INFERENCE CORP /CA/, 10-Q, 2000-06-14

INFERENCE CORP /CA/
10-Q, 2000-06-14
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<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, 2000 0-26334

( ) 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 7, 2000, there were 7,967,655 shares of the Registrant's Class A
Common Stock, par value $0.01 per share, and no shares of the Registrant's
Class B Common Stock, par value $0.01 per share.

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<PAGE>

INFERENCE CORPORATION

Index
<TABLE>
<CAPTION>
Page
----
<S> <C>
Part I FINANCIAL INFORMATION

ITEM 1. Condensed Consolidated Financial Statements

Condensed Consolidated Balance Sheets at
April 30, 2000 and January 31, 2000................................................. 3

Condensed Consolidated Statements of Operations and Comprehensive
Loss for the Three Months Ended April 30, 2000 and 1999............................. 4

Condensed Consolidated Statements of Cash Flows for the
Three Months Ended April 30, 2000 and 1999............................................ 5

Notes to Condensed Consolidated Financial Statements.................................. 7

ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................................. 11

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk............................ 24

Part II OTHER INFORMATION

ITEM 1. Legal Proceedings..................................................................... 26

ITEM 2. Changes in Securities................................................................. 26

ITEM 3. Defaults upon Senior Securities....................................................... 26

ITEM 4. Submission of Matters to a Vote of Security Holders................................... 26

ITEM 5. Other Information..................................................................... 26

ITEM 6. Exhibits and Reports on Form 8-K...................................................... 26

Signature............................................................................. 27

Index to Exhibits..................................................................... 28
</TABLE>
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<PAGE>

PART I
FINANCIAL INFORMATION

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

INFERENCE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

April 30, January 31,
2000 2000
--------- -----------
<S> <C> <C>

ASSETS

Current assets:
Cash and cash equivalents ................... $ 11,985 $ 17,244
Accounts receivable, net .................... 5,592 4,299
Other current assets ........................ 1,283 1,061
-------- --------
Total current assets ..................... 18,860 22,604

Property and equipment, net ...................... 1,752 1,858
Intangible assets, net ........................... 823 884
Other assets ..................................... 464 470
-------- --------
$ 21,899 $ 25,816
======== ========

LIABILITIES AND SHAREHOLDERS' EQUITY

Current liabilities:
Accounts payable ............................ $ 826 $ 1,134
Accrued salaries and related items .......... 2,103 2,289
Other accrued liabilities ................... 2,533 2,384
Deferred revenue ............................ 5,115 5,019
-------- --------
Total current liabilities ................ 10,577 10,826

Shareholders' equity:
Common stock ................................ 79 78
Additional paid-in capital .................. 49,525 49,308
Accumulated other comprehensive loss ........ (329) (371)
Accumulated deficit ......................... (37,953) (34,025)
-------- --------
Total shareholders' equity ............... 11,322 14,990
-------- --------
$ 21,899 $ 25,816
======== ========

</TABLE>

See accompanying notes.

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<PAGE>

INFERENCE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS

(in thousands, except per share data)

Three Months Ended
April 30,
-------------------
2000 1999
--------- --------
<S> <C> <C>

Revenues:
Products .................................. $ 2,920 $ 3,077
Services .................................. 3,037 3,317
------- -------
Total revenues ......................... 5,957 6,394

Operating costs and expenses:
Cost of product revenue ................... 420 158
Cost of service revenue ................... 1,656 1,684
Product development ....................... 1,521 1,447
Selling and marketing ..................... 4,522 3,922
General and administrative ................ 1,399 829
Amortization of intangible assets ......... 61 -
Acquisition related ....................... 325 677
------- -------
Total operating costs and expenses ..... 9,904 8,717
------- -------
Loss from operations ........................... (3,947) (2,323)
Interest income ................................ 215 279
Other expenses, net ............................ (196) (10)
------- -------
Net loss ....................................... $(3,928) $(2,054)
======= =======

Other comprehensive loss:
Foreign currency translation adjustment ... 42 17
------- -------
Comprehensive loss ..................... $(3,886) $(2,037)
======= =======

Per share information:
Basic and diluted net loss per share ...... $ (0.50) $ (0.29)
======= =======
Shares used in computing net loss per
share..................................... 7,858 7,053
======= =======
</TABLE>
See accompanying notes.
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<PAGE>

INFERENCE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

<TABLE>
<CAPTION>
Three Months Ended
April 30,
---------------------
2000 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss .................................................. $(3,928) $(2,054)
Adjustments to reconcile net loss to net
cash used by operating activities:
Acquired in-process research and development ........ -- 450
Stock-based compensation ............................ 13 --
Depreciation and amortization ....................... 351 320
Changes in operating assets and liabilities, net of
effects from acquisition of Verix Software:
Accounts receivable ........................... (1,293) (140)
Other current assets .......................... (222) (537)
Other assets .................................. 6 455
Accounts payable .............................. (308) (248)
Accrued salaries and related items ............ (186) (738)
Other accrued liabilities ..................... 149 608
Deferred revenue .............................. 96 (249)
------- ------
Net cash used by operating activities .......................... (5,322) (2,133)

Cash flows from investing activities:
Net cash paid for acquisition of Verix Software ........... -- (84)
Purchases of property and equipment ....................... (184) (257)
------- ------
Net cash used by investing activities .......................... (184) (341)

Cash flows from financing activities:
Net proceeds from issuance of common stock ................ 205 227
------- ------
Net cash provided by financing activities ...................... 205 227
------- ------

Effect of exchange rate differences on cash .................... 42 17
------- -------

Net decrease in cash and cash equivalents ...................... (5,259) (2,230)
Cash and cash equivalents at beginning of period ............... 17,244 25,761
------- -------

Cash and cash equivalents at end of period ..................... $11,985 $23,531
======= ========
</TABLE>
See accompanying notes.

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<PAGE>

INFERENCE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS - (Continued)

(in thousands)

Three Months Ended
April 30,
------------------
2000 1999
--------- -------

<S> <C> <C>
Supplemental disclosure of cash flow information:
Income taxes paid during the period .............. $ 3 $ 6
------- -------

Supplemental disclosure of investing transactions:
Acquisition of Verix Software:
Fair value of assets acquired ................. $ -- $ 1,571
Issuance of common stock....................... -- (1,106)
Cash paid...................................... -- (100)
Accrued acquisition costs...................... -- (281)
------- -------
Liabilities assumed .............................. $ -- $ 84
======= =======
</TABLE>

See accompanying notes.

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<PAGE>

INFERENCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

The accompanying 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, 2000, included in our Annual Report
on Form 10-K. The results of operations for the three months ended April 30,
2000 are not necessarily indicative of the results to be expected for the entire
fiscal year.

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.

Certain prior period amounts have been reclassified to conform to the
current period presentation.

2. Software Revenue Recognition

We recognize revenue in accordance with Statement of Position 97-2,
Software Revenue Recognition ("SOP 97-2"), as amended by Statement of Position
98-4, Deferral of the Effective Date of a Provision of SOP 97-2 ("SOP 98-4"),
and Statement of Position 98-9, Modification of SOP 97-2, Software Revenue
Recognition, With Respect to Certain Transactions ("SOP 98-9"). We derive
revenue from the sale of software licenses, post-contract support ("support")
and other services. Support includes telephone technical support, bug fixes, and
rights to unspecified upgrades on a when-and-if available basis. Services
include installation, training, and consulting to meet specific customer needs.
In software arrangements that include rights to software products, specified
upgrades, support and/or other services, we allocate the total arrangement fee
among each deliverable based on the fair value of each of the deliverables
determined based on vendor-specific objective evidence. When vendor-specific
objective evidence of fair value of a product cannot be determined on the basis
of separate sales of that product, we determine such fair value by deducting the
fair value of the support and other services from the fair value of the total
arrangement.

Revenue from license fees is recognized when persuasive evidence of an
agreement exists, delivery of the product has occurred, the fee is fixed or
determinable and collectibility is probable. If the fee due from the customer
is not fixed or determinable, revenue is recognized as payments become due from
the customer. If collectibility is not considered probable, revenue is
recognized when the fee is collected.

Revenue allocable to support is recognized on a straight-line basis over
the period support is provided.

Arrangements that include other software services are evaluated to
determine whether those services are essential to the functionality of other
elements of the arrangement. When services are considered essential, revenue
under the arrangement is recognized using contract accounting (completed
contract method). When services are not considered essential, the revenue
allocable to the software services is recognized as the services are performed.

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<PAGE>

INFERENCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

3. Earnings Per Share

Statement of Financial Accounting Standard ("SFAS") No. 128, "Earnings Per
Share", requires the presentation of basic and diluted earnings per share
("EPS"). Basic EPS is calculated by dividing net income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted EPS is calculated giving effect to all dilutive potential
common shares that were outstanding during the period. Dilutive potential
common shares are calculated using the treasury stock method and represent
incremental shares issuable upon exercise of our outstanding options.

Options to purchase 2,292,000 shares and 2,253,000 shares of common stock
were outstanding at April 30, 2000 and 1999, respectively, but were not included
in the computation of diluted net loss per share as a result of their anti-
dilutive effect. Such stock options could have a dilutive effect in future
periods.

4. New Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activity." SFAS 133
requires that an entity recognize all derivatives on the balance sheet at fair
value. In June 1999, the FASB issued SFAS No. 137, "Accounting for Derivative
Instruments and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133." SFAS 137 defers the effective date of SFAS 133 unitl fiscal
years beginning after June 15, 2000. We do not anticipate that the adoption of
SFAS 133, as amended, will have a significant effect on our results of
operations or financial position.

In December 1999, the Securities and Exchange Commission ("SEC") staff
issued Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in
Financial Statements." The SAB states that all registrants are expected to apply
the accounting and disclosures described in it. The SEC staff, however, will not
object if registrants that have not applied this accounting do not restate prior
financial statements provided they report a change in accounting principle in
accordance with APB Opinion No. 20, "Accounting Changes," by cumulative catch-up
adjustment no later than the second quarter of the fiscal year beginning after
December 15, 1999. We are currently evaluating the impact, if any, of SAB 101 on
our revenue recognition policy and our consolidated financial statements.

In March 2000, the FASB issued FASB Interpretation No. 44, Accounting for
Certain Transactions Involving Stock Compensation, an interpretation of APB
Opinion No. 25 (Interpretation). The Interpretation generally provides for
prospective application of grants or modifications to existing stock options or
awards made after June 30, 2000. However, for certain transactions the guidance
is effective after December 15, 1998 and January 12, 2000. We believe the
adoption of this pronouncement will have no material impact on our financial
position and results of operations.

5. Business Acquisition

On April 30, 1999, we acquired all of the outstanding capital stock of
Verix Software ("Verix"), a privately held developer of Web direct sales
applications for e-commerce companies, for approximately $1,487,000. The
acquisition was accounted for using the purchase method of accounting and the
results of Verix' operations have been combined with those of Inference since
the date of acquisition. In connection with this transaction, we incurred a
charge of $450,000 related to in-process research and development.

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<PAGE>

INFERENCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

6. Segment, Geographic and Significant Customer Data

The method for determining what information to report concerning operating
segments is based on the way that management organizes these segments within
Inference for making operational decisions and assessments of financial
performance. Our chief operating decision maker is considered to be our Chief
Executive officer ("CEO"). The CEO reviews financial information presented on a
consolidated basis accompanied by separate information about revenues and
operating loss by region and by division for making operating decisions and
assessing financial performance.

In fiscal 1999 and 1998, we operated in one segment, the development and
marketing of problem resolution software products. In the third quarter of
fiscal 2000, we introduced two distinct new products, k-Commerce Sales and k-
Commerce Support Enterprise. To best capitalize on the opportunities presented
by our new offerings, we realigned our resources into two separate product
divisions, k-Commerce Support Sales ("k-C Sales") and k-Commerce Support
Enterprise ("k-C Support"). The separate financial information on a product
division basis reviewed by the CEO during the quarter ended April 30, 2000 is as
follows (in thousands):

<TABLE>
<CAPTION>
Total Operating Identifiable
Revenues Loss Assets
-------------- --------------- --------------
<S> <C> <C> <C>
k-C Support................................. $ 5,853 $ 1,363 $ 20,316
k-C Sales .................................. 104 2,584 1,583
------- ------- --------
$ 5,957 $ 3,947 $ 21,899
======= ======= ========
</TABLE>

We currently operate in three primary regions, North America (principally
comprised of U.S. sales), Europe and Asia Pacific (which comprise international
activities). Information relating to the business operations of these regions
is as follows (in thousands):

<TABLE>
<CAPTION>
Total Operating Identifiable
Revenues Loss Assets
-------------- --------------- --------------
<S> <C> <C> <C>
Three months ended April 30, 2000:
North America..................... $ 2,986 $ 3,911 $ 16,951
International..................... 2,971 36 4,948
---------- ---------- ---------
Total......................... $ 5,957 $ 3,947 $ 21,899
========== ========== =========

Three months ended April 30, 1999:
North America..................... $ 3,933 $ 2,084 $ 27,841
International..................... 2,461 239 6,568
---------- ---------- ---------
Total......................... $ 6,394 $ 2,323 $ 34,409
========== ========== =========
</TABLE>

No customer accounted for more than 10% of revenues in the quarter ended April
30, 2000 and 1999.

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<PAGE>

INFERENCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)

7. Litigation

On January 20, 2000, our Board of Directors authorized the transfer of our
InferenceFind meta-search technology to InFind.com, Inc. ("InFind").
Additionally, the Board approved an initial seed investment of up to $250,000,
with additional funding to be subject to the Board's approval of the business
plan related to product viability for the InferenceFind technology. We will
receive an equity interest in the new entity in exchange for our contributions.
We have also agreed to house the new start-up in our Novato facility for a
period of six months. We began funding the operations of InFind during the
quarter ended April 30, 2000. We invested a total of $75,000 in InFind during
the current quarter, all of which was expensed and included in other expenses
due to recurring net losses of this entity. Additionally, our balance sheet as
of April 30, 2000 and January 31, 2000 included no amounts related to the
InferenceFind technology.

We have received notice from a former employee alleging rights to the
technology transferred to InFind. To date, no formal claim has been filed.
Management believes the former employee's assertion to be without merit and
intends to defend it vigorously. However, an unfavorable outcome would
adversely impact our ability to move forward with this project and impair our
investment in InFind.

8. Pending Acquisition of Inference

On March 16, 2000, Inference and eGain Communications Corporation ("eGain")
announced a definitive agreement under which eGain will acquire all of the
outstanding common stock of Inference in exchange for eGain common stock. Under
the terms of the agreement, Inference shareholders will receive 0.1865 shares of
eGain common stock for each share of Inference common stock. This exchange
ratio is subject to a "collar" mechanism of 10% above and below $53.906, the 20
day average closing price for eGain's common stock as of March 15, 2000. The
collar mechanism will be employed three days prior to closing of the proposed
merger. At that time, in the event the 20 day average closing price for eGain's
common stock is below $48.516, then the exchange ratio of 0.1865 will be
recalculated to equal (0.1865 x $48.516)/the average share price. Similarly, in
the event the 20 day average closing price for eGain's common stock exceeds
$59.297, then the exchange ratio of 0.1865 will be recalculated to equal (0.1865
x $59.297)/the average share price. The merger is subject to Inference
shareholder approval. We recorded acquisition expenses of $325,000 in the
quarter ended April 30, 2000 in connection with costs associated with the
pending merger. No adjustment to the recorded amounts of assets or liabilities
that may result from this transaction has been made in the accompanying
consolidated financial statements.

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<PAGE>

ITEM 2. MANAGEMENT'S DISCUSSION AND ANAYLSIS OF FINANCIAL
CONDITION AND
RESULTS OF OPERATIONS

In addition to historical information contained herein, this Form 10-Q
contains forward-looking statements that are subject to certain risks, trends
and uncertainties that could cause actual results to differ materially from
those expressed in or implied by such forward-looking statements. Factors that
could cause or contribute to differences in the final results include, but are
not limited to, risks related to our pending merger with eGain Communications
Corporation, timeliness of new k-Commerce product releases, fluctuations in
quarterly operating results, the size and timing of customer orders for product
licenses, changes in the competitive marketplace, market acceptance and customer
demand for k-Commerce product offerings and the potential loss of key employees.
First quarter financial results are not an indication of future results.
Further information on potential factors that may affect future results are
discussed further in the section of this Form 10-Q entitled "Additional Factors
That May Affect Future Results," and "Quantitative and Qualitative Disclosures
about Market Risk." Readers should also carefully review the business and risk
factors described in the documents Inference files from time to time with the
Securities and Exchange Commission, including, without limitation, the Annual
Report on Form 10-K, Current Reports on Form 8-K and Registration Statement on
Form S-3.

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 months ended April 30,
2000 and 1999:

Three Months Ended
April 30
2000 1999
------- --------
<S> <C> <C>

Revenues:
Products ................................... 49% 48%
Services ................................... 51% 52%
------- -------
Total revenues .......................... 100% 100%

Operating costs and expenses:
Products ................................... 7% 2%
Services ................................... 28% 26%
Product development ........................ 26% 23%
Selling and marketing ...................... 76% 61%
General and administrative ................. 23% 13%
Amortization of intangible assets .......... 1% --
Acquisition related ........................ 5% 11%
------- -------
Total ................................... 166% 136%
------- -------
Loss from operations ................................. (66%) (36%)
======= =======
</TABLE>

Three Months Ended April 30, 2000 and 1999

Revenues

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<PAGE>

support, bug fixes, and rights to unspecified upgrades on a when-and-if
available basis. Services include installation, training, and consulting to meet
specific customer needs. In software arrangements that include rights to
software products, specified upgrades, support and/or other services, we
allocate the total arrangement fee among each deliverable based on the fair
value of each of the deliverables determined based on vendor-specific objective
evidence. When vendor-specific objective evidence of fair value of a product
cannot be determined on the basis of separate sales of that product, we
determine such fair value by deducting the fair value of the support and other
services from the fair value of the total arrangement.

Revenue from license fees is recognized when persuasive evidence of an
agreement exists, delivery of the product has occurred, the fee is fixed or
determinable and collectibility is probable. If the fee due from the customer is
not fixed or determinable, revenue is recognized as payments become due from the
customer. If collectibility is not considered probable, revenue is recognized
when the fee is collected.

Revenue allocable to support is recognized on a straight-line basis over
the period support is provided.

Total revenues decreased to $5,957,000 in the three months ended April 30,
2000 from $6,394,000 in the three months ended April 30, 1999. Total revenues
from the Americas operations decreased to $2,986,000 in the three months ended
April 30, 2000 from $3,933,000 in the three months ended April 30, 1999,
representing a 24% decrease. Total international revenues increased to
$2,971,000 in the three months ended April 30, 2000 from $2,461,000 in the three
months ended April 30, 1999, representing a 21% increase. Total international
revenues for the three months ended April 30, 2000 and 1999 represented 50% and
38% of total revenues, respectively. We currently have subsidiaries in the
United Kingdom and the Netherlands, offering licenses and consulting services,
and have relationships with 10 distributors worldwide, serving Europe, the
Middle East and Africa, Asia and the Pacific Rim. International operations,
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 our future international operations and,
consequently, our results of operations and financial condition.

Product Revenue

Product revenue decreased to $2,920,000 in the three months ended April 30,
2000 from $3,077,000 in the three months ended April 30, 1999, representing a 5%
decrease.

Product revenue from the Americas operations decreased 32% to $1,261,000 in
the three months ended April 30, 2000 from $1,856,000 in the three months ended
April 30, 1999. International product revenue increased 36% to $1,659,000 in the
three months ended April 30, 2000 from $1,221,000 in the three months ended
April 30, 1999. We experienced lower unit sales volumes in the quarter ended
April 30, 2000 from both the Americas and International operations, which caused
a decrease in Americas product revenue. International product revenue increased,
however, due to an increase in the average dollar transaction size. Product
revenue represented 49% and 48% of total revenues for the three months ended
April 30, 2000 and 1999, respectively. During the three months ended April 30,
2000, three customers in the aggregate accounted for 38% of total product
revenue, while during the three months ended April 30, 1999, one customer
accounted for 16% of total product revenue.

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<PAGE>

Service Revenue

Service revenue consists of maintenance revenue and consulting revenue.
Total service revenue decreased to $3,037,000 in the three months ended April
30, 2000 from $3,317,000 in the three months ended April 30, 1999, representing
an 8% decrease.

Service revenue from the Americas operations decreased to $1,725,000 in the
three months ended April 30, 2000 from $2,077,000 in the three months ended
April 30, 1999, representing a 17% decrease. Service revenue from the Americas
operations included maintenance revenue of $1,087,000 and $1,083,000 in the
three months ended April 30, 2000 and 1999, respectively, and consulting revenue
of $638,000 and $994,000 in the three months ended April 30, 2000 and 1999,
respectively. The decrease in consulting revenue was primarily attributable to a
decline in domestic consulting projects due to lower unit sales volumes during
the three months ended April 30, 2000.

International service revenue increased to $1,312,000 in the three months
ended April 30, 2000 from $1,240,000 in the three months ended April 30, 1999,
representing a 6% increase. International service revenue included maintenance
revenue of $740,000 and $705,000 in the three months ended April 30, 2000 and
1999, respectively, and consulting revenue of $572,000 and $535,000 in the three
months ended April 30, 2000 and 1999, respectively.

Cost of Product Revenue

Cost of product revenue, consisting primarily of the costs of product media
and duplication, manuals, packaging materials, personnel-related costs, shipping
expenses and royalties paid to partners and third-party vendors, increased to
$420,000 in the three months ended April 30, 2000 from $158,000 in the three
months ended April 30, 1999, representing a 166% increase. The increase was
primarily attributable to royalties of $233,000 due to our partner, eGain
Communications Corporation. The gross margin on product revenue was 86% and 95%
for the three months ended April 30, 2000 and 1999, respectively. The decrease
was primarily related to an increase in royalty expense.

As part of our development of the k-Commerce product line, we have
incorporated certain third party technology into our products, allowing us to
focus on providing quality, performance and functionality in our technology. To
the extent that we are required to pay royalties to these third parties, the
gross margin on product revenues will decrease accordingly.

Cost of Service Revenue

Cost of service revenue, consisting principally of personnel-related costs
for consulting, training and technical support, decreased to $1,656,000 in the
three months ended April 30, 2000 from $1,684,000 in the three months ended
April 30, 1999, representing a 2% decrease. The gross margin on service revenue
was 45% and 49% for the three months ended April 30, 2000 and April 30, 1999,
respectively. The gross margin on service revenue was slightly lower in the
three months ended April 30, 2000, which was primarily due to a significant
decrease in consulting revenue from our domestic operations, while the cost of
consulting services from our domestic operations remained relatively constant.

Product Development

Product development expenses consist primarily of employee-related costs,
including salaries and benefits, in addition to equipment and facility costs
incurred in the research, design, development and enhancement of our products.
Product development expenses increased to $1,521,000 in the three months ended
April 30, 2000 from $1,447,000 in the three months ended April 30, 1999,
representing a 5% increase. The increase was primarily attributable to the costs
associated with the product development organization of our k-Commerce Sales
division, which was not in existence during the three months ended April 30,
1999. During

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<PAGE>

the three months ended April 30, 2000, we continued to invest heavily in our
product development efforts related to our k-Commerce Sales products. The
increase in the aforementioned costs was partially offset by a decreased
headcount in the product development organization of our k-Commerce Support
Enterprise division. We incurred substantial product development costs in fiscal
2000 to complete the development of our k-Commerce Support Enterprise products,
which was released in October 1999. Consequently, our investment in product
development related to this product was significantly reduced subsequent to the
release of the product. Product development expenses as a percentage of total
revenues were 26% and 23% for the three months ended April 30, 2000 and 1999,
respectively.

Sales and Marketing

Sales and marketing expenses consist primarily of salaries, benefits and
commissions of sales and marketing personnel, trade shows and promotional
expenses, and non-chargeable customer field service and sales support. Sales and
marketing expenses increased to $4,522,000 in the three months ended April 30,
2000 from $3,922,000 in the three months ended April 30, 1999, representing a
15% increase. The increase was primarily attributable to sales and marketing
activity related to the promotion of our k-Commerce Sales products during the
three months ended April 30, 2000. There were no sales and marketing costs
associated with these products during the three months ended April 30, 1999. The
increase in the aforementioned costs was partially offset by a decrease in sales
expenses related to our k-Commerce Support products, which primarily resulted
from decreased headcount in both our domestic and international sales
organizations. Sales and marketing expenses as a percentage of total revenues
were 76% and 61% for the three months ended April 30, 2000 and 1999,
respectively.

General and Administrative

General and administrative expenses consist of the personnel costs for
finance and accounting, human resources, information systems and general
management of Inference. General and administrative expenses increased to
$1,399,000 in the three months ended April 30, 2000 from $829,000 in the three
months ended April 30, 1999, representing a 69% increase. The increase in
general and administrative expenses was primarily due to a reallocation of
management resources resulting from our corporate realignment in the beginning
of fiscal 2001, in which we created two independent operating units focused
around our two product lines. In addition, during the three months ended April
30, 1999, we received a significant reimbursement of legal fees by our insurance
carrier in connection with our litigation with ServiceSoft Corporation. This
caused a significant reduction in general and administrative expenses during
that quarter. General and administrative expenses as a percentage of total
revenues were 23% and 13% for the three months ended April 30, 2000 and 1999,
respectively.

Amortization of Intangible Assets

We recorded amortization of intangible assets of $61,000 for the three
months ended April 30, 2000. This was based upon gross intangible assets of
$1,067,000 recorded in connection with the acquisition of Verix Software on
April 30, 1999.

Acquisition related

We recorded acquisition expenses of $325,000 in the quarter ended April 30,
2000 in connection with costs associated with the pending merger with eGain
Communications Corporation ("eGain"). We incurred a total of $677,000 in
acquisition charges during the quarter ended April 30, 1999, which were
primarily related to the acquisition of Verix Software.

Interest Income and Other Expenses, Net

Interest income and other expenses, net, primarily interest income,
decreased to $19,000 in the three months ended April 30, 2000 from $269,000 in
the three months ended April 30, 1999, representing a 93% decrease. The decrease
was primarily due to a decrease in interest income as a result of a reduction in
cash

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balances and an increase in foreign exchange losses. In addition, our investment
in InFind.com, Inc., an entity we began funding during the three months ended
April 30, 2000, has been written off and included in other expenses as a result
of recurring net losses generated by this entity.

Liquidity and Capital Resources

Cash and cash equivalents at April 30, 2000 were $11,985,000, a decrease of
$5,259,000 since January 31, 2000. Working capital at April 30, 2000 was
$8,283,000.

Net cash used in operating activities amounted to $5,322,000 during the
three months ended April 30, 2000, as compared to net cash used in operating
activities of $2,133,000 during the three months ended April 30, 1999. The
significant increase was primarily attributable to operating losses of our k-
Commerce Sales division, which was not in existence during the three months
ended April 30, 1999.

Investing activities for the three months ended April 30, 2000 included
$184,000 for purchases of property and equipment. We had no significant capital
commitments as of April 30, 2000.

Cash provided by financing activities for the three months ended April 30,
2000 included $205,000 for the issuance of 57,000 shares of our common stock..

Our international operations are principally transacted in British pounds.
Translation into our reporting currency, the U.S. dollar, has not historically
had a material impact on our financial position. Additionally, our net assets
denominated in currencies other than the functional currency have not exposed us
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, we have 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 our
financial position.

ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS

Risks Related to the Merger with eGain

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In addition, neither Inference nor eGain may terminate the merger agreement
or "walk away" from the merger solely because of changes in the market price of
eGain common stock or our common stock. Accordingly, the dollar value of eGain
common stock that our stockholders will receive upon the merger's completion
will depend on the market value of eGain common stock when the merger is
completed, and may decrease from the date shareholders submit their proxies. The
share price of eGain common stock is subject to the general price fluctuations
in the market for publicly traded equity securities and has experienced
significant volatility.

Our officers and directors have conflicts of interest that may influence them to
recommend the adoption of the merger agreement

The directors and officers of Inference participate in arrangements and
have continuing indemnification against liabilities that provide them with
interests in the merger that are different from, or in addition to, our
shareholders, including the following:

. The executive officers of Inference have outstanding stock options to
purchase an aggregate of 1,019,617 shares of our common stock as of May
5, 2000, of which approximately 691,868 are

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Failure to complete the merger could negatively impact our stock price and
future business and operations

If the merger is not completed for any reason, we may be subject to a
number of material risks, including the following:

. We may be required under limited circumstances to pay eGain a
termination fee of up to $3.6 million.

. The price of our common stock may decline to the extent, if any, that
the current market price of our common stock reflects an assumption by
investors that the merger will be completed.

. Costs incurred by Inference related to the merger, such as legal and
accounting fees and a portion of financial advisor fees, must be paid
even if the merger is not completed.

In addition, our customers, in response to the announcement of the merger,
may delay or defer decisions concerning Inference. We derive a significant
portion of its license revenues each quarter from a small number of relatively
large orders. Any delay or deferral in those decisions by our customers could
have a material adverse effect on our business, regardless of whether the merger
is ultimately completed. Similarly, current Inference employees may experience
uncertainty about their future roles with eGain until eGain's strategies with
regard to Inference are announced or actually effected. This may adversely
affect our ability to attract and retain key management, sales, marketing and
technical personnel.

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Further, if the merger is terminated and our board of directors determines
to seek another merger or business combination, there can be no assurance that
we will be able to find a partner willing to pay an equivalent or more
attractive price than the price to be paid in the merger. In addition, while the
merger agreement is in effect, subject to very narrowly defined exceptions, we
are prohibited from soliciting, initiating or encouraging or entering into
certain transactions, such as a merger, sale of assets or other business
combination, with any party other than eGain. These factors could also adversely
affect our common stock price.

The merger may be consummated even though material adverse changes to either
company's business results from the announcement of the merger or changes in
general economic conditions or the companies' industry generally

In general, either party can refuse to complete the merger if there is a
material adverse change affecting the other party between now and the closing.
Certain types of changes will not prevent the merger from going forward,
however, even if they would have a material adverse effect on eGain or
Inference. For example, changes affecting the economy as a whole or changes
affecting the industry in which eGain or Inference operates, and changes
resulting from the announcement of the merger will not allow either party to
walk away from the merger.

If material adverse changes occur, but eGain and Inference are still
required to complete the merger based on the terms of the merger agreement,
eGain's stock price may suffer. This in turn may reduce the value of the merger
to eGain and Inference stockholders. While eGain and Inference might seek to
renegotiate the merger in these circumstances, there can be no assurance that
eGain and Inference would in fact do so or that eGain and Inference would be
successful.

eGain and Inference may not achieve the benefits they expect from the merger if
they fail to integrate the operations and business of the two companies

eGain and Inference entered into the merger agreement with the expectation
that the merger will result in significant benefits to the combined company.
Achieving the benefits of the merger depends on the efficient and successful
integration of the two companies' operations, technologies, businesses and
personnel. The difficulties, costs and delays involved in integrating the
companies, which may be substantial, may include:

. Inability to successfully integrate product technologies

. Distracting management and other key personnel from the business of the
combined company

. Potential incompatibility of business cultures

. Costs and delays in implementing common systems and procedures,
particularly in integrating different information systems

. Possible negative effects on customer service

. Inability to retain and integrate key management, technical, sales and
customer support personnel

The combined company intends to offer its products and services to the
customers of each of the constituent companies. Although the companies have
jointly sold their products to customers in the past, there can be no assurance
that either company's customers will have any interest in the other company's
products and services in the future. The failure of these cross-marketing
efforts would diminish the benefits expected to be realized by this merger. In
addition, eGain intends after the merger to develop new products and services
that combine the technology of both eGain and Inference. To date, the companies
have not thoroughly investigated the obstacles to developing and marketing these
new products and services in a timely and efficient way. There can be no
assurance that eGain will be able to overcome these obstacles, or that there
will be a market for new products and services developed by eGain after the
merger.

Our principal offices are located in Novato, California, while eGain's
principal offices are located in Sunnyvale, California. There are currently no
plans to relocate either of these principal offices. For the merger to be
successful, eGain must successfully integrate our operations and personnel with
eGain's operations and personnel, which may be difficult because of two separate
office locations. Failure to complete the integration successfully could result
in the loss of key personnel or customers.

Risks Related to Inference's Separate Business

We have recently experienced quarterly losses, we expect to incur losses in the
near future and we may not ever become profitable

We have now experienced losses in five of the last six quarters. As of
April 30, 2000, we had an accumulated deficit of approximately $38 million. We
expect to continue to incur net losses in the near future and possibly longer.
We anticipate that our expenses will continue to be high in the foreseeable
future as we continue to grow our k-Commerce Sales division, develop our
technology and expand our distribution channels. These efforts may prove more
expensive than we currently anticipate and we may not succeed in increasing our
revenue sufficiently to offset these higher expenses. If our revenues fail to
keep pace with our expenses, we will continue to incur losses. If we do achieve
profitability in any period, we cannot be certain that we will sustain or
increase such profitability on a quarterly or annual basis.

Failure to achieve broad market acceptance of the k-Commerce suite of products
may materially adversely affect our revenue

Broad market acceptance of our k-Commerce Sales products and k-Commerce
Support Enterprise products are critical to our future success. As a result, a
decline in demand for or failure to achieve broad market acceptance of k-
Commerce products as a result of competition, technological change or otherwise
would have a material adverse effect on our business, operating results and
financial condition. As part of the k-Commerce initiative, we have entered into
several partnering agreements for the purposes of extending the offerings and
capabilities of our products. There can be no assurance that these relationships
will translate into increased revenues or additional demand for our products.

Delays in product development may materially adversely affect our revenue

Our primary product development effort is focused on further building and
enhancing the k-Commerce product lines. There can be no assurance that the
further development of these new product lines will be completed successfully or
on a timely basis or that the product will include the features required to
achieve

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market acceptance. Our future operations will be substantially dependent on the
k-Commerce product lines, and failure to achieve market acceptance of this
family of products would have a material adverse effect on our business,
operating results and financial condition.

We have in the past experienced delays in software development, and there
can be no assurance that we will not experience further delays in connection
with our current product development or future development activities. Software
products as complex as those offered by us may contain undetected errors when
first introduced or as new versions are released. Despite the quality assurance
procedures we currently have in place, there can be no assurance that errors
will not be found in our new or enhanced products after commencement of
commercial shipments, or that modifications to such products will not be
required to satisfy customer requirements, resulting in loss of or delay in
market acceptance. Delays or difficulties associated with new product
introductions or product enhancements could have a material adverse effect on
our business, operating results and financial condition.

There are many factors, including some beyond our control, that may cause
fluctuations in our quarterly operating results

We have experienced significant quarterly fluctuations in operating results
and we anticipate that such fluctuations will continue in the future depending
on a number of factors described below, including many that are beyond our
control. As a result, we believe that quarter-to-quarter comparisons of our
financial results are not necessarily meaningful, and should not be relied upon
as an indication of our future performance. These factors include:

. Changes in demand for our software, including changes in industry growth
rates for our products

. Varying size, timing and contractual terms of customer orders for our
products

. Fluctuation of consulting service revenue depending upon the status of
projects

. Varying budgeting cycles of our existing and potential customers

. Any downturn in our customers' businesses, in the domestic economy or in
international economies where our customers do substantial business

. Changes in our pricing policies resulting from competitive pressures
such as aggressive price discounting by our competitors

. Our ability to develop and introduce on a timely basis new products or
enhanced versions of our existing software

. Changes in the mix of revenues attributable to domestic and
international sales

. Seasonal buying patterns which tend to peak in the fourth quarter

. Changes in the mix of revenue attributable to higher-margin software
license revenue as opposed to substantially lower-margin service revenue

Certain of the above factors can have a particularly significant effect on
our quarterly results, and they include the following:

Fluctuations in large contract license revenue. 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. To the extent we rely on these large
orders to meet

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our quarterly operating objectives, failure to close such contracts in
compliance with SOP 97-2, as modified by SOP 98-4 and SOP 98-9, and in a
specified time period, could adversely affect our operating results.

Varying sales cycle. Product revenue is also difficult to forecast because
the market for client/server and Web-based software products is rapidly
evolving, and our sales cycle, from initial trial to multiple copy purchases and
the provision of support services, varies substantially from customer to
customer. Because our 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. We also may
choose to reduce prices or to increase spending in response to competition or to
pursue new market opportunities, which may adversely affect our operating
results. Accordingly, we believe that period-to-period comparisons of our
results of operations may not be meaningful and should not be relied upon as an
indication of future performance.

Potential changes in mix of license and service revenues. Historically, a
majority of our revenue has been attributable to the licensing of our software
products. Changes in the mix of software products and services sold by us,
including the mix between higher margin software products and lower margin
maintenance, consulting and training, could materially affect our operating
results for future quarters.

Due to all of the foregoing factors, it is likely that in some future
quarters our operating results will be below the expectations of investors.
Regardless of the general outlook for our business, the announcement of
quarterly operating results below investor expectations is likely to result in a
decline in the trading price of our Class A Common Stock.

Impact of Year 2000 issue

In prior years, we discussed the nature and progress of our plans to become
Year 2000 ready. In late 1999, we completed our remediation and testing of
systems. As a result of those planning and implementation efforts, we have
experienced no significant disruptions in mission critical information
technology and non-information technology systems and believe those systems have
successfully responded to the Year 2000 date change. We are not aware of any
material problems resulting from Year 2000 issues, either with our products, our
internal systems, or the products and services of third parties. We will
continue to monitor our mission critical computer applications and those of our
suppliers and vendors throughout the year 2000 to ensure that any latent Year
2000 matters that may arise are addressed promptly.

Our industry changes rapidly due to evolving technology standards and our future
success will depend on our ability to continue to meet the sophisticated needs
of our customers

The market for our products changes rapidly and our future success will
depend on our ability to continue to timely meet changing market conditions and
customer demands. The market for our 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, our success depends upon our ability to continue to enhance our
existing products, respond to customer requirements, develop and introduce, in a
timely manner, new products incorporating technological advances and to address
the increasingly sophisticated needs of our customers by supporting existing and
emerging hardware, software, database and networking platforms. We will have to
develop and introduce enhancements to our existing products and new products on
a timely basis to keep pace with technological developments, evolving industry
standards and changing customer requirements. We expect that we will have to
respond quickly to:

. Rapid technological change

. Changing customer needs

. Frequent new product introductions

. Evolving industry standards that may render existing products and
services obsolete

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To the extent one or more of our competitors introduce products that more
fully address customer requirements, our business, operating results and
financial condition could be adversely affected. There can be no assurance that
we will be successful in developing and marketing new products or enhancements
to our existing products on a timely basis or that any new or enhanced products
will adequately address the changing needs of the marketplace. As a result, our
position in existing markets or potential markets could be eroded rapidly by
product advances. The life cycles of our products are difficult to estimate. Our
growth and future financial performance will depend in part upon our ability to:

. Continue to enhance our existing products

. Develop and introduce new applications that keep pace with technological
advances on a timely and cost-effective basis

. Meet changing customer requirements

. Match or exceed the product deliveries of our competitors

If we are 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, our business, operating results and financial
condition will be materially and adversely affected. From time to time, we or
our competitors may announce new products, capabilities or technologies that
have the potential to replace or shorten the life cycles of our 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
our business, operating results and financial condition.

We expect that our product development efforts will continue to require
substantial investments to be able to attract and retain qualified software
development engineers. We may not have sufficient resources to make the
necessary investments. Any of these events could have a material adverse effect
on our business, quarterly and annual operating results and financial condition.

We may lose large customer purchases that may materially adversely affect our
revenue

We occasionally sell our products to large customers. Large customers are
expected to deploy our products in business critical operations, which involve
significant capital and management commitments by such customers. Potential
large customers generally commit significant resources to an evaluation of
available software and require us to expend substantial time, effort and money
educating them about the value of our solutions. Sales of our products to such
customers require an extensive sales effort throughout a customer's organization
because decisions to purchase such products generally involve the evaluation of
the software by a significant number of customer personnel in various functional
and geographic areas, each often having specific and conflicting requirements. A
variety of factors, including factors over which we have little or no control,
may cause potential large customers to favor a particular supplier or to delay
or forego a purchase. As a result of these or other factors, the sales cycle for
our products to these large customers is long, typically ranging between three
and nine months. As a result of the length of the sales cycle and the
significant selling expenses resulting from selling to large customers, our
ability to forecast the timing and amount of specific sales is limited. The
delay or failure to complete, in compliance with SOP 97-2, as modified by SOP
98-4 and SOP 98-9, one or more large transactions to which we have devoted
significant resources could have a material adverse effect on our business,
operating results and financial condition and could cause significant variations
in our operating results from quarter to quarter.

We may not be able to recruit and retain the personnel we need to sustain or
grow our business

We consider our relationship with our employees to be good, and there has
never been an interruption in our business activities due to labor unrest.
However, our future performance is contingent upon the

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uninterrupted service of key sales, technological and executive management staff
and upon the maintenance of conditions that can help attract and retain capable
salespeople, technicians and managers.

We may not be successful in attracting, training and retaining qualified
personnel, and the failure to do so, particularly in key functional areas such
as product development and sales, could materially adversely affect our
business, results of operations and financial condition. Competition for such
personnel in the computer software industry is intense, and in the past we have
experienced difficulty in recruiting qualified personnel, especially developers
and sales personnel. The demand for qualified personnel is particularly acute in
the San Francisco Bay Area, due to the large number of software companies and
the low unemployment in the region. Our future success will likely depend in
large part on our ability to attract and retain additional experienced sales,
technical, marketing and management personnel. We expect competition for
qualified personnel to remain intense, and we may not succeed in attracting or
retaining such personnel.

Competition may affect the amount of revenue we can generate from sales of our
products and services which could adversely affect our business

The market for customer relationship management software is highly
competitive, and there are certain competitors with substantially greater sales,
marketing, development and financial resources than us. Among our major
competitors in the problem identification and resolution segment of the market
are Kana Communications, Inc., Primus Knowledge Systems, Inc., Ask Jeeves, Inc.
and Servicesoft, Inc., as well as other smaller privately held companies.
Furthermore, many potential customers implement low-end text retrieval solutions
or develop internal applications as an alternative to acquiring software and
services from third-party vendors such as Inference. Among our major competitors
in the online merchandising segment are Broadvision Inc., Vignette Corporation
and Art Technology Group.

We believe that the competitive factors affecting the market for our
products and services include vendor and product reputation; product quality,
performance and price; product functionality and features; product scalability;
product integration with other enterprise applications; the availability of
products on multiple platforms; product ease-of-use; and the quality of customer
support services, documentation and training. The relative importance of each of
these factors depends upon the specific customer involved. There can be no
assurance that we will be able to compete effectively with respect to any of
these factors.

Our present or future competitors may be able to develop products
comparable or superior to those offered by us or they may be able to adapt more
quickly than us to new technologies and evolving customer requirements. In order
to be successful in the future, we must respond to technological change,
customer requirements and competitors' current products and innovations. In
particular, while we are currently developing additional product enhancements
that we believe address customer requirements, there can be no assurance that we
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 we will
be able to continue to compete effectively in our markets, that competition will
not intensify or that future competition will not have a material adverse effect
on our business, operating results and financial condition.

Our future revenue is substantially dependent upon service revenue; which is
dependent on future sales of our software products

We depend on our installed customer base for service revenue. Service
revenue depends in part on ongoing renewals of support contracts by our
customers, some of which may not renew their support contracts. Therefore, our
current customers may not necessarily generate significant service revenue in
future periods. In addition, our customers may not necessarily purchase
additional products or professional services. Our service revenue is also
dependent upon the continued use of these services by our installed customer
base. Service revenue represented 57% of total revenues for fiscal 2000, 43% for
fiscal 1999 and 53% for fiscal 1998. We anticipate that service revenue will
continue to represent a significant percentage of total revenues. Because
service revenue has lower gross margins than license revenue, a continued
increase in the percentage of total revenues represented by service revenue or
an unexpected decrease in license revenue

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could have a detrimental impact on overall gross margins and operating results.
If service revenue is lower than anticipated, our business, financial condition
and operating results could be materially and adversely affected.

The market price of our Class A Common Stock will likely be subject to
substantial price and volume fluctuations due to a number of factors, certain of
which are beyond our control

Stock prices and trading volumes for many software companies fluctuate
widely for a number of reasons, including some reasons which may be unrelated to
their businesses or results of operations. This market volatility, as well as
general domestic or international economic, market and political conditions,
could materially adversely affect the market price of our common stock without
regard to our operating performance. In addition, our operating results may be
below the expectations of public market analysts and investors. If this were to
occur, the market price of our common stock would likely decrease significantly.
The market price of our common stock has fluctuated significantly in the past
and may continue to fluctuate significantly because of:

. Future announcements concerning us or our competitors

. Quarterly variations in operating results

. Announcements of technological innovations

. Changes in product pricing policies by us or our competitors

. Litigation relating to proprietary rights or otherwise

. Market uncertainty about our financial condition or business prospects
or the prospects for our market in general

. Revenues or results of operations that do not match analysts'
expectations

. The introduction of new products or product enhancements by us or our
competitors

. General business conditions in our industry

. Changes in the mix of revenues attributable to license and maintenance
sales

. Seasonal trends in technology purchases and other general economic
conditions

Errors in our products or the failure of our products to conform to customer
specifications or expectations could result in our customers asserting claims
for damages against us or in decreased sales of our products

Because our software products are complex, they often contain errors or
"bugs" that can be detected at any point in a product's life cycle. While we
continually test our products for errors and work with customers through our
customer support services to identify and correct bugs in our software, we
expect that errors in our products will continue to be found in the future.
Although many of these errors may prove to be immaterial, certain of these
errors could be significant. Detection of any significant errors may result in,
among other things, loss of, or delay in, market acceptance and sales of our
products, diversion of development resources, injury to our reputation, or
increased service and warranty costs. These problems could materially adversely
affect our business and future quarterly and annual operating results.

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A key determinative factor in our future success will continue to be the
ability of our products to operate and perform well with existing and future
leading, industry-standard application software products intended to be used in
connection with our products. Failure to meet in a timely manner existing or
future interoperability and performance requirements of certain independent
vendors could adversely affect the market for our products.

Commercial acceptance of our products and services could also be adversely
affected by critical or negative statements or reports by brokerage firms,
industry and financial analysts and industry periodicals concerning us, our
products, business or competitors or by the advertising or marketing efforts of
competitors, or other factors that could affect consumer perception.

Product liability claims asserted against us in the future could adversely
affect our business

Our license agreements with our customers typically contain provisions
designed to limit our exposure to potential product liability claims. However,
it is possible that the limitation of liability provisions contained in our
license agreements may not be effective under the laws of certain jurisdictions.
Although we have not experienced any product liability claims to date, the sale
and support of our products may entail the risk of such claims, and there can be
no assurance that we will not be subject to such claims in the future. In
particular, issues relating to Year 2000 compliance have increased awareness of
the potential adverse effects of software defects and malfunctions. While we
carry insurance policies covering this type of liability, these policies may not
provide sufficient protection should a claim be asserted. A material product
liability claim could materially adversely affect our business.

We rely heavily on our intellectual property rights that offer only limited
protection against potential infringers; if we cannot protect our intellectual
property rights, our business could be adversely affected

Our success depends in part upon our proprietary technology. Although case-
based reasoning technology ("CBR") is available in the public domain, we believe
implementation of the CBR technology is proprietary. We rely primarily on a
combination of copyright, trademark and trade secret laws, confidentiality
procedures and licensing arrangements to establish and protect our proprietary
rights. We have been awarded several patents for our CBR and related technology.
Our CBR technology is embedded in our current k-Commerce and CBR family of
products. Despite the precautions we have taken, it may be possible for an
unauthorized third party to copy or otherwise obtain and use our products,
technology or other information that we regard 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 we do not operate.
We may also be unable to protect our technology because:

. Unauthorized third parties may be able to copy aspects of our products
or obtain and use our proprietary information. This could occur through
our licensing activities where we provide third parties with access to
our data model and other proprietary information underlying our licensed
applications

. Our competitors may independently develop similar or superior technology

. Policing unauthorized use of our software is difficult

. The laws of some foreign countries do not protect our proprietary rights
to the same extent as do the laws of the United States

. "Shrink-wrap" and/or "click-wrap" licenses may be wholly or partially
unenforceable under the laws of certain jurisdictions

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We may have to employ litigation to enforce our intellectual property
rights, to protect our trade secrets or to determine the validity and scope of
the proprietary rights of others and any litigation could prove to be
unsuccessful, result in substantial costs and diversion of resources and could
materially adversely affect our business, future operating results and financial
condition. In addition, we generally provide our products to end-users under
signed license agreements. These agreements are negotiated with and signed by
the licensee. We occasionally publish articles regarding our technical
developments in industry publications that may prevent us from obtaining patent
protection for ideas contained in such publications, thus increasing the
availability to third parties of fundamental aspects of our technology. Our
means of protecting our proprietary rights may not be adequate and our inability
to protect our intellectual property rights may adversely affect our business
and financial condition.

Third parties could assert that our products infringe their intellectual
property rights, which could adversely affect our business

We are not aware that any of our products infringe upon the proprietary
rights of third parties. There can be no assurance, however, that third parties
will not claim such infringement by us with respect to current or future
products. Any claims of this type could affect our relationships with existing
customers and may prevent future customers from licensing our products. Any of
these type of claims, with or without merit, could be time consuming, result in
costly litigation, cause product shipment delays or require us to enter into
royalty or licensing agreements. Royalty or license agreements may not be
available on acceptable terms or at all. If we were found to have infringed upon
the proprietary rights of third parties, we 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 our business,
operating results and financial condition. We expect that we will increasingly
be subject to infringement claims as the number of products and competitors in
the customer support software industry grows and the functionality of such
products overlaps with other industry segments. As a result of these factors,
infringement claims could materially adversely affect our business.

Our future success is dependent on the continued growth and commercial
acceptance of the Web

Our future success depends in part upon the widespread adoption of the Web
as a primary medium for business applications and communications. If the Web
does not continue to increase in importance as a commercial medium, our
business, operating results and financial condition could be materially
affected. Critical issues concerning the commercial use of the Web, such as
security, reliability, cost, accessibility and quality of service, remain
unresolved and may negatively affect the growth of Web use or the attractiveness
of business communications over the Web.

We may become subject to litigation

We may become subject to legal proceedings and claims that arise in the
ordinary course of business. We currently believe that the ultimate amount of
liability, if any, with respect to any pending actions, either individually or
in the aggregate, will not materially affect our financial position, results of
operations or liquidity. 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 our results of operations and cash flows as a result of
defense costs, diversion of management resources and other factors.

Item 3. Quantitative and Qualitative Disclosure about Market Risk

Our international operations are exposed to international business risks as well
as fluctuations in the value of foreign currency

Our international sales are made mostly from our foreign sales subsidiaries
in their respective countries and are typically denominated in the local
currency of each country. These subsidiaries also incur most of

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their expenses in the local currency. Accordingly, all foreign subsidiaries use
the local currency as their functional currency.

Our exposure to foreign exchange rate fluctuations arises in part from
intercompany accounts in which costs incurred in the United States are charged
to our foreign sales subsidiaries. These intercompany accounts are typically
denominated in the functional currency of the foreign subsidiary in order to
centralize foreign exchange risk with the parent company in the United States.
We are also exposed to foreign exchange rate fluctuations as the financial
results of foreign subsidiaries are translated into U.S. dollars in
consolidation. As exchange rates vary, these results, when translated, may vary
from expectations and adversely impact overall expected results. The effect of
foreign exchange rate fluctuations in fiscal 2000 was not material.

In addition, these subsidiaries, which represented approximately 43% of our
total revenue in fiscal 2000, are subject to risks typical of an international
business, including, but not limited to the following, the occurrence of any of
which could materially adversely impact our business, operations and financial
condition:

. Difficulties in staffing and managing international operations

. Problems in collecting accounts receivable

. Longer payment cycles

. Fluctuations in currency exchange rates

. Seasonal reductions in business activity during the summer months in
Europe and certain other parts of the world

. Uncertainties relating to political, economic and tax circumstances

. Recessionary environments in foreign economies

. Increases in tariffs, duties, price controls or other restrictions on
foreign currencies or trade barriers imposed by foreign countries

Costs associated with ensuring that our products and internal operating systems
are able to effectively work with the Euro conversion may adversely affect our
business

On January 1, 1999, a new currency, the Euro, became the legal currency for
eleven of the fifteen member countries of the European Economic Community.
Between January 1, 1999 and January 1, 2002, governments, companies and
individuals may conduct business in these countries in both the Euro and the
existing national currencies. On January 1, 2002, the Euro will become the sole
currency in these countries.

We are taking steps to evaluate internal system capabilities, review the
ability of financial institution vendors to support Euro transactions and
examine current marketing and pricing policies and strategies in light of the
Euro conversion. Although, we have not yet completed evaluating the impact of
the Euro conversion on our functional currency designations, the cost of this
effort is not expected to have a material adverse effect on our results of
operations and financial condition. There can be no assurance, however, that all
issues related to the Euro conversion have been identified and that any
additional issues would not have a material effect on our results of operations
or financial condition.

The conversion to the Euro also may have competitive implications on our
pricing and marketing strategies, the impact of which are not known at this
time. Additionally, we are at risk to the extent our principal European
suppliers and customers are unable to deal effectively with the impact of the
Euro conversion.

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We are exposed to market rate risk for changes in interest rates

Our exposure to market rate risk for changes in interest rates relate
primarily to our investment portfolio. We currently do not use derivative
financial instruments. We invest, by policy, our excess cash balances in money
market accounts, debt instruments of the U.S. Government and its agencies, and
in high-quality corporate issuers, and limit the amount of credit exposure to
any one issuer. As of April 30, 2000, our investments consisted solely of funds
contained in money market accounts. Investments in both fixed rate and floating
rate interest earning instruments carry a degree of interest rate risk. Fixed
rate securities may have their fair market value adversely impacted due to a
rise in interest rates, while floating rate securities may produce less income
than expected if interest rates fall. Due in part to these factors, our future
investment income may fall short of expectations due to changes in interest
rates.

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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

Exhibit
Number Exhibit
------ -------

27 Financial Data Schedule.

(b) Reports on Form 8-K

1. On March 17, 2000, we filed a Form 8-K with the Securities and
Exchange Commission reporting that on February 24, 2000 Inference
announced financial results for the quarter and year ended January 31,
2000.

2. On March 20, 2000, we filed a Form 8-K with the Securities and
Exchange Commission related to the merger with eGain.

3. On March 21, 2000, we filed a Form 8-K with the Securities and
Exchange Commission related to the merger with eGain.

4. On June 6, 2000, we filed a Form 8-K with the Securities and
Exchange Commission reporting that on May 31, 2000 Inference announced
financial results for the quarter ended April 30, 2000.

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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/ PHILIP D. RANGER
-------------------------------------------
PHILIP D. RANGER
Vice President And Chief Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)

Dated: June 14, 2000

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INDEX TO EXHIBITS

Exhibit
Number Exhibit
------ -------

27 Financial Data Schedule

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