<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
APRIL 30, 1998 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 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 June 8, 1998, there were 5,994,238 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.
-1-
<PAGE>
INFERENCE CORPORATION
INDEX
<TABLE>
<CAPTION>
Page
------------
PART I FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements (Unaudited)
<S> <C>
Condensed Consolidated Balance Sheets
at April 30, 1998 and January 31, 1998.......................................... 3
Condensed Consolidated Statements of Operations for the
Three Months Ended April 30, 1998 and 1997..................................... 4
Condensed Consolidated Statements of Cash Flows for the
Three Months Ended April 30, 1998 and 1997...................................... 5
Notes to Condensed Consolidated Financial Statements............................. 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................................. 10
PART II OTHER INFORMATION
ITEM 1. Legal Proceedings................................................................. 17
ITEM 2. Changes in Securities............................................................. 17
ITEM 3. Defaults upon Senior Securities................................................... 17
ITEM 4. Submission of Matters to a Vote of Security Holders............................... 17
ITEM 5. Other Information................................................................. 17
ITEM 6. Exhibits and Reports on Form 8-K.................................................. 17
Signature......................................................................... 18
</TABLE>
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<PAGE>
INFERENCE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
APRIL 30, JANUARY 31,
1998 1998
--------------- ---------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 25,529,000 $ 28,010,000
Accounts receivable, net................................. 5,438,000 5,770,000
Other current assets..................................... 473,000 935,000
------------ ------------
Total current assets.................................... 31,440,000 34,715,000
Property and equipment, net............................... 2,087,000 2,114,000
Other assets.............................................. 75,000 167,000
------------ ------------
$ 33,602,000 $ 36,996,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................... $ 696,000 $ 623,000
Accrued salaries and related items....................... 1,079,000 1,301,000
Other accrued liabilities................................ 2,141,000 1,670,000
Deferred revenue......................................... 3,906,000 4,464,000
------------ ------------
Total current liabilities............................... 7,822,000 8,058,000
Shareholders' equity:
Common stock............................................. 74,000 75,000
Additional paid-in capital............................... 47,751,000 48,255,000
Accumulated deficit...................................... (22,045,000) (19,392,000)
------------ ------------
Total shareholders' equity.............................. 25,780,000 28,938,000
------------ ------------
$ 33,602,000 $ 36,996,000
============ ============
</TABLE>
See accompanying notes.
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<PAGE>
INFERENCE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED APRIL 30,
------------------------------------
1998 1997
----------------- -----------------
REVENUES:
<S> <C> <C>
Products......................................... $ 3,075,000 $ 3,218,000
Services......................................... 3,274,000 3,876,000
----------- -----------
Total revenues................................. 6,349,000 7,094,000
OPERATING COSTS AND EXPENSES:
Cost of product revenues......................... 217,000 243,000
Cost of service revenues......................... 1,839,000 2,207,000
Product development.............................. 1,065,000 1,045,000
Sales and marketing.............................. 3,733,000 3,960,000
General and administrative....................... 1,201,000 923,000
Restructuring.................................... 1,321,000 --
----------- -----------
Total operating costs and expenses............. 9,376,000 8,378,000
----------- -----------
Loss from operations............................... (3,027,000) (1,284,000)
Interest income.................................... 326,000 355,000
Interest income (expense) and other, net........... 48,000 (14,000)
----------- -----------
Loss before income taxes........................... (2,653,000) (943,000)
Provision for income taxes......................... -- --
----------- -----------
Net loss........................................... $(2,653,000) $ (943,000)
=========== ===========
Basic and diluted net loss per share............... ($ 0.36) ($ 0.12)
=========== ===========
Shares used in computing basis and diluted
net loss per share................................ 7,446,000 8,111,000
=========== ===========
</TABLE>
See accompanying notes.
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<PAGE>
INFERENCE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED APRIL 30,
---------------------------------------
1998 1997
------------------- ------------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss......................................................... ($ 2,653,000) ($ 943,000)
Adjustments to reconcile net loss to
net cash provided by (used in) operating activities:
Depreciation and amortization.................................. 248,000 226,000
Stock based compensation expense............................... 80,000 --
Changes in operating assets and
liabilities:
Accounts receivable.......................................... 332,000 2,640,000
Other current assets......................................... 462,000 13,000
Other assets................................................. 92,000 (20,000)
Accounts payable............................................. 73,000 (249,000)
Accrued salaries and related items........................... (222,000) (99,000)
Other accrued liabilities.................................... 471,000 (219,000)
Deferred revenue............................................. (558,000) (331,000)
------------- -----------
Net cash (used in) provided by operating activities.............. (1,675,000) 1,018,000
CASH FLOWS FROM INVESTING ACTIVITIES:
Maturity of short-term investments............................... -- 987,000
Purchases of property and equipment.............................. (221,000) (281,000)
------------- -----------
Net cash (used in) provided by investing activities.............. (221,000) 706,000
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock....................... 14,000 21,000
Repurchase of common stock....................................... (599,000) (1,302,000)
------------- -----------
Net cash used in financing activities............................ (585,000) (1,281,000)
------------- -----------
Net (decrease) increase in cash and cash equivalents............. (2,481,000) 443,000
Cash and cash equivalents at beginning of period................. 28,010,000 28,620,000
------------- -----------
Cash and cash equivalents at end of period....................... $ 25,529,000 $29,063,000
============= ===========
- ---------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Income taxes paid during the period.............................. $ 68,000 $ 12,000
============= ===========
</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 accruals and 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, 1998, included in the Annual Report
on Form 10-K. The results of operations for the three months ended April 30,
1998 are not necessarily indicative of the results to be expected for the entire
fiscal year.
2. SIGNIFICANT ACCOUNTING POLICIES
Consolidation
The 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.
Foreign Currency Translation
Assets and liabilities of the Company's wholly owned foreign subsidiaries
are translated at period-end exchange rates, and revenues and expenses are
translated at the weighted average monthly exchange rates. Foreign exchange
transaction gains and losses and translation adjustments are not material in the
periods presented.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
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<PAGE>
INFERENCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(Unaudited)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Revenue Recognition
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. If the Company has significant future obligations to the
customer, revenues are recognized when such obligations are satisfied.
Service revenues result from contracts with customers for the development
and support of system applications. Service revenues are generally recognized as
the services are performed. Fixed-price service contracts are recognized on a
percentage of completion basis, based on the level of effort performed. The
Company may enter into transactions that include both product license and
service elements. As such service elements, typically, do not include
alterations to the software, the license fees are recognized upon delivery of
the product, and the service revenues are recognized as performed.
The Company enters into maintenance and support agreements with customers
whereby the Company provides technical support and certain product updates.
Maintenance revenues received are deferred and recognized on a straight-line
basis over the maintenance support period, generally one year. If software
maintenance fees are provided for in the product license fee or at a significant
discount in a license agreement, a portion of the license fee equal to the
estimated fair value of these amounts will be allocated to deferred maintenance
revenue. Maintenance and support revenues are included in service revenues in
the accompanying Consolidated Statements of Income.
Deferred revenues primarily relate to post-contract customer support which
has been paid by customers prior to the performance of the services.
-7-
<PAGE>
INFERENCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Net Loss Per Share
The following table sets forth the computation of basic and diluted net
income per common share for the three months ended April 30, 1998 and 1997 (in
thousands, except per share information):
<TABLE>
<CAPTION>
1998 1997
------------- -------------
<S> <C> <C>
Numerator:
Net loss.......................................... ($ 2,653) ($ 943)
======== =======
Denominator:
Denominator for basic net income per
common share-weighted-average shares
outstanding......................................
7,446 8,111
Effect of dilutive securities:
Stock options and warrants.................... -- --
-------- -------
Dilutive potential common shares.............. -- --
-------- -------
Denominator for diluted net income per
common share adjusted weighted-average
shares for assumed conversions.................. 7,446 8,111
======== =======
Basic and diluted net income per share ($ 0.36) ($0.12)
======== =======
</TABLE>
As of April 30, 1998 and 1997, there were 1,652,000 and 1,677,000 options to
acquire shares of common stock with weighted-average exercise prices of $3.82
and $5.63, respectively, which could potentially dilute basic earnings per share
in the future, but which were not included in diluted loss per share as their
effect was anti-dilutive in the periods presented.
3. RESTRUCTURING COSTS
In March 1998, the Company appointed Charles W. Jepson to succeed Peter R.
Tierney as president and chief executive officer. Jepson's appointment closely
followed the promotion of Ralph Barletta to senior vice president of Product
Development, who replaced John Binns in that position. Jepson and Barletta
joined Glen Vondrick and Philip Padfield, both appointed to their positions in
the last 15 months as senior vice president, Americas and Far East Operations
and vice president, Sales and Marketing, Europe, Middle East and Africa,
respectively.
In February 1998, the Company announced a reduction in the number of its
employees by approximately 12 percent. This action was taken to better align
operating expenses with the recent revenue trends. The Company recorded a
restructuring charge, primarily related to severance costs, during the three
months ended April 30, 1998 in the amount of approximately $1.3 million,
$170,000 of which remain unpaid at April 30, 1998.
-8-
<PAGE>
INFERENCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)
4. NEW ACCOUNTING PRONOUNCEMENTS
Software Revenue Recognition
Effective February 1, 1998, the Company adopted the American Institute of
Certified Public Accountants ("AICPA") Statement of Position, "Software Revenue
Recognition" ("SOP 97-2"), which provides guidance on applying generally
accepted accounting principles in recognizing revenue on software transactions,
as amended by AICPA SOP 98-4. Prior years were not restated and the adoption of
SOP 97-2 did not have a material adverse affect on the revenues or net loss for
the period.
Reporting Comprehensive Income
Effective February 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
SFAS 130 establishes rules for reporting and displaying comprehensive income and
its components. The adoption of SFAS 130 had no impact on the Company's net loss
or shareholders' equity for the three months ended April 30, 1998, because the
comprehensive loss was the same as the net loss for such period and there are no
necessary adjustments reported in shareholders' equity.
Disclosures about Segments of an Enterprise and Related Information
Effective February 1, 1998, the Company adopted the Statement of Financial
Accounting Standards No. 131, "Disclosures About Segments of An Enterprise and
Related Information" ("SFAS 131"), which superseded SFAS No. 14, "Financial
Reporting for Segments of a Business Enterprise." SFAS 131 established standards
for the way that public business enterprises report information about operation
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports. SFAS 131 also establishes standards for related disclosures about
products and services, geographic areas, and major customers. The adoption of
SFAS 131 did not affect the results of operations or financial position, but may
affect the disclosure of the segment information that will be disclosed in the
Company's fiscal 1999 Annual Report on Form 10-K.
5. LITIGATION
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, and believes that the ultimate outcome of this matter will not
have a material adverse impact on the Company's financial position, results of
operations or cash flows. However, the ultimate outcome of any litigation is
uncertain. If an unfavorable outcome were to occur,the impact could be material.
Furthermore, any litigation, regardless of the outcome, can have an adverse
impact on the Company's results of operations as a result of defense costs,
diversion of management resources, and other factors.
-9-
<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 any revisions to these forward-looking statements 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.
THREE MONTHS ENDED APRIL 30, 1998 AND APRIL 30, 1997
The following table sets forth the percentages that certain statement of
operations items are to total revenues for the three months ended April 30, 1998
and 1997:
<TABLE>
<CAPTION>
Three months ended
April 30,
---------------------
1998 1997
-------- --------
<S> <C> <C>
Revenues:
Products 48% 45%
Services 52% 55%
---- ----
Total 100% 100%
Operating costs and expenses:
Products 3% 3%
Services 29% 31%
Product development 17% 15%
Selling and marketing 59% 56%
General and administrative 19% 13%
Restructuring 21% --
---- ----
Total 148% 118%
---- ----
Loss from operations (48%) (18%)
==== ====
</TABLE>
Revenues
The Company's revenues are derived principally from two sources: (i) fees for
licenses of the Company's software products and technology and (ii) fees for
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.
-10-
<PAGE>
Total revenues decreased to $6,349,000 in the three months ended April 30,
1998 from $7,094,000 in the three months ended April 30, 1997, representing a
11% decrease. During each of the three month periods ended April 30, 1998 and
1997, one customer accounted for 13% of total revenues.
Total revenues from the Americas operations decreased to $3,708,000 in the
three months ended April 30, 1998 from $4,532,000 in the three months ended
April 30, 1997, representing a 18% decrease. Total international revenues
increased to $2,641,000 in the three months ended April 30, 1998 from $2,562,000
in the three months ended April 30, 1997, representing a 3% increase. Total
international revenues for the three months ended April 30, 1998 and April 30,
1997 represented 42% and 36% of total revenues, respectively. The Company
currently has subsidiaries in the United Kingdom, France and the Netherlands,
offering licenses and consulting services, and manages over 15 distributors
worldwide, serving Europe, the Middle East and Africa, and Asia and the Pacific
Rim. International revenues, however, 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.
Product Revenues
Product revenues decreased to $3,075,000 in the three months ended April 30,
1998 from $3,218,000 in the three months ended April 30, 1997, representing a 4%
decrease. The decline in revenues from products was due to lower unit sales
volumes; the prices of the Company's products have remained relatively constant.
Product revenues represented 48% and 45% of total revenues for the three months
ended April 30, 1998 and April 30, 1997, respectively. During each of the three
month periods ended April 30, 1998 and 1997, one customer accounted for 27% and
29% of total product revenues, respectively.
Product revenues from the Americas operations decreased to $1,892,000 in the
three months ended April 30, 1998 from $2,210,000 in the three months ended
April 30, 1997, representing a 14% decrease. International product revenues
increased to $1,183,000 in the three months ended April 30, 1998 from $1,008,000
in the three months ended April 30, 1997, representing a 17% increase.
Service Revenues
Total service revenues decreased to $3,274,000 in the three months ended April
30, 1998 from $3,876,000 in the three months ended April 30, 1997, representing
a 16% decrease.
Service revenues from the Americas operations decreased to $1,816,000 in the
three months ended April 30, 1998 from $2,322,000 in the three months ended
April 30, 1997, representing a 22% decrease. International service revenues
decreased to $1,458,000 in the three months ended April 30, 1998 from $1,554,000
in the three months ended April 30, 1997, representing a 6% 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 to $217,000 in the
three months ended April 30, 1998 from $243,000 in the three months ended April
30, 1997, representing a 11% decrease. The gross margin on product revenues was
93% and 92% for the three months ended April 30, 1998 and April 30, 1997,
respectively.
-11-
<PAGE>
Cost of Service Revenues
Cost of service revenues, consisting principally of personnel-related costs
for consulting, training and technical support, decreased to $1,839,000 in the
three months ended April 30, 1998 from $2,207,000 in the three months ended
April 30, 1997, representing a 17% decrease. The gross margin on service
revenues was 44% and 43% for the three months ended April 30, 1998 and April 30,
1997, respectively. The gross margin on service revenues continues to be
slightly higher than usual as a result of a greater percentage of the services
business coming from the Company's maintenance support business, which earns a
much higher gross margin than the professional services business. It is expected
that the gross margin on service revenues will continue to vary, depending on
the revenue mix of professional services and maintenance support.
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 to $1,065,000 in the three months ended April
30, 1998 from $1,045,000 in the three months ended April 30, 1997, representing
a 2% increase. Product development expense as a percentage of revenues was 17%
and 15% for the three months ended April 30, 1998 and April 30, 1997,
respectively. The Company believes that continued commitment to product
development will be required for the Company's CBR Products to obtain a
competitive advantage. Accordingly, the Company intends to allocate increasing
resources to product research and development, but such expenses may continue to
vary as a percentage of total revenues.
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 to $3,733,000 in the three months ended April 30,
1998 from $3,960,000 in the three months ended April 30, 1997, representing a 6%
decrease. Sales and marketing expense as a percentage of revenues was 59% and
56% for the three months ended April 30, 1998 and April 30, 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 to $1,201,000 in the
three months ended April 30, 1998 from $923,000 in the three months ended April
30, 1997, representing a 30% increase. The increase in general and
administrative expenses was primarily the result of legal fees associated with
on-going litigation matters. General and administrative expense as a percentage
of revenues was 19% and 13% for the three months ended April 30, 1998 and April
30, 1997, respectively.
Restructuring
In March 1998, the Company appointed Charles W. Jepson to succeed Peter R.
Tierney as president and chief executive officer. Jepson's appointment closely
followed the promotion of Ralph Barletta to senior vice president of Product
Development, who replaced John Binns in that position. Also, in February 1998,
the Company announced a reduction of its employees by approximately 12 percent.
The Company recorded a restructuring charge, primarily related to severance
costs, during the three months ended April 30, 1998 in the amount of
approximately $1.3 million.
Other Income, Net
Other income and expense, net, primarily interest income, was $374,000 in the
three months ended April 30, 1998 compared to $341,000 in the three months ended
April 30, 1997.
LIQUIDITY AND CAPITAL RESOURCES
-12-
<PAGE>
Cash and cash equivalents at April 30, 1998 were $25,529,000, a decrease of
$2,481,000 since January 31, 1998. Working capital at April 30, 1998 was
$23,618,000.
Net cash used in operating activities amounted to $1,675,000 during the three
months ended April 30, 1998, as compared to net cash provided by operating
activities of $1,018,000 during the three months ended April 30, 1997.
Investing activities for the three months ended April 30, 1998 included
$221,000 for purchases of property and equipment. The Company has no significant
capital commitments as of April 30, 1998.
Cash used in financing activities for the three months ended April 30, 1998
included $599,000 for the repurchase of 127,000 shares of the Company's common
stock.
The Company's international operations are principally transacted in British
pounds. 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 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, taking into consideration
the anticipated effect of cash flows 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 will continue in the future. Typically, revenues, operating income
and net income for the Company's fourth quarter are higher than those for the
first quarter of the following year. In addition, 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 or completed. 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.
Due to all of the foregoing factors, it is likely that in some future quarters
the Company's operating results will be below the expectations of investors.
Regardless of the general outlook for the Company's business, the announcement
of quarterly operating results below investor expectations is likely to result
in a decline in the trading price of the Company's Class A Common Stock.
-13-
<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, respond to customer
requirements, and to develop and introduce, in a timely manner, new products
incorporating technological advances. To the extent one or more of the Company's
competitors introduce products that more fully address customer requirements,
the Company's business, operating results and financial condition 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. From time to
time, the Company or its competitors may announce new products, capabilities or
technologies that have the potential to replace or shorten the life cycles of
the Company's existing products. There can be no assurance that announcements of
currently planned or other new products will not cause customers to delay their
purchasing decisions in anticipation of such products, which could have a
material adverse effect on the Company's business, operating results and
financial condition.
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 in the problem identification and resolution segment of the market
are Clarify, Inc. and Software Artistry, Inc. (a business unit of Tivoli
Systems, Inc., a subsidiary of IBM Corporation) and other smaller privately held
companies. Furthermore, many potential customers implement low-end text
retrieval solutions or develop internal 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 increased 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.
-14-
<PAGE>
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.
Dependence on Key Personnel; New Members of the Executive Management Team. The
Company has recently experienced significant changes to its executive management
team. Those who have recently joined or have been appointed to the executive
management team include Charles Jepson, President and Chief Executive Officer;
Ralph Barletta, Senior Vice President of Product Development; Glen Vondrick,
Senior Vice President of Americas; and Philip Padfield, Vice President of
International Sales and Marketing, all who have been in their positions less
than 15 months. There can be no assurance that the new members of the Company's
management team will work effectively together or with the rest of the Company's
management. 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. In addition, the Company
has recently hired, and plans to continue to hire, a significant number of
development engineers to design and implement improvements to the Company's
technologies.
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 copyright,
trademark and trade secret laws, confidentiality procedures and licensing
arrangements to establish and protect its proprietary rights. The Company has
been awarded three patents for its Case-Based Reasoning technology which 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 generally provides its products to end-users under signed license
agreements. These agreements are negotiated with and signed by the licensee. The
Company occasionally publishes articles regarding its technical developments in
industry publications that may prevent the Company from obtaining patent
protection for ideas contained in such publications, thus increasing the
availability to third parties of fundamental aspects of the Company's
technology.
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 was 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.
-15-
<PAGE>
Year 2000 Compliance. The Company is aware of the issues associated with the
programming code in existing computer systems as the year 2000 approaches. The
"year 2000 problem" is pervasive and complex, as virtually every computer
operation will be affected in some way by the rollover of the two-digit year
value to 00. The issue is whether computer systems will properly recognize date
sensitive information when the year changes to 2000. Systems that do not
properly recognize such information could generate erroneous data or cause a
system to fail. Management does not currently anticipate that the Company will
incur significant operating expenses or be required to invest heavily in
computer systems improvements to be year 2000 compliant. However, significant
uncertainty exists concerning the potential costs and effects associated with
any year 2000 compliance requirements. Any year 2000 compliance problems of
either the Company or its vendors could materially adversely affect the
Company's business, results of operations and financial condition.
Inference Corporation is firmly committed to ensure its commercially available
CBR software products are "Year 2000 Ready." All Company products are capable of
correctly identifying, manipulating, and performing calculations on dates later
than December 31, 1999, where operations based on dates held in 2 digit format
are affected due to re-sequencing from 99 to 00. The Company institutes, within
its product design specifications, the requirement that internal date
representations are held in full format and manipulations are not performed on
short formats. This assumes the software is used in accordance with its
associated documentation and provided that when the software is linked up to
other components, such components factor in the calendar date on the same
conditions as the Company's products.
Risks Associated with Potential Acquisitions. As part of its business
strategy, the Company may in the future review acquisition prospects that would
complement its existing product offerings, augment its market coverage or
enhance its technological capabilities, or that may otherwise offer growth
opportunities. Such acquisitions by the Company could result in potentially
dilutive issuances of equity securities, the incurrence of debt and contingent
liabilities or amortization expenses related to goodwill and other intangible
assets, any of which could materially adversely affect the Company's operating
results. Acquisitions entail numerous risks, including difficulties in the
assimilation of acquired operations, technologies and products, diversion of
management's attention to other business concerns, risks of entering markets
which the Company has no or limited prior experience and potential loss of key
employees of acquired organizations. No assurance can be given as to the
ability of the Company to successfully integrate any businesses, products,
technologies or personnel that might be acquired in the future, and the failure
of the Company to do so could have a material adverse effect on the business,
operating results and financial condition of the Company
Litigation. The Company is subject to legal proceedings and claims that arise
in the ordinary course of business. Management currently believes that the
ultimate amount of liability, if any, with respect to any pending actions,
either individually or in the aggregate, will not materially affect the
financial position, results of operations or liquidity of the Company. However,
the ultimate outcome of any litigation is uncertain. If an unfavorable outcome
were to occur, the impact could be material. Furthermore, any litigation,
regardless of the outcome, can have an adverse impact on the Company's results
of operations as a result of defense costs, diversion of management resources,
and other factors.
-16-
<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
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K
None.
(b) Reports on Form 8-K
On March 6, 1998, the Company filed a Form 8-K with the Securities and
Exchange Commission reporting that on March 4, 1998, the Company had appointed
Charles W. Jepson as its new President and Chief Executive Officer.
-17-
<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: June 10, 1998
-18-
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