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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 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 1934:
Yes |X| No |_|
As of November 13, 2003, there were 37,558,098 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 .................................. 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk..... 38
Item 4. Controls and Procedures........................................ 40
PART II. OTHER INFORMATION.............................................. 40
Item 1. Legal Proceedings.............................................. 40
Item 6. Exhibits and Reports on Form 8-K............................... 40
SIGNATURE ............................................................... 41
INDEX TO
EXHIBITS ............................................................... 42
2
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
September 30, December 31,
2003 2002
ASSETS
Current assets:
Cash and cash equivalents $ 162,271 $ 130,154
Short-term investments 33,545 29,188
Accounts receivable, net 43,941 44,839
Inventories, net 1,244 2,568
Prepaid expenses and other current assets 14,130 13,317
Deferred income taxes 802 802
Total current assets 255,933 220,868
Property, net 28,359 34,641
Long-term investments 21,705 25,864
Goodwill 24,676 16,907
Intangible assets, net 8,169 3,029
Deferred income taxes 20,047 21,792
, Other assets 4,322 4,935
Total assets $ 363,211 $ 328,036
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable 10,484 7,706
Customer deposits 6,248 2,962
Accrued compensation and benefits 23,549 20,729
Unearned maintenance revenue 45,024 38,945
Other accrued liabilities 13,174 15,224
Total current liabilities 98,479 85,566
Unearned maintenance revenue and other liabilities 2,009 3,565
Commitments and contingencies (Note 9)
Stockholders' equity:
Preferred stock - $0.10 par value; 7,000,000 shares
authorized; none issued and outstanding
Common stock - $0.01 par value; 100,000,000 shares
authorized; 37,922,123 issued and 36,824,123
shares outstanding at September 30, 2003; and
37,014,512 shares issued and 35,916,512 shares
outstanding at December 31, 2002 218,339 206,676
Retained earnings 58,452 53,178
Accumulated other comprehensive income(loss) 499 (6,382)
Treasury stock, at cost; 1,098,000 shares (14,567) (14,567)
Net stockholders' equity 262,723 238,905
Total liabilities and stockholders' equity $ 363,211 $ 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 Sept 30, Nine Months Ended Sept 30,
2003 2002 2003 2002
Revenue:
Software $ 35,320 $ 30,538 $ 104,397 $ 96,128
Customer support 41,162 37,838 121,024 111,682
Professional services and education 12,162 12,751 36,095 43,078
Hardware 745 1,975 2,039 6,682
Total revenue 89,389 83,102 263,555 257,570
Costs:
Software 3,800 2,484 10,416 7,239
Customer support 9,660 9,604 28,144 29,499
Professional services and education 10,586 11,361 32,001 38,003
Hardware 827 1,337 2,882 4,847
Total cost of revenue 24,873 24,786 73,443 79,588
Gross Profit 64,516 58,316 190,112 177,982
Operating expenses:
Sales and marketing 34,405 32,338 103,660 97,388
Research and development 19,049 17,764 58,031 53,993
In-process research and development - - - 400
General and administrative 8,241 7,455 24,393 24,248
Total operating expenses 61,695 57,557 186,084 176,029
Operating income 2,821 759 4,028 1,953
Other income, net 632 1,045 3,297 3,874
Income before income taxes 3,453 1,804 7,325 5,827
Provision for income taxes 967 415 2,051 1,340
Net income $ 2,486 $ 1,389 $ 5,274 $ 4,487
Earnings per share:
Basic $ 0.07 $ 0.04 $ 0.15 $ 0.13
Diluted $ 0.06 $ 0.04 $ 0.14 $ 0.12
Weighted-average shares outstanding:
Basic 36,588 35,629 36,234 35,511
Diluted 38,494 36,445 37,471 36,803
See accompanying notes to unaudited condensed consolidated financial statements.
4
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(In thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
Net income $ 2,486 $ 1,389 $ 5,274 $ 4,487
Other comprehensive income:
Foreign currency translation adjustments 1,582 156 6,942 5,147
Unrealized gains on securities:
Unrealized holding gains(loss) (23) 12 (61) 26
Total other comprehensive income 1,559 168 6,881 5,173
Comprehensive income $ 4,045 $ 1,557 $ 12,155 $ 9,660
See accompanying notes to unaudited condensed consolidated financial statements.
5
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Nine Months Ended
September 30,
2003 2002
Cash flows from operating activities:
Net income $ 5,274 $ 4,487
Adjustments to reconcile net income to net cash
provided by operating activities:
Purchased in-process research and development - 400
Depreciation and amortization 14,759 16,160
Loss on sale of fixed assets 14 13
Provision for doubtful accounts 52 354
Deferred income taxes 1,746 16
Stock option income tax benefit 2,129 -
Changes in operating assets and liabilities,
net of the effects of acquisitions:
Accounts receivable 2,871 (5,526)
Inventories 1,373 417
Prepaid expenses and other current assets 2,423 (3,100)
Accounts payable 2,026 (861)
Accrued compensation and benefits 1,840 3,918
Customer deposits and advances 3,264 (1,781)
Unearned maintenance revenue 2,916 6,870
Income taxes payable (1,590) (1,199)
Other (3,304) (4,213)
Net cash provided by operating activities 35,793 15,955
Cash flows from investing activities:
Capital expenditures (6,809) (8,592)
Proceeds from sale of property 129 44
Note receivable from officer - (1,900)
Cash paid for acquisitions, net of cash acquired (8,073) (9,359)
Purchases of marketable securities (81,354) (103,529)
Proceeds from sales and maturities of marketable 77,805 94,621
securities
Net cash used in investing activities (18,302) (28,715)
Cash flows from financing activities:
Proceeds from issuance of common stock 9,485 3,875
Principal payments on capital lease obligations (5) (1,293)
Net cash provided by financing activities 9,480 2,582
Effect of exchange rate changes on cash and cash 5,146 4,138
equivalents
Net increase in cash and cash equivalents 32,117 (6,040)
Cash and cash equivalents, beginning of year 130,154 107,502
Cash and cash equivalents, end of period 162,271 101,462
Supplemental cash flow information:
Interest paid 36 65
Income taxes paid $ 2,221 $ 2,897
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" or "FileNet") reflect all
adjustments (consisting of normal recurring adjustments) necessary to
present fairly the financial position of the Company at September 30, 2003,
the results of its operations and its comprehensive operations for the
three and nine months ended September 30, 2003 and 2002, and its cash flows
for the nine months ended September 30, 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 (the "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 Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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 acquisition
of certain assets and certain liabilities of eGrail, Inc. in April 2002,
and the acquisition of Shana Corporation in April 2003 were 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.
As of the first day of July of each year, goodwill is tested for impairment
by determining if the carrying value of each reporting unit exceeds its
fair value. We engaged an independent valuation firm to determine the
business enterprise value for each of our three reporting units and to
perform an impairment analysis as of July 1, 2003 in accordance with SFAS
142. The analysis indicated there was no impairment of goodwill in any of
the three reporting units. As of September 30, 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
7
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.
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. The adoption of the
provisions of SFAS No. 146 in the three and nine months ended September 30,
2003 did not have a material impact on the Company's consolidated results
of operations or financial position.
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 and nine months ended
September 30, 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." 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, for the three and nine months ended September 30, 2003 and 2002:
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands, except per share amounts) 2003 2002 2003 2002
Net income, as reported $ 2,486 $ 1,389 $ 5,274 $ 4,487
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards, net
of related tax effects (1,636) (1,987) (5,732) (6,547)
Pro forma net income (loss) 850 (598) (458) (2,060)
Earnings per share:
Basic earnings per share - as reported $ 0.07 $ 0.04 $ 0.15 $ 0.13
Basic earnings (loss) per share - pro forma 0.02 (0.02) (0.01) (0.06)
Diluted earnings per share - as reported 0.06 0.04 0.14 .12
Diluted earnings (loss) per share - pro forma $ 0.02 $ (0.02) $ (0.01) $ (0.06)
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. For purposes of computing proforma net
income, the Company estimates the fair value of each option grant and employee
stock purchase plan right on the date of grant using the Black-Scholes
option-pricing model. 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, while the options issued by the Company are subject
to both vesting and restrictions on transfer. In addition, option-pricing models
require 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.
The assumptions used to value the option grants and the purchase rights are
stated as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
Expected term (in years) 2-5 2-5 2-5 2-5
Expected volatility 63% 70% 63 - 66% 70%
Risk free interest rates 3.15% 2.16 - 4.81% 3.15% 2.16 - 4.81%
Expected dividend 0% 0% 0% 0%
9
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 September 30, 2003. The
adoption of FIN 46 did not have a material impact on the Company's consolidated
results of operations or its financial position.
In April 2003, FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 (1) clarifies under
what circumstances a contract with an initial net investment meets the
characteristics of a derivative discussed in paragraph 6(b) of Statement 133,
(2) clarifies when a derivative contains a financing component, (3) amends the
definition of an underlying derivative to conform it to language used in FIN 45,
and (4) amends certain other existing pronouncements, which will collectively
result in more consistent reporting of contracts as either derivatives or hybrid
instruments. SFAS No. 149 is effective for contracts and hedging relationships
entered into or modified after June 30, 2003. The adoption of SFAS No. 149 did
not have a material impact on the Company's consolidated financial statements or
financial position.
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both debt and equity and requires
an issuer to classify the following instruments as liabilities in its balance
sheet:
o a financial instrument issued in the form of shares that is
mandatorily redeemable and embodies an unconditional obligation that
requires the issuer to redeem it by transferring its assets at a
specified or determinable date or upon an event that is certain to
occur;
o a financial instrument, other than an outstanding share, that embodies
an obligation to repurchase the issuer's equity shares, or is indexed
to such an obligation, and requires the issuer to settle the
obligation by transferring assets; and
o a financial instrument that embodies an unconditional obligation that
the issuer must settle by issuing a variable number of its equity
shares if the monetary value of the obligation is based solely or
predominantly on (1) a fixed monetary amount, (2) variations in
something other than the fair value of the issuer's equity shares, or
(3) variations inversely related to changes in the fair value of the
issuer's equity shares.
SFAS No. 150 is effective for financial instruments entered into or modified
after May 31, 2003 and is effective for all other financial instruments as of
the first interim period beginning after June 15, 2003. SFAS No. 150 is to be
implemented by reporting the cumulative effect of a change in accounting
principle. The adoption of SFAS No. 150 did not have a material impact on the
Company's consolidated financial statements or financial position.
Reclassifications. Certain reclassifications have been made to prior-years'
balances to conform to the current-year's presentation.
10
3. ACQUISITIONS
On April 2, 2002, the Company acquired certain assets and assumed certain
liabilities of eGrail, Inc. ("eGrail"), a Web content management company.
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. The purchase
price for the acquisition consisted of $9.0 million in cash consideration
and direct acquisition costs of $359,000.
On April 2, 2003, the Company completed a stock purchase acquisition of
Shana Corporation ("Shana"), an electronic forms management company. This
strategic acquisition provides technology and experience to expand the
Company's ECM offering with Enterprise Forms Management capability, which
contributed to the purchase price and resulted in goodwill. The purchase
price for the acquisition consisted of $8.55 million in cash consideration,
less $938,000 of acquired cash, plus $184,000 in acquisition expenses and
$277,000 paid for Non-Compete Agreements.
In accordance with SFAS No. 141, "Business Combinations," these
acquisitions were accounted for under the purchase method of accounting.
The purchase price was allocated as follows:
eGrail, Inc. Shana Corp.
April 2, 2002 April 2, 2003
(In thousands)
Net tangible assets $ 581 $ 2,725
Patents 24 -
Acquired technology 3,300 4,000
Technical manuals and design documents - 600
Customer maintenance relationships - 800
In-process research and development 400 -
Non-Compete Agreements - 277
Liabilities assumed (739) (2,494)
Goodwill 5,793 3,103
Total purchase price $ 9,359 $ 9,011
Less cash acquired - (938) .
Net cash paid $ 9,359 $ 8,073
The Company allocated the purchase price for these acquisitions based on
fair value. Statement of Financial Accounting Concepts No. 7 defines fair
value as the amount at which an asset (or liability) could be bought or
sold in a current transaction between willing parties, that is, other than
in a forced or liquidation sale.
The valuation of the eGrail assets included $400,000 of in-process research
and development, which 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 WCM 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 12-month period. As of March 31,
2003 the project was complete and the Company incurred approximately $4.8
million of research and development expenses related to the project. 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. The
remaining purchase price of $6.0 million was primarily allocated to
tangible assets and goodwill. Goodwill of $5.8 million was tax deductible
for this asset purchase.
11
The acquisition of Shana resulted in acquired technology, technical manuals
and design documents, and customer maintenance relationships. Since Shana
had recently completed Version 4.1 of its eForms product, there was no
in-process research and development underway at the time of the
acquisition. Shana's technology manuals and design documents are the
"roadmaps" for the eForms technology and will be used by FileNet in its
product development. Recurring maintenance revenues are expected and
estimable for Shana's customers based on the older and newer versions of
eForms technology. The acquired technology of $4.0 million, the technical
manuals and design documents of $600,000, and the customer maintenance
relationships of $800,000 were assigned a useful life of five years. The
remaining purchase price of $3.6 million was allocated primarily to
goodwill.
In accordance with SFAS No. 142, goodwill for both the eGrail and Shana
acquisitions will not be amortized and was reviewed for impairment as part
of the annual analysis performed in July. (See Note No. 4.) Although the
goodwill stemming from the Shana stock purchase is non-deductible for
Canadian tax purposes, a Section 338(g) election will result in the
reduction of taxable income for U.S. tax purposes on this transaction.
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 nine-month
periods ended September 30, 2002 presented below assumes that the eGrail
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. No pro forma information has been presented for
the Shana acquisition, as the result did not have a material impact on the
financial statements of the Company during the reporting period.
Nine Months Ended
September 30,
2003 Actual 2002 Pro Forma
(In thousands)
Revenue $ 263,555 $ 258,322
Net income 5,274 2,634
Earnings per share:
Basic $ 0.15 $ 0.07
Diluted $ 0.14 $ 0.07
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.
(See Note No.2) Intangible assets with definite lives must be amortized
over their estimated useful lives. Shana goodwill and intangible assets
were recorded in the financial statements of the Company's Canadian
subsidiary and a portion of the goodwill and intangible assets for previous
acquisitions was allocated to the financial statements of the Company's
Ireland subsidiary. This results in fluctuations in foreign exchange
translation gains and losses. The following table represents the balance of
goodwill as of December 31, 2002 and the changes in goodwill for the nine
months ended September 30, 2003:
12
Goodwill (in thousands)
Balance as of December 31, 2002 $ 16,907
Goodwill acquired during the period 3,103
Adjustments 3,498
Foreign currency gain 1,168
Balance as of September 30, 2003 $ 24,676
Adjustments to goodwill included $1.7 million for the write-off of a
prepaid royalty and the recognition of a $1.7 million deferred tax asset.
Prior to the Shana acquisition, FileNet licensed the eForms technology from
Shana under an agreement that resulted in a prepaid royalty. The remaining
balance of this prepaid royalty fee was considered additional investment in
Shana and was allocated to goodwill. A deferred tax asset was recorded
under purchase accounting for the estimated future tax effects of the
identified intangibles with a corresponding entry to goodwill of $1.7
million.
Acquired technology, technical manuals and design documents, customer
maintenance relationships, non-compete agreements and patents are the
Company's only intangible assets subject to amortization under SFAS No.
142. These assets were recorded in connection with the acquisition of
assets of eGrail in April 2002 and the acquisition of Shana in April 2003,
and are comprised of the following as of December 31, 2002 and September
30, 2003:
Intangible Assets Subject to Amortization
Foreign
Balance as of December 31, 2002 Accumulated Currency
(In thousands) Gross Amortization Fluctuation Net
Acquired technology and other intangibles $ 3,468 $ (532) $ 79 $ 3,015
Non-compete agreements - - - -
Patents 25 (12) 1 14
Total $ 3,493 $ (544) $ 80 $ 3,029
Foreign
Balance as of September 30, 2003 Accumulated Currency
(In thousands) Gross Amortization Fluctuation Net
Acquired technology and other intangibles $ 8,868 $ (1,705) $ 756 $ 7,919
Non-compete agreements 277 (58) 27 246
Patents 25 (23) 2 4
Total $ 9,170 $ (1,786) $ 785 $ 8,169
NOTE - other intangibles include technical manuals and customer maintenance
relationships.
13
Acquired technology, technical manuals and design documents, and customer
maintenance relationships are being amortized over a useful life of five
years, patents are being amortized over a useful life of two years, and the
non-compete agreements are being amortized over a period of between two and
three years. Amortization expense for amortizing intangible assets was
approximately $500,000 and $1,177,000 for the three and nine months ended
September 30, 2003, and $176,000 and $344,000 for the three and nine months
ended September 30, 2002. We determined that these assets were not impaired
as of September 30, 2003.
Estimated future amortization expense (excluding foreign exchange effect)
of purchased intangible assets as of September 30, 2003 is as follows (in
thousands):
Fiscal Year Amount
2003 (remaining 3 months) $ 514
2004 2,041
2005 2,008
2006 1,942
2007 1,368
2008 296
Total Amortization Expense $ 8,169
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 dilutive
options excluded from the basic EPS calculation for the three and nine
months ended September 30, 2003 were 1,906,000 and 1,237,000 shares,
compared to 816,000 and 1,292,000 for the comparable periods in 2002. The
following table sets forth the computation of basic and diluted earnings
per share for the three and nine months ended September 30, 2003 and 2002:
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
(In thousands, except per share amounts)
Net Income $ 2,486 $ 1,389 $ 5,274 $ 4,487
Shares used in computing
basic earnings per share 36,588 35,629 36,234 35,511
Dilutive effect of stock plans 1,906 816 1,237 1,292
Shares used in computing
diluted earnings per share 38,494 36,445 37,471 36,803
Earnings per basic share $ .07 $ .04 $ .15 $ .13
Earnings per diluted share $ .06 $ .04 $ .14 $ .12
14
6. ACCUMULATED OTHER COMPREHENSIVE LOSS
Accumulated other comprehensive income for the nine months ended September
30, 2003 is comprised of the following:
Foreign
Currency Unrealized Accumulated Other
Translation Holding Comprehensive
(In thousands) Adjustment Gain(Loss) Gain(Loss)
Balance, December 31, 2002 $ (6,448) $ 66 $ (6,382)
Nine month period changes 6,942 (61) 6,881
Balance, September 30, 2003 $ 494 $ 5 $ 499
7. OPERATING SEGMENT DATA
The Company has prepared operating segment information in accordance with
SFAS No. 131, "Disclosures About Segments of An Enterprise and Related
Information," to report components that are evaluated regularly by the
Company's chief operating decision maker, or decision-making group, in
deciding how to allocate resources and in assessing performance. The
Company is organized geographically and by line of business. The line of
business management structure is the primary basis upon which financial
performance is assessed and resources allocated.
The Company's reportable operating segments include Software, Customer
Support, Professional Services and Education, and Hardware. The Software
operating segment develops and markets the Company's Enterprise Content,
Business Process and Forms 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 after
these allocations have been made to each segment.
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.
15
Operating segments data for the three and nine months ended September 30,
2003 and 2002 are as follows:
In thousands Three months ended Nine months ended
September 30, September 30,
2003 2002 2003 2002
Software
Revenue $ 35,320 $ 30,538 $ 104,397 $ 96,128
Operating loss (15,028) (14,822) (46,891) (40,272)
Customer Support
Revenue $ 41,162 $ 37,838 $ 121,024 $ 111,682
Operating income 17,885 16,156 51,889 44,343
Professional Services and Education
Revenue $ 12,162 $ 12,751 $ 36,095 $ 43,078
Operating loss 13 (742) (553) (2,421)
Hardware
Revenue $ 745 $ 1,975 $ 2,039 $ 6,682
Operating income (loss) (49) 167 (417) 303
Total
Revenue $ 89,389 $ 83,102 $ 263,555 $ 257,570
Operating income 2,821 759 4,028 1,953
8. STOCK OPTIONS
The following is a summary of stock option transactions regarding all stock option plans for the three
months ended September 30, 2003:
Weighted-Average
Number of Exercise
Options Price
Balance, June 30, 2003 8,587,463 $ 15.22
Granted (weighted-average fair value of $9.19) 202,900 19.97
Exercised (457,298) 11.58
Canceled (104,900) 15.64
Balance, September 30, 2003 8,228,165 $ 15.53
16
The following table summarizes information concerning outstanding and exercisable stock options at
September 30, 2003:
Options Outstanding Options Exercisable
Weighted-Average
Remaining Weighted-Average Weighted-Average
Range of Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life (Years) Price Exercisable Price
$ 1.39 - 9.00 1,420,896 4.12 $ 7.97 1,420,646 $ 7.97
9.17 - 12.86 1,655,694 7.62 11.97 790,612 11.21
12.97 - 14.19 1,551,055 7.59 13.47 751,516 13.59
14.39 - 18.45 1,534,449 7.52 16.77 781,122 16.60
19.53 - 24.88 1,438,979 6.97 22.52 1,089,018 22.78
25.00 - 41.84 627,092 5.81 28.14 555,878 28.22
$ 1.39 - 41.84 8,228,165 6.74 $ 15.53 5,388,792 $ 15.56
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 September
30, 2003 were as follows:
(In thousands)
2003 (remaining 3 months) $ 3,670
2004 12,388
2005 10,775
2006 9,993
2007 9,325
2008 8,197
Thereafter 6,548
Total $ 60,896
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.
17
The following table represents the warranty activity and balance for the
nine months ended September 30, 2003 and 2002:
(In thousands) 2003 2002
Beginning balance at January 1 $ 728 $ 772
Additions 678 856
Deductions (916) (904)
Ending balance at September 30 $ 490 $ 724
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.
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 obtains
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 September 30, 2003. Approximately $0.4 million of the
$1.3 million is secured by cash deposit.
The Company indemnifies its directors and officers to the maximum extent
permitted under the laws of the State of Delaware.
The Company has not recorded a liability for the guarantees and indemnities
described above 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. The
Company's product warranty liability as of September 30, 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 condition.
18
11. FOREIGN CURRENCY TRANSACTIONS
As of September 30, 2003, the Company had forward foreign exchange
contracts outstanding totaling approximately $ 0.9 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 September 30, 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 September 30, 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. Accrued interest
as of September 30, 2003 was approximately $34,000. 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 July 30, 2002. However, its terms cannot be renewed or materially
modified in the future.
John Savage, a member of the Board of Directors and the Audit Committee of
the Board, is Managing Partner of Alliant Partners, which acted as
financial advisor to eGrail in connection with our acquisition of assets
from eGrail and was paid approximately $500,000 by eGrail. Accordingly,
John Savage recused himself from all discussions related to the acquisition
of eGrail assets by the Company and abstained from voting on the
transaction.
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. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates," "may,"
"will" and variations of these words or similar expressions are intended to
identify forward-looking statements. In addition, any statements that refer
to expectations, projections or other characterizations of future events or
19
circumstances, including any underlying assumptions, are forward-looking
statements. These statements are not guarantees of future performance and
are subject to risks, uncertainties and assumptions that are difficult to
predict. Therefore, our actual results could differ materially and
adversely from those expressed in any forward-looking statements as a
result of various factors. 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 under the
heading "Risk Factors That May Affect Future Results" 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 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, process and connectivity
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. The FileNet P8 architecture is designed to
provide an integrated solution for our customers to easily configure,
design, build and deploy a variety of enterprise-wide ECM applications 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.
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
20
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 a specified 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
our 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. Consulting engagements
average from one to three months. We do not make changes to the standard
software code in the field. Revenue from these services and from training
classes is recognized as such services are delivered and accepted by the
customer. Revenue and cost is recognized using the percentage-of-completion
method for fixed-price consulting contracts. 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.
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 is 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. The Company engaged
an independent valuation firm to determine the business enterprise value
for each of our three reporting units and to perform an impairment analysis
as of July 1, 2003 in accordance with SFAS 142. The analysis indicated
21
there was no impairment of goodwill in any of the three reporting units. As
of September 30, 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 asset due to uncertainty regarding the future realization
based on historical taxable income, projected future taxable income, and
the expected timing of the reversals of existing temporary differences. If
we operate at a loss or are unable to generate sufficient future taxable
income we could be required to increase the valuation allowance against all
or a significant portion of our deferred tax assets which would result in a
substantial increase to our effective tax rate and could result in a
material adverse impact on our operating results. Conversely, if we
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 temporary decrease to our effective tax rate and an increase to
additional paid in capital.
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.
22
Results of Operations
The following table sets forth certain consolidated statements of
operations data as a percentage of total revenue for the periods indicated:
Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
Revenue:
Software 39.5% 36.7% 39.6% 37.3%
Customer support 46.1 45.5 45.9 43.4
Professional services and education 13.6 15.4 13.7 16.7
Hardware 0.8 2.4 0.8 2.6
Total revenue 100.0 100.0 100.0 100.0
Cost of revenue:
Software 4.3 3.0 4.0 2.8
Customer support 10.8 11.5 10.7 11.4
Professional services and education 11.8 13.7 12.1 14.8
Hardware 0.9 1.6 1.1 1.9
Total cost of revenue 27.8 29.8 27.9 30.9
Gross Profit 72.2 70.2 72.1 69.1
Operating expenses:
Sales and marketing 38.5 38.9 39.3 37.8
Research and development 21.3 21.4 22.0 21.0
In-process research and development - - - 0.1
General and administrative 9.2 9.0 9.3 9.4
Total operating expenses 69.0 69.3 70.6 68.3
Operating income 3.2 .9 1.5 .8
Other income, net 0.7 1.3 1.3 1.5
Income before income tax 3.9% 2.2% 2.8% 2.3%
23
Revenue
Total revenue for the three months ended September 30, 2003 was $89.4
million compared to $83.1 million for the three months ended September 30,
2002, an increase of $6.3 million, or 8%. Total revenue for the nine months
ended September 30, 2003 was $263.6 million compared to $257.6 million for
the nine months ended September 30, 2002, an increase of $6.0 million, or
2%. International revenue for the three and nine months ended September 30,
2003 was 24% and 29% of total revenue, compared to 29% and 28% for the
three and nine months ended September 30, 2002. The increases in total
revenue for the three-month and nine-month periods ended September 30, 2003
as compared to the same periods in 2002, resulted from increases in
software and customer support revenue partially offset by decreases in
professional services and hardware revenue. These trends are more fully
discussed and explained below.
Software: Software revenue consists of fees earned from the licensing of
our software products to customers. Software revenue increased $4.8
million, or 16%, to $35.3 million for the three months ended September 30,
2003, from $30.5 million for the three months ended September 30, 2002.
Software revenue increased $8.3 million, or 9%, to $104.4 million for the
nine months ended September 30, 2003, from $96.1 million for the nine
months ended September 30, 2002. Software revenue represented 40% and 37%
of total revenue for the three months ended September 30, 2003 and
September 30, 2002, respectively. Software revenue represented 37% of total
revenue for the nine months ended September 30, 2003 and September 30,
2002, respectively.
The increase in software revenue is the result of a combination of larger
transactions, continued sales of additional software licenses to existing
customers in our key vertical industries of financial services and
insurance, and heightened demand for our content management and business
process product offerings. We believe enterprise content management
continues to be a priority for companies in our key vertical industries. If
overall economic conditions strengthen and if technology spending increases
as a consequence of this improvement, we anticipate that demand for our
software products, particularly in our key vertical industries, will result
in an increase.
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 $3.3 million,
or 9%, to $41.1 million for the three months ended September 30, 2003 from
$37.8 million for the three months ended September 30, 2002. Customer
support revenue increased $9.3 million, or 8%, to $121.0 million for the
nine months ended September 30, 2003 from $111.7 million for the nine
months ended September 30, 2002. Customer support revenue represented 46%
and 45% of total revenue for the three months ended September 30, 2003 and
September 30, 2002, respectively. Customer support revenue represented 46%
of total revenue for the nine months ended September 30, 2003 compared to
43% 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
and add-on customer software sales made during the three months ended
September 30, 2003. Our solutions tend to be mission critical applications
for our customers and consequently we have experienced a high rate of
renewal on maintenance contracts from our customer base. However, over time
the growth rate for customer support revenue is dependent on our success in
achieving software revenue growth and high rates of customer satisfaction.
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 performed on a time and
material basis or under a fixed price contract. Professional services and
education revenue decreased $0.6 million, or 5%, to $12.2 million for the
24
three months ended September 30, 2003 from $12.8 million for the three
months ended September 30, 2002. Professional services and education
revenue decreased $7.0 million, or 16%, to $36.1 million for the nine
months ended September 30, 2003 from $43.1 million for the nine months
ended September 30, 2002. Professional services and education revenue
represented 14% and 15% of total revenue for the three months ended
September 30, 2003 and September 30, 2002, respectively. Professional
services and education revenue represented 14% of total revenue for the
nine months ended September 30, 2003 compared to 17% for the comparable
period in 2002.
Professional services revenue and education revenue is dependent on the
level and the nature of software sales over time. Generally, software sales
for new customer system implementations will generate larger professional
service consulting engagements and training enrollments than sales of
additional licenses to existing customer installations. In our recent
quarters, software revenue has been characterized by repeat purchases for
additional software licenses that do not require large-scale professional
services engagements. Additionally, the professional service market in
general has experienced significant pricing pressure resulting in reduced
revenue. These factors have reduced professional services and education
revenue. However, as more fully discussed in the software revenue section,
if software sales increase to our installed base and new customers, we
would expect that demand for consulting and education would increase over
the next several quarters.
Hardware: Hardware revenue is generated primarily from the sale of 12-inch
Optical Storage And Retrieval ("OSAR") libraries. Hardware revenue
decreased $1.3 million, or 65%, to $0.7 million for the three months ended
September 30, 2003 from $2.0 million for the three months ended September
30, 2002. Hardware revenue decreased $4.7 million, or 70%, to $2.0 million
for the nine months ended September 30, 2003 from $6.7 million for the nine
months ended September 30, 2002. Hardware revenue represented slightly less
than 1% of total revenue for the three months ended September 30, 2003,
compared to 2% for the comparable period of 2002. Hardware revenue
represented less than 1% of total revenue for the nine months ended
September 30, 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 in the
future.
Cost of Revenue
Total cost of revenue increased $0.1 million, or less than 1%, to $24.9
million for the three months ended September 30, 2003, from $24.8 million
for the comparable period in 2002. Total cost of revenue decreased $6.2
million, or 8%, to $73.4 million for the nine months ended September 30,
2003, from $79.6 million for the comparable period in 2002. The decrease
for the nine-month period is primarily due to the decrease in the cost of
professional services and education revenue and hardware revenue as more
fully discussed below.
Software: Cost of software revenue includes royalties paid to third
parties, amortization expense for acquired technology and other intangible
assets, partner commissions, software media costs, and the cost to
manufacture and distribute software. The cost of software revenue increased
$1.3 million, or 52%, to $3.8 million for the three months ended September
30, 2003 from $2.5 million for the three months ended September 30, 2002.
The cost of software revenue increased $3.2 million, or 44%, to $10.4
million for the nine months ended September 30, 2003 from $7.2 million for
the nine months ended September 30, 2002. The costs of software revenue
represented 11% and 8% of the related software revenue for the three months
ended September 30, 2003 and September 30, 2002, respectively. The costs of
software revenue represented 10% and 8% of the related software revenue for
the nine months ended September 30, 2003 and September 30, 2002,
respectively.
The increase in cost of software revenue for the three and nine month
periods of 2003, as compared to the same periods in 2002, is due primarily
to higher partner commission expense and the additional amortization
expense of acquired technology and other intangible assets associated with
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the acquisitions of eGrail in April 2002 and Shana in April 2003. We
anticipate cost of software revenue as a percentage of software revenue to
remain comparable to current levels in future periods, however additional
technology acquisitions or unexpected increases in third party royalty
costs could increase cost of software revenue in the future.
Customer Support: Cost of customer support revenue includes costs of
customer support personnel, cost of supplies and spare parts, and the cost
of third-party hardware maintenance. The cost of customer support revenue
increased $0.1 million, or 1%, to $9.7 million for the three months ended
September 30, 2003 from $9.6 million for the three months ended September
30, 2002. The cost of customer support revenue decreased $1.4 million, or
5%, to $28.1 million for the nine months ended September 30, 2003 from
$29.5 million for the nine months ended September 30, 2002. These costs
represented 23% and 25% of the related customer support revenue for the
three months ended September 30, 2003 and 2002, respectively. These costs
represented 23% and 26% of the related customer support revenue for the
nine months ended September 30, 2003 and 2002, respectively.
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. The decrease in cost
of customer support revenue for nine months ended September 30, 2003
compared to the same period in 2002 is primarily attributable to lower
variable compensation expense and lower supplies cost. Going forward, we
expect cost of customer support revenue to remain relatively stable in 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 $0.8 million,
or 7%, to $10.6 million for the three months ended September 30, 2003 from
$11.4 million for the three months ended September 30, 2002. The cost of
professional services and education revenue decreased $6.0 million, or 16%,
to $32.0 million for the nine months ended September 30, 2003 from $38.0
million for the nine months ended September 30, 2002. These costs
represented 87% and 89% of the related professional services and education
revenue for the three months ended September 30, 2003 and 2002,
respectively. These costs represented 89% and 88% of the related
professional services and education revenue for the nine months ended
September 30, 2003 and 2002, respectively.
The decrease in cost of professional services and education revenue in 2003
compared to 2002 was primarily attributable to a reduction in the use of
third-party independent consultants, as well as lower variable compensation
expense; all directly related to the decrease in professional services and
education 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 $0.5
million, or 38%, to $0.8 million for the three months ended September 30,
2003 from $1.3 million for the three months ended September 30, 2002. The
cost of hardware revenue decreased $1.9 million, or 40%, to $2.9 million
for the nine months ended September 30, 2003 from $4.8 million for the nine
months ended September 30, 2002. The decrease in cost of hardware revenue
is directly related to the decrease in sales of OSAR library products. The
increase in costs as a percentage of sales reflects the fixed operating
costs relative to reduced sales volume. This operating segment is not a
strategic focus for us.
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Operating Expenses
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
$2.1 million, or 6%, to $34.4 million for the three months ended September
30, 2003 from $32.3 million for the three months ended September 30, 2002,
and represented 38% and 39% of total revenue for these respective periods.
Sales and marketing expense increased $6.3 million, or 6%, to $103.7
million, 6%, for the nine months ended September 30, 2003 from $97.4
million for the nine months ended September 30, 2002, and represented 39%
and 38% of total revenue for these respective periods.
The increase in sales and marketing expense in the quarter ended September
30, 2003 and during the first nine months of 2003 was primarily due to
investment in our sales and marketing capabilities that include targeted
contact and campaign management for specific industries, and channel
partner development expenses associated with the launch of our FileNet P8
product. This increase was partially offset by reduced variable
compensation expense. We expect sales and marketing expense to be at
approximately 39% of revenue in the near-term due to the continuing
investment in demand generation capabilities for targeted customers through
our direct and indirect sales channels.
Research and Development: Research and development expense primarily
consists of costs of personnel to support product development. Research and
development expense increased $1.2 million to $19.0 million, 7%, for the
three months ended September 30, 2003 from $17.8 million for the three
months ended September 30, 2002, and represented 21% of total revenue for
these respective periods. Research and development expense increased $4.0
million to $58.0 million, for the nine months ended September 30, 2003 from
$54.0 million for the nine months ended September 30, 2002, and represented
22% and 21% of total revenue for these respective periods.
The increase year over year in the first nine months of 2003 is the result
of increased third party development expense and increased headcount. We
are transitioning our development labor base from purely direct personnel
to a mix of internal and third party developers. Third party developers
tend to be located in lower labor cost countries. Over time, we believe we
will be able to lower our per developer cost through the use of these third
party resources. However, in the near term, some duplicate expenses will be
incurred as our development programs are transitioned to third party
developers. Third party development costs for the nine months ended
September 30, 2003 was $2.4 million compared to $1.3 million for the same
period in 2002. Research and development employee headcount totaled 464 for
the period ended September 30, 2003 compared to 459 for the same period in
2002. Increased internal headcount resulted in higher compensation,
benefits and relocation costs related to the eGrail and Shana acquisitions
in April of 2002 and 2003, respectively. This increase was partially offset
by a decrease in variable compensation expense.
Our research and development efforts are focused on enhancing and
maintaining our enterprise content management capabilities within the
FileNet P8 product line. These efforts will focus on enhancements to our
FileNet P8 platform, Business Process Management, Web Content Management
and the development of integrated records management and other
capabilities. We intend to complement internal development with third-party
software through OEM agreements and may execute additional technology
acquisitions. We expect that competition for qualified technical personnel
will remain strong 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. We expect research and development
expense to be at approximately 21% of revenue in the near term.
27
In-process Research and Development: There has been no in-process research
and development expensed during 2003. The acquisition of the eGrail assets
acquired in April 2002 included $400,000 of in-process research and
development, which was expensed upon acquisition because technological
feasibility had not been established and no future alternative uses,
existed.
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 increased $0.7
million, or 9%, to $8.2 million, for the three months ended September 30,
2003 from $7.5 million for the three months ended September 30, 2002, and
represented 9% of total revenue for these respective periods. General and
administrative expense increased $0.1 million, or less than 1%, to $24.4
million for the nine months ended September 30, 2003 from $24.3 million for
the nine months ended September 30, 2002, and represented 9% of total
revenue for these respective periods.
General and administrative expense was essentially unchanged during the
first nine months of 2003 compared to the first nine months of 2002 due to
cost containment programs that have been in effect over the last eighteen
months. We expect general and administrative expenses to remain at
approximately 9% of revenue for the near term.
Amortization of Purchased Intangible Assets
The April 2002 purchase of eGrail assets resulted in intangible assets
comprised of acquired technology of $3.3 million and patents of $24,000,
with assigned useful lives of five years and two years, respectively. The
April 2003 purchase of Shana resulted in $5.7 million of intangible assets;
comprised of acquired technology of $4.0 million, customer maintenance
relationships of $800,000 and technology manuals and design documents of
$600,000. All intangible assets for the Shana acquisition were assigned a
useful life of five years. Non-compete agreements with former executives of
Shana were valued at $277,000 and were assigned a useful life of between
two and three years.
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 $0.6 million for
the three months ended September 30, 2003 compared to other income, net of
$1.0 million for the three months ended September 30, 2002. Other income,
net was $3.3 million for the nine months ended September 30, 2003 compared
to other income, net of $3.8 million for the nine months ended September
30, 2002. Other income decreased slightly between comparable periods due to
reduced investment earnings between comparable periods partially offset by
foreign exchange gains.
Income Taxes
Our combined federal, state and foreign annual effective tax rate for the
three months ended September 30, 2003, is 28% compared to 23% for the
comparable period in 2002. The combined federal, state and foreign annual
effective tax rate for the nine months ended September 30, 2003, is 28%
compared to 23% for the comparable period in 2002. The provision for income
taxes differs from the tax computed at the federal statutory income tax
rate due primarily to earnings considered as permanently reinvested in
foreign operations. The increased tax rate in 2003 was primarily due to the
mix of income earned by our domestic operations versus the foreign
subsidiaries.
We have a deferred net tax asset of approximately $22.6 million and a
valuation allowance of approximately $23.8 million as of September 30,
2003. FileNet management will continue weighing various factors throughout
the year to assess the recoverability of its recorded deferred assets and
28
the need for any valuation allowance against such amounts. Recoverability
of the deferred tax assets is dependent on profitability from operations
going forward. If we were to reverse the entire valuation allowance in the
future, we would record a non-cash charge to increase additional reported
paid in capital by approximately $9.0 million, and tax expense would
decrease (causing an increase in earnings) by approximately $10.0 million
to $14.0 million.
Liquidity and Capital Resources
At September 30, 2003, combined cash, cash equivalents and investments
totaled $217.5 million, an increase of $32.3 million from December 31,
2002.
Cash provided by operating activities during the nine months ended
September 30, 2003 totaled $35.8 million and resulted primarily from:
additions to net income for depreciation and amortization expense of $14.8
million, net income of $5.3 million, an increase of $3.3 million in
customer deposits and advances, an increase in unearned maintenance revenue
related to prepaid maintenance contracts of $2.9 million and a decrease in
accounts receivable of $2.9 million. The increase in unearned maintenance
revenue is primarily the result of the growth in our base of annual support
contracts resulting from new customer sales and sales of additional
products to the existing base. Additionally, a significant number of
maintenance contracts renew early in the year and are amortized ratably
throughout the year resulting in a lower balance in unearned maintenance by
December 31.
For the nine months ended September 30, 2003, cash used for investing
activities totaled $18.3 million and included: Shana acquisition of $8.1
million, capital expenditures of $6.8 million and a net purchase of
marketable securities of $3.5 million.
Cash provided by financing activities totaled $9.5 million and was a result
of proceeds received from the exercise of employee stock options and stock
purchases under the employee stock purchase plan.
On June 27, 2003, our $5.0 million multi-currency revolving line of credit
expired in accordance with its terms and was not renewed because the cost
of carrying the line did not justify the level of usage. We believe we will
be able to meet our bank guarantee needs through our existing bank
relationships in the United States and internationally.
Contractual cash obligations of significance include operating leases for
our corporate offices, sales offices, development and manufacturing
facilities, non-cancelable operating leases for other equipment, some of
which have renewal options and generally provide for escalation of the
annual rental amount. (See Note No. 9 to the Notes to Unaudited Condensed
Consolidated Financial Statements for additional details.)
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 12 months.
Other Financial Instruments
We conduct business on a global basis in several currencies. Accordingly,
we are exposed to movements in foreign currency exchange rates. We enter
into forward foreign exchange contracts to minimize the short-term impact
of currency fluctuations on monetary assets and liabilities denominated in
currencies other than the functional currency of the relevant entity. We do
not enter into foreign exchange forward contracts for trading purposes.
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 as other income in the consolidated statements of
operations. 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
29
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.
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. and our April 2003 acquisition of Shana
Corporation were accounted for in compliance with this pronouncement (See
Note No. 3 to the Notes to the Unaudited Condensed Consolidated Financial
Statements 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. As of the first day of
July of each year, goodwill is tested for impairment by determining if the
carrying value of each reporting unit exceeds its fair value. We engaged an
independent valuation firm to determine the business enterprise value for
each of our three reporting units and to perform an impairment analysis as
of July 1, 2003 in accordance with SFAS 142. The analysis indicated there
was no impairment of goodwill in any of the three reporting units. As of
September 30, 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 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. The adoption of this standard did not
have a material impact on our consolidated financial position and results
of operations.
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.
30
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 and nine months ended September 30, 2003 did not have a material
impact on our 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 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 September
30, 2003. The adoption of FIN 46 did not have a material impact on our
consolidated results of operations or financial position.
In April 2003, FASB issued SFAS No. 149, "Amendment of Statement No. 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 (1) clarifies
under what circumstances a contract with an initial net investment meets
the characteristic of a derivative discussed in paragraph 6(b) of Statement
No. 133, (2) clarifies when a derivative contains a financing component,
(3) amends the definition of an underlying derivative to conform it to
language used in FIN 45, and (4) amends certain other existing
pronouncements, which will collectively result in more consistent reporting
of contracts as either derivatives or hybrid instruments. SFAS No. 149 is
effective for contracts and hedging relationships entered into or modified
after June 30, 2003. The adoption of SFAS No. 149 did not have a material
impact on our consolidated financial statements or financial position.
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No.
150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both debt and equity and
requires an issuer to classify the following instruments as liabilities in
its balance sheet:
o a financial instrument issued in the form of shares that is
mandatorily redeemable and embodies an unconditional obligation
that requires the issuer to redeem it by transferring its assets
at a specified or determinable date or upon an event that is
certain to occur;
31
o a financial instrument, other than an outstanding share, that
embodies an obligation to repurchase the issuer's equity shares,
or is indexed to such an obligation, and requires the issuer to
settle the obligation by transferring assets; and
o a financial instrument that embodies an unconditional obligation
that the issuer must settle by issuing a variable number of its
equity shares if the monetary value of the obligation is based
solely or predominantly on (1) a fixed monetary amount, (2)
variations in something other than the fair value of the issuer's
equity shares, or (3) variations inversely related to changes in
the fair value of the issuer's equity shares.
SFAS No. 150 is effective for financial instruments entered into or
modified after May 31, 2003 and is effective for all other financial
instruments as of the first interim period beginning after June 15, 2003.
SFAS No. 150 is to be implemented by reporting the cumulative effect of a
change in accounting principle. The adoption of SFAS No. 150 did not have a
material impact on our consolidated financial statements or 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
Except for the historical information and discussions contained herein,
statements contained in this Form 10-Q may constitute "forward looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements are based on current expectations and assumptions that
involve a number of risks, uncertainties and other factors that could cause
actual results to differ materially from recent results or from our anticipated
future results. We operate in a rapidly changing economic and technological
environment that presents numerous risks. Prospective and existing investors are
strongly urged to carefully consider the various cautionary statements and risks
set forth in this quarterly report and our other public filings. Many of these
risks are beyond our control and are driven by factors that we cannot predict.
The following discussion highlights some of these risks.
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. 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. Consequently, our prior operating results should not necessarily be
considered indicative of future operating results.
Factors, which may cause our operating results to fluctuate, 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 the length of our sales cycle;
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; or,
o seasonality in technology purchases.
32
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. We have multiple competitors
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.
Other competitive risks include, but are not limited to:
o We anticipate significant future consolidation as the software
industry matures. Large well-established software firms like Oracle,
IBM and Adobe may enter our market by adding content management
features to their existing suite of products. EMC Corporation, a data
storage hardware company, has announced its intention to acquire
Documentum. Other large, well-capitalized hardware firms like Sun
Microsystems may enter our market by acquiring our competitors to
pursue revenue growth opportunities;
o Many of our competitors are also our distribution channel partners.
For example, IBM competes with us in the content management market,
but also implements our software solutions through the IBM Global
Services business unit. This type of vertical integration of software
development and system integration capabilities may be viewed by our
customers as a key competitive advantage;
o Some of our competitors are also our key technology suppliers. For
example, IBM's Crossworlds business unit supplies a key technology for
our business process management software. Our inability to license
future releases of key technology from these competitive vendors could
limit the technical capabilities of our products.
We cannot predict new competitors entering our market through acquisitions or
other alliances. In order to be successful in the future, we must respond to
technological change, customer requirements and competitors' current software
products and innovations. We may not be able to compete effectively in our
target markets. 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.
33
A significant portion 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 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 and requirements for localized products;
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 multiple overlapping tax regimes;
o currency restrictions and currency exchange fluctuations;
o the burden of complying with a wide variety of complex foreign laws,
regulations and treaties;
o spreading our management resources to cover multiple countries; or,
o longer collection cycles and higher risk of non-collection and bad
debt expense.
Any of these factors could reduce the amount of revenue we realize from our
international operations in the future.
The market for content management solutions may not grow as we anticipate,
and may decline, and our products may not gain acceptance within this market.
Our future financial performance will depend primarily on the continued growth
of the markets for our software products and services as well as our ability to
capture a larger share of those markets. Our primary product offerings address
the new and emerging market for content management solutions. This market is
developing rapidly, and while we believe this market is growing and will
continue to grow, particularly as new regulations are introduced that focus on
controlling the flow of information within organizations to ensure compliance
with disclosure and other obligations, there can be no assurance that these
markets will continue to grow as we anticipate, or that our products and
solutions will gain acceptance within these markets. If the markets we serve,
particularly the market for enterprise content management solutions, fail to
grow or grow more slowly than we currently anticipate, or if our products and
solutions do not gain acceptance within these markets, our business, financial
condition and operating results would be harmed.
We have adopted a strategy of developing a unified platform for enterprise
content management products and related services, and we must effectively manage
the transition of our products and services to this platform or our revenue may
suffer. Our future success depends, in part, on our ability to execute on our
strategy of delivering a unified platform and framework for Enterprise Content
Management. To date, the majority of our revenue has been generated by sales of
licenses to our diverse content management products and related services. Our
unified platform strategy requires us to adapt our legacy products and develop
new products for our new FileNet P8 platform. We expect that this family of
products and services will continue to account for the majority of our future
revenue, making us highly dependent on continued sales of this single product
family. If we do not make an effective transition from existing products and
services to our FileNet 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.
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
34
to customer requirements. In addition, our ability to generate revenues from the
sale of customer support, education and professional services is substantially
dependent on our ability to generate new sales of our software products. We may
not be successful 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
technical difficulties that could delay or prevent the successful development,
introduction and sale of these products and enhancements. 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 are dependent on customers concentrated in a small number of industries.
Our customers are concentrated in the insurance, financial services, government,
manufacturing, telecommunications and utilities industries. We may not be
successful in obtaining significant new customers in different industry segments
and we expect that sales of our products to a limited number of customers in a
limited number of industry segments will continue to account for a large portion
of our revenue in the future. If we are not successful at obtaining significant
new customers or if a small number of customers cancel or delay their orders for
our products, then our business and our prospects could be harmed. Consolidation
within the financial services and insurance industry could further reduce our
customers and future prospects. As many of our significant customers are
concentrated in a small number of industry segments, if business conditions in
one of those industry segments decline, then orders for our products from that
segment may decrease, which could negatively impact our business, financial
condition and operating results and cause the price of our common stock to fall.
We must devote substantial resources to software development, and we may
not realize revenue from our development efforts for a substantial period of
time. Introducing new products that rapidly address changing market demands
requires a continued high level of investment in research and development. Our
product development and engineering expenses were $58.0 million, or 22% of total
revenue, for the nine months ended September 30, 2003 and $ 54.0 million, or 21%
of total revenue, for the nine months ended September 30, 2002. The costs
associated with software development are increasing, including the costs of
recruiting and retaining engineering talent and acquiring or licensing new
technologies. The majority of our investment in new and existing market
opportunities must be made prior to our ability to generate revenue from these
new opportunities. These investments of money and resources must be made based
on our prediction of new products and services that the market needs and will
accept. As a result, our operating results could be adversely affected if our
predictions of market demand are incorrect and we are not able to realize the
level of revenues we expect from new products or if that revenue is
significantly delayed.
We are increasing our use of third party software developers and may have
difficulty enforcing our agreements with them. To help manage costs, we have
contracted with third party software development companies overseas,
particularly in India where labor costs are lower, to perform a significant
portion of our software development and customer technical support work. As a
result, we will become increasingly dependent on these third party developers
for continued development and maintenance of several of our key products. If any
of these third party developers were to terminate their relationship with us,
our efforts to develop new products and improve existing products could be
significantly delayed and our ability to provide product support to our
customers could be impaired. In addition, since the majority of these third
party developers are located outside the United States, our ability to enforce
our agreements with them may be limited.
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
35
loss of the services of one or more key employees could have a material adverse
effect on our operating results. We do not have employment agreements with any
of the members of our United States-based senior management. We do have
employment contracts with members of our international management that commit
them to a notification period.
We 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. We cannot assure that in the
future we will be successful in attracting and retaining such personnel.
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.
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:
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;
o valuations of acquired assets or businesses that are less than
expected; or
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.
Our business is highly automated for the execution of marketing, selling
and technical support functions. We depend on the integrity of our information
systems network connectivity to perform these business functions. Significant
business interruption could occur at our Costa Mesa headquarters facility due to
a natural disaster such as earthquake, which could cause a prolonged power
outage and the inability for key personnel to perform their job functions. We
have taken precautionary measures including implementing a disaster recovery
plan to mitigate this risk.
36
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. Intellectual property
rights often cannot be enforced without engaging in litigation, which involves
devotion of significant resources, can divert management attention and has
uncertain outcomes. 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 to avoid further infringement or that we could obtain
necessary licenses to use the infringed rights on acceptable terms, or 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 Systems Inc., EMC Corporation, ILOG Corporation,
Arbortext, Inc., Venetica Corporation and Verity, Inc. Certain of these
agreements have minimum purchase requirements and/or require prepayments which
usage is limited to a specific time frame, 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.
37
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 announcements of technological innovations or new products or product
enhancements by us or our competitors;
o key management changes;
o changes in accounting regulations;
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;
o acquisitions in the past have been primarily cash based transactions.
Future acquisitions may include stock, which could dilute EPS and
possibly reduce shareholder value;
o we may not be able to hedge all foreign exchange risk due to the
significant fluctuation of the Euro to the US Dollar and our ability
to predict the mix of sales orders denominated in the Euro at the end
of each fiscal quarter;
o reduced stock value may restrict our access to equity financing to
fund further acquisitions using stock;
o industry analyst opinions may increase our stock price volatility and
reduce shareholder value; 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates primarily
to our investment portfolio. We have not used derivative financial instruments
in our investment portfolio. We place our investments with high-quality issuers
and, by policy, limit the amount of credit exposure to any one issuer. We
protect and preserve our invested funds by limiting default, market and
reinvestment risk. Our investments in marketable securities consist primarily of
high-grade corporate and government securities with maturities of less than
three years. Investments purchased with an original maturity of three months or
less are considered to be cash equivalents. We classify all of our investments
as available-for-sale. Available-for-sale securities are carried at fair value,
with unrealized gains and losses, net of tax, reported in a separate component
of stockholders' equity. Average maturity of our investment portfolio is 4.1
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 September 30, 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
38
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 September 30, 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 $258,000 at September 30, 2003 and
approximately $271,000 at September 30, 2002. 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 $515,000 at September 30, 2003 and
approximately $541,000 at September 30, 2002.
The following table provides information about our cash and cash equivalents and
our investment portfolio at September 30, 2003 (dollars in thousands):
.
Estimated Fair
(In thousands) Cost Value
Debt Securities
Due in one year or less:
Short-term munis-taxable $ 8,339 $ 8,359
Corporate 13,642 13,647
Governments/Agencies 11,539 11,539
Total due in one year 33,520 33,545
Due in one to three years:
Taxable munis - -
Corporate 2,222 2,208
Government/Agencies 19,500 19,497
Total due in three years 21,722 21,705
Grand total $ 55,242 $ 55,250
Actual maturities may differ from contractual maturities because the issuer of
the securities may have the right to repurchase such securities. We classify
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 September 30, 2003,
we had forward foreign exchange contracts outstanding totaling approximately
$0.9 million in ten currencies. These contracts were opened on the last business
day of the quarter and mature within three months.
39
Cumulative other comprehensive loss decreased by $6.9 million for the nine
months ended September 30, 2003 due to unrealized foreign currency translation
gains resulting from the strengthening of the Euro against the U.S. dollar
during the first nine months 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 nine months ended September 30, 2003.
Item 4. Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's Exchange Act
reports is recorded, processed, summarized and reported within the time periods
specified in the Securities and Exchange Commission's rules and forms and that
such information is accumulated and communicated to the Company's management,
including its Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow for timely decisions regarding required disclosure. In
designing and evaluating the disclosure controls and procedures, management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and in reaching a reasonable level of assurance, management
necessarily was required to apply its judgment in evaluating the cost-benefit
relationship of possible controls and procedures.
As of September 30, 2003, the end of the quarter covered by this report, an
evaluation was carried out under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
the Company's Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures as required by SEC
Rule 13a - 15(b). Based on the foregoing, the Company's Chief Executive Officer
and Chief Financial Officer concluded that the Company's disclosure controls and
procedures were effective at the reasonable assurance level.
There has been no change in the Company's internal controls over financial
reporting during the Company's most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, the Company's internal
controls over financial reporting.
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) Reports on Form 8-K
No reports on Form 8-K were filed in the quarter ended September 30, 2003.
40
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FILENET CORPORATION
November 13, 2003 By: /s/ Sam M. Auriemma
Date Sam M. Auriemma, Senior Vice President
(Principal Financial and Accounting Officer,
Authorized Signatory)
and Chief Financial Officer
41
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* 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).
10.1.2* 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).
10.2*+ 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).
10.2.1*+ Amendment to the 1995 Stock Option Plan approved by
Registrant's Board of Directors dated May 7, 2003 (filed as
Exhibit 10.2.1 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2003).
10.2.2*+ Amended Form of 1995 Executive Officer Stock Option
Agreement (filed as Exhibit 10.2.2 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003).
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).
42
10.6*+ Amended and Restated FileNet Corporation 1998 Employee
Stock Purchase Plan (filed as Appendix B to Registrant's
Definitive Proxy Statement on Schedule 14A, for the
Registrant's 2002 Annual Meeting of Stockholders, filed on
April 18, 2002).
10.7*+ FileNet Corporation International Employee Stock Purchase
Plan (filed as Appendix C to Registrant's Definitive Proxy
Statement on Schedule 14A, for the Registrant's 2002 Annual
Meeting of Stockholders, filed on April 18, 2002).
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)
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, (filed as Exhibit 10.14 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2002).
10.14.1*+ 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 September 30, 2002).
10.14.2*+ 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
September 30, 2002).
10.14.3*+ Amendment to the 2002 Incentive Award Plan dated May 7, 2003
(filed as Exhibit 10.14.3 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003).
10.15* Stock Purchase Agreement dated April 2, 2003 by and among
Registrant, FileNet Nova Scotia Corporation, Shana
Corporation and certain Sellers (filed as Exhibit 10.15 to
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2003).
10.15.1* Escrow Agreement dated April 2, 2003 by and among FileNet
Nova Scotia Corporation, certain Sellers and Bennett Jones
LLP (filed as Exhibit 10.15.1 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003).
10.16*+ Amended and Restated Letter Agreement dated May 15, 2003 by
and between Registrant and Lee D. Roberts, Chief Executive
Officer (filed as Exhibit 10.161 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003).
10.17*+ Form of Amended and Restated Letter Agreement, dated May
15, 2003, by and between Registrant and the Chief Financial
Officer and President (filed as Exhibit 10.17 to
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2003)(1).
10.18*+ Form of Amended and Restated Letter Agreement by and among
Registrant and certain Executive Officers (filed as Exhibit
10.18 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003)(2).
10.19*+ CEO Severance Agreement together with Addendum II to Stock
Option Agreement between Registrant and Mr. Lee D. Roberts
(filed as Exhibit 10.19 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003).
10.20+ Non-Statutory Stock Option Agreement between Registrant
and Mr.Kenneth F. Fitzpatrick.
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
43
32.1 Certification of Chief Executive Officer
32.2 Certification of Chief Financial Officer
------------- ------------------------------------------------------------
* Incorporated herein by reference
+ Management contract, compensatory plan or arrangement
(1) Amended and Restated Letter Agreement, dated May 15, 2003 was entered
into by and between Registrant and Messrs. Sam Auriemma, Chief
Financial Officer and Ron L. Ercanbrack, President
(2) Amended and Restated Letter Agreement, dated May 15, 2003 was entered
into by and between Registrant and Messrs. Martyn D. Christian, David
D. Despard, Frederick P. Dillon, Karl J. Doyle, Michael W. Harris,
William J. Kreidler, Chas W. Kunkelmann, Philip Rugani, Daniel S.
Whelan, Franz X. Zihlmann, Ms. Katharina M. Mueller and Ms. Audrey N.
Schaeffer. Mr. Kenneth F. Fitzpatrick entered in a Letter Agreement,
dated September 2, 2003 on substantially the same terms and
conditions.
44
EXHIBIT 10.20
FILENET CORPORATION
NON-QUALIFIED STOCK OPTION AGREEMENT
FOR KENNETH FITZPATRICK
This Non-Qualified Stock Option Agreement is entered into by FileNet
Corporation, a Delaware corporation hereinafter referred to as "Company," and
Kenneth Fitzpatrick, who is concurrently being hired as Chief Marketing Officer
of the Company, hereinafter referred to as "Optionee."
WHEREAS, the Compensation Committee (the "Committee") has approved a stock
option grant to Optionee in order to induce Optionee to agree to be employed by
the Company and to serve the Company in the capacity of Chief Marketing Officer;
WHEREAS, the Option to purchase shares of its Common Stock granted pursuant
to this agreement has been awarded outside of and not pursuant to any of the
Company's existing employee benefit plans; and
WHEREAS, the Committee has determined that it would be to the advantage and
best interest of the Company and its stockholders to grant the Option provided
for herein to the Optionee as an inducement to enter into the service of the
Company and as an incentive for increased efforts during such service, and has
advised the Company thereof and instructed the undersigned officers to issue
said Option.
NOW, THEREFORE, in consideration of the mutual covenants herein contained
and other good and valuable consideration, receipt of which is hereby
acknowledged, the parties hereto do hereby agree as follows:
ARTICLE I.
DEFINITIONS
Section 1.1.
Whenever the following terms are used in this Agreement, they shall have
the meaning specified below unless the context clearly indicates to the
contrary. The masculine pronoun shall include the feminine and neuter, and the
singular the plural, where the context so indicates.
Agreement shall mean this Stock Option Agreement.
Board shall mean the Board of Directors of the Company.
Cause shall mean: (i) Optionee's commission of any act of theft, fraud,
embezzlement or dishonesty; or (ii) Optionee's willful or intentional misconduct
adversely affecting the business or affairs of the Company or any Subsidiary; or
(iii) Optionee's unauthorized use or disclosure of confidential information or
trade secrets of the Company or any Subsidiary. The foregoing definition shall
not be deemed to be inclusive of all acts or omissions that the Company or any
Subsidiary may consider as grounds for the dismissal or discharge of any
Optionee.
Change in Control shall mean a change in ownership or control of the
Company effected through any of the following transactions:
(a) Any person or related group of persons (other than the Company or a
person that, prior to such transaction, directly or indirectly
controls, is controlled by, or is under common control with, the
Company) directly or indirectly acquires beneficial ownership (within
the meaning of Rule 13d-3 under the Exchange Act) of securities
possessing more than 50% of the total combined voting power of the
Company's outstanding securities pursuant to a tender or exchange
offer made directly to the Company's stockholders which the Board does
not recommend such stockholders accept; or
(b) There is a change in the composition of the Board over a period of 36
consecutive months (or less) such that a majority of the Board members
(rounded up to the nearest whole number) ceases, by reason of one or
more proxy contests for the election of Board members, to be comprised
of individuals who either (i) have been Board members continuously
since the beginning of such period, or (ii) have been elected or
nominated for election as Board members during such period by at least
a majority of the Board members described in clause (i) who were still
in office at the time such election or nomination was approved by the
Board.
Committee shall mean the Compensation Committee of the Board, as
constituted from time to time.
Common Stock shall mean the common stock of the Company, par value $0.01
per share.
Code shall mean the Internal Revenue code of 1986, as amended.
Corporate Transaction shall mean:
(a) The stockholders of the Company approve a merger or consolidation of
the Company with any other corporation (or other entity), other than a
merger or consolidation which would result in the voting securities of
the Company outstanding immediately prior thereto continuing to
represent (either by remaining outstanding or by being converted into
voting securities of the surviving entity) more than 50% of the
combined voting power of the voting securities of the Company or such
surviving entity outstanding immediately after such merger or
consolidation; provided, however, that a merger or consolidation
effected to implement a recapitalization of the Company (or similar
transaction) in which no person acquires more than 25% of the combined
voting power of the Company's then outstanding securities shall not
constitute a Change in Control; or
2
(b) The stockholders of the Company approve a plan of complete liquidation
of the Company or an agreement for the sale or disposition by the
Company of all or substantially all of the Company's assets.
DRO shall mean a domestic relations order as defined by the Code or Title I
of the Employee Retirement Income Security Act of 1974, as amended, or the rules
thereunder.
Employee shall mean any officer or other employee (as defined in accordance
with Section 3401(c) of the Code) of the Company, or of any corporation that is
a Subsidiary.
Exchange Act shall mean the Securities Exchange Act of 1934, as amended.
Expiration Date shall mean the date on which the Option expires as
specified on the Signature Page hereof.
Fair Market Value of a share of Common Stock as of a given date shall be
(a) the average of the high and low selling prices of a share of Common Stock on
the principal exchange or the Nasdaq Stock Market on which shares of Common
Stock are then trading, if any (or as reported on any composite index which
includes such principal exchange), on such date, or if shares were not traded on
such date, then on the next preceding date on which a trade occurred, or (b) if
Common Stock is not traded on an exchange or the Nasdaq Stock Market, but is
quoted on Nasdaq or a successor quotation system, the average of the closing
representative bid and asked prices for the Common Stock on such date as
reported by Nasdaq or such successor quotation system, or (c) if Common Stock is
not publicly traded on an exchange and not quoted on Nasdaq or a successor
quotation system, the Fair Market Value of a share of Common Stock as
established by the Committee acting in good faith.
Option shall mean the non-qualified stock option granted to Optionee under
this Agreement.
Optionee shall mean Kenneth Fitzpatrick.
Permitted Transferee shall mean, any child, stepchild, grandchild, parent,
stepparent, grandparent, spouse, former spouse, sibling, niece, nephew,
mother-in-law, father-in-law, son-in-law, daughter-in-law, brother-in-law, or
sister-in-law, including adoptive relationships, of Optionee, any person sharing
Optionee's household (other than a tenant or employee), any trust in which these
persons (or Optionee) control the management of assets, and any other entity in
which these persons (or Optionee) own more than fifty percent of the voting
interests, or any other transferee specifically approved by the Committee after
taking into account any state or federal tax or securities laws applicable to
transferable options.
Rule 16b-3 shall mean Rule 16b-3 promulgated under the Exchange Act, as
such Rule may be amended from time to time.
Securities Act shall mean the Securities Act of 1933, as amended.
3
Subsidiary shall mean any corporation in an unbroken chain of corporations
beginning with the Company if each of the corporations other than the last
corporation in the unbroken chain then owns stock possessing fifty percent (50%)
or more of the total combined voting power of all classes of stock in one of the
other corporations in such chain.
Termination of Employment shall mean the time when the employee-employer
relationship between the Optionee and the Company or any Subsidiary is
terminated for any reason, with or without cause, including, but not by way of
limitation, a termination by resignation, discharge, death, disability or
retirement; but excluding (a) terminations where there is a simultaneous
reemployment or continuing employment of Optionee by the Company or any
Subsidiary, (b) at the discretion of the Committee, terminations which result in
a temporary severance of the employee-employer relationship, and (c) at the
discretion of the Committee, terminations which are followed by the simultaneous
establishment of a consulting relationship by the Company or a Subsidiary with
the Optionee. The Committee, in its absolute discretion, shall determine the
effect of all matters and questions relating to Termination of Employment,
including, but not by way of limitation, the question of whether a Termination
of Employment resulted from a discharge for good cause, and all questions of
whether a particular leave of absence constitutes a Termination of Employment
and the vesting, exercise and other terms of the Option during a leave of
absence.
ARTICLE II.
GRANT OF OPTION
Section 2.1. Grant of Option
Effective as of the grant date set forth on the Signature Page hereof, the
Company irrevocably grants to the Optionee the Option to purchase any part or
all of the aggregate number of shares of Common Stock set forth on the Signature
Page hereof, all upon the terms and conditions set forth in this Agreement.
Section 2.2. Purchase Price
The purchase price of the shares of Common Stock covered by the Option is
set forth on the Signature Page hereof, and shall not be subject to commission
or other charge.
Section 2.3. Consideration to Company
In consideration of the granting of this Option by the Company, the
Optionee agrees to render faithful and efficient services to the Company or its
any Subsidiary, with such duties and responsibilities as the Company or any
Subsidiary shall from time to time prescribe, for a period of at least one (1)
year from the date this Option is granted.
4
ARTICLE III.
PERIOD OF EXERCISABILITY
Section 3.1. Commencement of Exercisability
The Option shall become exercisable in the time and manner set forth on the
Signature Page hereof. Except as otherwise may be provided by the Committee, no
portion of the Option that is unexercisable at Termination of Employment shall
thereafter become exercisable.
Section 3.2. Duration of Exercisability
The installments for exercisability provided on the Signature Page are
cumulative. Each such installment that becomes exercisable as provided on the
Signature Page shall remain exercisable until it becomes unexercisable under
Section 3.3.
Section 3.3. Expiration of Option
Except to the extent otherwise set forth in any severance, change in
control or employment agreement (see section 5.8), if applicable, the Option may
not be exercised to any extent by anyone after the first to occur of the
following events:
(a) The expiration of ten (10) years from the date the Option was granted,
as set forth on the Signature Page hereof;
(b) The time of the Optionee's Termination of Employment for Cause;
(c) The expiration of three (3) months from the date of the Optionee's
Termination of Employment by reason of his retirement, resignation or
termination of his employment not for Cause, unless the Optionee dies
within said three-month period;
(d) The expiration of one (1) year from the date of the Optionee's
Termination of Employment by reason of his disability;
(e) The expiration of one (1) year from the date of the Optionee's death;
or
(f) The effective date of a Corporate Transaction, unless the successor
corporation or a parent or subsidiary of the successor corporation
assumes or substitutes the Option as described in Section 3.5. At
least fifteen (15) days prior to the effective date of a Corporate
Transaction as to which the successor corporation or a parent or
subsidiary of the successor corporation does not assume or substitute
the Option, the Committee shall give the Optionee notice of such event
if the Option has then neither been fully exercised nor become
unexercisable under this Section 3.3.
5
Section 3.4. Tax Consequences
The Optionee acknowledges that, the Option granted under this Agreement
shall be treated for all purposes as not qualifying under Section 422 of the
Code and therefore shall be subject to taxation as a non-qualified option.
Section 3.5. Acceleration of Option
(a) This Option, to the extent outstanding at the time of a Corporate
Transaction, but not otherwise fully exercisable, shall automatically
accelerate so that this Option shall, immediately prior to the
effective date of the Corporate Transaction, become vested and
exercisable for all of the shares of Common Stock subject to the
Option. No such acceleration of this Option, however, shall occur if
and to the extent this Option is, in connection with the Corporate
Transaction: (i) to be assumed by the successor corporation (or parent
or subsidiary thereof) or to be substituted with a comparable right to
purchase or receive, for each share of optioned stock subject to the
Option immediately prior to the Corporate Transaction, the
consideration (whether stock, cash, or other securities or property)
received in the Corporate Transaction by the holders of Common Stock
for each share held on the effective date of the transaction; or (ii)
to be replaced with a cash incentive program of the successor
corporation which preserves the spread existing on the Option shares
at the time of the Corporate Transaction (the excess of the Fair
Market Value of such Option shares over the aggregate exercise price
payable for those shares, appropriately adjusted) and provides for
subsequent pay-out in accordance with the Option exercise schedule.
The determination of Option comparability under clause (i) shall be
made by the Committee, and such determination shall be final, binding
and conclusive.
(b) Immediately following the Corporate Transaction, this Option shall
terminate and cease to be outstanding, except to the extent assumed or
substituted by the successor corporation (or parent or subsidiary
thereof) in connection with the Corporate Transaction.
(c) If this Option is assumed in connection with the Corporate
Transaction, then this Option shall be appropriately adjusted,
immediately after such Corporate Transaction, to apply to the number
of and class of securities which would have been isssuable to the
Optionee in consummation of such Corporate Transaction had the Option
been exercised immediately prior to such Corporate Transaction, and
appropriate adjustments shall also be made to the exercise price;
provided, that the aggregate exercise price shall remain the same.
(d) This Agreement shall not in any way affect the right of the Company to
adjust, reclassify, reorganize or otherwise change its capital or
business structure or to merge, consolidate, dissolve, liquidate or
sell or transfer all or any part of its business or assets.
ARTICLE IV.
EXERCISE OF OPTION
Section 4.1. Person Eligible to Exercise
Except for any person to whom the Option has been transferred pursuant to
Section 5.2, during the lifetime of the Optionee, only he or she may exercise
the Option (or any portion thereof). After the death of the Optionee, any
exercisable portion of the Option may, prior to the time when such portion
becomes unexercisable under Section 3.3, be exercised by his or her personal
representative or by any person empowered to do so under the deceased Optionee's
will or under the then applicable laws of descent and distribution.
Section 4.2. Partial Exercise
Any exercisable portion of the Option or the entire Option, if then wholly
exercisable, may be exercised in whole or in part at any time prior to the time
when the Option or portion thereof becomes unexercisable under Section 3.3.
Section 4.3. Manner of Exercise
The Option, or any exercisable portion thereof, may be exercised solely by
delivery to the Secretary of the Company or his or her designee of all of the
following prior to the time when the Option or such portion becomes
unexercisable under Section 3.3:
(a) A notice complying with the applicable rules established by the
Committee stating that the Option, or a portion thereof, is exercised;
(b) Such representations and documents as the Committee, in its absolute
discretion, deems necessary or advisable to effect compliance with all
applicable provisions of the Securities Act and any other federal or
state securities laws or regulations. The Committee may, in its
absolute discretion, also take whatever additional actions it deems
appropriate to effect such compliance including, without limitation,
placing legends on share certificates and issuing stop-transfer
notices to agents and registrars;
(c) In the event that the Option shall be exercised pursuant to Section
4.1 by any person or persons other than the Optionee, appropriate
proof of the right of such person or persons to exercise the Option;
(d) Full cash payment to the Company for the shares with respect to which
the Option, or portion thereof, is exercised. However, the Committee
may, in its discretion, (i) allow payment, in whole or in part,
through the delivery of shares of Common Stock which have been owned
by the Optionee for at least six months, duly endorsed for transfer to
the Company with a Fair Market Value on the date of delivery equal to
the aggregate exercise price of the Option or exercised portion
thereof; (ii) allow payment, in whole or in part, through the
7
surrender of shares of Common Stock then issuable upon exercise of the
Option having a Fair Market Value on the date of Option exercise equal
to the aggregate exercise price of the Option or exercised portion
thereof; (iii) allow payment, in whole or in part, through a broker
cashless exercise procedure whereby the Optionee delivers a notice
that the Optionee has placed a market sell order with a broker with
respect to shares of Common Stock then issuable upon exercise of the
Option, and the broker timely pays the Option exercise price; or (iv)
allow payment through any combination of the consideration provided in
the foregoing subparagraphs; and
(e) The receipt by the Company of full payment for such shares, including
payment of any applicable withholding tax, which in the discretion of
the Committee may be in the form of consideration used by the Optionee
to pay for such shares under Section 4.3(d).
Section 4.4. Conditions to Issuance of Stock Certificates.
The Company shall not be required to issue or deliver any certificate or
certificates for shares of stock purchased upon the exercise of any Option or
portion thereof prior to fulfillment of all of the following conditions:
(a) The admission of such shares to listing on all stock exchanges on
which such class of stock is then listed;
(b) The completion of any registration or other qualification of such
shares under any state or federal law, or under the rulings or
regulations of the Securities and Exchange Commission or any other
governmental regulatory body which the Committee shall, in its
absolute discretion, deem necessary or advisable;
(c) The obtaining of any approval or other clearance from any state or
federal governmental agency which the Committee shall, in its absolute
discretion, determine to be necessary or advisable; and
(d) The lapse of such reasonable period of time following the exercise of
the Option as the Committee may establish from time to time for
reasons of administrative convenience.
Section 4.5. Rights as Stockholder
The Optionee shall not have any stockholder rights with respect to the
shares of common stock purchasable upon exercise of the option until such person
shall have exercised the option, paid the exercise price and applicable taxes,
satisfies all other conditions of exercise and become a holder of record of the
purchased shares.
8
ARTICLE V.
OTHER PROVISIONS
Section 5.1. Administration
The Committee shall have the power to interpret this Agreement and to adopt
such rules for the administration, interpretation and application of the
Agreement as are consistent therewith and to interpret or revoke any such rules.
All actions taken and all interpretations and determinations made by the
Committee in good faith shall be final and binding upon the Optionee, the
Company and all other interested persons. No member of the Committee shall be
personally liable for any action, determination or interpretation made in good
faith with respect to the Agreement or the Option. In its absolute discretion,
the Board may at any time and from time to time exercise any and all rights and
duties of the Committee under this Agreement except with respect to matters
which under Rule 16b-3 or Section 162(m) of the Code, or any regulations or
rules issued thereunder, are required to be determined in the sole discretion of
the Committee.
Section 5.2. Option Generally Not Transferable
(a) Neither the Option nor any interest or right therein or part thereof
shall be liable for the debts, contracts or engagements of the
Optionee or his successors in interest or shall be subject to
disposition by transfer, alienation, anticipation, pledge,
encumbrance, assignment or any other means whether such disposition be
voluntary or involuntary or by operation of law by judgment, levy,
attachment, garnishment or any other legal or equitable proceedings
(including bankruptcy), and any attempted disposition thereof shall be
null and void and of no effect; provided, however, that this Section
5.2 shall not prevent transfers by will or by the applicable laws of
descent and distribution or, with the consent of the Committee,
pursuant to a DRO or pursuant to Section 5.2(b).
(b) Notwithstanding Section 5.2(a), with the prior consent of the
Committee, which consent may be withheld in the sole discretion of the
Committee, the Optionee may transfer the Option to any one or more
Permitted Transferees, subject to the following terms and conditions
and such other terms and conditions that may be imposed by the
Committee:
(i) the Option shall not be assignable or transferable by the
Permitted Transferee other than by will or the laws of descent
and distribution;
(ii) the Option shall continue to be subject to all the terms and
conditions of the Option as applicable to the Optionee (other
than the ability to further transfer the Option); and
(iii)the Optionee and the Permitted Transferee execute any and all
documents requested by the Committee, including, without
limitation documents to (A) confirm the status of the transferee
as a Permitted Transferee, (B) satisfy any requirements for an
exemption for the transfer under applicable federal and state
securities laws and (C) evidence the transfer.
9
Section 5.3. Shares to Be Reserved
The Company shall at all times during the term of the Option reserve and
keep available such number of shares of stock as will be sufficient to satisfy
the requirements of this Agreement.
Section 5.4. Notices
Any notice to be given under the terms of this Agreement to the Company
shall be addressed to the Company in care of its Secretary, and any notice to be
given to the Optionee shall be addressed to him at the address of record given
on the Signature Page hereof or to any updated address provided by the Optionee.
By a notice given pursuant to this Section 5.4, either party may hereafter
designate a different address for notices to be given to him. Any notice that is
required to be given to the Optionee shall, if the Optionee is then deceased, be
given to the Optionee's personal representative if such representative has
previously informed the Company of his status and address by written notice
under this Section 5.4.
Section 5.5. Titles
Titles are provided herein for convenience only and are not to serve as a
basis for interpretation or construction of this Agreement.
Section 5.6. Construction
This Agreement shall be administered, interpreted and enforced under the
laws of the State of California, without resort to that State's conflict-of-laws
rules.
Section 5.7. Conformity to Securities Laws
The Optionee acknowledges that this Agreement is intended to conform to the
extent necessary with all provisions of the Securities Act and the Exchange Act
and any and all regulations and rules promulgated by the Securities and Exchange
Commission thereunder, including without limitation Rule 16b-3. Notwithstanding
anything herein to the contrary, this Agreement shall be administered, and the
Option is granted and may be exercised, only in such a manner as to conform to
such laws, rules and regulations. To the extent permitted by applicable law,
this Agreement shall be deemed amended to the extent necessary to conform to
such laws, rules and regulations.
Section 5.8. More Favorable Terms of Severance Programs Take Precedence
To the extent the terms and conditions contained in any severance or change
in control program, plan or agreement, or any employment agreement, with the
Optionee provide more favorable terms for the Option then those set forth herein
(including without limitation terms regarding accelerated vesting and extended
exercise periods), the more favorable terms of any such severance or change in
control program, plan or agreement or any employment agreement with the Optionee
will control.
10
Section 5.9. Data Privacy
As a condition of the grant of the Option, Optionee consents to the
collection, use, processing and transfer of personal data as described in this
paragraph. Optionee understands that the Company and its affiliates hold certain
personal information about Optionee, including Optionee's name, home address and
telephone number, date of birth, social security number or global identification
number, salary, nationality, job title, any shares of the Company stock or the
Company positions held, details of all options or any other entitlement to
shares awarded, canceled, exercised, vested, unvested or outstanding in
Optionee's favor, for the purpose of managing and administering this Agreement
("Data"). Optionee further understands that the Company and/or its affiliates
will transfer Data amongst themselves as necessary for the purpose of
implementation, administration and management of Optionee's participation in
this Agreement, and that the Company and/or any of its affiliates may each
further transfer Data to any third parties assisting the Company in the
implementation, administration and management of this Agreement. Optionee
understands that these recipients may be located in the United States, the
European Economic Area, or elsewhere. Optionee authorizes them to receive,
possess, use, retain and transfer the Data, in electronic or other form, for the
purposes of implementing, administering and managing Optionee's participation in
this Agreement, including any requisite transfer of such Data as may be required
for the administration of this Agreement and/or the subsequent holding of shares
of stock on Optionee's behalf to a broker or other third party with whom
Optionee may elect to deposit any shares of stock purchased under this
Agreement. Optionee understands that Optionee may, at any time, review Data,
require any necessary amendments to it or withdraw the consents herein in
writing by contacting the Secretary of the Company. Withdrawal of consent may,
however, affect Optionee's ability to exercise or realize benefits from the
Option.
[SIGNATURE PAGE FOLLOWS]
FileNet Corporation
ID: 95-3757924
Signature Page to Non-Qualified Stock Option Agreementof Kenneth Fitzpatrick
Option Number: _________________
Effective as of September 2, 2003, you have been granted a Non-Qualified Stock
Option to buy 100,000 shares of Common Stock of FileNet Corporation at a
purchase price per share of $21.115.
The total option price of the shares granted is $2,111,500.
Your Option shares will become vested in installments pursuant to the vesting
schedule set forth below.
Number of Shares Vesting Date
25,000 shares September 2, 2004
(25% of grant)
2,083 shares The second day of each month thereafter, commencing
(approx. 1/36th of with October 2, 2004 and continuing through September
75% of grant) 2, 2006
2,084 shares The second day of each month thereafter, commencing
(approx. 1/36th of with October 2, 2006 and continuing through September
75% of grant) 2, 2007 (at which time the Option will be fully vested)
Each vesting installment is subject to earlier termination as provided in the
Agreement.
Your right to exercise the Option expires September 2, 2013, subject to earlier
termination pursuant to the Agreement to which this Signature Page is a part.
By your signature and the Company's signature below, you and the Company agree
that these options are granted under and governed by the terms and conditions of
the Non-Qualified Stock Option Agreement to which this Signature Page is a part.
FileNet Corporation
_____________________________ __________________
By: Lee Roberts, Date
Chief Executive Officer
______________________________ __________________
KENNETH FITZPATRICK Date
EXHIBIT 31.1
Certification of Chief Executive Officer Pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
I, Lee D. Roberts, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of FileNet
Corporation;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, 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 report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably likely
to materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 13, 2003
/s/ Lee D. Roberts .
Lee D. Roberts
Chief Executive Officer
EXHIBIT 31.2
Certification of Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Sam M. Auriemma, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q of FileNet
Corporation;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, 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 report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably likely
to materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 13, 2003
/s/ Sam M. Auriemma .
Sam M. Auriemma
Chief Financial Officer
EXHIBIT 32.1
Certification of Chief Executive Officer
Certification Pursuant To 18 U.S.C. Section 1350,
As Adopted Pursuant To Section 906
of The Sarbanes-Oxley Act of 2002
Pursuant to 18 U.S.C.ss.1350, as created by Section 906 of the Sarbanes-Oxley
Act of 2002, the undersigned officer of FileNET Corporation (the "Company"),
hereby certifies, to such officer's knowledge, that:
(i) the accompanying Quarterly Report on Form 10-Q of the Company for the
fiscal period ended September 30, 2003 (the "Report") fully complies with the
requirements of Section 13(a) or Section 15(d), as applicable, of the Securities
Exchange Act of 1934, as amended; and
(ii) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: November 13, 2003
/s/ Lee D. Roberts .
Lee D. Roberts
Chairman of the Board and
Chief Executive Officer
The foregoing certification is being furnished solely to accompany the Report
pursuant to 18 U.S.C.ss.1350, and is not being filed for purposes of Section 18
of the Securities Exchange Act of 1934, as amended, and is not to be
incorporated by reference into any filing of the Company, whether made before or
after the date hereof, regardless of any general incorporation language in such
filing.
A signed original of this written statement required by Section 906 has been
provided to FileNet Corporation and will be retained by FileNet Corporation and
furnished to the Securities and Exchange Commission or its staff upon request.
EXHIBIT 32.2
Certification of Chief Financial Officer
Certification Pursuant To 18 U.S.C. Section 1350,
As Adopted Pursuant To Section 906
of The Sarbanes-Oxley Act of 2002
Pursuant to 18 U.S.C.ss.1350, as created by Section 906 of the Sarbanes-Oxley
Act of 2002, the undersigned officer of FileNET Corporation (the "Company"),
hereby certifies, to such officer's knowledge, that:
(i) the accompanying Quarterly Report on Form 10-Q of the Company for the
fiscal period ended September 30, 2003 (the "Report") fully complies with the
requirements of Section 13(a) or Section 15(d), as applicable, of the Securities
Exchange Act of 1934, as amended; and
(ii) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: November 13, 2003
/s/ Sam M. Auriemma .
Sam M. Auriemma
Senior Vice President
and Chief Financial Officer
The foregoing certification is being furnished solely to accompany the Report
pursuant to 18 U.S.C.ss.1350, and is not being filed for purposes of Section 18
of the Securities Exchange Act of 1934, as amended, and is not to be
incorporated by reference into any filing of the Company, whether made before or
after the date hereof, regardless of any general incorporation language in such
filing.
A signed original of this written statement required by Section 906 has been
provided to FileNet Corporation and will be retained by FileNet Corporation and
furnished to the Securities and Exchange Commission or its staff upon request.