<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended Commission File Number
July 31, 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 September 3, 1998, there were 5,862,477 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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<PAGE>
INFERENCE CORPORATION
INDEX
<TABLE>
<CAPTION>
Page
------------
<S> <C>
Part I FINANCIAL INFORMATION
ITEM 1. Condensed Consolidated Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets
at July 31 and January 31, 1998................................................. 3
Condensed Consolidated Statements of Operations for the Three and
Six Months Ended July 31, 1998 and 1997......................................... 4
Condensed Consolidated Statements of Cash Flows for the
Six Months Ended July 31, 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............................................. 8
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................................................................. 18
ITEM 6. Exhibits and Reports on Form 8-K.................................................. 18
Signature......................................................................... 19
</TABLE>
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<PAGE>
INFERENCE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
July 31, January 31,
1998 1998
--------------- ---------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 24,381,000 $ 28,010,000
Accounts receivable, net................................. 6,016,000 5,770,000
Other current assets..................................... 463,000 935,000
------------ ------------
Total current assets.................................... 30,860,000 34,715,000
Property and equipment, net............................... 1,859,000 2,114,000
Other assets.............................................. 123,000 167,000
------------ ------------
$ 32,842,000 $ 36,996,000
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable......................................... $ 624,000 $ 623,000
Accrued salaries and related items....................... 1,317,000 1,301,000
Other accrued liabilities................................ 2,554,000 1,670,000
Deferred revenue......................................... 4,362,000 4,464,000
------------ ------------
Total current liabilities............................... 8,857,000 8,058,000
Shareholders' equity:
Common stock............................................. 71,000 75,000
Additional paid-in capital............................... 46,563,000 48,255,000
Accumulated deficit...................................... (22,649,000) (19,392,000)
------------ ------------
Total shareholders' equity.............................. 23,985,000 28,938,000
------------ ------------
$ 32,842,000 $ 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 July 31, Six Months Ended July 31,
----------------------------------- -----------------------------------
1998 1997 1998 1997
---------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Revenues:
Products......................................... $4,118,000 $ 2,709,000 $ 7,193,000 $ 5,927,000
Services......................................... 3,394,000 4,011,000 6,668,000 7,886,000
---------- ----------- ----------- -----------
Total revenues................................. 7,512,000 6,720,000 13,861,000 13,813,000
Operating costs and expenses:
Cost of product revenues......................... 161,000 246,000 378,000 488,000
Cost of service revenues......................... 1,723,000 2,097,000 3,562,000 4,304,000
Product development.............................. 1,437,000 1,141,000 2,502,000 2,185,000
Sales and marketing.............................. 3,738,000 3,484,000 7,471,000 7,443,000
General and administrative....................... 1,046,000 983,000 2,247,000 1,907,000
Restructuring.................................... 253,000 -- 1,574,000 --
---------- ----------- ----------- -----------
Total operating costs and expenses............. 8,358,000 7,951,000 17,734,000 16,327,000
---------- ----------- ----------- -----------
Loss from operations............................... (846,000) (1,231,000) (3,873,000) (2,514,000)
Interest income.................................... 330,000 379,000 656,000 733,000
Interest expense and other, net.................... (88,000) (54,000) (40,000) (68,000)
---------- ----------- ----------- -----------
Net loss........................................... $ (604,000) $ (906,000) $(3,257,000) $(1,849,000)
========== =========== =========== ===========
Net loss per share................................. $ (0.08) $ (0.11) $ (0.44) $ (0.23)
========== =========== =========== ===========
Shares used in computing basic and diluted
net loss per share........................... 7,242,000 7,915,000 7,342,000 8,011,000
========== =========== =========== ===========
</TABLE>
See accompanying notes.
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<PAGE>
INFERENCE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Six Months Ended July 31,
---------------------------------------
1998 1997
------------------ ------------------
<S> <C> <C>
Cash flows from operating activities:
Net loss........................................................ $(3,257,000) $(1,849,000)
Adjustments to reconcile net loss to
net cash (used in) provided by operating activities:
Depreciation and amortization.................................. 560,000 420,000
Stock based compensation expense............................... 80,000 --
Changes in operating assets and
liabilities:
Accounts receivable.......................................... (246,000) 3,681,000
Other current assets......................................... 472,000 (157,000)
Other assets................................................. 44,000 (37,000)
Accounts payable............................................. 1,000 14,000
Accrued salaries and related items........................... 16,000 (449,000)
Other accrued liabilities.................................... 884,000 (85,000)
Deferred revenue............................................. (102,000) (1,122,000)
----------- -----------
Net cash (used in) provided by operating activities.............. (1,548,000) 416,000
Cash flows from investing activities:
Maturity of short-term investments............................. -- 987,000
Purchases of property and equipment............................ (305,000) (745,000)
----------- -----------
Net cash (used in) provided by investing activities............ (305,000) 242,000
Cash flows from financing activities:
Net proceeds from issuance of common stock..................... 249,000 229,000
Repurchase of common stock..................................... (2,025,000) (2,601,000)
----------- -----------
Net cash used in financing activities.......................... (1,776,000) (2,372,000)
----------- -----------
Net decrease in cash and cash equivalents........................ (3,629,000) (1,714,000)
Cash and cash equivalents at beginning of period................. 28,010,000 28,620,000
----------- -----------
Cash and cash equivalents at end of period....................... $24,381,000 $26,906,000
=========== ===========
Supplemental disclosure of cash flow information:
Income taxes paid during the period............................. $ 89,000 $ 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 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 Company's Annual Report on Form
10-K. The results of operations for the three and six months ended July 31, 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.
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 have not been restated and the
adoption of SOP 97-2 did not have a material effect on the revenues or net loss
for the three and six months ended July 31, 1998.
3. LITIGATION
In July 1998, the Company and ServiceSoft Corporation jointly agreed to
settle on-going litigation entitled Inference Corporation v. ServiceSoft
Corporation (Civil Case No. C97-03414). See Item I of Part II.
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<PAGE>
INFERENCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED)
4. RESTRUCTURING COSTS
In July 1998, the Company downsized operations in its subsidiary in France.
This action was taken to better align operating expenses with recent revenue
trends in France and to allow for increased investment of funds in the domestic
market. As a result, the Company recorded a restructuring charge, related to
lease abandonment and severance charges, during the three months ended July 31,
1998 in the amount of $253,000, all of which remained unpaid at July 31, 1998.
In the quarter ended April 30, 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. In addition,
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. The Company recorded a restructuring charge,
primarily related to severance costs, during the three months ended April 30,
1998 in the amount of approximately $1.3 million.
5. NET LOSS PER SHARE
The following table sets forth the computation of basic and diluted net
income per common share for the three and six months ended July 31, 1998 and
1997 (in thousands, except per share information):
<TABLE>
<CAPTION>
Three Months Ended July 31, Six Months Ended July 31,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Numerator:
Net loss............................................ ($ 604) ($ 905) ($ 3,257) ($ 1,849)
========= ========== ========== ==========
Denominator:
Denominator for basic net income per common
share--weighted-average shares outstanding......... 7,242 7,915 7,342 8,011
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.................... 7,242 7,915 7,342 8,011
========= ========== ========== ==========
Basic and diluted net income per share.............. ($ .08) ($ .11) ($ .44) ($ .23)
========= ========== ========== ==========
</TABLE>
As of July 31, 1998 and 1997, there were 2,269,000 and 1,759,000 options to
acquire shares of common stock at weighted-average prices of $3.83 and $5.42 per
share, respectively, which could potentially dilute basic earnings per share in
the future, but which were not included in the computation of diluted loss per
share as their effect was anti-dilutive in the periods presented.
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<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements contained hereunder regarding matters that are not
historical facts are forward-looking statements (as such term is defined in the
rules promulgated pursuant to the Securities Act of 1933, as amended (the
"Securities Act")). Such forward-looking statements are subject to certain
risks, trends and uncertainties; thus, actual results may differ materially from
those expressed in or implied by such forward-looking statements. Factors that
could cause or contribute to such differences include, but are not limited to,
fluctuations in quarterly operating results, the size and timing of customer
orders, rapid technological change and product transitions, and competitive
actions in the marketplace. The Company undertakes no obligation to release
publicly 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,
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.
Results of Operations
The following table sets forth the percentages that certain statement of
operations items are to total revenues for the three and six months ended July
31, 1998 and 1997:
<TABLE>
<CAPTION>
Three Months Ended July 31, Six Months Ended July 31,
---------------------------- ----------------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Products 55% 40% 52% 43%
Services 45% 60% 48% 57%
---- ---- ---- ----
Total 100% 100% 100% 100%
Operating costs and expenses:
Products 2% 3% 3% 3%
Services 23% 31% 26% 31%
Product development 19% 17% 18% 16%
Selling and marketing 50% 52% 54% 54%
General and administrative 14% 15% 16% 14%
Restructuring 3% -- 11% --
---- ---- ---- ----
Total 111% 118% 128% 118%
---- ---- ---- ----
Loss from operations (11%) (18%) (28%) (18%)
==== ==== ==== ====
</TABLE>
THREE MONTHS ENDED JULY 31, 1998 AND JULY 31, 1997
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.
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<PAGE>
Total revenues increased to $7,512,000 in the three months ended July 31, 1998
from $6,720,000 in the three months ended July 31, 1997, representing a 12%
increase. During each of the three month periods ended July 31, 1998 and 1997,
one customer accounted for 12% of total revenues.
Total revenues from the Americas operations increased to $4,252,000 in the
three months ended July 31, 1998 from $3,784,000 in the three months ended July
31, 1997, representing a 12% increase. Total international revenues increased to
$3,260,000 in the three months ended July 31, 1998 from $2,936,000 in the three
months ended July 31, 1997, representing an 11% increase. Total international
revenues for the three months ended July 31, 1998 and July 31, 1997 represented
43% and 44% 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 increased to $4,118,000 in the three months ended July 31,
1998 from $2,709,000 in the three months ended July 31, 1997, representing a 52%
increase. The increase in revenues from products was due to higher unit sales
volumes; the prices of the Company's products have remained relatively constant.
Product revenues represented 55% and 40% of total revenues for the three months
ended July 31, 1998 and July 31, 1997, respectively. During the three month
periods ended July 31, 1998 and 1997, one customer accounted for 21% and 31% of
total product revenues, respectively.
Product revenues from the Americas operations increased to $2,396,000 in the
three months ended July 31, 1998 from $1,267,000 in the three months ended July
31, 1997, representing an 89% increase. International product revenues increased
to $1,722,000 in the three months ended July 31, 1998 from $1,442,000 in the
three months ended July 31, 1997, representing a 19% increase.
Service Revenues
Total service revenues decreased to $3,394,000 in the three months ended July
31, 1998 from $4,011,000 in the three months ended July 31, 1997, representing a
15% decrease. The decrease in service revenues, in the face of increasing
product revenues, is primarily attributable to the time lag between when product
deals are closed and consulting projects commence, as well as a decrease in the
average size of consulting engagements.
Service revenues from the Americas operations decreased to $1,856,000 in the
three months ended July 31, 1998 from $2,517,000 in the three months ended July
31, 1997, representing a 26% decrease. International service revenues decreased
to $1,538,000 in the three months ended July 31, 1998 from $1,494,000 in the
three months ended July 31, 1997, representing a 1% 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 $161,000 in the
three months ended July 31, 1998 from $246,000 in the three months ended July
31, 1997, representing a 35% decrease. As a result of such decreases, the gross
margin on product revenues increased to 96% for the three months ended July 31,
1998 from 91% in the three month period ended July 31, 1997. The decrease in
cost of product revenues is primarily attributable to certain cost reduction
programs undertaken by the Company during the current quarter.
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<PAGE>
Cost of Service Revenues
Cost of service revenues, consisting principally of personnel-related costs
for consulting, training and technical support, decreased to $1,723,000 in the
three months ended July 31, 1998 from $2,097,000 in the three months ended July
31, 1997, representing an 18% decrease. The gross margin on service revenues was
49% and 48% for the three months ended July 31, 1998 and July 31, 1997,
respectively. The gross margin on service revenues continues to be slightly
higher than in previous periods 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, and recruiting fees in addition to equipment and
facility costs, incurred in the research, design, development and enhancement of
software products. Product development expenditures increased to $1,437,000 in
the three months ended July 31, 1998 from $1,141,000 in the three months ended
July 31, 1997, representing a 26% increase. Product development expense as a
percentage of revenues was 19% and 17% for the three months ended July 31, 1998
and July 31, 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 increased to $3,738,000 in the three months ended July 31,
1998 from $3,484,000 in the three months ended July 31, 1997, representing a 7%
increase. The Company intends to aggressively hire sales personnel to staff and
expand its direct sales force. Sales and marketing expense as a percentage of
revenues was 50% and 52% for the three months ended July 31, 1998 and July 31,
1997, respectively.
General and Administrative
General and administrative expense consists of the personnel costs for finance
and accounting, human resources, information systems and general management of
the Company. General and administrative expense increased to $1,046,000 in the
three months ended July 31, 1998 from $983,000 in the three months ended July
31, 1997, representing a 6% increase. The increase in general and administrative
expenses was primarily the result of legal fees associated with ServiceSoft
litigation. General and administrative expense as a percentage of revenues was
14% and 15% for the three months ended July 31, 1998 and July 31, 1997,
respectively.
Restructuring
In July 1998, the Company downsized operations in its subsidiary in France.
This action was taken to better align operating expenses with recent trends of
lower revenues in operations in France and to allow for investment of funds in
the U.S. market. As a result, the Company recorded a restructuring charge
related to lease abandonment and severance costs in the amount of $253,000 in
the quarter ended July 31, 1998.
Other Income, Net
Other income and expense, net, primarily interest income, was $242,000 in the
three months ended July 31, 1998 compared to $325,000 in the three months ended
July 31, 1997.
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<PAGE>
SIX MONTHS ENDED JULY 31, 1998 AND JULY 31, 1997
Revenues
Total revenues increased to $13,861,000 in the six months ended July 31, 1998
from $13,813,000 in the six months ended July 31, 1997, representing an increase
of less than 1%.
Total revenues from the Americas operations decreased to $7,960,000 in the six
months ended July 31, 1998 from $8,316,000 in the six months ended July 31,
1997, representing a 4% decrease. Total international revenues increased to
$5,901,000 in the six months ended July 31, 1998 from $5,497,000 in the six
months ended July 31, 1997, representing a 7% increase. Total international
revenues for the six months ended July 31, 1998 and July 31, 1997 represented
43% and 40% of total revenues, respectively.
Product revenues increased to $7,193,000 in the six months ended July 31, 1998
from $5,927,000 in the six months ended July 31, 1997, representing a 21%
increase. The increase in revenues from products was due to higher unit sales
volumes; the prices of the Company's products have remained relatively constant.
Product revenues represented 52% and 43% of total revenues for the six months
ended July 31, 1998 and July 31, 1997, respectively. During the six months
ended July 31, 1998, two customers accounted in the aggregate for 24% of total
product revenues, or 12% of total revenues, while during the six months ended
July 31, 1997, two customers accounted in the aggregate for 30% of total product
revenues, or 13% of total revenues.
Product revenues from the Americas operations increased to $4,288,000 in the
six months ended July 31, 1998 from $3,477,000 in the six months ended July 31,
1997, representing a 23% increase. International product revenues increased to
$2,905,000 in the six months ended July 31, 1998 from $2,450,000 in the six
months ended July 31, 1997, representing a 19% increase.
Total service revenues decreased to $6,668,000 in the six months ended July
31, 1998 from $7,886,000 in the six months ended July 31, 1997, representing a
15% decrease. The decrease in service revenues, in the face of increasing
product revenues, is primarily attributable to the time lag between when product
deals are closed and consulting projects commence, as well as a decrease in the
average size of consulting engagements.
Service revenues from the Americas operations decreased to $3,672,000 in the
six months ended July 31, 1998 from $4,839,000 in the six months ended July 31,
1997, representing a 24% decrease. International service revenues decreased to
$2,996,000 in the six months ended July 31, 1998 from $3,047,000 in the six
months ended July 31, 1997, representing a 2% decrease.
Cost of Product Revenues
Cost of product revenues, consisting primarily of the costs of product media
and duplication, manuals, packaging materials, personnel-related costs, shipping
expenses and royalties paid to third-party vendors, decreased to $378,000 in the
six months ended July 31, 1998 from $488,000 in the six months ended July 31,
1997, representing a 23% decrease. As a result of such decreases, the gross
margin on product revenues increased to 95% for the six months ended July 31,
1998 from 92% in the six month period ended July 31, 1997. The decrease in cost
of revenues is primarily attributable to certain cost reduction programs
undertaken by the Company during the current year.
Cost of Service Revenues
Cost of service revenues decreased to $3,562,000 in the six months ended July
31, 1998 from $4,304,000 in the six months ended July 31, 1997, representing a
17% decrease. The gross margin on service revenues was 47% and 45% for the six
months ended July 31, 1998 and July 31, 1997, respectively. Cost of service
revenues typically varies depending on the revenue mix of training, consulting
services and technical support.
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<PAGE>
Product Development
Product development expense increased to $2,502,000 in the six months ended
July 31, 1998 from $2,185,000 in the six months ended July 31, 1997,
representing a 15% increase. Product development expense as a percentage of
total revenues was 18% and 16% for the six months ended July 31, 1998 and July
31, 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 increased to $7,471,000 in the six months ended
July 31, 1998 from $7,443,000 in the six months ended July 31, 1997,
representing an increase of less than 1%. The Company intends to aggressively
hire sales personnel to staff and expand its direct sales force. Sales and
marketing expense as a percentage of total revenues was 54% for both the six
month periods ended July 31, 1998 and July 31, 1997.
General and Administrative
General and administrative expense increased to $2,247,000 in the six months
ended July 31, 1998 from $1,907,000 in the six months ended July 31, 1997,
representing an 18% increase. This increase is primarily attributable to
increased legal costs associated with ServiceSoft litigation. General and
administrative expense as a percentage of total revenues was 16% and 14% for the
six months ended July 31, 1998 and July 31, 1997, respectively.
Restructuring
In July 1998, the Company downsized operations in its subsidiary in France.
This action was taken to better align operating expenses with recent revenue
trends in France and to allow for increased investment of funds in the domestic
market. As a result, the Company recorded a restructuring charge, related to
lease abandonment and severance charges, during the three months ended July 31,
1998 in the amount of $253,000, all of which remained unpaid at July 31, 1998.
In the quarter ended April 30, 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. In addition, 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. 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 and Expense
Other income and expense, primarily interest income, decreased to $616,000 in
the six months ended July 31, 1998 from $665,000 in the six months ended July
31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents at July 31, 1998 were $24,381,000, a decrease of
$3,629,000 since January 31, 1998. Working capital at July 31, 1998 was
$22,003,000.
Net cash used in operating activities amounted to $1,548,000 during the six
months ended July 31, 1998, as compared to net cash provided by operating
activities of $416,000 during the six months ended July 31, 1997.
-12-
<PAGE>
Investing activities for the six months ended July 31, 1998 included $305,000
for purchases of property and equipment. The Company has no significant capital
commitments as of July 31, 1998.
Cash used in financing activities for the six months ended July 31, 1998
included $2,025,000 for the repurchase of 499,000 shares of the Company's Class
A 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>
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 is in the process of working with its software
vendors to assure that they are prepared for the year 2000. 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.
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 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.
-14-
<PAGE>
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.
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. 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.
-15-
<PAGE>
Uncertainty of Proprietary Rights. The Company's success depends in part upon
its proprietary technology. Although case-based reasoning ("CBR") 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 CBR 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.
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
On July 29, 1998, the Company and ServiceSoft Corporation ("ServiceSoft")
agreed to settle their litigation, entitled Inference Corporation v. ServiceSoft
Corporation (Civil Case No. C97-03414 MJJ), in the United States District Court
Northern District of California in San Jose, under which the Company claimed
patent and copyright infringement, breach of contract, intentional interference
with prospective business interest and unfair competition. Subsequently,
ServiceSoft denied those charges and filed a counterclaim claiming intentional
interference with prospective business interest, trade defamation and unfair
competition. As part of the settlement, the Company granted ServiceSoft a
patent license. Under the terms of the settlement, the parties executed mutual
releases and dismissed all claims and counterclaims asserted in the litigation.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) On June 17, 1998, the Company's 1998 annual meeting of stockholders
("Annual Meeting") was held.
(b) The shareholders approved the election of the three nominees for the Class
II directors of the Company's Board of Directors for a term of three years.
The following nominees received the number of votes set forth below
opposite their respective names:
<TABLE>
<CAPTION>
NOMINEE FOR WITHHELD
------- --- --------
<S> <C> <C> <C>
Charles W. Jepson 4,986,000 666,000
C. Scott Gibson 4,984,000 667,000
*Thomas Davenport 4,983,000 669,000
</TABLE>
(c) In addition to the election of the Class II directors, the following
matters were voted on at the Annual Meeting:
1. The appointment of Ernst & Young LLP as the Company's independent public
auditors for the fiscal year ending January 31, 1999 was ratified with
5,609,000 votes in favor, 37,000 against and 5,000 abstentions.
2. The amendment to the Company's 1993 Stock Option Plan to increase the
number of shares of Class A Common Stock available for issuance thereunder
by 800,000 shares was not approved with 1,370,000 votes in favor, 1,537,000
against, 45,000 abstentions, and 2,700,000 broker non-votes.
3. The approval of the Charles W. Jepson Stock Option Plan was ratified
with 2,079,000 votes in favor, 834,000 against, 39,000 abstentions, and
2,700,000 broker non-votes.
* Mr. Davenport resigned from the Company's Board of Directors as of August 1,
1998, due to location and time requirements of his new position with Anderson
Consulting in the Boston, Massachusetts area.
-17-
<PAGE>
ITEM 5. OTHER INFORMATION
The Securities and Exchange Commission (the "SEC") has recently amended its
Rule 14a-4, which governs the use by the Company of discretionary voting
authority with respect to certain stockholder proposals. SEC Rule 14a-4(c)(1)
provides that, if the proponent of a stockholder proposal fails to notify the
Company at least 45 days prior to the month and day of mailing the prior year's
proxy statement, the proxies of the Company's management would be permitted to
use their discretionary authority at the Company's next annual meeting of
stockholders if the proposal were raised at the meeting without any discussion
of the matter in the proxy statement. In order to provide stockholders with
notice of the deadline for the submission of such proposals for the Company's
1999 Annual Meeting of Stockholders, the Company hereby notifies all
stockholders of the Company that after March 31, 1998 any stockholder proposal
submitted outside the process of SEC Rule 14a-8 will be considered untimely for
purposes of SEC Rules 14a-4 and 14a-5(e).
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits required by Item 601 of Regulation S-K
Exhibit 27 Financial Data Schedule
(b) Reports on Form 8-K
None.
-18-
<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/ Mark A. Wolf
------------------------
Mark A. Wolf
Vice President,
Acting Chief Financial Officer
(Principal Financial and
Accounting Officer)
Dated: September 11, 1998
19
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<PAGE>
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<FISCAL-YEAR-END> JAN-31-1999
<PERIOD-START> FEB-01-1998
<PERIOD-END> JUL-31-1998
<CASH> 24,381,000
<SECURITIES> 0
<RECEIVABLES> 6,016,000
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 30,860,000
<PP&E> 5,216,000
<DEPRECIATION> 3,357,000
<TOTAL-ASSETS> 32,842,000
<CURRENT-LIABILITIES> 8,857,000
<BONDS> 0
0
0
<COMMON> 71,000
<OTHER-SE> 23,914,000
<TOTAL-LIABILITY-AND-EQUITY> 32,842,000
<SALES> 13,861,000
<TOTAL-REVENUES> 13,861,000
<CGS> 378,000
<TOTAL-COSTS> 3,940,000
<OTHER-EXPENSES> 4,076,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (3,257,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,257,000)
<DISCONTINUED> 0
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