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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 00-15997
FILENET CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924
(State or other jurisdiction of (I.R.S. Employer
corporation or organization Identification No.)
3565 Harbor Boulevard, Costa Mesa, CA 92626
(Address of principal executive offices) (Zip code)
(714) 327-3400
(Registrant's telephone number including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes |X| No |_|
As of November 11, 2002, there were 35,905,953 shares of the Registrant's common stock
outstanding.
FILENET CORPORATION
Index
Page
Number
PART I. FINANCIAL INFORMATION.......................................... 3
Item 1. Unaudited Condensed Consolidated Financial Statements ........ 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................. 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk..... 26
Item 4. Controls and Procedures........................................ 27
PART II. OTHER INFORMATION.............................................. 27
Item 1. Legal Proceedings.............................................. 27
Item 6. Exhibits and Reports on Form 8-K............................... 27
SIGNATURE ............................................................... 28
CERTIFICATIONS ............................................................... 29
INDEX TO
EXHIBITS ............................................................... 31
2
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
FILENET CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share amounts)
September 30, December 31,
2002 2001
ASSETS
Current assets:
Cash and cash equivalents $ 101,462 $ 107,502
Short-term investments 46,726 64,660
Accounts receivable, net 43,738 36,909
Inventories, net 2,575 2,993
Prepaid expenses and other current assets 12,840 9,521
Deferred income taxes 2,877 2,779
Total current assets 210,218 224,364
Property, net 37,568 44,206
Long-term investments 28,129 -
Goodwill 16,572 9,953
Intangible assets, net 3,139 182
Deferred income taxes 21,429 21,445
Other assets 5,028 1,489
Total assets $ 322,083 $ 301,639
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,615 $ 8,282
Customer deposits 3,076 4,848
Accrued compensation and benefits 22,262 17,804
Unearned maintenance revenue 40,074 30,996
Income taxes payable 2,746 3,999
Other accrued liabilities 12,353 13,685
Total current liabilities 88,126 79,614
Unearned maintenance revenue and other liabilities 4,597 6,200
Commitments and contingencies (Note 9)
Stockholders' equity:
Preferred stock - $.10 par value; 7,000,000 shares
authorized; none issued and outstanding - -
Common stock - $.01 par value; 100,000,000 shares
authorized; 36,741,049 shares issued and 35,643,049
shares outstanding at September 30, 2002; and
36,389,682 shares issued and 35,291,682 shares
outstanding at December 31, 2001 203,401 199,526
Retained earnings 49,393 44,906
Accumulated other comprehensive loss (8,867) (14,040)
243,927 230,392
Treasury stock, at cost; 1,098,000 shares (14,567) (14,567)
Net stockholders' equity 229,360 215,825
Total liabilities and stockholders' equity $ 322,083 $ 301,639
See accompanying notes to unaudited condensed consolidated financial statements.
3
FILENET CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
Revenue:
Software $ 30,538 $ 26,932 $ 96,128 $ 88,463
Customer Support 37,838 33,372 111,682 95,201
Professional services and education 12,751 17,489 43,078 53,423
Hardware 1,975 2,788 6,682 10,836
Total revenue 83,102 80,581 257,570 247,923
Costs:
Software 2,484 2,253 7,239 5,636
Customer Support 9,604 9,042 29,499 32,494
Professional services and education 11,361 14,025 38,003 47,356
Hardware 1,337 2,565 4,847 8,039
Total cost of revenue 24,786 27,885 79,588 93,525
Gross Profit 58,316 52,696 177,982 154,398
Operating expenses:
Research and development 17,764 16,936 53,993 52,548
Selling, general and administrative 39,793 40,287 121,636 127,064
In-process research and development - - 400 -
Total operating expenses 57,557 57,223 176,029 179,612
Operating income (loss) 759 (4,527) 1,953 (25,214)
Other income, net 1,045 1,671 3,874 1,505
Income (loss) before income taxes 1,804 (2,856) 5,827 (23,709)
Provision (benefit) for income taxes 415 (628) 1,340 (5,215)
Net income (loss) $ 1,389 $ (2,228) $ 4,487 $(18,494)
Earnings (loss) per share:
Basic $ 0.04 $ (0.06) $ 0.13 $ (0.53)
Diluted $ 0.04 $ (0.06) $ 0.12 $ (0.53)
Weighted average shares outstanding:
Basic 35,629 35,008 35,511 35,096
Diluted 36,445 35,008 36,803 35,096
See accompanying notes to unaudited condensed consolidated financial statements.
4
FILENET CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS (UNAUDITED)
(In thousands)
Three Months Nine Months
Ended September 30, Ended September 30,
2002 2001 2002 2001
Net income (loss) $ 1,389 $ (2,228) $ 4,487 $ (18,494)
Other comprehensive income (loss):
Foreign currency translation adjustments 156 2,642 5,147 (1,986)
Unrealized gains on securities:
Unrealized holding gains 12 72 26 163
Total other comprehensive income (loss) 168 2,714 5,173 (1,823)
Comprehensive income (loss) $ 1,557 $ 486 $ 9,660 $ (20,317)
See accompanying notes to unaudited condensed consolidated financial statements.
5
FILENET CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Nine Months Ended September 30,
2002 2001
Cash flows from operating activities:
Net income (loss) $ 4,487 $ (18,494)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Purchased in-process research and development 400 -
Depreciation and amortization 16,160 18,166
Loss on sale of fixed assets 13 262
Provision for doubtful accounts 354 800
Deferred income taxes 16 (8,896)
Changes in operating assets and liabilities, net of
the effects of
acquisition:
Accounts receivable (5,526) 42,115
Inventories 417 313
Prepaid expenses and other current assets (3,100) (421)
Accounts payable (861) (7,115)
Accrued compensation and benefits 3,918 (5,633)
Customer deposits and advances (1,781) 3,284
Accrued legal fees - (2,478)
Unearned maintenance revenue 6,870 13,360
Income taxes payable (1,199) (2,881)
Other (4,213) 1,406
Net cash provided by operating activities 15,955 33,788
Cash flows from investing activities:
Capital expenditures (8,592) (15,103)
Proceeds from sale of property 44 287
Note receivable from officer (1,900) -
Cash paid for acquisition (9,359) -
Purchases of marketable securities (103,529) (108,953)
Proceeds from sales and maturities of marketable securities 94,621 86,803
Net cash used in investing activities (28,715) (36,966)
Cash flows from financing activities:
Proceeds from issuance of common stock 3,875 5,386
Principal payments on capital lease obligations (1,293) (519)
Net cash provided by financing activities 2,582 4,867
Effect of exchange rate changes on cash and cash equivalents 4,138 (1,212)
Net increase (decrease) in cash and cash equivalents (6,040) 477
Cash and cash equivalents, beginning of year 107,502 101,497
Cash and cash equivalents, end of period $ 101,462 $ 101,974
Supplemental cash flow information:
Interest paid $ 65 $ 57
Income taxes paid $ 2,897 $ 6,794
See accompanying notes to unaudited condensed consolidated financial statements.
6
FILENET CORPORATION
Notes To Condensed Consolidated Financial Statements
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial
statements of FileNET Corporation (the "Company") reflect adjustments
(consisting of normal recurring adjustments) necessary to present fairly
the financial position of the Company at September 30, 2002, the results of
its operations and its comprehensive operations for the three and nine
months ended September 30, 2002 and 2001 and its cash flows for the nine
months ended September 30, 2002 and 2001. Certain information and footnote
disclosures normally included in financial statements have been condensed
or omitted pursuant to rules and regulations of the Securities and Exchange
Commission ("SEC"), although the Company believes that the disclosures in
the condensed consolidated financial statements are adequate to ensure the
information presented is not misleading. These condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto, and Management's Discussion and
Analysis of Financial Condition and Results of Operations, contained in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2001 filed with the SEC on March 28, 2002. The results of operations for
the interim periods are not necessarily indicative of the operating results
for the year.
Certain reclassifications have been made to the prior year's condensed
consolidated financial statements to conform to the current year's
presentation.
2. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS No. 141, "Business Combinations," which
was effective immediately. SFAS No. 141 requires that the purchase method
of accounting be used for all business combinations initiated after June
30, 2001 and it eliminated the pooling-of-interests method. The adoption of
this standard did not have a significant impact on the Company's
consolidated financial statements. The Company's April 2002 acquisition of
certain assets and certain liabilities of eGrail, Inc. has been accounted
for in compliance with this pronouncement (see Note 3 for details).
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which the Company adopted January 1, 2002. SFAS No. 142 requires
that goodwill and other intangible assets with indefinite useful lives no
longer be amortized, but instead be tested for impairment at least annually
and written down when impaired. SFAS No. 142 requires purchased intangible
assets other than goodwill to be amortized over their useful lives unless
these lives are determined to be indefinite. In accordance with this
Standard, the Company no longer amortizes goodwill and indefinite life
intangible assets but evaluates their carrying value annually or when
events or circumstances indicate that their carrying value may be impaired.
Assembled workforce no longer meets the definition of a separately
identified intangible asset under the provisions of SFAS No. 141, and the
unamortized balance of $182,000 was reclassified as goodwill at January 1,
2002. The Company ceased amortizing the goodwill balance of $10.1 million
from its 2000 acquisition of Applications Partner, Inc. as of January 1,
2002. The Company had no indefinite life intangible assets as of January 1,
2002. In accordance with SFAS No. 142, the Company is required to perform a
two-step transitional impairment review. The first step of this review was
completed by June 30, 2002 with the determination of the fair value of the
Company's reporting units in order to identify whether the fair value of
each reporting unit is less than its carrying amount. In the event that the
fair value of the reporting unit is less than the carrying amount, the
second step of the test would be required to determine if the carrying
value of goodwill exceeds the implied value. The Company determined that it
did not have a transitional impairment of goodwill and as of Septemeber 30,
2002, no impairment of goodwill has been recognized. Goodwill will be
tested for impairment annually on July 1st of each year or earlier if
indicators of potential impairment exist. If estimates change, a materially
different impairment conclusion could result.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets." This Statement addresses financial
accounting and reporting for the impairment of long-lived assets and for
the disposal of long-lived assets and discontinued operations. SFAS No. 144
superseded SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of," and is effective for
7
fiscal years beginning after December 15, 2001. The adoption of this
Standard on January 1, 2002 did not have a material impact on the Company's
financial position and results of operations.
In November 2001, the FASB announced Emerging Issues Task Force ("EITF")
Topic No. D-103, "Income Statement Characterization of Reimbursements
Received for Out-of-Pocket Expense Incurred", is required to be applied in
financial reporting periods beginning after December 15, 2001. The EITF
requires companies to characterize reimbursements received for
out-of-pocket expenses as revenues in the statement of operations.
Historically, the Company has netted reimbursements received for
out-of-pocket expenses against the related expenses in the statement of
operations. Application of this EITF requires that comparative financial
statements for prior periods be reclassified to comply with the guidance.
The Company adopted this EITF as of January 1, 2002 and has reclassified
its prior period consolidated financial statements to conform to the
current presentation. The adoption of this EITF did not have a material
effect on total revenues or gross margin percentages and has no impact on
results of operations as it required an equivalent increase to both revenue
and cost of revenue. Revenue and cost of revenue increased by $512,000 for
the three months ended September 30, 2001 and increased by $1.7 million for
the nine months ended September 30, 2001. Comparable numbers for 2002 are
not available as out-of-pocket expenses are characterized as revenue upon
invoicing.
In July 2002, the FASB issued SFAS 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses financial accounting and
reporting for costs associated with exit or disposal activities and
supersedes EITF Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS 146 requires that costs
associated with exit or disposal activities be recognized when they are
incurred rather than at the date of a commitment to an exit or disposal
plan. SFAS 146 also establishes that the liability should initially be
measured and recorded at fair value. The Company will adopt the provisions
of SFAS 146 for exit or disposal activities that are initiated after
December 31, 2002.
3. ACQUISITIONS
On April 2, 2002, the Company acquired certain assets and assumed certain
liabilities of eGrail, Inc. ("eGrail"), a Web content management company,
for $9.0 million in cash. This strategic acquisition provides additional
Web Content Management ("WCM") software application capabilities that
expand the Company's position in the Enterprise Content Management ("ECM")
market, which contributed to the purchase price that resulted in goodwill.
In accordance with SFAS No. 141, "Business Combinations," the acquisition
has been accounted for under the purchase method of accounting. The
purchase price for the acquisition consisted of $9.0 million cash and
direct acquisition costs of $359,000. The purchase price was allocated as
follows (in thousands):
Net tangible assets $ 581
Goodwill 5,793
Patents 24
Acquired technology 3,300
In-process research and development 400
Liabilities assumed (739)
$ 9,359
The amount allocated to in-process research and development and acquired
technology was determined through established valuation techniques in the
high-technology industry by an independent third-party appraiser.
In-process research and development was expensed upon acquisition because
technological feasibility had not been established and no future
alternative uses existed. New product development underway at eGrail at the
time of the acquisition included the next generation of their Web Content
Management product that was in the early stages of design and only 5%
complete at the date of the acquisition. The cost to complete the project
was estimated at approximately $3.0 million to occur over a twelve-month
period. As of September 30, 2002 the Company has incurred approximately
$1.9 million of research and development expenses related to the project.
The remaining purchase price was primarily allocated to tangible assets and
goodwill. The acquired technology of $3.3 million was assigned a useful
life of five years and patents of $24,000 were assigned a useful life of
two years. In accordance with SFAS No. 142, goodwill will not be amortized
but will be reviewed for impairment on an annual basis. Goodwill is tax
deductible for this asset purchase.
8
Actual results of operations of the acquired eGrail business, as well as
assets and liabilities of the acquired eGrail business, are included in the
unaudited condensed consolidated financial statements from the date of
acquisition. Therefore, the Company's financial results for the nine months
ended September 30, 2002 include the actual results of the aquired eGrail
business from the date of acquisition. The pro forma results of operations
data for the nine-month periods ended September 30, 2001 and 2002 presented
below assume that the acquisition had been made at the beginning of fiscal
2001. The pro forma data is presented for informational purposes only and
is not necessarily indicative of the results of future operations nor of
the actual results that would have been achieved had the acquisitions taken
place at the beginning of fiscal 2001 (in thousands):
Nine Months Ended September 30,
2000 2001
Revenue $ 258,322 $ 251,895
Net Income (Loss) 3,120 (26,035)
Earnings (Loss) per share:
Basic $ 0.09 $ (0.74)
Diluted $ 0.08 $ (0.74)
Alliant Partners acted as financial advisors to eGrail in this transaction
and was paid approximately $500,000 by eGrail. John Savage, a member of
FileNET's Board of Directors and the Audit Committee of FileNET's Board of
Directors, is Managing Partner of Alliant Partners and, accordingly,
recused himself from all discussions related to the transaction and
abstained from voting on this transaction.
4. GOODWILL AND PURCHASED INTANGIBLE ASSETS
In acquisitions accounted for using the purchase method, goodwill is
recorded as the difference, if any, between the aggregate consideration
paid for an acquisition and the fair value of the net tangible and
identified intangible assets acquired. Statement No. 142 requires that
ratable amortization of goodwill and indefinite life intangibles be
replaced with periodic review and analysis of goodwill for possible
impairment. Intangible assets with definite lives must be amortized over
their estimated useful lives. On January 1, 2002 the Company adopted SFAS
No. 142, and as a result, goodwill is no longer amortized. Summarized below
are the effects on net income (loss) per share data if the Company had
followed the amortization provisions of SFAS 142 for all periods presented
(in thousands, except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
Net income (loss):
As reported $ 1,389 $ (2,228) $ 4,487 $ (18,494)
Add: goodwill amortization,
net of taxes - 608 - 1,787
Adjusted net income (loss) $ 1,389 $ (1,620) $ 4,487 $ (16,707)
Basic net income (loss) per share:
As reported $ 0.04 $ (0.06) $ 0.13 $ (0.53)
Add: goodwill amortization, net of taxes - 0.02 - 0.05
Adjusted basic net income (loss)
per share $ 0.04 $ (0.04) $ 0.13 $ (0.48)
Diluted net income (loss) per share:
As reported $ 0.04 $ (0.06) $ 0.12 $ (0.53)
Add: goodwill amortization, net of taxes - 0.02 - 0.05
Adjusted diluted net income (loss)
per share $ 0.04 $ (0.04) $ 0.12 $ (0.48)
9
A portion of goodwill and intangible assets were allocated to our Ireland
subsidiary and therefore the following tables reflect amounts resulting
from foreign exchange translation.
The following table presents the changes in goodwill allocated to the
reportable segments during the first nine months of 2002 (in thousands):
Balance at Foreign Balance at
December 31, Currency September 30,
2001 Acquired Adjustments Fluctuation 2002
Software $ 4,914 $ 3,654 $ 90 $ 318 $ 8,976
Customer support 3,271 406 60 212 3,949
Professional services
and education 1,768 1,733 32 114 3,647
Hardware - - - - -
Total $ 9,953 $ 5,793 $ 182 $ 644 $ 16,572
The acquired goodwill resulted from the acquisition of the eGrail business
in April 2002. The adjustments were due to the reclassification of the
assembled workforce intangible to goodwill at January 1, 2002 as a result
of the adoption of SFAS 142.
Acquired technology and patents are the Company's only intangible assets
subject to amortization under Statement No. 142. These assets were recorded
in connection with the April 2002 eGrail acquisition and are comprised of
the following as of September 30, 2002 (in thousands):
Foreign
Accumulated Currency
Gross Amortization Fluctuation Net
Acquired technology $ 3,468 $ (347) $ (1) $ 3,120
Patents 25 (6) - 19
$ 3,493 $ (353) $ (1) $ 3,139
Acquired technology is being amortized over a useful life of five years and
patents are being amortized over a useful life of two years. Amortization
expense for amortizing intangible assets was $176,400 for the three months
ended September 30, 2002 and $344,500 for the nine months ended September
30, 2002 and estimated future amortization expense (excluding foreign
exchange effect) of purchased intangible assets as of September 30, 2002 is
as follows (in thousands):
Fiscal
Year Amount
2002 (remaining 3 months) $ 168,190
2003 672,760
2004 663,190
2005 660,000
2006 660,000
2007 165,000
$ 2,989,140
5. EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed by dividing net income (loss)
for the period by the weighted average number of common shares outstanding
during the period. Diluted earnings per share is computed by dividing net
income by the weighted average number of common shares outstanding plus the
dilutive effect of outstanding stock options and shares issuable under the
10
employee stock purchase plan using the treasury stock method. The dilutive
loss per share excludes these adjustments, as the impact would be
antidilutive. The antidilutive effect for the three and nine months ended
September 30, 2001 would have been 772 and 1,239 shares, respectively. The
following table sets forth the computation of basic and diluted earnings
(loss) per share for the three and nine months ended September 30, 2002 and
2001:
(In thousands, except per share amounts) Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
Net income (loss) $ 1,389 $ (2,228) $ 4,487 $ (18,494)
Shares used in computing
basic earnings (loss) per share 35,629 35,008 35,511 35,096
Dilutive effect of stock plans $ 816 $ - $ 1,292 $ -
Shares used in computing
diluted earnings (loss) per share 36,445 35,008 36,803 35,096
Earnings (loss) per basic share $ 0.04 $ (0.06) $ 0.13 $ (0.53)
Earnings (loss) per diluted share $ 0.04 $ (0.06) $ 0.12 $ (0.53)
6. ACCUMULATED OTHER COMPREHENSIVE LOSS
Accumulated other comprehensive loss as of September 30, 2002 is comprised
of the following:
Foreign Unrealized Accumulated
Currency Holding Other
Translation Gains Comprehensive
(in thousands) Adjustment (Losses) Operations
Balance, December 31, 2001 $ (14,079) $ 39 $ (14,040)
Current period changes 5,147 26 5,173
Balance September 30, 2002 $ (8,932) $ 65 $ (8,867)
7. OPERATING SEGMENT DATA
The Company has prepared operating segment information in accordance with
SFAS No. 131, "Disclosures About Segments of An Enterprise and Related
Information," to report components that are evaluated regularly by the
Company's chief operating decision maker, or decision making group, in
deciding how to allocate resources and in assessing performance. The
Company is organized geographically and by line of business. The line of
business management structure is the primary basis upon which financial
performance is assessed and resources allocated.
The Company's reportable operating segments include Software, Customer
Support, Professional Services and Education, and Hardware. The Software
operating segment develops and markets the Company's Enterprise Content
Management and Business Process Management software products. The Customer
Support segment provides after-sale support for software, as well as
providing software upgrades when and if available pursuant to the Company's
right to new versions program. The Professional Services and Education
segment provides fee-based implementation and technical services related to
the Company's software products, and also provides training. The Hardware
operating segment manufactures and markets the Company's line of Optical
Storage And Retrieval ("OSAR") libraries.
The financial results of the segments reflect allocation of certain
functional expense categories consistent with the basis and manner in which
Company management internally disaggregates financial information for the
purpose of assisting in making internal operating decisions, which are not
the same as GAAP reporting. The Company evaluates performance based on
stand-alone segment operating results. Because the Company does not
11
evaluate performance based on the return on assets at the operating segment
level, assets are not tracked internally by segment. Therefore, segment
asset information is not presented.
Operating segments data for the three and nine months ended September 30,
2002 and 2001 are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
In thousands 2002 2001 2002 2001
Software
Revenue $ 30,538 $ 26,932 $ 96,128 $ 88,463
Operating loss (14,822) (17,343) (40,272) (46,807)
Customer Support
Revenue $ 37,838 $ 33,372 $ 111,682 $ 95,201
Operating income 16,156 12,984 44,343 25,944
Professional Services and
Education Revenue $ 12,751 $ 17,489 $ 43,078 $ 53,423
Operating income (loss) (742) 191 (2,421) (3,586)
Hardware
Revenue $ 1,975 $ 2,788 $ 6,682 $ 10,836
Operating income (loss) 167 (359) 303 (765)
Total
Revenue $ 83,102 $ 80,581 $ 257,570 $ 247,923
Operating income (loss) 759 (4,527) 1,953 (25,214)
8. STOCK OPTIONS
The following is a summary of stock option transactions regarding all stock
options plans for the nine months ended September 30, 2002:
Number of Weighted
Options Exercise Price
Balances, December 31, 2001 8,010,453 $ 15.56
Granted (weighted average fair value of $7.02) 1,247,530 13.82
Exercised (181,760) 9.56
Canceled (421,869) 21.42
Balances, September 30, 2002 8,654,354 $ 15.14
12
The following table summarizes information concerning outstanding and
exercisable stock options at September 30, 2002:
Options Outstanding Options Exercisable
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Price Outstanding Life Price Exercisable Price
$ 1.39 - $ 9.00 1,785,120 5.06 $ 7.95 1,599,166 $ 8.00
9.17 - 12.86 1,762,094 8.12 11.68 666,798 10.76
12.97 - 14.81 1,650,232 8.35 13.58 605,369 13.73
15.16 - 22.53 1,874,810 8.12 17.81 772,541 17.97
23.47 - 41.84 1,582,098 7.30 25.57 1,030,023 25.88
$ 1.39 - $ 41.84 8,654,354 7.38 $ 15.14 4,673,897 $ 14.73
The Company accounts for its stock-based compensation plans in accordance
with APB Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations. The following table summarizes the Company's net
income (loss) and net income (loss) per share on a pro forma basis had
compensation cost for the Company's stock-based compensation plans been
determined based on the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation" for the nine months ended September 30, 2002:
(In thousands, except per share amounts)
Net income - as reported $ 4,487
Net loss - pro forma (2,060)
Diluted earnings per share - as reported 0.12
Basic and diluted loss per share - pro forma $ (0.06)
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model using an expected volatility
of 70%, risk-free interest rates of 2.16% to 4.81% and an expected life of
one year from vest date. Pro forma compensation cost of shares issued under
the Employee Qualified Stock Purchase Plan is measured based on the
discount from market value on the date of purchase in accordance with SFAS
No. 123.
9. LEGAL PROCEEDINGS
In the normal course of business, the Company is subject to ordinary
routine litigation incidental to the business. While the results of this
litigation cannot be predicted with certainty, the Company believes that
the final outcome of these matters will not have a materially adverse
effect on its consolidated results of operations or financial condition.
10. RELATED PARTY TRANSACTIONS
In July 2001, the Compensation Committee of the Company's Board of
Directors entered into discussions with Lee Roberts, the Company's Chief
Executive Officer, regarding a secured loan by the Company to Mr. Roberts
to enable him to purchase a home in Orange County, California. In July
2001, the Compensation Committee forwarded its recommendation to the Board
to approve, in principle, a secured loan, in the amount of $1.2 million to
Mr. Roberts. In September 2001, the Compensation Committee approved, in
principle, an increase in the previously requested loan amount to $1.9
million, subject to review of final loan documents and approval of the
Board. In May 2002, the Compensation Committee reviewed proposed loan
documentation for a secured loan to Mr. Roberts and forwarded its
recommendation to the Board to approve the loan on the terms set forth in
the loan documents. The loan documents provided that the loan would be
secured by the real estate purchased by Mr. Roberts. Subsequently, on June
5, 2002, the Board approved the loan documents and the loan. As of
September 30, 2002, FileNET has an outstanding secured note receivable from
13
Mr. Roberts in the amount of $1.9 million that relates to the
above-referenced loan and is included in other assets on the condensed
consolidated balance sheet. The note bears interest at 2.89% per annum.
Accrued interest on the principal balance of this note is payable annually
beginning February 15, 2003 and on each February 15th thereafter until the
entire principal balance becomes due. The entire outstanding principal
balance of this note and any accrued interest is due and payable at the
earliest of (a) June 7, 2005, (b) one year after termination of Mr.
Roberts' employment by the Company, or (c) ninety (90) days after voluntary
termination of employment by Mr. Roberts. The difference between the stated
interest rate of the note and a fair value interest rate of 7% was recorded
as a discount that is being amortized over the term of the note to
compensation expense using the effective interest method. The loan to Mr.
Roberts is permitted under Section 13 of the Securities Exchange Act of
1934 as amended by Section 402 of the Sarbanes-Oxley Act on July 30, 2002
because it was outstanding on that date, however, its terms cannot be
renewed or materially modified after July 30, 2002.
1. FOREIGN CURRENCY TRANSACTIONS
As of September 30, 2002, the Company had forward foreign exchange
contracts outstanding totaling approximately $14,590,485 in nine
currencies. These contracts were opened on the last business day of the
quarter and mature within three months. Accordingly, the fair value of such
contracts is zero at September 30, 2002.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995, Section 21E
of the Securities Exchange Act of 1934, as amended, and Section 27A of the
Securities Act of 1933, as amended, and is subject to the safe harbors created
by those sections. These forward-looking statements are subject to a number of
risks and uncertainties, including those discussed in "Risk Factors That May
Affect Future Results" below and in the notes to our consolidated financial
statements for the year ended December 31, 2001. The actual results that we
achieve may differ materially from any forward-looking statements, which reflect
management's opinions only as of the date hereof. We undertake no obligation to
revise or publicly release the results of any revisions to these forward-looking
statements. Readers should carefully review the risk factors described below and
in other documents we file from time to time with the Securities and Exchange
Commission, including our Annual Report on Form 10-K for the fiscal year ended
December 31, 2001.
Overview
FileNET Corporation develops, markets, implements and services Enterprise
Content Management ("ECM") and Business Process Management software products and
eBusiness applications and solutions for selected vertical markets. Our software
products enable organizations to improve operational efficiency and leverage
their content resources through the delivery of efficient, flexible, and
scalable enterprise process management solutions. We also offer professional
services and training for the implementation of these software solutions, as
well as 24 hours a day, seven days a week technical support and services to our
customers on a global basis.
Significant Accounting Policies
We prepare the consolidated financial statements of FileNET in conformity with
accounting principles generally accepted in the United States of America. The
consolidated financial statements include our accounts and the accounts of our
wholly-owned subsidiaries. All intercompany balances and transactions have been
eliminated. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. The
significant accounting policies we believe are most critical to aid in fully
understanding and evaluating our reported financial results include the
following:
Revenue Recognition. Revenues from sales of software licenses sold through
direct and indirect channels, which do not contain multiple elements, are
recognized upon shipment of the related product if the requirements of Statement
of Position ("SOP") 97-2, as amended, are met. If the requirements of SOP 97-2,
including evidence of an arrangement, delivery, fixed or determinable fee,
collectibility or vendor specific evidence about the value of an element are not
met at the date of shipment, revenue is not recognized until such elements are
known or resolved. Software license revenue for arrangements to deliver
unspecified additional software products in the future is recognized ratably
over the term of the arrangement, beginning with the initial shipment. Revenue
from post-contract customer support is recognized ratably over the term of the
14
contract. Revenue from professional services and education is recognized as such
services are delivered and accepted by the customer. Anticipated losses on
fixed-price professional services contracts are recognized in the period when
they become known. We recognize other revenue at the time of product delivery
and accrue any remaining costs, including vendor obligations. Based on
historical experience, we maintain a sales return allowance for the estimated
amount of potential returns. While such returns have historically been minimal
and within our expectations of the allowances established, we cannot guarantee
that we will continue to experience the same return rates that we have in the
past.
Accounts Receivable. We evaluate the creditworthiness of our customers prior to
order fulfillment and we perform ongoing credit evaluations of our customers to
adjust credit limits based on payment history and the customer's current
creditworthiness. We monitor collections from our customers and maintain a
provision for estimated credit losses that is based on historical experience and
on specific customer collection issues. While such credit losses have
historically been within our expectations and the provisions established, we
cannot guarantee that we will continue to experience the same credit loss rates
that we have in the past. Since our revenue recognition policy requires
customers to be creditworthy, our accounts receivable are based on customers
whose payment is reasonably assured. Our accounts receivable are derived from
sales to a wide variety of customers. We do not believe a change in liquidity of
any one customer or our inability to collect from any one customer would have a
material adverse impact on our financial position.
Deferred Income Taxes. Deferred income taxes reflect the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes. We
maintain a valuation allowance against a portion of the deferred tax asset due
to uncertainty regarding the future realization based on historical taxable
income, projected future taxable income, and the expected timing of the
reversals of existing temporary differences. If we operate at a loss or are
unable to generate sufficient future taxable income we could be required to
increase the valuation allowance against all or a significant portion of our
deferred tax assets which would result in a substantial increase to our
effective tax rate and could result in a material adverse impact on our
operating results.
Accounting for the Impairment or Disposal of Long-Lived Assets. We account for
the impairment and disposition of long-lived assets in accordance with the
Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." In accordance with SFAS No. 144, long-lived assets to be held are reviewed
for events or changes in circumstances that indicate that their carrying value
may not be recoverable. In August 2001, the Financial Accounting Standards Board
("FASB") issued SFAS No. 144, "Accounting for Impairment or Disposal of
Long-Lived Assets." This statement addresses financial accounting and reporting
for the impairment of long-lived assets and for the disposal of long-lived
assets. SFAS No. 144 superseded SFAS No. 121, and is effective for fiscal years
beginning after December 15, 2001. We evaluate the carrying value of intangible
assets for impairment of value based on undiscounted future cash flows, which
are subject to change. While we have not experienced impairment of intangible
assets in prior periods, we cannot guarantee that there will not be impairment
in the future. Any future impairment charge would negatively affect our results
of operations.
Research and Development Costs. We expense research and development costs as
incurred. No amounts are required to be capitalized in accordance with SFAS No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed," because our software is substantially completed
concurrently with the establishment of technological feasibility.
Results of Operations
The following table sets forth certain consolidated statements of operations
data as a percentage of total revenue for the periods indicated:
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
Revenue:
Software 36.7% 33.4% 37.3% 35.7%
Customer support 45.5 41.3 43.4 38.4
Professional services and education 15.4 21.7 16.7 21.5
15
Hardware 2.4 3.6 2.6 4.4
Total Revenue 100.0 100.0 100.0 100.0
Cost of revenue:
Software 3.0 2.8 2.8 2.3
Customer support 11.5 11.2 11.4 13.1
Professional services and education 13.7 17.5 14.8 19.1
Hardware 1.6 3.1 1.9 3.2
Total cost of revenue 29.8 34.6 30.9 37.7
Gross Profit 70.2 65.4 69.1 62.3
Operating expenses
Research and development 21.4 21.0 21.0 21.2
Selling, general and administrative 47.9 50.0 47.2 51.3
In-process research and development - - 0.1 -
Total operating expenses 69.3 71.0 68.3 72.5
Operating income (loss) 0.9 (5.6) 0.8 (10.2)
Other income, net 1.3 2.1 1.5 0.6
Income (loss) before income tax 2.2% (3.5)% 2.3% (9.6)%
Revenue
Total revenue increased to $83.1 million, or 3% for the three months ended
September 30, 2002 from $80.6 million for the three months ended September 30,
2001. International revenue accounted for 29% of total revenue, or $24.4
million, for the three months ended September 30, 2002 and 22% of total revenue,
or $17.8 million, for the three months ended September 30, 2001. Total revenue
was $257.6 million for the nine months ended September 30, 2002 and $247.9
million for the comparable nine months ended September 30, 2001, representing an
increase of $9.7 million, or 4%. International revenue accounted for 28% of
total revenue, or $71.2 million, for the nine months ended September 30, 2002
and 25% of total revenue, or $62.3 million, for the nine months ended September
30, 2001. These increases in revenue were primarily attributable to increases in
software and customer support revenue partially offset by decreases in
professional services and hardware revenues as more fully discussed below.
Software: Software revenue consists of fees earned from the licensing of our
software products to customers. Software revenues increased to $30.5 million, or
13% for the three months ended September 30, 2002 from $26.9 million for the
three months ended September 30, 2001. Software revenue represented 37% of total
revenue for the three months ended September 30, 2002 compared to 33% for the
comparable period of 2001. Software revenue increased to $96.1 million, or 9%
for the nine months ended September 30, 2002 from $88.5 million for the nine
months ended September 30, 2001. Software revenue represented 37% of total
revenue for the nine months ended September 30, 2002 compared to 36% for the
comparable period of 2001. These increases in software revenue were primarily
due to a small increase in demand for our products in both the United States and
internationally. We remain, however, in an uncertain economic environment and in
a prolonged slowdown in IT spending that could cause our software revenue to
decline. We do not anticipate market conditions to improve significantly in the
near term.
Customer Support: Customer support revenue consists of revenue from software
maintenance contracts, "fee for service" revenues and the sale of spare parts
and supplies. Customer support revenue increased to $37.8 million, or 13% for
the three months ended September 30, 2002 from $33.4 million for the three
months ended September 30, 2001. Customer support revenue represented 45% of
total revenue for the three months ended September 30, 2002 compared to 41% for
16
the comparable period of 2001. Customer support revenue increased to $111.7
million, or 17% for the nine months ended September 30, 2002 from $95.2 million
for the nine months ended September 30, 2001. Customer support revenue
represented 43% of total revenue for the nine months ended September 30, 2002
compared to 38% for the comparable period of 2001. The increases in customer
support revenue were primarily due to the growth in our base of customers who
receive ongoing maintenance as a result of new customer sales and sales of
additional products to our installed base along with a high rate of renewal on
the existing base. However, the occurrence of a prolonged economic slowdown that
continues to reduce software revenue would result in a decrease in the future
growth rate of customer support revenue.
Professional Services and Education: Professional services and education revenue
is generated primarily from consulting and implementation services provided to
end users of our software products, technical consulting services provided to
our resellers and training services provided to end users and resellers.
Professional services are generally performed on a time and material basis.
Professional services and education revenue decreased to $12.8 million, or 27%
for the three months ended September 30, 2002 from $17.5 million for the three
months ended September 30, 2001. Professional services and education revenue
represented 15% of total revenue for the three months ended September 30, 2002
compared to 22% for the comparable period in 2001. Professional services and
education revenue decreased to $43.1 million, or 19% for the nine months ended
September 30, 2002 compared to $53.4 million for the comparable period of 2001.
Professional services and education revenue represented 17% of total revenue for
the nine months ended September 30, 2002 compared to 22% for the comparable
period in 2001. The economic slow down, particularly in North America, resulted
in fewer and smaller consulting engagements. This slow down, coupled with
pricing pressures, has negatively impacted professional services and education
revenues and we do not expect a significant improvement in the near future.
Hardware: Hardware revenue is generated primarily from the sale of 12-inch
Optical Storage And Retrieval ("OSAR") libraries. Hardware revenue decreased to
$2.0 million, or 29% for the three months ended September 30, 2002 from $2.8
million for the three months ended September 30, 2001. Hardware revenue
represented 2.4% of total revenue for the three months ended September 30, 2002
compared to 3.5% for the comparable period of 2001. Hardware revenue decreased
to $6.7 million, or 38% for the nine months ended September 30, 2002 from $10.8
million for the comparable period of 2001. Hardware revenue represented 2.6% of
total revenue for the nine months ended September 30, 2002 compared to 4.4% for
the comparable period of 2001. The decline in hardware revenue reflects that
hardware is not a strategic focus for us and we expect hardware revenue to
continue to decrease as a percent of total revenue.
Cost of Revenue
Total cost of revenue decreased to $24.8 million, or 11% for the three months
ended September 30, 2002 from $27.9 million for the comparable period in 2001.
Total cost of revenue decreased to $79.6 million, or 15% for the nine months
ended September 30, 2002 from $93.5 million for the comparable period in 2001.
The decrease for the three month comparison is primarily due to the decrease in
the cost of professional services and education revenue as discussed below. The
nine month decrease is primarily due to decreases in customer support and
professional services cost of revenue as discussed below.
Software: Cost of software revenue includes royalties paid to third parties,
amortization of acquired technology, partner commissions, software media costs,
and the cost to manufacture and distribute software. The cost of software
revenue increased to $2.5 million, or 9% for the three months ended September
30, 2002 from $2.3 million for the three months ended September 30, 2001. These
costs represented 8% of the related software revenue for the three months ended
September 30, 2002 and September 30, 2001. The cost of software revenue
increased to $7.2 million, or 28% for the nine months ended September 30, 2002
from $5.6 million for the nine months ended September 30, 2001. These costs
represented 8% and 6% of the related software revenue for the nine months ended
September 30, 2002 and 2001, respectively. The increases in cost of software
revenue for the three and nine months ended September 30, 2002 compared to the
same periods in 2001 are primarily the result of increased royalty fees due to
increased utilization of third party software products in 2002 and the addition
of amortization of acquired technology, which was $173,000 and $337,000 for the
three and nine months ended September 30, 2002, respectively, compared to none
in 2001. Going forward we anticipate cost of software revenue as a percent of
software revenue to remain comparable to current levels.
Customer Support: Cost of customer support revenue includes costs of customer
support personnel, cost of supplies and spare parts, and the cost of third-party
hardware maintenance. The cost of customer support revenue increased to $9.6
million, or 7% for the three months ended September 30, 2002 from $9.0 million
for the three months ended September 30, 2001. These costs represented 25% and
27% of the related customer support revenue for the three months ended September
30, 2002 and 2001, respectively. The cost of customer support revenue decreased
to $29.5 million, or 9% for the nine months ended September 30, 2002 from $32.5
million for the nine months ended September 30, 2001. These costs represented
26% and 34% of the related customer support revenue for the nine months ended
September 30, 2002 and 2001, respectively. The increase in cost of customer
17
support revenue in absolute dollars for the three months ended September 30,
2002 compared to the same period in 2001 is primarily attributable to higher
variable compensation and benefit costs. The decreases in both cost of customer
support revenue in absolute dollars and as a percentage of customer support
revenue for the nine months ended September 30 2002 compared to the same period
in 2001 is primarily attributable to lower compensation cost as a result of a
reduction in workforce in the first half of 2001. The decrease in cost of
customer support revenue expressed as a percentage of customer support revenue
is due to automation and process improvements that allowed growth in the
customer base, which generated increased revenue, without a proportional
increase in support personnel and cost. Going forward we expect customer support
cost of revenue to remain relatively stable in absolute dollars for the near
term.
Professional Service and Education: Cost of professional services and education
revenue consists primarily of costs of professional services personnel, training
personnel, and third-party independent consultants. The cost of professional
services and education revenue decreased to $11.4 million, or 19% for the three
months ended September 30, 2002 from $14.0 million for the three months ended
September 30, 2001. These costs represented 89% and 81% of the related
professional services and education revenue for the three months ended September
30, 2002 and 2001, respectively. The cost of professional services and education
revenue decreased to $38.0 million, or 20% for the nine months ended September
30, 2002 from $47.4 million for the nine months ended September 30, 2001. These
costs represented 88% and 89% of the related professional services and education
revenue for the nine months ended September 30, 2002 and 2001, respectively. The
decrease in absolute dollars was primarily attributable to a reduction in the
use of third-party independent consultants, as well as lower commission and
variable compensation expense, all directly related to the decrease in
professional services revenue. We expect professional services and education
costs as a percentage of professional services and education revenue to vary
from period to period depending on the utilization rates of internal resources
and the mix between the use of internal resources and third party independent
consultants.
Hardware: Cost of hardware revenue includes the cost of assembling and
distributing our OSAR library products, the cost of hardware integration
personnel, and warranty costs. The cost of hardware revenue decreased to $1.3
million, or 50% for the three months ended September 30, 2002 from $2.6 million
for the three months ended September 30, 2001. These costs represented 65% and
92% of the related hardware revenue for the three months ended September 30,
2002 and 2001, respectively. The cost of hardware revenue decreased to $4.8
million, or 40% for the nine months ended September 30, 2002 from $8.0 million
for the nine months ended September 30, 2001. These costs represented 72% and
74% of the related hardware revenue for the nine months ended September 30, 2002
and 2001, respectively. The decrease in absolute dollars is directly related to
the decrease in sales of OSAR library products.
Operating Expenses
Research and Development: Research and development expense primarily consists of
costs of personnel to support product development. Research and development
expense increased to $17.8 million, or 5% for the three months ended September
30, 2002 from $16.9 million for the three months ended September 30, 2001, and
represented 21% of total revenue for these respective periods. Research and
development expense increased to $54.0 million, or 3% for the nine months ended
September 30, 2002 from $52.5 million for the nine months ended September 30,
2001, and represented 21% of total revenues for each period. The increase year
over year is primarily the result of increased compensation and benefit costs
associated with additional headcount from the eGrail acquisition that took place
in April 2002.
Our research and development efforts are focused on developing our ECM
capabilities. These efforts will focus on improvements in Business Process
Management, Content Management, Web Content Management and associated
applications to provide a richer product offering to our customers. We intend to
complement internal development with third party software through OEM agreements
and may execute additional technology acquisitions. New product development
underway at eGrail at the time of the acquisition included the next generation
of their Web Content Management product that was in the early stages of design
and only 5% complete at the date of the acquisition. The cost to complete the
project was estimated at approximately $3.0 million to occur over a twelve-month
period. As of September 30, 2002 the Company has incurred approximately $1.9
million of research and development expenses related to the project.
We expect that competition for qualified technical personnel, while easing due
to the global economic slowdown in the short-term, will remain intense and may
result in higher levels of compensation expense for us in the future. We believe
that research and development expenditures, including compensation of technical
personnel, are essential to maintaining our competitive position and expect
these costs will continue to constitute a significant percentage of total
revenue.
18
Selling, general and administrative: Selling, general and administrative expense
consists primarily of salaries, benefits, sales commissions and other expenses
related to the direct and in-direct sales force; various marketing expenses; the
cost of other market development programs; personnel costs for finance,
information technology, legal, human resources and general management; and the
cost of outside professional services. Selling, general and administrative
expense decreased to $39.8 million, or 1% for the three months ended September
30, 2002 from $40.3 million for the three months ended September 30, 2001, and
represented 48% and 50% of total revenues for these respective periods. Selling,
general and administrative expense decreased to $121.6 million, or 4% for the
nine months ended September 30, 2002 from $127.1 million for the nine months
ended September 30, 2001, and represented 47% and 51% of total revenues for
these respective periods. The decreases in 2002 were primarily due to reduced
recruitment and advertising expenses, as well as reduced sales commission
expense. The elimination of goodwill amortization, which was $751,000 for the
three months ended September 30, 2001 and $2.3 million for the nine months ended
September 30, 2001, also contributed to this decrease (see "Amortization of
Goodwill and Intangible Assets" below).
We expect operating expenses to remain at or slightly above these current levels
for the near term.
Amortization of Goodwill and Identifiable Intangible Assets
In connection with our acquisition of certain assets from API on May 18, 2000,
the purchase price amount allocated to goodwill of $14.6 million was being
amortized over a useful life of five years and assembled workforce of $386,000
was being amortized over a useful life of three years. These amortization costs
were recorded in selling, general and administrative expense. We ceased
amortizing goodwill and assembled workforce as of the beginning of the first
quarter of 2002 in compliance with SFAS No. 142. In contrast, we recognized
$751,000 of amortization expense in the three months ended September 30, 2001
and $2.3 million of amortization expense in the nine months ended September 30,
2001. Assembled workforce no longer meets the definition of a separately
identified intangible asset under the provisions of SFAS No. 141, "Business
Combinations," and the unamortized balance of $182,000 was reclassified as
goodwill at January 1, 2002. SFAS No. 142 is effective for new business
combinations that occur after June 30, 2001. Accordingly, goodwill of $5.8
million that was recorded in April 2002 in connection with the eGrail
acquisition will not be amortized. We had no indefinite life intangible assets
as of January 1, 2002. We will evaluate the carrying value of goodwill annually
or when events or circumstances indicate that their carrying value may be
impaired. In accordance with SFAS No. 142, we are required to perform a two-step
transitional impairment review. We completed the first step of this review by
June 30, 2002 with the determination of the fair value of our reporting units in
order to identify whether the fair value of each reporting unit is less than its
carrying amount. In the event that the fair value of the reporting unit is less
than the carrying amount, the second step of the test would be required to
determine if the carrying value of goodwill exceeds the implied value. We
determined that we did not have a transitional impairment of goodwill and as of
September 30, 2002, no impairment of goodwill has ben recognized. Goodwill will
be tested for impairment annually on July 1st of each year or earlier if
indicators of potential impairment exist. If estimates change, a materially
different impairment conclusion could result.
Other Income, Net
Other income, net consists primarily of interest income earned on our cash and
cash equivalents, short and long-term investments, and other items including
foreign exchange gains and losses, the gain (loss) on sale of fixed assets, and
interest expense. Other income, net was $1.0 million for the three months ended
September 30, 2002 compared to other income, net of $1.7 million for the three
months ended September 30, 2001. This decrease was primarily related to reduced
interest income as a result of lower interest rates in 2002 compared to 2001.
Other income, net for the nine months ended September 30, 2002 was $3.9 million
compared to other income, net of $1.5 million for the comparable nine-month
period in 2001. This increase was primarily due to a one-time charge of $4.0
million for a legal settlement that was recorded in the second quarter of 2001.
Included in other income, net in the second quarter of 2002 is a net gain on
foreign exchange of $1.1 million related to the strengthening of the euro
against the U.S. dollar during the quarter.
Income Taxes
Our combined federal, state and foreign annual effective tax rate for the three
and nine months ended September 30, 2002, is 23% compared to 22% for the
comparable periods in 2001. FileNET management will continue weighing various
factors for the remainder of the year to assess the recoverability of its
recorded deferred assets and the need for any valuation allowance against such
amounts. Any adjustment to the valuation allowance could affect the effective
tax rate in subsequent quarters.
19
Liquidity and Capital Resources
At September 30, 2002, combined cash, cash equivalents and investments totaled
$176.3 million, an increase of $4.1 million from December 31, 2001. Cash
provided by operating activities during the nine months ended September 30, 2002
totaled $16.0 million and resulted primarily from an increase in unearned
maintenance revenue related to prepaid maintenance contracts, an increase in
accrued compensation and benefits, net income, and additions to net income for
depreciation and amortization expense, offset by increases in accounts
receivable and an increase in prepaid expenses. Cash used for investing
activities totaled $28.7 million and included capital expenditures of $8.6
million, a $1.9 million note receivable from an officer, $9.4 million for the
eGrail acquisition, and net purchases of marketable securities of $8.9 million.
Cash provided by financing activities totaled $2.6 million and was a result of
proceeds received from the exercise of employee stock options and stock
purchases under the employee stock purchase plan offset by payments on capital
lease obligations. Exchange rate changes during the first nine months of 2002
provided an increase in cash of $4.1 million.
Accounts receivable increased to $43.7 million at September 30, 2002 from $36.9
million at December 31, 2001. This increase is primarily a result of higher days
sales outstanding due to slightly slower overall collections. Current
liabilities increased to $88.1 million at September 30, 2002 from $79.6 million
at December 31, 2001 primarily due to an increase in unearned maintenance
revenue from $31.0 million at December 31, 2001 to $40.0 million at September
30, 2002. This increase is primarily the result of the growth in our base of
annual support contracts resulting from new customer sales and sales of
additional products to the existing base. Additionally, a significant number of
maintenance contracts renew early in the year and are amortized ratably
throughout the year resulting in the lower balance in unearned maintenance by
December 31.
We have a $5.0 million multi-currency revolving line of credit available until
June 27, 2003. Borrowings under the arrangement are unsecured and bear interest
at one hundred and twenty-five basis points over the London Interbank Offered
Rate. A standby letter of credit fee of one hundred and twenty five basis points
per annum and a commitment fee of fifty basis points is assessed against any
undrawn amounts. There were no borrowings outstanding against our line of credit
at September 30, 2002. We have been using the line of credit as collateral for
issuance of letters of credit valued at approximately $500,000 in Europe for
certain government sales contracts and a small number of vendor contracts. We
are subject to certain financial covenants that include, but are not limited to,
compliance with specific balance sheet ratios, no two consecutive quarterly
losses, an aggregate loan limit to the officers not to exceed $5.0 million, and
a capital expenditure limit under this line of credit. As of September 30, 2002,
we were in compliance with all covenants.
Contractual cash obligations include third party license agreements, operating
leases for our corporate offices, sales offices, development and manufacturing
facilities, and other equipment under non-cancelable operating leases, some of
which have renewal options and generally provide for escalation of the annual
rental amount. The following table summarizes future minimum payments required
under these contractual obligations at September 30, 2002:
(In thousands)
2002 (remaining three months) $ 3,735
2003 14,718
2004 11,020
2005 9,635
2006 8,867
Thereafter 1,993
Total $ 49,968
Other contractual cash obligations include a short-term capital lease that
expires December 31, 2002 and has a remaining cash commitment of $511,000 at
September 30, 2002.
We expect capital expenditures to be slightly above current levels for the
remainder of 2002. We believe that our present cash balances together with
internally generated funds and credit lines will be sufficient to meet our
working capital and capital expenditure needs for at least the next twelve
months.
Other Financial Instruments
We enter into forward foreign exchange contracts as a hedge against the effects
of fluctuating currency exchange rates on monetary assets and liabilities
denominated in currencies other than the functional currency of the relevant
entity. We are exposed to market risk on the forward exchange contracts as a
result of changes in foreign exchange rates; however, the market risk should be
offset by changes in the valuation of the underlying exposures. Gains and losses
20
on these contracts, which equal the difference between the forward contract rate
and the prevailing market spot rate at the time of valuation, are recognized in
the consolidated statement of operations. These contracts mature every three
months at the end of each quarter. We open new hedge contracts on the last
business day of each quarter that will mature at the end of the following
quarter. The counterparties to these contracts are major financial institutions.
We use commercial rating agencies to evaluate the credit quality of the
counterparties and do not anticipate nonperformance by any counterparties. We do
not anticipate a material loss resulting from any credit risks related to any of
these institutions.
Recent Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 141, "Business Combinations," which was
effective immediately. SFAS No. 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001;
and it eliminated the pooling-of-interests method. The adoption of this standard
did not have a significant impact on our consolidated financial statements. Our
April 2002 acquisition of certain assets of eGrail, Inc. was accounted for in
compliance with this pronouncement (see Note 3 for details).
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which we adopted January 1, 2002. SFAS No. 142 requires that goodwill
and other intangible assets with indefinite useful lives no longer be amortized,
but instead be tested for impairment at least annually and written down when
impaired. SFAS No. 142 requires purchased intangible assets other than goodwill
to be amortized over their useful live unless these lives are determined to be
indefinite. In accordance with this Standard, we no longer amortize goodwill and
indefinite life intangible assets but evaluate their carrying value annually or
when events or circumstances indicate that their carrying value may be impaired.
Assembled workforce no longer meets the definition of a separately identified
intangible asset under the provisions of SFAS No. 141, Business Combinations,
and the unamortized balance of $182,000 was reclassified as goodwill at January
1, 2002. We ceased amortizing the goodwill balance of $10.1 million from our
2000 acquisition of Applications Partner Inc. as of January 1, 2002. We had no
indefinite life intangible assets as of January 1, 2002. In accordance with SFAS
No. 142, we are required to perform a two-step transitional impairment review.
We completed the first step of this review by June 30, 2002 with the
determination of the fair value of our reporting units in order to identify
whether the fair value of each reporting unit is less than its carrying amount.
In the event that the fair value of the reporting unit is less than the carrying
amount, the second step of the test would be required to determine if the
carrying value of goodwill exceeds the implied value. We determined that we did
not have a transitional impairment of goodwill and as of September 30, 2002, no
impairment of goodwill has been recognized. Goodwill will be tested for
impairment annually on July 1st of each year or earlier if indicators of
potential impairment exist. If estimates change, a materially different
impairment conclusion could result.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets." This Statement addresses financial accounting
and reporting for the impairment of long-lived assets and for the disposal of
long-lived assets and discontinued operations. SFAS No. 144 superseded SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of," and is effective for fiscal years beginning after
December 15, 2001. The adoption of this Standard on January 1, 2002 did not have
a material impact on our financial position and results of operations.
In November 2001, the FASB announced Emerging Issues Task Force ("EITF") Topic
No. D-103, "Income Statement Characterization of Reimbursements Received for
Out-of-Pocket Expense Incurred", is required to be applied in financial
reporting periods beginning after December 15, 2001. The EITF requires companies
to characterize reimbursements received for out-of-pocket expenses as revenues
in the statement of operations. Historically, we have netted reimbursements
received for out-of-pocket expenses against the related expenses in the
statement of operations. Application of this EITF requires that comparative
financial statements for prior periods be reclassified to comply with the
guidance. We adopted this EITF as of January 1, 2002 and have reclassified our
prior period consolidated financial statements to conform to the current
presentation. The adoption of this EITF did not have a material effect on total
revenues or gross margin percentages and has no impact on results of operations
as it required an equivalent increase to both revenue and cost of revenue.
Revenue and cost of revenue for the three months ended September 30, 2001
increased by $512,000 and increased by $1.7 million for the nine months ended
September 30, 2001. Comparable numbers for 2002 are not available as out-of
pocket expenses are characterized as revenue upon invoicing.
In July 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities," which addresses financial accounting and reporting
for costs associated with exit or disposal activities and supersedes EITF Issue
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." SFAS 146 requires that costs associated with exit or disposal
activities be recognized when they are incurred rather than at the date of a
commitment to an exit or disposal plan. SFAS 146 also establishes that the
21
liability should initially be measured and recorded at fair value. We will adopt
the provisions of SFAS 146 for exit or disposal activities that are initiated
after December 31, 2002.
Other Matters
European Monetary Union. On January 1, 1999, 11 of the 15 member countries of
the European Union established fixed conversion rates between their existing
sovereign currencies and the euro. These countries agreed to adopt the euro as
their common legal currency from that date. The legacy currencies remained legal
tender in these countries as a denomination of the euro between January 1, 1999
and January 1, 2002. Beginning on January 1, 2002, euro-denominated bills and
coins are now issued for cash transactions. For a period of up to six months
from this date, both legacy currencies and the euro were legal tender. By July
1, 2002, the participating countries withdrew all legacy currencies and now use
the euro.
We have made the necessary changes to our internal business systems to support
transactions denominated in the euro, including establishing euro price lists
for affected countries. We have been transacting in the euro currency since 1999
and have evaluated the impact the euro has had on our financial condition and
results of operations. Based on this evaluation to date, we currently do not
believe that there has been or will be a material impact on our financial
condition or results of operations as a result of the euro conversion.
Environmental Matters. We are not aware of any issues related to environmental
matters that have, or are expected to have, a material affect on our business
Risk Factors That May Affect Future Results
Our business, financial condition, operating results and prospects can be
impacted by a number of factors, including but not limited to those set forth
below and elsewhere in this report, any one of which could cause our actual
results to differ materially from recent results or from our anticipated future
results. Factors that may affect our business, financial condition and results
of operations include:
Our quarterly operating results may fluctuate in future periods and are not
predictable and, as a result, we may fail to meet expectations of investors and
analysts, causing our stock price to fluctuate or decline. Prior growth rates in
our revenue and operating results should not necessarily be considered
indicative of future growth or operating results. Our operating results have
fluctuated in the past and we anticipate our future operating results will
continue to fluctuate due to many factors, some of which are largely beyond our
control. These factors include, but are not limited to, the following:
o the industry-wide slow down in IT spending;
o general domestic and international economic and political conditions;
o the discretionary nature of our customers' budget and purchase cycles
and the absence of long-term customer purchase commitments;
o the tendency to realize a substantial percentage of our revenue in the
last weeks, or even days, of each quarter;
o the potential for delays or deferrals of customer orders;
o the budget cycles of our customers;
o the size, complexity and timing of individual transactions;
o changes in foreign currency exchange rates and the impact of the euro
currency;
o the length of our sales cycle;
o variations in the productivity of our sales force;
o the level of software product sold and price competition;
o the timing of new software introductions and software enhancements by
us and our competitors;
o the mix of sales by products, software, services and distribution
channels;
o project overruns associated with fixed price contracts;
o acquisitions by us and our competitors;
o our ability to develop and market new software products and control
costs;
o the quality of our customer support; and
o the level of international sales.
The decision to implement our products is subject to each customer's resources
and budget availability. Our quarterly sales generally include a mix of medium
sized orders, along with several large individual orders, and as a result, the
loss or delay of an individual large order could have a significant impact on
our quarterly operating results and revenue. Our operating expenses are based on
projected revenue trends and are generally fixed. Therefore, any shortfall from
22
projected revenue may cause significant fluctuations in operating results from
quarter to quarter. As a result of these factors, revenues and operating results
for any quarter are subject to fluctuations and are not predictable with any
significant degree of accuracy. Therefore, we believe that period-to-period
comparisons of our results of operations should not be relied upon as
indications of future performance. Moreover, such factors could cause our
operating results in a given quarter to be below the expectations of public
market analysts and investors. In either case, the price of our common stock
could decline materially.
The markets in which we operate are highly competitive and we cannot be sure
that we will be able to continue to compete effectively, which could result in
lost market share and reduced revenue. The markets we serve are highly
competitive and we expect competition to intensify. Our future financial
performance will depend primarily on the continued growth of the markets for our
software products and services as well as the purchase of our products by
customers in these markets. If the markets we serve fail to grow or grow more
slowly than we currently anticipate, our business, financial condition and
operating results would be harmed. These intensely competitive markets can
change rapidly. There are multiple competitors of ours and there may be future
competitors, some of which have or may have substantially greater sales,
marketing, development and financial resources. As a consequence, our present or
future competitors may be able to develop software products comparable or
superior to those offered by us, offer lower priced products or adapt more
quickly than we do to new technologies or evolving customer requirements. In
order to be successful in the future, we must respond to technological change,
customer requirements and competitors' current software products and
innovations. We cannot assure that we will be able to continue to compete
effectively in our target markets or that future competition will not have a
material adverse effect on our business, financial condition or results of
operations. In addition, current and potential competitors have established or
may establish cooperative relationships among themselves or with third parties
to increase the ability of their products to address the needs of the markets we
serve. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. Increased
competition may result in price reductions, reduced gross margins and loss of
market share, any of which could have a material adverse effect on our business,
financial condition and results of operations.
We must develop and sell new products to keep up with rapid technological change
in order to achieve future revenue growth and profitability. The market for our
software and services is characterized by rapid technological developments,
evolving industry standards, changes in customer requirements and frequent new
product introductions and enhancements. Our ability to continue to sell products
will be dependent upon our ability to continue to enhance our existing software
and services offerings, develop and introduce, in a timely manner, new software
products incorporating technological advances and respond to customer
requirements. Our future success also depends, in part, on our ability to
execute on our strategy of developing a framework for Business Process
Management solutions for the ECM market. This strategy may require us to develop
and maintain relations with technology partners. We may not be successful in
maintaining these relationships or in developing, marketing and releasing new
products or new versions of our products that respond to technological
developments, evolving industry standards or changing customer requirements. We
may also experience difficulties that could delay or prevent the successful
development, introduction and sale of these products and enhancements. In
addition, these products and enhancements may not adequately meet the
requirements of the marketplace and may not achieve any significant degree of
market acceptance. If we fail to successfully maintain or establish
relationships with technology partners or to execute on our integrated product
solution strategy, or if release dates of any future products or enhancements
are delayed, or if these products or enhancements fail to achieve market
acceptance when released, our business operating results and financial condition
could be materially harmed. In the past, we have experienced delays in the
release dates of enhancements and new releases to our products and we cannot
assure that we will not experience significant future delays in product
introduction. From time to time, our competitors or we may announce new software
products, capabilities or technologies that have the potential to replace or
shorten the life cycles of our existing software products. We cannot assure that
announcements of currently planned or other new software products will not cause
customers to delay their purchasing decisions in anticipation of such software
products, and such delays could have a material adverse effect on our business
and operating results.
Protection of our intellectual property and other proprietary rights is limited,
which could result in the use of our technology by competitors or other third
parties. There is risk of third-party claims of infringement, which could expose
us to litigation and other costs. Our success depends, in part, on our ability
to protect our proprietary rights to the technologies used in our principal
products. We rely on a combination of copyrights, trademarks, trade secrets,
patents, confidentiality procedures and contractual provisions to protect our
proprietary rights in our software products. We cannot assure that our existing
or future copyrights, trademarks, trade secrets, patents or other intellectual
property rights will have sufficient scope or strength to provide meaningful
protection or a commercial advantage to us. In addition, the laws of some
foreign countries do not protect our proprietary rights to the same extent, as
do the laws of the United States. Our inability to protect our intellectual
property may have a material adverse effect on our business, financial condition
and results of operations.
23
We may, from time to time, be notified that we are infringing certain patent or
intellectual property rights of others. While there are no material actions
currently pending against us for infringement of patent or other proprietary
rights of third parties, we cannot assure that third parties will not initiate
infringement actions against us in the future. Combinations of technology
acquired through past or future acquisitions and our technology will create new
software products and technology that also may give rise to claims of
infringement. Infringement actions can result in substantial costs and diversion
of resources, regardless of the merits of the actions. If we were found to
infringe upon the rights of others, we cannot assure that we could redesign the
infringing products or could obtain licenses on acceptable terms, if at all.
Additionally, significant damages for past infringement could be assessed or
future litigation relative to any such licenses or usage could occur. An adverse
disposition of any claims or the advent of litigation arising out of any claims
of infringement may have a material adverse effect on our business, financial
condition and results of operations.
We depend on certain strategic relationships in order to license third-party
products and revenue related to these products could be at risk if we were
unable to maintain these relationships. In order to expand the distribution of
our products and broaden our product offerings, we have established strategic
relationships with a number of indirect channel partners and other consultants
that provide marketing and sales opportunities for us. We have entered into key
formal and informal agreements with other companies such as IBM Crossworlds,
Microsoft Corporation, SAP AG, Siebel Systems Inc, Sun Microsystems, Inc., BEA,
EMC and Verity, Inc. Certain of these agreements do not have minimum purchase
requirements and/or are cancelable at will. We cannot assure that these
companies will not reduce or discontinue their relationships with, or support
of, FileNET and our products. Our failure to maintain these relationships, or to
establish new relationships in the future, could harm our business, financial
condition and results of operations.
We currently license certain software from third parties, including software
that is integrated with internally developed software and used in our products
to perform key functions. In the past, we have had difficulty renewing certain
licenses. The failure to continue to maintain these licenses would prohibit us
from selling certain products. We cannot assure that such third parties will
remain in business, that they will continue to support their software products
or that their software products will continue to be available to us on
acceptable terms. The loss or inability to maintain any of these software
licenses could result in shipment delays or reductions in software shipments
until equivalent software can be developed, identified, licensed, and
integrated. This could adversely affect our business, financial condition or
results of operations.
We must retain and attract key executives and personnel who are essential to our
business, which could result in increased personnel expenses. Our success
depends to a significant degree upon the continued contributions of our key
management, as well as other marketing, technical and operational personnel. The
loss of the services of one or more key employees could have a material adverse
effect on our operating results. We also believe our future success will depend
in large part upon our ability to attract and retain additional highly skilled
management, technical, marketing, product development and operational personnel
and consultants. There is competition for such personnel; particularly software
developers, professional service consultants and other technical personnel, and
pay scales in the software industry have significantly increased. We cannot
assure that in the future we will be successful in attracting and retaining such
personnel.
A significant percent of our revenue is derived internationally and we are
subject to many risks internationally, which could put our revenue at risk.
Historically, we have derived approximately 25%-30% of our total revenue from
international sales through our worldwide network of subsidiaries and channel
partners. International business is subject to certain risks including, but not
limited to, the following:
o tariffs and trade barriers;
o varying technical standards;
o political and economic instability;
o reduced protection for intellectual property rights in certain
countries;
o difficulties in staffing and maintaining foreign operations;
o difficulties in managing foreign distributors;
o varying requirements for localized products;
o potentially adverse tax consequences;
o currency restrictions and currency exchange fluctuations including
those related to the euro;
o the burden of complying with a wide variety of complex foreign laws,
regulations and treaties;
o the possibility of difficulties in collecting accounts receivable; and
o longer payment cycles.
Any of these factors could have a material adverse effect on our business,
financial condition or results of operations in the future.
24
If our products contain errors we could incur unplanned expenses and delays that
could result in reduced revenue, lower profits, and harmful publicity. Software,
services and products as complex as those we sell are susceptible to errors or
failures, especially when first introduced or deployed. Our software products
are often intended for use in applications that are critical to a customer's
business. As a result, our customers may rely on the effective performance of
our software to a greater extent than the market for software products
generally. Despite internal testing and testing by current and potential
customers, new products or enhancements may contain undetected errors or
performance problems that are discovered only after a product has been installed
and used by customers. Errors or performance problems could cause delays in
product introduction and shipments or could require design modifications, either
of which could lead to a loss in or delay of revenue. These problems could cause
a diversion of development resources, harm our reputation or result in increased
service or warranty costs, or require the payment of monetary damages, any of
which could harm our business, operating results and financial condition. While
our license agreements with customers typically contain provisions designed to
limit our exposure to potential product liability claims, it is possible that
such limitation of liability provisions may not be effective under the laws of
certain jurisdictions.
Our stock price has been and may continue to be volatile causing fluctuations in
the market price of our stock, which would impact shareholder value. The trading
price of our common stock has fluctuated in the past and is subject to
significant fluctuations in response to the following factors, among others,
some of which are beyond our control:
o variations in quarterly operating results;
o fluctuations in our order levels;
o changes in earnings estimates by analysts;
o announcements of technological innovations or new products or
product enhancements by us or our competitors;
o key management changes;
o changes in joint marketing and development programs;
o developments relating to patents or other intellectual property
rights or disputes;
o developments in our relationships with our customers, resellers
and suppliers;
o our announcements of significant contracts, acquisitions,
strategic partnerships or joint ventures;
o general conditions in the software and computer industries;
o fluctuations in general stock market prices and volume, which
are particularly common among highly volatile securities of
Internet and software companies; and
o other general economic and political conditions.
In recent months, the stock market, in general, has experienced extreme price
and volume fluctuations that have affected the market price for many companies
in industries similar to ours. Some of these fluctuations have been unrelated to
the operating performance of the affected companies. These market fluctuations
may decrease the market price of our common stock in the future.
We depend on a single source for certain hardware components and revenue related
to these products could be at risk if we were unable to obtain inventory.
Certain components for the Company's proprietary 12-inch OSARs are available
only from a single source. Any inability to obtain components in the amounts
needed on a timely basis could result in delays in product shipments that could
have an adverse effect on the Company's operating results. The Company has
qualified 5 1/4-inch optical storage and retrieval devices from an alternative
source which could be utilized by the Company's customers in the event of any
interruptions in the delivery of components for the Company's own OSAR product.
Acquisitions of companies or technologies may result in disruptions to our
business and diversion of management attention, which could cause our financial
performance to suffer. As part of our business strategy, we frequently evaluate
strategic acquisition opportunities. For example, on April 2, 2002, we acquired
certain assets and assumed certain liabilities of eGrail, Inc., a Web content
management company, for a purchase price of $9.0 million in cash. We anticipate
that our future growth may depend in part on our ability to identify and acquire
complementary businesses, technologies or product lines. Acquisitions involve
significant risks and could divert management's attention from the day-to-day
operations of our ongoing business. Additionally, such acquisitions may include
numerous other risks, including, but not limited to the following:
o difficulties in the integration of the operations, products and
personnel of the acquired companies;
o the incurrence of debt;
o liabilities and risks that are not known or identifiable at the
time of the acquisition;
o difficulties in retaining the acquired company's customer base; and
o the potential loss of key personnel of the acquired company.
25
If we fail to successfully manage future acquisitions or fully integrate future
acquired businesses, products or technologies with our existing operations, we
may not receive the intended benefits of the acquisitions and such acquisitions
may harm our business and financial results.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates primarily
to our investment portfolio. We have not used derivative financial instruments
in our investment portfolio. We place our investments with high-quality issuers
and, by policy, limit the amount of credit exposure to any one issuer. We
protect and preserve our invested funds by limiting default, market and
reinvestment risk. Our investments in marketable securities consist primarily of
high-grade corporate and government securities with maturities of less than
three years. Investments purchased with an original maturity of three months or
less are considered to be cash equivalents. We classify all of our investments
as available-for-sale. Available-for-sale securities are carried at fair value,
with unrealized gains and losses, net of tax, reported in a separate component
of stockholders' equity. Average maturity of our investment portfolio is 4.5
months; therefore the movement of interest rates should not have a material
impact on our balance sheet or income statement.
The following table provides information about our cash and cash equivalents and
our investment portfolio at September 30, 2002 (dollars in thousands):
Weighted
Average
Portfolio Balance Yield
Cash and Equivalents-Domestic $ 52,793 1.79%
Cash and Equivalents-International 48,669 2.97%
Short Term Municipals - Taxable 8,089 2.03%
Commercial Paper 2,996 1.93%
Corporate 7,249 2.38%
Governments/Agencies 56,521 2.38%
Total $ 176,317 2.37%
The contractual maturities of investments at September 30, 2002 are shown below.
Actual maturities may differ from contractual maturities because the issuer of
the securities may have the right to repurchase such securities. The Company
classifies short-term investments in current assets as all such investments are
available for current operations.
(In thousands) Estimated
Cost Fair Value
Debt Securities
Due in one year or less:
Short-term munis-taxable $ 5,751 $ 5,752
Commercial paper 2,996 2,996
Corporate 3,535 3,536
Governments/Agencies 34,381 34,442
Due in one to three years:
Taxable Munis 2,334 2,337
Commercial Paper - -
Corporate 3,699 3,714
Government/Agencies 22,054 22,078
Total $ 74,750 $ 74,855
26
Foreign Currency Fluctuations and Inflation
Our performance can be affected by changes in foreign currency values relative
to the U.S. dollar in relation to the Company's revenue and operating expenses.
As of September 30, 2002, we had forward foreign exchange contracts outstanding
totaling approximately $14,590,485 in nine currencies. These contracts were
opened on the last business day of the quarter and mature within three months.
Cumulative other comprehensive loss decreased $5.2 million for the nine months
ended September 30, 2002 due to unrealized foreign currency translation gains
resulting from the strengthening of the euro against the U.S. dollar during the
second quarter of 2002.
Management believes that inflation has not had a significant impact on the
prices of our products, the cost of our materials, or our operating results for
the three and nine months ended September 30, 2002 and 2001.
Item 4. Controls and Procedures
(a) We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our reports under
the Securities Exchange Act of 1934 is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and
forms, and that such information is accumulated and communicated to
our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and
management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and
procedures.
Within 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based on the foregoing, our Chief
Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective.
(b) Changes in internal controls. There were no significant changes in our
internal controls or in other factors that could significantly affect
our internal controls subsequent to the date of the evaluation.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See Notes to Consolidated Financial Statements.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The list of exhibits contained in the accompanying Index to Exhibits is
herein incorporated by reference.
(b) Reports on Form 8-K
On August 14, 2002, the Registrant filed a report on Form 8-K relating
to the Registrant's Regulation FD Disclosure and Certifications of the
Chief Executive Officer and Chief Financial Officer.
27
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FILENET CORPORATION
November 13, 2002
Date
By: /s/ Sam M. Auriemma
Sam M. Auriemma, Senior Vice President, Finance
(Principal Financial and Accounting Officer)
and Chief Financial Officer
28
CERTIFICATION
I, Lee D. Roberts, Chief Executive Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of FileNET Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
November 13, 2002
Date
/s/ Lee D. Roberts
Lee D. Roberts
Chief Executive Officer
29
CERTIFICATION
I, Sam M. Auriemma, Chief Financial Officer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of FileNET Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
November 13, 2002
Date
/s/ Sam M. Auriemma
Sam M. Auriemma
Chief Financial Officer
30
Index to Exhibits
Exhibit
No. Exhibit Description
3.1* Restated Certificate of Incorporation, as amended (filed as Exhibit 3.1 to
Registrant's Form S-4 filed on January 26, 1996; Registration No.
333-00676).
3.1.1* Certificate of Amendment of Restated Certificate of Incorporation (filed
as Exhibit 3.1.1 to Registrant's Form S-4 filed on January 26, 1996;
Registration No. 333-00676).
3.2* Bylaws (filed as Exhibit 3.2 of the Registrant's registration statement on
Form S-1, filed on July 21, 1987; Registration No. 33-15004).
4.1* Form of certificate evidencing Common Stock (filed as Exhibit 4.1 to
Registrant's registration statement on Form S-1, filed on July 21, 1987;
Registration No. 33-15004).
4.2* Rights Agreement, dated as of November 4, 1988 between FileNET Corporation
and the First National Bank of Boston, which includes the form of Rights
Certificate as Exhibit A and the Summary of Rights to Purchase Common
Shares as Exhibit B (filed as Exhibit 4.2 to Registrant's registration
statement on Form S-4 filed on January 26, 1996; Registration No.
333-00676).
4.3* Amendment One dated July 31, 1998 and Amendment Two dated November 9, 1998
to Rights Agreement dated as of November 4, 1988 between FileNET
Corporation and BANKBOSTON, N.A. formerly known as The First National Bank
of Boston (filed as Exhibit 4.3 to Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1998).
4.4* Amendment Three dated November 30, 2001 to Rights Agreement dated as of
November 4, 1988 between FileNET Corporation and Equiserve Trust Company,
N.A., successors to BANKBOSTON, N.A. (filed as Exhibit 4.4 to Registrant's
Annual Report on Form 10-K filed for the year ended December 31, 2001).
10.1* Second Amended and Restated Credit Agreement (Multi-currency) by and
between the Registrant and Bank of America National Trust and Savings
Association dated June 30, 1999, effective June 30, 1999 (filed as Exhibit
10.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1999) as amended by a Waiver and First Amendment to Credit
Agreement dated as of June 29, 2001 and by a letter amendment dated as of
April 5, 2002.
10.1.1* Waiver and First Amendment to Credit Agreement (Multi-currency) by and
between the Registrant and Bank of America, N.A., formerly known as Bank of
America National Trust and Savings Association, dated June 29, 2001,
effective June 29, 2001 (filed as Exhibit 10.1 to Registrant's Annual
Report on Form 10-K filed for the year ended December 31, 2001).
10.1.2* Letter amendment dated as of April 5, 2002 and Third Amendment to Credit
Agreement (Multi-currency) by and between the Registrant and Bank of
America, N.A., dated as of June 28, 2002 (filed as Exhibit 10.1.2 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30,
2002).
10.2*+ Amended and Restated 1995 Stock Option Plan of FileNET (filed as Exhibit
99.1 to Registrant's registration statement on Form S-8 filed on October
15, 2001; Registration No. 333-71598).
10.3*+ Second Amended and Restated 1986 Stock Option Plan of FileNET
Corporation, together with the forms of Incentive Stock Option Agreement
and Non-Qualified Stock Option Agreement (filed as Exhibits 4(a), 4(b) and
4(c), respectively, to the Registrant's registration statement on Form S-8,
filed on June 10, 1992; Registration No. 33-48499), the first Amendment
thereto (filed as Exhibit 4(d) to the Registrant's registration statement
on Form S-8, filed on October 4, 1993; Registration No. 33-69920), and the
Second Amendment thereto (filed as Appendix A to the Registrant's
Definitive Proxy Statement on Schedule 14A for the Registrant's 1994 Annual
Meeting of Stockholders, filed on April 29, 1994).
10.4*+ Non-Statutory Stock Option Agreement (with Notice of Grant of Stock
Option and Special Addendum) between Registrant and Mr. Lee Roberts (filed
as Exhibit 99.17 to Registrant's registration statement on Form S-8 filed
on August 20, 1997).
10.5*+ Non-Statutory Stock Option Agreement (with Notice of Grant of Stock
Option and Special Addendum) between Registrant and Mr. Ron Ercanbrack
(filed as Exhibit 99.19 to Registrant's registration statement on Form S-8
filed on August 20, 1997).
10.6*+ Amended and Restated FileNET Corporation 1998 Employee Stock Purchase
Plan (filed as Appendix B to Registrant's Definitive Proxy Statement on
Schedule 14A, for the Registrant's 2002 Annual Meeting of Stockholders,
filed on April 18, 2002).
10.7*+ FileNET Corporation International Employee Stock Purchase Plan (filed as
Appendix C to Registrant's Definitive Proxy Statement on Schedule 14A, for
the Registrant's 2002 Annual Meeting of Stockholders, filed on April 18,
2002).
31
10.8* Lease between the Registrant and C. J. Segerstrom and Sons for the
headquarters of the Company, dated September 1, 1999 (filed as Exhibit
10.23 to Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 1999).
10.9* Asset Purchase Agreement between the Registrant and Application Partners,
Inc. dated May 18, 2000 (filed as Exhibit 10.24 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2000).
10.10*+ Written Compensation Agreement and Non-Statutory Stock Option Agreement
(with Notice of Grant of Stock Option and Special Addendum) between
Registrant and Mr. Sam Auriemma (filed as Exhibit 99.1 and 99.2 to
Registrant's registration statement on Form S-8, filed on April 20, 2001;
Registration No. 333-59274).
10.11* Asset Purchase Agreement dated April 2, 2002 by and between 3565
Acquisition Corporation and eGrail, Inc. (filed as Exhibit 10.1 to
Registrant's Current Report on Form 8-K, filed on April 12, 2002). 10.12*+
Secured Promissory Note between Registrant and Mr. Lee D Roberts dated June
14, 2002 (filed as Exhibit 10.12 to Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 2002).
10.13*+ Option Exchange Agreement between Registrant and Mr. Ron L. Ercanbrack,
dated May 22, 2002, together with form of Incentive Stock Option Agreement
and Grant Notice. (filed as Exhibit 10.13 to Registrant's Quarterly Report
on Form 10-Q for the quarter ended June 30, 2002).
10.14*+ The 2002 Incentive Award Plan, as approved by stockholders at the
Registrant's Annual Meeting on May 22, 2002, together with the forms of
Incentive Option Agreement and Non-Qualified Stock Option Agreement for
Independent Directors (filed as Exhibit 10.14 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002).
10.14.1+ Amended Form of 2002 Incentive Award Plan Incentive Option Agreement
(with Notice of Grant of Stock Option).
10.14.2+ Amended Form of 2002 Incentive Award Plan Non-qualified Stock Option
Agreement for Independent Directors (with Notice of Grant of Stock Option).
* Incorporated herein by reference
+ Management contract, compensatory plan or arrangement
32
Exhibit 10.14.1
Effective as of 2002
2002 STOCK OPTION AGREEMENT
TERMS AND CONDITIONS
These Terms and Conditions constitute a part of the Stock Option Agreement,
concerning certain Options granted by FileNET Corporation, a Delaware
corporation hereinafter referred to as "Company," to the grantee of the Company
(or a Subsidiary of the Company) listed on the Notice of Grant, hereinafter
referred to as "Optionee." These Terms and Conditions and the Notice of Grant
are collectively referred to as the "Agreement."
WHEREAS, the Company wishes to afford the Optionee the opportunity to
purchase shares of its $0.01 par value Common Stock;
WHEREAS, the Company wishes to carry out The 2002 Incentive Award Plan of
FileNET Corporation, as the same may be amended from time to time (the "Plan")
(the terms of which are hereby incorporated by reference and made a part of this
Agreement); and
WHEREAS, the Administrator under the Plan has determined that it would be
to the advantage and best interest of the Company and its stockholders to grant
the Option provided for herein to the Optionee as an inducement to enter into or
remain in the service of the Company or a Subsidiary of the Company and as an
incentive for increased efforts during such service, and has advised the Company
thereof and instructed the undersigned officers to issue said Option.
NOW, THEREFORE, in consideration of the mutual covenants herein contained
and other good and valuable consideration, receipt of which is hereby
acknowledged, the parties hereto do hereby agree as follows:
ARTICLE I.
DEFINITIONS
Whenever the following terms are used in this Agreement, they shall have
the meaning specified below unless the context clearly indicates to the
contrary. The masculine pronoun shall include the feminine and neuter, and the
singular the plural, where the context so indicates. Capitalized terms used but
not defined in this Agreement shall have the meaning ascribed to such terms in
the Plan.
Section 1.1. Cause
"Cause" shall mean: (i) Optionee's commission of any act of theft, fraud,
embezzlement or dishonesty; or (ii) Optionee's willful or intentional misconduct
adversely affecting the business or affairs of the Company or any Subsidiary; or
(iii) Optionee's unauthorized use or disclosure of confidential information or
trade secrets of the Company or any Subsidiary. The foregoing definition shall
not be deemed to be inclusive of all acts or omissions that the Company or any
Subsidiary may consider as grounds for the dismissal or discharge of any
Optionee.
ARTICLE II.
GRANT OF OPTION
Section 2.1. Grant of Option
Effective as of the date set forth on the Notice of Grant, the Company
irrevocably grants to the Optionee the option to purchase any part or all of the
aggregate number of shares of its Common Stock set forth on the Notice of Grant,
all upon the terms and conditions set forth in this Agreement (the "Option").
Section 2.2. Purchase Price
The purchase price of the shares of Common Stock covered by the Option is
set forth on the Notice of Grant, and shall not be subject to commission or
other charge.
Section 2.3. Consideration to Company
In consideration of the granting of this Option by the Company, the
Optionee agrees to render faithful and efficient services to the Company or its
any Subsidiary, with such duties and responsibilities as the Company or any
Subsidiary shall from time to time prescribe, for a period of at least one (1)
year from the date this Option is granted.
ARTICLE III.
PERIOD OF EXERCISABILITY
Section 3.1. Commencement of Exercisability
The Option shall become exercisable in the time and manner set forth on the
Notice of Grant. Except as otherwise may be provided by the Administrator, no
portion of the Option that is unexercisable at Termination of Employment shall
thereafter become exercisable.
Section 3.2. Duration of Exercisability
The installments provided for in Section 3.1 are cumulative. Each such
installment that becomes exercisable pursuant to Section 3.1 shall remain
exercisable until it becomes unexercisable under Section 3.3.
2
Section 3.2.1. Expiration of Option
Except to the extent otherwise set forth in any severance, change in
control or employment agreement (see section 5.8), if applicable, the Option may
not be exercised to any extent by anyone after the first to occur of the
following events:
(a) The expiration of ten (10) years from the date the Option was granted,
as set forth on the Notice of Grant;
(b) The time of the Optionee's Termination of Employment for Cause;
(c) The expiration of three (3) months from the date of the Optionee's
Termination of Employment by reason of his retirement, resignation or
termination of his employment not for Cause, unless the Optionee dies
within said three-month period;
(d) The expiration of one (1) year from the date of the Optionee's
Termination of Employment by reason of his disability;
(e) The expiration of one (1) year from the date of the Optionee's death;
or
(f) The effective date of a Corporate Transaction, unless the successor
corporation or a parent or subsidiary of the successor corporation
assumes or substitutes the Option as described in Section 3.5. At
least fifteen (15) days prior to the effective date of a Corporate
Transaction as to which the successor corporation or a parent or
subsidiary of the successor corporation does not assume or substitute
the Option, the Administrator shall give the Optionee notice of such
event if the Option has then neither been fully exercised nor become
unexercisable under this Section 3.3.
Section 3.3. Special Tax Consequences
The Optionee acknowledges that, to the extent that the aggregate fair
market value of stock with respect to which "incentive stock options" (within
the meaning of Section 422 of the Code, but without regard to Section 422(d) of
the Code), including all or such portion of the Option elected by the Optionee
to be treated as an incentive stock option, are exercisable for the first time
by the Optionee during any calendar year (under the Plan and all other incentive
stock option plans of the Company and any Subsidiary of the Company) exceeds
$100,000, such options shall be treated for all purposes as not qualifying under
Section 422 of the Code and therefore shall be subject to taxation as
non-qualified options. The Optionee further acknowledges that the rules set
forth in the preceding sentence shall be applied by taking options into account
in the order in which they were granted. For purposes of these rules, the fair
market value of stock shall be determined as of the time the option with respect
to such stock option is granted.
Section 3.4. Acceleration of Option
(a) This Option, to the extent outstanding at the time of a Corporate
Transaction, but not otherwise fully exercisable, shall automatically
accelerate so that this Option shall, immediately prior to the
effective date of the Corporate Transaction, become exercisable for
3
all of the Option Shares at the time subject to this Option and may be
exercised for any or all of those Option Shares as fully-vested shares
of Common Stock. No such acceleration of this Option, however, shall
occur if and to the extent this Option is, in connection with the
Corporate Transaction: (i) to be assumed by the successor corporation
(or parent or subsidiary thereof) or to be substituted with a
comparable right to purchase or receive, for each share of optioned
stock subject to the Option immediately prior to the Corporate
Transaction, the consideration (whether stock, cash, or other
securities or property) received in the Corporate Transaction by
holders of Common Stock for each share held on the effective date of
the transaction; or (ii) to be replaced with a cash incentive program
of the successor corporation which preserves the spread existing on
the Option shares at the time of the Corporate Transaction (the excess
of the Fair Market Value of such Option shares over the aggregate
exercise price payable for those shares, appropriately adjusted) and
provides for subsequent pay-out in accordance with the Option exercise
schedule. The determination of Option comparability under clause shall
be made by the Plan Administrator, and such determination shall be
final, binding and conclusive.
(b) Immediately following the Corporate Transaction, this Option shall
terminate and cease to be outstanding, except to the extent assumed or
substituted by the successor corporation (or parent or subsidiary
thereof) in connection with the Corporate Transaction.
(c) If this Option is assumed in connection with the Corporate
Transaction, then this Option shall be appropriately adjusted,
immediately after such Corporate Transaction, to apply to the number
of and class of securities which would have been issuable to the
Optionee in consummation of such Corporate Transaction had the Option
been exercised immediately prior to such Corporate Transaction, and
appropriate adjustments shall also be made to the exercise price;
provided, that the aggregate exercise price shall remain the
same.
(d) This Agreement shall not in any way affect the right of the
Corporation to adjust, reclassify, reorganize or otherwise change its
capital or business structure or to merge, consolidate, dissolve,
liquidate or sell or transfer all or any part of its business or
assets.
ARTICLE IV.
EXERCISE OF OPTION
Section 4.1. Person Eligible to Exercise
(a) Except as provided in Section 4.1(b), during the lifetime of the
Optionee, only he or she may exercise the Option (or any portion
thereof), unless it has been disposed of with the consent of the
Committee pursuant to a DRO. After the death of the Optionee, any
exercisable portion of the Option may, prior to the time when such
portion becomes unexercisable under Section 3.3, be exercised by his
or her personal representative or by any person empowered to do so
under the deceased Optionee's will or under the then applicable laws
of descent and distribution.
4
(b) Notwithstanding Section 4.1(a), with the consent of the Administrator,
the Optionee may transfer the Option to any one or more Permitted
Transferees, subject to the following terms and conditions:
(i) the Option shall not be assignable or transferable by the
Permitted Transferee other than by will or the laws of descent
and distribution;
(ii) the Option shall continue to be subject to all the terms and
conditions of the Option as applicable to the Optionee (other
than the ability to further transfer the Option); and
(iii) the Optionee and the Permitted Transferee execute any and all
documents requested by the Administrator, including, without
limitation documents to (A) confirm the status of the transferee
as a Permitted Transferee, (B) satisfy any requirements for an
exemption for the transfer under applicable federal and state
securities laws and (C) evidence the transfer.
Section 4.2. Partial Exercise
(a) Any exercisable portion of the Option or the entire Option, if then
wholly exercisable, may be exercised in whole or in part at any time
prior to the time when the Option or portion thereof becomes
unexercisable under Section 3.3.
Section 4.3. Manner of Exercise
The Option, or any exercisable portion thereof, may be exercised solely by
delivery to the Secretary of the Company or his or her designee of all of the
following prior to the time when the Option or such portion becomes
unexercisable under Section 3.3:
(a) A notice complying with the applicable rules established by the
Administrator stating that the Option, or a portion thereof, is
exercised;
(b) Such representations and documents as the Administrator, in its
absolute discretion, deems necessary or advisable to effect compliance
with all applicable provisions of the Securities Act and any other
federal or state securities laws or regulations. The Administrator
may, in its absolute discretion, also take whatever additional actions
it deems appropriate to effect such compliance including, without
limitation, placing legends on share certificates and issuing
stop-transfer notices to agents and registrars;
(c) In the event that the Option shall be exercised pursuant to Section
4.1 by any person or persons other than the Optionee, appropriate
proof of the right of such person or persons to exercise the Option;
(d) Full cash payment to the Company for the shares with respect to which
the Option, or portion thereof, is exercised. However, the
Administrator may, in its discretion, (i) allow a delay in payment up
to 30 days from the date the Option, or portion thereof, is exercised;
(ii) allow payment, in whole or in part, through the delivery of
shares of Common Stock which have been owned by the Optionee for at
least six months, duly endorsed for transfer to the Company with a
5
Fair Market Value on the date of delivery equal to the aggregate
exercise price of the Option or exercised portion thereof; (iii) allow
payment, in whole or in part, through the surrender of shares of
Common Stock then issuable upon exercise of the Option having a Fair
Market Value on the date of Option exercise equal to the aggregate
exercise price of the Option or exercised portion thereof; (iv) allow
payment, in whole or in part, through a broker cashless exercise
procedure whereby the Optionee delivers a notice that the Optionee has
placed a market sell order with a broker with respect to shares of
Common Stock then issuable upon exercise of the Option, and that the
broker has been directed to pay a sufficient portion of the net
proceeds of the sale to the Company in satisfaction of the Option
exercise price, and payment of such proceeds is made to the Company
upon settlement of such sale; or (v) allow payment through any
combination of the consideration provided in the foregoing
subparagraphs (ii), (iii) and (iv). The Administrator may also permit
other forms of payment in its discretion as authorized by the Plan;
and
(e) The receipt by the Company of full payment for such shares, including
payment of any applicable withholding tax, which in the discretion of
the Administrator may be in the form of consideration used by the
Optionee to pay for such shares under Section 4.3(d).
Section 4.4. Conditions to Issuance of Stock Certificates.
The Company shall not be required to issue or deliver any certificate or
certificates for shares of stock purchased upon the exercise of any Option or
portion thereof prior to fulfillment of all of the following conditions:
(a) The admission of such shares to listing on all stock exchanges on
which such class of stock is then listed;
(b) The completion of any registration or other qualification of such
shares under any state or federal law, or under the rulings or
regulations of the Securities and Exchange Commission or any other
governmental regulatory body which the Administrator shall, in its
absolute discretion, deem necessary or advisable;
(c) The obtaining of any approval or other clearance from any state or
federal governmental agency which the Administrator shall, in its
absolute discretion, determine to be necessary or advisable; and
(d) The lapse of such reasonable period of time following the exercise of
the Option as the Administrator may establish from time to time for
reasons of administrative convenience.
Section 4.5 Rights as Stockholder
The holder of the option shall not have any stockholder rights with respect
to the shares of common stock purchasable upon exercise of the option until such
person shall have exercised the option, paid the exercise price and applicable
taxes, satisfies all other conditions of exercise and become a holder of record
of the purchased shares.
6
ARTICLE V.
OTHER PROVISIONS
Section 5.1. Administration
The Administrator shall have the power to interpret the Plan and this
Agreement and to adopt such rules for the administration, interpretation and
application of the Plan as are consistent therewith and to interpret or revoke
any such rules. All actions taken and all interpretations and determinations
made by the Administrator in good faith shall be final and binding upon the
Optionee, the Company and all other interested persons. No member of the
Administrator shall be personally liable for any action, determination or
interpretation made in good faith with respect to the Plan or the Option. In its
absolute discretion, the Board may at any time and from time to time exercise
any and all rights and duties of the Administrator under this Plan except with
respect to matters which under Rule 16b-3 or Section 162(m) of the Code, or any
regulations or rules issued thereunder, are required to be determined in the
sole discretion of the Administrator.
Section 5.2. Option Not Transferable
Except as provided in Section 4.1(b), neither the Option nor any interest
or right therein or part thereof shall be liable for the debts, contracts or
engagements of the Optionee or his successors in interest or shall be subject to
disposition by transfer, alienation, anticipation, pledge, encumbrance,
assignment or any other means whether such disposition be voluntary or
involuntary or by operation of law by judgment, levy, attachment, garnishment or
any other legal or equitable proceedings (including bankruptcy), and any
attempted disposition thereof shall be null and void and of no effect; provided,
however, that this Section 5.2 shall not prevent transfers by will or by the
applicable laws of descent and distribution or, with the consent of the
Committee, pursuant to a DRO.
Section 5.3. Shares to Be Reserved
The Company shall at all times during the term of the Option reserve and
keep available such number of shares of stock as will be sufficient to satisfy
the requirements of this Agreement.
Section 5.4 Notices
Any notice to be given under the terms of this Agreement to the Company
shall be addressed to the Company in care of its Secretary, and any notice to be
given to the Optionee shall be addressed to him at the address of record given
on the Notice of Grant or to any updated address provided by the Optionee. By a
notice given pursuant to this Section 5.4, either party may hereafter designate
a different address for notices to be given to him. Any notice that is required
to be given to the Optionee shall, if the Optionee is then deceased, be given to
the Optionee's personal representative if such representative has previously
informed the Company of his status and address by written notice under this
Section 5.4.
7
Section 5.5 Titles
Titles are provided herein for convenience only and are not to serve as a
basis for interpretation or construction of this Agreement.
Section 5.6 Construction
This Agreement shall be administered, interpreted and enforced under the
laws of the State of California, without resort to that State's conflict-of-laws
rules.
Section 5.7 Conformity to Securities Laws
The Optionee acknowledges that the Plan and this Agreement are intended to
conform to the extent necessary with all provisions of the Securities Act and
the Exchange Act and any and all regulations and rules promulgated by the
Securities and Exchange Commission thereunder, including without limitation Rule
16b-3. Notwithstanding anything herein to the contrary, the Plan shall be
administered, and the Option is granted and may be exercised, only in such a
manner as to conform to such laws, rules and regulations. To the extent
permitted by applicable law, the Plan and this Agreement shall be deemed amended
to the extent necessary to conform to such laws, rules and regulations.
Section 5.8 More Favorable Terms of Severance Programs Take Precedence
To the extent the terms and conditions contained in any severance or change
in control program, plan or agreement, or any employment agreement, with the
Optionee provide more favorable terms for the Option then those set forth herein
(including without limitation terms regarding accelerated vesting and extended
exercise periods), the more favorable terms of any such severance or change in
control program, plan or agreement or any employment agreement with the Optionee
will control.
Section 5.9 Data Privacy
As a condition of the grant of the Option, Optionee consents to the
collection, use, processing and transfer of personal data as described in this
paragraph. Optionee understands that the Company and its Affiliates hold certain
personal information about Optioneee, including Optionee's name, home address
and telephone number, date of birth, social security number or global
identification number, salary, nationality, job title, any shares of the Company
stock or the Company positions held, details of all options or any other
entitlement to shares awarded, canceled, exercised, vested, unvested or
outstanding in Optionee's favor, for the purpose of managing and administering
the Plan ("Data"). Optionee further understands that the Company and/or its
Affiliates will transfer Data amongst themselves as necessary for the purpose of
implementation, administration and management of Optionee's participation in the
Plan, and that the Company and/or any of its Affiliates may each further
transfer Data to any third parties assisting the Company in the implementation,
administration and management of the Plan. Optionee understands that these
recipients may be located in the United States, the European Economic Area, or
elsewhere. Optionee authorizes them to receive, possess, use, retain and
transfer the Data, in electronic or other form, for the purposes of
implementing, administering and managing Optionee's participation in the Plan,
8
including any requisite transfer of such Data as may be required for the
administration of the Plan and/or the subsequent holding of shares of stock on
Optionee's behalf to a broker or other third party with whom Optionee may elect
to deposit any shares of stock purchased under the Plan. Optionee understands
that Optionee may, at any time, review Data, require any necessary amendments to
it or withdraw the consents herein in writing by contacting the Secretary of the
Company. Withdrawal of consent may, however, affect Optionee's ability to
exercise or realize benefits from the Option.
9
FileNET Corporation
ID: 95-3757924
Form of Notice of Grant of Stock Options
and Option Agreement
Employee Name Option Number: xxxxxxx
Street Address Plan: xxxxxxx
City, CA USA Zip Code
Effective_______________, you have been granted a(n) [Incentive/Non-Qualified]
Stock Option to buy _________ shares of FileNET Corporation (the Company) stock
at $____________ per share.
The total option price of the shares granted is $_______________.
Shares in each period will become fully vested on the date shown.
Shares Vest Type Full Vest Expiration
xxx xxxxxxxxx xxxxxxxx xxxxxxxx
xxx xxxxxxxxx xxxxxxxx xxxxxxxx
By your signature and the Company's signature below, you and the Company agree
that these options are granted under and governed by the terms and conditions of
the 2002 Incentive Award Plan and the Option Agreement, all of which are located
on and may be accessed via FileNET's Intranet, now.
FileNET Corporation Date
Employee Name Date
Date:
Time:
10
Exhibit 10.14.2
Effective as of 2002
FILENET CORPORATION
NON-QUALIFIED 2002 STOCK OPTION AGREEMENT
FOR INDEPENDENT DIRECTORS
TERMS AND CONDITIONS
These Terms and Conditions constitute a part of the Stock Option Agreement,
concerning certain Options granted by FileNET Corporation, a Delaware
corporation hereinafter referred to as "Corporation," to the director of the
Corporation listed on the Notice of Grant, hereinafter referred to as
"Optionee." These Terms and Conditions and the Notice of Grant are collectively
referred to as the "Agreement."
Recitals
WHEREAS, the Corporation wishes to carry out The 2002 Incentive Award Plan
of FileNET Corporation, as the same may be amended from time to time (the
"Plan"), the terms of which are hereby incorporated by reference and made a part
of this Agreement; and
WHEREAS, in order to provide such directors with a meaningful incentive to
continue to serve as members of the Corporation's Board, the Plan provides for
the automatic grant to the Corporation's Independent Directors of Options to
purchase the Corporation's common stock over the period of such director's Board
service to the Corporation; and
WHEREAS, the Optionee is an Independent Director of the Corporation;
WHEREAS, all capitalized terms in this Agreement shall have the meaning
assigned to them in the Plan.
Agreement
NOW, THEREFORE, in consideration of the mutual covenants herein contained
and other good and valuable consideration, receipt of which is hereby
acknowledged, the parties hereto do hereby agree as follows:
1. Grant of Option. The Corporation hereby irrevocable grants to
Optionee, as of the grant date specifiedon the Notice of Grant (the
"Grant Date"), a Non-Qualified Option to purchase up to the number of
shares of the Corporation's Common Stock, par value $0.01 per share,
specified on the Notice of Grant (the "Option"). The exercise price
per share of Common Stock subject to the Option is set forth on the
Notice of Grant, which is the average of the high and low selling
price per share of Common Stock as of the Option Grant Date, and shall
not be subject to commission or other charge.
2. Vesting.
(a) The Option shall vest 25% per year on each of the first, second,
third and fourth anniversary of the Option Grant Date, provided
the Optionee continues as an Independent Director on each such
anniversary.
(b) Notwithstanding the foregoing:
(i) in the event of Termination of Directorship due to death or
Permanent Disability, the Option shall become automatically
100% vested and exercisable in full upon such date of
Termination of Directorship; and
(ii) in the event of a Change in Control or Corporate
Transaction, the Option shall become automatically 100%
vested and exercisable in full upon such Change in Control
or upon the fifth day immediately preceding the consummation
of such Corporate Transaction.
(c) In no event shall any portion of the Option vest following
Optionee's Termination of Directorship.
(d) The vesting installments provided for in this Section 2 are
cumulative. Each such installment that becomes exercisable shall
remain exercisable until the Option terminates or expires under
Section 3.
3. Option Term and Exercise Period.
(a) The Option shall have a term of ten (10) years measured from the
Option Grant Date and shall accordingly expire, and become
unexercisable at the close of business on the Option expiration
date specified on the Notice of Grant, subject to earlier
termination in accordance with the following paragraph (b).
(b) The Option shall terminate and may not be exercised to any extent
by anyone as of the first to occur of the following events:
(i) The expiration of ten (10) years from the Option Grant Date;
or
(ii) The expiration of twelve (12) months from the date of the
Optionee's Termination of Directorship for any reason.
(iii) The effective date of a Corporate Transaction, unless the
Board waives this provision in connection with such
transaction and such waiver is consistent with Rule 16b-3,
or unless the Option is, in connection with such Corporate
Transaction, either assumed by the successor or survivor
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corporation (or parent or subsidiary thereof) or replaced
with a comparable right with respect to share of the capital
stock of the successor or survivor corporation (or parent or
subsidiary thereof).
(c) Upon the Termination of Directorship, the portion of the Option
representing shares that are not at that time vested shall
immediately terminate and cease to be outstanding.
4. Limited Transferability.
(a) Except as may be permitted pursuant to paragraph (b) below, the
Option shall be neither transferable nor assignable by Optionee
other than by will or by the laws of descent and distribution and
may be exercised during Optionee's lifetime only by Optionee.
After the death of the Optionee, any exercisable portion of the
Option may, prior to the time when such portion terminates and
becomes unexercisable under Section 3, be exercised by his or her
personal representative or by any person empowered to do so under
the deceased Optionee's will or under the then applicable laws of
descent and distribution.
(b) Notwithstanding paragraph (a) above, the Option may be assigned
in whole or in part during Optionee's lifetime to the Optionee's
spouse in accordance with the terms of a DRO, and, with the
consent of the Administrator, the Optionee may transfer the
Option to any one or more Permitted Transferees, subject to the
following terms and conditions:
(i) the Option shall not be assignable or transferable by the
Permitted Transferee or such spouse other than by will or
the laws of descent and distribution;
(ii) the Option shall continue to be subject to all the terms and
conditions of the Option as applicable to the Optionee
(other than the ability to further transfer the Option); and
(iii) the Optionee and the Permitted Transferee or such spouse,
as applicable, shall execute any and all documents requested
by the Administrator, including, without limitation
documents to (A) confirm the status of the transferee as a
Permitted Transferee or the validity of the DRO, (B) satisfy
any requirements for an exemption for the transfer under
applicable federal and state securities laws, and (C)
evidence the transfer.
5. Corporate Transaction. In the event of a Corporate Transaction, that
portion of the Option representing shares that are not then vested
shall automatically become 100% vested so that the Option shall, as of
five days prior to the effective date of such Corporate Transaction,
become exercisable in full. Effective as of the Corporate Transaction,
this Option shall terminate and cease to be exercisable, except to the
extent the Option is assumed by the successor or survivor corporation
(or parent or subsidiary thereof) or replaced with a comparable right
with respect to share of the capital stock of the successor or
survivor corporation (or parent or subsidiary thereof) in such
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Corporate Transaction, or unless the Board waives this provision in
connection with such Corporate Transaction and such waiver is
consistent with Rule 16b-3.
6. Change in Control. In the event of a Change in Control, that portion
of the Option representing shares that are not vested shall
automatically become 100% vested so that the Option shall, as of the
effective date of such Change in Control, become exercisable in full.
7. Manner of Exercising Option. All or a portion of an exercisable Option
shall be deemed exercised upon delivery of all of the following to the
Secretary of the Company or his or her designee:
(a) A notice complying with the applicable rules established by the
Administrator stating that the Option, or a portion thereof, is
exercised;
(b) Such representations and documents as the Administrator, in its
absolute discretion, deems necessary or advisable to effect
compliance with all applicable provisions of the Securities Act
and any other federal or state securities laws or regulations.
The Administrator may, in its absolute discretion, also take
whatever additional actions it deems appropriate to effect such
compliance including, without limitation, placing legends on
share certificates and issuing stop-transfer notices to agents
and registrars;
(c) In the event that the Option shall be exercised pursuant to
Section 4 by any person or persons other than the Optionee,
appropriate proof of the right of such person or persons to
exercise the Option;
(d) Full cash payment to the Company for the shares with respect to
which the Option, or portion thereof, is exercised. However, the
Administrator may, in its discretion, (i) allow payment, in whole
or in part, through the delivery of shares of Common Stock which
have been owned by the Optionee for at least six months, duly
endorsed for transfer to the Company with a Fair Market Value on
the date of delivery equal to the aggregate exercise price of the
Option or exercised portion thereof; (ii) allow payment, in whole
or in part, through the surrender of shares of Common Stock then
issuable upon exercise of the Option having a Fair Market Value
on the date of Option exercise equal to the aggregate exercise
price of the Option or exercised portion thereof; (iii) allow
payment, in whole or in part, through the delivery of property of
any kind which constitutes good and valuable consideration; (iv)
allow payment, in whole or in part, through a broker cashless
exercise program whereby the Optionee delivers a notice that the
Optionee has placed a market sell order with a broker with
respect to shares of Common Stock then issuable upon exercise of
the Option, and that the broker has been directed to pay a
sufficient portion of the net proceeds of the sale to the Company
in satisfaction of the Option exercise price, and such proceeds
is then made to the Company upon settlement of such sale; or (v)
allow payment through any combination of the consideration
provided in the foregoing subparagraphs. The Administrator may
also permit other forms of payment in its discretion as
authorized by the Plan; and
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(e) The receipt by the Company of full payment for such shares,
including payment of any applicable withholding tax, which in the
discretion of the Administrator may be in the form of
consideration used by the Optionee to pay for such shares under
Section 7.
8. Conditions to Issuance of Stock Certificates. The Company shall not be
required to issue or deliver any certificate or certificates for
shares of stock purchased upon the exercise of any Option or portion
thereof prior to fulfillment of all of the following conditions:
(a) The admission of such shares to listing on all stock exchanges on
which such class of stock is then listed;
(b) The completion of any registration or other qualification of such
shares under any state or federal law, or under the rulings or
regulations of the Securities and Exchange Commission or any
other governmental regulatory body which the Administrator shall,
in its absolute discretion, deem necessary or advisable;
(c) The obtaining of any approval or other clearance from any state
or federal governmental agency which the Administrator shall, in
its absolute discretion, determine to be necessary or advisable;
and
(d) The lapse of such reasonable period of time following the
exercise of the Option as the Administrator may establish from
time to time for reasons of administrative convenience.
9. Stockholder Rights. The holder of the Option shall not have any
stockholder rights with respect to the shares of Common Stock
purchasable upon exercise of the Option until such person shall have
exercised the Option, paid the exercise price and applicable taxes,
satisfies all other conditions of exercise and become a holder of
record of the purchased shares.
10. Adjustment in Option Shares.
(a) Should any change be made to the Common Stock by reason of any
stock split, stock dividend, recapitalization, combination of
shares, exchange of shares or other change affecting the
outstanding Common Stock as a class without the Corporation's
receipt of consideration, or in the event of a Corporate
Transaction or Change in Control, appropriate adjustments shall
be made to (i) the number and/or class of securities subject to
this Option and (ii) the exercise price in order to reflect such
change and thereby preclude a dilution or enlargement of benefits
hereunder.
(b) This Agreement shall not in any way affect the right of the
Corporation to adjust, reclassify, reorganize or otherwise change
its capital or business structure or to merge, consolidate,
dissolve, liquidate or sell or transfer all or any part of its
business or assets.
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11. Successors and Assigns. The provisions of this Agreement shall inure
to the benefit of, and be binding upon, the Corporation and its
successors and assigns and Optionee, Optionee's assigns and the legal
representatives, heirs and legatees of Optionee's estate.
12. Notices. Any notice required to be given or delivered to the
Corporation under the terms of this Agreement shall be in writing and
addressed to the Corporation at its principal corporate offices
attention Corporate Secretary. Any notice required to be given or
delivered to Optionee shall be in writing and addressed to Optionee at
the address of record indicated on the Notice of Grant or to any
updated address provided by the Optionee. By a notice given pursuant
to this Section 12, either party may hereafter designate a different
address for notices to be given to him. Any notice that is required to
be given to the Optionee shall, if the Optionee is then deceased, be
given to the Optionee's personal representative if such representative
has previously informed the Corporation of his status and address by
written notice under this Section 12.
13. Construction. This Agreement and the Option evidenced hereby are made
and granted pursuant to the automatic Option grant program in effect
under the Plan and are in all respects limited by and subject to the
applicable terms of the Plan.
14. Governing Law. The interpretation, performance and enforcement of this
Agreement shall be governed by the laws of the State of California
without resort to that State's conflict-of-laws rules.
15. Conformity to Securities Laws. The Optionee acknowledges that the Plan
and this Agreement are intended to conform to the extent necessary
with all provisions of the Securities Act and the Exchange Act and any
and all regulations and rules promulgated by the Securities and
Exchange Commission thereunder, including without limitation Rule
16b-3. Notwithstanding anything herein to the contrary, the Plan shall
be administered, and the Option is granted and may be exercised, only
in such a manner as to conform to such laws, rules and regulations. To
the extent permitted by applicable law, the Plan and this Agreement
shall be deemed amended to the extent necessary to conform to such
laws, rules and regulations.
16. Data Privacy Consent. As a condition of the grant of the Option,
Optionee consents to the collection, use, processing and transfer of
personal data as described in this paragraph. Optionee understands
that the Company and its Affiliates hold certain personal information
about Optioneee, including Optionee's name, home address and telephone
number, date of birth, social security number or global identification
number, salary, nationality, job title, any shares of the Company
stock or the Company positions held, details of all options or any
other entitlement to shares awarded, canceled, exercised, vested,
unvested or outstanding in Optionee's favor, for the purpose of
managing and administering the Plan ("Data"). Optionee further
understands that the Company and/or its Affiliates will transfer Data
amongst themselves as necessary for the purpose of implementation,
administration and management of Optionee's participation in the Plan,
and that the Company and/or any of its Affiliates may each further
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transfer Data to any third parties assisting the Company in the
implementation, administration and management of the Plan. Optionee
understands that these recipients may be located in the United States,
the European Economic Area, or elsewhere. Optionee authorizes them to
receive, possess, use, retain and transfer the Data, in electronic or
other form, for the purposes of implementing, administering and
managing Optionee's participation in the Plan, including any requisite
transfer of such Data as may be required for the administration of the
Plan and/or the subsequent holding of shares of stock on Optionee's
behalf to a broker or other third party with whom Optionee may elect
to deposit any shares of stock purchased under the Plan. Optionee
understands that Optionee may, at any time, review Data, require any
necessary amendments to it or withdraw the consents herein in writing
by contacting the Secretary of the Company. Withdrawal of consent may,
however, affect Optionee's ability to exercise or realize benefits
from the Option.
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FileNET Corporation
ID: 95-3757924
Form of Notice of Grant of Stock Options
and Option Agreement
Employee Name Option Number: xxxxxxx
Street Address Plan: xxxxxxx
City, CA USA Zip Code
Effective_______________, you have been granted a(n) [Incentive/Non-Qualified]
Stock Option to buy _________ shares of FileNET Corporation (the Company) stock
at $____________ per share.
The total option price of the shares granted is $_______________.
Shares in each period will become fully vested on the date shown.
Shares Vest Type Full Vest Expiration
xxx xxxxxxxxx xxxxxxxx xxxxxxxx
xxx xxxxxxxxx xxxxxxxx xxxxxxxx
By your signature and the Company's signature below, you and the Company agree
that these options are granted under and governed by the terms and conditions of
the 2002 Incentive Award Plan and the Option Agreement, all of which are located
on and may be accessed via FileNET's Intranet, now.
FileNET Corporation Date
Employee Name Date
Date:
Time:
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