<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
OCTOBER 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 December 8, 1997, there were 6,681,429 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 October 31 and January 31, 1997........................... 3
Condensed Consolidated Statements of Operations
for the Three and Nine Months Ended
October 31, 1997 and 1996.................................... 4
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended October 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.............................................. 13
ITEM 2. Changes in Securities.......................................... 13
ITEM 3. Defaults upon Senior Securities................................ 13
ITEM 4. Submission of Matters to a Vote of Security Holders............ 13
ITEM 5. Other Information.............................................. 13
ITEM 6. Exhibits and Reports on Form 8-K............................... 13
Signature...................................................... 14
Exhibit Index.................................................. 15
Exhibit 11..................................................... 16
</TABLE>
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<PAGE>
INFERENCE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
October 31, January 31,
1997 1997
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................ $ 29,273,000 $ 28,620,000
Short-term investments................... - 987,000
Accounts receivable, net................. 5,997,000 9,794,000
Other current assets..................... 933,000 692,000
------------ ------------
Total current assets.................. 36,203,000 40,093,000
Property and equipment, net.............. 2,305,000 2,055,000
Other assets............................. 110,000 93,000
------------ ------------
$ 38,618,000 $ 42,241,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable......................... $ 934,000 $ 1,113,000
Accrued salaries and related items....... 1,422,000 1,539,000
Other accrued liabilities................ 1,894,000 2,082,000
Deferred revenue......................... 4,138,000 5,396,000
------------ ------------
Total current liabilities............. 8,388,000 10,130,000
Shareholders' equity:
Common stock............................. 78,000 82,000
Additional paid-in capital............... 49,656,000 52,048,000
Accumulated deficit...................... (19,504,000) (20,019,000)
------------ ------------
Total shareholders' equity............ 30,230,000 32,111,000
------------ ------------
$ 38,618,000 $ 42,241,000
============ ============
</TABLE>
See accompanying notes.
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INFERENCE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
-------------------------- ---------------------------
1997 1996 1997 1996
------------ ----------- ------------- -----------
<S> <C> <C> <C> <C>
REVENUES:
Products............................... $ 3,236,000 $ 3,454,000 $ 9,163,000 $13,935,000
Services............................... 3,785,000 4,015,000 11,671,000 12,034,000
------------ ----------- ------------- -----------
Total revenues......................... 7,021,000 7,469,000 20,834,000 25,969,000
OPERATING COSTS AND EXPENSES:
Cost of product revenues............... 243,000 318,000 732,000 1,034,000
Cost of service revenues............... 1,886,000 2,338,000 6,190,000 7,081,000
Product development.................... 1,222,000 962,000 3,407,000 2,507,000
Sales and marketing.................... 4,600,000 4,227,000 12,043,000 12,546,000
General and administrative............. 950,000 898,000 2,856,000 2,522,000
------------ ----------- ------------- -----------
Total operating costs and expenses... 8,901,000 8,743,000 25,228,000 25,690,000
------------ ----------- ------------- -----------
Income (loss) from operations............. (1,880,000) (1,274,000) (4,394,000) 279,000
Gain from sale of investment.............. 3,824,000 --- 3,824,000 ---
Costs of attempted secondary offering..... --- 74,000 --- (241,000)
Non-employee stock option expenses........ --- --- --- (215,000)
Interest income........................... 351,000 328,000 1,057,000 958,000
Interest expense and other, net........... 68,000 29,000 28,000 18,000
------------ ----------- ------------- -----------
Income (loss) before income taxes......... 2,363,000 (843,000) 515,000 799,000
Provision for income taxes................ --- --- --- 25,000
------------ ----------- ------------- -----------
Net income (loss)......................... $ 2,363,000 $ (843,000) $ 515,000 $ 774,000
============ =========== ============= ===========
Net income (loss) per share............... $ 0.29 $ ( 0.10) $ 0.06 $ 0.09
============ =========== ============= ===========
Shares used in computing
net income (loss) per share............ 8,055,000 8,176,000 8,158,000 8,689,000
============ =========== ============= ===========
</TABLE>
See accompanying notes.
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<PAGE>
INFERENCE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
October 31,
-----------------------------
1997 1996
------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................ $ 515,000 $ 774,000
Adjustments to reconcile net income to
net cash used in operating activities:
Gain on sale of investment.............................................. (3,824,000) -
Depreciation and amortization........................................... 673,000 649,000
Changes in operating assets and liabilities:
Accounts receivable................................................. 3,797,000 (827,000)
Other current assets................................................ (241,000) (631,000)
Other assets........................................................ (17,000) 5,000
Accounts payable.................................................... (179,000) (693,000)
Accrued salaries and related items.................................. (117,000) (2,000)
Other accrued liabilities........................................... (188,000) (141,000)
Deferred revenue.................................................... (1,258,000) 137,000
------------- ------------
Net cash used in operating activities................................... (839,000) (729,000)
CASH FLOWS FROM INVESTING ACTIVITIES:
Maturity of short-term investments...................................... 987,000 7,314.000
Net proceeds from sale of investment.................................... 3,824,000 -
Purchases of property and equipment..................................... (923,000) (1,015,000)
------------- ------------
Net cash provided by investing activities............................... 3,888,000 6,299,000
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock.............................. 297,000 2,025,000
Repurchase of common stock.............................................. (2,693,000) -
------------- ------------
Net cash provided by (used in) financing activities..................... (2,396,000) 2,025,000
------------- ------------
Net increase in cash and cash equivalents................................ 653,000 7,595,000
Cash and cash equivalents at beginning of period......................... 28,620,000 18,619,000
------------- ------------
Cash and cash equivalents at end of period............................... $ 29,273,000 $ 26,214,000
============= ============
_________________________
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid during the period......................................... $ 5,000 $ 20,000
============= ============
Income taxes paid during the period..................................... $ 16,000 $ 79,000
============= ============
</TABLE>
See accompanying notes.
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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 10Q 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 nine months ended
October 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 per
share calculations for the three months ended October 31, 1996 or the nine
months ended October 31, 1997; however, for the three months ended October 31,
1997 and for the nine months ended October 31, 1996, basic net income per share
would income by $0.01. The impact of SFAS 128 on the calculation of fully
diluted earnings per share is not expected to be material.
3. GAIN ON SALE OF INVESTMENT
In August 1996, the Company agreed to sell its minority investment in
Limbex Corporation ("Limbex") to Quarterdeck Corporation ("Quarterdeck"),
pursuant to Quarterdeck's acquisition of the outstanding shares of Limbex. In
August 1997, the Company received approximately 1.4 million shares of
Quarterdeck common stock pursuant to the August 1996 agreement. These shares
were sold in the open market during the quarter ended October 31, 1997, and a
resulting gain from sale of investment was recorded in the amount of $3,824,000.
4. 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
exercise, 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 timimg 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 nine month periods ended October 31, 1997, the Company did
not meet its planned operating objectives, resulting in a year over year decline
in revenues, both in product and services. The Company attributes the decline in
revenues to several factors, including but not limited to: a) lower productivity
by the sales representatives in all geographic areas; b) the significant
turnover in sales personnel early in the year, especially in the Americas
operations, which resulted in a sales force that lacks experience in selling the
Company's products; and c) the increased competitive environment in which the
Company operates. While the Company saw improvement in revenue production during
the third quarter from the Americas operations, which the Company believes is
the result of the improving productivity of new sales personnel that have been
hired during the past nine months, the Company also experienced a significant
shortfall in revenues from International operations. Due to the decrease in
sales productivity in all International territories, especially in Germany, the
Netherlands and France, the Company closed its sales offices in Germany and the
Netherlands, and reduced the operations of the France sales office, thereby
focusing the primary direct International sales activities in the UK, with
distributors serving the rest of world territories.
In addition, the Company has recently focused on a sales strategy that
leverages the Company's Internet self-service problem resolution product,
CasePoint Webserver. The Company believes that CasePoint Webserver is a
technological leader in self-service over the Internet, and with it and the
Company's client-server products, the Company will be able to exploit the
emerging self-service and knowledge management solutions markets. However, the
Internet self-service and knowledge management markets are both emerging, and
there can be no assurances that the Company will maintain a leading position in
those markets.
THREE MONTHS ENDED OCTOBER 31, 1996 AND OCTOBER 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 6% from $7,469,000 in the three months ended
October 31, 1996 to $7,021,000 in the three months ended October 31, 1997, due
to various factors discussed above in the Overview.
Total revenues from the Americas operations increased from $3,753,000 in
the three months ended October 31, 1996 to $4,436,000 in the three months ended
October 31, 1997, representing an 18% increase. Total international revenues
decreased from $3,716,000 in the three months ended October 31, 1996 to
$2,585,000 in the three months ended October 31, 1997, representing a 30%
decrease. Total international revenues for the three months ended October 31,
1996 and October 31, 1997 represented 50% and 37% of total revenues,
respectively. During the quarter ended October 31, 1997, the Company made the
decision to discontinue the direct product sales organizations in Germany and
the Netherlands, and to reduce the investment in the direct product sales
organization in France. The Company currently has agreements with over 20
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 $3,454,000 in the three months ended October
31, 1996 to $3,236.000 in the three months ended October 31, 1997, representing
a 6% decrease. The decline in revenues from products was due to significantly
lower unit sales volumes, primarily as a result of factors previously discussed
in Overview. The prices of the Company's products have remained relatively
constant. Product revenues represented 46% of total revenues for the three
months ended October 31, 1996 and October 31, 1997. During the three months
ended October 31, 1997, one customer accounted for 13% of total product
revenues, or 6% of total revenues.
Product revenues from the Americas operations increased from $1,392,000 in
the three months ended October 31, 1996 to $2,114,000 in the three months ended
October 31, 1997, representing a 52% increase. International product revenues
decreased from $2,062,000 in the three months ended October 31, 1996 to
$1,122,000 in the three months ended October 31, 1997, representing 46%
decrease.
Total service revenues decreased from $4,015,000 in the three months ended
October 31, 1996 to $3,785,000 in the three months ended October 31, 1997,
representing a 6% decrease.
Service revenues from the Americas operations decreased from $2,361,000 in
the three months ended October 31, 1996 to $2,322,000 in the three months ended
October 31, 1997, representing a 2% decrease. International service revenues
decreased from $1,654,000 in the three months ended October 31, 1996 to
$1,463,000 in the three months ended October 31, 1997, representing a 12%
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 $318,000 in
the three months ended October 31, 1996 to $243,000 in the three months ended
October 31, 1997, representing a 24% decrease. The gross margin on product
revenues was 91% and 92% for the three months ended October 31, 1996 and
October 31, 1997, respectively.
Cost of Service Revenues
Cost of service revenues, consisting principally of personnel-related costs
for consulting, training and technical support, decreased from $2,338,000 in the
three months ended October 31, 1996 to $1,886,000 in the three months ended
October 31, 1997, representing a 19% 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 42% and 50% for
the three months ended October 31, 1996 and October 31, 1997 respectively. The
gross margin on service revenues for the three months ended October 31, 1997 was
significantly higher than usual as a result of the achievement of certain
billing milestones relating to various consulting projects, the high utilization
of both the America's and international consultants, as well as the continued
high rate of renewals associated with the Company's maintenance support
business. 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 $962,000 in the three months ended
October 31, 1996 to $1,222,000 in the three months ended October 31, 1997,
representing a 27% increase. This increase is principally 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 13% and 17% for the three months ended October 31, 1996
and October 31, 1997, respectively.
Selling and Marketing
Selling 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. Selling and
marketing expense increased from $4,227.000 in the three months ended October
31, 1996 to $4,600,000 in the three months ended October 31, 1997, representing
a 9% increase. This increase is principally due to the result of certain
restructuring costs associated with the closing of the German and Dutch sales
offices, as well as increased marketing costs. Selling and marketing expense as
a percentage of total revenues was 57% and 66% for the three months ended
October 31, 1996 and October 31, 1997, respectively.
General and Administration
General and administration expense consists of the personnel costs for
finance and accounting, human resources, information systems and general
management of the Company. General and administration expense increased from
$898,000 in the three months ended October 31, 1996 to $950,000 in the three
months ended October 31, 1997, representing a 6% increase. This increase is
primarily attributable to increased staffing, both domestically and
internationally. General and administration expense as a percentage of total
revenues were 12% and 14% for the three months ended October 31, 1996 and
October 31, 1997, respectively.
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<PAGE>
NINE MONTHS ENDED OCTOBER 31, 1996 AND OCTOBER 31, 1997
Revenues
Total revenues decreased 20% from $25,969,000 in the nine months ended
October 31, 1996 to $20,834,000 in the nine months ended October 31, 1997.
Total revenues from the Americas operations decreased from $15,748,000
in the nine months ended October 31, 1996 to $12,752,000 in the nine months
ended October 31, 1997, representing a 19% decreased. Total international
revenues decreased from $10,221,000 in the nine months ended October 31, 1996 to
$8,082,000 in the nine months ended October 31, 1997, representing a 21%
decrease. The decreases in revenues are principally due to various factors that
were discussed previously in Overview. Total international revenues for the nine
months ended October 31, 1996 and October 31, 1997 represented 39% of total
revenues.
Product revenues decreased from $13,935,000 in the nine months ended
October 31, 1996 to $9,163,000 in the nine months ended October 31, 1997,
representing a 34% 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 54% and 44% of
total revenues for the nine months ended October 31, 1996 and October 31, 1997,
respectively. During the nine months ended October 31, 1997, three customers
accounted in the aggregate for 24% of total product revenues, or 10% of total
revenues.
Product revenues form the Americas operation decreased from $8,484.000
in the nine months ended October 31, 1996 to $5,591,000 in the nine months ended
October 31, 1997, representing a 34% decreased. International product revenues
decreased from $5,451,000 in the nine months ended October 31, 1996 to
$3,572,000 in the nine months ended October 31, 1997, representing a 34%
decrease.
Total service revenues decreased from $12,034,000 in the nine months
ended October 31, 1996 to $11,671,000 in the nine months ended October 31, 1997,
representing a 3% decreased.
Service revenues from the Americas operations decreased from $7,264,000
in the nine months ended October 31, 1996 to $7,161,000 in the nine months ended
October 31, 1997, representing a 1% decreased. International service revenues
decreased from $4,770,000 in the nine months ended October 31, 1996 to
$4,510,000 in the nine months ended October 31, 1997, representing a 5%
decreased.
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
$1,034,000 in the nine months ended October 31, 1996 to $732,000 in the nine
months ended October 31, 1997, representing a 29% decrease. The gross margin on
product revenues was 93% and 92% for the nine months ended October 31, 1996 and
October 31, 1997, respectively.
Cost of Service Revenues
Cost of service revenues decreased from $7,081,000 in the nine months
ended October 31, 1996 to $6,190,000 in the nine months ended October 31, 1997,
representing a 13% decrease. The gross margin on service revenues was 41% and
47% for the nine months ended October 31, 1996 and October 31, 1997,
respectively. Cost of service revenues typically varies depending on the
revenue mix of training, consulting services and technical support. The gross
margin on service revenues for the three months ended October 31, 1997 was
significantly higher than usual as a result of the achievement of certain
billing milestones relating to various consulting projects, the high utilization
of both the America's and international consultants, as well as the continued
high rate of renewal associated with the Company's maintenance support business.
It is expected that this higher than usual gross margin on service revenues will
not continue.
Product Development
Product development expense increased from $2,507,000 in the nine months
ended October 31, 1996 to $3,407,000 in the nine months ended October 31, 1997,
representing a 36% increase. This increase is principally 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 10% and 16% for the nine months ended October 31, 1996 and
October 31, 1997, respectively.
<PAGE>
Selling and Marketing
Selling and marketing expense decreased from $12,546,000 in the nine months
ended October 31, 1996 to $12,043,000 in the nine months ended October 31, 1997,
representing a 4% 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. Selling and marketing expenses as a
percentage of total revenues was 48% and 58% for the nine months ended October
31, 1996 and October 31, 1997, respectively.
General and Administration
General and administration expense increased from $2,522,000 in the nine
months ended October 31, 1996 to $2,856,000 in the nine months ended October
31, 1997, representing a 13% increase. This increase is primarily attributable
to increase staffing, both domestically and internationally. General and
administration expense as a percentage of total revenues were 10% and 14% for
the nine months ended October 31, 1996 and October 31, 1997, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents and short-term investments at October 31, 1997 were
$29,273,000, a decrease of $334,000 since January 31, 1997. Working capital at
October 31, 1997 was $27,815,000.
Net cash used in operating activities amounted to $839,000 during the nine
months ended October 31, 1997, as compared to net cash used in operating
activities of $729,000 during the nine months ended October 31, 1996. The
primary sources of cash from operating activities the nine months ended October
31, 1997 were the gain on sale of investment and the collection of accounts
receivable.
Investing activities for the nine months ended October 31, 1997 included
$923,000 for purchases of property and equipment. Cash provided from investing
activities included gain on sale of investment of $3,824,000. The Company had
no significant capital commitments as of October 31, 1997.
Cash used in financing activities for the nine months ended October 31,
1997 included $2,693,000 for the repurchase of approximately 472,000 shares of
the Company's common stock.
The Company's international operations are principally transacted in
British pound sterling. 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 sterling and the U.S. dollars, 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, primarily the British pound sterling, and the
U.S. dollars 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.
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<PAGE>
ADDITIONAL FACTORS THAT MAY AFFECT FIXTURE 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.
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 scalability; 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 customers 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.
-11-
<PAGE>
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.
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 CaseBase 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 of 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.
-12-
<PAGE>
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In September 1997, the Company filed a complaint (the "Complaint") in the
United States District Court - Northern District of California in San Jose (case
number C97-03414) charging ServiceSoft Corporation ("ServiceSoft") with patent
infringement, copyright infringement, breach of contract, intentional
interference with prospective business interest and unfair competition. In
October 1997, ServiceSoft filed its answer to the Complaint and denied the
charges made in the Complaint, and ServiceSoft also filed a counterclaim (the
"Counterclaim") charging the Company with intentional interference with
prospective business advantage, trade defamation and unfair competition. The
Counterclaim seeks unspecified damages, costs and non-monetary relief,
including, among other things, a declaration of non-infringement and a
declaration of invalidity and unenforceability of a patent with respect to the
Company's CBR technology. In November 1997, the Company answered the
Counterclaim and denied all of the claims made by ServiceSoft in the
Counterclaim. The Company believes that the Counterclaim is without merit. The
Company intends to vigorously prosecute the Complaint and defend the
Counterclaim.
ITEM 2. CHANGES IN SECURITIES
In July 1995, the Company completed an initial public offering, pursuant to
a registration statement on form S-1, of 2,530,000 shares of its Class A Common
Stock (including the underwriters' overallotment of 330,000 shares) at $11.00
per share. Of the 2,530,000 shares sold in the offering, 2,130,000 shares were
sold by the Company, and 400,000 shares were sold by stockholders of the
Company. The managing underwriters were Prudential Securities Incorporated, J.P.
Morgan Securities, Inc. and SoundView Financial Group, Inc. The offering has
been terminated and all of the shares were sold. The Company received
approximately $20.1 million, net of underwriters' discounts and commissions
(approximately $1.6 million), and offering expenses (approximately $1.7
million). The principal purpose of the offering was to raise cash for working
capital and other general corporate purposes, and if opportunities became
available, to invest in complementary businesses, products and technologies. The
Company invested the offering proceeds in treasury bills and in short term,
investment grade, interest bearing securities. At the three and nine month
periods ended October 31, 1997, all of the offering proceeds had been used for
general corporate purposes or included in working capital. Except with respect
to underwriting commissions paid to J.P. Morgan Securities, Inc., the holder of
approximately 18% of the Company's Common Stock immediately after the offering,
none of the expenses incurred in the offering constituted direct of indirect
payments to directors, officers or general partners of the Company or to their
associates or persons owning 10% or more of any class of equity security of the
Company or to any affiliate of the Company.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8K
(a) Exhibits required by Item 601 of Regulation S-K
Exhibit
Number Exhibit
------ -------
11 Statement of Computation of Earnings Per Share.
(b) Reports on Form 8-K
None.
-13-
<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: December 12, 1997
-14-
<PAGE>
EXHIBIT INDEX
Sequentially
Exhibit Numbered
Number Description of Exhibit Page
------ ---------------------- ----
11 Statement of Computation of Earnings Per Share 16
-15-
<PAGE>
EXHIBIT 11
INFERENCE CORPORATION
STATEMENT OF COMPUTATION OF EARNINGS PER SHARE
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
OCTOBER 31, OCTOBER 31,
------------------------ ----------------------
1997 1996 1997 1996
------- ------- ------ --------
<S> <C> <C> <C> <C>
PRIMARY--
Average common shares outstanding..................... 7,837,691 8,175,565 7,952,815 8,026,809
Net effect of dilutive options and warrants-
based on the treasury stock method using
average market price (1)............................. 217,375 -- 204,938 622,249
----------- ----------- ----------- -----------
8,055,066 $ 8,175,565 $ 8,157,753 $ 8,689,058
=========== =========== =========== ===========
Net income (loss)..................................... $ 2,363,000 ($ 843,000) $ 515,000 $ 774,000
=========== =========== =========== ===========
Net income (loss) per share........................... $ 0.29 ($ 0.10) $ 0.06 $ 0.09
=========== =========== =========== ===========
</TABLE>
______________
(1) Application of the modified treasury stock method did not have a dilutive
effect on net income per share.
-16-
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-31-1998
<PERIOD-START> FEB-01-1997
<PERIOD-END> OCT-31-1997
<CASH> $29,273,000
<SECURITIES> 0
<RECEIVABLES> $6,162,000
<ALLOWANCES> $165,000
<INVENTORY> 0
<CURRENT-ASSETS> $36,203,000
<PP&E> $4,729,000
<DEPRECIATION> $2,424,000
<TOTAL-ASSETS> $38,618,000
<CURRENT-LIABILITIES> $8,388,000
<BONDS> 0
0
0
<COMMON> $78,000
<OTHER-SE> $30,152,000
<TOTAL-LIABILITY-AND-EQUITY> $38,618,000
<SALES> $20,834,000
<TOTAL-REVENUES> $20,834,000
<CGS> $6,922,000
<TOTAL-COSTS> $12,043,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,000
<INCOME-PRETAX> 515,000
<INCOME-TAX> 0
<INCOME-CONTINUING> 515,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 515,000
<EPS-PRIMARY> .06
<EPS-DILUTED> .06
</TABLE>
