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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 March 31, 2003
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 |_|
Indicate by check mark whether the Registrant is an accelerated filer as defined in Rule
12b-2 of the Securities Exchange Act of 1943:
Yes |X| No |_|
As of May 13, 2003, there were 36,208,052 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 .................................. 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk..... 31
Item 4. Controls and Procedures........................................ 33
PART II. OTHER INFORMATION.............................................. 33
Item 1. Legal Proceedings.............................................. 33
Item 6. Exhibits and Reports on Form 8-K............................... 33
SIGNATURE ............................................................... 34
CERTIFICATIONS ............................................................... 35
INDEX TO
EXHIBITS ............................................................... 37
2
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
March 31, December 31,
2003 2002
ASSETS
Current assets:
Cash and cash equivalents $ 152,321 $ 130,154
Short-term investments 24,571 29,188
Accounts receivable, net 40,461 44,839
Inventories, net 2,547 2,568
Prepaid expenses and other current assets 15,103 13,317
Deferred income taxes 802 802
Total current assets 235,805 220,868
Property, net 32,401 34,641
Long-term investments 32,633 25,864
Goodwill 17,146 16,907
Intangible assets, net 2,894 3,029
Deferred income taxes 21,799 21,792
Other assets 5,436 4,935
Total assets $ 348,114 $ 328,036
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 5,916 $ 7,706
Customer deposits 4,016 2,962
Accrued compensation and benefits 23,955 20,729
Unearned maintenance revenue 55,291 38,945
Other accrued liabilities 12,897 15,224
Total current liabilities 102,075 85,566
Unearned maintenance revenue and other liabilities 3,281 3,565
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; 37,077,498 shares issued and 35,979,498
shares outstanding at March 31, 2003; and
37,014,512 shares issued and 35,916,512 shares
outstanding at December 31, 2002 207,206 206,676
Retained earnings 54,514 53,178
Accumulated other comprehensive loss (4,395) (6,382)
Treasury stock, at cost; 1,098,000 shares (14,567) (14,567)
Net stockholders' equity 242,758 238,905
Total liabilities and stockholders' equity $ 348,114 $ 328,036
See accompanying notes to unaudited condensed consolidated financial statements.
3
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended
March 31,
2003 2002
Revenue:
Software $ 35,522 $ 31,240
Customer support 38,698 36,563
Professional services and education 12,131 15,836
Hardware 698 2,602
Total revenue 87,049 86,241
Costs:
Software 3,008 2,081
Customer support 9,769 10,088
Professional services and education 11,080 13,455
Hardware 802 1,925
Total cost of revenue 24,659 27,549
Gross Profit 62,390 58,692
Operating expenses:
Sales and marketing 34,399 32,289
Research and development 19,302 17,305
General and administrative 7,826 8,188
Total operating expenses 61,527 57,782
Operating income (loss) 863 910
Other income, net 1,045 908
Income before income taxes 1,908 1,818
Provision for income taxes 572 454
Net income $ 1,336 $ 1,364
Earnings per share:
Basic $ 0.04 $ 0.04
Diluted $ 0.04 $ 0.04
Weighted average shares outstanding:
Basic 35,942 35,362
Diluted 36,623 37,224
See accompanying notes to unaudited condensed consolidated financial statements.
4
FILENET CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(In thousands)
Three Months Ended
March 31
2003 2002
Net income 1,336 1,364
Other comprehensive income (loss):
Foreign currency translation adjustments 1,997 (410)
Unrealized gains on securities:
Unrealized holding gains (10) (75)
Total other comprehensive income (loss) 1,987 (485)
Comprehensive income 3,323 879
See accompanying notes to unaudited condensed consolidated financial statements.
5
FILENET CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Three Months Ended
March 31
2003 2002
Cash flows from operating activities:
Net income $ 1,336 $ 1,364
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 4,907 5,398
Loss on sale of fixed assets 37 14
Provision for doubtful accounts 18 278
Deferred income taxes (6) (46)
Changes in operating assets and liabilities,
net of the effects of
acquisition:
Accounts receivable 4,653 (3,448)
Inventories 22 253
Prepaid expenses and other current assets (997) (2,504)
Accounts payable (1,830) 778
Accrued compensation and benefits 3,034 2,617
Customer deposits and advances 1,048 (56)
Unearned maintenance revenue 15,821 13,378
Income taxes payable (385) (52)
Other (967) (3,370)
Net cash provided by operating activities 26,691 14,604
Cash flows from investing activities:
Capital expenditures (2,507) (2,566)
Proceeds from sale of property 68 6
Purchases of marketable securities (28,020) (21,318)
Proceeds from sales and maturities of
marketable securities 23,655 18,900
Net cash used in investing activities (6,804) (4,978)
Cash flows from financing activities:
Proceeds from issuance of common stock 530 1,081
Principal payments on capital lease obligations (5) (423)
Net cash provided by financing activities 525 658
Effect of exchange rate changes on cash
and cash equivalents 1,755 (287)
Net increase in cash and cash equivalents 22,167 9,997
Cash and cash equivalents, beginning of year 130,154 107,502
Cash and cash equivalents, end of period $ 152,321 $ 117,499
Supplemental cash flow information:
Interest paid $ 7 $ 28
Income taxes paid $ 950 $ 548
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 March 31, 2003, the results of its
operations, its comprehensive operations and its cash flows for the three
months ended March 31, 2003 and 2002. 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, contained in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2002 filed with
the SEC on March 28, 2003. The results of operations for the interim
periods are not necessarily indicative of the operating results for the
year, or any other future period.
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. 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 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 does not amortize 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.
On the first day of July of each year goodwill will be tested for
impairment by determining if the carrying value of each reporting unit
exceeds its fair value. As of March 31, 2003, no impairment of goodwill has
been recognized. 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 the Company's
consolidated financial position and results of operations.
7
In July 2002, the FASB issued SFAS No. 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 Emerging Issues Task Force (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 No. 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 No. 146 also
establishes that the liability should initially be measured and recorded at
fair value. The Company adopted the provisions of SFAS No. 146 for exit or
disposal activities initiated after December 31, 2002.
In November 2002, the FASB issued FASB Interpretation No. ("FIN") 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees and Indebtedness of Others," an
interpretation of FASB Statement Nos. 5, 57 and 107, and rescission of FIN
34, "Disclosure of Indirect Guarantees of Indebtedness of Others." FIN 45
elaborates on the disclosures to be made by the guarantor in its interim
and annual financial statements about its obligations under certain
guarantees that it has issued. It also requires that a guarantor recognize,
at the inception of a guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. The provisions related to
recognizing a liability at inception of the guarantee for the fair value of
the guarantor's obligations does not apply to product warranties or to
guarantees accounted for as derivatives. The initial recognition and
measurement provisions of this interpretation are applicable on a
prospective basis to guarantees issued or modified after December 31, 2002,
while the disclosure requirements are effective for financial statements
for interim or annual periods ending after December 15, 2002. The adoption
of the recognition provisions of FIN 45 in the three months ended March 31,
2003 did not have a material impact on the Company's consolidated results
of operations or financial position.
In December 2002, the FASB Issued SFAS No. 148, "Accounting for Stock-Based
Compensation Transition and Disclosure," an amendment of SFAS No. 123. This
statement amends SFAS No. 123, "Accounting for Stock-Based Compensation,"
to provide alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on
reported results. The transition guidance and annual disclosure provisions
of SFAS No. 148 are effective for fiscal years ending after December 15,
2002. The interim disclosure provisions are effective for financial reports
containing financial statements for interim periods beginning after
December 15, 2002. The adoption of SFAS No. 148 did not have a material
impact on the Company's consolidated results of operations or financial
position.
8
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 three months ended March 31, 2003 and 2002:
(In thousands, except per share amounts) March 31, March 31,
2003 2002
Net income, as reported $ 1,336 $ 1,364
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards, net
of related tax effects (2,039) (2,462)
Pro forma net loss $ (703) $ (1,098)
Earnings per share:
Basic earnings per share - as reported $ 0.04 $ 0.04
Basic earnings (loss) per share - pro forma (0.02) (0.03)
Diluted earnings per share - as reported 0.04 0.04
Diluted earnings (loss) per share - pro forma $ (0.02) $ (0.03)
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model. The March 31, 2003
calculation was based on an expected volatility of 66%, risk-free interest
rates of 1.96% to 4.76%, dividend yield of zero and an expected life of two
to five years. The March 31, 2002 calculation was on expected volatility of
75%, risk-free interest rates of 2.16% to 4.84%, dividend yield of zero and
an expected life of two to five years. 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. The Black-Scholes option-pricing model was
developed for use in estimating the value of traded options that have no
vesting restrictions and are fully transferable. In addition,
option-pricing models require the input of highly subjective assumptions
including the expected stock price volatility. The Company uses projected
data for expected volatility and expected life of its stock options based
upon historical data.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities." In general, a variable interest entity is a
corporation, partnership, trust, or any other legal structure used for
business purposes that either (a) does not have equity investors with
voting rights or (b) has equity investors that do not provide sufficient
financial resources for the entity to support its activities. FIN 46
requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The consolidation requirements of FIN 46
apply immediately to variable interest entities created after January 31,
2003. The consolidation requirements apply to older entities in the first
fiscal year or interim period beginning after June 15, 2003. Certain of the
disclosure requirements apply in all financial statements issued after
January 31, 2003, regardless of when the variable interest entity was
established. The Company does not have any variable interest entities as of
March 31, 2003. The adoption of FIN 46 did not have a material impact on
the Company's consolidated results of operations or its financial position.
Reclassifications. Certain reclassifications have been made to prior-years'
balances to conform to the current-year's presentation.
9
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
was 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 March 31, 2003 the project is complete and the Company
incurred approximately $4.8 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.
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. The pro forma results of operations data for the three-month
period ended March 31, 2003 and 2002 presented below assumes that the
acquisition had been made at the beginning of fiscal 2002. 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 acquisition taken place at the
beginning of fiscal 2002 (in thousands):
Three Months Ended March 31,
2003 2002
Revenue $ 87,049 $ 86,993
Net income / (loss) 1,336 (453)
Earnings per share:
Basic $ 0.04 $ (0.01)
Diluted $ 0.04 $ (0.01)
10
4. GOODWILL AND PURCHASED INTANGIBLE ASSETS
In acquisitions accounted for using the purchase method, goodwill is
recorded for 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. SFAS No. 142 requires a periodic
review of goodwill and indefinite life intangibles for possible impairment.
Intangible assets with definite lives must be amortized over their
estimated useful lives. A portion of goodwill and intangible assets was
allocated to our Ireland subsidiary at the time of acquisition, which
results in foreign exchange translation fluctuation. The following table
represents the balance of goodwill by reportable segment as of December 31,
2002 and the changes in goodwill for the three months ended March 31, 2003
(in thousands):
Balance at Foreign Balance at
December 31, Currency March 31,
2002 Acquired Adjustments Fluctuation 2003
Software $ 9,141 $ - $ - $ 118 $ 9,259
Customer support 4,059 - - 79 4,138
Professional services
and education 3,707 - - 42 3,749
Hardware - - - - -
Total $ 16,907 $ - $ - $ 239 $ 17,146
Acquired technology and patents are the Company's only intangible assets
subject to amortization under SFAS No. 142. These assets were recorded in
connection with the April 2002 eGrail acquisition and are comprised of the
following as of March 31, 2003 (in thousands):
Foreign
Accumulated Currency
Gross Amortization Fluctuation Net
Acquired technology $ 3,468 $ (721) $ 137 $ 2,884
Patents 25 (16) 1 10
$ 3,493 $ (737) $ 138 $ 2,894
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 $183,000 for the three months
ended March 31, 2003 and estimated future amortization expense (excluding
foreign exchange effect) of purchased intangible assets as of March 31,
2003 is as follows (in thousands):
Fiscal
Year Amount
2003 (remaining 9 months) $ 548
2004 724
2005 721
2006 721
2007 180
2008 -
$ 2,894
11
5. EARNINGS PER SHARE
Basic earnings per share are computed by dividing net income 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 employee
stock purchase plan using the treasury stock method. The number of
anti-dilutive options excluded from the EPS calculation for the three
months ended March 31, 2003 and 2002 were 681 and 1,862 shares,
respectively. The following table sets forth the computation of basic and
diluted earnings per share for the three months ended March 31, 2003 and
2002:
(In thousands, except per share amounts) Three Months Ended
March 31,
2003 2002
Net income $ 1,336 $ 1,364
Shares used in computing
basic earnings per share 35,942 35,362
Dilutive effect of stock plans 681 1,862
Shares used in computing
diluted earnings per share 36,623 37,224
Earnings per basic share $ 0.04 $ 0.04
Earnings per diluted share $ 0.04 $ 0.04
6. ACCUMULATED OTHER COMPREHENSIVE LOSS
Accumulated other comprehensive loss as of March 31, 2003 is comprised of
the following:
Foreign Unrealized Accumulated
Currency Holding Other
Translation Gains Comprehensive
(in thousands) Adjustment (Losses) Operations
Balance, December 31, 2002 $ (6,448) $ 66 $ (6,382)
Current period changes 1,997 (10) 1,987
Balance, March 31, 2003 $ (4,451) $ 56 $ (4,395)
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.
12
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 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 is not
the same as Generally Accepted Accounting Principles reporting. The Company
evaluates performance based on stand-alone segment operating results.
Because the Company does not 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 months ended March 31, 2003 and 2002
are as follows:
Three Months Ended
March 31,
In thousands 2003 2002
Software
Revenue $ 35,522 $ 31,240
Operating loss (14,747) (12,425)
Customer Support
Revenue $ 38,698 $ 36,563
Operating income 16,964 13,665
Professional Services and Education
Revenue $ 12,131 $ 15,836
Operating loss (975) (445)
Hardware
Revenue $ 698 $ 2,602
Operating income (loss) (379) 115
Total
Revenue $ 87,049 $ 86,241
Operating income 863 910
13
8. STOCK OPTIONS
The following is a summary of stock option transactions regarding all stock
options plans for the three months ended March 31, 2003:
Weighted-
Number of Exercise
Options Price
Balances, December 31, 2002 8,706,316 $ 15.12
Granted (weighted-average fair
value of $6.20) 167,650 12.76
Exercised (62,986) 8.41
Canceled (74,996) 17.81
Balances, March 31, 2003 8,735,984 $ 15.10
The following table summarizes information concerning outstanding and
exercisable stock options at March 31, 2003:
Options Outstanding Options Exercisable
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Price Outstanding Life (Years) Price Exercisable Price
$ 1.39-$9.00 1,724,257 4.58 $ 7.96 1,687,682 $ 7.94
9.17-12.86 1,825,774 7.96 11.91 617,785 10.68
12.97-15.16 1,852,101 8.08 13.56 758,575 13.71
15.17-21.13 1,722,521 7.61 17.68 876,411 17.85
21.38-41.84 1,611,331 6.81 25.38 1,256,056 25.52
$ 1.39-$41.84 8,735,984 7.04 $ 15.10 5,196,509 $ 15.03
9. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases its 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. Amounts related to deferred
rent are recorded in other accrued liabilities on the consolidated balance
sheet. Future annual minimum lease payments under all non-cancelable
operating leases with an initial term in excess of one year as of March 31,
2003 were as follows:
(In thousands)
2003 (remaining 9 months) $ 8,896
2004 12,236
2005 10,431
2006 9,819
2007 9,092
2008 7,317
Thereafter 7,627
Total $ 65,418
14
Product Warranties
The Company provides a 90-day warranty for its hardware products against
defects in materials and workmanship and for its software products against
substantial nonconformance to the published documentation at time of
delivery. For hardware products the Company accrues warranty costs based on
historical trends in product return rates and the expected material and
labor costs to provide warranty services. For software products, the
Company records the estimated cost of technical support during the warranty
period. A provision for these estimated warranty costs is recorded at the
time of sale or license. If the Company were to experience an increase in
warranty claims compared with historical experience, or costs of servicing
warranty claims were greater than the expectations on which the accrual had
been based, gross margins could be adversely affected.
The following table represents the warranty activity and balance for the
three months ended March 31, 2003 and 2002 (in thousands):
2003 2002
Beginning balance at December 31 728 772
Additions 225 269
Deductions (316) (391)
Ending balance at March 31 637 650
Guarantees and Indemnities
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." The initial recognition and initial measurement
provisions apply on a prospective basis to guarantees issued or modified
after December 15, 2002. The disclosure requirements are effective for
financial statements of interim and annual periods ending after December
15, 2002.
The Company has made guarantees and indemnifications, under which it may be
required to make payments to a guaranteed or indemnified party, in relation
to certain transactions. In connection with the sales of its products, the
Company provides intellectual property indemnities to its customers.
Guarantees and indemnities to customers in connection with product sales
and service generally are subject to limits based upon the amount of the
related product sales or service. Payment by the Company is conditioned
upon the other party filing a claim pursuant to the terms and conditions of
the agreement. The Company may challenge this claim and may also have
recourse against third parties for certain payments made by the Company.
Predicting the maximum potential future payment under these agreements is
not possible due to the unique facts and circumstances involved with each
agreement. Historically, the Company has made no payments under these
agreements. The fair value of guarantees issued during the three months
ended March 31, 2003 is insignificant.
In connection with certain facility leases and other performance
guarantees, the Company has guaranteed payments on behalf of some of its
subsidiaries. To provide subsidiary guarantees, the Company either uses its
$5.0 million line of credit as collateral to unconditionally guarantee the
performance of locally denominated bank guarantees or it obtains both
secured and unsecured bank guarantees from local banks. These bank
guarantees totaled an equivalent of approximately $1.3 million issued in
local currency in Europe and Asia as of March 31, 2003.
The Company indemnifies its directors and officers to the maximum extent
permitted under the laws of the State of Delaware. There have been no
modifications or new guarantees issued during the first quarter of fiscal
year 2003. The Company has not recorded a liability for these guarantees
and indemnities in the accompanying consolidated balance sheet and the
maximum amount of potential future payments under such guarantees and
indemnities is not determinable, other than as described above.
15
The Company's product warranty liability as of March 31, 2003 is disclosed
in this item under the heading "Product Warranties."
10. LEGAL PROCEEDINGS
In the normal course of business, the Company is subject to ordinary
routine litigation and claims incidental to business. While the results of
litigation and claims cannot be predicted with certainty, management
believes that the final outcome of these matters will not have a materially
adverse effect on the Company's consolidated results of operations or
financial conditions.
11. FOREIGN CURRENCY TRANSACTIONS
As of March 31, 2003, the Company had forward foreign exchange contracts
outstanding totaling approximately $ 15.5 million in 10 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 March 31, 2003.
12. RELATED-PARTY TRANSACTIONS
In July 2001, the Compensation Committee of the Company's Board of
Directors the ("Board") 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 March 31, 2003, FileNet has an
outstanding secured note receivable from Mr. Roberts in the amount of $1.9
million that relates to the above-referenced loan and is included in other
assets on the 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. Imputed
interest for the difference between the stated interest rate of the note
and a fair value interest rate of 7% was recorded as compensation expense
and a discount that is being amortized over the term of the note to
interest income 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 in the future.
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, who acted as financial advisors to eGrail and was paid
approximately $500,000 by eGrail. Accordingly, John Savage recused himself
from all discussions related to the acquisition between FileNet and eGrail
and abstained from voting on the transaction.
16
13. SUBSEQUENT EVENTS
On April 2, 2003, the Company acquired Shana Corporation, an electronic
forms management company, for a purchase price of $8.5 million in cash. The
Company believes that electronic forms management is an increasingly
important technology and is an essential component of electronic content
management. The Company expects that current regulatory compliance
initiatives in healthcare, education and manufacturing will increase the
demand for forms technology.
In accordance with SFAS No. 141, "Business Combinations," the purchase
method of accounting will be used to record this acquisition and the
purchase price is expected to be allocated primarily to goodwill and other
intangible assets. The Company is currently in the process of obtaining an
independent appraisal of the fair value of the tangible and intangible
assets acquired in order to allocate the purchase price in accordance with
SFAS No. 141. The preliminary valuation indicates that net tangible and
identified intangible assets have an estimated fair value of approximately
$7.0 million. The difference between the purchase price and estimated fair
value of the net tangible and identified intangible assets will be recorded
as goodwill. We do not anticipate any in-process research and development
costs.
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 and 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, 2002. 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, 2002. Our filings with the Securities and
Exchange Commission, including our Annual Reports on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those
filings, pursuant to Sections 13(a) and 15(d) of the Securities and
Exchange Act of 1934, are available free of charge at www.filenet.com, when
such reports are available at the Securities and Exchange Commission Web
site.
Overview
FileNet Corporation develops, markets, sells and supports Enterprise
Content Management ("ECM") software to enable organizations to improve
operational efficiency and leverage their content resources to make
decisions faster. In the first quarter of 2003 we introduced FileNet P8,
our new architecture that provides a unified platform and framework for
ECM. This approach is intended to offer our customers the ability to easily
configure, design, build and deploy a variety of enterprise-wide ECM
solutions to meet a broad range of content management needs within a single
scalable framework. 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.
17
Critical Accounting Policies and Estimates
The consolidated financial statements of FileNet are prepared 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 revenue and expenses
during the reporting period. Actual amounts could differ from estimates.
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. FileNet accounts for the licensing of software in
accordance with the American Institute of Certified Accountants ("AICPA")
Statement of Position ("SOP") 97-2, "Software Revenue Recognition." We
enter into contracts for the sale of our products and services. The
majority of these contracts relate to single elements and contain standard
terms and conditions. However, there are agreements that contain multiple
elements or non-standard terms and conditions. Contract interpretation is
sometimes required to determine the appropriate accounting, including how
the price should be allocated among the deliverable elements and when to
recognize revenue.
Software license revenue generated from sales through direct and indirect
channels, which do not contain multiple elements, are recognized upon
shipment and passage of title of the related product, if the requirements
of SOP 97-2, 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 these elements are known
or resolved. Fees are deemed to be fixed and determinable for transactions
with a set price that is not subject to refund or adjustment and payment is
due within 90 days from the invoice date. Software license revenue from
channel partners is recognized when the product is shipped and sale by the
channel partner to an end user is confirmed.
For arrangements with multiple elements, we allocate revenue to each
element of a transaction based upon its fair value as determined in
reliance on vendor specific objective evidence. This evidence of fair value
for all elements of an arrangement is based on the normal pricing and
discounting practices for those products and services when sold separately.
If fair value of any undelivered element cannot be determined objectively,
we defer the revenue until all elements are delivered, services have been
performed or until fair value can objectively be determined.
Customer support contracts are renewable on an annual basis and provide
after-sale support for our software, as well as software upgrades under the
Company's right to new versions program, on a when-and-if-available basis.
Revenue from post-contract customer support is recognized ratably over the
term of the arrangement, which is typically 12 months.
Professional services revenue consists of consulting and implementation
services provided to end users of our software products and technical
consulting services provided to our resellers. The majority of these
consulting engagements average from one to three months and are generally
not essential to the functionality of the software. Revenue from these
services and from training classes is recognized as such services are
delivered and accepted by the customer. Fixed-price consulting contracts
are the exception and because estimates of costs applicable to these
contracts are reasonably dependable, revenue is recognized using the
percentage-of-completion method. However, revenue and profit are subject to
revision as the contract progresses and anticipated losses on fixed-price
professional services contracts are recognized in the period when they
become known.
18
Allowance for Doubtful Accounts and Sales Returns. 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
constantly monitor collections from our customers and maintain an allowance
for estimated credit losses that is based on historical experience and on
specific customer collection issues. While credit losses have historically
been within our expectations and the provisions established in our
financial statements, 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 consolidated financial position. Based on historical
experience, we also maintain a sales return allowance for the estimated
amount of potential returns. While product returns have historically been
minimal and within our expectations and the allowances established by us,
we cannot guarantee that we will continue to experience the same return
rates that we have in the past.
Goodwill and Other Intangible Assets. Goodwill is recorded at cost and is
not amortized. 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. On the first day of July of each
year goodwill will be tested for impairment by determining if the carrying
value of each reporting unit exceeds its fair value. We also periodically
evaluate whether events and circumstances have occurred which indicate that
the carrying value of goodwill may not be recoverable. As of March 31,
2003, no impairment of goodwill has been recognized. If estimates change, a
materially different impairment conclusion could result.
Long-Lived Assets. Property, plant and equipment, intangible assets, and
capitalized software costs are recorded at cost less accumulated
depreciation or amortization. They are amortized using the straight-line
method over estimated useful lives of generally three to six years. The
determination of useful lives and whether or not these assets are impaired
involves judgment and are reviewed for impairment whenever events or
circumstances indicate that the carrying amount of such assets may not be
recoverable. We evaluate the carrying value of long-lived assets and
certain identifiable intangible assets for impairment of value based on
undiscounted future cash flows resulting from the use of the asset and its
eventual disposition. While we have not experienced impairment of
intangible assets in prior periods, we cannot guarantee that there will not
be impairment in the future.
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 assets 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 consolidated operating results. Conversely,
if the Company continues to generate profits and ultimately determines that
it is more likely than not that all or a portion of the remaining deferred
tax assets will be utilized to offset future taxable income, the valuation
allowance could be decreased or eliminated all together, thereby resulting
in a substantial decrease to our effective tax rate.
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.
19
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
March 31,
2003 2002
Revenue:
Software 40.8% 36.2%
Customer support 44.5 42.4
Professional services and education 13.9 18.4
Hardware .8 3.0
Total Revenue 100.0 100.0
Cost of revenue:
Software 3.5 2.4
Customer support 11.2 11.7
Professional services and education 12.7 15.6
Hardware .9 2.2
Total cost of revenue 28.3 31.9
Gross Profit 71.7 68.1
Operating expenses
Sales and marketing 39.5 37.4
Research and development 22.2 20.1
General and administrative 9.0 9.5
Total operating expenses 70.7 67.0
Operating income (loss) 1.0 1.1
Other income, net 1.2 1.1
Income (loss) before income tax 2.2% 2.2%
Revenue
As more fully discussed and explained below, total revenue increased
slightly to $87.0 million for the three months ended March 31, 2003 from
$86.2 million for the three months ended March 31, 2002. International
revenue accounted for 29% of total revenue, or $25.5 million, for the three
months ended March 31, 2003, compared to 27%, or $23.1 million for the same
period in 2002. These increases in revenue were primarily attributable to
increases in software and customer support revenue partially offset by
decreases in professional services and hardware revenue.
Software: Software revenue consists of fees earned from the licensing of
our software products to customers. Software revenue increased $4.3
million, or 14%, to $35.5 million for the three months ended March 31,
2003, from $31.2 million for the three months ended March 31, 2002.
Software revenue represented 41% of total revenue for the three months
ended March 31, 2003 compared to 36% for the comparable period of 2002. The
increase in software revenue was primarily due to an increase in demand for
our content management solutions associated with our broader product
offering coupled with a slightly more favorable business climate worldwide.
Additionally, we were successful in increasing our software revenue from
20
our existing customers as they expanded the use of our products. We remain,
however, in a difficult economic environment where a global reduction in
Information Technology spending could have a negative effect on our
software revenue growth going forward.
Customer Support: Customer support revenue consists of revenue from
software maintenance contracts, "fee for service" revenue and the sale of
spare parts and supplies. Customer support revenue increased $2.1 million,
or 6%, to $38.7 million for the three months ended March 31, 2003 from
$36.6 million for the three months ended March 31, 2002. Customer support
revenue represented 44.5% of total revenue for the three months ended March
31, 2003 compared to 42.4% for the comparable period of 2002. The increase
in customer support revenue was 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 from the existing base. However, the occurrence of a
prolonged economic slowdown that negatively impacts software revenue growth
would result in a reduced future growth rate for 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 $3.7 million, or 23%, to $12.1 million for the three months ended
March 31, 2003 from $15.8 million for the three months ended March 31,
2002. Professional services and education revenue represented 14% of total
revenue for the three months ended March 31, 2003 compared to 18% for the
comparable period in 2002. The revenue decrease in the first quarter of
2003 compared to the first quarter of 2002 is reflective of the continuing
economic slowdown that has resulted in fewer and smaller consulting
engagements for professional services, particularly in North America. This
trend, coupled with pricing pressures, has negatively impacted professional
services and education revenue 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 $1.9 million, or 73%, to $0.7 million for the three months ended
March 31, 2003 from $2.6 million for the three months ended March 31, 2002.
Hardware revenue represented slightly less than 1% of total revenue for the
three months ended March 31, 2003, compared to 3% for the comparable period
of 2002. 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 percentage of total revenue and in absolute dollars.
Cost of Revenue
Total cost of revenue decreased $2.8 million, or 10%, to $24.7 million for
the three months ended March 31, 2003, from $27.5 million for the
comparable period in 2002. 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.
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 $0.9 million, or 43% to $3.0 million for the
three months ended March 31, 2003 from $2.1 million for the three months
ended March 31, 2002. The absolute dollar costs represented 8% and 7% of
the related software revenue for the three months ended March 31, 2003 and
March 31, 2002, respectively. As a percentage of software revenue these
costs were effectively unchanged. Going forward, we anticipate cost of
software revenue as a percentage of software revenue to remain comparable
to current levels.
21
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
decreased $0.3 million, or 3%, to $9.8 million for the three months ended
March 31, 2003 from $10.1 million for the three months ended March 31,
2002. These costs represented 25% and 28% of the related customer support
revenue for the three months ended March 31, 2003 and 2002, respectively.
The decrease in cost of customer support revenue in absolute dollars for
the three months ended March 31, 2003 compared to the same period in 2002
is primarily attributable to cost controls and lower supplies costs. The
decrease in cost of customer support revenue as a percentage of customer
support revenue was primarily due to automation and process improvements
that allowed growth in the customer and revenue base 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 Services 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 $2.3 million,
or 17%, to $11.1 million for the three months ended March 31, 2003 from
$13.4 million for the three months ended March 31, 2002. These costs
represented 92% and 85% of the related professional services and education
revenue for the three months ended March 31, 2003 and 2002, 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 $1.1
million, or 58%, to $0.8 million for the three months ended March 31, 2003
from $1.9 million for the three months ended March 31, 2002. These costs
represented 114% and 73% of the related hardware revenue for the three
months ended March 31, 2003 and 2002, respectively. The decrease in
absolute dollars is directly related to the decrease in sales of OSAR
library products. As we have discussed previously, this operating segment
is not a strategic focus for us.
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 $19.3 million, or 12%, for the three
months ended March 31, 2003 from $17.3 million for the three months ended
March 31, 2002, and represented 22.2% and 20.1% of total revenue for these
respective periods. The increase in absolute dollars year over year in the
first quarter of 2003 is primarily the result of increased headcount
resulting in higher compensation, benefits and relocation costs related to
the April 2002 eGrail acquisition. We expect research and development
expense to be at approximately 21% of revenue in the near-term due to the
continuing enhancement of ECM capabilities and the added costs associated
with the acquisition of Shana Corporation on April 2, 2003.
Our research and development efforts are focused on enhancing our ECM
capabilities within the P8 product suite. These efforts will focus on
enhancements to our Business Process Management and Web Content Management
products and the development of integrated records management and
integrated collaborative capabilities. We intend to complement internal
development with third-party software through OEM agreements and may
execute additional technology acquisitions.
22
We expect that competition for qualified technical personnel 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.
Sales and Marketing: Sales and marketing expense consists primarily of
salaries and benefits, sales commissions and other expenses related to the
direct and indirect sales force, various marketing expenses and the cost of
other market development programs. Sales and marketing expense increased to
$34.4 million, or 7%, for the three months ended March 31, 2003 from $32.3
million for the three months ended March 31, 2002, and represented 39.5%
and 37.4% of total revenue for these respective periods. The increase in
2003 was primarily due to additional trade show and channel partner
development expenses associated with the launch of our FileNet P8 ECM
product that occurred in the first quarter of 2003.
General and Administrative: General and administrative expense consists
primarily of personnel costs for finance, information technology, legal,
human resources and general management, and the cost of outside
professional services. General and administrative expense decreased to $7.8
million, or 4%, for the three months ended March 31, 2003 from $8.2 million
for the three months ended March 31, 2002, and represented 9.0% and 9.5% of
total revenue for these respective periods. The decrease in first quarter
2003 compared to first quarter 2002 was primarily due to on-going cost
containment.
We expect operating expenses to remain at, or slightly above, these current
levels for the near term.
Amortization of Purchased Intangible Assets
Acquired technology of $3.3 million resulting from the asset purchase of
eGrail in April 2002 was assigned a useful life of five years and patents
of $24,000 were assigned a useful life of two years. Amortization of
acquired technology is recorded on a straight-line basis as a cost of
software revenue and amortization of patents is recorded on a straight-line
basis as an operating expense. Amortization expense was approximately
$183,000 for the three months ended March 31, 2003 for both acquired
technology and patents. We determined that these assets were not impaired
at March 31, 2003.
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 March 31, 2003 compared to other income, net of $0.9
million for the three months ended March 31, 2002. This increase was
primarily related to interest on increased cash balances.
Income Taxes
Our combined federal, state and foreign annual effective tax rate for the
three months ended March 31, 2003, is 30% compared to 25% for the
comparable periods in 2002. The increased tax rate in 2003 was primarily
due to the unfavorable mix of income between domestic and foreign
jurisdictions. FileNet management will continue weighing various factors
for the remainder of the year to assess the recoverability of our recorded
deferred assets and the need for any adjustment to the valuation allowance
against such amounts. Any adjustment to the valuation allowance could
impact the effective tax rate in subsequent quarters.
23
Liquidity and Capital Resources
At March 31, 2003, combined cash, cash equivalents and investments totaled
$209.5 million, an increase of $24.3 million from December 31, 2002. Cash
provided by operating activities during the three months ended March 31,
2003 totaled $26.7 million and resulted primarily from an increase in
unearned maintenance revenue related to prepaid maintenance contracts of
$15.8 million, additions to net income for depreciation and amortization
expense of $4.9 million, net income of $1.3 million and a decrease in
accounts receivable of $4.7 million. A larger percentage of prepaid annual
maintenance contracts renew in the first quarter of each year compared to
subsequent quarters, resulting in an increase in unearned maintenance
revenue.
Cash used for investing activities totaled $6.8 million and included
capital expenditures of $2.5 million and net purchases of marketable
securities of $4.4 million. Cash provided by financing activities totaled
$0.5 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.
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 125 basis points over the London Interbank Offered Rate. A
standby letter of credit fee of 125 basis points per annum and a commitment
fee of 50 basis points are assessed against any unused amounts. There were
no borrowings outstanding against our line of credit at March 31, 2003. 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 March 31,
2003, we were in compliance with all such covenants.
Contractual cash obligations of significance include 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. (See Note 9).
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 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.
24
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 our consolidated
financial statements. Our April 2002 acquisition of certain assets and
certain liabilities 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 lives unless
these lives are determined to be indefinite. In accordance with this
standard, we do not 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. On the first day of
July of each year, goodwill will be tested for impairment by determining if
the carrying value of each reporting unit exceeds its fair value. As of
March 31, 2003, no impairment of goodwill has been recognized. 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
consolidated financial position and results of operations.
In July 2002, the FASB issued SFAS No. 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 No. 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 No. 146 also establishes that the
liability should initially be measured and recorded at fair value. We
adopted the provisions of SFAS No. 146 for exit or disposal activities
initiated after December 31, 2002.
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees and
Indebtedness of Others," an interpretation of FASB Statement Nos. 5, 57 and
107, and rescission of FIN 34, "Disclosure of Indirect Guarantees of
Indebtedness of Others." FIN 45 elaborates on the disclosures to be made by
the guarantor in its interim and annual financial statements about its
obligations under certain guarantees that it has issued. It also requires
that a guarantor recognize, at the inception of a guarantee, a liability
for the fair value of the obligation undertaken in issuing the guarantee.
The provisions related to recognizing a liability at inception of the
guarantee for the fair value of the guarantor's obligations does not apply
to product warranties or to guarantees accounted for as derivatives. The
initial recognition and measurement provisions of this interpretation are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002, while the disclosure requirements are effective for
financial statements for interim or annual periods ending after December
15, 2002. The adoption of the recognition of provisions of FIN 45 in the
three months ended March 31, 2003 did not have a material impact on its
consolidated results of operations or financial position.
25
In December 2002, the FASB Issued SFAS No. 148, "Accounting for Stock-Based
Compensation Transition and Disclosure," an amendment of SFAS No. 123. This
statement amends SFAS No. 123, "Accounting for Stock-Based Compensation,"
to provide alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on
reported results. The transition guidance and annual disclosure provisions
of SFAS No. 148 are effective for fiscal years ending after December 15,
2002. The interim disclosure provisions are effective for financial reports
containing financial statements for interim periods beginning after
December 15, 2002. The adoption of SFAS No. 148 did not have a material
impact on our consolidated results of operations or financial position.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities." In general, a variable interest entity is a
corporation, partnership, trust, or any other legal structure used for
business purposes that either (a) does not have equity investors with
voting rights or (b) has equity investors that do not provide sufficient
financial resources for the entity to support its activities. FIN 46
requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The consolidation requirements of FIN 46
apply immediately to variable interest entities created after January 31,
2003. The consolidation requirements apply to older entities in the first
fiscal year or interim period beginning after June 15, 2003. Certain of the
disclosure requirements apply in all financial statements issued after
January 31, 2003, regardless of when the variable interest entity was
established. We do not have any variable interest entities as of March 31,
2003. The adoption of FIN 46 did not have a material impact on our
consolidated results of operations or our financial position.
Other Matters
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.
26
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 size, complexity and timing of individual transactions;
o changes in foreign currency exchange rates;
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 projected revenue may cause
significant fluctuations in operating results from quarter to quarter. As a
result of these factors, revenue 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 that could result in reduced
revenue.
27
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 unified platform and framework for Enterprise
Content Management. This strategy requires us to make long-term investments
and commit significant resources based on our prediction of new products
and services that the market needs and will accept. Our strategy also
requires 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 our prediction of 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 sales.
We must effectively manage our new product and services transitions or
our revenue may suffer. If we do not make an effective transition from
existing products and services to our P8 architecture, our revenue may be
seriously harmed. Among the factors that make a smooth transition difficult
are delays in development, variations in pricing, delays in customer
purchases in anticipation of new introductions and customer demand for the
new offerings. If we incur delays in customer purchases or do not
accurately estimate the market effects of new introductions, future demand
for our products and services and our revenue may be seriously harmed.
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. Any inability to
protect our intellectual property may harm our business and competitive
position.
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
28
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 could result in significant costs or reduce our ability to
market any affected products.
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 have minimum purchase
requirements and/or require prepayments which usage is limited to a
specific timeframe while others 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. In addition, it is
possible that as a consequence of a merger or acquisition transaction
involving one of these third parties, certain restrictions could be imposed
on our business that had not been imposed prior to the transaction. This
could adversely affect our sales.
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 services 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 political and economic instability;
o tariffs and trade barriers;
o varying technical standards;
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 accounts receivable cycles and financial instability among customers.
29
Any of these factors could reduce the amount of revenue we realize
from our international operations in the future.
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. 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 years, 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.
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 we
recently completed the acquisitions of eGrail and Shana. 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:
30
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.
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 5.5
months; therefore the movement of interest rates should not have a material
impact on our balance sheet or income statement.
At any time, a significant increase/decrease in interest rates will have an
impact on the fair market value and interest earnings of our investment
portfolio. We do not currently hedge this interest rate exposure. We have
performed a sensitivity analysis as of March 31, 2003 and 2002, using a modeling
technique that measures the change in the fair values arising from a
hypothetical 50 basis points and 100 basis points adverse movement in the levels
of interest rates across the entire yield curve, which are representative of
historical movements in the Federal Funds Rate with all other variables held
constant. The analysis covers our investment and is based on the weighted
average maturity of our investments as of March 31, 2003 and 2002. The
sensitivity analysis indicated that a hypothetical 50 basis points adverse
movement in interest rates would result in a loss in the fair values of our
investment instruments of approximately $286,000 at March 31, 2003 and
approximately $275,000 at March 31, 2001. Similarly a hypothetical 100 basis
points adverse movement in interest rates would result in a loss in the fair
values of our investments of approximately $573,000 at March31, 2003 and
approximately $550,000 at March 31, 2002.
31
The following table provides information about our cash and cash equivalents and
our investment portfolio at March 31, 2003 (dollars in thousands):
Estimated Fair
(In thousands) Cost Value
Debt Securities
Due in one year or less:
Short-term munis-taxable $ 2,202 $ 2,206
Corporate 5,665 5,690
Governments/Agencies 16,669 16,675
Total due in one year $ 24,536 $ 24,571
Due in one to three years:
Taxable Munis $ 3,493 $ 3,513
Corporate 2,084 2,084
Government/Agencies 27,001 27,036
Total due in three years $ 32,578 $ 32,633
Grand total $ 57,114 $ 57,204
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.
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 our revenue and operating expenses. We have
entered into forward foreign exchange contracts primarily to hedge amounts due
from and the net assets of selected subsidiaries denominated in foreign
currencies (mainly in Europe and Asia Pacific) against fluctuations in exchange
rates. We have not entered into forward foreign exchange contracts for
speculative or trading purposes. Our accounting policies for these contracts are
based on our designation of the contracts as hedging transactions. The criteria
we use for designating a contract as a hedge include the contract's
effectiveness in risk reduction and one-to-one matching of derivative
instruments to underlying transactions. Gains and losses on foreign exchange
contracts are recognized in income in the same period as gains and losses on the
underlying transactions. If an underlying hedged transaction were terminated
earlier than initially anticipated, the offsetting gain or loss on the related
forward foreign exchange contract would be recognized in income in the same
period. In addition, since we enter into forward contracts only as a hedge, any
change in currency rates would not result in any material net gain or loss, as
any gain or loss on the underlying foreign currency denominated balance would be
offset by the gain or loss on the forward contract. Our forward contracts
generally have an original maturity of three months. As of March 31, 2003, we
had forward foreign exchange contracts outstanding totaling approximately $15.5
million in ten currencies. These contracts were opened on the last business day
of the quarter and mature within three months.
Cumulative other comprehensive loss decreased $2.0 million for the three months
ended March 31, 2003 due to unrealized foreign currency translation gains
resulting from the strengthening of the euro against the U.S. dollar during the
first quarter of 2003.
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 months ended March 31, 2003.
32
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 Note 10 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) No reports on Form 8-K were filed during the first quarter of 2003.
33
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
May 14, 2003
Date
By: /s/ Sam M. Auriemma
Sam M. Auriemma, Senior Vice President
(Principal Financial and Accounting Officer)
and Chief Financial Officer
34
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.
May 14, 2003
Date
/s/ Lee D. Roberts
Lee D. Roberts
Chief Executive Officer
35
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.
May 14, 2003
Date
/s/ Sam M. Auriemma
Sam M. Auriemma
Chief Financial Officer
36
Index to Exhibits
The following exhibits are filed herewith or incorporated by reference:
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, 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, 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 registration statement on
Form 10-Q for the quarter ended September 30, 1998).
4.4* Amendment Three dated November 30, 2002 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,
2002).
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, 2002 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 among the Registrant and
Bank of America, N.A., formerly known as Bank of America National Trust and Savings Association,
dated June 29, 2002, effective June 29, 2002 (filed as Exhibit 10/1 to Registrant's Annual Report
on Form 10-K filed for the year ended December 31, 2002).
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, 2002; 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, Registration No. 33-48499), the first Amendment thereto (filed as Exhibit 4(d) to the
Registrant's registration statement on Form S-8, Registration No. 33-69920), and the Second
Amendment thereto (filed as Appendix A to the Registrant's Proxy Statement 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).
37
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).
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 registration statement 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 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, 2002;
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 (filed as Exhibit 10.14.1 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2003).
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 (filed as Exhibit 10.14.2 to Registrant's
Quarterly Report on Form 10-Q for the quarter ended March 31, 2003).
* Incorporated herein by reference
+ Management contract, compensatory plan or arrangement
38