<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended Commission File Number
July 31, 1997 0-26334
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
INFERENCE CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-3436352
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
100 ROWLAND WAY
NOVATO, CALIFORNIA 94945
(415) 893-7200
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
---------------------------
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 at least the past 90 days.
Yes x No _____
-----
As of September 2, 1997, there were 6,648,468 shares of the Registrant's Class A
Common Stock, par value $0.01 per share, and 1,190,332 shares of the
Registrant's Class B Common Stock, par value $0.01 per share, outstanding.
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INFERENCE CORPORATION
INDEX
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PART I FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets
at July 31 and January 31, 1997 ...................................................... 3
Condensed Consolidated Statements of Operations for the
Three and Six Months Ended July 31, 1997 and 1996..................................... 4
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended July 31, 1997 and 1996 .............................................. 5
Notes to Condensed Consolidated Financial Statements .................................. 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................................................. 7
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings ..................................................................... 14
ITEM 2. Changes in Securities ................................................................. 14
ITEM 3. Defaults upon Senior Securities........................................................ 14
ITEM 4. Submission of Matters to a Vote of Security Holders.................................... 14
ITEM 5. Other Information...................................................................... 14
ITEM 6. Exhibits and Reports on Form 8-K....................................................... 14
Signature ............................................................................. 15
Exhibit Index.......................................................................... 16
Exhibit 3.1............................................................................ 17
Exhibit 11............................................................................. 18
</TABLE>
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<PAGE>
INFERENCE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
JULY 31, JANUARY 31,
1997 1997
------------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............. $ 26,906,000 $ 28,620,000
Short-term investments................ -- 987,000
Accounts receivable, net.............. 6,113,000 9,794,000
Other current assets.................. 849,000 692,000
------------ ------------
Total current assets................. 33,868,000 40,093,000
Property and equipment, net............ 2,380,000 2,055,000
Other assets........................... 130,000 93,000
------------ ------------
$ 36,378,000 $ 42,241,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable...................... $ 1,127,000 $ 1,113,000
Accrued salaries and related items.... 1,090,000 1,539,000
Other accrued liabilities............. 1,997,000 2,082,000
Deferred revenue...................... 4,274,000 5,396,000
------------ ------------
Total current liabilities............ 8,488,000 10,130,000
Shareholders' equity:
Common stock.......................... 78,000 82,000
Additional paid-in capital............ 49,680,000 52,048,000
Accumulated deficit................... (21,868,000) (20,019,000)
------------ ------------
Total shareholders' equity........... 27,890,000 32,111,000
------------ ------------
$ 36,378,000 $ 42,241,000
============ ============
</TABLE>
See accompanying notes.
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<PAGE>
INFERENCE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
------------------------------ -------------------------------
1997 1996 1997 1996
-------------- ------------- -------------- --------------
<S> <C> <C> <C> <C>
REVENUES:
Products..................................... $ 2,709,000 $5,503,000 $ 5,927,000 $10,481,000
Services..................................... 4,011,000 3,870,000 7,886,000 8,019,000
----------- ---------- ----------- -----------
Total revenues............................. 6,720,000 9,373,000 13,813,000 18,500,000
OPERATING COSTS AND EXPENSES:
Cost of product revenues..................... 246,000 371,000 488,000 716,000
Cost of service revenues..................... 2,097,000 2,311,000 4,304,000 4,743,000
Product development.......................... 1,141,000 834,000 2,185,000 1,545,000
Sales and marketing.......................... 3,484,000 4,130,000 7,443,000 8,318,000
General and administrative................... 983,000 875,000 1,907,000 1,625,000
----------- ---------- ----------- -----------
Total operating costs and expenses......... 7,951,000 8,521,000 16,327,000 16,947,000
----------- ---------- ----------- -----------
Income (loss) from operations.................. (1,231,000) 852,000 (2,514,000) 1,553,000
Costs of attempted secondary offering.......... -- (315,000) -- (315,000)
Non-employee stock option expenses............. -- -- -- (215,000)
Interest income................................ 379,000 330,000 733,000 651,000
Interest expense and other, net................ (54,000) (3,000) (68,000) (32,000)
----------- ---------- ----------- -----------
Income (loss) before income taxes.............. (906,000) 864,000 (1,849,000) 1,642,000
Provision for income taxes..................... -- -- -- 25,000
----------- ---------- ----------- -----------
Net income (loss).............................. $ (906,000) $ 864,000 $(1,849,000) $ 1,617,000
=========== ========== =========== ===========
Net income (loss) per share.................... $ (0.11) $ 0.10 $ (0.23) $0.19
=========== ========== =========== ===========
Shares used in computing
net income (loss) per share.............. 7,915,000 8,780,000 8,011,000 8,692,000
=========== ========== =========== ===========
</TABLE>
See accompanying notes.
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<PAGE>
INFERENCE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JULY 31,
-----------------------------
1997 1996
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................................................... $(1,849,000) $ 1,617,000
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization...................................... 420,000 388,000
Changes in operating assets and liabilities:
Accounts receivable.............................................. 3,681,000 (1,422,000)
Other current assets............................................. (157,000) (777,000)
Other assets..................................................... (37,000) (15,000)
Accounts payable................................................. 14,000 (523,000)
Accrued salaries and related items............................... (449,000) (57,000)
Other accrued liabilities........................................ (85,000) (369,000)
Deferred revenue................................................. (1,122,000) 78,000
----------- -----------
Net cash provided by (used in) operating activities.................. 416,000 (1,080,000)
CASH FLOWS FROM INVESTING ACTIVITIES:
Maturity of short-term investments................................... 987,000 3,607,000
Purchases of short-term investments.................................. -- (51,000)
Purchases of property and equipment.................................. (745,000) (666,000)
----------- -----------
Net cash provided by investing activities............................ 242,000 2,890,000
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock........................... 229,000 1,662,000
Repurchase of common stock........................................... (2,601,000) --
----------- -----------
Net cash provided by (used in) financing activities.................. (2,372,000) 1,662,000
----------- -----------
Net increase (decrease) in cash and cash equivalents................. (1,714,000) 3,472,000
Cash and cash equivalents at beginning of period..................... 28,620,000 18,619,000
----------- -----------
Cash and cash equivalents at end of period........................... $26,906,000 $22,091,000
=========== ===========
________________________
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid during the period...................................... $ 3,000 $ 19,000
=========== ===========
Income taxes paid during the period.................................. $ 12,000 $ 56,000
=========== ===========
</TABLE>
See accompanying notes.
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<PAGE>
INFERENCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary to present fairly the
financial information have been included. This financial information should be
read in conjunction with the consolidated financial statements and notes thereto
for the year ended January 31, 1997, included in the Annual Report on Form 10-K.
The results of operations for the three and six months ended July 31, 1997 are
not necessarily indicative of the results to be expected for the entire fiscal
year.
The condensed consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany balances
and transactions have been eliminated in consolidation.
2. NET INCOME (LOSS) PER SHARE
Net income (loss) per share is computed using the weighted average number of
shares of common stock outstanding. Common equivalent shares from stock options
and warrants (using the treasury stock method) have been included in the
computation when dilutive.
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, "Earnings per Share" ("SFAS 128"), which is effective for the Company's
fiscal year ending January 31, 1998. At that time, the Company will be required
to change the method currently used to compute net income per share and to
restate all prior periods. Under SFAS 128, the dilutive effect of stock options
and warrants will be excluded in the calculation of primary or basic earnings
per share. The adoption of SFAS 128 is expected to have no impact on the net
loss per share for the three or six months ended July 31, 1997; however, for the
three months ended July 31, 1996, basic net income per share would increase by
$0.01, and for the six months ended July 31, 1996, basic net income per share
would increase by $0.01. The impact of SFAS 128 on the calculation of fully
diluted earnings per share is not expected to be material.
3. NON-EMPLOYEE STOCK OPTION RELATED EXPENSES
During the three months ended April 30, 1996, the Company incurred payroll-
related taxes of $215,000 as a result of the exercise of non-qualified stock
options held by former Inference employees. In connection with these option
exercises, the Company will be able to take a tax deduction, if and when
adequate taxable income is earned, for the related compensation expense.
However, the tax benefit will be accounted for when utilized as an adjustment to
shareholders' equity.
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements contained hereunder regarding matters that are not
historical facts are forward-looking statements (as such term is defined in the
rules promulgated pursuant to the Securities Act of 1933, as amended (the
"Securities Act")). Such forward-looking statements are subject to certain
risks, trends and uncertainties; thus, actual results may differ materially from
those expressed in or implied by such forward-looking statements. Factors that
could cause or contribute to such differences include, but are not limited to,
fluctuations in quarterly operating results, the size and timing of customer
orders, rapid technological change and product transitions, and competitive
actions in the marketplace. The Company undertakes no obligation to release
publicly the result of any revisions to these forward-looking statements that
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events. Readers should also carefully
review the business and risk factors described in the documents the Company
files from time to time with the Securities and Exchange Commission,
specifically the Annual Report on Form 10-K and Quarterly Reports on Form 10-Q
and any Current Reports on Form 8-K filed by the Company.
The following discussion should be read in conjunction with the condensed
consolidated financial statements and notes thereto.
OVERVIEW
In the three and six month periods ended July 31, 1997, the Company did not
meet its planned operating results, which included a year over year decline in
product revenues, both in the Americas and internationally. The Company
attributes the decline in product revenues to several factors, including but not
limited to: a) implementing the Company's new sales distribution model - which
includes the establishment of direct territorial and market oriented sales teams
and channel/partner sales teams; b) lower productivity by the sales
representatives in all geographic areas; c) the impact on the Americas sales
organizations from the hiring of a new Senior Vice President; d) the significant
turnover in sales personnel world-wide, especially in the Americas operations;
and e) the increased competitive environment in which the Company operates.
THREE MONTHS ENDED JULY 31, 1996 AND JULY 31, 1997
Revenues
The Company's revenues are derived principally from two sources: (i) fees from
licenses of the Company's software products and technology and (ii) fees from
consulting services, maintenance (technical support and upgrades of software
products) and training. Product revenues result principally from non-cancelable
license agreements that provide customers the non-exclusive right to use the
products for a fixed term or on a perpetual basis. Such revenues are recognized
upon: (i) execution of a binding agreement; (ii) shipment of the product to the
customer; (iii) when the license fee is fixed or determinable; and (iv) when
collectability is reasonably assured. Revenues from consulting and training are
recognized as the related services are performed, and maintenance revenues are
deferred and recognized over the term of the Company's maintenance contracts,
typically one year.
Total revenues decreased 28% from $9,373,000 in the three months ended July
31, 1996 to $6,720,000 in the three months ended July 31, 1997, due to various
factors discussed above in the Overview.
Total revenues from the Americas operations decreased from $6,175,000 in the
three months ended July 31, 1996 to $3,784,000 in the three months ended July
31, 1997, representing a 39% decrease. Total international revenues decreased
from $3,198,000 in the three months ended July 31, 1996 to $2,936,000 in the
three months ended July 31, 1997, representing an 8% decrease. Total
international revenues for the three months ended July 31, 1996 and July 31,
1997 represented 34% and 44% of total revenues, respectively. The Company
currently has subsidiaries in the United Kingdom, Germany, France and the
Netherlands, offering licenses and consulting services, and also agreements with
over 15 distributors worldwide, serving Europe, the Middle East and Africa, and
Asia and the Pacific Rim. International revenues are subject to various risks,
including unexpected changes in regulatory requirements, tariffs and other trade
barriers; costs and risks of localizing products for foreign countries; longer
accounts receivable payment cycles; potentially adverse tax consequences;
repatriation of earnings; exchange rate fluctuations; and the burdens of
complying with a wide variety of foreign laws. There can be no assurance that
such factors will not have an adverse effect on the revenues from the Company's
future international sales and, consequently, the Company's results of
operations.
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<PAGE>
Product revenues decreased from $5,503,000 in the three months ended July 31,
1996 to $2,709,000 in the three months ended July 31, 1997, representing a 51%
decrease. The decline in revenues from products was due to significantly lower
unit sales volumes, because of factors previously discussed in Overview; the
prices of the Company's products have remained relatively constant. Product
revenues represented 59% and 40% of total revenues for the three months ended
July 31, 1996 and July 31, 1997, respectively. During the three months ended
July 31, 1997, one customer accounted for 31% of total product revenues, or 12%
of total revenues.
Product revenues from the Americas operations decreased from $3,827,000 in the
three months ended July 31, 1996 to $1,267,000 in the three months ended July
31, 1997, representing a 67% decrease. International product revenues decreased
from $1,676,000 in the three months ended July 31, 1996 to $1,442,000 in the
three months ended July 31, 1997, representing a 14% decrease.
Total service revenues increased from $3,870,000 in the three months ended
July 31, 1996 to $4,011,000 in the three months ended July 31, 1997,
representing a 4% increase.
Service revenues from the Americas operations increased from $2,348,000 in the
three months ended July 31, 1996 to $2,517,000 in the three months ended July
31, 1997, representing a 7% increase. International service revenues decreased
from $1,522,000 in the three months ended July 31, 1996 to $1,494,000 in the
three months ended July 31, 1997, representing a 2% decrease.
Cost of Product Revenues
Cost of product revenues, consisting primarily of the costs of product media
and duplication, manuals, packaging materials, personnel-related costs, shipping
expenses and royalties paid to third-party vendors, decreased from $371,000 in
the three months ended July 31, 1996 to $246,000 in the three months ended July
31, 1997, representing a 34% decrease. The gross margin on product revenues was
93% and 91% for the three months ended July 31, 1996 and July 31, 1997,
respectively. The lower gross margin for the three months ended July 31, 1997
was the result the decreased product sales volume.
Cost of Service Revenues
Cost of service revenues, consisting principally of personnel-related costs
for consulting, training and technical support, decreased from $2,311,000 in the
three months ended July 31, 1996 to $2,097,000 in the three months ended July
31, 1997, representing a 9% decrease. Cost of service revenues typically varies
depending on the revenue mix of training, consulting services and technical
support. The gross margin on service revenues was 40% and 48% for the three
months ended July 31, 1996 and July 31, 1997, respectively. The gross margin on
service revenues for the three months ended July 31, 1997 was higher as a result
of the achievement of certain significant milestones relating to various
consulting projects, the high utilization of America's consultants, as well as
the continued high rate of renewal associated with the Company's maintenance
support business. Going forward, it is expected that this higher than usual
gross margin on service revenues will not continue.
Product Development
Product development expense consists primarily of employee-related costs,
including salaries, benefits, equipment and facility costs, incurred in the
research, design, development and enhancement of software products. Product
development expenditures increased from $834,000 in the three months ended July
31, 1996 to $1,141,000 in the three months ended July 31, 1997, representing a
37% increase. This increase is primarily the result of the Company's strategy to
continue to invest in enhancing and further developing the CBR Content Navigator
product line. Product development expense as a percentage of total revenues was
9% and 17% for the three months ended July 31, 1996 and July 31, 1997,
respectively.
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<PAGE>
Sales and Marketing
Sales and marketing expense consists primarily of salaries, benefits and
commissions of sales and marketing personnel, trade shows and promotional
expenses, and non-chargeable customer service and sales support. Sales and
marketing expense decreased from $4,130,000 in the three months ended July 31,
1996 to $3,484,000 in the three months ended July 31, 1997, representing a 16%
decrease. This decrease is the result of reduced headcount in the Company's
sales force in the Americas and internationally. The Company intends to
aggressively hire sales personnel to staff and expand its direct sales force,
primarily in the Americas. Sales and marketing expense as a percentage of total
revenues was 44% and 52% for the three months ended July 31, 1996 and July 31,
1997, respectively.
General and Administrative
General and administrative expense consists of the personnel costs for finance
and accounting, human resources, information systems and general management of
the Company. General and administrative expense increased from $875,000 in the
three months ended July 31, 1996 to $983,000 in the three months ended July 31,
1997, representing a 12% increase. This increase is primarily attributable to
increased staffing, both domestically and internationally. General and
administrative expense as a percentage of total revenues was 9% and 15% for the
three months ended July 31, 1996 and July 31, 1997, respectively.
Interest Income, Expense and Other
Other income and expenses, primarily interest income, decreased from $327,000
in the three months ended July 31, 1996 to $325,000 in the three months ended
July 31, 1997.
SIX MONTHS ENDED JULY 31, 1996 AND JULY 31, 1997
Revenues
Total revenues decreased 25% from $18,500,000 in the six months ended July 31,
1996 to $13,813,000 in the six months ended July 31, 1997.
Total revenues from the Americas operations decreased from $11,995,000 in the
six months ended July 31, 1996 to $8,316,000 in the six months ended July 31,
1997, representing a 31% decrease. Total international revenues decreased from
$6,505,000 in the six months ended July 31, 1996 to $5,497,000 in the six months
ended July 31, 1997, representing a 15% decrease. Total international revenues
for the six months ended July 31, 1996 and July 31, 1997 represented 35% and 40%
of total revenues, respectively.
Product revenues decreased from $10,481,000 in the six months ended July 31,
1996 to $5,927,000 in the six months ended July 31, 1997, representing a 43%
decrease. The decline in revenues from products was due to significantly lower
unit sales volumes; the prices of the Company's products have remained
relatively constant. Product revenues represented 57% and 43% of total revenues
for the six months ended July 31, 1996 and July 31, 1997, respectively. During
the six months ended July 31, 1997, two customers accounted in the aggregate for
30% of total product revenues, or 13% of total revenues.
Product revenues from the Americas operations decreased from $7,092,000 in the
six months ended July 31, 1996 to $3,477,000 in the six months ended July 31,
1997, representing a 51% decrease. International product revenues decreased from
$3.389,000 in the six months ended July 31, 1996 to $2,450,000 in the six months
ended July 31, 1997, representing a 28% decrease.
Total service revenues decreased from $8,019,000 in the six months ended July
31, 1996 to $7,886,000 in the six months ended July 31, 1997, representing a 2%
decrease.
Service revenues from the Americas operations decreased from $4,903,000 in the
six months ended July 31, 1996 to $4,839,000 in the six months ended July 31,
1997, representing a 1% decrease. International service revenues decreased from
$3,116,000 in the six months ended July 31, 1996 to $3,047,000 in the six months
ended July 31, 1997, representing a 2% decrease.
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Cost of Product Revenues
Cost of product revenues, consisting primarily of the costs of product media
and duplication, manuals, packaging materials, personnel-related costs, shipping
expenses and royalties paid to third-party vendors, decreased from $716,000 in
the six months ended July 31, 1996 to $488,000 in the six months ended July 31,
1997, representing a 32% decrease. The gross margin on product revenues was 93%
and 92% for the six months ended July 31, 1996 and July 31, 1997, respectively.
Cost of Service Revenues
Cost of service revenues decreased from $4,743,000 in the six months ended
July 31, 1996 to $4,304,000 in the six months ended July 31, 1997, representing
a 9% decrease. The gross margin on service revenues was 41% and 45% for the six
months ended July 31, 1996 and July 31, 1997, respectively. Cost of service
revenues typically varies depending on the revenue mix of training, consulting
services and technical support.
Product Development
Product development expense increased from $1,545,000 in the six months ended
July 31, 1996 to $2,185,000 in the six months ended July 31, 1997, representing
a 41% increase. This increase is the result of the Company's strategy to
continue to invest in enhancing and further developing the CBR Content Navigator
product line. Product development expense as a percentage of total revenues was
8% and 16% for the six months ended July 31, 1996 and July 31, 1997,
respectively.
Sales and Marketing
Sales and marketing expense decreased from $8,318,000 in the six months ended
July 31, 1996 to $7,443,000 in the six months ended July 31, 1997, representing
an 11% decrease. This decrease is the result of reduced headcount in the
Company's sales force in the Americas and internationally. The Company intends
to aggressively hire sales personnel to staff and expand its direct sales force,
primarily in the Americas. Sales and marketing expense as a percentage of total
revenues was 45% and 54% for the six months ended July 31, 1996 and July 31,
1997, respectively.
General and Administrative
General and administrative expense increased from $1,625,000 in the six months
ended July 31, 1996 to $1,907,000 in the six months ended July 31, 1997,
representing a 17% increase. This increase is primarily attributable to
increased staffing, both domestically and internationally. General and
administrative expense as a percentage of total revenues was 9% and 14% for the
six months ended July 31, 1996 and July 31, 1997, respectively.
Interest Income, Expense, Other and Provision for Income Taxes
Other income and expense, primarily interest income, increased from $619,000
in the six months ended July 31, 1996 to $665,000 in the six months ended July
31, 1997. The Company's provision for income taxes in the six months ended July
31, 1996 represented the accrual of foreign taxes and federal alternative
minimum taxes.
-10-
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents and short-term investments at July 31, 1997 were
$26,906,000, a decrease of $2,701,000 since January 31, 1997. Working capital
at July 31, 1997 was $25,380,000.
Net cash provided by operating activities amounted to $416,000 during the six
months ended July 31, 1997, as compared to net cash used in operating activities
of $1,080,000 during the six months ended July 31, 1996.
Investing activities for the six months ended July 31, 1997 included $745,000
for purchases of property and equipment. The Company has no significant capital
commitments as of July 31, 1997.
Cash used in financing activities for the six months ended July 31, 1997
included $2,601,000 for the repurchase of approximately 452,000 shares of the
Company's common stock.
The Company's international operations are principally transacted in British
pounds and German marks. Translation into the Company's reporting currency, the
U.S. dollar, has not historically had a material impact on the Company's
financial position. Additionally, the Company's net assets denominated in
currencies other than the functional currency has not exposed the Company to
material risk associated with fluctuations in currency rates. Given this and the
relatively stable nature of the exchange rates, historically, between the
British pound and the German mark, and the U.S. dollar, the Company has not
considered it necessary to use foreign currency contracts or other derivative
instruments to manage changes in currency rates. However, future changes in the
exchange rates between the foreign currencies and the U.S. dollar could have an
adverse effect on the Company's financial position.
The Company believes that existing cash balances, together with anticipated
cash flow from operations, will be sufficient to meet its working capital and
capital expenditure requirements for at least the next twelve months.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
Fluctuations in Quarterly Operating Results. The Company has experienced
significant quarterly fluctuations in operating results and anticipates such
fluctuations in the future. The Company has historically recognized a
substantial portion of its license revenues in the last month of the quarter,
typically in the last week. The Company generally ships orders as they are
received and as a result has little or no backlog. Quarterly revenues and
operating results therefore depend on the volume and timing of orders received
during the quarter, which are difficult to forecast. In addition, consulting
service revenues tend to fluctuate as projects, which may continue over several
quarters, are undertaken, completed, or as contract milestones are achieved.
Operating results may also fluctuate due to factors such as the demand for the
Company's products; the size and timing of customer orders; the introduction of
new products and product enhancements by the Company or its competitors; the
budgeting cycles of customers; changes in the proportion of revenues
attributable to licenses and service fees; changes in the level of operating
expenses; and competitive conditions in the industry. The value of individual
licenses as a percentage of quarterly revenues can be substantial, and
particular licenses may generate a substantial portion of the operating profits
for the quarter in which they are signed. The sales cycle typically ranges from
three to nine months, and license signing may be delayed for a number of reasons
outside of the control of the Company. Because the Company's staffing and other
operating expenses are based on anticipated revenues, a substantial portion of
which is not typically generated until the end of each quarter, delays in the
receipt of orders can cause significant variations in operating results from
quarter to quarter. The Company also may choose to reduce prices or to increase
spending in response to competition or to pursue new market opportunities, which
may adversely affect the Company's operating results. Accordingly, the Company
believes that period-to-period comparisons of its results of operations may not
be meaningful and should not be relied upon as an indication of future
performance. Furthermore, there can be no assurance that the Company will
achieve profitability.
-11-
<PAGE>
Rapid Technological Change; Product Transitions. The market for the Company's
products is characterized by rapid technological developments, evolving industry
standards, swift changes in customer requirements and frequent new product
introductions and enhancements. As a result, the Company's success depends upon
its ability to continue to enhance its existing products, develop and introduce
in a timely manner new products incorporating technological advances, and
respond to customer requirements. To the extent one or more of the Company's
competitors introduce products that more fully address customer requirements,
the Company's business could be adversely affected. There can be no assurance
that the Company will be successful in developing and marketing new products or
enhancements to its existing products on a timely basis or that any new or
enhanced products will adequately address the changing needs of the marketplace.
If the Company is unable to develop and introduce new products or enhancements
to existing products in a timely manner in response to changing market
conditions or customer requirements, the Company's business, operating results
and financial condition will be materially and adversely affected.
Competition. The market for customer support software is highly competitive,
and there are certain competitors with substantially greater sales, marketing,
development and financial resources than the Company. Among the Company's major
competitors are Answer Systems, Inc., Astea International Inc., Clarify, Inc.
and Software Artistry, Inc. Furthermore, many potential customers develop
internal solutions by creating business applications that eliminate the need to
acquire software and services from third-party vendors such as the Company.
The Company believes that the competitive factors affecting the market for the
Company's products and services include vendor and product reputation; product
quality, performance and price; product functionality and features; product
scaleability; product integration with other enterprise applications; the
availability of products on multiple platforms; product ease-of-use; and the
quality of customer support services, documentation and training. The relative
importance of each of these factors depends upon the specific customer involved.
There can be no assurance that the Company will be able to compete effectively
with respect to any of these factors.
The Company's present or future competitors may be able to develop products
comparable or superior to those offered by the Company or adapt more quickly
than the Company to new technologies or evolving customer requirements. In order
to be successful in the future, the Company must respond to technological
change, customer requirements and competitors' current products and innovations.
In particular, while the Company is currently developing additional product
enhancements that the Company believes address customer requirements, there can
be no assurance that the Company will successfully complete the development or
introduction of these additional product enhancements on a timely basis or that
these product enhancements will achieve market acceptance. Accordingly, there
can be no assurance that the Company will be able to continue to compete
effectively in its market, that competition will not intensify or that future
competition will not have a material adverse effect on the Company's business,
operating results and financial condition.
Pricing. The Company believes that its products are competitively priced with
other products in the customer support market. However, the market for the
Company's products is highly competitive, and the Company expects that it will
face increasing pricing pressures from its current competitors and new market
entrants. Any material reduction in the price of the Company's products would
negatively affect gross margins and could materially adversely affect the
Company's business, operating results and financial condition if the Company
were unable to increase unit sales. In addition, the Company expects increased
competition and intends to invest significantly in its business. As a result,
there can be no assurance that the Company will remain profitable on a quarterly
or annual basis.
Dependence Upon Key Personnel. In recent years, the Company has experienced
changes in its operations which have placed significant demands on the Company's
administrative, operational and financial resources. The Company's future
performance depends in significant part upon the continued service of its key
technical, sales and senior management personnel. The loss of the services of
one or more of these key employees could have a material adverse effect on the
Company's business, operating results and financial condition. The Company's
future success also depends on its ability to attract and retain highly
qualified technical, sales and managerial personnel. Competition for such
personnel is intense, and there can be no assurance that the Company can retain
its key employees or that it can attract, assimilate or retain other highly
qualified personnel in the future.
Product Concentration. The Company currently derives substantially all of its
revenues from licenses of CBR products and associated services. Broad market
acceptance of CBR products is critical to the Company's future success. As a
result, a decline in demand for or failure to achieve broad market acceptance of
CBR products as a result of competition, technological change or otherwise would
have a material adverse effect on the business, operating results and financial
condition of the Company.
-12-
<PAGE>
Possible Volatility of Stock Price. The trading price of the Company's Class A
Common Stock has been and is 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 recommendations by securities analysts and other events
or factors. In addition, the stock market has experienced volatility that has
particularly affected the market prices of equity securities of many technology
companies and that often has been unrelated to the operating performance of such
companies. These broad market fluctuations may adversely affect the trading
price of the Company's Class A Common Stock.
Uncertainty of Proprietary Rights. The Company's success depends in part upon
its proprietary technology. Although case-based reasoning technology is
available in the public domain, the Company believes its implementation of the
CBR technology is proprietary. The Company relies on a combination of patent,
copyright, trademark and trade secret laws, confidentiality procedures and
licensing arrangements to establish and protect its proprietary rights. In
December 1996, the Company was awarded two patents for its Case-Base Reasoning
technology. The Company's CBR technology is embedded in its CBR family of
products. Despite the precautions the Company has taken, it may be possible for
an unauthorized third party to copy or otherwise obtain and use the Company's
products, technology or other information that the Company regards as
proprietary or to develop similar products or technology independently. In
addition, effective trademark, copyright and trade secret protection may be
unavailable or limited in certain foreign countries where the Company operates.
The Company is not aware that any of its products infringe upon the
proprietary rights of third parties. There can be no assurance, however, that
third parties will not claim such infringement by the Company with respect to
current or future products. The Company expects that it will increasingly be
subject to such claims as the number of products and competitors in the customer
support software market grows and the functionality of such products overlaps
with other industry segments. Any such claims, whether or not they are
meritorious, could result in costly litigation or require the Company to enter
into royalty or licensing agreements. Such royalty or license agreements, if
required, may not be available on terms acceptable to the Company or at all. If
the Company were found to have infringed upon the proprietary rights of third
parties, it could be required to pay damages, cease sales of the infringing
products and redesign or discontinue such products, any of which could have a
material adverse effect on the Company's business, operating results and
financial condition.
-13-
<PAGE>
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) On June 24, 1997, the Company's 1997 annual meeting of shareholders
("Annual Meeting") was held.
(b) The shareholders approved the election of the two nominees for the Class
I directors of the Company's Board of Directors for a term of three
years. The following nominees received the number of votes set forth
below opposite their respective names:
<TABLE>
<CAPTION>
NOMINEE FOR WITHHELD
------- --- --------
<S> <C> <C>
Dean O. Allen 5,376,000 300,000
William D. Griffin 5,376,000 300,000
</TABLE>
(c) In addition to the election of the Class I directors, the following
matters were approved at the Annual Meeting:
1. The appointment of Ernst & Young LLP as the Company's independent
public auditors for the ending January 31, 1998 was ratified with
5,613,000 votes in favor, 40,000 against and fiscal year 23,000
abstentions.
2. The amendment to the Company's Certificate of Incorporation to
increase the total authorized number of shares of the Company's Class
A Common Stock by 10,000,000 was approved by a vote of 5,142,000 in
favor, 1,716,000 against, 7,000 abstentions and 1,174,000 broker non-
votes. (The approval of this proposal required the affirmative vote of
the holders of a majority of the shares of the Company's Class A
Common Stock and Class B Common Stock, voting together as a single
class, present at the Annual Meeting in person or by proxy.)
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K
<TABLE>
<CAPTION>
Exhibit
Number Exhibit
------ -------
<S> <C>
3.1 Certificate of Amendment to the Registrant's Certificate of
Incorporation.
11 Statement of Computation of Earnings Per Share.
</TABLE>
(b) Reports on Form 8-K
None.
-14-
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
INFERENCE CORPORATION
/s/ William D. Griffin
----------------------
WILLIAM D. GRIFFIN
SENIOR VICE PRESIDENT,
CHIEF FINANCIAL OFFICER AND SECRETARY
(Principal Financial and
Accounting Officer)
Dated: September 4, 1997
-15-
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Sequentially
Exhibit Numbered
Number Description of Exhibit Page
------ ---------------------- ----
<S> <C> <C>
3.1 Certificate of Amendment to the Registrant's Certificate of Incorporation 17
11 Statement of Computation of Earnings Per Share 18
</TABLE>
-16-
<PAGE>
EXHIBIT 3.1
CERTIFICATE OF AMENDMENT
TO CERTIFICATE OF INCORPORATION
OF
INFERENCE CORPORATION
(PURSUANT TO SECTION 242 OF THE
GENERAL CORPORATION LAW OF THE STATE OF DELAWARE)
Inference Corporation, a Delaware corporation (the "Corporation"), does
hereby certify that:
1. The first paragraph of Article Fourth of the Corporation's
Certificate of Incorporation is amended to read in its entirety as follows:
The Corporation is authorized to issue three classes of capital stock,
designated Class A Common Stock, Class B Common Stock and Preferred Stock. The
total number of shares of stock which the Corporation shall have authority to
issue is Twenty-Nine Million (29,000,000) shares, consisting of Twenty-Five
Million (25,000,000) shares of Class A Common Stock, par value $.01 (the "Class
A Common Stock"), Two Million (2,000,000) shares of Class B Common Stock, par
value $.01 (the "Class B Common Stock"), and Two Million (2,000,000) shares of
Preferred Stock, par value $.01 (the "Preferred Stock"). The Class A Common
Stock and the Class B Common Stock are collectively referred to herein as the
"Common Shares."
IN WITNESS WHEREOF, the undersigned has duly executed this Certificate
of Amendment on this 25th day of August, 1997.
INFERENCE CORPORATION
By: /s/ Peter R. Tierney
-------------------------
Peter R. Tierney, President
Attest:
/s/ William D. Griffin
- --------------------------------
William D. Griffin, Secretary
-17-
<PAGE>
EXHIBIT 11
INFERENCE CORPORATION
STATEMENT OF COMPUTATION OF EARNINGS PER SHARE
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31,
-------------------------- ---------------------------
1997 1996 1997 1996
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
PRIMARY --
Average common shares outstanding.......................... 7,914,580 8,091,112 8,011,333 7,951,613
Net effect of dilutive options and warrants -
based on the treasury stock method using
average market price (1)................................. -- 688,815 -- 740,766
---------- ---------- ----------- ----------
7,914,580 8,779,927 8,011,333 8,692,379
========== ========== =========== ==========
Net income (loss).......................................... $ (906,000) $ 864,000 $(1,849,000) $1,617,000
========== ========== =========== ==========
Net income (loss) per share................................ $ (0.11) $ 0.10 $ (0.23) $ 0.19
========== ========== =========== ==========
</TABLE>
_____________
(1) Application of the modified treasury stock method did not have a dilutive
effect on net income per share.
-18-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JAN-31-1998
<PERIOD-START> FEB-01-1997
<PERIOD-END> JUL-31-1997
<CASH> 26,906,000
<SECURITIES> 0
<RECEIVABLES> 6,278,000
<ALLOWANCES> 165,000
<INVENTORY> 0
<CURRENT-ASSETS> 33,868,000
<PP&E> 4,551,000
<DEPRECIATION> 2,171,000
<TOTAL-ASSETS> 36,378,000
<CURRENT-LIABILITIES> 8,488,000
<BONDS> 0
0
0
<COMMON> 78,000
<OTHER-SE> 27,812,000
<TOTAL-LIABILITY-AND-EQUITY> 36,378,000
<SALES> 13,813,000
<TOTAL-REVENUES> 13,813,000
<CGS> 4,792,000
<TOTAL-COSTS> 7,443,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 68,000
<INCOME-PRETAX> (1,849,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,849,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,849,000)
<EPS-PRIMARY> (.23)
<EPS-DILUTED> (.23)
</TABLE>
