versata. In fiscal 2009, other income (expense), net decreased $2.5 million primarily due to unfavorable foreign exchange rate movements against the U.S. dollar that occurred prior to our adopting a hedging program in December 2008. Subsequent to the sale of our Indian subsidiary, our foreign exchange exposure has been substantially eliminated.

Interest Income

Interest income consists primarily of interest earned on cash balances and short-term investments. Interest income decreased in fiscal year 2009 due to lower cash balances and interest rates. We anticipate that interest income in fiscal 2010 will decline relative to fiscal 2009 as a result of lower cash balances and lower interest rates.

Provision for Income Taxes

We incurred income taxes of approximately $157,000 for fiscal year 2009 and approximately $361,000 for fiscal year 2008. As of March 31, 2009, we had federal and state net operating loss carryforwards of approximately $166.5 million and $87.3 million, respectively. As of March 31, 2009, we also had federal and state research and development tax credit carryforwards of approximately $3.1 million and $4.3 million, respectively.

The fiscal 2009 and 2008 tax provisions vary from the expected provision or benefit at the U.S. federal statutory rate due to the recording of valuation allowances against our U.S. operating loss and the effects of different tax rates in our foreign jurisdictions. Given our history of operating losses and our inability to achieve profitable operations, it is difficult to accurately forecast how results will be affected by the realization of net operating loss carryforwards.

SFAS No. 109 provides for the recognition of deferred tax assets if realization of such assets is more likely than not. Based upon the weight of available evidence, which includes our historical operating performance and the reported cumulative net losses in all prior years, we have provided a full valuation allowance against our net deferred tax assets. We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis.

In addition, the Housing and Economic Recovery Act of 2008 ("Act"), signed into law in July 2008 and modified under the Economic Stimulus Act of 2009, allows taxpayers to claim refundable AMT or research and development credit carryovers if they forego bonus depreciation on certain qualified fixed assets placed in service from the period between April 2008 through December 2009. We estimated and recognized the credit based on fixed assets placed into service through the twelve months ended March 31, 2009. During the twelve months ended March 31, 2009 we recorded a net income tax benefit of $13,756 for a U.S. federal refundable credit as provided by the Act.

Liquidity and Capital Resources

                                                           2009          2008
                                                             (in thousands)
     Cash, cash equivalents and short-term investments   $ 23,452      $  35,213
     Working capital                                     $ 20,180      $  30,762
     Net cash used for operating activities              $ (8,002 )    $ (22,162 )
     Net cash provided by investing activities           $ 10,470      $  15,014
     Net cash used for financing activities              $ (2,808 )    $    (484 )

Our primary sources of liquidity consisted of approximately $23.5 million in cash, cash equivalents and short-term investments as of March 31, 2009 compared to approximately $35.2 million in cash, cash equivalents and short-term investments as of March 31, 2008.

Net cash used in operating activities was $8.0 million for the twelve months ended March 31, 2009, resulting primarily from our net loss of $8.4 million, a $3.3 million increase in accounts receivable and a $1.6 million increase in prepaid expenses and other current assets. These decreases in cash flows from operating activities were partially offset by a $1.9 million increase in deferred revenues and a $2.7 million increase in accounts payable.

Net cash used in operating activities was $22.2 million for the twelve months ended March 31, 2008, resulting primarily from our net loss of approximately $23.9 million. Adjustments for non-cash expenses include a net non-cash charge for litigation settlement of $6.1 million, stock based compensation expenses of $1.5 million, depreciation and amortization of approximately $0.7 million, a decrease in accounts payable of approximately $2.5 million and a decrease in accrued liabilities of approximately $3.8 million.

Net cash provided by investing activities was $10.5 million for the twelve months ended March 31, 2009, resulting primarily from $8.2 million of net proceeds of short-term investments, and $2.6 million in net proceeds from the sale of our Indian subsidiary, which was completed on March 31, 2009.

Net cash provided by investing activities was $15.0 million for the twelve months ended March 31, 2008, which was primarily due to net proceeds from the maturity of short-term investments.

As a result of current adverse financial market conditions, investments in some financial instruments may pose risks arising from liquidity and credit concerns. Although we believe our current investment portfolio has very little risk of impairment, we cannot predict future market conditions or market liquidity and can provide no assurance that our investment portfolio will remain unimpaired.

Net cash used in financing activities was $2.8 million for the twelve months ended March 31, 2009, resulting primarily from $2.0 million in costs to defend our Rights Agreement, as well as $0.8 million of payments on our note payable to Versata.

Net cash used in financing activities was $0.5 million for the twelve months ended March 31, 2008, which was primarily due to $0.2 million in payments on our note payable to Versata and $0.3 million used to purchase treasury stock.

We expect to incur significant operating costs for the foreseeable future. We expect to fund our operating costs, as well as our future capital expenditures and liquidity needs, from a combination of available cash balances and internally generated funds. We have no outside debt, and do not have any plans to enter into borrowing arrangements. As a result, our net cash flows will depend heavily on the level of future sales, changes in deferred revenues, our ability to manage costs and ongoing legal proceedings.

We believe our cash, cash equivalents, and short-term investment balances as of March 31, 2009 should be adequate to fund our operations through at least March 31, 2010. However, given the significant changes in our business and results of operations in the last 12 months, the fluctuation in cash and investment balances may be greater than presently anticipated. See "Risk Factors." After the next 12 months, we may find it necessary to obtain . . .